INTERNATIONAL POLITICAL ECONOMY

Keynesian Economics in
Developed Countries 1945-1975
Great Depression 1929
• Great Depression hit developed countries in 1929
– Started in the US, and then it spread to other countries

• It started as a Stock Market Crash at NYSE (Wall Street)

– Stock values were highly overvalued at that time

• It was then compounded by many other factors

– Generalized industrial overproduction
– Impact of deflation on domestic debts
– International debts pending from WWI
– Erroneous Fiscal/Monetary policy mix in the US and other countries
– Lack of firewalls in the financial system to avoid spreading bank runs
– Major drought in Great Plain agricultural states (“Dust bowl”)
– Increasing trade barriers, import duties, and currency devaluations across the countries in a futile
attempt to promote local industries (“Beggar thy neighbor”)
Keynes: analysis
• John Maynard Keynes (1883-1946)
“The General Theory of Employment,
Interest and Money” (1936)

• He noticed that the high level of unemployment in the Great Depression

was not explained by Classical Economics
– Classical Economics state that unemployment cannot exist for long in an unregulated
labor market, as salaries would simply go down till hiring starts again
– But during the Great Depression, even if salaries were going down and manufacturing
capacity was abundant, unemployment continued
• He concluded that the problem was in the lack of Aggregate Demand
– If private consumption is very low, there is not enough Demand to restart the economy
– As there is a lot of idle labor and idle manufacturing capacity, if Demand starts again, it
will create its own Supply
Keynes: proposal
• Thesis: Government must heavily intervene in the economy and increase
public spending (Fiscal Policy) in order to increase Aggregate Demand
– In addition, money supply must increased aligned with the corresponding increase in
Aggregate Demand (Monetary Policy). This was not so clearly understood at that time
– Fiscal/Monetary Policy Mix is explained in the IS-LM Model
• Multiplier Effect: as public spending reaches workers via salaries, they
spend these new salaries and increase again Aggregate Demand
– This will help to moderate the issue of increasing public deficits
• Once the economy is running again, governments should cut spending and
increase selectively taxes in order to rebalance the budgets, but always
ensuring a Welfare State and some levels of wealth redistribution
– Taxes should be progressive (rich must pay higher % than poor)
Bretton Woods
• International conference in Bretton Woods, NH (1944)
– Keynes chaired the British delegation
• Purpose is to create an international economic system that:
– Follows a clear set of Rules and Regulations
– Allows for some level of Policy Independence
• Countries can impose Capital Controls and adjust their Exchange Rates
– Avoids volatility of Exchange Rates
• US Dollar becomes the official Global Reserve Currency
– USD can be exchanged to gold at 35 usd/ounce
– A system of Fixed (but Adjustable) Exchange Rates was set up for all other countries
• Three major institutions are created:
– IMF oversees the Exchange Rate system and provides helps if balance of payments issues
arise
– World Bank (IBRD) finances reconstruction projects of war torn countries
– World Trade Organization (at that time known as GATT) applies the rules for Global Trade
that will prevent “Beggar Thy Neighbor” policies
Marshall Plan
• Marshall Plan (officially the European Recovery Program, ERP) is an
American initiative passed in 1948 for foreign aid to Western Europe
• Volume was over $12 billion (equivalent to over $128 billion as of 2020)
• Goals of the plan
– Support the recovery of war-torn Europe
– Strengthen trade partners for the future
– Stop the spreading of Communism in Europe (Cold War approach)
• There is an open debate about its impact
– Direct economic impact was not so high (about 0,5% GDP increase in affected
countries)
– But its political impact was huge, as it expanded the political, economic, and
soft power of the US in Western Europe
– It opened the door for European integration (future European Union)
– It led to the creation of the OECD (1961), a organization to coordinate
economic policy across the West
Les Trente Glorieuses
• The application of Keynesian theories and the Bretton Woods system
during the period 1945-1975 led to the highest level of social and
economic development in history for western countries
– Creation of Welfare State
– Major wealth redistribution
– Major advancement of Middle Class
– Major improvements in Health and Education
• But at the beginning of 1970s, Keynesian system was in crisis
– Limitations of Keynesian economics
• Government expansion in the economy had created inefficiency and high levels of
bureaucracy
• The 1973 Oil Crisis created Stagflation (unemployment plus inflation), which cannot
be explained by Keynesian economics
– Limitations of the Bretton Woods system
• Recovery of West European countries challenged the central role of US dollar in the
economy, and created pressure for multiple adjustments of the exchange rates
• US dollar overflow in the 1970s (due to Vietnam War) created inflation in the US,
that was exported to the rest of the world as well due to the system of Fixed
Exchange Rates
• This led to a drop of confidence in the US dollar and a major demand for exchange
Bibliography
• Books
– Thomas Oatley “International Political Economy” 6th edition, Univ. of North Carolina Chapel Hill

• Articles
https://en.wikipedia.org/wiki/Keynesian_economics

• Videos
https://www.youtube.com/watch?v=62DxELjuRec Great Depression (5 min)
https://www.youtube.com/watch?v=qtAeINU3FKM&t=2s Keynes (11 min)
https://www.youtube.com/watch?v=cYNVB5iqydk Keynesian economics (8 min)
https://www.youtube.com/watch?v=-6bVeDab6UA Bretton Woods (2 min)
https://www.youtube.com/watch?v=wuOOK7aU1TY Bretton Woods (8 min)
https://www.youtube.com/watch?v=yQJOWRYeKlQ Marshall Plan (1 min)