It is now 70 years since Michal Kalecki wrote the seminal “Political Aspects of Full Employment”. It is quite simply the clearest and most insightful essay I have ever read. Even if you don’t read anything else about economics or politics or the human condition, read it! And it is short. Now that is out of the way, this post is going to be an attack on the main thesis of that essay.

Michal Kalecki’s aspiration was for the economy to provide well for us all with  minimal imposition on anyone. That aspiration is shared by pretty much everyone despite extremely diverse political persuasions and equally diverse conceptions of how to achieve it. There is no longer much debate that Michal Kalecki was misguided in his “plan A” as to how to achieve it. He favoured a socialist command economy and  “Political Aspects of Full Employment” is merely his “plan B” capitalist alternative. Long after writing “Political Aspects of Full Employment” Michal Kalecki actually moved back to Poland to participate in being a socialist central planner. He resigned in frustration with the realities of socialism – enough said.

Michal Kalecki’s “Political Aspects of Full Employment” instead is all about how a capitalist economy apparently could in principle always be administered such that there was never any unemployment much as there was no unemployment in WWII Britain when and where the essay was written. He describes how in order to fight WWII an immense increase in production was mobilised using government deficit spending without any difficulty whatsoever in funding it all. Where the essay gets really interesting is where he unpicks why such a system is generally only politically acceptable during times of war or under a Fascist regime (he noted that the Nazis had full employment policies as soon as they took power). He saw Fascism as something to be avoided by peaceful democratic countries beating them at their own game and extending war time deficit spending policies into peacetime. He also made astonishingly prophetic warnings about the troubles that might result. He predicted the industrial unrest of the 1970s, the subsequent moderation of full employment policies and the secular decline in interest rates of the “great moderation”. In my opinion however Michal Kalecki failed to spot a crucial flaw in the system and that glitch is increasingly smothering our economy now.

Michal Kalecki wrote:

If full employment is maintained by government spending financed by borrowing, the national debt will continuously increase.  This need not, however, involve any disturbances in output and employment, if interest on the debt is financed by an annual capital tax.  The current income, after payment of capital tax, of some capitalists will be lower and of some higher than if the national debt had not increased, but their aggregate income will remain unaltered and their aggregate consumption will not be likely to change significantly.  Further, the inducement to invest in fixed capital is not affected by a capital tax because it is paid on any type of wealth.  Whether an amount is held in cash or government securities or invested in building a factory, the same capital tax is paid on it and thus the comparative advantage is unchanged.  And if investment is financed by loans it is clearly not affected by a capital tax because if does not mean an increase in wealth of the investing entrepreneur.  Thus neither capitalist consumption nor investment is affected by the rise in the national debt if interest on it is financed by an annual capital tax.”

Note that Michal Kalecki is not saying that government spending needs to be matched by taxation. He is saying that merely the interest due on the debt needs to be. Clearly he believed that although an asset tax sufficient to pay the interest would not impede the economy (for the reasons he gives), an asset tax sufficient to balance the budget would or else would be politically unacceptable. Presumably he envisioned that endless increases in the productivity of the economy would allow the interest payments for the ever larger debt to stay as a proportionately modest burden and so require an equally proportionately modest asset tax. The only change over time would be the stock of government debt securities held by investors.

My argument is that that stock of government debt securities causes behavioural changes that derail the system. They are risk free financial assets (1). They enable people to save for the future and be certain of being able to draw down the full nominal amount irrespective of how the economy has performed in the interim. If it were not for such risk free financial assets, the only way to provide for the future financially would be to provide for it in terms of maintaining enough productive capacity to meet that future claim. As such, risk free financial assets disconnect finance from reality. Owners of the risk free financial assets become a constituency who own wealth that as it increases does nothing to increase or even maintain real world capacity to honour that financial claim. So long as the government exists*, the debt will be paid even if the economy is mired in depression.

Currently government securities are issued both as conventional bonds and as inflation protected index linked bonds and of course as cash. Such assets are most valuable when assets that depend on a productive economy are doing worst. In the case of long dated bonds, such as the 50year gilts and 50year index linked gilts we have in the UK, even the prospect of the economy taking a nose dive causes a surge in their market value. In a deflationary depression 50year conventional gilts will make you a fortune whilst a stagflationary depression will do the same for holders of 50year index linked gilts. Both asset classes plummet in price whenever an economic recovery seems likely. I’m not claiming that some cabal of evil geniuses is conspiring to derail the economy on purpose in order to enrich themselves. I’m simply saying that people with power and influence have a safety net that detaches their financial interests from the real economy. If it were not for risk free financial assets then everyone would be painfully aware that in order to preserve any of their wealth the economy would need to be productive. As it stands many people are frankly complacent. They have the view that we ought to ensure an economic recovery so long as doing so doesn’t risk impairing their personal fortune. It is a distant abstract “wouldn’t it be nice” hope rather than a desperate imperative.  The consequent fall in economic output causes shortages that are suffered by those without the risk free financial assets. In many cases the political force comes from people who do not follow bond prices directly and don’t give the matter much detailed thought; they simply are reassured by professional asset managers that their pensions and savings are well taken care of. They probably genuinely believe that the problem is the fault of those who are suffering its consequences.

Ironically it is those who own the most extensive personal safety net of risk free financial assets who are now behind the political force to ensure that further deficits are brought to a halt even though such expansion is our current way of holding off economic depression. That is an inbuilt characteristic of the system. In my view that is the design flaw that has led us to where we are now. The hope that government debt would not increase relative to economic output has been undone by the behavioural changes induced by holding that debt. The only solution that I can see is to adopt an economic policy that eliminates involuntary unemployment and yet does not increase the stock of risk free financial assets and so does not build up a constituency that is opposed to full employment.

As Michal Kalecki described, replacing all other taxes with a generalised asset tax frees economic activity from taxation. He clearly expounded that such a tax could meet interest repayment obligations however large without impeding the economy. Perhaps we need to face up to the thorny possibility of using such a tax to balance the budget over the business cycle. I’ve explored such a tax system in more detail in

1, This discussion only applies to countries with monetary sovereignty (such as the USA, UK, Japan, Brazil, Canada, Australia, etc). Countries that are in the Eurozone do not have monetary sovereignty. Of course many citizens of Eurozone countries own the government securities of foreign countries that do have monetary sovereignty and so hold a safety net in that way. That is partly why the prices of US treasury bonds increase so much whenever the Euro crisis takes a turn for the worse. See page 14 of this pdf for a discussion of the Euro and monetary sovereignty.

* Of course continued existence of the state is a prerequisite for risk free financial assets to maintain their value. The Nazi government securities were all voided after WWII. Holders of government securities are a constituency that has an interest in maintaining the government and perhaps that is a motivation behind surplus countries such as Singapore issuing government debt securities.

Related material on the web:      Depression is a choice – Interfluidity     Michal Kalecki on the Great Moderation -Interfluidity       Bill Mitchell on Michal Kalecki The Political Aspects of Full Employment     Michal Kalecki wiki page

Crises of Capitalism and Social Democracy John Bellamy Foster Interviewed by Bill Blackwater (I added this link on 29May2013)

Phony Fear Factor – Paul Krugman (added 12Aug2013)

Peter Cooper on Kalecki’s Political Aspects of Full Employment (added 20Aug2013)

 MMT stabilization policy – some comments & critiques -Interfluidity (link added 24Nov2013)