Macroeconomic Policy and Sustainability

Read this article for additional perspective about macroeconomic goals and the inherent conflict among them as they relate to a global environmental context.

Redefining Macroeconomic Theory and Policy for the Twenty-First Century

A macroeconomics that is consistent with sustainable development must return to, and expand upon, the fundamental principles of Keynes, without the dilution inherent in the neoclassical interpretation. An initial list of the characteristics of such a macroeconomics should include:

Simplicity and transparency. This appears to contradict the post-Walrasian emphasis on complexity. But we should remember that consistency is the hobgoblin of little minds, and that great ideas are typically capable of fairly simple expression. Even a theory involving great mathematical complexity in its formal derivation may have fairly straightforward policy conclusions.

One of the great problems with current macroeconomics is that, unlike the relatively simple microeconomics of markets, it is enormously confusing. After following many tortuous arguments about expectations, shocks, rigidities, and short- and long-term effects, the student of macroeconomics is likely to be totally confused. One macroeconomics text lists seven different explanations for recession: traditional Keynesianism, misperception theory, real business cycle theory, sectoral shift models, new Keynesian theories of wage and price rigidities, coordination failures, and political business cycle theory – each with completely different policy implications.

In contrast, an ecologically oriented macroeconomics should focus on a simple basic principle: since unregulated markets are volatile and often socially and environmentally disruptive, informed government intervention using fiscal, monetary, and other policy tools is essential. There can be differences over the appropriate policy mix, but there can be no doubt that an activist government role is required to promote economic, environmental, and social sustainability.

Promotion of social goals. The more radical formulation of the Keynesian critique is fatal to the concept of market "optimality". Once the self-regulating Walrasian world evaporates, it becomes apparent that many social goals can only be achieved through collective action using democratic institutions of governance. Thus the need for government intervention is more than simply a technical requirement for macroeconomic stability. It represents the only feasible way of achieving goals which are essential for well-being, and which are not supplied, or inadequately supplied, through the market.

The implicitly anti-democratic free-market paradigm insists that dollar votes should rule and the public sphere should be minimized. While conservative economists are free to argue this as their political preference, they should not be able to appeal to any supposed professional consensus to justify it. A realistic macroeconomics requires a different approach, which is why New Classical theorists have attempted to reduce macroeconomics to non-existence. The reassertion of a distinct macroeconomic theory involves, as Keynes recognized, an essential role for social choice. This, not free-market ideology, should be the main message of economists to policy-makers and the public.

Concern for equity. Even the World Bank has acknowledged that "equity also remains a central concern of the state". As we have noted, earlier Keynesian theories placed emphasis on equitable distribution, both as a social goal and to promote a more stable macroeconomic system. In addition, as Adelman and Amsden have argued, equitable distribution is a strong precondition for effective economic growth in developing economies. In a world of ecological limits, issues of equity take on a particular importance since increased consumption for the poor may depend on moderated consumption by the rich. This reality calls for new attention to the preconditions for macroeconomic stability with limited consumption growth.

Environmental protection and growth limits. These issues were not on Keynes' agenda, but as Daly and others have emphasized, they must be an essential part of a twenty-first century macroeconomics. Heyes proposes the addition of an EE schedule indicating environmental equilibrium to the standard IS-LM diagram. The EE schedule is an interesting construction, since it depends both on the installation of environmentally cleaner technology, assumed to be related to the real interest rate (which determines the slope of EE), and on the level of environmental regulation in the economy (which determines its placement). It is not clear whether environmental factors can truly be captured by such a relatively simple formulation (just as IS-LM itself tends to oversimplify macroeconomic relationships). However, a fairly clear and commendable implication of the IS-LM-EE analysis is that economic growth must be accompanied by cleaner technology and stronger environmental regulation. In this sense, Heyes' proposal fits well with our earlier admonition that ecological macroeconomics should have straightforward and comprehensible policy implications.

Sustainable trade policies. One of the important aspects of the expanding critique of free trade and globalization is the issue of control of macroeconomic policy. Critics of free trade have pointed to its negative environmental and social effects, and its tendency to expand corporate power. An equally important concern is the tendency of regional and global free-trade regimes to remove fiscal and monetary policy from national control. This is at issue, for example, in the attempt to promote a common currency within the European Union.

Extensive opposition in Britain and other countries has forced European leaders to retreat on their timetable for the euro. What reasons do people have to be concerned about this issue, other than an affection for traditional currencies? Very good reasons. Not only is national cultural autonomy weakened by a soulless euro, but more substantively, control over monetary policy passes from elected national governments and their central banks to a European authority whose democratic mandate is at best weak. People sense that this represents an important aspect of loss of control over their economic destinies.

In the Asian crisis, countries like Malaysia and China, with controls on capital movements, were to some degree isolated from the recessionary contagion. In the wake of the crisis, Joseph Stiglitz and others have criticized the ideological dogmatism that led to an insistence on eliminating barriers to capital movement in East Asia in the name of free trade. While this led to short-term profit opportunities for international financial institutions, it left the area vulnerable to massive speculative capital flows – something which Keynes warned about, and which has led James Tobin to propose the "Tobin tax" on international capital movements.

International institutional reform. Keynes and others similarly minded were instrumental in setting up the Bretton Woods institutions to provide international macroeconomic stability. By the end of the century, these institutions were showing their age. One major problem is the lack of global environmental institutions, or of any prominent place for environmental concerns in the mandates of existing institutions. Another is the capture of international monetary policy-making by economists oriented towards contractionary "classical medicine" approaches. As Paul Streeten has long advocated, this approach disserves development and should be replaced by more aggressive policies aimed at recirculating capital and disseminating technology to promote sustainable development.

The development of such institutions and policies involves a careful consideration of which macroeconomic policy functions are best performed at a national, and which at an international level. Given the other goals of environmental protection and equity mentioned above, the current combination of rapid globalization and classically-oriented contractionary policies is clearly inappropriate, and it is not surprising that it has led to growing resentment and opposition.