 I want to make the point, which is central to my work and has been central to my work for a long time, that if we are to change the world, it is very important that we understand how it operates. And by that I mean not just understand what we don't like about it, but understand what we don't see that's working beneath the surface, understand currents which are below the surface and deeper and operate over a longer time, because these channel and limit outcomes. And so if you imagine that going to the future is like going from Earth to Mars, you definitely do not want to be on a spaceship made by people who don't know physics and don't know engineering and just hope that their will power will get them there, because you can be guaranteed that that will fail. And the worst part is that failure is often imposed on the people that are not the ones responsible for the failure. As you know in Europe more than anywhere else, people can have positions that they can act out on and the consequences are on other people. So my whole life is therefore being motivated by an important premise that if we are going to join in trying to change the world, it's very, very important to understand how it operates and what currents are deeper than those that we normally see. I want to tell you an interesting story in regard to that. Marx and Engels as you know were young postgraduate students in 1848 when the crisis broke out and they immediately set out to try to overthrow capitalism. Marx in Paris and Engels in Germany fighting with workers and then they lost and they ended up as exiles in England where they were members of a communist party called the League of Communists. And they felt that when the next moment came for political activity, they should be prepared with a better understanding of theory. And this was a big debate in the League of Communists because others felt that the issue was have sufficient will, sufficient energy and take care of it. But Marx and Engels particularly felt that to understand capitalism and its recurrence of these moments and its historical patterns you need to get into its structure. For this they were effectively expelled from the League of Communists which makes Marx and Engels the first Marxist to be expelled from a communist party. Unfortunately that pattern was repeated many times. I come from a background in a developing country Pakistan and looking in there you can see for a long time that you have educated people, you have a structure that was inherited from colonialism but it was a potential. You can see that yet significant failures and increasing failures in the country. I then lived in Kuwait for some time and there the opposite problem occurs and Pakistan there's not enough money in Kuwait there's too much money and yet you also have inequality and poverty there too and that's what led me to study economics. And since I came from an engineering background I thought economics would be explained to me why development didn't work in Pakistan where there was no money and it why didn't work in Kuwait where there was too much money. Well I discovered that economics as I was taught it did not even address the question. Instead what my professors taught me and I had by the way the best three of the professors that I had at Columbia were Nobel laureates in economics but what they taught me was a fictitious vision of capitalism. A vision which was constructed in the 1890s we know this because the originators of this Mengar, Walras, Javins wanted to have a different story of capitalism than the story they were inheriting politically. The story in which there was an anti-capitalist movement, socialism was on the agenda, the Ricardian labor theory of value was there, the idea that there was conflict between capital and labor that labor was exploited and they wanted to construct a different story and the story they constructed was of an ideal capitalism a fictitious capitalism in which everything is perfect in which markets are the servants of humanity and if allowed to work they produce the best of all possible social outcomes. Now that is still the story that is taught in every textbook in economics in every program in fact more now than in my time because in my time Keynesian economics which was the 1970s was still around but after the turn to the right neoliberal economics that began in the 1980s those other points of view have been abolished entirely in any economics department everywhere including I am sure in Brussels you will find that the story begins with this fictitious quasi-religious image of perfect capitalism. Now so what practical people don't need to be constrained by this you would think but in fact they are because in order then to explain the world that you see which is so different from the world that is taught in the textbooks and is embodied in the minds of the experts you have to introduce imperfections that is to say you the textbook story doesn't hold so there must be something wrong and the wrong is somewhere outside that textbook so we say people don't behave rationally governments intervene and prevent the market from working unions restrict the free flow of labor and the proper pricing of labor social policies and environmental policies stifle and mis allocate resources this is standard standard in not only in the textbook including the policies in every government of the world today every minister every finance minister every head of the IMF and the world bank and the WTO are trained in these ideas and are picked because they are trained in these ideas or because at least apply these ideas I want to say that we can analyze capitalism and I'm going to exemplify it by talking about trade and globalization and migration but we can understand capitalism in a completely different way a way that was actually the the dominant vision before this what we call neoclassical economics became dominant so there was a dominant vision in Smith and Ricardo and Marx but also in Keynes and Kalecki which is the idea that you develop your theory by analyzing the world you see rather than idealizing the world and then finding that it doesn't fit your textbook story if you look in the history of capitalism you see that it is structured by competition and conflict and recurrent crises why crises because crises are the way that the system balances itself it lurches over to too much peaks and then falls down to too little and then comes back again on the rise and so the cycle is the process of balance in a system where nobody has any direct say on the outcomes all the outcomes are discrepant and they get reconciled the discrepancies get reconciled by overshooting and undershooting the other features you notice in capitalism is that inequality is persistent it is as old as a history of capitalism i'm going to show you some data on that and you see also that the state has always been involved in the market it's a complete fiction to imagine the market as something in which the state simply comes in and stifles the state has been the foundation of the market the protector of the market protector of different nations we know this through history and we know this through concrete studies but the state modifies capitalism it does not abolish the patterns it channels them why is that because as long as it is a capitalist state it must push the state the system in a direction that is deemed socially desirable and even the meaning of that changes over time but it does not abolish those patterns because the patterns are embedded deep they're embedded in the very heart of the capitalist system which is the profit motive now i'm going to say this a lot the profit motive that is the thing that drives the system and that explains why despite waves of state intervention patterns repeat themselves inequality repeats itself booms and busts repeat themselves great depressions repeat themselves in the developed countries developed the richest countries in the last 85 years we've had the great depression of the 1930s the stagflation crisis of the 1970s and then of course the global crisis that began in 2008 what is really astonishing is that that order of depressions roughly 40 to 50 years the so called long waves and the depressions associated with them can be found going all the way back to the origins of capitalism and i have a book everybody has a book um and this one is called capitalism competition conflict and crises and the aim of the book is to show you that you can construct a very detailed analysis of how capitalism operates i'm going to show you a little bit of that on trade which is just one chapter in this book but you can analyze prices wages inequality unemployment inflation long waves and business cycles and a variety of other things interest rates the stock market all of these can be analyzed from a unified framework a framework which can be found in in a broad outline in the classical tradition and in k-engine economics but can be put together so that we do not have to see what we see as a departure from some ideal framework but rather as a normal consequence of the framework of the system in which we live and this is very different than what you find in orthodox textbooks it is my quixotic goal to push for a different type of curriculum in economics needless to say this is not a popular idea in my profession but to start from the way that darwin starts or newton starts or einstein starts or marx and smith and ricardo start which is to analyze the reality of the system and extract from it the fundamental principles so that when we come to the operation we can see them as exemplifying those principles whether we like the outcomes or not it's very important to understand where they come from so from this point of view profit and the associated motives that are attached to it are like an invisible force field i think we all recall in high school science or maybe even younger nowadays you can take a sheet of paper with iron filings and if you have a magnet underneath and you shake the paper then even though the filings have no goal they end up reflecting the magnetic field underneath the paper and that is because that channeling from the field is invisible unless you let things move around and then you begin to see patterns develop this is my understanding of what smith means by the invisible hand invisible hand does not mean that people behave on self interest and produce optimal outcomes this is the fiction of orthodox economics it is rather that they are hidden forces that channel outcomes in some direction and produce specific patterns and in this book i i not only developed a theoretical foundation for this argument i contrast that to both orthodox economics and uh heterodox post-kinesian economics and others marxist economics and i also address the empirical evidence every chapter in the book does those three things develop the theory compare it to other theories and then compare to the key point of comparison which is the actual object of investigation that's why the title of the book is capitalism it's not about what marx said or smith said or smith said or collette key said it is about what capitalism does in all theories have to be uh understood and addressed from their ability to explain that now one of the implications of this is that we can understand the world without accusing it of being imperfect which is the standard explanation both in orthodox economics and leftist economics i'm going to come back to that point orthodox economics says that the imperfection is that the intervention of the state uh prevents the market from functioning properly the intervention of unions and of cultural practices which are not market friendly the left says it is the fact that corporations are too big that their competition no longer operates that uh there's collusion um and that the outcomes come from that power relation between the big and the small i want to argue that both of those are tied together because the both of them come from the opposite idea that there is some functioning of the system that is called perfect competition perfect capitalism and that what we seek has to be explained what we see in front of us has to be explained as an imperfection that prevents the market from operating properly i want to show you that what we get is exactly the proper functioning of the market inequality crises poverty the migration patterns we're seeing now the the the problems in the uh EU Greece versus Germany they are perfectly understandable as the normal operations of the market now obviously i can't do all of that it would take us about a year but i can talk about the application of this point of view to international trade i should add one more thing here sometimes people say well economics is too mathematical or it's too abstract and therefore it was more concrete it would understand i think that's a mistake all theoretical structures begin from an abstraction the issue is whether the abstraction is an idealization or it's a typification there's a difference an idealization attempts to present the starting point as perfection and then moves away from it to the imperfection of the world i suppose everyone here has read the bible since well three major religions begin from some version of that as you know the story is very simple in the beginning there was perfection and then comes the snake of scarcity who talks to eve and then eve of course is the source of the first imperfection uh and then adam falls for that and then from then on we are all the result of this past on series of imperfections now then there's a very formal parallel between orthodox economics and the biblical story which i don't have time to develop here but i talk about in my book a lot but there's another way to begin which is quite different wish to say that capitalism is a class structure but class it's an abstraction also it's if it's misunderstood it's understood as something that is just there all the time it's a point of departure to explain actual locations within class it has always been built on gender and race and ethnicity differences and exploitations capitalism is a conflictual structure has always been from the beginning conflict between capitalism and non-capitalism conflict within capitalism between capital and labor but also between capital and capital and between labor and labor and that set of conflicts produces outcomes i want to show you that those outcomes are the ones we see now today and have always seen so if there is a point here is that the abstraction should guide you to the reality by introducing more concrete elements so that when you see the reality you understand it as determined at different levels at the fundamental level at the more concrete national or social level and that gives you a sense of the different hierarchy of forces operating on the reality sometimes people say that the problem with economics is that it's too mathematical but that's like saying that the problem with the story of the church is that it's told in latin it's not the latin which makes the story the latin is merely the form of cloaking the story so that you don't see its simplicity and falsity also mathematics is used in orthodox economics as a means of cloaking the vision but that doesn't mean that the problem is mathematics mathematics is a tool like any other tool and when used and where appropriate it can have some powerful consequences but then it has to be used for your purposes not its purposes so we have to use it as a tool not become a tool of it my own training as a former engineer certainly means that i was not mystified when i went to graduate school by the mathematics in fact i was utterly mystified by the story that was being told of how capitalism works and the mathematics merely ends up representing it or misrepresenting the reality so what is the key point markets do work they work for what their purpose is and their purpose is profit now once you understand that you see that the patterns are easily explainable from that point of view they achieve balance in and through imbalance or as marx puts it somewhere they achieve order in and through disorder disorder is the means of balance and order so the big mistake in approaching markets is to think of markets as to think of their goal which is profit as being identical to good for people what's good for profit is not necessarily good for people and in fact one could argue is systematically in some domains bad for people but then the problem comes not from an imperfection of the market the bad aspect is one of its perfections firms have to fight to survive competition as the classic economist longo pointed out is a war in which firms that can cut costs can beat out firms that are not nations that can cut costs beat out nations whose costs are higher that competitive process is one in which the imperative to lower costs is something that permits the people the firms that are successful from surviving and growing and prevents them allows them to survive allows them to grow allows them to become powerful but what cuts costs well certainly if you can push down labor wages that cuts costs you can make people work 16 hours a day it was done in Europe in the beginning was done in the United States in the 19th century is done in China and Asia today that's good that is the job of the market to keep wages down keep working hours long if you can use child labor because it's cheaper that's good that is part of the motivation and consequence of profit markets can also provide employment they increase standards living with they're successful though they may displace some people they pick up other people they create employment and unemployment they create new activities and they wipe out old ways of life if we understand that then when we start talking about the consequences we don't like we have to understand that we have to talk about the driving force it's not an oversight that markets create environmental damage it's an absolutely natural and proper outcome that you would do yourself if you were in that position and your position depended on being successful in the United States there is a recent controversy about something called the epi-pen I don't know people read about it but people who have severe allergies can die from these allergies if you happen to be allergic to peanuts and there's a little bit of peanut and food you get you go into shock and you can die and one of the ways you can protect yourself against that is to have a little pen that gives you an injection that gives you a chemical that keeps you from this shock a company in the United States has the patent on these pens and they've raised the prices systematically from what they were $30 a pen to something like $300 a pen and even though that meant that now a lot of people cannot get the pen and they've been consequence of that airlines used to carry the epi-pen on them if you have a shock they cannot afford now at $600 for two pens they can't afford to carry them so they don't anymore now people are very angry and upset about this they've jumped up and down and screamed and there have been congressional hearings but the woman who is the CEO says I don't understand what the problem is my job is to make profit it's not to help people I have a patent on this pen and by raising the price by 10 times I'm making profit from my company and for myself also her salary is huge as Donald Trump would say huge and she's doing the right thing now if we're going to stop that we can't say that she's a bad person she's exemplifying the logic of her position and so if we don't like those outcomes we have to then go up against the the logic itself one of the things I try to show in the book also is that this recurrence of depressions of which the current one is uh was on schedule uh is part of the logic of the system too because patterns develop in which booms develop and then everybody rides at the boom thinking it's never going to end and then when the tide breaks and it comes back down then everybody is swamped and these patterns can be shown and I do a lot of empirical evidence here to show that they are absolutely normal and intrinsic now to make the transition to the current discussion there's been a rising tide since the crisis of 2008 which in which we are still embedded that we have to do something about the outcomes about international poverty by national poverty about inequality about stagnation about unemployment and people typically have partitioned themselves into two schools the what might be called the German school at least exemplified by the Bundesbank and by the ECB is the idea that we need to go to have more markets more competition more competitiveness Greece needs to be taught that to be successful wages have to be lower unemployment has to be raised so that the welfare state is collapsed and if that causes generation or two to lose their livelihoods and their future that's just a necessary consequence of getting them back to the path that will make them rich in the future this is a logical and clear extension of the orthodox theory of economic analysis austerity causes these dislocations because this school believes that they need to have the dislocations and the poverty and the misery to bring people back to the right path on the other side progressives generally argue that the state should be stepping in to provide jobs to provide stimulus deficits which are not permitted in the EU but certainly are permitted in the United States in many countries and to pump up the economy that way so these are the two opposing views one of the things I tried to show in the book is that both of these views have some fatal weaknesses and I won't say what those are now because maybe you can buy the book and take a look but they're fatal because they misunderstand how markets work they're quasi right that is to say they have right in some respects but wrong in some very fundamental respects that means that if you're going to thread this path between these two opposing potential disasters you have to be very careful to understand what the limits are of different types of actions political and policy actions so with with that let me oh i'm sorry one other thing I wanted to say this rising tide against orthodox economics has reached the point where even people in power and influence are recognizing that we cannot keep teaching economics that misrepresent the world so fundamentally and then expect the people who are trained in that tradition to help us solve the problems that they have created through their training and here I cite that I cite a editorial from financial times which needless to say is hardly a leftist paper but notice what it says this is its critique of economics as it's taught in the universities and embedded in the minds of all people in power the typical economics course starts with the study of how rational agents interact in frictionless markets producing an outcome that is best for everyone only later does it cover those wrinkles and perversities that characterize real economic behavior such as anti competitive practices or unstable financial markets as students advance there's a growing bias towards mathematical elegance when the uglier world intrudes uglier real world intrudes it only prompts the question this is all very well in practice but how does it work in theory then the ft goes on to say the steps needed to bring economic teaching into the real world do not require the invention of anything new or exotic the curriculum should embrace economic history and pay more attention to unorthodox thinkers such as Joseph Schumprader Frederick Hyatt and yes even Carl Marx this is a financial time speaking faculties need to restore links with other fields such as psychology and anthropology whose insights can explain phenomena that economics cannot economics professor should make the study of how people act the starting points of course is not an afterthought where i teach this is what we do where when i teach this is what i do and i my hope is that more people will understand that the problem lies not just in tweaking policy but changing the fundamentals of the world understanding of the world which means changing economic theory as it is taught and represented to young people who are going to in fact lead us into the future i'm going to now apply this kind of application this is only a small part of my chapter in international trade but it brings out the essential issue of how we to understand globalization from a different point of view and if we look in the history of international trade we see that they have been persistent trade imbalances through fixed and flexible exchange rates they've always been capital flows though now we talk about globalization and capital flows is a very old in capitalism inequality has grown as capitalism has developed some nations have succeeded using trade to better themselves and others have not there's always been a large pool of employed and partially employed people in the history of capitalism it moves around to different places and different times and in the present era these large pools of people desperate people cut off of employment and displaced from any alternatives are the core of the push and pressure for the mobility of labor across the world every country erects barriers to this mobility of labor and yet the gaps are so great that people are literally willing to die to cross over and that i argue is a necessary and natural consequence of how markets work so that if we want to change that we have to intervene in the actual functioning of markets we know of course i don't have to tell any europeans that integration into the market does not lead to automatic equality in fact it can lead to enhanced inequality and the theory of trade international trade is very important source of explanation of that uh germany at one end and greece at the other i've talked before about the debate between austerity and stimulus as a fundamental theoretical difference and i also began by mentioning the logic the correct logic from the point of view of orthodox theory of austerity policies which is to bring markets back into competitive balance now orthodox economics tells us that free markets will lead to full employment and increased income and wealth yet we know historically that globalization has been attended by highly uneven development and increased inequality within and between nations i'm speaking here not only of the neoliberal era but historically earlier eras but let's say beginning in the 1980s and as i've said on the right the focus is on the idea that countries are not competitive and on the left the focus is on monopoly large corporations corporations and unfair trade but if you understand that real competition is a war of all against all and that there are winners and losers that firms set prices and they need to cut costs so that they can effectively compete that they therefore have to search for or create raw materials that they have to search for or create cheap labor and that free trade is merely the international expression of competition then what we see begins to fall into place in a very simple way but before i get to the explanation which i want to offer i want to just run through how orthodox economics explains the market explains free trade the first thing you learn if you take a course in economics i wonder how many people here have suffered through an economics course all right well the rest of you are lucky but you can pick up a text you can read it and the first thing you learn is that competition competitive markets produce optimal social outcomes it's actually called Pareto optimality it's a formal definition and automatic full employment of labor you've left to themselves markets will produce the best of all possible outcomes and then they go on to tell you that if you have countries in free trade who if you open up trade between countries that are unequal in their costs then something miraculous happens which is the countries whose costs are low and therefore they have an advantage in trade they will sell goods abroad and don't import much so then have balance of trade surpluses versus countries whose costs are too high the miracle is that free trade will cause the costs of the lower cost countries to rise and of the higher cost countries to fall until some point the countries have enough of low cost goods to compete with each other and you get balance trade this was an argument invented by David Ricardo it's called the theory of comparative cost and it operates through the mechanism of either flexible exchange rates or movements of money quantities I will get into that if you have questions about it and my book spends quite a bit of time on that but what's striking is that this tells you that you do not have to worry if you are backward as far international competition is concerned because by choosing to specialize in those goods that your costs are comparatively lower even if they might have been higher before you will end up benefiting from free trade it's very interesting that this model implies that developing countries should simply expose themselves to free trade because then they will achieve this wonderful outcome and they shouldn't try to intervene by building up industry or import substitution or export support because the theory tells you don't need that yet every developed capitalist country in the world has done the opposite the little book by Hajun Chang professor at Cambridge called kicking away the ladder I strongly recommend that little book it's quite well known now is C-H-A-N-G and it's called kicking away the ladder and what professor Chang does is show that every advanced country of the world including every country in Europe manipulated and interfered in trade until they had sufficient advantage in the world that they could compete starting with England and including Germany and Switzerland and also of course the United States so the history of free trade is that it isn't free until you have an advantage in England in the United States Chang points out that American leaders said we are not going to fall for this British nonsense of free trade we will support it when we ourselves have enough strong industries that it's in our advantage to say that they should be free trade because then we can go into other countries if you are a trained economist you have to believe that no matter how unequal trading partners are both sides will benefit from free trade under competitive conditions but then another problem arises suppose I open up trade between a high-cost region and a low-cost region then won't it be true that the high-cost region will begin to suffer due to competition from the low-cost region and there'll be unemployment there and there'll be problems well this is where the other part of neoclassical theory comes into play because it says that markets will automatically adjust to maintain full employment in both countries now you might think this is an abstract issue but when NAFTA was being originally proposed the government was going through a big fight about whether NAFTA would benefit all the countries US and Mexico and Canada or it would harm some and benefit others and so I recall something like 23 studies were commissioned 18 of those studies assumed there was going to be continuous full employment in the United States and Mexico throughout before during and after NAFTA now how could anyone looking at Mexico let alone the United States make the assumption of continuous full employment the answer is because that's built into the models and they were applying the models to estimate the consequences of opening up trade on the assumption that there would be no job loss and that is something that every orthodox economist gets drilled into their head his or her head and then has to struggle to leave behind in some way from this point of view the adjustment between unequal countries has no cost because full employment is maintained all the time and then if you add on capital flows what do capital flows do well capital flows will bring capital from the rich country with technology and knowledge and all that to the poor country and therefore it'll make them even better so there it cannot be any disadvantage to free trade or free capital mobility the trouble is that there is no support from the empirical evidence for these kinds of propositions it doesn't prevent them from being taught but there is really they're contradicted by the empirical evidence let's start with the proposition that trade creates an automatic balance between countries so that their trade will be balanced that is their exports will equal their imports this is Japan and the U.S. over the post-war period from 1960 to 2010 roughly 2008 and here you see the balance of trade as a percentage of GDP of the U.S. you can see that it was close to zero and then the U.S. becomes highly unbalanced it becomes a big deficit country Japan had a small balance of trade surplus in the early parts and then it had a bigger balance of trade surplus now if orthodox theory was correct and orthodox economists say this themselves then these graphs should be all fluctuating around this line the zero line they should all be here so one of the big problems in orthodox economics is explain why trade doesn't balance today that issue comes about you hear it all the time we know that one of the duals of the U.S. imbalance is China's surplus and Japan's surplus and Germany's surplus the United States has always accused Germany Japan South Korea and now China of interfering in the market by fixing their exchange rates and that from their point of view explains why there is an imbalance because if the trade if the theory was correct and the free markets work they would be balanced so this must be some imbalance due to interference if you go to the studies of how and by the way I hear this all the time ministers politicians people on the left China interferes in the market by fixing its exchange rate when you go to the studies of where they come they come to that conclusion the studies begin by the premise that free trade will cause balance and that therefore the imbalance must be due to an interference and then they they estimate from there the degree of interference of China in other words they have no direct evidence for the interference it's in inference from the theory itself and these are the the high level theories that are published in the journals and cited in the newspapers it's not just those countries this is the uk starting off with a surplus and then going down to deficit this is canada starting with the deficit and going to a surplus this is germany starting with that surplus that the u.s. hated so much then the transition then unified germany with the deficit then going back to surplus this is australia deficit deficit deficit deficit deficit and these are long periods of time we're talking about we're talking at close to 50 years so it's not as if the theory is working itself out it doesn't work and the question is why this kind of outcome has raised a series of explanations of course people have to explain it heterodox economists say that they free trade they accept the idea that free trade would make countries competitive but they say that trade isn't free the real world is full of heterogeneous elements economies of scale so that firms are not all like imperfect competition power monopoly power state power hegemonic national power and from their point of view then you need the intervention of the state to make things come out right in other words you need the state ironically to bring you back to what the theory says is the normal outcome this is also what kainz in economics kainz himself says capitalism tends to not be what the orthodoxy says but i kainz have an answer which is the state can bring you back to this ideal and perfection and he says that explicitly and it also argues orthodox economics argues that the countries that have succeeded are the ones that let the market operate now we know that's not true but textbooks skip that part one branch of orthodox economics says that admits that the real world is not competitive and they admit what the left says what the left claims imperfect competition oligopoly monopoly national power but then they say well but then the answer is simple let's get rid of all of these interventions so let's cut back the welfare state that's a big intervention in the market let's stop supporting unemployment by giving incomes to people who are without jobs because that prevents them from looking for jobs that's attack unions because unions prevent wages from being what the market would give you so their answer is very simple that's the austerity answer and it follows from the theory what is surprising is that both sides believe that trade free trade would give you balance and they only differ about what to do about the balance but not at the cause of the imbalance which is interferences or imperfections of some sort i have argued throughout my work that the it's a trap to talk about the opposition between perfect and imperfect competition because you can't have imperfect competition without having perfect competition you cannot say that humans are imperfect ever since the fall from heaven without believing in heaven and so you have to start if you're going to do it from a different point of view and as i said the point there is to start from the idea that competition is a real process with real outcomes and powerful structures it's a war at the micro level it's a war between employers and employees but also between the employed and the unemployed between firms in one area and their competitors between firms in one nation and their competitors so it is a war of all against all it can be modulated but it cannot be abolished unless you have abolished capitalism itself one of the consequences of this is you can show empirically that prices are regulated by real costs now this is a point that adam smith made and it's a pretty obvious simple point the prices of commodities depend essentially on their costs plus some kind of normal profit determined by competition so costs play a very central role in determining relative prices in my book i show dozens of dozens of studies and do my own studies of relative prices in advanced countries showing that you can explain them from this principle in the same way one of the arguments i make and develop theoretically in the book is that the prices of goods in different countries are what are called the terms of trade the price of exports relative to the price of imports in the same currency to the exchange rate enters is regulated by the real cost of exports and the real cost of imports i'm going to skip over the argument here it takes a little development and i want to get to some of the applications but this is not a new argument it's an adam smith adam smith says the trade is not regulated by benefits for the nation it's regulated by profits said why do people become importers because by importing goods from another country or region they can make a profit why do they become exporters because by selling in another country region they make a profit so trade as he points out is regulated by profitability but profitability is but prices are regulated by profitability and costs and so it's possible to show that the same argument applies to trade that prices of countries or the terms of trade which are the real exchange rates between countries are regulated by the real costs of exports and imports the real cost of producing goods in those two countries and those costs depend on two things fundamentally productivity and real wages so from that point of view a country which has high productivity at least in its export sector and very low wages has a tremendous advantage that country is china now but before that was korea but before that was japan and before that was germany the advantage of high productivity and low wages is that your costs are lower and that gives you a tremendous advantage in international trade now if this is true then the exchange rate the real exchange of a country is not a free variable that a country can set it's set by its production conditions its labor conditions and by the competitors conditions so that you can then explain the movements of real exchange rates through these fundamental conditions here for instance is the trade balance as i showed before of japan and us here going up to 2011 and you can see as i showed before the us trade balance goes highly negative this line here is the zero line so if it's below the trade balance is negative which means that exports are smaller than imports and here it's highly positive which means that exports are bigger than imports is it because the japanese manipulate the exchange rates and the us for some foolish reason does not manipulate its exchange rate i would argue not i'd argue that in fact it is because the exchange rates the real exchange rates are regulated by the costs here is the us real exchange rate this is standard data published by the federal reserve board of the us from 1960 to 2011 and you can see that the us real effective exchange rate goes down japan's goes up and but these are index numbers you cannot tell the level you can only tell the direction an index number to just remind you is a number with which you divide by some base here so that you can't tell what the level is you can only tell the trend so it seems as if the us is becoming more competitive and japan is becoming less competitive and that is true but if us costs are higher and japanese costs are lower then it's there's room for japanese costs to rise and us costs to fall and still the us would be at a disadvantage so you have to look more concretely at the level of the costs productivity and real wages you not just at the exchange rates so if it's true that the real exchange rates are determined by underlying forces then we should be able to see that in the book i calculate the real adjusted unit labor costs in the united states effective that is the unit labor costs of us goods relative to the goods of its competitors and here is the us real exchange rate its prices relative to the prices of its competitors and you can see a tremendous correlation between these two and i developed a theoretical basis for that in the book but what that tells me is that we can explain these patterns not from policy but from the fundamental structure of wages and productivity and competitiveness in the two countries same thing for japan this is japan's the dark line is the real effective exchange rate the light line is the adjusted real unit labor costs now that means that this is the same explanation between countries that do apply within a country if i want to know why the costs of two things are different we i mean why the prices of two things are different over the long run not in any moment then i have to look at the cost structure and that cost structure is always mutating and moving i'm going to skip a little bit here and talk about some of the implications of this approach if this is true then we have a rule of thumb for what the appropriate exchange rate is what the market exchange rate is exchange rate that the market will bring you back to and in fact the point i'm making is that the market does bring you back to an exchange rate which is consistent with the cost structure that implies that if you want a country to become more competitiveness then you have to lower unit real unit labor costs which means either lowering real wages and or raising productivity and that is exactly the issue in the debate between Greece and Germany now the Greeks are being forced to become more competitive through the collapse of the welfare state collapse of support of unions and collapse of the standard living of workers and hence the collapse of real wages productivity however has not been raised that's the other possible path and that's not being done i'm going to skip some of this and if this argument is true then we'd expect to see that less competitive countries will suffer persistent trading balances so that we'd expect to see conversely that more competitive countries will will enjoy trade surpluses now anybody going to china is struck by the enormous productivity and intensity and length of the working day and by the low wages even in the export sectors the wages have been rising a little bit but they are very low compared to europe and they're very low compared to the united states and every business person knows that that is one of the sources of the great advantage china has in trade this device is an iphone it is produced in china steve jobs would ask why is it produced in china and he said are you joking it's produced in china because i can get workers working 16 hours a day for two dollars and 35 cents an hour and they do very good work and it would not be possible to make it in the united states or even mexico because it would not be the price would be out of the range of people china's advantage has come because it has understood the real laws of international trade as japan did as korea did and has applied them to its advantage now if that's true then what we see in the imbalance between countries is in fact regulated by structural factors then the short run solution might be to prevent the the worst consequences of this imbalance but the longer run will have to be to bring these structural factors back into line sometimes people say germany runs a trade surplus which it does by policy well that's true if you consider the support and development of high quality high productivity industry a state policy which is absolutely true that's how the u.s also developed its industries that's how china developed and so that's a policy but that's not a policy that you can just wave your hands and have happened it involves a structural transformation of the economy itself now i want to end by talking a little bit about more pessimistic outcomes if capitalism is motivated as i believe by the profit motive then there's no guarantee that jobs will continue to be produced on the level that people need robotization is widespread planned everything we do now can be done by a machine at some point in the future i took a ride in a tesla which is a self-driving car so many cars are self-driving the the risk for that self-driving car is not people like me who are just enjoying the ride of somebody else's car i don't have a tesla the risk is of course to all those people who make their living driving trucks across the world because that transportation now can be replaced by automatic devices will that mean that they will suddenly move go on and become uh uh massage therapists and nuclear physicists i don't think so i think there's going to be a growing pool of people displaced by these new technologies and unable to get back into the world of of life of connections to people and of income through employment anyway and that's going to cause a huge and even worse imbalance that we see now the reserve army of labor to use box's word on a world scale is very big it's been very big for a long time and now it's literally as it's been rising overflowing the barriers which have been set up to prevent people from moving a national and global inequality has uh grown except for china china's insertion onto the world stage has reduced national inequality but you take china out then you don't see it at all it's all located in one country and whether it's a capitalist country or some other kind of uh market developed country is a big debate now but to attribute it to free markets is crazy because what china does not do is free markets it definitely has very controlled and directed markets and then there's a question in the environment we are facing a global catastrophe uh and the environmental level and yet this is an absolutely natural consequence of the profit motive you can't tell people not to do it unless you can prevent them from doing it and also offer them other opportunities one of which is to make profits from solar and all of that being tried but the incentive at the micro level is to dump your stuff if you don't have to pay to clean it up then you get an advantage and we have to accept that that is a natural consequence what does this imply about the long-term future of capitalism there are many people who are writing about it now from the left and the right who are seeing it as pessimistic i happen to think it's actually a pretty uh uh adaptive system in the sense that capitalism will survive but it doesn't mean that people will go back to the old benefits because profit is not the same thing as benefits to people i can easily imagine large numbers of people across the world cut off our employment and blocked from moving perhaps some at the best they can get some minimal benefits but that's a kind of death because there's no purpose in the life and there's no uh future in that life and people understandly are revolting against that revolting against the local conditions and then globally revolting against the prime mover which is the system itself where that's going to lead i don't know but it doesn't seem to me uh it's going to lead to any simple solution i noticed by the way that one solution to this if we don't have enough jobs for people is to eliminate people it seems like a pretty rational solution how do we eliminate people where there's war there's disease there's conflict we're already doing that environmental disaster but there's also to reduce the birth rate and to reduce the birth rate either is in china by fiat which now they're trying to reverse or through the simple operations of the capitalist system where if everybody has a job and everybody is more or less equal children become less and less probable i mean there's a lot of studies piquetti has all these studies of the growth rate of advanced capitalist countries falling to below replacement without anybody pushing it just through the natural development of capitalism so the system is very flexible very adaptive but i think the future looks very bleak so if i sound like donald trump is because he's partly right as is bernie sanders partly right and hopefully we can come up some ways to to modify these outcomes and perhaps even block them thank you