Obstfeld, Globalist

This Maurice Obstfeld op-ed in the FT is a perfect distillation of the orthodox position on trade. Obstfeld is the guardian of free-trade orthodoxy ex officio as head of research at the IMF; he’s also done the circuit of top US departments and is co-author of one of the most widely used undergraduate textbooks. [1]

The op-ed is, of course, against tariffs. This isn’t news. I was at a session on trade policy at the American Economic Association last year, where the chair introduced the panel by saying, “Obviously, if you are in this room then you are for free trade, as much as we can get,” which is a pretty fair description of the range of opinion among credentialed economists. But it’s still striking how many of the tenets of faith Obstfeld manages to hit in 250 words.

Start with the explanation for why trade deficits are not necessarily bad:

“For example, they can help countries finance productive long-term investments that ultimately raise national income and wealth.”

This is the classic argument for international integration. Poor countries, by accepting capital inflows (the ambiguity between capital as money and capital as means of production is essential to the argument) can finance more investment and thereby achieve faster income growth than they would be able to on the basis of domestic savings alone. Obstsfeld’s “for example” is misleading here — as I’ve pointed out before, the option of running trade deficits is the entire benefit of free flows of portfolio investment in the orthodox theory.

Analytically, the op-ed’s key passage is:

A country’s overall trade balance is a macroeconomic phenomenon that mirrors whether it spends less than its income or more. In contrast, the structure of bilateral trade reflects the international division of labor – based on each country’s comparative advantage.

Here we have three key planks of orthodox trade economics. First, the airtight seal between “macro” and “micro” analysis, which protects us from discovering that these are two incompatible approaches based on mutually contradictory assumptions. Second, the anti-Keynesian macro component, with income fixed and savings as a constraint. Third, the bland invocation of the “international division of labor,” as if this were an anodyne technical fact and not a hierarchical, unequal relationship between the rich and poor worlds.

The macroeconomic part of Obstfeld’s argument is that trade restrictions “would not alter the fact that the US spends more than it earns — the source of the overall US deficit.” It is, of course, true as a matter of accounting that the current account deficit is equal to the government deficit plus the difference between private investment and private saving. Writing “the source” implies that this is a causal relationship and not just an accounting one — that how much the US “earns” is independent of the trade position. But there’s a problem — additional US exports constitute additional income for US businesses and households. An increase in US exports (or fall in imports) would, all else equal, increase savings by an exactly equal amount. So it’s not obvious how savings can be a constraint on the trade balance.

The argument that trade policy cannot change the overall deficit because national saving is fixed, is simply a transposition of the “Treasury view” of the 1930s that public investment could not increase output or employment since it would draw on the fixed supply of national saving and would crowd out an equal amount of private investment. It’s wrong for the same reason: Exports, like investment, create their own saving. It’s straightforward to show how interventions like tariffs or devaluations can generate some mix of higher output and a move toward trade surplus, while all the accounting identities are satisfied. This was a standard feature of older textbooks, and of many more recent ones in the form of the IS-LM-BP model, even if it’s not there in the more recent Obstfeld-Krugman books.

Obstfeld himself seems to have some misgivings about this argument, since he adds the caveat “for a country at full employment, like the US.” He also warns that trade restrictions “could derail the world economy’s current expansion,” which is obviously inconsistent with the idea that saving and investment are determined prior to trade balances.

It’s also striking that while Obstfeld acknowledges that “trade balances can of course be excessive” (the “of course” here functioning as a dismissal) there is no hint anywhere else in the op-ed about what the dangers of excessive deficits might be or how they could arise.

On the micro side, Obstfeld simply repeats variations on the same formula several times: trade restrictions “can badly distort the international division of labor.”

This sounds fine: division of labor is good, distorting is bad. (Distort is one of the many keywords that allows economic theory to appear to make contact with observable reality by confusing a technical meaning with an everyday one.) But what this formula actually means is: The countries that are rich, should remain rich. The countries that are poor, should remain poor. The countries that specialize in higher education and software and pharmaceuticals should retain their monopolies, the countries that specialize in plantation agriculture and sweatshop clothing should keep on doing that. “Comparative advantage” means that the hewers of wood and drawers of water are destined to remain such. Everybody should stay in their lane.

The “international division of labor” is a gesture at models that start from the premise that countries’ productive potential is fixed, given by nature or god. It is directly opposed to the idea of economic development, which starts from the premise that productive potentials are contingent and path-dependent, and that the whole goal of policy is to change — “distort”, if you will — the international division of labor.

These phrases might not have leaped out at me so much if I hadn’t just been reading Quinn Slobodian’s Globalists. (It’s a great book — look for my review in the Boston Review of Books sometime soon.) As Slobodian lucidly recounts, the real content of Obstfeld’s pieties was expressed more clearly by Mont Pelerin luminaries like Wilhelm Ropke, who

believed that an economically equal world might simply be impossible, and that developing countries might have to remain underdeveloped as a way of preventing possible ‘over-industrialization and underagriculturalization of the world.’ … the conditions for industrialization in the Third World did not exist. .. ‘The rich countries of today are rich because, along with the necessary prerequisites of modern technology, they have a particular form of economic organization that responds to their spirit.’ … Ropke believed that the ‘lack of punctuality, reliability, inclination to save and create’ … meant that industrialization schemes in the Global South were ‘doomed to fail.’

The position these early neoliberals were arguing against was the “global New Deal” which aimed not to reinforce the global division of labor, but to erase it through a convergence between the poor and rich worlds — in the memorable words of Senator Kenneth Wherry, to “lift Shanghai up and up, ever up, until it is just like Kansas City.” It’s worth emphasizing how diametrically opposed Obstfeld’s 2018 vision of trade is to Wherry’s 1940 one. Comparative advantage and the international division of labor are, for Obstfeld, fixed and god-given. You’d think the fact that Shanghai has in fact risen up well above Kansas City — and more broadly, that China, the greatest economic growth story of our times, has violated every one of his precepts — would give him pause. But it doesn’t seem to.

The neoliberals of the 1940s and 50s took exactly Obstfeld’s line. In Slobodian’s summary, their “critique of mainstream development theories began with the conviction that the industrialization of formerly agricultural areas … distorted the international division of labor and led nations to specialize in branches of production for which their natural endowments were unsuited.” Since so many people in the newly independent South were unhappy with their current position in the division of labor, this led naturally to calls for restrictions on political rights in the former colonies, and of non-whites in South Africa and elsewhere.

Obstfeld would, I’m sure, be appalled at the frank racism of Ropke. But Ropke at least had an explanation for why the benefits of industry and technology should be concentrated in a small part of the globe — the genetic-slash-cultural superiority of white Europeans. What’s Obstfeld’s explanation for why the “undistorted” international division of labor happens to so favor Europe and North America? Is it the climate?

 

[1] I’ve assigned Obstfeld’s textbook. It’s pretty good, as mainstream texts go.

31 thoughts on “Obstfeld, Globalist”

  1. I have to digest this link between the “international division of labor” and protectionism/mercantilism.

    However, as a first tought, the idea that “developed” countries have higer income than less developed ones because of the international division of labor (as opposed to a more genericval multipurpose technologic dominance) implies that rich countries have a sort of “quasi rents” (I think this is the term):

    Suppose that in a country that is mostly based in agriculture there is an industrial boom, so that many people will leave the field to become blue collars, generally because of higer wages for blue collers VS farming workers.
    As long as industrial capital makes higer profits than agricultural capital, money will be poured into industry from agriculture, until the profit rate more or less equilibrates; contemporaneously the wage premium to attract workers in blue collar occupations will fall.
    At the end, in theory we have an equilibrium where capitalists have the same profits in agriculture or industry, and workers have more or less the same wages both in agriculture and in industry.

    However this idea of the international division of labour between an industrialised north and an agricultural south is based on the principle that this equilibrium doesn’t extend to the whole world: before the agricultural wages and prices start to rise, our country begins to trade with the rest of the world, which is mostly at a lower technological stage, so that industrial labor and capital continue to get an outsized return forever (or at least for a longer period).

    I think that it’s clearer if we think in terms of an imperfect LTV:

    In both Ireland and England, 1kg of corn takes an hour to produce and costs 1$, while a shirt takes five hours and costs 5$; furthermore total production is split more or less equally between the two trades, 50% of the popiulation working in each, thus the average worker produces 5kg of corns plus a shirt in a 10 hours day of work, for an output of 10$.

    But in England, because of the industrial revolution, productivity in shirtmaking rises so that now a shirt only takes 3 hours to make, while corn productivity stays the same. I’ll also assume that preferences in consumption stay the same, so that Englishman will still want to consume 1 shirt for every 5kg of corn they produce.

    But in order too get there, they have to shift some workers from shirtmaking to corn farming, because I’m assuming fixed consumption preferences but different changes in productivity, so they have to shift from a 50%/50% distribution of labour to a 37,5%/62,5% distribution of labour; once they get there the average english worker will hace an output of 1,25 shirts and 6,25 Kg of corn per 10 hours of work, an output increase of +25%.

    The output increase is lower than the productivity increase in shirtmaking (that was of +67%) because more people have to shift in agriculture to keep the proper shirt/corn output preference.

    How would this happen in pratice?

    1) we start from the original price equilibrium of 5/1 between shirts and corn, one innovator uses the new industrial technology to produce shirts with only 3h of labour and thus, at the 5/1 price, he makes a lot of profits;
    2) other capitalists see the advantage and everyone tries to introduce the new technology; competition in shirts goes up while competition in corn doesn’t, until shirtmakers are forced to lowe prices. Those who can’t sustain the lower prices go bankrupt and various shirt workers (or previous artisans) are sent back to the land.
    3) ultimately, the price ratio becomes 3/1, the people employed in the two trades get to the 37,5/62,5 ratio, and wages and profits in the two trades equalise. At this point there has been an increase of 25% in overall productivity, but this is much less than the initial high profits of the first innovator, who could sell at the 5/1 price ratio.

    But if England can trade with Ireland before it reaches the point 2, and Ireland for some reason is not able to idustrialise, all English workers and capitalists can go into shirtmaking while mantaining the 5/1 price ratio, since Ireland (and the rest of the world) are big enough to buy all the english exports; and if they are not big enough they can trade at a 4/1 price ratio that is low enough to kill all irish competitors, and still much better than the 3/1 “autarky” price ratio.

    This is in fact the strategy followed by all european industrial (and imperialist) powers, and the “infant industry” theory developed agains it says that the Irish should refuse the lwer priced English shirts in order to give time to their own shirt industri to develop.

    If we look at this 4/1 price ratio situation, we see that the average English worker produces 3.3 shirts a day, and since he wants 5kg of corn for every 1 shirt, at the 4/1 ratio, he will keep 1.45 shirt and trade the remaining 1,85 for 7,4 Kg of corn.
    This means that, in this non autarky situation, english worker overall productivity increased by 45%, much more than the 25% of the “autarky” situation.
    But this is due to the fact that the English have a quasi rent on shirtmaking, as the Irish cannot compete with them (the Irish also have a gain on trade, since the 4/1 ratio is still better than their own 5/1 autarky price ratio, however these gains are lower than the 25% overall gain if they can reproduce english technology, so for them “protection” of their shirt industry makes sense, as long as this can lead to the development of the new industrial technology).

    Now, the problem for the English is that, in order to have their nice +40% gain in productivity, they necessariously have to trade with the Irish, otherwise they have to accept the +25% “autarky” productivity increase (that is the “true” productivity increase, ignoring the quasi rents). But if they have a completely free trade, the Irish will soon or later develop their shirt industry anyway, just by copying the English one, and then the productivity gain will rise to 25% for the Irish, but fall to 25% for the English: they will see an apparent fall in productivity, due to the disappearence of the quasi rent; they thus want free market up to a certain limit, but they doin’t want their technology to leak out.

    If we get to Trump’s protectionism, it seems to me that it’s based on the idea of preventing the rise of China, and thus preserve USA’s quasi rent; but this is a problem (apart of other considerations) because the quasi rent only exists as long as the USA can trade with the outside. In fact if the USA reshores those parts of the production chain that went outside, it will lose in terms of apparent productivity because it wiull be foregoing the quasi rents, as if in my example the English forbade the import of corn from Ireland.

    But all this has nothing to do with the level of employment, that is arguably what Trump promised to his supporters, so the two arguments are quite different: a fall in imports will increase employment only as far as the imported goods are substituted by locally produced goods, but not if the falling imports just translate in diminished consumption.
    If for example we assume that unemployment follows a Goodwin-like cycle, so that when wages rise the economy will just tumble because profit fall too much, the hoped for increase in wages will not materialise because the fall in profits for USA businesses due to the fact that they have to pay higer wages will just cause a recession (the Goodwin cycle IMHO explains too much, in the sense that it makes any policy look useless since the economic cycle will just place wages and profits in their right places automatically, something that doesn’t really happen in reality, at least if we assume a fixed level for expected profits).

    So I think that the two arguments should be treated as different, and that the muddling of the two is a way to pass in some large quantity of bullshit, such as the idea that Trump is trying to make it easier for USA corporations to invest in China in order to increase jobs in the USA, or more or less everything brexit.

  2. man I would like to read Obstfeld’s response to this, because I’m guessing that if he did not encounter them as an attack on him, he’d be sympathetic to the points you are making.

  3. I’d also be interested in a response. Who knows, I might get one — on the internet, not only may a cat look at a king, but a king sometimes looks at a cat.

    (Tho if I wanted to maximize the chance of a reply I would have made the tone less aggressive.)

  4. An interesting read. Not to rain on the global free traders parade but from the extensive amount I have read on the future of oil we are at or nearing the end of “cheap oil” (roughly 2050) and increasingly entering “expensive oil” which will most likely run out in 2100. The dates vary depending if your an optimist or pessimist.
    Jeremy Grantham of GMO fund management has written extensively in his quarterly letters about the climate change and fossil fuel resource supplies declining. We a businessman such as Grantham is worried and then maybe it’s time to rethink global trade. Most climate change experts stress that we must keep what ever fossil fuels are in the ground there or risk severe climate issues.

    So three scenarios 1. Ideally all remaining fossil fuels must stay in the ground to prevent catastrophic climate change. 2. Increasing fuel costs make globalization very expensive. 2. At some point we will run out of fossil fuels.

    It seems at some point global trade will reach limits and we will return to local or national economies by default.

    I envision something along the lines of the demise of Easter Island and the native cutting their own throat by cutting down the last palm tree. In like manner I can see a freighter going from China to the US and stalled in the middle of the ocean because it ran out of fuel.

    Yes 2050 or 2100 are a long way away but my three scenarios above still apply in my opinion. Anybody heard of an new way to power a massive cargo ship other than fossil fuels??

    1. You can run a massive cargo ship with a nuclear reactor. Those already power aircraft carriers, submarines and ice-breakers. No CO2!

      1. Good Catch. I thought about using nuclear reactors for powering cargo ships after my above post. However my point was that global trade or any trade for that matter will no longer be just an economics problem but will be an environmental problem as well. Economics should have considered environmental issues decades ago The fact that we have conducted business and economics as if externalities and the environment do not matter is foolhardy. Today a product may have parts that come from all over the globe, i.e. the supply chain. We act like children in a candy store where there are no consequences. When the fossil fuel economy ends it will change economics and business practices. The fact that we need to consume every last resource before we start caring about the planet leads back to my Easter Island comparison above. I am not a Marxist but there is a good book by John Bellamy Foster called “The Ecological Rift: Capitalism’s War on Earth”. An interesting read.

  5. I’m always amused and revolted when the economist says something like:

    – Never reason from an accounting identity –

    It is inevitable that those who say it don’t know accounting, don’t know its proper place in economics, and don’t know what they are saying.

    “The argument that trade policy cannot change the overall deficit because national saving is fixed, is simply a transposition of the “Treasury view” of the 1930s that public investment could not increase output or employment since it would draw on the fixed supply of national saving and would crowd out an equal amount of private investment. It’s wrong for the same reason: Exports, like investment, create their own saving.”

    That is one type of reasoning from an accounting identity, and it is obviously correct. It is the type of reasoning that understands the implications of correctly closing accounting identities at the start and the end of a time period. The fact that a marginal export immediately creates its own capital outflow through the international banking system should be trivial to understand, but how many economists do you think would grasp this? And marginal saving shows up at the same time. If things like investment, saving, and income are the meat and bones of economic thinking, then economics is inextricably linked to an understanding of how the accounting for this stuff works, not only at a point in time, but over time. The “Treasury view” is both laughably and tragically erroneous for its fumbling ineptitude at understanding simple accounting dynamics. And it keeps reappearing decade after decade in mainstream economic teaching. To the degree that Keynes invented macroeconomics, he did it by inventing the macro accounting appreciation that is the foundation of thinking about stuff like the paradox of thrift and in rejecting the Treasury view.

    The economics profession at large is hideously unaware of how accounting is a deep part of the substance of its subject matter. This is the only explanation for how fundamental mistakes in thinking like Obstfeld’s can keep reappearing.

    1. The fact that a marginal export immediately creates its own capital outflow through the international banking system should be trivial to understand, but how many economists do you think would grasp this?

      Not very many, in my experience. I think it would be a quite unusual undegraduate or graduate class in international finance (let alone trade!) that discussed the role of the banking system at all. This is part of the larger obsession with price adjustment as the sole coordinating mechanism in the economy, to the exclusion of the passive buffers that actually ensure that payments balance.

      The economics profession at large is hideously unaware of how accounting is a deep part of the substance of its subject matter.

      Couldn’t agree more. My friend and coauthor Arjun sometimes says that done properly, macroeconomics would just be accounting plus history.

    1. I’ll be delighted to look at it.

      I find it hard to believe I know more about the theory of international trade than Krugman.

      I don’t find it hard.

  6. Thanks, always interesting points. I am increasingly struck by how much the top echelons of the subject are just as struck by muddled thinking on international macro issues as many less exalted commentators. I also strongly agree with JKH on accounting, in his comment just above.

    This point about treating CA deficits/surpluses as just the outcome of macro flows, as if these had no independent micro drivers, is a case in point of how economists seem not to understand what identities do and do not tell you.

    By means of evidence …. Krugman made a striking argument a couple of weeks back in one of his op-eds. In an article on Trump and the China tariffs he said the following:

    “Overall, the U.S. trade deficit is just the flip side of the fact that America attracts more inward investment from foreigners than the amount Americans invest abroad. Trade policy has nothing to do with it”

    I nearly fell off my chair when I read this. I can accept the argument that capital flows drive assets prices, FX rates and so on, and this has an impact on trade flows.

    But Krugman is seemingly going much further, implying that there is some demand for “net foreign investment” which magically drives an equivalent CA deficit/surplus. In my mind has totally misunderstood what the identities really mean.

    A rather simple example. Suppose we have a trade instrument that diverts demand from imports to a domestic supplier. Domestic incomes rise, and even with unchanged sector savings rates, national savings will rise, narrowing the CA deficit (assuming for simplicity that investment is fixed).

    Outcome is that domestic aggregate “saving” rises, simply because domestic income rises, not because savings rates change, and this narrows the saving/investment gap in a macro sense, and lowers the CA deficit. But these macro outcomes arise due to micro changes, not because of some macro desire for higher saving.

    Not sure why this is so hard to see for so many smart people. There is an article in today’s FT (25/4) on narrowing CA deficits in emerging markets, and the head of Oxford economics (a consultancy, but highly respected) makes a similar conceptual error, confusing the net flows and gross capital flows.

  7. Of course, you can have the reverse causality – you could have a shift in a sector savings ratio which spill over into higher/lower import demand, affecting the trade or CA balance that way too. But that just highlights how careful one has to be to disentangle causal chains in macroeconomics. Economics is hard.

  8. Of course, I realize I am not telling you anything new – you make the same points in your piece – I just like to vent occasionally 🙂

  9. Mainstream economics is imprisoned by Dunning Kruger. Because of its failure to incorporate accurate accounting thought processes for monetary and financial transactions, it gets economic causality backwards on a panoramic scale.

    MMT was a momentary ray of light. But it practices intellectual deception compounded by nasty disposition. Using the right starting point, it almost immediately fails in presentation integrity by presenting counterfactual monetary descriptions as factual. The motive appears to be about stoking mass consumption of ideological bias.

    It is not possible for a country to create a direct net capital flow with the rest of the world. Autonomous capital outflows can only create offsetting capital inflows. Conversely, marginal exports automatically create capital outflows. So it is incoherent to claim that a net capital inflow would somehow lead to a natural trade deficit. It is more coherent to suggest that relatively plentiful and likely risky autonomous gross capital inflows might create a foreign exchange effect favorable to the cost of imports, along with an excess position in lower risk gross capital outflows (e.g. money) which might then be converted at least in part to consumption via a trade deficit. It is then that kind of trade deficit knock on effect that converts an originally induced gross capital flow equivalence to a net capital inflow configuration.

    There are many ironies in academic economic thought. One is that Keynes was trained as a mathematician. But he used virtually no equations in the General Theory. That’s because mathematical reasoning comprises more than equations, particularly in the area of the kind of algebra to which Keynes was likely exposed. Conversely, DSGE differential calculus has been sprayed into the intellectual atmosphere by thinkers who by comparison are fake mathematicians. The exposure of backwards classical thinking by Keynes had nothing to do with the superficial minutiae of differential calculus. But it seems these calculators will never understand the deeper logical message of Keynes. If they don’t know accounting and the banking system, they can’t.

    (Not to pick on Krugman, but in fact he is a stellar example on the international capital flow front.)

    1. I frequently read the blog Naked Capitalism and they are proponents of MMT. Some of MMT makes sense to me and some seems a bit ideological. Can you provide some links to academic papers/books that support your objections to MMT? Like every theory there are pros and cons. Thanks

    2. Yes, exactly. Swapping one financial asset for another affects the financial account of the BoP in a neutral way, with either gross foreign assets and gross liabilities both rising, or both falling. Such transactions may have effects (asset price changes, changes in credit flows) which affect trade flows, but they cannot in themselves create a net capital flow. That can only come via an exchange of goods/services for assets (your “marginal exports”). I think you nailed it on Keynes too.

  10. JWM:
    “the ambiguity between capital as money and capital as means of production is essential to the argument”
    That’s the main problem, however I think we could also speak about “debt” instead of “capital as money”. In any case today it’s the poor country (China) that is supplying capital to the rich one (USA)

    Obstfeld:
    “A country’s overall trade balance is a macroeconomic phenomenon that mirrors whether it spends less than its income or more. In contrast, the structure of bilateral trade reflects the international division of labor – based on each country’s comparative advantage.”

    I have to say that I agree with Obstfeld here. The “comparative advantage” says that e.g. Germany trades in dishwashers while Italy trades in cars, but by itself it doesn’t tell us wether Germany will be a net exporter to Italy or the reverse.

    JWM:
    “the bland invocation of the “international division of labor,” as if this were an anodyne technical fact and not a hierarchical, unequal relationship between the rich and poor worlds.”

    True, but this is mostly the “infant industry” argument, it has nothing to do with trade balances. Also I don’t think that the “infant industry” argument makes sense for the USA, apparently the most technologically developed economy in the world.

    JWM:
    “It’s wrong for the same reason: Exports, like investment, create their own saving. It’s straightforward to show how interventions like tariffs or devaluations can generate some mix of higher output and a move toward trade surplus, while all the accounting identities are satisfied.”

    The second sentence isn’t implied by the first: an increase in exports depends by an increase in demand by other countries, tariffs cannot cause an increase in demand by other countries. Tariffs can decrease imports, which would lead to a “better” trade balance without actually create more demand.
    You have to assume that because of the tariffs there is a substitution between imports and locally produced goods, but IMHO you can’t just assume an 1 to 1 substitution, plus there is the disadvantage of the other countries placing trade barriers against you.
    Also, re devaluation, how do you “devalue” in pratice? The Chinese government IIRC bought USA bonds to keep the Yuan low, thus in pratice vendor-financing the USA deficits, is the USA government going to buy Chinese or EU bonds? The problem is that “devaluation” implies a change in macroeconomic policy, specifically that the USA will use some money to buy foreign debt, instead than in consumption, so you can’t use devaluations as a different option than a macroeconomic policy.

    JWM:
    “This sounds fine: division of labor is good, distorting is bad. (…) But what this formula actually means is: The countries that are rich, should remain rich.”

    I agree with this, but in the current contest (of the rich USA imposing tariffs on poorer China) it’s actually the tariffs that are supposed to keep the rich rich and the poor poor.
    It’s more something like: yeah, the free market worked for our advantage up to today, but now is working for the Chinese’s advantage, so screw them, tariffs!
    From this point of view “neoprotectionism” is more like an extension of “neoliberalism” than the opposite of it.

    ——

    My opinion is this: currently more or less all countries are in a situation of potential underconsumption, and thus governments have to stimulate their economies in various ways, otherwise both the employment level and wages would fall below acceptable levels.
    But since international trade is quite easy, those countries that “stimulate” more the economy will also tend to become net importers, or if you prefer stimulus will partially leak outside.

    On this, I think that Obstfeld is correct because he implies that the cause of the USA deficit is the high level of internal, debt driven demand, but he fails to realise that this is a consequence of a situation of potential underconsumption.

    The problem is that this idea of increasing the trade balance is sold as a solution for various and opposite problems: it’s supposed to increase employment, increase wages, and also increase profits; but this could happen only if this increase in the trade balance was caused by an increase of foreign demand, not by limiting imports, so either profits or wages will have to pay for neoprotectionism, and I strongly suspect that it won’t be profits to fall.

  11. JKH,

    “It is inevitable that those who say it don’t know accounting, don’t know its proper place in economics, and don’t know what they are saying.”

    Could you explain how you see accounting’s “proper place” in economics?

    1. I don’t want to abuse the commenting space, so I’d simplify it as – accounting is a subset of economics. It’s a foundational logic framework, or should be. Especially in the case of monetary systems, but imaginary barter as well. You can’t understand banking and finance without it. And it’s essential for closure in macroeconomic thinking of all kinds. A most terrible quote from a very prominent new Keynesian blogger/professor: “That’s not economics. That’s accounting.”

      1. JKH,

        OK with your comments.

        The thing with accounting is that we have to remind ourselves that it is ex post. Some people use identities as if they were ex ante behavioural relationships. The sectoral balance equation seems to be much abused in this way.

        1. You are absolutely right that there are many examples of how people can push accounting identities in the wrong direction and claim misleading conclusions about causality. This is usually due to a basic error in underestimating the complexity of colliding variables. And I think you’re right that there may well be a lot of abuse around in invoking sector balance constraints in order to come up with somewhat biased conclusions. But there are examples are where it’s more wisely used as well.

          But I think your comment also embeds what I consider to be a pretty big category error that misses the more fundamental role and value of accounting in finance and economics.

          The error is in this:

          “We have to remind ourselves that it is ex post”

          It is not just ex post.

          It is ex post, current, and ex ante.

          And this goes to the heart of the usefulness of so-called “modelling” in economics.

          Accounting is ex ante in the sense that any projection, simulation, scenario analysis, etc. that attempts to consider the future must be exhibited within a framework of accounting coherence that links past, present, and future. In other words, there must be a consistent projection of what we typically see as ex post into the framework for a possible future. This is what so-called stock-flow consistency is all about, in effect. And it’s how Keynes was able to come up with things like the paradox of thrift and similar stuff. He was considering conceivable outcomes, which means he was considering what is possible for the future. He developed macro accounting logic as a foundation for thinking about the future.

          Krugman occasionally uses this way of thinking in calling out what he considers to be the false logic of freshwater economics. Understanding that income changes when government spending changes in a way that results in new output is pretty fundamental (Treasury view stuff). Ironically and unfortunately, Krugman is one of the worst when it comes to understanding bank accounting, which is essential to an understanding of how banks works. So-called endogenous money is simply a fact of life.

          Any so-called model that attempts to project the future must project future accounting results that connect seamlessly with the current configuration and with ex post prior results.

          As a type of mathematics – which is what it is – accounting is no more ex post than calculus or algebra. It can be applied to analysis of the past and the present, and to considerations of what is possible in the future.

          Finally, this type of consideration of the future is part and parcel of risk analysis and risk management – which again is essential to finance and economics. This all has to be done on a coherent accounting platform and on a smooth continuum from past to future.

          Anyway, that’s the way I see it. I just think it’s quite dangerous to think in terms of accounting being ex post. That can degenerate into an excuse for thinking sloppily about the future.

  12. JKH,

    “It is ex post, current, and ex ante.”

    I more or less disagree with this statement.

    For me, accounting is about recording what has happened.

    Of course, accounting is used in ex ante modelling but as a record of anticipated results. What generates the results is a behavioural model. Otherwise, with a pure accounting model you can argue anything you want without having to demonstrate or justify how you got there. You could say revenue equals X – you have generated your record of anticipated results – i.e. your accounting model. But where does “X” come from?

    “That can degenerate into an excuse for thinking sloppily about the future.”

    Yes, I agree that can happen if accounting is neglected. In a way, accounting can assist in validating your behavioural model.

  13. “That can degenerate into an excuse for thinking sloppily about the future.”

    Also, I would equally argue that arguing from an accounting model could also lead you to think sloppily about the future.

  14. Henry,

    “What generates the results is a behavioural model. Otherwise, with a pure accounting model you can argue anything you want without having to demonstrate or justify how you got there. You could say revenue equals X – you have generated your record of anticipated results – i.e. your accounting model. But where does “X” come from?”

    Who said anything about the absence of behavior or the absence of behavioral assumptions or the absence of behavioral “models” in generating simulated future results? Not me. Check it. If that were the case, I’d have to believe that behavior was not a factor in producing actual accounting results ex post – in order to be consistent in my ignorance of this aspect across time. I’d like to think that at least in this limited application I’m not quite that thick.

  15. JKH,

    I have to say I was taken aback by your initial statement, which set the scene, and the tenor of the remainder of your comments:

    “I’m always amused and revolted when the economist says something like:

    – Never reason from an accounting identity –”

    This all seemed rather dogmatic.

    I don’t know that I would go as far as, “Never reason from an accounting identity”. However, I would certainly say, be very careful if you do reason from an accounting identity.

    1. If you are going to argue from an accounting identity, or from any other basis, it is certainly very wise to be very careful.

      Especially depending upon just who you are arguing with.

      In my experience, if you are going to argue with JKH, it is very wise to leave room to modify your argument very quickly because if it isn’t exactly right, JKH is going to point out what is wrong with it in very clear terms in very short order.

      But it seems you have already realized this to some extent.

  16. Jerry,

    JKH is an ubiquitous commentator whose comments I am always interested to read.

    On this occasion he seemed to have gone way over the top. I was hoping he would clarify exactly where he stood, which he has of course now done.

    I guess the tone of his comments speaks to his long standing frustrations with economists. There’s a lot to be frustrated about. 🙂

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