Abba Lerner: Economic theorist and father of functional finance
Abba Ptachya Lerner (1903–1982) was born in Bessarabia Russia, now located in Romania, At age 3 his family emigrated to the UK. He was raised in the East End of London and was employed as a machinist, a capmaker, a teacher of Hebrew and a Rabbinical student, and also tried his hand at business. As a young man he had socialist leanings and was involved with the UK Fabians, and he taught himself basic Economics.
He enrolled at the London School of Economics in 1929. While there he was taught by John Hicks, Lionel Robbins and F. A. Hayek. He was originally heavily influenced by the neo-classical economist Lionel Robbins. He married Alice Sendak in 1930, and they had twin children – Marion and Lionel – in 1932. At some point their marriage ended, and he later remarried to Daliah Goldfarb at the age of 57.
He published several first-rank papers in economic theory and still found time to launch the Review of Economic Studies with Paul Sweezy and Ursula Webb (who later was to become John Hicks’ wife). His ‘student’ papers catapulted him into the frontlines of the “Paretian revival” of the 1930s which consolidated neo-classical theory.
A six-month stint at Cambridge in 1934- 1935 brought him into contact with John Maynard Keynes’ “Cambridge Circus,” which changed his ideas about macro- economics and unemployment dramatically. Lerner subsequently became perhaps the first economist outside that charmed inner circle to truly grasp the meaning of Keynes’ General Theory and, as a result, became also one of the leading pioneers of the Keynesian Revolution. Immediately upon publication of Keynes’ The General Theory in 1936, Lerner recognized its significance and from that point forward he turned his attention to exploring and extending Keynesian macroeconomics.
He emigrated to the U.S. in 1937, and over the next forty years he published numerous articles and books while moving from one university to another. His capacity to befriend his intellectual opponents such as Milton Friedman and Barry Goldwater was legendary, as his thinking was straddled across both neo-classical and Keynesian theory.
His academic stops included Columbia, Virginia, Kansas City, Amherst, New School for Social Research, Roosevelt, Johns Hopkins, Michigan State, UC Berkeley, Queens College, and Florida State. His thinking went through several transitions over his lifetime. He entered the LSE as a self-described socialist; he left there as a neoclassical economist. And after The General Theory appeared, he became an avowed Keynesian.
His writings were extremely diverse. For example, long before Nobel laureates Bertil Ohlin and Paul Samuelson had formalized the factor-price equalization theorem of international trade, Lerner had asserted and proved that under perfectly competitive conditions the prices of the factors of production in various nations would be equalized through the free trade of products. He was also the first person to establish that economic efficiency depended on the price of products equalling their marginal costs. Lerner, therefore, is credited with providing the first rigorous statement of Pareto optimality. In this same regard, he was a key figure in the development of the theory of market socialism. In addition, he established an index of monopoly power and advanced a theory of sellers’ inflation.
Abba Lerner articulated a fiscal strategy for a federal government which takes Keynesian macroeconomic analysis to its logical conclusion and it became known as functional finance. Based on effective demand principle and chartalism, functional finance, is a theory of purposeful financing (and funding) to meet explicit goals, including the attainment of full employment. According to this theory, taxation is not designed to fund expenditure or finance investment, but to maintain low inflation. He believed that an excess of planned saving over planned investment caused unemployment.
Politicians could solve this problem by counteracting excess saving by increasing the budget deficit. Thus government officials would reduce tax revenue and /or increase public spending during times of recession. which policy would push the government budget into deficit. Government spending into the economy would increase aggregate demand and lower unemployment.
Functional finance can be understood as follows:
- The government should be concerned with balancing supply and demand at full employment rather than balanc- ing the budget.
- If aggregate demand at full employment production falls short of the output at that level, then the government should take action to increase demand, by such measures as cutting taxes, increasing government purchases or giving increased transfer payments.
- An increase in taxation is not for the purpose of raising revenue, but rather to reduce consumer demand by taking away buying power from consumers.
- If the government needs funding to increase government purchases or for transfer payments it can do so via the mechanisms of (a) borrowing through the sale of government bonds, or (b) through the direct creation of money.
- So long as aggregate demand does not exceed aggregate supply, there will be no inflationary pressure.
- The use of fiscal policy and monetary policy as the twin tools employed within Keynesian economics has been credit- ed to Abba Lerner by historians such as David Colander and to some extent David Landes.
Lerner’s other achievements
Abba Lerner’s symmetry theorem states that an import tariff can have the same effects as an export tax. The so-called Lerner Index measures potential monopoly power as the negative inverse of demand elasticity.
Lerner also improved on a formula of Alfred Marshall, subsequently known as the Marshall–Lerner condition. He developed a model of market socialism, which differed from the pure planned economy, which became known as the Third Way. He also contributed to the Lange-Lerner-Taylor theorem which is a neoclassical economic model for a hypothetical socialist economy based on public ownership of the means of production as well as a trial-and-error approach to determining output targets and achieving economic equilibrium and Pareto efficiency. In this model, the state owns non-labour factors of prod- uction, and markets allocate final goods and consumer goods. However by the 1960s Lerner began to distance himself from his early work on socialism.
He improved the calculations made by Wilhelm Launhardt on the effect of terms of trade.
He developed the concept of distributive efficiency, which shows that economic equality will produce the greatest total happiness with a given amount of wealth. The Lerner-Samuelson theorem goes back to Lerner. Simply stated the theorem says that when the prices of output goods are equalized between countries – as they move to free trade, then the prices of input factors (capital and labour) will also become equalized between countries. This theory was independently discovered by Lerner in 1933 but was published much later in 1952 by Ohlin and Samuelson.
He also developed the NAIRU concept before Friedman and Phelps (in Ch 14 of his Economics of Employment 1951). He termed it “low full employment” and contrasted it to “high full employment,” the maximum employment achievable by implementing functional finance.
- Colander, David (December 1984), “Was Keynes a Keynesian or a Lernerian?”, Journal of Economic Literature 22: 1571–79, argues for the influence of Lerner’s interpretation Keynes in “textbook” Keynesianism.
- Abba Ptachya Lerner, 1903-1982″ by David S. Landes, 1994, Biographical Memoirs of NAS [online] [pdf]
- Lerner, Abba P. Flation: Not Inflation of Prices, Not Deflation of Jobs. New York: Quadrangle Books, 1972.
- Lerner, Abba P. Economics of Employment, McGraw-Hill, 1951.
- Abba Lerner and David C. Colander, MAP: A Market Anti-inflation Plan, New York: Harcourt Brace Jovanovich, 1980.
- Scitovsky, T. “Lerner’s Contributions to Economics,” Journal of Economic Literature 22 (December 1984), 1547