------------ EH.NET BOOK REVIEW --------------
Published by EH.NET (December 2006)
James C. W. Ahiakpor, _Classical Macroeconomics: Some Modern
Variations and Distortions_. New York: Routledge, 2003. xvii + 256
pp. $120 (cloth), ISBN: 0-415-15332-8.
Reviewed for EH.NET by Marin Muzhani, Department of Economics,
University of Florence, Italy.
James Ahiakpor has written a fascinating book which readers will find
difficult to put down. Students of macroeconomics should not deprive
themselves of the opportunity to study this rich volume on classical
macroeconomics.
The broad range of the book presents difficulties to the reviewer
since it is difficult to cover it adequately in a few pages. Ahiakpor
may have had this difficulty, too, since his treatment is sometimes
(but not often) cursory, wordy and not very helpful. I have chosen a
few topics to show both the range of the book and the shortcomings of
the treatment.
About half the chapters were published in journals from the mid-1980s
and to the late 1990s. The preface describes the difficulties
encountered from referees when Ahiakpor submitted papers on Keynes's
misinterpretation of "capital" in the classical theory of interest.
Indeed, his goal is to explain the confusions and misinterpretations
of classical macroeconomics - especially the theory of capital and
interest --contained in textbooks covering the works of B�hm-Bawerk,
Fisher, Wicksell and Hayek.
The second chapter looks directly at the theory of value, which is
one of the foundations of macroeconomic analysis. This chapter
restates the theory of value in Smith, Ricardo, Malthus and Mill and
interprets it in a straightforward way without variations and
distortions. The main point is that the classical theory of exchange
value is not about the utilities of commodities but the ratio in
which different units of goods are exchanged for one another.
Ahiakpor emphasizes that the misinterpretation of the classical
theory of value by Austrians, Marxists and other economists
influenced several writers including Alfred Marshall. Later this
theory was distorted by Paul Douglas (1928) and Emil Kauder (1953)
who influenced other modern writers, and attempts to restate it have
not been wholly successful. The correct interpretation of the
classical theory of value is based on the cost of production measured
in terms of the quantity of labor. The concept of utility is
essential but should not be considered as a measure of exchangeable
value. Valuable quotations from classical works are given to support
this argument.
A rich but pithy chapter three tackles the difficult task of
establishing the definition of money. The classical economists
defined money as a particular commodity (such as gold and silver)
used to measure the value of other commodities and which, most
important, serves as a medium of exchange. They held a clear
distinction between money credit and capital. Ahiakpor emphasizes the
idea that a correct understanding of classical theories requires a
very careful distinction of money from credit, and credit from
"capital" and capital goods. Capital is supposed to arise from
savings or loans. According to the author, the classical distinction
between money and savings or "capital" is more helpful than the
modern definition of money. A high-powered currency in the classical
definition is supposed to explain better the changes in the price
level or the value of money from the supply and demand for money. The
latter determines the rate of interest. This statement is completely
different from Keynes's argument that the quantity of money
determines the supply of liquid resources and therefore the rate of
interest. In fact, during the Great Depression it was the change in
high-powered currency or in the quantity of money that caused the
fall in savings as the public increased its demand for cash balances.
Because of this, the increase in the reserve-deposit ratio of banks,
the money supply multiplier was reduced and the currency stock
declined rapidly. So the classical savings theory of growth confirms
that the significant decline in GDP during the Great Depression came
as a result of considerable contraction in savings.
In chapter four reexamines of the classical theory of interest, the
price level, and inflation. In the classics the theory of the price
level is almost a direct application of the theory of value. The
price level is determined by the supply and demand for money. In the
same way interest is established as by the supply and demand for
capital. It is the borrowed "capital" that is offered and taken in
loan on the basis of the borrower's ability to pay back the credit.
In this context interest is described as the cost of credit. Thus the
classical theory of interest is more logical on the meaning of
"capital." Robertson and Friedman are the two modern economists that,
remarkably, have included the classical credit theory or the
loanable-funds theory in their works. In effect, "the classical
version is superior because it avoids the confusion between money and
credit which Friedman correctly notes as plaguing the Keynesian
monetary or liquidity preference theory of interest" (p. 77). Hence
the application of the classical theory of value to "capital" better
explains the determination of interest rates than the traditional
Keynesian money supply and demand theory of interest. Keynes
misinterpreted the classical theory of interest. He incorrectly
included hoarding in the classical definition of saving and his
contemporaries were not able to persuade him of his erroneous
criticism of the classical theory of capital.
Chapters six, seven and eight deal with the Austrian theory of
capital and interest, Wicksell's monetary theory and Fisher's
macroeconomic analysis. The Austrian school and predominantly Eugen
B�hm-Bawerk interpreted capital-goods as "capital" only in the
classical theory of interest and proceeded incorrectly to criticize
it. B�hm-Bawerk introduced the theory of time-preference in place of
the classical theory of capital. He observed that interest is a
premium borrowers are willing to pay for their impatience for present
consumption. The production process is affected by variations in the
rate of interest and more roundabout methods are adopted when the
rate of interest falls.
Wicksell reacted to the classical theory of interest. He believed
that observed high interest rates with high rate of inflation and low
interest rates with low rates of inflation contradict the classical
theory of interest. He developed the "cumulative process" by which
deviations between the market and "natural" rates of interest cause
the price level to change continually. According to chapter seven,
Wicksell repeated almost the same theory of price dynamics as in
classics, except that in his model the process starts from banks
lowering their rates of interest without any new injection of money.
Irving Fisher rejected the classical "capital" supply and demand
theory of interest and adopted the Austrian time-preference theory.
In conflict with his time-preference theory of interest, Fisher
defined "capital" as an asset that yields a flow of income over time,
which is quite different from the classical flow-of-funds concept.
Fisher associated the "stock of goods" with a fixed quantity existing
at an instant of time and "capital" as capital goods only. His
principal differences with classical monetary analysis include the
notion of circulating currency to include money and bank deposits.
But the inclusion of bank deposits in his analysis is inconsistent
with the process of inflation.
Chapter ten is all about Kyenes's full-employment argument. Keynes
attributed erroneously to the classics the forced-saving doctrine
where increases in the money supply may boost real output and
employment in the short run while lowering the rate of interest and
raising the price level. Keynes's misinterpretation of the classics
was based on his presumption that Say's Law of Markets must be
founded on the assumption of full employment. He criticized the
classics for not recognizing the existence of hoarding while arguing
the Law of Markets. His contemporaries including Pigou and Robertson,
despite their attempts to correct his assumptions, did not give a
clear interpretation of Keynes's inaccuracy. "Rather, they attempted
to sketch their own versions of classical economics, much to their
disadvantage" (p. 175). Although some may agree with this statement,
I must disagree. Rather than sketching their versions of classical
economics, they developed new assumptions in the classical tradition
regarding full employment -- about which the classics were not
comprehensible at all.
Chapter eleven explains the success of the IS-LM model created by
Hicks in spreading Keynesian macroeconomics and at the same time
Keynes's distortion of classical macroeconomics. The IS-LM model
based on changes in the supply and demand for money to explain
interest rates does not take into consideration the determination of
the price level from supply and demand for money as in the classical
quantity theory. This model implies that the price level rises from
increases in the quantity of money only after an economy has reached
its full productivity capacity or full employment reaching the
position of equilibrium (for a static state). However a real monetary
economy is much more complex than the IS-LM model represents. The
IS-LM model is inconsistent with economies experiencing high rates of
unemployment, high rates of inflation and continuous economic
fluctuations and hardly can be applied in modern realities. Despite
distortions and variations claimed by the author, the IS-LM model
still remains the basis for every undergraduate textbook in
macroeconomics. It is the first and the most simple, well-known
macroeconomic model combining real and monetary factors, making it
easy for anyone with some basic notions in economics to understand
the dimensions and the complexity of a national economy. This model
merely shows the daily macroeconomic problems but certainly does not
resolve them.
The mythology of Keynesian multiplier is developed in chapter twelve.
The concept of the multiplier is based on consumption spending and on
incomes that derive from expenditure. People normally consume a
portion of their income and such purchases for consumption are
incomes for producers who in turn make investments. The consumption
spending is a means by which aggregate demand is raised and the
growth of output and employment is promoted. Saving in Keynes's view,
as opposed to the classics, has no special effect on supplying the
funds for investment. Ahiakpor states that the Keynesian multiplier
is nothing more than a misinterpretation of the classical definition
of saving to include the hoarding cash. It is founded on a
misconception of the role of consumption rather than production in
the income determination process. The question raised in the
Keynesian multiplier is: "From where do people find the means to make
their consumption purchases?" Keynes rejected the classical concept
that production is the source of income and, therefore, comes from
savings supply. Increased output in one sector, by increasing the
demand for the output in other sectors causes an increase in their
production also. This process is described as a "multiplier effect"
(quite different from the Keynesian multiplier) and is supposed to
affect major sectors of an economy. Ahiakpor argues that: "Keynes's
argument that saving is not needed to finance investment spending
because the multiplier process makes it possible for investments to
pay themselves through additional savings out of newly created income
may have given confidence to supporters of public works program, but
it is simply fallacious" (p. 209).
The Keynesian revolution (or the Keynesian event) can be summarized
in a few words. The Keynesian theoretical event can be expressed in
terms of the combination of his multiplier theory with his liquidity
preference theory. For many governments it is a primary duty to
control the level of total effective demand for goods and services.
If demand is insufficient to provide full employment, it is
government's duty to raise it by stimulating the injections
(investment, and government expenditure) and by reducing the
proportions of income saved (or paid in taxes). If demand is
excessive, then it is the government's duty to restrain the
injections. This general task of controlling the level of total
effective demand throughout the economy was not recognized to be a
duty of government before the Second World War (and especially during
the nineteenth century); it has at least been generally so recognized
since the war.
This duty, unfortunately, was not a major concern for classics.
Despite their efforts, the classics were not able to set up a
consistent macroeconomic model in which the economic system adjusted
itself to full employment. The legacy of Keynes can be recapitulated
in Pigou's remarks: " Nobody before him, so far as I know, had
brought all the relevant factors, real and monetary at once, together
in a single formal scheme, through which their interplay could be
coherently investigated" (p. 175).
As Ahiakpor suggests, it is true that by a very "careful reading" we
may find more consistency in the classics than is generally believed,
but it is also true that by using the same method of study we may
find a lot of anomalies and contradictions which enable us to
appreciate the classical explanation today.
The greatest value of the book is to professional economists, chiefly
because of some of the penetrating suggestions, and its coverage of
an immense range of subjects bearing on development.
The inherent importance of the principal theme, the forceful
reasoning with which it is developed, the excellent style and the
wealth of topics covered will ensure that this book will be read by
all seriously interested in the subject.
Marin Muzhani is Associate Researcher in Economics at the University
of Florence, Italy. His book _From the Path of "Warranted Growth" to
Technological Progress and Endogenous Growth: The Evolution of the
Theory of Growth in the Post-war Period, Six Decades of Controversies
in the Theory of Economic Growth_ will be published soon in English.
Other papers and publications are related to modern monetary theories
such as optimum currency areas, endogenous money and monetary unions.
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