Interview with Alejandro Nadal

The Key Organizing Principle of Society:
Macroeconomics – Markets or Sustainability

Part 1: The Myth of the Invisible Hand
Part 2: The Day That Capitalism Changed Forever

Mexico City, Mexico

	Dr. Alejandro Nadal at his home in Mexico City. All photos by Nic Paget-Clarke.
	Traffic and colorful housing apartment buildings in Mexico City.
	Double-decker buses introduced into Mexico City in 2018.
	The National Museum of Anthropology in Mexico City.
	Alejando Nadal in Mexico City.

Part 1: The Myth of the Invisible Hand
1.1: The Distinction Between Markets and Capitalism
1.2: The Emergence of Economic Theory
1.3: The Myth of the Invisible Hand
1.4: A Market Society in which You Commodify Labor
1.5: Macroeconomics: Looking at the Economy as a Whole
1.6: Packages of Ideology and Crisis
1.7: Understanding the Key Role of Aggregate Demand

Part 2: The Day That Capitalism Changed Forever
2.8: Bretton Woods -- How Do We Organize the Monetary System?
2.9: Trust, Money, and Seigniorage
2.10: The Separation of Finance from the Real Economy
2.11: Private Banks as the Most Important Source of Money Supply
2.12: The Banking and Financial Sector
2.13: Macroeconomic Priorities for Social and Environmental Sustainability

Download the entire interview PDF.

Part 1:
The Myth of the Invisible Hand

1.1: The Distinction Between Markets and Capitalism

In Motion Magazine: Can you please talk about why markets and capitalism are not the same thing?

Alejandro Nadal: Markets have existed all along human history, you can say in general terms. You had markets in Babylon. You had markets in Egypt. You had markets in Mesopotamia, and in Rome and Greece, of course, in classical times. But you didn’t have capitalism.

The reason why there is this distinction and why we have to make this distinction, is that people tend to identify capitalism … the narrative of capitalism has been that capitalism is a natural way in which human societies should be organized, or have been organized through history. History becomes like a long quest for the development of this natural way in which societies, human societies, are organized. This is a complete fallacy.

First of all, you identify the fact that markets existed all along and therefore they existed in and before capitalism. The second idea that needs to be understood is that these markets, they existed but they were not the way that society was organized. They were always, let’s say, embedded -- that’s the work of a great thinker, Karl Polanyi. They were embedded in society. Society was always organized around, let’s say, some hierarchical principle. Maybe you had a king. There was a division of labor. Everybody was going around their own tasks in society. Some had to go fishing. Some were doing agriculture. And at the end of the day, or the economic period, you had to distribute the products of these different groups of people.

Maybe the king had a system that was centralized and there was a distribution of these goods. There was production and distribution but it was not carried out by a market. There were markets, there were individual markets. Maybe there was a guy who made sandals, and there were women who were weaving, whatever. You had individual markets, but the way in which society was organized made it such that these markets were embedded in a larger social system which was not dominated by a market, or by market forces.

Differing organizing principles of society

In the eighteenth century, very recently, this changed completely, radically. The market became the central principle for social organization and you ended up with a market society, and all other social relations now were embedded in a big market.

Do you see what I mean? You had markets before, in previous times. Individual markets existed. You even had money. You had monetary transactions and you had prices. But all of these things were embedded in a social system that was organized along different lines, different principles -- like reciprocity, hierarchies, kinship. All of these things were the organizing principles of society. You did have individual markets but there comes a period of history in humankind in which this is radically changed and you have a market and other social relations embedded in a market society.

This is very recent. There is a transition which starts in the seventeenth century but it culminates mid- to end-of the eighteenth century. You start having a market society.

In Motion Magazine: Was this because of the industrial revolution?

Alejandro Nadal: It was because of a whole bunch of things happening. It is related first to the enclosures, (Editor: the “enclosures” were a variety of processes which literally enclosed and privatized, with hedges and fences, community-owned and community-used open land and forest land.) and then it intensifies with the industrial revolution. It’s before the industrial revolution. In fact, the industrial revolution couldn’t have happened without this transformation already taking place. Polanyi’s book, which was published in the 1940s (1944) called The Great Transformation, it talks about this exactly, about how it happened, how it came about.

People resisted this transformation. Communities and societies resisted this transformation. They understood the danger of this transformation and the perils for human society, for humanity, and they resisted. But it came about nonetheless. The role of the state was (also) very important. This is why market (versus) state, this juxtaposition is another fallacy. The role of the state in bringing about this market society was absolutely crucial.

When I say that people understood the perils of this, I mean that they understood that when you do this all social relations become subservient to the idea of commodification and of transforming social relations into mercantile, commercial relations -- therefore, putting a price on everything.

Transforming labor into a commodity

(And) this is also closely related to the tendency of markets today, in this market society, to put a price on everything. Everything becomes a commodity, even things like social relations. Not only your daily needs for food intakes, for example, become a space for profits, and a space for markets, but even things like friendships and family relations become contaminated with the idea that there is an economic interest.

So, I’ve spoken about what is a market society, where does it come from, how recent it is. (But) I haven’t spoken about capitalism. This is very closely related to the development of capitalism. The role of enclosures is closely related to the fact that you need, for capitalism to develop, you need to liberate a whole bunch of people, as a group of people, from the land and from these other hierarchical social relations that existed, from the feudal relations. So, you open a space in which you can hire people and transform their labor into a commodity, which was something that did not exist under feudalism.

1.2: The Emergence of Economic Theory

The difference between Aristotle and Adam Smith

In Motion Magazine: Is this when ethics changed, as you were discussing earlier in reference to your next book?

Alejandro Nadal: Well, yes, in the sense that when you develop a market society, you also develop a very strange form of discourse, or analysis, which we now call economic theory, or economics. And this form of talking about society is again also very new. We say all the time that the father of economics is Adam Smith, and yes there is a transition there too, (but) before Adam Smith, before the eighteenth century in Europe, you had a lot of people talking about money, and prices, gold, and accumulation of wealth. Everybody was talking about these things because you do have markets and you have prices and you have money and people think about these things, all the way back to Aristotle -- even before him.

Aristotle was a guy who analyzed prices and analyzed monetary transactions (but his analysis) had nothing to do with the way economists talk about prices and money (now) -- in spite of the fact that books of history of economic analysis, for example, all of them say, “The whole thing started with Aristotle because he was the first guy to analyze prices and monetary transactions.” That’s not true.

Yes, he analyzed prices and money, but he analyzed them as part of his thinking about ethics and politics. Prices and money come into the analysis but they don’t dominate the analysis. The perspective on prices and money is an ethical perspective and a political perspective.

For example, money for Aristotle is not a means of exchange. It is not a reserve of value. It is not a unit of accounting. It is an ethical and a political object -- which radically changes your view of his analysis. The same thing with prices. The whole discussion in Aristotle about a just price, what is a just price, has nothing to do with how we calculate prices today or how economic theory today goes about talking about prices. From Aristotle, you have an ethical and a metaphysical perspective of prices and money. There’s a huge historical chasm that differentiates the analysis of Aristotle and the analysis of economic theory on prices and money. That is something that is totally lost today. Nobody deals with these things except students of philosophy, for example.

He analyses prices but it has nothing to do with the analysis of economic theory.

“The eternal laws that regulate the economic mechanism”

So, once you have a market society developing, … (you have this) very strange discourse about how this market society works. And this is where you get this idea of mechanism. All of a sudden you had a society in which there is a crucial dimension of social life which is ruled by its own rationality and its own laws.

“We as economists,” this is Adam Smith now talking, I’m putting words in his mouth, “Our task as economists is to unravel the laws, the eternal laws that regulate this mechanism, the economic mechanism. We need to understand how prices are formed; how our resources are allocated; profits and wages; and interest rates; and money. We need to understand all these things. And thankfully we have an economic theory that is developing, allowing us to understand these things.” There was a mechanism out there that was the market society that needs this analysis.

So, economic theory co-develops with the emergence of the market society.

In Motion Magazine: Was that a good idea?

Alejandro Nadal: Well, it was a good idea from the perspective of the dominant classes, or dominant social groups that were also emerging. Because once you do this, you say, “Look, this mechanism, it evolved naturally. Here it is. It has great advantages. We are producing wealth.” This is Adam Smith, you know (his book) The Wealth of Nations.

“We are producing wealth as never before in the history of humankind. The division of labor is beneficial.” And how this market society works, especially capitalist society, the capitalist market economy works, “is highly beneficial. We live in the best of all possible worlds and economic theory is a scientific way of proving that we are doing fine and we should let this mechanism operate with its own rationality. It works fine.”

This is the ‘Invisible Hand.’

1.3: The Myth of the Invisible Hand

The two components

Alejandro Nadal: The Invisible Hand myth has two components. Number one, which is what everybody knows, is that, “Greed is OK, is good, because we are looking out for our self-interest, but we are doing something beneficial for society in the aggregate.”

And this is the paradoxical thing. This is why it is such an important myth. If everybody is greedy they will stab each other in the back. “No,” Adam Smith says, “No, that is not true. If we let people operate freely, in spite of the fact that they are greedy, as if guided by an invisible hand, they will in the aggregate reach a beneficial outcome for everyone.”

(And), the crucial thing here is not only, ‘What is the mechanism by which the Invisible Hand works?’ The other question is, ‘What does the outcome look like?’

How does the Invisible Hand work?

So, the first question -- ‘How does the Invisible Hand work?’ Let’s look at markets and prices and how they interact. This is why General Equilibrium Theory is, let’s say, the descendant of this idea -- this is why the fathers of General Equilibrium Theory recognize themselves in the Invisible Hand metaphor of Adam Smith: they are trying to give a scientific proof that it is not only a metaphor, it is a scientific fact. “We are going to prove that through a mathematical model.”

By the way, spoiler, this failed. They could never come out with a mathematical model that showed how market forces compete. “The competition between consumers and producers, all these things lead to a socially beneficial outcome which is called ‘general equilibrium’ in which the individual plans of greedy individuals become compatible through market forces.” That scientific research program failed (and) it is really well known.

It is well known among the theoreticians that developed this, but it is kept out of sight and all that failure is forgotten. Everybody talks as if that theory had been successful, that you have successfully proven through the rationality of the mathematical model that this is a scientific fact. (But) that’s a failure; kept out of sight -- and the failure is not taught at universities. On the contrary, teaching of these things is totally distorted and misleading.

What does the outcome look like?

Now, the other part of the myth is, ‘What does the outcome look like?’ Just imagine that you have a theory about the Invisible Hand that is saying that individuals are guided as by an Invisible Hand but there is a social conflict among them -- that is the outcome. That would be terrible, no? The outcome would be negative. You would need to combat market forces. Right?

For the ideologues and the people that were making this theory, their research program had one key objective: to prove that the outcome is beneficial for everyone. This is crucial. If you don’t prove that, then your theory -- from the perspective of the ‘establishment,’ the power of the elites, of the dominant classes -- is a terrible theory. “I don’t want to hear about it.”

So, they took it upon their backs. They had this load, and they had to carry the load. They took it upon themselves to prove that the outcome was beneficial. They (sought to) prove that if you have an equilibrium, it is beneficial for everyone. And, if you have an allocation of resources that is beneficial for everyone then that is a ‘general equilibrium’ – meaning that the quantities of any commodity offered in the market and demanded in that market are equal. That’s equilibrium – supply and demand – ‘supply equals demand.’

The crucial thing is that ‘supply equals demand.’ The producers that take this supply to the market, and the consumers that demand this commodity in the market, are both happy. They are maximizing their profit functions and their utility functions, or their satisfaction parameters. OK?

The outcome is not only ‘supply equals demand,’ the outcome is that at those quantities and at those prices every agent in society is extremely happy. They’ve realized their plan. That was the research paradigm that economic theory had all along since Adam Smith, all the way until General Equilibrium Theory. (But,) this research program failed.

The big question is, do market forces when left freely to operate – and by ‘market forces’ I mean the competition between producers, within themselves, and consumers within themselves, bidding in the market there – these market forces, do they lead to this beautiful outcome? That failed. The dynamics of the market – that is what failed.

But is this equilibrium stable?

(But), let’s accept you have an equilibrium in which everybody is happy. ...(Now) the big question is, ‘Is this equilibrium stable?’ And initially that meant, ‘If I disturb it, are there economic forces unleashed within the system, in the mechanism, that restore the equilibrium -- or not?’ For example, if I have a bowl and I have a marble here at the bottom -- it’s in equilibrium. It’s at a resting point. If I disturb that ball, it goes around and comes back to that equilibrium -- that equilibrium is stable. The analogy here would be, “If I disturb it, does it come back to equilibrium?”

Then the question became even more interesting and more relevant. ‘Given any starting point, do these forces lead to equilibrium or not? ‘In other words, -- coming back to the bowl -- ‘If I drop this marble here, or here, does it go to this resting point or not? Yes, in that case yes. But, if I have a pyramid and I have a marble, and I start here, the marble will not come to this equilibrium point. It will go to another resting point.’

The analogy in economics was exactly that -- to prove that markets, this mechanism in market society, (was stable.) (And they wanted to do this) because it existed already, they were having this transformation in Europe. Market relations were becoming dominant all over Europe.

Adam Smith’s theory of the guiding forces of this great transformation?

And this was the world in which Adam Smith was writing. He was a very intelligent guy. He was looking at this fresco, this landscape in Europe, and he says, “Wow, this is amazing. This thing is being transformed.” And he looks in a very particular manner -- with Bacon’s rationality in mind. (Editor: Francis Bacon was an English philosopher and scientist). He’s going to unravel the laws that are the guiding principles, the guiding forces of this great transformation taking place. And he comes up with something that most economists have never seen.

(Adam Smith’s book) The Wealth of Nations is a very large book. The first six chapters are pure theory of prices -- though nobody talks about it (today). Everybody talks about the Invisible Hand, or monopolies. (But) Adam Smith has a theory of the process of how this market works. It is called the “Theory of the Gravitation of Market Prices Around Natural Prices.” You have a fixed axis of reference, which are natural prices, rigorously defined, and then you have market prices that gravitate around this axis of reference. Those are the first six chapters of Adam Smith. The discourse of Adam Smith, you can put it in mathematical terms.

And, by the way, this theory of prices of Adam Smith is very, very different from General Equilibrium Theory, but there is a continuity between them. The idea (is) that we need to specify and demonstrate rationally, scientifically, that the Invisible Hand metaphor is more than a metaphor, that it is a faithful description of how a market society works. (But, up) until today, economists do not have a theory, a mathematical model showing how a market society works. As simple as that.

Failed as a scientific endeavor

If you had a fully-packed stadium and the world was looking at the center and in the center you were having all these disciplines coming by, you would have astrophysicists and they would be interrogated. “What were your achievements after a thousand years of work?” And they would describe expanding universes and galaxies and the Hubble Effect. “Very good, very interesting.”

“OK, let’s talk to biologists.” And they would come in and say, “We have a great theory of evolution. There are scientific debates. We understand how evolution works.” “OK, great.”

And then they would bring economists. “What was your achievement as a scientific discipline? What have you guys done? Have you shown that the Invisible Hand works?” And they would have to say, “We worked for two hundred years trying to develop a model to show that the Invisible Hand works, that the competitive forces of markets lead to equilibrium at which the outcome is beneficial for everyone.”

“OK, that’s interesting. And what was the result?” “We failed. The models that we have show that the equilibrium exists and is stable -- that market forces lead to an equilibrium beneficial for everyone -- in only two cases, and they are both logically inconsistent. (Editor: Nadal here refers to economic studies of instances of “gross substitutes” and “the weak axiom of revealed preference.”) Those are the only two cases in which an Invisible Hand works.

The interviewer would have to tell them, “So, you guys have failed.” And the economist, if he was an honest one, would have to say, “Yes, we failed in that attempt.” And everyone in the stadium would boo them.

These are some of the metaphors I use when I write papers to try to explain that this is a scandal. Economists like to parade their theory as, “We use mathematics. We are scientific. Not like sociology or anthropology which are very strange. Economists, we are very rigorous. We use mathematics.” That’s right, you use mathematics and when you understand those mathematics, it is very easy to say, “You guys are naked … the emperor is naked. Precisely because you use mathematics, it is easier to say that your discourse has no basis whatsoever. You have failed as a scientific endeavor.”

It is true. It is ideology.

1.4: A Market Society In Which You Commodify Labor

The elimination of ethics

So, let’s go back to the market society and capitalism. “At some stage, what capitalism needs,’ this is Polanyi again speaking, “you need to transform labor into a commodity and you need to talk about land as a commodity.” And then he says, “You need to talk about money as a commodity.” And there I disagree. I think Polanyi was not conversant with monetary theory. You don’t need to transform money into a commodity. You need to take away the power that society or the king, let’s say the sovereign power, has over monetary creation. And you have to give that to a segment of the capitalist class, which we call bankers. But that’s a different story.

In essence, market economies require to dominate the total space of society, of social relations. And, yes, we do have a party or a fiesta with my family and that’s not entirely market transactions. But those kinship and family relations are not the key organizing principle of society. The key organizing principle of society is now market rationality, prices, and profits. The origin of capitalism is a market society in which you commodify labor. Basically, that’s the crucial turning point. And that’s where we are today.

(But, as I mentioned earlier,) there was the resistance of communities, which is very well analyzed in Polanyi’s book. They understood the dangers of this. And, for me, the crucial danger is the destruction of ethics, the elimination of ethics from the social space, because now all relations are regulated by this mechanism, by this mechanism of prices -- price formation. That’s what really dominates social relations, social dynamics. Generosity becomes an anecdote in this society. “It’s great that you are generous and you gave 10 pesos to a beggar. Yes, ok, that’s fine. But it is aside from your real social life in which you aim at making better income. If you have to push your neighbor down the cliff, you will. And that’s ok because this is market rationality.”

Today, under neoliberalism, you see this to an extreme. The whole idea that, “Listen, if you work really hard you may succeed -- you will succeed.” We know that’s not true, but that’s the ideology. And the backdrop of that ideology is this market society in which everything is commodified and thought about in terms of prices.

The danger was very real. A very serious danger. (But) I have an optimistic view on the whole thing. I think that this will change. How? I don’t know. But I think that it will change because this history is very recent. This market, this view of society and of social relations is very, very recent. If I say the eighteenth century, we are talking 250 years, maybe 300 years. But humans have been on the planet for 200,000 years. Two hundred thousand years. It’s only a tiny part of human history that is dominated by this really amazing, crazy idea that through this mechanism and numerical magnitudes that social relations are developed. That is very recent. Before this you had wars and you had empires and you had terrible things happening, but at the same time societies did not have this idea -- never had this idea.

For an ancient, for somebody in classic Greece -- if I went back in time and described to them what was going on today, Aristotle would have said, “I told you so.” He did, in a way, (when) talking about interest in Chrematistics, his book on politics. There’s a chapter on money, (and) that’s where he says this famous phrase, and everybody quotes it, “Interest is counter to nature”. The idea that a sum of money begets more money through the passage of time by interest. It isn’t only bad because it’s too much, or too little, it’s counter to nature. And for Aristotle, that is the worst thing you can say.

He says that money circulation that involves interest payments is dangerous because it can destroy the city, la ciudad, and the social order. It can destroy the social fabric, as we would say today. It can destroy society. He would tell us, “I told you guys. Two thousand years ago, I told you.”

So, it’s a fascinating, it’s a thrilling story. I’m optimistic because I think in those 200,000 years there’s more room for solidarity than what we find today in human societies. I hope and I’m confident that this period will be somehow reversed.

It will take some time. It won’t be next week.

1.5: Macroeconomics: Looking at the economy as a whole

Do we get crisis sometimes?

In Motion Magazine: You mention in one of your books, Rethinking Macroeconomics for Sustainability, that John Maynard Keynes invented macroeconomics. What is macroeconomics? And if he invented it, what was there before?

Alejandro Nadal: Macroeconomics, to define it, would be the analysis of how capitalist economy works as a whole -- not (just) looking at the steel industry or the market for shoes. It’s, how do all of these sectors interact with each other? Not only in terms of price formation, but in terms of when I look at the aggregate do they generate enough employment?

For example, do monetary aggregates play the role that they are supposed to play when I look individually and say, “I need money for this market to operate”? Yes, but (what about) the entire society, how do monetary aggregates operate? And do we get crisis sometimes? Is there room for a general crisis? (And) not only in the shoe market because there’s too many people demanding shoes and producers can’t cover that demand; or, contrary to that, there is not enough supply and everybody wants shoes and there are problems with the shoe industry because there’s not enough leather. Or whatever.

We are talking about a general crisis in which you have important levels of people unemployed and therefore prone to all sorts of crazy ideas, like maybe fascism. This is what Keynes was thinking of, these things. Macroeconomics is looking at the economy as a whole. How does it work? How does it operate? Is it stable or not? The entire economy, is it prone to crisis or not? That’s what really macroeconomics is looking at.

What is your level of aggregate demand?

So, this means looking at how people save -- savings, investment -- is investment enough? And when Keynes wrote, he knew very well what economic theory was before his writings. He had been trained in that. In fact, he tried to develop that sympathetically. “This is great, but how does it work?” He was trying to develop how it worked and in doing that he understood this was not such a great idea.

He develops a discourse in which he looks at how the economy works as a whole. Before his time, this had not been done. You had partial, we could call them, forefathers, precedents, people talking about how it came down that people could accumulate gold or wealth in metallic form, precious metals, things like that. But nobody was looking at how does the economy work as a whole -- in terms of does consumption and investment allow for enough aggregate demand so that entrepreneurs are attracted by that demand and invest and people can consume that? Is aggregate demand enough to maintain a level of consumption and development in that economy? Or, are there other forces that lead to problems?

When he started writing, the Great Depression was starting, in 1929. In 1930, Keynes was still struggling with a lot of theoretical questions that he hadn’t made up his mind about how these things work. But he already had this idea that there is something wrong with capitalist economies. And, basically, the whole idea was that aggregate demand could be insufficient to generate full employment.

In other words, if you have aggregate demand you have investment opportunities. And, if you have investment opportunities, you create jobs. So, the whole thing hinges around what is your level of aggregate demand? For him, aggregate demand is a driving principle of the economy. It was totally different for Marx.

Instability, crisis with a different perspective

In Motion Magazine: How does (Karl) Marx fit into all this? Wasn’t he looking at the whole picture?

Alejandro Nadal: Yes. And, by the way, Keynes had no kind words for Marx. He was totally ignorant of Marx, but he didn’t like the idea.

Obviously, Marx was looking at the whole, but not in the same way. For example, I said precursors of Keynes, well, Marx, in book two of Capital, he develops something called ‘the schemas of reproduction.’ The question that Marx poses is, “I’ve analyzed how the exploitation takes place. The source of profits is unpaid labor. That’s what I call exploitation.” Marx would say that, “Now I have to show you guys how a capitalist economy works.” So, he sets (up) the schemas, diagrams, in which the capitalist economy works in a stable manner because you have investment here and it circulates to the guys who produce the machinery and these guys buy other things. These are schematic ways of showing how a capitalist economy works and works fine.

This is the interesting thing about Marx. In those schemas of production there is no room for crisis. The capitalist system works perfectly fine, because what he is trying to show is that in this economy in which there is exploitation the economy works. The profits of capitalism do not arise from corruption or robbery. Capitalists don’t steal from workers, they exploit them. In true commerce it is unpaid labor, surplus labor, surplus value which is appropriated by the capitalist class and this is what he tries to show. He wants to show how on a daily basis this is how this thing operates. It is not disturbed by endogenous forces.

If you want to look at that -- the theory of crisis -- then you have to go all the way into book three of Capital and then you will have some explanation of crisis. But, in fact, Marx doesn’t have a macroeconomic theory of crisis.

Marxists today have developed parts of his thoughts and original new lines of research. They can develop a theory of crisis, even monetary crisis. But Marx’s thought on these things was totally different. He was trying to prove that capitalism is synonymous with exploitation. That is what he was trying to prove. He was not trying to prove that capitalism is unstable or prone to crisis, although there is that undercurrent in Marxist analysis. This is why I say that Keynes was the guy that inaugurated this way of thinking.

Now, you can go back and say, “OK, what about a macroeconomic analysis, taking Marx as the starting point? -- taking the exploitation of capitalism as the starting point for macroeconomic analysis.” That is being done and there are Marxist authors that do that. But I think it is accurate to say that Keynes was the first guy who really opened up a new field of analysis which was macroeconomics.

The big advantage of macroeconomics is if you look at the economy as a whole, then you are able to understand how the system works. How this mechanism works. You are able to approach the whole question of instability of the system, of crisis, with a different perspective. If you don’t do that then you are talking about the crisis in the ice cream industry, but that doesn’t allow you to look at the entire system.

So, the big question of Keynes was, “How was it that we have today socially unacceptable levels of unemployment that can last for a long period of time? How is that possible? And the question is very important because that is a very dangerous situation.” Of course, (as I said,) he was thinking of fascism. Remember that in 1919 Keynes wrote his little book on The Economic Consequences of The Peace, and he’s alerting people, saying, “Hey guys, down the road something really nasty is going to happen in Germany.” And it did. He didn’t know exactly how it would play out, but he was saying, “Guys, these war reparations in Germany are unpayable.”

Then, in 1929, he’s looking at this implosion of the most developed capitalist economy in the world, the U.S., with unemployment, the Great Depression, unemployment skyrocketing to 25%. He’s really concerned. Don’t forget, in the interim he’s also looking, literally, at Germany and he has seen the rise of fascism in Italy. In the ’30s, he’s looking at Germany as “some strange things are happening there.” But before that he’s also looking at the Soviet Union. There was a Russian revolution. “You have fascism, you have Stalin and the Soviet Union -- something is going on. If you want, you call it communism, or whatever, but that’s another danger.” He likes capitalism. He’s fond of capitalism. He wants to save it from itself. He sees capitalism as not stable.

1.6: Packages of Ideology and Crisis

From the Welfare State to Neoliberalism

In Motion Magazine: In line with that, one of the words you used when you were writing about what some people call neoliberalism, is “package”, as in “a package of policies.” Is macroeconomics an overview of a whole economic system, but then people apply on top of that overview various packages?

Alejandro Nadal: That’s right.

In Motion Magazine: ... packages which come from their own ideologies or theories?

Alejandro Nadal: Right.

In Motion Magazine: So, for a while, people used some of Keynes approaches – and that was a package of macroeconomic policies.

Alejandro Nadal: The Welfare State.

In Motion Magazine: And then there’s Import Substitution Industrialization, and after that the Neoliberal packet? You are saying it’s a level of analysis from which point you can then say, “We need to take various monetary and fiscal policies and apply them in such and such a way?”

Alejandro Nadal: Right. Absolutely. Macroeconomics just said you look at economies as a whole, how can it work. The big questions are, ‘Is this prone to crisis? Number one.’ ‘Number two, how can I have a macroeconomic system that is beneficial for most of the people?’

Let’s say, we have a question for the Welfare State, “How do we organize this economic mechanism so that most people benefit and they don’t have to suffer things like unemployment, things like that? Or inequality and poverty? There are different approaches to this.

Let’s say you believe that the Invisible Hand is a beautiful theory, which it is not, but OK, let’s say you believe that. “Well, we need to organize a macroeconomic policy package that allows for the Invisible Hand to work. Yes, we are going to need taxes but let’s minimize that. We are going to need public expenditures but we will also minimize that because we don’t want to distort markets. And we don’t want to distort the way the Invisible Hand works because we know it works beautifully.” It’s an ideological perspective.

And, as far as monetary policies (go), well, again, “Let’s be very careful because the central bank can be used by governments to print money and then you have inflation and this will have terrible impacts on society. So, let’s put the central bank outside of the reach of the politicians and let’s call that autonomy for the central bank, blah, blah, blah.”

That would be, say, a theoretical approach to macroeconomics. That’s a neoliberal approach, basically, because it’s based on the idea that you do have a theory of the Invisible Hand that shows that it works beautifully.

Macroeconomics and climate change

A different approach to macroeconomics would be, number one, “We don’t have that theory of the Invisible Hand. And even if we did, we know by social experience, by historical experience, that macroeconomic relations (can) lead to very serious problems. We know that in our world today -- of inequality, of international imbalances, of crisis of all types. And therefore, we need a different kind of macroeconomic package.

You have two competing paradigms, and you can throw in the environment also. We need to do that. The whole idea of that book is, “Hey guys, everybody talks about the environment but normally you don’t see people discussing the environment, things like climate change, and macroeconomic relations. The global economy, how is it working? How are these economies operating? Do interest rates and exchange rates and monetary aggregates have anything to do with emissions of greenhouse gases?”

Of course, they have a lot of things to do with that. Just think of investment – replacing old technologies with new ones. You are talking about investment. Immediately you are talking macroeconomics. Immediately. And, therefore, you are talking about monetary relations, interest rates, exchange rates.

The division of work that humans have found today to talk about the environment is really inadequate. Totally inadequate, to put it mildly, because if I look at the global discussions of climate change they are totally unrelated, divorced, separated completely from any discussion about the global economy. That doesn’t make any sense. When I look at the reports of the Intergovernmental Panel on Climate Change, the IPCC, there’s absolutely no mention whatsoever of these very fundamental issues and macroeconomics.

For example, the global economy has been growing at lower rates for the last three decades. The rate of growth of the global economy has been going down. The average global growth rates for the world between 1945 and 1975 were something like 4.8 percent per year. If you look at the period 1975 to 2000, that rate of growth was cut like 40%. The average global rate was something like 2.8 percent, a maximum of 3%. It has been going down.

Is that good or bad for emissions of CO2? Is that good or bad for deforestation? Is that good or bad for the environment? How did that play out? Well, the environment has continued to be degraded at alarming rates even though growth has been slowing down. Of course, you have a large global economy today, more population than before, but you need to rethink the relation between growth rates and environmental degradation in a different manner. What are the drivers of this degradation if growth is going down? What is happening?

Competing paradigms

If you look at these two competing paradigms of macroeconomics you have to compare them, and not with the Invisible Hand myth or with microeconomic theory. Leave that aside. Just look at the empirical reality that we encounter today. If you look, the first thing that will hit you in the face will be the global financial crisis, the Great Financial Crisis. The GFC – it is becoming an acronym that I encounter more and more.

The crisis in 2008 is something that explodes in your face when you are doing macroeconomics. And, basically, because the models that we used in macroeconomic theory up to 2007 had no room for crisis. Those models were models for a good weather day. “If you are sailor, you have a model that says how to sail in calm seas with bright skies. Everything is fine.” And then all of a sudden you find yourself in a storm. “Oh, my model didn’t mention anything about storms and there are thirty-foot waves. I’ve never encountered these things.” That’s macroeconomics up to 2007. It’s an ideological paradigm saying that everything is fine.

In fact, the way macroeconomics can be described up to that date is the following. “The markets work fine, that’s a key assumption - - the competitive forces lead to equilibrium.” But, number two, “There are all sorts of interventions, frictions, rigidities. Governments make mistakes. Politicians are corrupt and they spend more money because they want to tend to their bases. There is greed. Unions, unions, my God, they impede wages from going down. That is a rigidity in the labor market and then the labor market doesn’t function smoothly. Our macroeconomic model assumed markets work fine, except for the fact that there are rigidities. We then have to look at these rigidities carefully and as much as possible get rid of them.”

That’s the neoliberal policy package.

Economic relations with other economies

In Motion Magazine: What is the Open Economy Model?

Alejandro Nadal: The open economy model is a different notion. It’s the same as what I’m saying, the only thing is that also you have an external sector. You have economic relations with other economies.

What I’m saying is, number one, look at macroeconomics, per se. It’s looking at the economy as a whole and you have these competing paradigms. And in addition, you can make things a little bit more complex and say, not only is there the economy as a whole, a self-contained thing, but this economy as a whole has relations with other economies through trade, through capital flows, investment, whatever. And these relations need to be taken into account because there are things like a balance of payments, which is the account of your external relations. And there is something called the exchange rate which is the relation between your currency and the currencies of other countries and it has a lot of impact on your activities.

Macroeconomics can become more complex when you deal with these international relations. “So, we need an open economy.” (But) it’s not a specific model. All macroeconomic models normally will make two distinctions. Is your economy big or small? Are you China or the U.S.? Or, are you Malaysia or Mexico? -- because it makes a lot of difference. When you are dealing with a Chinese economy you know that the activities of the Chinese economy will impact international prices. For example, the price of oil – if China contracts you have a problem, the price of oil will go down worldwide. The size of your economy matters. That’s the first distinction when you are dealing with macroeconomic systems: are you a large or small economy?

The second distinction is, are you talking about the economy as a self-contained, enclosed system or are you also taking into consideration international economic relations: trade and financial relations with other economies? First, we analyze the economy as a closed economy to get a grasp of ideas, but then we need to have a more realistic model that has economic relations with other economies. And we call that the Open Economy Model.

The two distinctions are: are you a small or big economy; and the second, are you a closed or open economy. But you are dealing with macroeconomics as a whole.

Then you choose your paradigm. Does your paradigm say that markets work beautifully and therefore we need to look at why is it that they are not working in a particular case? (Or, do) you have another paradigm saying, “I don’t think it’s the rigidities by themselves. I think you have some other very serious problems.”

Essentially, Keynes says, “Even if you have perfect price flexibility, … even if the Invisible Hand works, (and we) assume you have price flexibility, you have no unions, no fiscal distortions, you don’t have any central banking printing too much money, even if everything is fine from the perspective of some rationality in economics -- the capitalist economy will run into problems.

Even if you have flexible prices in all markets, the capitalist economy will run into problems.” That’s Keynes.

1.7: Understanding the Key Role of Aggregate Demand

The two components of aggregate demand

In Motion Magazine: Are you referring to the three fundamental perceptions of his which you highlight in your book? 1) uncertainty in investment, 2) the key role of aggregate demand, and 3) the demand for money is determined by liquidity preference.

Alejandro Nadal: Exactly. You will have problems because aggregate demand may not be sufficient to ensure that you have full employment. Keynes says these things because he has this outlook: there was uncertainty; there was instability.

Aggregate demand has two components. One is consumption. One is investment. When you invest, you demand. When you set up a plant you need cement, you need steel, you need machinery. You will demand things from other industries. When you are a consumer, you go to the supermarket and you buy all sorts of things. That’s another source of demand. So, you have two sources of aggregate demand.

Consumption is very stable. Everybody needs to buy clothes and food, but it is insufficient for full employment. Why? Because you consume less than you get in your income. When your income grows, your consumption also grows but at a smaller rate. He called this the ‘Marginal Propensity to Consume is Less Than One.’ Meaning that for every new extra dollar that you get as an income, you will not spend the entire dollar. Well, maybe at the beginning you will respond with some consumption -- but next week you will not go and spend the entire new dollar on consumption. You will spend less, maybe 80 cents. And the other 20 cents you save. You save, you put aside.

That consumption is stable. Everybody needs to buy food and basic necessities, but it is not sufficient to maintain aggregate demand at the level required by the system to maintain full employment. If it were, it meant that all these industries would be tending to that aggregate demand coming from consumption and they would hire a lot of labor and they would lead us to full employment. But it’s not. You spend less than you get as an income.

The gap could be filled by investment because investment is the other source of aggregate demand. As I said, you buy cement, inputs, etc. (But) the problem with investments is that it could be sufficient to fill the gap (but) ... it depends on your – and this comes with another metaphor in economics – your ‘animal spirits’ -- it comes from your expectations.

You, as an entrepreneur, as an investor, you sit down and we would be sitting here, “What are the opportunities for investment, right now?” And I would say, “You know, Nic, today the outlook is not very good. All the industries that we have examined are not doing well. There is over-investment, all sorts of problems. So, let’s take the money and speculate on the foreign-exchange markets, or do something else with it. I don’t advise you to set up a plant right now for the production of glasses or cigarettes, or whatever, because things are not well in the economy.”

And that’s the outlook we have, of negative expectations, so we don’t invest. But tomorrow we wake up and we say, “Have you seen the news? Everything is doing fine. Let’s go for this plant on plastics. We’ll go into the field of plastics.” It depends on which way the wind is blowing, and your perception and your expectations, your animal spirits. Investments could be enough to fill the gap for aggregate demand to generate full employment, but it is unstable.

“The more people we hire the more wages are distributed in the economy”

So, you have two sources of aggregate demand. One is stable but insufficient. The other one could be sufficient but it’s unstable. Keynes, his response to that is, “OK, let’s fill the gap of aggregate demand. Let’s stabilize the economy by making sure that aggregate demand is always sufficient to generate full employment.”

And notice that when I say this, ‘aggregate demand is sufficient,’ I’m meaning that investors will look at aggregate demand and say, “Wow, this market is moving along fine. Let’s invest and therefore let’s hire people.” This is a virtuous circle because the more people we hire the more wages are distributed in the economy, the more purchasing power that you have in the economy, the more aggregate demand you have, the more investment … all the way to paradise. This is how he’s looking at things.

So yes, (there are) these two paradigms: – (with one) saying, “We have rigidities;” and Keynes saying, “Even if you get rid of all rigidities and you have fully flexible markets all across the entire economy, even then you may have a problem because aggregate demand may not be sufficient.”

And for people in 1936 to understand this ... it was a revolution.

A recipe for a crisis

... (But) it is not only insufficiency of aggregate demand. ... One problem is low wages. What should wages look like? In a truly Keynesian perspective, wages would have to be adequate, and he would be against the idea of depressing wages because you depress aggregate demand.

In a crisis, people don’t know what to do and would say, “As a capitalist, my problem is I encounter a demand, it is receding, it is not growing. What do I need to do? I need to lower my prices. How do I do that? Well, I need to cut costs of production. The very first cut I can make today is to lower wages. Or fire some workers. Or put them on a part-time basis. I need to lower my wage bill so that I can lower my prices so that I can maintain my profitability.

If I do that, I’m taking aggregate demand out of the equation. I am contributing to the entire reduction of aggregate demand.” But if every capitalist does that (‘I mean for me it’s fine, it makes a lot of sense’) – but for the entire capitalist class to do this, then you will depress aggregate demand and you will depress your source of profitability, and you will invest less. You invest less, you create less aggregate demand in the next round, and less investment, and so you have a recipe for a crisis. You have a vicious circle and instead of going to paradise you are going to hell. You are going downwards.

The key idea was Keynes saying, “Even if it works fine, you still have a macroeconomic problem due to the deficiency in aggregate demand.” If your economy is not growing, or it’s growing in a very erratic pattern, and then you lower wages, which is what happened in the United States (-- then you have a crisis).

Part 2: The Day That Capitalism Changed Forever

Download the entire interview PDF.

Published in In Motion Magazine December 3, 2018.

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