Author Archives: Asad Zaman

Published in Dawn, 7th Dec 2018 with title: A Lopsided System

SADLY, it is true that ‘money makes the world go round’. But, it is also true that very few people understand how. This article is an attempt at explaining the basics of our global trading system.

A good starting point is the Bretton-Woods conference which took place in 1944, while the Second World War was still raging. The two World Wars had drained the treasuries of the European states, making the gold standard impossible to maintain. An entirely new system had to be created to enable global trade for the post-War era. At the Bretton-Woods conference, the most sensible proposal for the global trading system was created and advocated by John Maynard Keynes. Unfortunately, the political power of the United States enabled it to quash this proposal. Instead, gold was replaced by the dollar standard, with the proviso that dollars could be exchanged for gold.

When the Vietnam War forced the US to print an excessive amount of dollars, president Richard Nixon declared in 1971 that dollars would no longer be backed by gold, creating a brave new world of currencies without any backing. Just like a fixed exchange rate is the natural consequence of pegging currencies to dollar or gold, so too a floating exchange rate system emerges naturally when there are no pegs for any currency

Today, the dollar is at the centre of the global trading system, and is as good as gold once was. Everyone needs dollars as reserves to back up their currencies. To acquire dollars, all countries other than the US, must strive to increase exports — this is how one earns dollars. The US can increase imports just by printing dollars, while the rest of world exports goods and services to earn dollars. Because dollars are the gold of the modern financial system, the US can print money without adverse consequences. For instance, the US printed trillions of dollars to finance the Iraq war, and other trillions to bail out the financial sector from the global financial crisis that was created by it.

If we pause to reflect, the consequences of the dollar-based global trading system are truly breathtaking. Because of mutual dependencies, no one can opt out of the global trading system. Everyone within the system needs dollars, and must strive to increase exports, in order to earn dollars. Net exports cannot increase, and cannot earn dollars, unless the US increases imports. In this financial colonisation of the world, everyone must strive to pay tributes in terms of goods to the US, while the latter country prints dollars to pay for them.

For anyone who falls behind in their payments of tributes, the IMF is there to ‘help out’ by extending a loan, which puts the borrowers deeper in debt enslavement. The results of this system whereby the US prints dollars in return for tributes in real goods provided by the rest of the world are obvious in terms of the immense disparities between American levels of consumption and those of the rest of the world.

A rough measure of how much tribute has been extracted is the current level the US debt, which is $21tr. About $15tr of this total amount has been acquired since 2000. As a benchmark for comparison, note that the world GDP, excluding the US, was around $60tr dollars in 2017. Many more details are required for a more accurate calculation of benefits which accrue to the US due to this dollar-based global trading system, which requires all of us to work hard at increasing exports, while the US printing presses work hard to print dollars to pay for them.

What can be done to replace this immensely lopsided and unjust global trading system, which gives tremendous benefits to the US at the expense of the rest of the world? The first opportunity was lost — rather, suppressed — when Keynes’ proposal for a symmetric trading system was rejected at the Bretton-Woods conference. Keynes’s original proposal continues to be attractive to this day, but many new ideas for how to structure global trading have also emerged over the past few decades.

There are two main concepts at the heart of all such proposals, which differentiate them from the current system. In any fair trading system which treats all countries equally, the target for all countries would be to balance exports and imports. The second concept is to place the burden of adjustment on countries with excess exports as well as those with excess imports. This is more equitable than the current system which places all the burden on the weaker country. With the emergence of China and the European Union as major players, the time is ripe for the demise of the dollar. With multiple centres of economic power, we may hope for a transition to a more equitable global trading system.


An Islamic WorldView

Most people admire and appreciate my educational credentials — BS Math 1974 from MIT completed in 3 years at age of 19, and Ph.D. Econ 1978 from Stanford at age 23.  They would find it difficult to imagine that it has taken me decades of life experience to recover from the damage that this education has done to me. The damage was done in so many different dimensions that it is hard to even catalog the whole list. However, before explaining this in greater detail, I must answer some questions which immediately arise whenever I make such statements.

Q1: Do I regret having had this education? To the contrary, I deeply appreciate having had this chance for training at the finest educational institutions that currently exist in the world. This type of education currently shapes minds and thinking of people all over the planet. Without having it, I would be…

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Concluding Paragraphs of Radical Paradigm Shifts, as edited and published in current RWER issue No. 85 — (reposted from RWER Blog)

The outcome of all this discussion can be summarized metaphorically by saying that we all use glasses to see the world. The direct world out there is a jumble of sensations – a matrix of points – which makes no sense by itself, and must be interpreted using our own frameworks, represented by the glasses. This means that ALL observations are tinged with subjectivity, and interpreted within the frameworks created by our past experiences, successes and failures, in viewing the world.

A paradigm shift occurs if we remove the glasses we use to view the world, and instead put on a different pair of glasses. A famous experiment  conducted by Professor Theodor Erismann, of the University of Innsbruck put reversing glasses on his student and assistant Ivo Kohler. It caused extreme disorientation and discomfort at first, but after about a week of stumbling around, he adapted to this new way of seeing the world. His subjective interpretative equipment learned to interpret the reversed image by performing an additional reversal within the brain to arrive at a correct image of the world. Now, when the glasses were removed, the world appeared to be upside down to Ivo.  On a much larger scale, this is what happened in Europe due to the Great Transformation[1] which transformed traditional society to a market society, where everything is viewed a commodity for sale.  Later, these ways of thinking were spread throughout the world by colonization and Western education. We learned to value everything according to its market price, and forgot that the most precious things cannot be purchased. Then it became easy to kill a million children, and destroy entire nations, for corporate profits. 

We can now understand the extreme difficulty of creating a paradigm shift. For those who have spent lifetimes learning to see the world with a specific pair of glasses, these glasses become melded into the flesh, and are impossible to remove. After failing to convince his contemporaries about his Quantum theory, Max Planck disappointedly realized that science progresses one funeral at a time. Thomas Kuhn also noted that paradigm shifts do not occur by converting those faithful to the old paradigm, but by inducting the young into the new worldview. Unlike the older generation, for younger and more flexible minds, it is possible to take off glasses manufactured in the Euclidean factory, and put on non-Euclidean glasses. Nonetheless, it is still a disconcerting and uncomfortable experience, which will not be undertaken unless there is some expectation of a great reward for this struggle and sacrifice. The costs of paradigm shift must be paid upfront – one loses the ability to talk to the mainstream when one describes the world using an alien framework. The rewards are in the future, and highly speculative and uncertain. Nonetheless, for reasons explained elsewhere,[2] it seems essential to make the effort – the survival of humanity is at stake.      read more 

[1] See my “Summary of The Great Transformation by Polanyi

[2] See Evaluating the Costs of Growth or Ecological Suicide.

IMPORTANT IMPLICATIONS: Article ends as above, but there are some very important implications that follow from this analysis. The first is that there are no objective facts. This strikes at the core of Logical Positivism. LP takes the observations as concrete, objective reality out there, which is independent of the subjective viewer. While it is likely true that there is an objective reality, our only access to this reality is using our own subjective apparatus for sensing reality, and what we see is the product of THREE factors — Objective Reality, Sensing Apparatus, Interpretation  — two of these factors are subjective, and are inevitably jumbled. It is impossible to extricate an objective reality.

When this was posted earlier as Radical Paradigm Shifts”  on RWER, there were 117 comments. Many of the commentators thought that THEY had the objective facts, the right model, they were frustrated at the inability of others to see what was so obvious, and thought that my article explained why. The realization that NO ONE has access to objective reality leads to a dramatic shift in perspective. What appears as objective reality to me (due to my failure to distinguish between my glasses, and what is out there), is just a subjective recreation, a picture in my mind. No one else can see this picture. So all effort at “explaining” is an effort at persuading others to look at the world from MY point of view. This means that FIRST we must appeal to the hearts of the people, to persuade them to listen to us, and to make the effort to see the world from my point of view. . However when we are in possession of facts (when we mistake our subjecive interpretation for objective reality), then those who do not agree with us are blind to reality, and insane (unable to see plain facts or use simple logic). The idea that there are objective facts, and that I can access them leads to arrogance. Subjectivity, and the need to persuade others to think like us requires humility.

Previous post on  Lecture 8A covers first 17m of video lecture in  Advanced Macro  — explains how different ways of articulating the micro-foundations for Keynesian Macro Concepts leads to dramatically different Macro Outcome.

This post is Lecture 8B — from 17m to 37m of video lecture linked at bottom of post. It attempts to make sense of the Keynesian explanation of unemployment based on insufficient aggregate demand. It concludes that several elements missing from Keynes must be added to get to a satisfactory explanation.

 Friedman’s Methodology  leads to crazy models: In previous post (  Lecture 8A – Microfoundations for Keynesian Economics ), we showed that even small differences in the micro-foundations could lead to very large differences in the macro outcomes. Depending on how we choose micro-foundations, we can get almost any result we like at the macro level. So the question arises: HOW should we construct our micro-foundations? How can we choose among the wide variety of possible micro-structures. This leads to a very serious methodological issue of what models are and how they relate to reality. On this topic, see my detailed discussion in post on Models and Reality. Briefly, the standard POV adopted in neoclassical textbooks is that the only job of models is the provide a match to observations. The inner details of the models can be arbitrary.  However neoclassical economists insist that a good model must have optimizing behavior by all agents, and the equilibrium outcome of the model should match observations. There is no requirement for models to be realistic.  Because realism or lack of it is not relevant,  Friedman’s methodology   states that significant models will have wildly inaccurate descriptive representations. This methodology leads to ridiculous and absurd models, which failed completely in the Global Financial Crisis (see  Quotes Critical of Economics ). In fact, as we have argued elsewhere, maximization does not describe either firm behavior or consumer behavior. Furthermore, behavior of a complex dynamic system cannot be understood by looking at its equilibria. So the methodological tenets of neoclassical economists are fundamentally wrong.

Critical Realism in Models: In this course, we take the POV that models are simplifications which help us to understand a complex reality. Because of this, realism is a requirement – we cannot allow wildly inaccurate descriptions. Realism has to be understood correctly. We want to strip away inessential elements and focus on simplest descriptions which capture the mechanisms that produce the phenomena of interest. The process of stripping away complexity can be said to create descriptive inaccuracy, but this is of a different type from the kind of absurdities created by conventional methodological stance a la Friedman. For example, when  massive empirical evidence proves that human agents do not maximize utilities , than we cannot made utility maximizing behavior as an explanation of any observed phenomena. Note that we may nonetheless assume utility maximization as a convenient placeholder for human behavior if the phenomenon we wish to explain does not depend very much on exact nature of human behavior. That is, if we believe that replacing utility maximization by many other types of behavior would lead to the same results.

The phenomenon we wish to explain is unemployment. Consider a simple fixed proportion production function where 10 LLs own 5 Acres of land each, and One Acre + One Laborer can produce 10 units of corn. Each LL can hire a maximum of 5 laborers, so if there are more than 50 laborers, the model will generate unemployment. Here we have a very simple model which produces unemployment. This model generates understanding – if we do not have sufficient productive capacity – ways to utilize laborers for production, then excess labor beyond maximum productive capacity will remain unemployed. When we come to the Great Depression, it is clear that this explanation will not suffice. This is because the economy did have full employment prior to the GD 29, and so potential there was capacity in the economy to employ all workers. So the problem is to find a model in which there is unemployment when the economy does have the capacity to hire all the labor. For example, suppose that there are 40 laborers in the economy given above. Then it is clear that all 40 CAN find productive employment. There is land to spare, and each laborer can produce 10 units of corn when allowed to work.

In this situation, there really is a puzzle as to how unemployment could emerge. Something must go wrong to prevent an activity which yield benefit to all participants – laborer would earn wages, and landlord would earn profits, and there are no parties which would be hurt by this additional production. If we can solve this puzzle, we may get some understanding of why unemployment occurs in the real world.

Keynes argued that money is an essential ingredient, and has real effects in the short and long run. He also stated explicitly the sequencing that wages are paid upon hiring laborers, and production takes place later. Let us try to use these two ideas as building blocks for a model where unemployment might occur. Since Keynes used a static one-period framework, we will also work with this same case.

Suppose initially that all laborers are paid PKR 100, which is the going nominal wage rate. All 40 are hired, and production takes place, creating 10 units each for a total of 400 units of corn. This sequencing, where payment is made in nominal terms, before the market for corn opens, has rather startling consequences, which run counter to intuition generated by neoclassical theories of price determination.

Model 1: Suppose a closed economy, and no use for corn other than sale on domestic market. Than all 400 units would be put on the market, while laborers have 4000 PKR as their wage earnings, which is all the money available to buy. So price of corn would be 10 PKR per unit, and every laborer would receive 10 units of corn – Wage equals marginal product of labor. But this is a very strange model because the LLs earn zero profits. Why would they go to the trouble of producing corn, if they earn nothing in the process – this question arises in a Market Economy, where production is done for profits.

Model 2: LLs can consume some of the corn, and put the rest on the market. Suppose each LL consumes 200 units of corn, and puts the remaining 200 units on the market. Now there is a total of 2000 units of corn on the market, while there is 4000 PKR available in wages to purchase the corn. So the price would be 20 PKR per unit of corn, and each laborer would be able to buy 5 units of corn, distinctly less than the Marginal Product of labor, which is 10 units of corn. This is a static equilibrium which can repeat. The landlords do not make any monetary profits, but they get to eat a vast amount of corn.

QUESTION: Why does wage fail to equal marginal product of labor in Model 2? The theory is that there would be competition among the LLs to increase the wage, because each has an extra acre of unutilized land, and if he can attract a laborer, he can make more profits. However, in the initial phase where wages are being paid, competition in nominal wages has no effect on outcome. Regardless of how high the money wage is, the price of corn will be set in exact proportion to get back all of the wage income. This illustrates how wages are set in nominal terms and the real wage is an outcome of the system as a whole, exactly as Keynes said.

Both of these models illustrate one of the basic principles of MMT – A sector cannot make profits unless it receives injections from the outside. All inside transactions cancel in monetary terms.

Model 3: The only way for Landlords to make monetary profits is to sell the surplus corn to some other sector. This could be the government, or it could be an urban sector (or any other sector of domestic economy), or it could be exported to the foreign sector. In all such cases, money which flows into the sector from the outside is the profit to the landlords.   As MMT tells us, the private profits of the agricultural/rural sector exactly offset losses of some other sector. How much can the landlords sell to the urban sector (for example)? According to neoclassical theory, there are technological constraints on the profits of the landlord. Their profit should be equal to the marginal product of Land, the input they supply to the production process. In the fixed proportions production function, the marginal product of 1 Acre of Land is equal to the marginal product of one laborer and both are equal to 10 units of corn. Adding up of the two marginal products to the total product does not hold. In this model, the Landlords can sell arbitrarily large amounts to external sectors, and leave arbitrarily small amounts for the domestic market. Regardless of how much or how little they put on the domestic market, the laborers will spend all their wage-money on purchasing the product.

It seems reasonable to think that landlords will leave subsistence amounts of corn on the domestic market, so as to prevent domestic unrest or revolutions, while marketing the rest for highest profit. Since the amount retained for domestic market is based on political considerations, it need not satisfy equilibrium conditions for profit maximization. That is the domestic price can be less than or higher than the foreign price at which the surplus over subsistence is sold.

So far, there is no unemployment in this model, and unemployment cannot exist unless some amount of produce remains unsold. If this happens, it would give a signal to the landlords that over-production has taken place, and they would make decision to reduce production. But how can produce remain unsold? Let us consider the Keynesian idea that the labors SAVE some portion of their wages for use later. This would reduce the effective demand and perhaps lead to surplus production which could not be sold. To see how this works, suppose the LLs sell 200 units of corn to external sector at some price p, making profits of 200p. The remaining 200 units of corn is put on the domestic market for sale, there is a total of 2000 units for sale, while the laborers have 4000 PKR in total income. If they spend all of their income on purchasing corn, the price of corn would be 20 PKR per unit and every laborer would get 5 units of corn.

Now suppose that the laborers decided to save half of their income for potential contingencies in the future. Saving 2000 PKR leaves them with 2000 PKR to purchase corn. When 2000 units are available for sale, the price will fall from 20 PKR/unit to 10 PKR/unit and all of the corn will be sold. Since all the corn is sold, there is no reason for the Landlords to limit production in the next round, and this situation can repeat.

If there is price rigidity, and the price of corn cannot fall from PKR 20/unit, THEN we have the possibility of surplus. Only 1000 units of corn can now be sold on the domestic market and 1000 units of corn remains as surplus. If this can be sold to some external sector – government, urban sector, foreign sector – then again there is no serious problem. But if there is some capacity limit on outside sales, then the surplus cannot be sold. In this case, the LandLords get the message that what was produced could not be sold, and so they should cut back on production. This can produce unemployment in the next period.

Lessons from this model/analysis

In one-period, static model, shortfall in aggregate demand can only come from fixed prices. This is not true in DYNAMIC Multi-period models, but these require more sophisticated analysis, which Keynes did not make. SAVINGS by laborers DOES create disequilibrium: Money profits to landlords become NEGATIVE. They do not recover in revenue what they paid in wages. However, this should result in declines in nominal wages. What happens depends on disequilibrium dynamics.

The final conclusion from all of these considerations is that the mechanism of insufficiency in aggregate demand which was used by Keynes to explain unemployment has not been sufficiently articulated. Many factors were left unspecified, all of which matter to the outcome. A well-articulated Model must specify the technology of production: Cobb-Douglass, IRTS, DRTS, Leontief. These all make a difference. In addition, market structure and sequencing must be specified. Do we have competition, monopoly, monopsony, posted prices or oral double auction. Who produces, and who markets the product. The Information Structure is also important – the Sequencing of Decisions and information flows, who know what and when?. Relative Bargaining Power, and Social Norms govern the outcomes. Of Vital importance is disequilibrium outcomes and how they are resolved. The Class Structure – Landlords, Laborers, Others, also matters – even in our simple models, consumer behavior of laborers is essentially different from that of the Landlords for structural reasons – Landlords do not consume out of wages they earn. Similarly, if the economy is driven by profits, then some other sector must be involved, because profits can only be earned if money is injected into the system. So a well-specified model must have multiple sectors, such as Domestic Other, External Sector, and Government.

We abandon Keynesian analysis of unemployment, noting that the explanation it provides is seriously complete, and must be augmented by additional factors. In particular, fixed prices does provide an explanation, but this is clearly a short run phenomena and to get a serious explanation along these lines requires consideration of disequilibrium dynamics. Subsequent analyses by many authors show the importance of debt, and in particular leveraged debt, which plays a key role in producing major financial crises. To introduce these ideas, we consider a different mechanism – Fisher’s theory of Debt-Deflation – which was also proposed as an explanation of unemployment and the Great Depression, but did not receive much attention in the mainstream. In recent times, elements of this theory have been picked up by Minsky, Koo, Mian and Sufi and others.

This post (Lecture 8B) covers the 20 minute segments from 17m to 37m of the lecture 8. The first 17m were covered in previous post on  Lecture 8A: Microfoundations Matter 

The remaining portion of the lecture explains Fisher’s Debt-Deflation Theory.

  Lecture 8A of Advanced Macroeconomics   — Outline below covers the first 17m of the lecture linked below at bottom of post.

1. EXCESS Savings reduce Effective Demand, Normal Savings Do Not

It seems clear that shortfalls in aggregate demand can lead to recessions, but only in presence of fixed prices. Furthermore, normal levels of savings cannot create such shortfalls – an abnormally high level of savings is required. This is because of factors discussed in “ The Subtleties of Effective Demand ”. Basically, if a normal level of savings is reduced from Aggregate Demand, this money is saved and goes on to period T+1. Similarly, the savings of last period T-1, is going to come into the present period T. This will exactly offset the shortfall in Aggregate Demand created by the savings. However, this will not happen if for some reason there is EXCESS savings, over and above normal levels. This excess S(T) > S*  will be not be compensated fully by S(T-1)=S*, where S* is the normal level of savings.

What could lead to abnormally high savings? It appears that debt can force people to earn money to pay off debt, reducing aggregate demand. Thus it appears that the Keynesian mechanism for creating unemployment as an equilibrium phenomenon relies on debt – without explicit mention. Once the role of debt is highlighted as the source of shortfall in aggregate demand, we examine in detail Fisher’s theory of Debt-Deflation, which never received the prominence that Keynes did. In the recent times, this theory has been resurrected, and is solidly backed by empirical evidence. See: Fisher-Minsky-Koo theory of debt-deflation.

2. Empirical Evidence favors Keynes Conjectures

Examination of the empirical evidence around the Great Depression period supports Keynesian ideas about Unemployment. The paper “Real wages, working time, and the Great Depression” by Hart & Roberts, 2010 shows that as unemployment increased, wages and prices both declined while real wage remained fairly constant (see  Lecture 7  for details). This shows that wage rigidity is NOT the explanation for high unemployment during the Great Depression. Furthermore, it supports the Keynesian idea that cutting nominal wages will not reduce real wages. Also the data refutes the RBC models. If random shocks reduce supply of labor increasing unemployment then the Marginal Product of Labor should increase so that nominal wages should be counter-cyclical. In fact, observed nominal wages are pro-cyclical.

Even the the broad macro perspective of Keynes is supported, explaining his theory of effective demand requires articulation of the micro-structure of the model. Post-Keynesians have strongly resisted/rejected this neoclassical demand from micro-structure, because the neoclassicals accept only one kind of micro-structure – with optimizing agents, equilibrium outcomes, and no uncertainty. Since this type of micro-structure is patently absurd, nothing is gained by knowing whether or not we can construct maximization/equilibrium/known future kind of model which supports Keynesian conclusions. The New Keynesians attempt to do this by providing neoclassical foundations which lead to Keynesian conclusions. Although this can be done, it is irrelevant. As clarified in Models and Reality, from the critical realist methodological perspective, our models should be believable simplifications of reality. While we reject  Friedman’s Folly of accepting wildly unrealistic models , we do argue that we need to provide realistic micro-foundations, based on reasonable descriptions of human behavior, structure of markets, role of money, and genuine uncertainty. This is because, as we will see, the Keynesian macro-phenomena, are very sensitive to these details.

3.  Microstructure Matters for Effective Demand.

One of the crucial insights from the behavioral/experimental economics literature is that small and apparently irrelevant details of experimental setup can make major differences in outcomes. The same is true of Keynesian Macroeconomic conclusions. Depending on how we set up the micro-details, the aggregate outcome can vary greatly (see also,  Lecture 7: Micro-structure Matters ). Below we discuss four different micro-structures, each of which leads to different results at the aggregate, macroeconomic level. We will show that four different micro-structures lead to four different outcomes.

4.  Four Micro-Structures: Four Outcomes

We consider the same model we have been working with (see:  Simple Model Explains Complex Keynesian Concepts ). There are 10 Landlords (LL) each with 5 Acres of Land and simple fixed proportion production function 1 Acre plus 1 Laborer produces 10 units of corn. Suppose the Money wage is 100 PKR per laborer, and there are 40 laborers.

A: Several Micro-Structures leading to subsistence wages:

The situation is one of shortage of labor, so in principle laborers should have power. But suppose market structure is as follows. At the beginning of the period, wages are paid in NOMINAL terms. Then production takes place. All product belongs to the landlords. All 40 laborers will be hired, and will receive pay of PKR 4000. At this point the market for corn is not open so the price is not known. Now, the landlords have all the output, and they have two options – they can market the corn to earn money, or they can self-consume the corn. Suppose this is a one-period economy, and consumption of corn is subject to diminishing marginal utility, but no satiation. Then the landlords will just eat all the corn, and will not put any on the market. To get a more realistic outcome, suppose there is satiation. There is a maximum limit to consumption of landlords. Then Landlord will market the surplus which remains after their maximum consumption. Since this is a one period economy, and money is worthless unless used to purchase corn, however much the landlords place on the market, all of the quantity will be purchased by the laborers – all PKR 4000 will be spent, and price will adjust to ensure that all marketed surplus is sold. It is easily possible for Landlords to market just enough corn to keep laborers at subsistence level, while extracting all the money they have been paid in wages.

Other ways to get the same result involve preventing the landlords from eating corn – corn is coarse food for peasants while the landlords only eat imported food. The landlords can export food at the foreign price, and use revenue to purchase foreign food. They can retain some food to sell on domestic market. However little they retain, the laborers will spend all their money on purchasing this food, so they can extract the entire amount paid as wages. Again, laborers can end up with subsistence wages.

Note that in all these models, nominal wages are determined at the beginning of the period and real wages depend on landlord decisions about how much product to put on the market at the end of the period.  This is how a monetary economy works.

B: Landlords get Subsistence Profits

Suppose we eliminate money from the economy and determine wages in terms of units of corn directly. Suppose landlords compete with each other to hire labor, offering them some share of the output (10 units of corn per laborer) as the wage. Since there is scarcity of labor and surplus of land, competition will lead to landlords ending up with the smallest possible share of corn. For example, in an experimental setup (using oral double auction type bargaining), the landlords will end up paying 9 units of corn in wages, and keeping one unit of corn in profits. Any landlord offering less – 8 units of corn – can be outbid for the laborer by some landlord who offers a higher wage.

C: Cobb-Douglas Production Function

Instead of fixed proportions, assume a Cobb-Douglass production function. Then we can set up a market structure such that Labor and Land both receive their marginal products, as per neoclassical theory. For example, Oral Double Auction pricing, where Landlords compete for laborers and laborers compete with each other for work, will lead to this result. However, a Posted Prices setup, where Landlords announce wages, can lead to capture of surplus by landlords.

D: Social Norms of Fairness:

We can also imagine other types of societies with other types of cultural norms. For example in a society with strong norms of fairness and equality, we could have a sharecropping situation. Each landlord hires four laborers. One “fair” solution would be to split 50-50 so that each laborer gets 5 units of corn, while each landlord gets 20 – 5 each from the 4 laborers he hires. An alternative fairs solution would be that each landlord gets 20% of the produce from each laborers. In this case, all landlords and laborers would end up with equal amounts, 8 units of corn.

5.  Conclusions:

We can create a vast variety of different models with different structures, and get very diverse results. For example, if the landlord hires laborers and owns the produce, this results in different outcomes from situations where landlord rents the land to the laborer and the laborer owns the produce. Depending on how money is used, and the sequence in which payments are made, and production takes place, and how the market for corn is organized after production, many different outcomes can result.

From this we conclude that the demand for Micro-Foundations for Keynesian Economics is legitimate, because how we specify the micro-foundations makes a huge difference. Keynes does not specify Market Structure, Technology, Social Norms, Institutions, Social Classes, Sectors of Economy, and many other factors of importance. All of these factors make a difference to the outcome.  Depending on HOW we specify these, we can get to different understandings and explanations of Effective Demand. Whether or not unemployment can exist and persist will depend on these factors which Keynes did not specify.

End of First Part of Lecture. To be continued – Next part discusses how one can get to Keynesian type unemployment equilibria. Video below contains the full lecture, covering this first part, as well and many other topics. The above post covers the first 17 minutes of the lecture.




In a rapidly changing world, ways of thinking which served us well in other eras, become obstacles to understanding, and reacting appropriately to change. Traditional economic theories, currently being taught all around the world,blinded economists to the possibility of the global financial crisis.The Queen of England went to London School of Economics to ask why “no one saw it coming?”.The US Congress appointed a committee to study why economic theories “dismissed the notion that a financial crisis was possible”. At the heart of this failure arewrong ideas about the role of money in the economy. All major schools of macroeconomics currently being taught around the globe teach that the quantity of money only affects the prices, and does not have any other effects on the real economy. Economists write that “money is a veil” – it hides the workings of the real economy, but does not play any role in it. Economists were blindsided by the crisis because models currently in use for policy making do not have a role for money, credit, banking, and debt, even though these were the factors responsible for the Global financial crisis.

The crisis made clear to all and sundry the vital role of money in the economy. Surprisingly, the mainstream economics profession has been extremely resistant to change. The same textbooks, theories and models which failed so drastically, continue to be used in teaching and policy making throughout the world. However, the space for unorthodoxy has expanded substantially, and a lot of new theories of money have emerged to challenge mainstream views. Among these, Modern Monetary Theory, which provides a radically different perspective on money, has emerged as a strong contender. This article aims to summarize some of the key insights of MMT, which creates new ways of looking at the world of fiat money that we live in today.

The starting point of MMT is that our thinking about money is conditioned by the view that money is based on gold, which leads us to ignore the radical differences between gold-backed money and “fiat” money, which comes into existence by government decree, and does not require any backing. With a gold-backed currency, the concept of a government deficit makes sense – the government must have gold, in order to spend it. However, with a fiat currency, a deficit must always be self-imposed; the government chooses not to print money in order to pay its obligations.The idea that the government does not have money to fund social welfare or investment is wrong, because the government creates money by sovereign fiat, and can always print as much money as it likes. MMT raises the question of why the government should impose taxes on citizens to generate revenue – why not just print the money instead? Readers who have been conditioned by economic theories will eagerly proffer the standard answer: because this will lead to inflation! But this answer is neither sufficient, nor satisfactory.

Based on his experiences as Governor of the New York Federal Reserve Bank, Daniel Tarullo has written that at present we do not have a working theory of inflation. Similarly, Joseph Stiglitz has written that the stable relationship between money and inflation broke down in the 1980’s, leaving us with no reliable guide to monetary policy. The Quantitative Easing program that was adopted in major world economies after the Global Financial Crisis involved printing huge amounts of money. However, to the surprise of economists, no inflation resulted, in conflict with standard theories of inflation. So, the idea that if the government prints money, inflation will necessarily result is not credible.

As experience of the past few decades has shown, there is no automatic relationship between printing money and inflation. A more sophisticated analysis is needed. MMT provides rather different answers to when and whether governments should print money, as well as the why of taxation. First let us consider the printing of money. Whether or not it is inflationary depends on how the printed money is used. For instance, if it is deposited in the accounts of billionaires and adds to their financial wealth, without being used for any other purpose, then it will not have any inflationary effect. If the money is used to purchase goods in a sector where the economy has excess capacity for production, then the demand stimulus will create an expansion, with increase in employment and in production. This is the Keynesian phenomenon – in a recession, where economy is below it peak production capacity, a monetary stimulus can create increases in employment without inflation. If the money is used to buy goods in sectors where economy is at peak productive capacity, then it will create inflation in the short run. What happens in the long run depends on whether the industry can expand to meet the excess demand.

Against this Keynesian possibility where printing money increases production and employment, there are many possible ways that money creation can harm the economy.If money is spent on land and stocks, this will lead to inflation in their prices. Money can also be used for purchase of luxury foreign goods, or transferred abroad in various forms. In such cases, increased demand for dollars would lead to depreciation of the exchange rates. Keynesian economists have suggested that dropping money from helicopters would be a useful policy to reduce unemployment in recessions. Modern Monetary Theory tells us that we need to be more discriminating in targeting the printing and distribution of money. If money goes to sectors of the economy where there is excess capacity, it will stimulate production and employment, without causing inflation. If it goes to domestic sectors operating at peak capacity, it will lead to domestic inflation. If it is exchanged for dollars and flows out of the country, it will lead to depreciation.

One of the key resulting insights is that the “deficit” numbers by themselves – whether in percentages of GNP or in absolute quantitative terms – are meaningless. The government can “sustain” any amount of deficit by printing money to pay its obligations. Of course, this is not a license for irresponsible spending. Creation of money, and its utilization in ways which do not enhance productive capacity of the domestic economy are sure to cause harm to the economy. Rather, MMT provides us with a license for responsible spending. If there are worthwhile projects which will utilize resources currently lying idle, then there is no need to be scared of the deficit numbers in spending on these projects. Viewed in this light, the project of building a million houses is not constrained by the budget of the government. Rather it is constrained by the availability of resources which are required for this purpose. If there is idle productive capacity in terms of labor, land, and materials, spending is this area will utilize them to the maximum. If the capacity does not exist, then a carefully balanced spending strategy, which builds capacity in a way coordinated with the increasing demand for utilization of this capacity, can be funded by deficit financing, without causing harm to the economy. Of course, it goes without saying that this requires skillful management and planning.

The strong focus on rationality, quantifiability, observability, and empiricism — putting the head over the heart — kills the marvelous magic of being alive — even a moment of life truly lived, packs a powerful punch — far greater than the lifetime of rational thought. Today, the catastrophic course which Descartes, the father of Western philosophy, took, has poisoned our lives, all over the planet. When one denies the immediate sensations, our pulsing hearts, racing breath, and tingling skin as evidence of our existence, and relies on the weak and faulty testimony of reason — I think therefore I am — this is equivalent to “feigning anesthesia”. Once this is done, it becomes possible to wonder — and have serious debates on — whether thought processes of the computers can be distinguished from those of humans, and derive ridiculous tests to assess this. Today, we need to learn to live as human beings again, instead of thinking machines, to bring back the magic to the beyond-words amazing gift of life in this un-imaginably precious world. Article below, published in The Express Tribune, June 20th, 2016, attempts to show how.


Max Weber wrote that “The fate of our times is characterized by rationalization and intellectualization, and, above all, by the ‘disenchantment of the world.’ Precisely the ultimate and most sublime values have retreated from public life …” The disenchantment of world leads to the modern view of the heart as merely a pump for circulation of blood.  The ancients had deeper understanding; as Pascal said “The heart has its reasons, which reason does not know. We feel it in a thousand things. It is the heart which experiences God, and not the reason. This, then, is faith: God felt by the heart, not by the reason.” Elevation of the head above the heart has led to a loss of wonder at the myriad mysteries of creation which surround us, and also caused deep damage to human lives in many dimensions. As our Poet Laureate Allama Iqbal emphasized: “At the dawn of Judgment, Gabriel told me, Never accept hearts which are enslaved by the mind.”

To make the best of the few moments that we are granted on this amazing planet, we must learn to appreciate the multiple paradoxes of this precious gift of life. On the one hand, “All we are is dust in the wind” – within the grandeur of the universe, and as just one among billions of people currently alive, my life is an insignificant speck. On the other hand, my life is all that matters to me, and the entire universe is contained within, and created by, my imagination. This simultaneous awareness of both truths diametrically opposed to each other, is not accessible to reason. However, poets have no difficulty with it; as Rumi said “You are not a drop in the ocean, you are the entire ocean, contained within a drop.”

When the heart and soul are removed from the picture, reason reduces man to a material object, just a drop in the ocean. Then it becomes possible say that the value of a man’s life is the sum of his lifetime earnings. Initial statements to this effect by secular and materialistic philosophers like Hume caused shock and horror. Nowadays, it has become widely accepted. The effects of this reduction have been profound in all dimensions of human life. Instead of recoiling with horror, we eagerly accept as the latest wisdom the idea of the “human resource”. Economists discuss human beings as inputs into the production process. The goal of the economic system is seen as the production of wealth, and the worth of a human being is calculated according to his ability to contribute to this goal. This comes from looking at only one side of the picture, the insignificance of a human life.

The other side of the picture is to realize that human lives are infinitely precious. Each human being is unique, with experiences and history like no one else. Each moment in our lives is new – no such moment has even existed before, and no such moment will ever arise in the future. Every moment presents us with unique opportunities to progress towards the infinite potential for growth planted within our souls. If we can grasp these opportunities, we can reach to heights that have never been scaled before in human history.

Consider the miracle of the seed, which defies all logic. The tiny seed has no arms, legs, eyes, or moving parts. Buried within the ground, it seeks out, and extracts from the soil, the hundreds of different chemicals required to manufacture roots, trunks, leaves, fruits, etc.  It unerringly sends roots downwards towards water, and the shoots upwards towards the sun, though it has no mechanisms to perceive directions. Within the seed, the Creator has implanted not just the design, but the full capabilities to manufacture not just a tree, but a forest. The potential planted within a human being is far greater. Those who realize it can achieve marvels. With training and discipline, humans can walk barefoot on fire, slow life processes down to survive being buried, break bricks with bare hands, accomplish incredible athletic acts, write literature and poetry of enduring excellence which inspires millions, and even greater spiritual feats which cannot be witnessed by others.

To put it in more prosaic and less poetic terms, the purpose of wealth is to provide the opportunity for all human beings to fulfill this potential, which cannot be measured in monetary terms. This reversal of the “human resource” idea is the central contribution of the capabilities approach to development, which emerged from the emphasis on Human Development pioneered by Mahbubul-Haq. This focus on the intangibles of human experience, which lead to the development of capabilities, is precisely what has gone missing from economic cost-benefit calculations.

Disenchantment, as reflected in the banishment of the ultimate and sublime values from the public domain, has resulted in impoverishment of human lives in many dimensions. We have learned the false and misleading lessons that our lives should be devoted to careers, production of wealth and the pursuit of pleasures. Recent research shows that while we are attracted by material possession, and short term gratification, long-run happiness comes from seeking enriching experiences, and emphasizing experiences over possession and consumption. Bringing back the magic into our lives requires paying heed to the wisdom of the ancients. Most important to our personal happiness is investing time on the social threads with which the fabric of our lives is woven. Generosity, acts of kindness, service to others, even at personal cost, contribute more to long run happiness than selfish maximization of short run pleasure. It is a central lesson of Ramazan that abstaining from desires, as well as other vices, and striving to do virtuous deeds, leads to spiritual growth. Spiritual growth is the core component of the development of character and capabilities. Let us use this opportunity to make a commitment to improving ourselves as human beings, as this is the most effective way of making the world a better place for all.

Related article: Social Revolutions – how individualism trumped social connections. My blog: An Islamic WorldView