In this episode, show host Gene Tunny explores the influential theories of economists Alvin Hansen, the “American Keynes”, and Evsey Domar. The episode was inspired by a first edition copy of Hansen and Perloff’s 1944 book “State and Local Finance in the National Economy” that Gene was gifted. It includes a handwritten inscription from Hansen to Domar, his student at Harvard. Key topics include the Keynesian IS-LM model, the secular stagnation hypothesis, and the Harrod-Domar growth model. The episode provides a rich historical context and examines the relevance of these theories to today’s economic challenges.
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What’s covered in EP245
- Book by Alvin Hansen and Harvey Perloff on State and Local Finance in the National Economy. (0:00)
- Alvin Hansen’s contributions to economics, including popularizing Keynes’s theory and teaching influential students such as Paul Samuelson and Evsey Domar. (5:06)
- IS-LM model. (11:13)
- Keynesian economics and secular stagnation hypothesis. (17:42)
- Fiscal policy and its impact on the economy. (25:28)
- Domar’s life and growth model. (32:29)
- Harrod-Domar model and its implications for economic policy. (39:00)
- Economic growth models and their limitations. (45:22)
Takeaways
- Secular Stagnation Hypothesis: Hansen’s theory suggesting that mature economies could face prolonged periods of low growth due to structural factors.
- IS-LM Model: Developed by Hansen and Hicks, this model became a foundational tool in macroeconomics for analyzing the effects of fiscal and monetary policy.
- Fiscal Perversity Hypothesis: Hansen and Perloff’s analysis showing that state and local fiscal policies can sometimes exacerbate economic downturns.
- Harrod-Domar Growth Model: An important Keynesian model that emphasizes the relationship between investment and economic growth, though not fully explaining long-term growth.
- Legacy and Influence: Both Hansen and Domar significantly shaped the development of economic theory and policy, influencing key areas such as social security and public investment strategies.
Links relevant to the conversation
Inscription from Hansen to Domar on Gene’s copy of State and Local Finance in the National Economy:
https://drive.google.com/file/d/167cJbNhxBJpsKRwSYGHxbjupX1Q3Iacx/view?usp=sharing
William Easterly’s paper on the Harrod-Domar model:
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=11020
Fiscal perversity papers:
Fabrizio Carmignani’s article “Can public expenditure stabilize output? Multipliers and
policy interdependence in Queensland and Australia”:
https://www.sciencedirect.com/science/article/abs/pii/S0313592615300242?via%3Dihub
Tamim Bayoumi and Barry Eichengreen’s paper “Restraining Yourself: The Implications of Fiscal Rules for Economic Stabilization”:
https://www.elibrary.imf.org/view/journals/024/1995/001/article-A002-en.xml
An abridged version of Skidelsky’s three-volume biography of Keynes:
https://www.penguin.com.au/books/john-maynard-keynes-9780143036159
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Transcript: Popularizing Keynes: How Alvin Hansen and Evsey Domar Shaped Post-War Macroeconomics – EP245
N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.
Gene Tunny 00:03
But if it’s the case that the households they’ve got, they’ve got plenty of goods and services, they’re living comfortably, then they might want to save more than businesses want to invest. And this creates a problem in the Keynesian model. Welcome to the economics explored podcast, a frank and fearless exploration of important economic issues. I’m your host, Gene Tunny. I’m a professional economist and former Australian Treasury official. The aim of this show is to help you better understand the big economic issues affecting all our lives. We do this by considering the theory evidence and by hearing a wide range of views. I’m delighted that you can join me for this episode. Please check out the show notes for relevant information. Now on to the show. Hello. This episode is about a book that I was gifted recently. It’s a book with a connection to two great mid 20th century economists. So these are economists who will be well known to anyone who’s studied macroeconomics, to say at least an intermediate level. The book is Alvin H Anson and Harvey s Perloff, state and local finance in the national economy. It was published by Norton in 1944 so during the Second World War. Now this book is meaningful to me because I read it during my economics honours year, and the fiscal perversity hypothesis that is presented in this book that was the topic of my honours thesis. So I’ll talk about that a bit later. The book that I’ve got. It’s a first edition of first printing, and it has a signed inscription from Hansen to his student, FCD Domar, who later became a famous economist in his own right. The inscription reads to FCD Domar with kindness. Regards. Elvin H Hanson, now going to the note in the book that came from the bookshop where this book was purchased. It’s it’s from Peter Harrington in London. The note tells us that the recipient, ebsy Domar, 1914 to 1997 was a prominent Russian Keynesian economist. Alvin Hansen, sometimes referred to as the American Keynes was a prominent public policy advisor in the Roosevelt and Truman administrations. This volume, written for the general reader, analysed the US economic conditions at the end of the Second World War and offered concrete advice for the development of local and national economies as the US entered the post war era. Okay, well, I mean, they the war was still going, but, I mean, fair enough. I mean, the Americans probably knew that they were going to win that war at the time, although, of course, there was still a lot more death and destruction to come. Okay, so I was really excited to get this book, just because of that, that connection to these, you know, very famous economists at the time of its publication, at the time of the publication of the book in 1944 alfon Hansen was a renowned figure. He was professor of political economy at Harvard University, and he was Special Economic Advisor to the Board of Governors of the Federal Reserve System. Now, Hansen lived from 1887 to 1975 and I’ll provide some more biographical details later. Hansen’s co author on this book was Harvey s Perloff. Now he was the junior of the two he was, he was an economist at the Fed, and he ended up going on to be in a being an advisor to President Kennedy, and he became Dean of the Graduate School of Architecture and Urban Planning at UCLA, and he died in 1983 this this book, it adds to my growing economic memorabilia collection, and I’ll probably do some future episodes on other pieces I have so. One of those is a chart on wartime economic planning from the Great British Australian economist Colin Clark. So I want to cover that one as well in a future episode. And I really like having these connections, no matter how small to great economists from the past. It reminds me of the great achievements that economists have made historically, and it gives us something all to aspire to. Now I want to talk about why Alvin Hansen and FC DOMA, why they are important economists, economists, why they’re important economists that we should all be familiar with. Now, before we get into it, I just want to say that this episode is brought to you by Lumo coffee, seriously healthy, organic coffee with Tripoli antioxidants of regular coffee. There’s a 10% discount for economics explored, listeners using the prono code 10. Explored. Check out the show notes for details. Okay, let’s begin by talking about Alvin Hansen, who I said, is the American canes. I mean, he’s a really big deal. He’s been credited with helping to create both the US Social Security system, so he was an advisor around the time that was created in the in the 30s during the Roosevelt administration, and he was, well, he’s also been credited with having contributed to the creation of the Council of Economic Advisors to the US president, more than anyone else. And this is what I think he’s he’s most famous for. He helped popularise Keynes’s General Theory. So Keynes’s General Theory of Employment, Interest and Money, he helped popularise that in the US and as a consequence, through out the world. Well, essentially because, you know, of the influence of the United States, and also the fact that the leading economics textbook in the post war period was Paul Samuelson’s economics, which was, yeah, I mean, how many editions? I mean, over a dozen editions. And Samuelson was a student of Hanson’s, okay, so Elvin Harvey Hanson. He was born in 1887 in Viborg, Viborg, V, I, B, O, R, G, I’ve possibly got that pronunciation wrong, South Dakota. He graduated from Yankton College in 1910 and then he studied at the University of Wisconsin, Madison, where he completed his PhD in 1918 his academic career began at Brown University, where he taught, and then moved to University of Minnesota, and he was there from 1919 to 1937 and in 1937 that’s when he moved to Harvard, and he became professor of political economy, And he held that position until he retired in 1957 now, obviously, if you’re at a place like Harvard, you’re going to have very good students. And he ended Hansen ended up teaching some very, very famous economists. I mentioned Paul Samuelson, before who was a Nobel Laureate in economics, you know, major contributions to economic theory. I should cover Samuelson in some more detail in a future episode. And the other student, and this is to to whom Hanson gave this, this copy of state and local finance in the national economy was FC Domar, and he’s known for developing the Harrod Domar model of economic growth. Well, he developed it independent of Roy Harrod, who we’ll talk about later. And you know, this is a very significant model of economic growth. It’s very important in the the history of macroeconomics, even if it’s not regarded as a, as a, you know, a model that actually describes the process of economic growth is a big, bit of a controversy about it. It’s it’s fallen out of favour. But that said it was very important in the development of our thinking about, well, the macro economy and about economic growth in that post war period. So I think it’s important that we all know about it, and we do recognise the contribution that Domar made in developing that model. Okay, so Hansen, he passed away on June 6, 1975 in Alexandria, Virginia. In which case it means he basically passed away the week before I was born, a few days different but, yeah, roughly a week before I was born, righto, so let’s go through three of Alvin Hansen’s major contributions, the first of his major contributions is the development or the the representation of Keynesian theory in a very stylized model of The macro economy. And he did this along with British economist John Hicks, who, who really, you know, first set this out in a in an article called Mr Keynes and the classics, and then Hansen developed his own presentation of it. But they’re very similar. I mean, it’s essentially the same model. It’s one at the same time as one of the most celebrated and also one of the one of the most controversial models of macroeconomics. It’s the IS LM model. So islm, and this is a workhorse model for macroeconomists. And when you read reports from, say, OECD or IMF or World Bank, and you read their discussion of macroeconomics, or if you listen to commentators in the media, underlying a lot of the commentary and analysis is Essentially a very basic islm model, and this model, in the model, I stands for investment, S for savings, L stands for liquidity preference, which is money demand, so people have a desire to hold money for its liquidity benefits. And M stands for money supply. Okay, so this is, this is a very important model. And you know what it what it shows is it will show how, say, an expansion of government spending will, will increase GDP, but depending on various parameters that could be crowded out because interest rates would increase, and that there is this offsetting crowding out effects. And then there’s debates about what those those parameters are and just how effective government spending is. And then you can also analyse what happens if you change the money supply. So if there’s a, you know, if there’s a expansionary monetary policy or a contractionary policy. So this is a model that is, that is widely used, but then it’s, it’s controversial because it, it doesn’t really take into account the fact that prices can adjust and that that can, you know, help an economy get restore itself to to full employment. It doesn’t take in the closed economy version. It doesn’t take into account international trade, capital flows, exchange rate effects. And this is what Tony Macon has said. And, you know, he’s argued that islm For particularly for a small, open economy like Australia, islm is in a very, a very good model. And he’s been very critical of that. And I’ve had Tony on I had him on the show. Unfortunately, Tony passed away a few years ago, but the episode I recorded with him in 2020 a fiscal vaccine for covid 19 is still available. So if you haven’t listened to that yet, please check it out. It’s really great. Okay, so that’s a bit of a discussion of islm. And I mean, as I said, controversial model, but there’s even a controversy over whether it actually captures the essence of what Keynes was saying. So depending on your viewpoint, islm either crisply captures the essence of Keynes’s theory or it’s a bastardization of that which Mrs Keynes’s main contributions. But that really is beyond the scope of this episode, even though it’s it’s an interesting little, little episode in the history of economic thought, and indeed, I may even think about covering it in the future. So if you’d be interested in hearing about that, then let me know, and I can dive more into islm and why it’s why it’s such an important model trying to try and give more of an explanation of it. Okay, we might move on to the next. Next major contribution of Alvin Hansen, and this is this secular stagnation hypothesis. This was presented in various forms by Hansen, and one of the famous presentations was in a 1938 American Economic Association presidential address. And the idea is that if you’ve got a mature economy, you may end up with prolonged periods of very low growth or no economic growth due to structural factors. And he identified a few structural factors that could lead to this, this secular stagnation, he called it, including the closure of the frontier, so the end of territorial expansion in the US. So he, he argued that that reduced opportunities for investment in economic growth. There was slowing population growth at the time. I mean, post war, there was a baby boom. So that was, well, that ended up being one factor, which meant that post war, America didn’t experience secular stagnation. So we’ll talk about that soon. And then also the, you know, there’s the possibility that technological progress could could slow down. And at various times in history, you do get that feeling that the the rate of technological progress is slowed down. There was a big, you know, wave of invention in the late 19th century and early early 20th century, as we really harnessed electromagnetism and automation the assembly line, and yes, there was a Real wave of technological progress. And you know, you could argue that that slowed down, and that’s where, you know, that could drive secular stagnation. And Robert Gordon is who’s a American economist, he’s argued that more recently, we’ve had a slowdown in invention and the, you know, rate of technological progress, although, of course, that’s going to be controversial, because now we’ve got AI, haven’t we? You know that’s there’s a huge debate over that. We might have to cover that in another episode too. But for our purposes, what matters is that these factors could mean that you end up always having this excess of desired savings over investment. So at the full employment level of output, at the full employment level of GDP. So the essence of, you know this, you can think of this in Keynesian terms, because the essence of Keynes’s theory, and this is captured in islm. It’s that at the level of GDP that would fully employ the population, it could be the case that households want to save a much higher amount in so in dollar terms, then businesses are willing to invest. So you get a particular level of GDP. You think about what that means in terms of title income, because GDP generates the income of the community, that’s the national income, and then households want to save out of that. But if it’s the case that the households they’ve got, they’ve got plenty of goods and services, they’re living comfortably, then they might want to save more than businesses want to invest. And this creates a problem in the Keynesian model, because, well, essentially GDP. In this think about GDP and generating income. So you can think about this from two perspectives. If you think about it from the perspective the income perspective, then total income less consumption spending of the households that is equal to the amount of that households want to save in that period. So let’s call that big S. That’s the level of savings. But if you look at GDP from the production side, GDP that is equal to consumption spending plus investment spending. Well, sorry, this is from the expenditure side. But what happens is that the amount of output produced in the economy adjusts to the total amount of expenditure or aggregate demand. So this is the key. This is one of the key mechanisms. In the Keynesian model. So what you end up having in the Keynesian model is that the level of GDP is determined in the short run by the level of aggregate demand, so the sum of consumption and investment spending in Keynes’s model, there’s no adjustment mechanism that ensures that the level of aggregate demand is always equal, or actually moves back towards the level of GDP that would fully employ the population. So this is a this is one of the major points in the Keynesian model that you know that and you can think about this. You can think about secular stagnation as reflecting a situation where it’s always the case that the level of savings that households want to want to take exceeds the level of investments that business will make. So why this? Again, why this is a problem? You can think about GDP as equal to consumption plus saving, or you can think about GDP as consumption plus investment. We’re ignoring government for the moment. This is a closed economy model, and if it’s the case that at that full employment level of GDP, that big S is less than the big I on the other side, well the level of expenditure ends up being insufficient to purchase the output that would be produced at that full employment level. And what ends up happening then is that the level of GDP falls, it adjusts, it contracts to reach an equilibrium where the level of savings ex post, so to speak. I think that’s the terminology they use, so the realised level of saving ends up equal to the level of investment spending by businesses, and that’s where you get that equilibrium. And what Hansen was arguing with this secular stagnation hypothesis, is that if you’ve got a situation where you’ve got this, you know, very high level of savings, but there’s insufficient desire by businesses to invest for the reasons he describes. Then you have this, this mismatch, and the economy won’t reach that full employment level, and you end up in this secular stagnation situation. Now you know, that can be interpreted as a Keynesian concept, and it led to pessimistic views regarding the prospects for the post war economy. And there are all sorts of, you know, there were predictions by by Hansen, and I think Paul Samuelson was, was also concerned about this, and he wrote about it in his textbook. He always sort of saw it as a possibility that this sort of thing could occur. But luckily, we we ended up having robust post war economic growth. So the secular stagnation hypothesis did not, did not come to fruition. And you know, reasons for that? Well, actually, we had a baby boom. For one, there was a there was a big demand for for new housing and and new infrastructure to accommodate the growing population. There was also, you know, they weren’t. There were technological advancements for the war. It’s not as if technological progress stopped. We had Dino major advances in in jet aeroplanes, for example, Boeing 747, and then we had, I mean, what else I mean? Look at, you know, developments in in computing after the war. So lots of technological advancement in those you know, there’s a lot of advancement in those 30 years after the war, so that, you know, then we get up to 1973 that that time, that period, and we have this slowdown, and then there all sorts of economic problems in the 70s, but at least for the first few decades, the roughly the 30 glorious years, as they they call it in France, we had strong economic growth throughout the advanced economies. And there was also the reconstruction effort in Europe, the Marshall Plan. We had the Japanese economic miracle after the war. So there were all sorts of things which meant that this whole secular stagnation didn’t happen. Okay, we’ll take a short break here for a word from our sponsor
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Gene Tunny 25:27
now. Back to the show. Now, incidentally, I should note that Larry Summers, the famous American economist, US Treasury Secretary at the end of the Clinton administration, Harvard professor, celebrated economist, he revived this concept of secular stagnation in the 2010s to characterise the slow recovery from the financial crisis. Now, again, you know something that’s going to it’s a controversial hypothesis, and we’ll probably have to cover that in a future episode. The point of this, what I’ve been talking about, is to note that, well, you know, we had Alvin Hansen 80 years ago or so hypothesise this for the US in the post war period. And it’s an interesting hypothesis. Luckily, it, it didn’t occur. Of course, you know, I think we should respect the intellectual contribution from a great economic thinker such as Albert Hanson, who has made so many, you know, he has done so much to advance our understanding of the macro economy and how it works and the business cycle, even if you know a particular hypothesis, hypothesis of his did not turn out. Now, one hypothesis of his that actually did turn out and is a correct hypothesis is the fiscal high perversity hypothesis, which is what I talked about at the start of this episode, and I might talk about this now. This is the hypothesis that was advanced in the book state and local finance in the national economy that has been the inspiration for this episode. And so this is in the 1944 book, and this is based on Hansen and Perloff analysis of of data from the the late 20s through the 30s and into the early 40s. And what they found was that the the fiscal policies of the state and local governments, and state and local governments are often, you know, economists may not, they often don’t pay them the attention that they deserve, even though, in aggregate, they do constitute a, you know, a very large amount of spending. What they found was that how the state and local governments were running their budgets, they were having destabilising effects on the economy. Now, if you’ve been listening to this show, or you’ve studied economics, or just from you know, you’ve absorbed this from elsewhere. I mean, you know that the whole the Keynesian view is that fiscal policy should be run in a counter cyclical fashion, so that when the economy goes into a recession, then you have a budget deficit, and then that helps, you know, that helps prevent the economy from being stuck in a slump. Governments will try to pump prime they will try to stimulate the economy through increasing the budget deficit, through spending measures or cutting taxes. But what Hansen and Perloff found is that for these state and local governments, they were actually doing the opposite. They were engaging in pro cyclical fiscal policy, in which case fiscal policy, so by their spending and taxation decisions, was actually making downturns worse, and it was actually, you know, adding to the the momentum in the recovery, or it was, it was, you know, arguably it could be, you know, there’s a risk there that then governments could be contributing to to inflation. But then, you know, they didn’t really that the period they were covering, there was probably little risk of that. They were more concerned about the the impact in depression. So in that period that we talk about, there was both the Great Depression from the, you know, 1929 through the the, you know, the early years of the 1930s and then there was the recession of 1937 1938 in the US. So they’re the the major events that that Hansen and Perloff were looking at, and they were. Noticing that fiscal policy for many states was actually going the wrong direction. It was contractionary in a time of downturn, and the reason for that was various constraints on state and local budgets, whereby, well, state governments, many state, I mean, dozens of state governments, it’s they have in the US, they have various balanced budget requirements. Okay? And so this can be lead to perverse fiscal policy, because if you’re trying to if, if the economy’s in a slump, and you’re getting more less tax revenue because of that, then to respect this balanced budget requirement, you may have to cut spending or increase taxes, which is the opposite of what the the standard Keynesian prescription is. And so uh, Hansen was arguing that state and local fiscal policies were behaving in a perverse fashion, and that the state and local politicians, they should recognise this and adopt a more, you know, sensible, adopt more sensible fiscal policies. And you know this, this is actually something that is still, can still be a problem today. And there are a couple of studies I’ll put links to in the show notes that that demonstrate that we have seen some fiscal perversity by US states and by Australian states in recent decades. And yes, interesting hypothesis, and it shows just the impact of what particular, particular constraints, particular rules can be. So again, very interesting analysis from Elvin Hansen. And you know something, you know he made a contribution that is still influencing economists and informing research to this day. Okay, so that’s, that’s about all I’ve got to say about Alvin Hansen. We’d better move on to his student, FC Domar. Now, hopefully I’m pronouncing his first name, right? If I’m not if, if anyone knows Russian, then please get in touch and inform me how to how to say that correctly. So. FC Domar, April 16, 1914 to April 119, 97 he was a Russian American economist. He was renowned for his contributions to economic growth theory, comparative economics and economic history. He was born in a town in what is now Poland. It was part of the Russian Empire at the time, if I’ve got that right. And he was raised in Harbin, Manchuria. Now he ended up growing up in Manchuria, is because his family moved there in 1916 his father was a small scale businessman, and says, Here is a Menshevik. So a Social Democrat, Menshevik, so I suppose he would have, well, he wouldn’t have been popular during the revolution, because the Bolsheviks ended up taking over and from the Mensheviks. So I don’t know whether he saw what was coming. But anyway, they relocated from from Russian from Russian Poland at the time to Manchuria, and the town they went to, it was a significant hub for the Chinese Eastern Railway, which was built by Russians and and there was a substantial Russian community with Russian newspapers, theatres, and even Russian laws and administration. So, yeah, I mean, just incredible, when you think about it. I mean, one minute you’re in Poland, and then the next year, growing up in Manchuria, yeah, that would have been an extraordinary upbringing for sure. Domar immigrated to the United States in 1936 and he earned degrees from UCLA, the University of Michigan and Harvard University, where he completed his PhD in Economics in 1947 so and through his career, he had positions at the Federal Reserve Board, the Carnegie Institute of Technology, the University of Chicago, Johns Hopkins and MIT, where he became the Ford international professor of economics. So, I mean, you know, all of those institutions are very, very well known, very prestigious. So, you know, he had a he had an amazing career. He’s best known for what’s called the Harrod Domar growth model. Now, this was developed independently of the British economy. Most Roy Harrod, who is famous for this model and also for writing the first biography of John Maynard Keynes. So Harrod knew Keynes, and could obviously provide a lot of insights into his life. I’ve never read that Keynes biography, but it’s cited in other Keynes biographies I’ve read, I think the best, incidentally, if you, if you’re interested, the best biography of Germano Keynes is probably Robert skidelsky’s Three volume biography, absolutely brilliant, and yeah, really provides a lot of insights into how you know what Keynes was thinking how he came to his his views, just the extraordinary life he led. And is working for the Treasury in Britain and then advising prime ministers and presidents and, you know, helping create the post war economic system. Just extraordinary life. But this isn’t about Keynes. This is about Domar. So let me get back onto it, as well as economic growth. He, he was important in our measurement of productivity growth, of technological change. There’s a concept called Domar aggregation. He did work on the Soviet economy, public debt, and the economics of serfdom and slavery. So something I might have to delve into that in a future ever. So that sounds fascinating, but we just don’t have time to cover that today. Daimar was a fellow of the American Academy of Arts and Sciences, and he served as vice president of the American Economic Association. He passed away in Concord, Massachusetts in 1997 Righto, let’s, let’s end this episode by talking about the Harrod Domar growth model. This is a Keynesian model. This is the model you get if you think about the implications of Keynes’s theory over several years, if you don’t just have this static model. So islm is a static model, and so is the Keynesian cross model, which is a much simpler representation of Keynes’s theory and doesn’t have the interest rate in it like islm does, if you think about Keynes’s model, or what Keynes was driving at in a dynamic setting, then you end up with, effectively, Harrod Domar growth model. And this is a Keynesian model, a growth model, in which there’s a there’s a razor’s edge, they talk about a razor’s edge solution, and what has to happen to maintain full employment is that you need capital investment. So investment spending by businesses on on capital goods, on buildings, on plant and equipment that needs to grow at a sufficient rate to absorb the additional savings that come with a higher GDP. So the idea is that you get additional capital investment, and then that expands your potential GDP. That expands the level of GDP at full employment. And there needs to be, there needs to be additional investment in the future, like the the amount of investment has to grow so that that is absorbed, so that ends up, it absorbs the savings at that higher level of GDP. And if that doesn’t happen, then the economy will fall into a slump. On the other hand, if there’s, if there’s too much investment, if a level investment ends up being too high, then the economy is going to have persistent inflation. Okay, so it’s a it’s a very it’s a model where you you could actually have a pessimistic reading of it. However, there’s another, another spin on it, which I’ll go through now. And the interesting thing about Harrod DOMA, so it it’s a model in which the secular stagnation that we talked about earlier, it’s possible, but it’s not certain. So the way that Mark blog, Mark blog, B, L, A, U, G, he was a famous economic historian. He wrote this absolutely amazing book called economic theory in retrospect, which is just essential reading for anyone who wants to study economics. I think he was at LSE better go back and figure out how to pronounce his name properly. I think I’ve always pronounced it, blog, Mark blog, he summarised the Harrod Domar model like this. The main points of it, the secular stagnation is not inevitable. Investment adds capacity to the economy, but this does not. Necessarily mean insufficient demand in the future. And what the model illustrates is that there’s always some rate of investment that’s high enough to create demand for the additional GDP of the previous levels of the previous period’s level of investment. Okay, so there was an amount of investment last year that expands the ability the economy to produce output in the next year. And that means a more savings by households. And then you need more investment in the next period than you had in the period before blogs. Blogs argument where the way he interprets the Harrod Domar model is that you can always find some rate of investment, or some growth of in capital investment that will actually create that demand for the additional GDP. So it’s not necessarily the case that the secular stagnation has to occur. You can get around it with the sufficiently high level of investment, I suppose. Well, you’re thinking, Well, that’s obvious. That’s essentially. That was the problem with secular stagnation. You don’t have enough in investment. He developed that in a 1946 model, and then in a 1949 paper and Econometrica, he concluded, where he talked about these growth issues as well, he concluded with some thoughts on, well, what does this all mean for policy? Does this? And you know, this is a very Keynesian way of looking at it, and this gives us an idea of, you know, how economists were thinking in this post war period. And there was a lot of, there was a lot of, you know, I guess, optimism about what governments could do to help keep economies on track, this idea of fine tuning the economy, so to speak. And as I’ve talked about in other episodes, and the experience of the 1970s and late, you know, and later episodes, I’d argue, has convinced many economists that this whole fine tuning thing is it’s not really the recipe for for a prosperous economy. And again, that’s a, you know, there’s a big debate about that as everything. So we’ll cover that again in a future episode. But, you know, I’m very sceptical of of fine tuning and discretionary fiscal policy, as you’re probably aware anyway, let’s, uh, let’s discuss what Domar wrote in that 1949 Econometrica paper, he talked about policies which would help an economy, you know, have the level of investment that is needed so to have investment increasing as the as the economy grows. And he wrote about various methods of encouraging private investments, such as low interest rates, incentive taxation, liberal loss offsets for income tax purposes, etc. A guaranteed growth of income as a method of creating investment opportunities should be explored in this connection. A guaranteed growth of income as a method of creating investment opportunities should be explored in this connection. I wonder if he’s talking about universal basic income or something like that. That’s interesting. I’ll have to think about that. I didn’t pick up that sentence The first time I read this paragraph, but that’s quite interesting. I mean, he’s maybe talking about Social Security or something like that, or, you know, I mean, the UBI people might take some they might be encouraged by that, like to think more about that. And the final thing he writes is, there is no inherent reason why public investment should not play a more important role as well. So that’s a very Keynesian notion. So the idea that if the private sector is not investing enough, then the solution is, let’s have the government step in and undertake that capital investment, undertake the public works to make sure that we’ve got enough aggregate demand to purchase the level of, you know, output that would, that would have it full employment. Okay, so very Keynesian model haradoma. It’s the first representation of, well, it’s the, it’s the it essentially represents the Keynesian model in a dynamic setting. So thinking about what does, what does the Keynesian model look like from year to year, if you, if you don’t just have a static model, you think about the implications of investment in the period previous period for your potential GDP, and what that means the. Aggregate demand has to, has to grow by what the level of investment spending has to grow by to be able to keep your economy at full employment. So, very, very clever model. I mean, it’s, you know, it’s one of those models that you learn about when you’re studying economics and you study the mathematics of it. It’s, it’s very elegant. However, it’s not a model of long term growth. It turns out it doesn’t actually tell us anything about what really drives long run growth. And for that, we need the solo Swan model, the neoclassical growth model, and we need to have, you know, an assumption around technological progress. So we need to think about technological progress now. There have been extensions of solo swan. There’s endogenous growth theory, which tries to model that technological progress. Well, again, another something for a future episode. The basic idea is that the Harrod Domar model is a, it’s a Keynesian model. It’s not really about long run growth. It’s about, it’s about the the macro economy over a period of, say, a few years or so. It’s it’s not about the long run, which is, you know, over 1020, 30, or even longer years. That’s, that’s what we tend to think of, think of when we’re thinking about models of economic growth and paradoma really isn’t that there’s a really brilliant paper by one of my favourite economists, William Easterly, who was an expert on foreign aid. He worked in, actually, he was in the World Bank, and he developed very well views on what the World Bank and, you know, what other organised international organisations were doing that were actually, you know, that ran counter to to the standard prescriptions. He’s a fascinating character, really good economist, so according to easterly in a 1997 World Bank paper, and I’ll link to that in the show notes. So 11 years later, so he’s writing about, he’s writing about domar’s 1946 paper here easterly writes that 11 years later, complaining of an ever guilty conscience he Domar disavowed the original model altogether. He said his purpose was to comment upon an esoteric debate on business cycles, not to derive an empirically meaningful rate of growth. He said his model made no sense for long run growth. Domar endorsed the new growth model of Robert Solow, which would dominate economists theoretical approach to growth for the next three decades. Okay, so that just shows his his intellectual calibre, his his confidence. He’s willing to admit okay, even though this is this models made me famous. It actually, you shouldn’t be reading too much into it, because it was on this well, how he describes what he describes as an esoteric it was relevant to an esoteric debate on business cycle, so it’s nothing to do with long run growth. However, you know, easterly noted that despite Domar even disavowing it as a model of long run growth, that Harrod Domar framework, or the model, ended up being influential in development economics, and it ended up, you know, encouraging development economic economists to characterise the economic development challenge in developing economies around the world as, you know, one of insufficient capital investment as as a challenge where that could be overcome by uh, concessional loans, by foreign aid, by assistance from the western economies to help, you know, stimulate investment or to to develop, you know, major, uh, capital investment projects and new hydroelectric dams, railways, uh, whatever, and he, yeah, he was very sceptic. He blamed, well, he thinks that the Harrod Domar model was influential in in that thinking, or that, that way of thinking about the economy, very Keynesian way of of thinking about it. And you know, easterly, he’s a noted critic of of a lot of the policies that World Bank and other international financial institutions aid institutions have been have been running in the post war period. And he’s more you know, he prefers free market, bottom up solutions rather than top down solutions. So really fascinating thinker, again, possibly a topic for a future podcast. So if you want to learn more about about these issues, then let me know. Please get in touch. And please get in touch with any questions you have or thoughts on this episode. I’ve tried to cover some fairly theoretical concepts this episode, and you know, it’s very possible I haven’t done them justice, or there are things that I didn’t explain as well as I could have explained. So please let me know what they are. If you’ve got your own views on any of these, these issues. So your own views on islm and what the contribution is, what the controversy is about, islm, you know, let me know what you think of that as a model of the economy. Let me know what you think about Keynes or secular stagnation. We can have think more more. We can talk more about what Larry Summers was saying in the 2010s that could be fascinating. And also models of economic growth, if you want to hear, learn more about how economists have been thinking about economic growth, and particularly this new growth theory, or endogenous growth theory, where we’re trying to model what’s driving economic growth in you know, to what extent is it improving your human capital? To what extent is it R and D and innovation, improving technology, the level of technology in an economy? To what extent is it? Institutional factors, rule of law, democracy, etc. There’s been a big literature on that in the last, oh, gee, nearly 40 years now since Paul Romer’s, uh, 1986 paper. Thing was 86 anyway, that’s, that’s something else we could talk about. Anyway. I think I’ve come to the end of this episode. I really love this book that I’ve been given, that have been gifted state and local finance in the national economy by Alvin Hansen and Harvey s Perloff. And it’s just great having this connection to those, those big names, Elvin Hansen and FC Domar. I’m looking at the inscription right now to FCD Domar with kindest regards. Elvin H Hanson, I’ll, I’ll put a some images of the book and the inscription in the show notes so you can check that out. Okay, thanks for listening. I really appreciate it, and I look forward to hearing from you. Thank you, righto. Thanks for listening to this episode of economics explored if you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact@economicsexplored.com or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting app lets you, then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week. You music.
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