May 212008

By Aftab Ahmad Khan

Keynes (1883-1946), undoubtedly was the greatest economist of the 20th century. He was a many sided genius who aside from economics, distinguished himself in the fields of mathematics, philosophy and literature. During his lifetime he wrote ten books, and close to one hundred articles, reviews and pamphlets. He presented a profound challenge to economic thinking of his time and laid the foundations of modern macro-economics.

From his earliest days he was an involved citizen. It was this involvement in public affairs which led him to make recommendations for revising the treaties after World War I and for ending the worldwide depression of the 1930s. During World II he advised the British government on the financing of its war efforts. He also made path breaking recommendations for the re-building of the international financial structure after World War II. His strong advocacy of measures designed to improve national and international economic management increases his stature in the company of scientific immortals. The noble laureate Prof. Samuelson measures him against Newton and Darwin.

Keynes, through a radical reformer of the capitalist system, nevertheless remains loyal to it. In the words of Prof. John Kenneth Galbraith: “Keynes was exceedingly comfortable with the economic system he so brilliantly explored. He was not attracted by Marx.”

As World War II drew to a close, Keynes participated in discussions regarding the detailed design of the post 1945 international economy. He was convinced that in the absence of conscious international economic management, the world economy could not be stabilised. This belief is re-enforced in what came to be known as the Bretton Wood system. This is the corpus of conventions and rules implicit or explicit in the Articles of Agreement of the International Monetary Fund (IMF) which were agreed upon at Bretton Woods, New Hampshire (USA), in July, 1944. That conference came together to finalise the details and ratify the outline of an agreement hammered over the previous two years between the British and the Americans (who at that time dominated the economic thinking of the allies).

The Bretton Woods agreement is primarily to be attributed to the dominant role of Keynes and Harry D. White, who at that timer was Assistant Secretary of the United States Treasury.

Both Keynes and White drew up their own different plans for reconstructing international monetary system. Keynes’ proposals envisaged the establishment of an international clearing union, involving the creation of a new international reserve asset called “bancor”. Countries would have most of their international reserves, not in the forms of gold or foreign exchange, but rather in the form of “bancor” deposits with he new clearing union. The proposal of the US Treasury, the White Plan, was essentially that the existing system based on gold exchange standard be retained and re-enforced by the creation of a stabilisation fund that eventually emerged.

It is well known that when the initial views of Keynes and White were in conflict, White almost always won. There was, however, one significant exception. This concerned the extent to which the Fund was to be a passive observer of the policies of its member counties. The Keynes Plan which insisted on Fund passivity in the policies of the member countries was ultimately accepted.

But even in this context there is a qualification, for a similar argument concerned the extent to which member countries ought to be able to draw automatically on the resources of the Fund when they were in balance of payments deficit. The British held that such drawings should be automatically available within the agreed limits, whereas the Americans increasingly insisted that drawings should be conditional upon adoption of approved balance of payments adjustment policies. This argument about the appropriate extent of Fund “conditionally” which started as far back as 1944 continues down to the present days.

The British thought they had won that battle at Bretton Woods and, in fact, everybody else seems to have thought that the American side had agreed that drawings would be essentially automatic. But it turned out that the decision not to fight everyone else was tactical and US domination of the Fund’s executive board was subsequently used to insist on Fund conditionally. The Fund’s policies involving a high degree of conditionality, for anything other than minimal drawings was accepted and built into the operational procedures of the Fund in the 1950s. It was only one of several decisions on which Keynes was defeated. There were some other more significant ones also. Keynes had envisaged his international clearing union as settling bilateral balances between a series of central banks. He had assumed that the exchange market transactions would be channelled through central banks as under the war time British system. White, on the other hand, envisaged return to competitive foreign exchange markets as was eventually incorporated in the agreement.

A second instance is provided between Keynes’ suggestion of a clearing union that would have held the account of individual countries In the form of the new reserve asset “bancor” which would have been exchanged between member countries and simple maintenance of the gold exchange standard supplemented by a stabilisation fund. Keynes again lost out. The third instance involved the proposal embodied in Keynes’ system, that interest be charged on excessive capital balance of “bancor”. A country that ran too big and cumulative balance of payments surplus would run up its balances of the “bancor”, but instead of being rewarded for that by earning interest would have had to pay interest. That idea was denounced at that time as penalising what was thought to be (erroneously as subsequently history revealed) the permanent surplus country USA and it had to be withdrawn.

Finally, there was a big difference in regard to the size of the Fund. The original American proposal was for a fund of some $5.5 billion. This was eventually topped in the agreement to $8.8 billion. Keynes, on the other had proposed initial over draft rights aggregating to a total $26 billion. Twenty six billion dollars in 1944 amount to something around $1000 billion in today’s dollars. Hence, on all the basic issues about the new international monetary order, Keynes’ proposals were rejected. In spite of this Keynes fought passionately for its acceptance by the British government, in which he succeeded. He made an eloquent speech in the House of Lords in its support.

Keynes’ enthusiasm for the Bretton Woods was presumably due to the fact that notwithstanding its gaps and shortcomings, it gave each country the freedom to manage its own internal economy for securing high employment and in the case of a large external account imbalance it permitted a nation to change its exchange rate. In the inter-war period Keynes had often urged managed exchange rate rather than a free floating or a rigidly fixed exchange rate in terms of the gold standard. Keynes had fought against Britain’s decision to re-peg gold in 1925, looking instead to exchange management as something that would give a country a degree of policy freedom to combine internal and external balance.

Keynes’ support for the Bretton Woods despite its inadequacies could be explained due to his passionate belief in the need for an international economic order of some form. In particular, he felt there was a need to have US participation and indeed leadership. He accordingly decided to accept defeat on particular issues for the sake of furthering cooperation.

Aside from the IMF, Keynes also considered the establishment of the World Bank as vital to the development of a vital to the development of a lively international economy. This institution was designed to provide capital resources for reconstruction of war ravaged economies as well as for meeting the development needs of under-developed countries. It soon became apparent, however, that the World Bank was insufficiently funded. The bank, however, proved to be a dynamic organisation with a distinct institutional style and spirit unmatched by any other international or bilateral development assistance organisation. In the course of its evolution, the bank has considerably broadened the scope of its lending and has assumed the role of principal spokesman to rich countries for the needs of the less developed world for external assistance. The new developments in Bank’s policies have been accompanied by a continuing change in the conception of bank management concerning the nature of development requirements and what the bank can do about them.

Keynes in his design of post-war monetary and financial system was not concerned with the subsequent demands of Third World countries for a new international economic order with a built-in mechanism for some measure of international re-distribution of income to benefit the poor countries. This was not the issue in his day, though it could be argued that it is a natural extension of his thought.

Source: The News, 19/5/2008

 Posted by at 10:46 pm

Leave a Reply

en English
%d bloggers like this: