The head of the International Monetary Fund warned today on her visit to Beijing that the global economy faces the risk of a "lost decade" with little or no growth and that without action, the world faces worsening financial instability and a possible collapse of demand. This news item also coincided with my morning lecture in History of Economic Thought on the economics of Thomas Malthus. Along with his theory of population, Malthus was also known for his ideas on the possibility of “general gluts” or long term under-consumption. What was old is new yet again.
According to Malthus, saving created investment spending which came into play faster than the growth of the population leading to surplus capital - hence, excess capacity and ultimately under-consumption, setting up a problem of secular stagnation. The solution, according to Malthus was to encourage economic agents to consume more to slow down saving and put in place public investment projects to use up the surplus capital and investment. In private correspondence, Malthus discussed with Ricardo the advisability of putting labour to work on public projects like road building. The attractiveness of this type of thinking to Keynes is obvious though Keynes linked “under-consumption” to “animal spirits” severing the link between saving and investment, which reduced aggregate demand.
What insights do this classical work provide for the current world economy? Good question. We have a sovereign debt and financial crisis that is undermining the consumption side of the economy. David Ricardo’s thinking on the English debt crisis of the early nineteenth century advocated going on the gold standard to stabilize the currency, pay as you go government financing - meaning no deficits, and a one time capital levy to pay off the debt. However, pay as you go financing combined with more taxation would certainly not boost the demand side of the economy. Malthus, on the other hand would suggest a program of government spending.
Since I’m keeping things simple, I would suggest that on the financial side, there is a need for a global lender of last resort to stabilize financial markets, sovereign debt, and currencies and reduce the uncertainty of the current piecemeal approach to crisis management. How this might be accomplished is beyond me. Borrowing from Malthus, on the commodity side, there is a need for a global spender of last resort to buttress the demand side and reduce the risk of secular stagnation. That used to be the American economy and its consumers. I’m not certain I see a replacement for the American role anywhere on the horizon though perhaps the head of the IMF is in China to see if they might want to step up to the plate.
Ultimately, I think resolving the current difficulties also comes down to a lack of economic institutions to deal with a more connected global economy. When push comes to shove, the international efforts of summits and meetings to deal with the crisis of interconnected global financial and commodity markets seem more akin to the diplomacy of the slower moving 19th century than the world of the 21st century. The framework to deal with the complexity of the world economic system consists of short term crisis management housed in an international institutional structure last revised in the aftermath of the Second World War. What should replace it is a good question.