Why both Keyensian and Free market economic schools are wrong…

Jess Sachs says recent crisis has exposed both these dominant schools of thought (just read on..he actually advocates planning!!):

Two schools of thought tend to dominate today’s economic debates. According to free-market economists, governments should cut taxes, reduce regulations, reform labor laws, and then get out of the way to let consumers consume and producers create jobs. According to Keynesian economics, governments should boost total demand through quantitative easing and fiscal stimulus. Yet neither approach is delivering good results. We need a new Sustainable Development Economics, with governments promoting new types of investments.

Free-market economics leads to great outcomes for the rich, but pretty miserable outcomes for everyone else. Governments in the United States and parts of Europe are cutting back on social spending, job creation, infrastructure investment, and job training because the rich bosses who pay for politicians’ election campaigns are doing very well for themselves, even as the societies around them are crumbling.

Yet Keynesian solutions – easy money and large budget deficits – have also fallen far short of their promised results. Many governments tried stimulus spending after the 2008 financial crisis. After all, most politicians love to spend money they don’t have.

The problem is both these schools misunderstand what drives investment:

The problem with both free-market and Keynesian economics is that they misunderstand the nature of modern investment. Both schools believe that investment is led by the private sector, either because taxes and regulations are low (in the free-market model) or because aggregate demand is high (in the Keynesian model).

Yet private-sector investment today depends on investment by the public sector. Our age is defined by this complementarity. Unless the public sector invests, and invests wisely, the private sector will continue to hoard its funds or return them to shareholders in the forms of dividends or buybacks.

The key is to reflect on six kinds of capital goods: business capital, infrastructure, human capital, intellectual capital, natural capital, and social capital. All of these are productive, but each has a distinctive role.

Business capital includes private companies’ factories, machines, transport equipment, and information systems. Infrastructure includes roads, railways, power and water systems, fiber optics, pipelines, and airports and seaports. Human capital is the education, skills, and health of the workforce. Intellectual capital includes society’s core scientific and technological know-how. Natural capital is the ecosystems and primary resources that support agriculture, health, and cities. And social capital is the communal trust that makes efficient trade, finance, and governance possible.

These six forms of capital work in a complementary way. Business investment without infrastructure and human capital cannot be profitable. Nor can financial markets work if social capital (trust) is depleted. Without natural capital (including a safe climate, productive soils, available water, and protection against flooding), the other kinds of capital are easily lost. And without universal access to public investments in human capital, societies will succumb to extreme inequalities of income and wealth.

What is needed is a long term plan for investments:

….in most countries, governments are not leading, guiding, or even sharing in the investment process. They are cutting back. Free-market ideologues claim that governments are incapable of productive investment. Nor do Keynesians think through the kinds of public investments that are needed; for them, spending is spending. The result is a public-sector vacuum and a dearth of public investments, which in turn holds back necessary private-sector investment.

Governments, in short, need long-term investment strategies and ways to pay for them. They need to understand much better how to prioritize road, rail, power, and port investments; how to make investments environmentally sustainable by moving to a low-carbon energy system; how to train young workers for decent jobs, not only low-wage service-sector employment; and how to build social capital, in an age when there is little trust and considerable corruption.

In short, governments need to learn to think ahead. This, too, runs counter to the economic mainstream. Free-market ideologues don’t want governments to think at all; and Keynesians want governments to think only about the short run, because they take to an extreme John Maynard Keynes’ famous quip, “In the long run we are all dead.”

Here’s a thought that is anathema in Washington, DC, but worthy of reflection. The world’s fastest growing economy, China, relies on five-year plans for public investment, which is managed by the National Development and Reform Commission. The US has no such institution, or indeed any agency that looks systematically at public-investment strategies. But all countries now need more than five-year plans; they need 20-year, generation-long strategies to build the skills, infrastructure, and low-carbon economy of the twenty-first century.

Did I read that right? Prof. Sachs actually advocating Chinese plans!! India just scrapped its planning commission and one still does not know what shall replace it..

The east has always looked at west for economic inspiration but west has always ignored east. Now a days, we read quite a few west guys looking eastwards for economic inspiration. And guess what? East is abandoning much of what the west is looking at.(apologies for twisted language..)


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