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Cherchez la Firme: A Response to Janet Yellen on Macroeconomic Research After the Crisis

In an address to the Federal Reserve Bank of Boston on October 14th 2016 Janet Yellen, Head of the US Federal Reserve, observed that both the Great Depression and the stagflation of the 1970s motivated new ways of thinking about economic phenomena and that the 2007-08 financial crisis and its aftermath might well prove to be a similar turning point. (28).

We agree that it should be in terms of enhancing understanding of the causes of the crisis and her questioning why a ‘Great Recovery’ has proved so elusive. Yet are concerned that, despite such a laudable ambition something central is missing from the feast of references that she cites – the transnational or multinational firm that was identified as meso in the sense of intermediate between micro and macroeconomics, yet dominating both. Neither the word transnational or multinational features in her address.

Moreover the mainstream economics that she cites has over-ridden what much of the rest of the world has well recognised in that a handful of banks and other financial institutions deemed to ‘too big to fail’ were salvaged with public funds on the grounds that letting them go under would have caused a macro financial meltdown unparalleled since 1929. Whereas what ensued, even with this salvage, was such a meltdown, while the costs of salvaging them in Europe caused a crisis for Eurozone member states which then was compounded by a pre-Keynesian concern with austerity on the false assumption that this, of itself, would assure recovery from the crisis (9).

In terms of her concern to gain a better understanding of international linkages we suggest that macroeconomic research could well gain from recognising the work of Hymer (11, 12) on transnational or multinational direct investment and its implications for uneven global development. Or realising that the theory of comparative advantage as presumed to be axiomatic in the HOS Heckscher-Ohlin-Samuelson theory entirely neglects UNCTAD evidence (24) that trade since the 1960s has been driven by the FDI of foreign direct investment to the point that, by 2004 half of the exports of China were from international firms locating in and exporting from her export zones (16).

As well as that the alleged Heckscher-Ohlin-Samuelson model of comparative advantage, assuming the maximisation of global welfare, is neither Heckscher’s (3), which was based on different factor proportions in production in more and less developed economies, nor Ohlin’s (17) but Samuelson’s (21, 22) not least since Ohlin recognised that foreign direct investment and production could substitute for exports, whereas Samuelson did not.

While the FDI of foreign direct investment also has compromised exchange rate theory on which the IMF, World Bank, GATT and the WTO have relied. As evidenced as early as the 1967 devaluation of sterling, multinational firms will not follow through a devaluation by one country with lower prices in others in which they already are selling (2, 10) since this would be to compete against themselves abroad (8, 10).

‘Finding the firm’ also addresses Ms. Yellen’s concern to gain a better understanding of financial linkages to the real economy. The US, like Britain, has experienced major de-industrialisation which relates more to mesoeconomics than macroeconomics. Icons such as the American auto giants relied on economies of scale and did not grasp the degree to which the Japanese multinationals locating in the States have gained competitive advantage through the continuous improvement of kaizen and economies of scope, or more with the same rather than more of the same.

In turn, with less profit opportunities at home from industry, US institutions turned to making money from financial derivatives with disastrous outcomes in the degree to which banks and insurance companies were influenced by ungrounded macroeconomic rational expectations and efficient market theories.

With regard to Ms. Yellen’s concern to gain a better analysis of the influence of demand on aggregate supply, mainstream macroeconomics also is in default. Thus, if macroeconomists are concerned to refer to them at all, their analysis of accelerator effects or capital stock adjustment decisions are national, whereas for decades they have been global for multinational corporations.

This also qualifies the assumption in IS/LM theory that big business is influenced in investment decisions by interest rates rather than demand. Which also should not be surprising in that, even in a less global era, the Oxford Studies in the Price Mechanism (18) found that no firm in in its research sample was influenced in its investment decisions by any interest rate rather than prospective demand.

The papers that Ms. Yellen cites in her references also give little insight to her concern with inflation dynamics or what now is concern with disinflation on such as scale that the European Central Bank, and others, have reduced interest rates to zero or negative levels. For the same reason that major firms are not significantly influenced in their investment decisions by interest rates rather than by demand. While, also, low or negative interest rates mean that pension funds cannot finance their pension obligations. (5, 9)

The conference organised by the Boston Fed, and which Ms. Yellen addressed, was explicitly concerned to analyse ‘Causes and Implications for Future Business Cycle Dynamics’ of the financial crisis. Yet neither her text nor her references include John Hicks on the trade cycle in which he stressed that a downturn in an economy can be offset by longer term “autonomous” investment which is not sensitive to short term changes in taxes or interest rates(4). While such counter cyclical long-term investment typically is public, not private and mainly bond financed.

Yet there is no reference in her address to the role of public investment, nor to its financing through bonds despite such bond funded investment financing the Roosevelt New Deal. It was this that recovered the US from the Depression following the 1929 financial crash when private confidence in a recovery had been shattered. In her valid concern to enhance macroeconomic research after the more recent crisis she also could encourage attention from Europeans on the analogy between the 1930s New Deal and what now could be a New Deal for Europe[i].

For example, US Treasury bonds do not count on the debt of the member states of the American union such as California or Delaware. Nor do the bonds of the European Investment Bank, bigger than the World Bank in its lending, count on the debt of the member states of the EU. This has been overlooked by senior figures in the European Council and Commission and by the German government on the mistaken assumption that they would need to be underwritten by national taxpayers, whereas the bonds of the European Investment Bank never have been dependent on such transfers by member states of the EU, nor on national guarantees (7, 9)[ii].

There also is the continued macroeconomic error of the European Commission in endorsing the crowding out hypothesis of Milton Friedman. Whereas, as Keynes stressed, public spending does not drain but sustains the private sector through investment, employment, income and fiscal multipliers. The average fiscal deficit of the US from 1933 to the outbreak of war was only 3%, i.e. the target rate of the so-called stability and growth pact of the EU, even if the austerity obsession of the Directorate for Economy and Finance of the European Commission has meant that there is little to no growth in Europe and that the stability of the euro now is in question. (9)

Further, macroeconomists regularly cite Walras on general equilibrium. Yet disregard his warnings in his later work that this was an intellectual device rather than realistic.(27) For, although pioneering general equilibrium as a theoretical model, Walras recognised that he had not been able to dynamise it, and that actual economic outcomes could be asymmetric. As well as, with minimal exceptions, economists ignored his case that all banks and other financial institutions should be either publicly owned, or mutual societies, since they otherwise would speculate with savers’ deposits and risk losing them.(26)

Or ritually citing Pareto on optimality yet, in the case of theories of rational expectations and efficient markets, disregarding his warning that while there was a psychological disposition to assume that the future would replicate the past this had no more basis than Pangloss in Voltaire’s Candide maintaining, over the ruins of Lisbon after the earthquake that destroyed it, that all still was and still would be for the best in the best of all possible worlds.(25) Nor recognising that, while Pareto reasoned in terms of derivatives as in calculus, and used it, he stressed that these are not ‘facts’, nor proof of them, but only a ‘conceptual scheme of the mind’.(19)

Yet macroeconomic theory cannot just ‘go back to Keynes’ who was seriously in error by targeting Jean-Paul Say as the straw man in his General Theory.14) Since Keynes assumed that in claiming that supply would create demand Say was reasoning for the short-term, whereas he was not. Say’s case was that long-term public investment would generate demand in the private sector, which it does, and in this regard influenced Napoleon to establish the French grande écoles such as for engineering, bridges and roads and mining. (22)

While Say’s case has been replicated with success in France since WW2, with long-term investment through meso scale public enterprise. The publicly owned EDF has successfully fulfilled the aim of postwar French planners to achieve more than 80% self-sufficiency in energy through nuclear power without the risks of a Three Mile Island meltdown. Renault, brought into public ownership after the war, gives France a partially nationally owned motor industry which Britain now lacks[iii]. The Diamant rocket was the basis for the EU’s Ariane satellite launcher. Concorde never made a profit and Britain would not co-finance the cleaner, quieter and larger Concorde 2 wanted by De Gaulle. (9) But it gave France the basis for a key role in the Airbus consortium which then ended Boeing’s hitherto near monopoly of civilian jet aircraft.

Besides which, there is neglect in the Yellen address of the degree to which not only macroeconomics can in principle lift economies and societies to higher levels of income and wellbeing but how Schumpeterian process and product innovation, at enterprise level, also can do so. (23)  As well as that the role of the State is not limited to creating the conditions in which the private sector might innovate, but can itself synergise the process or create entirely new innovation.

Thus, in the US, the DARPA federal project gave start-up finance for small firms, some of which then became giants, such as Hewlett Packard. This included semiconductors, human computer interface research, and the early stages of the internet. The Orphan Drug Act enabled small firms to improve their technology platforms, scale up their operations and become major players such as Genzyme, Biogen, Amgen and Genentech. The National Nanotechnology Initiative created an entirely new technology with widespread applications in both industry and services. (15)

Yet, in terms of the theory of oligopoly, and power relations, recognised by Kalecki, if neglected by Keynes, big business also can gain a decisive influence on macroeconomic and macro financial policy (11). In Brussels it has more lobbyists than there are civil servants in the European Commission.

As also with econometricians at JPMorganChase and AIG, drawing on rational expectations and efficient market theories, and assuming a Great Moderation since the ‘rolling back of the State’ from the 1980s, claiming that the 8% reserve requirements of for US financial institutions were too high and that they should be dropped to 2%, which influenced the decision to repeal the Glass-Steagall Act, lowered reserves to such a level, and paved the path to the cliff of the 2007-8 financial crash, as well as needing the salvage of Chase and causing the collapse of AIG.(9)

And, further, the power to block effective accounting and accountability. Such as the proposal that there should be a meso dimension to input-output analysis by Eurostat, tracing the multinational reach of big business which otherwise is accounted only on a national basis. This was supported by Jacques Delors and also gained the interest of Leontief. But was blocked by big business pressure after Delors retired as President of the European Commission.(7)   While meso accounting also could achieve transparency on tax avoidance by big business in that its multinational range enables it to transfer price in a manner not open to smaller national firms.

Otherwise, however, some financial policy, without using the concept, is endorsing the conceptual framework of mesoeconomics has recognised the difference between meso and micro institutions. Such as the proposal for a banking union in the EU not being concerned to gain detailed information from the 6.000 financial institutions in Europe, but from the 130 of them that dominate macro financial outcomes. Which could gain from a meso dimension to input-output modelling of both their behaviour and intentions. (7)

Much of this, and concern to distinguish meso from micro economics, was elaborated in the 1970s and in some depth in two volumes published in 1987 (5, 6) of which a reviewer in the Journal of Economic Literature wrote: ‘In scope, comprehensiveness, accessibility and insight, these books have no equal. Economists, especially teachers of economics, are in his debt’.

But which, thereafter, was not to be the case. Both monetarists and Keynesians were too wedded to standard micro-macro syntheses. Of which we suggest that one of the reasons has been that, without partial equilibrium, and thus limits to the market share of firms, they could not posit the general equilibrium models to which, unlike Walras, who distinguished pure theory from actual outcomes, they have been addicted.

Nor, frankly, are we optimistic that the meso dimension will gain traction among those who for years have assumed with Milton Friedman in terms of the theory of the firm that ‘size does not matter’. (1) Yet in terms of ‘too big to fail’ and the dynamics of globalisation, as well as the case of the reviewer in the Journal of Economic Literature that it could enhance the realism of economic theory, the relevance of economics teaching and the application of policy prescriptions, mesoeconomics deserves both recognition as a concept and sustained research. While a meso accounting and accountability agenda is one that both the Fed and the European Central Bank arguably should support.


[i] The New Deal took place in the context of a 30% devaluation of the US$ against gold, and the imposition of a 50% Smoot-Hawley tariff.

[ii] The credit worthiness of the EIB is dependent on the creditworthiness of its shareholders, EU member states.

[iii] Volkswagen of Germany is also publicly owned.



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