Lerner was born
in Bessarabia, Russia on 28 October 1903. After immigrating to England in 1906,
Lerner earned a B.Sc., Economics, 1932 and Ph.D., Economics, 1943, both from the
London School of Economics (LSE), and eventually received an honorary doctorate
from Northwestern University in 1973. He was the recipient of a number of
awards, fellowships, and prizes at LSE, including the Director’s First Year
Essay Prize (1930); Tooke Scholarship (1930); Hugh Lewis Essay Prize (1932,
bracketed); both the Gonner and Gladstone Memorial Prizes for first place in
B.Sc. in Economics (1932); LSE Research Fellowship (1932-4); and the Leon
Fellowship of the University of London (1934-35). Lerner also began his academic
career as an Assistant Lecturer at LSE (1935-37), and was a founding co-editor
of the Review of Economic Studies from 1933-7. In 1937, Lerner emigrated
to the United States, becoming a naturalized citizen in 1949, and, except for
later visiting positions in teaching, research, and policy in Europe and Israel,
remained there until his death in Tallahassee, Florida 27 October 1982.
Lerner had a
Rockefeller Fellowship in the U.S. (1938-9), and began his academic career there
as a visiting professor at the University of California—Berkeley (Spring 1938)
and a Lecturer in Economics at Columbia University (Fall 1939-40). He then held
positions at the University of [Missouri] Kansas City (Assistant Professor,
1940-2); New School for Social Research (Associate Professor, 1942-6;
Professor, 1946-7); Roosevelt University (Professor, 1947-9); Michigan State
(Professor, 1959-65); University of California—Berkeley (Professor, 1965-71);
Queen’s College, City University of New York (Distinguished Professor, 1971-8);
and Florida State University (Professor, 1978-82). Lerner held visiting
positions at the University of Virginia (Spring 1940); Amherst College (Fall
1942-3); Roosevelt College (Spring, Summer 1947); New School (Summer 1948,
1950); Hebrew University (1954-6); Columbia University (Spring, Summer 1957);
Johns Hopkins (1957-8); Berkeley (1958-9; Summer 1960, 1962, 1973); Michigan
State (Summer 1958, 1959); University of Hawaii (summer 1965); University of Tel
Aviv (1965-6); and Florida State University (Winter and Spring 1976, 1977).
Lerner was also
active in consulting and policy-making positions, public and private. He was a
consultant to the Rand Corporation (Summer 1949), the Economics Commission for
Europe (Geneva, Fall 1950-1), and the Institute for Mediterranean Affairs
(1958-9), served on the Economic Advisory Staff in Israel (1953-5), and was an
advisor to The Israeli Treasury and the Bank of Israel (1955-6).
Among his
numerous professional honors and distinctions, Lerner was named a Fellow of the
Econometric Society in 1950, the Center for Advanced Study in the Behavioral
Sciences, Stanford, in 1960-1, and the American Academy of Arts and Sciences in
1971. He was named a Distinguished Fellow of the American Economic Association
(AEA) in 1966 and an Honorary Fellow of LSE in 1970. Lerner also served as Vice
President of the AEA (1963), Regent Lecturer at the University of
California—Santa Barbara (1964); President of the University Centers for
National Alternatives (1973); President of the Atlantic Economic Society
(1979-80), and President of the Western Economic Association (1983; deceased:
James Buchanan, Acting President). Lerner was also named a Member of the
National Academy of Sciences in 1974.
Keynes, in a
letter written at sea on a voyage to the United States during which he read
Lerner’s The Economics of Control (1944) wrote to Lerner that he had
‘written two books largely distinct…which you have placed within one cover’
(Colander and Landreth, 1996, p. 116). This accurately describes not only the
book, but Lerner’s fifty years of economic scholarship, which covers both
microeconomics and macroeconomics; neoclassical and Keynesian frameworks; theory
and policy; and a faith in markets and a commitment to democratic socialism.
Lerner’s early,
energetically prolific years at LSE were prior to his introduction to the ‘New
Economics’ (Keynes), though he had independently studied the works of some
Marxist and institutionalist economists, and so reflected both his studies with
Robbins, Hayek, J. R. Hicks and the other LSE faculty of the neoclassical
marginalist microeconomics and his dedication to a brand of market socialism he
would describe as ‘socialist free enterprise’. Using plain English and plane
geometry (Samuelson [1964, p. 170] would later refer to the Lerner of this
period as a ‘diagram man’ who wrote ‘ideal scientific prose’), Lerner clarified,
extended, elaborated, and graphically depicted a number of concepts and proofs
in Marshallian neoclassical theory and general equilibrium welfare economics.
Many of these demonstrations would eventually become the standard textbook
presentations of these concepts. His first publication, for example, written
after studying economics part-time for two years, ‘The Diagrammatical
Representation of Cost Conditions in International Trade’ (1932), was the first
paper to use community indifference curves to demonstrate the equilibrium in a
two-country model. This was followed by a number of papers that conducted
similar geometric exercises for other concepts, including, e.g., the demand-side
of trade theory, elasticity of demand, and elasticity of substitution (Lerner
1933a, 1933b, 1934a).
Two 1934 papers
in the Review of Economic Studies demonstrate Lerner’s transition from a
clarifier and disseminator of economic principles to sophisticated inaugurator
of new lines of research. ‘The Concept of Monopoly and the Measurement of
Monopoly Power’ (1934b) demonstrated why marginal-cost pricing is a necessary
and sufficient condition for ‘Pareto-optimality’ (allocative efficiency), the
meaning of the ‘social optimum’ (no one can be made better off without making
someone else worse off), and how perfect competition guarantees and monopoly
precludes its attainment. This was nothing less than ‘[t]he first clear,
rigorous and definitive statement of Pareto optimality’ (Scitovsky, 1984, 1551).
As Samuelson put it, ‘Today this may seem simple, but I can testify that no one
at Chicago or Harvard could tell me in 1935 exactly why P=MC [price = marginal
cost] was a good thing’ (Samuelson, 1964, p. 173).
The second
paper, ‘Economic Theory and Socialist Economy’ (1934c), was the initial
contribution of five important papers on the theory of market socialism written
by Lerner during his LSE years. Along with those of Fred M. Taylor and Oskar
Lange (Lerner’s fellow student at LSE), Lerner’s contributions dealt with a
myriad of analytical issues involved in identifying the behavioral rules for
attaining optimal resource allocation in a socialist economy. The ‘Lange-Lerner
Theorem’ became a cornerstone of one side of the famous ‘socialist calculation
debate’: in theory, a socialist economy could be at least as efficient as
a private enterprise economy, provided the state planners employ the price
system to realize allocative optimality as in a market economy (again, P = MC!);
in practice, since a free market system never achieves the social optimum due to
numerous market imperfections, a socialist economy in which prices are set as if
in perfect competition will be more efficient.
Two additional
papers from this period are worthy of note in that both remained unpublished
until much later and so were eventually recognized to have anticipated important
contributions by others. The first, ‘Factor Prices and International Trade’
(1952 [1933]), was nothing less than a demonstration of the ‘factor price
equalization theorem’, a proof that (under the usual assumptions) product
mobility was an adequate substitute for factor mobility in producing a tendency
for factor prices (and not only product prices) to become equalized between
countries engaged in free trade. When Samuelson (1948) published his proof of
the theorem, Robbins recalled Lerner’s presentation in a seminar fifteen years
earlier and it was published in Economica in 1952. The other,
‘Paleo-Austrian Capital Theory’ (1980 [1931-2]), utilizing three-dimensional
diagrams, demonstrated with two simple adjustments that Hayek’s concept of the
average period of production had the interest rate fully integrated in it,
protecting it from criticisms by Frank Knight and John Hicks and rendering
unnecessary the subsequent reformulation by Hicks. What is additionally
remarkable is that the original paper could not be found, but Lerner had ‘a
vivid memory of the diagram from which I found it easy to reconstruct the
content of the essay’—some 45 years later!
This work, all
produced prior to Lerner’s emigrating to the U.S. in 1937, established his
reputation as a brilliant economist and much of it would be modified and
extended in the first of the ‘two books…placed within one cover’, as Keynes
referred to it, of his magnum opus, The Economics of Control
(1944), which had also served as his doctoral dissertation. The ‘second book’
would cover macroeconomics and Keynesian theory, whereas the first was strictly
neoclassical microeconomics, but what the two shared is Lerner’s
imaginatively-precise analytical powers, his laser-sharp deductive ability to
push an argument to its furthest possible logical conclusion. Sometimes, when
these arguments had been begun by others, the originators were astonished to
find that their models led to conclusions they had never imagined (and sometimes
of which they disapproved!).
Lerner’s
receipt of the LSE’s Leon Post-Graduate Study Fellowship for 1934-5 funded his
visit to Cambridge University, initially planned for two months to ‘clear…up the
nonsense’ he had heard in some previous meetings with Joan Robinson, but which
turned into six months, ‘during which time they persuaded me they made sense’
(Colander and Landreth, 1996, p. 90). The ‘they’ refers to the ‘circus’ of
economists around the ‘Political Economy Club’ (or ‘Keynes Club’), including
John Maynard Keynes, Joan Robinson, Austin Robinson, Richard Kahn, and others
such as Lorie Tarshis and Robert Bryce. Lerner is thought to be ‘the first
economist outside of Keynes’s inner circle to grasp the nature and importance
of’ The General Theoryof Employment, Interest, and Money (Keynes,
1936). While this experience resulted in a shift in Lerner’s focus from
neoclassical microeconomics to Keynesian macroeconomics, he continued to apply a
similar approach and methodology as in his earlier contributions, both as a
clarifier and elaborator of concepts in straight-ahead scientific prose and an
originator of new ideas through taking arguments to their logical conclusion.
His first
contribution to this literature, ‘Mr. Keynes’ “General Theory of Employment,
Interest and Money”’ (1936), which Keynes himself read and approved, was a
‘clarified popularization for sophisticated but non-theoretically oriented
policy makers’, published in the International Labour Review (Sobel,
1983, pp. 8-9). In it Lerner demonstrated some of the simple but
counter-intuitive results of the Keynesian model, such as the paradox of thrift
(an attempt by an economy as a whole to increase its savings will cause
consumption, income, and employment to fall, with savings remaining equal to
investment). Lerner was an active participant in the flurry of articles
attacking and defending the General Theory especially on the topics
relating to savings and investment (e.g., Lerner, 1938).
Lerner’s move
to the United States in 1937 did not interrupt his work, and coincided with the
initial publication of the idea that would become his most enduring
contribution, Functional Finance. In an article entitled ‘The Economic Steering
Wheel’ (1941) published in the University [of Kansas City] Review
while Lerner was on the faculty of the University of Kansas City (now University
of Missouri—Kansas City), his first regular, full-time appointment in the U.S.,
he used the analogy of driving an automobile to defend the use of government
controls to ‘steer’ the economic system onto the right path. While respecting
market forces, Lerner likened laissez-faire to a refusal to take hold of
the ‘economic steering wheel’. The article was the first to lay out the
principles of Functional Finance, although he had not yet coined that term:
government should use its fiscal and monetary authority to maintain aggregate
effective demand at the full employment level, prevent inflation, and keep
interest rates at the level required for the optimal level of investment; if
these actions should conflict with the principles of ‘sound finance’ (i.e.,
result in budget deficits and increase the national debt, etc.), ‘so much the
worse for these principles. The government press shall print any money that may
be needed for carrying out these rules’ (1941, p. 5).
It was after
his move from Kansas City to the New School for Social Research that Lerner laid
out the principles of Functional Finance in detail, and by name, in ‘Functional
Finance and the Federal Debt’ (1943), probably Lerner’s most famous article,
originally published in the New School’s Graduate Faculty journal, Social
Research, but reprinted numerous times in a variety of collections over many
years.
Functional
Finance has been subject to a number of misconceptions, e.g., that it promotes
big deficits. Functional Finance simply refers to an approach to public finance
that sees the federal budget and the management of the national debt as means
to economic prosperity. This notion needn't assume any particular a priori
relation between government expenditures and revenues or a priori most
desirable absolute or relative size of the national debt:
The central idea is that government
fiscal policy, its spending and taxing, its borrowing and repayment of loans,
its issue of new money and its withdrawal of money, shall all be undertaken with
an eye only to the results of these actions on the economy and not to any
established traditional doctrine about what is sound and what is unsound. This
principle of judging only by effects has been applied in many other
fields of human activity, where it is known as the method of science opposed to
scholasticism. The principle of judging fiscal measures by the way they work or
function in the economy we may call Functional Finance... Government
should adjust its rates of expenditure and taxation such that total spending in
the economy is neither more nor less than that which is sufficient to purchase
the full employment level of output at current prices. If this means there is a
deficit, greater borrowing, “printing money”, etc., then these things in
themselves are neither good nor bad, they are simply the means to the desired
ends of full employment and price stability. (Lerner, 1943, p. 354, original
emphases)
Thus, Functional Finance does not say
anything about what the budget should be prior to economic analysis. If it is
concluded that under particular circumstances, a balanced budget describes the
best means to economic prosperity, then even a balanced budget is not
inconsistent with a functional approach to public finance. ‘Sound money’ is
therefore only inconsistent with Functional Finance if the balanced budget is
seen as an end in itself,rather than as a means to an end.
If a balanced budget—or a surplus, to reduce the national debt—is insisted upon,
even if it may be shown to have negative economic consequences (or be
impossible), then this is not Functional Finance (it is, actually,
‘dysfunctional finance’). Likewise, Functional Finance does not stipulate that
bigger deficits are ‘better’ or that deficits are ‘good’, in and of themselves;
what concerns us are the effects.
Such an
approach has an immediate result that at first glance may appear shocking or
surprising: neither taxing nor government “borrowing” are funding operations.
Decisions concerning taxation are to be made only with regard to the economic
effects in terms of the promotion of full employment, price stability, or other
economic goals, and not ever because ‘the government needs to make money
payments’ (Lerner, 1943, p. 354). Likewise, ‘the government should borrow only
if... the effects’ of borrowing are desired, for example ‘if otherwise the rate
of interest would be too low’ (Lerner, 1943, p. 355).
These points
of view were repeated and elaborated by Lerner in his 1951 book, The
Economics of Employment:
[T]axes should never be imposed
for the sake of the tax revenues. It is true that taxation makes money available
to the government, but this is not an effect of any importance because money can
be made available to the government so much more easily by having some created
by the Treasury. (1951, p. 131, original emphasis).
Likewise,
‘borrowing’ is also not a funding operation for Lerner.
What are the
purposes of taxation and borrowing, if not to fund government spending? The
purpose of taxation for Lerner is its ‘effect on the public of
influencing their economic behavior’ (Lerner, 1951, p. 131, original emphasis)
including, as we will see below, creating a demand for government fiat currency.
Like taxation, borrowing is not a funding operation; rather, it is a means of
managing reserves and controlling the overnight interest rate when the
government runs a budget deficit:
[T]he spending of money...out of
deficits keeps on increasing the stock of money [and bank reserves] and this
keeps on pushing down the rate of interest. Somehow the government must
prevent the rate of interest from being pushed down by the additions to the
stock of money coming from its own expenditures.... There is an obvious way of
doing this. The government can borrow back the money it is spending
(Lerner, 1951, p. 10-11, original emphases).
Two extraordinary results follow from
Lerner’s analysis here. First, the implication is that ‘borrowing’ logically
follows, rather than precedes, government spending. In fact, this
analysis questions the accuracy and relevance of the term ‘borrowing’ itself for
discussing government bond sales. Second, note that the budget deficit is
causing interest rates to fall, the exact opposite from what traditional
theory has long predicted (i.e., ‘deficits cause high interest rates’).
The role of
taxation and borrowing, reserve management and interest rate maintenance will
become clearer upon examination of two, less well-known, Lerner contributions,
‘Money as a Creature of the State’ (1947) and his Encyclopaedia Britannica
entry on ‘Money’ (1946), which place him squarely in the Keynes-Knapp Chartalist
school, and which is key to fully understanding the possibility and
effectiveness of Functional Finance. The ability of the government to conduct
fiscal and monetary policy according to the principles of Functional Finance is
made possible by the fact that, as the title of Lerner’s paper states, ‘money
[i]s a creature of the state’:
The government—which is what the state
means in practice—by virtue of its power to create or destroy money by fiat and
its power to take money away from people by taxation, is in a position to keep
the rate of spending of the economy at the level required to fill its two great
responsibilities, the prevention of depression, and the maintenance of the value
of money. (Lerner, 1947, p. 314)
In adopting this view Lerner followed
Keynes, who in his Treatise on Money accepted the main thrust of Knapp’s
‘State Theory of Money’ (Keynes, 1930, p. 4, p. 6n1; Knapp, 1924). The state
has the power not only to tax, but to designate what will suffice to retire tax
obligations, that is, what it will accept at its pay offices. By determining
public receivability, the state can create a demand for otherwise worthless
pieces of paper, leading to general acceptability. The state can issue this
currency, and use it to purchase goods and services from the private sector:
The modern state can make anything it
chooses generally acceptable as money and thus establish its value quite apart
from any connection, even of the most formal kind, with gold or backing of any
kind. It is true that a simple declaration that such and such is money will not
do, even if backed by the most convincing constitutional evidence of the state's
absolute sovereignty. But if the state is willing to accept the proposed money
in the payment of taxes and other obligations to itself the trick is done.
Everyone who has obligations to the state will be willing to accept the pieces
of paper with which he can settle the obligations, and all other people will be
willing to accept those pieces of paper because they know that taxpayers, etc.,
will accept them in turn. On the other hand if the state should decline to
accept some kind of money in payment of obligations to itself, it is difficult
to believe that it would retain much of its general acceptability...What this
means is that whatever may have been the history of gold, at the present time,
in a normally well-working economy, money is a creature of the state. Its
general acceptability, which is its all-important attribute, stands or falls by
its acceptability by the state. (Lerner, 1947, p. 313)
Thus, a variety of state powers, such as
government's ability to tax, declare public receivability, create and destroy
money, buy and sell bonds, and administer the prices it pays for goods and
services purchased from the private sector, constitute a menu of instruments
with which full employment and stability of the value of the currency may be
promoted.
The importance
of the Lernerian contributions of Functional Finance and ‘money as a creature of
the state’ are hard to overstate. Keynes called this ‘second of the two books
which you have placed within one cover…very original and grand stuff’:
I shall have to
try when I get back [to England, from his trip to the U.S.] to hold a seminar
for the heads of the Treasury on Functional Finance. It will be hard going—I
think I shall ask them to let me hold a seminar for their sons instead, agreeing
beforehand that, if I can convince the boys, they will take it from me that it
is so! (Colander and Landreth, 1995, pp. 116-7)
Keynes does not
trust that the heads of the Treasury can understand, because, as Lerner often
noted, ‘Functional Finance is seen to run counter to economic principles’ (1951,
p. 142). Functional Finance, or Keynesian economics taken to its furthest
logical conclusions (causing one author to ask, ‘Was Keynes a Keynesian or a
Lernerian?’ [Colander, 1984]), was, in its application to unemployment, Lerner
admitted, ‘topsy-turvy economics’ (1951, pp. 142-5).
But this is no
objection at all. Topsy-turvy economics is just what is appropriate for an
economy that is suffering from unemployment. An economy suffering from
unemployment is an upside-down economy for which only a topsy-turvy
economic theory is of any use. (1951, pp. 142-43)
By an
‘upside-down economy’, Lerner means an economy in which strongly held
traditional economic principles, such as those regarding thrift and the
economical use of scarce resources, do not hold. Lerner noted that when there
is unemployment, efficiency becomes inefficient: ‘an increase in efficiency in
any particular productive process does not result in any increase in efficiency
in the economy as a whole…The savings due to greater technical efficiency merely
go to waste in more unemployment’ (1951, pp. 143-4). Likewise, when there is
unemployment a country has to suffer over its trade balance, because it must
worry about rising unemployment stemming from an increase in the value of its
imports over the value of exports. Since ‘[t]he input of the foreign trade
industry consists of the effort involved in the manufacture of our exports’ and
‘[t]he output of our foreign trade industry consists of the imports which it
yields to us for our use’, exports are a cost and imports are a
benefit (1951, p. 321). Thus, when a nation attempts to cure its
unemployment problems by reducing its trade deficit, it is promoting costs and
restricting benefits!
One final
interesting result of Lerner’s Functional Finance is worthy of note here:
‘printing money’ in and of itself has no effect on the economy whatsoever and
therefore should not be considered when conducting macroeconomic analysis and
policymaking (contrary to those who claim that printing money is inflationary,
for example). For Lerner, there are six (or three pairs of) fiscal instruments
of government: taxing and spending, buying and selling, borrowing and lending.
Only if the money printed is spent on goods and services or lent through issuing
bonds or otherwise given away will there be some economic impact, but these
impacts are already covered through the consideration of the six fiscal
instruments: ‘The printing of money is not an instrument of policy. It is only
a servant of those policies, just like printing stationery used in the various
government departments’ (1944, pp. 312-4):
To sacrifice
the prevention of deflation because of shortage of money which could be printed
is no more sensible than to refrain from carrying out any other important
government action because the necessary paper forms or stationery would have to
be printed. (1951, p. 133)
Lerner’s
promotion of Functional Finance led to his engagement in debates concerning the
‘burden’ of the national debt and the harmful effects of large and persistent
government budget deficits (e.g., 1961a). One point worthy of note here, is that
Functional Finance not only opposes the ‘deficit hawk’ view of government budget
deficits as almost always and everywhere harmful (causing high interest rates,
inflation, crowding out private spending, and/or a burden on future
generations), but also the ‘deficit dove’ view that if the Federal government
kept a capital budget or measured deficits and the national debt differently,
they would not look as big. Lerner felt the doves ceded too much to the ‘sound
money’ view, and that this would eventually come back to haunt them, a position
that seems quite prescient in light of budgetary politics in the last two
decades of the 20th century (Lerner, 1951, pp. 15-6).
During the
1950s, and possibly as early as the late 1940s, Lerner began to become concerned
with what he later called ‘sellers’ inflation’ (e.g., 1961b). In his early
versions of Functional Finance, inflation was seen as the result of excess
aggregate demand, and therefore reducing spending and/or increasing taxation was
seen as the cure. But as it became apparent to him that there were other
sources of inflation, such as those due to supply-side or cost-push factors,
this simple policy for demand-side inflation was no longer sufficient for
managing the value of currency. In addition to other types of inflation, Lerner
also began to note that inflation did not begin at true full employment, but
well before that point. Thus, he even began to use terms like ‘low full
employment’ and ‘high full employment’, anticipating the idea of a NAIRU
(non-accelerating inflation rate of unemployment) or ‘natural’ rate of
unemployment (Lerner, 1951).
In the face of
these developments, Lerner dedicated himself to the study of stagflation, and
the evaluation and formulation of various income policies, market anti-inflation
plans (or MAPs), and wage-price controls (Lerner and Colander, 1980). These
issues preoccupied Lerner for the rest of his career. He suffered a stroke
while in Jerusalem in 1980, and although his speech was impaired he was able to
continue working until shortly before his death in Florida in 1982. Lerner was
survived by his second wife, Daliah, and two children from a previous marriage.
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