HOW TO PAY FOR THE WAR
Posted on May 16, 2019 by L. Randall Wray | 8
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Remarks by L. Randall Wray at
“The Treaty of Versailles at 100: The Consequences of the Peace”, a conference
at the Levy Economics Institute, Bard College, May 3, 2019.
I’m going to talk about war,
not peace, in relation to our work on the Green New Deal—which I argue is the
big MEOW—moral equivalent of war—and how we are going to pay for it. So I’m
going to focus on Keynes’s 1940 book— How To Pay for the War—the war that
followed the Economic Consequences of the Peace.
Our analysis (and the MMT
approach in general) is in line with JM Keynes’s approach. Keynes rightly
believed that war planning is not a financial challenge, but a real resource
problem.
The issue was not how the
British would pay for the war, but rather whether the country could produce
enough output for the war effort while leaving enough production to satisfy
civilian consumption.
To estimate the amount left
for consumption we need to determine the maximum current output we can produce
domestically, how much we can net import and how much we need for the war.
My argument is that this is
precisely how we prepare for the Green New Deal. “Paying for” the GND is not a
problem—the only question is: do we have the resources and technological
know-how to rise to the challenge.
While in normal times we
operate with significant underutilization of capacity, during war, Keynes
argued, we move from the “age of plenty” to the “age of scarcity” since what is
available for consumption is relatively fixed.
At the same time, more output
produced for military use means more income, which, if spent on consumption
would push up prices. Hence, some of the purchasing power must be withdrawn to
prevent inflation. Thus, Keynes rightly viewed taxes as a tool for withdrawing
demand, not paying for government spending.
He thought taxes could be used
to withdraw half of the added demand. The other half would have to come through
savings, voluntary or “forced”.
Voluntary savings would only
work if everyone saved enough, which can’t be guaranteed. If households don’t
save enough, they bid up prices while consuming the same amount of resources,
but paying more. The business ”profiteers” would get a windfall income, some
saved and the rest taxed away (so businesses would effectively act as tax
collectors for the Treasury—the extra consumer demand facing a relatively fixed
supply of consumption goods would generate extra tax revenues on profits).
Thus voluntary saving plus
taxes would still withdraw demand, but on the backs of workers and to the
benefit of profiteers. If workers demanded and got higher wages, the process
would simply repeat itself with wages constantly playing catch-up to price
increases as workers consumed the same amount of real resources.
Keynes’s preferred solution
was deferred consumption. Instead of taxing away workers’ income, which would
prevent them from enjoying the fruits of their labor forever (and possibly
reduce support for the war effort), he proposed to defer their consumption by
depositing a portion of their wages in “blocked” interest-earning deposits.
This solution would avoid
inflation, while at the same time more evenly distribute financial wealth
toward workers.
Furthermore, this would solve
the problem of the slump that would likely follow the war, as workers could
increase consumption after the war at a measured pace, spending out of their
deferred income.
Keynes recognized that it is
not easy for a “free community” to organize for war. It would be necessary to
adapt the distributive system of a free community to the limitations of war,
when the size of the “cake” would be fixed.
One could neither expect the
rich to make all of the necessary sacrifice, nor put too much of the burden on
those of low means. Simply taking income away from the rich would not free up a
sufficient quantity of resources to move toward the war effort—their propensity
to consume is relatively low and they have the ways and means to avoid or evade
taxes.
But taking too much income
away from those with too little would cause excessive suffering—especially in
light of the possibility they’d face rising prices on necessities.
To avoid a wage-price spiral,
labor would have to agree to moderate wage demands. This would be easier to
obtain if a promise were made that workers would not be permanently deprived of
the benefits of working harder now.
In other words, the choice
facing workers is to forego increased consumption altogether, or to defer it.
In return for working more now, they would be paid more later—accumulating
financial wealth in the meantime.
He recommended three
principles to guide war planning:
1) use deferred compensation
to reward workers;
2) tax higher incomes while
exempting the poor; and
3) maintain adequate minimum
standards for those with lower incomes such that they would be better off, not
worse off, during the war.
The deferred compensation
would be released in installments, timed with the slump that would follow the
war. The system would be “self-liquidating both in terms of real
resources and of finance”—as resources were withdrawn from the military they
could turn to civilian production, with the deferred compensation providing the
income needed to buy that output.
While Keynes argued that “some
measure of rationing and price control should play a part” he argued that these
should be secondary to taxes and deferred compensation. Rationing
impinges on consumer choice and inevitably has differential impacts across
individuals. Price controls can create shortages.
In any case, he argued that an
effective program of deferred income will make rationing and price controls
easier to implement.
What Keynes wanted to avoid
was the UK experience of WWI when the cost of living rose an average of 20-25%
annually over the course of the war, and wage hikes tended to match price
hikes, but with about a one year lag.
This allowed sufficient but
permanent loss of consumption by workers to shift resources to the war.
By contrast, both the US and
the UK managed to contain inflation pressures much more successfully in
WWII—the UK hit double digit inflation only in 1940 and 1941, and had
remarkably low inflation during the remainder of the war; the US barely reached
above 10% only in 1942 and in other years inflation ranged from 1.7% to 8%.
Both of them adopted a variety
of anti-inflation policies that approximated Keynes’s policy. Given the
circumstances, the policies were remarkably effective.
Note that in the US,
government spending rose to nearly half of GDP—with the budget deficit rising
to 15% of GDP and the national debt climbing to 100% of GDP. In light of that
massive mobilization, it is amazing how low inflation was.
I think this will also happen
as the GND is phased in—the growth rate will accelerate sharply and the
government’s share of GDP will grow from the current 25% or so toward 35% of
GDP. At the same time, there will be reduction of private spending on
healthcare so we end up with maybe an overall boost of GDP of maybe 2.5%.
If desired, we can reduce the
stimulus through deferred consumption—perhaps through a surcharge on payrolls
that will be returned through more generous benefits after the GND “war” cools
down. Me? I’m an optimist. I believe the GND boost will put us on a sustained
higher growth path, without inflation, that will generate the additional
resources required.
If we compare that to the WWII
build up, all of this seems quite manageable. And the inflation effect will be
much lower—in part because we are not producing stuff to blow things up and in
part because we face strong deflationary pressures from the east—a couple of
billion workers have joined the global production force to keep inflation down.
And some of this shift toward
the GND will be reversed quickly once the new infrastructure is in place and we
have greened our economy. We will release the deferred compensation and we
might end up with a government that is permanently bigger but not by that
much—say a third of the economy instead of a quarter. Again, that is no big
deal.
We long ago became a
post-agricultural society. Since WWII we’ve transitioned to a post industrial
society. It makes sense that we are going to have a bigger government since
most provisioning already is, and will increasingly be, coming from the service
sector—an area where public service Trumps private service—in education, care
services—aged and young, healthcare, the arts, and many forms of
environmentally-friendly recreation. More parks, less shopping.
In another important
contribution—Economic Possibilities for our Grandchildren— written in 1930,
Keynes speculated about our future– a time when “for the first time since his
creation man will be faced with his real, his permanent problem—how to use his
freedom from pressing economic cares, how to occupy the leisure, which science
and compound interest will have won for him, to live wisely and agreeably and
well.”
By Keynes’s timeline, this
should have been reached by 2030. We’ve timed our GND to be completed by 2030.
We have 10 years to make Keynes’s vision become reality. The alternative is
annihilation.
Some (both heterodox and
orthodox alike) argue we just cannot “afford” survival. It is cheaper to just
keep doing what we’ve been doing and hope for a different result. That is not
only the definition of insanity, but it is—as Keynes would say—unnecessarily
defeatist.
The challenge is big; the
alternative is unacceptable.
(*Our report, How to Pay
for the Green New Deal, by Yeva Nersisyan and L. Randall Wray, will be
published soon at the Levy Economics Institute.)
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