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P. R. Brahmananda

JAMES Tobin, a Nobel Laureate in economics, acclaimed as the foremost macroeconomist in the Keynesian tradition in the US, passed away last week. Tobin, who was professor emeritus at Yale University, was ailing for some time. He had studied at Harvard under Alvin Hansen, considered in his time as the American Keynes. Tobin spent all his working life in Yale University. He was renowned as a great teacher and also as the distinguished PhD guide of a number of brilliant students like R. C. Porter, Alan Heston, Douglas Hestor and Hugh Patrick, all of whom have worked on monetary and financial economics.

Tobin made his name through his early articles on the role of money-wage rate flexibility in the Keynesian theory. Gradually, he widened the scope of choice for the use of money in purchases of various types of assets. Keynes had considered that the only alternative for holding money was to purchase a fixed coupon-yield bond. Robertson had commented on the narrow range in Keynes for the alternative uses of money. Earlier, Alfred Marshall in his famous evidence to an Indian Currency Commission had included purchases of financial assets as an alternative to the holding of money. It was to the distinct credit of John Hicks and James Tobin to have extended the alternatives to the holding of money to a wide range of assets. Hicks applied the indifference curve approach for the study of portfolio choice. Simultaneously, Tobin included the purchases of shares, bonds, real capital assets as falling within the purview of portfolios on which money could be expended. Tobin characterised different individuals according to whether they were risk avoiders, risk averters, and risk takers. Risk avoiders would prefer to hold money or fixed yield bonds with guarantee of return of the principal, equivalent to the nominal value when they were purchased. Risk averters would place a high premium on certainty of yield and on ready marketability of assets without much loss. Risk takers would place a premium on the measure of variability of yields and seek to make profits from fluctuations in the market value of assets. Shares primarily belong to the last category. If human beings have different characteristics regarding their attitudes to risks, and these attitudes are stable, the portfolio choice theory becomes relevant and becomes like the demand theory for different consumption goods. If a market is characterised by different types of human beings with different attitudes to risks, an increase in money supply would necessarily have some effect on the rate of interest, bringing it down.

Keynes had stated that a market would be characterised by great instability with regard to expectations. There were no fixed attitudes to risks among operators and players in the market. Normally, a market would be characterised by bulls and bears. But, expectations are down, all bulls would become bears, and when expectations were rising high, all bears would become bulls. This is the reason why Keynes did not develop the portfolio choice theory as such. When the market is characterised by bearishness all around, any amount of money would not lead to a fall in the rate of interest. Hicks and Tobin departed from Keynes approach and treated the financial market as akin to markets for consumption goods.

Tobin could argue that monetary policy leading to an expansion in money could lead to a reduction in the interest rate given the two postulates referred to earlier. Keynes had ruled out any role for monetary policy under pessimistic expectations. But, Tobin had allowed scope for monetary policy even under the above conditions.

The next step that Tobin took was to relate the reductions in the interest rate to upward movements in share prices. The market capitalisation of firms would go up when share prices move up in response to the policy of reduction in interest rates. When share prices move up, the market values become greater than the historical capital values of the firms. The ratio of market values to capital values is the q-ratio. When the q-ratio goes up, there tends to be capital gains on shares and this should, according to Tobin, lead to a recovery in businesses. New capital investments would take place. Real investment was related to the q-ratio and this itself was largely related to the interest rate policy.

Tobin's theory of monetary policy thus provided a link between money and interest rates, a link between interest rates and the q-ratio and a link between the q-ratio and real investment. Tobin's contribution thus was to reinstate the role of monetary policy in business cycles. Money had a role in stabilisation of incomes, contrary to the position taken by Keynes. If fluctuations occur in the background of steady growth, stabilisations can occur through monetary policies.

Tobin's analysis introduced a new channel for the operation of monetary policies.

There was a vigorous controversy between Friedman and Tobin on the mechanism through which money affects the real system. Friedman used the quantity theory as a theory of nominal incomes with a stability property for the demand for money, given the level of the nominal income. Friedman had assumed excess capacities in equipment and labour and argued that expansion of money given the stability of demand for money would lead to an expansion in nominal national income and in real national income. Friedman did not think that the effect of increase in money would be a definite reduction in the interest rates. He had to postulate stable relations between commodity stocks and the stock of money and real wealth and the stock of money. But, Friedman did permit interest rates to fall in the transition to the expansion of income. But, interest rates would move up again. The fall in interest rates was a temporary phase for Friedman. But, for Tobin, the mechanism was different and there is an enduring fall in the rate of interest. Friedman did not accept the portfolio choice theory with respect to assets and Tobin did not accept the stable demand for money approach. Interestingly, both of them had provided a role for money in affecting the real system under conditions of underemployment.

Tobin is considered the father of the theory of choice among financial assets. But, empirically, as the recent experience in America indicates, monetary action leading to a reduction in interest rates does not always work. The stock markets do not move up in a firm manner when interest rates are reduced. The US authorities adopt other instruments like tax cuts, etc, to stimulate recovery. Tobin's q-ratio was once so famous that students in Yale University had the q-ratios printed on their shirts. They were thus identified as belonging to Yale! Probably, Mr Sinha does not know that he himself was a dogged, but unconscious believer, till recently in the q-ratio! His earlier economic adviser Dr Kelkar knew about the q-ratio. But, blissfully Mr Sinha did not. Any way, the q-ratio did not work in India. Mr Sinha's budgets could not stimulate a real investment boost through the mechanism of moving share prices up by announcing reductions in the interest rates in the Budget or immediately thereafter. When the first reduction did not work, a second reduction was brought about, and even when this did not work, a further reduction was sought for. Tobin would have been happy to know that the Indian Finance Minister was the greatest disciple of the q-ratio theory!

Several years ago, Kaldor thought that TTK was his disciple, when he introduced the expenditure tax. But, TTK announced in Parliament that he did not know anything about Kaldor. Economists must beware of having finance ministers adopting their ideas and implementing them. In his memoirs, I. G. Patel wrote that when you write a speech for the minister, he exercises ownership rights over them! He thinks that he himself has originally thought up those ideas! There is a wonderful story of an Egyptian author who translated Keynes's General Theory into Arabic, but claimed it as his own work. There were no copyrights in Egypt at that time. Most economists in the US use the word new-classical economics and attribute it to Lucas. But, long before Lucas came on the scene, an Indian economist had written at least two books with the title containing the term new-classical economics. Many foreign-returned Indian economists, and even the Nobel Committee, probably think that the copyright belongs to the distinguished American economist. Is it not said that originality often consists in not mentioning the source of one's ideas! Of course, the portfolio approach was earlier developed by Markowitz, who also received a Nobel prize, but after Tobin. Markowitz himself thought that he developed the ideas after his teacher John Williams. In the long run, all economists are dead and what matters who thought of the new ideas first.

Tobin had claims to at least two other ideas. In a growth context, Tobin argued that money, after causing the rate of interest to go down, would lead to a rise in capital intensity of output and to a rise in the real national income due to the increase in the productivity of labour. A young economist by the name of Sidrauski of the Yale University developed this idea further, linking money to growth. But, he passed away rather young.

Tobin along with Nordhaus introduced the concept of gross national welfare product in place of gross national product. In the former, the consequences of environmental degradation, etc, are deducted from GNP.

James Tobin and his wife had come to India in December 1984. The Indian Economic Association's annual conference was at Agra. The Tobins specially came to the meeting and Tobin conveyed the greetings of the American Economic Association to the Indian fraternity. The previous night they had hoped to see the Taj Mahal shrouded in moonlight, but the clouds had covered the moon. There were many clouds between the moon and the Taj Mahal, just as Keynes had said there were many slips between the lip of real investment and the cup of liquidity. The clouds, probably, did not care for the q-ratio, like our speculators in the stock market.

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