The Slack Wire

Reading Notes: Demand and Productivity

Here are two interesting articles on demand and productivity that people have recently brought to my attention.

The economic historian Gavin Wright — author of the classic account of the economic logic of the plantation — just sent me a piece he wrote a few years ago on the productivity boom of the 1990s. As he said in his email, his account of the ‘90s is very consistent with the suggestions I make in my Roosevelt paper about how strong demand might stimulate productivity growth.

In this article, Wright traces the idea that high wage regions will experience faster productivity growth back to H. J. Habbakuk’s 1962 American and British Technology in the Nineteenth Century. Then he assembles a number of lines of evidence that rapid wage growth drove the late-1990s productivity acceleration, rather than vice versa.

He points out that the widely-noted “productivity explosion” of the 1920s — from 1.5 percent a year to over 5 percent — was immediately preceded by a period of exceptionally strong wage growth: “The real price of labor in the 1920s … was between 50 and 70 percent higher than a decade earlier.” [1] The pressure of high wages, he suggests, encouraged the use of electricity and other general-purpose technologies, which had been available for decades but only widely adopted in manufacturing in the 1920s. Conversely, we can see the productivity slowdown of the 1970s as, at least in part, a result of the deceleration of wage growth, which — Wright argues — was the result of institutional changes including the decline of unions, the erosion of the minimum wage and other labor regulations, and more broadly the shift back toward “‘flexible labor markets,’ reversing fifty years of labor market policy.”

Turning to the 1990s, the starting point is the sharp acceleration of productivity in the second half of the decade. This acceleration was very widely shared, including sectors like retail where historically productivity growth had been limited. The timing of this acceleration has been viewed as a puzzle, with no “smoking gun” for simultaneous productivity boosting innovations across this range of industries over a short period. But “if you look at the labor market, you can find a smoking gun in the mid-1990s. … real hourly wages finally began to rise at precisely that time, after more than two decades of decline. … Unemployment rates fell below 4 percent — levels reached only briefly in the 1960s… Should it be surprising that employers turned to labor-saving technologies at this time?” This acceleration in real wages, Wright argues, was not the result of higher productivity or other supply-side factors; rather “it is most plausibly attributed to macroeconomic conditions, when an accommodating Federal Reserve allowed employment to press against labor supply for the first time in a generation.”

The productivity gains of the 1990s did, of course, involve new use of information technology. But the technology itself was not necessarily new. “James Cortada [2004] lists eleven key IT applications in the retail industry circa 1995-2000, including electronic shelf levels, scanning, electronic fund transfer, sales-based ordering and internet sales … with the exception of e-business, the list could have come from the 1970s and 1980s.”

Wright, who is after all a historian, is careful not to argue that there is a general law linking higher wages to higher productivity in all historical settings. As he notes, “such a claim is refuted by the experience of the 1970s, when upward pressures on wages led mainly to higher inflation…” In his story, both sides are needed — the technological possibilities must exist, and there must be sufficient wage pressure to channel them into productivity-boosting applications. I don’t think anyone would say he’s made a decisive case , but if you’re inclined to a view like this the article certainly gives you more material to support it.

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A rather different approach to these questions is this 2012 paper by Servaas Storm and C. W. M. Naastepad. Wright is focusing on a few concrete episodes in the history of a particular country, which he explores using a variety of material — survey and narrative as well as conventional economic data. Storm and Naastepad are proposing a set of general rules that they support with a few stylized facts and then explore via of the properties of a formal model. There are things to be learned from both approaches.

In this case the model is simple: output is demand-determined. Demand is either positive or negative function of the wage share (i.e. the economy is either wage-led or profit-led). And labor productivity is a function of both output and the wage, reflecting two kinds of channels by which demand can influence productivity. And an accounting identity says that employment growth is qual to output growth less labor productivity growth. The productivity equation is the distinctive feature here. Storm and Naastepad adopt as “stylized facts” — derived from econometric studies but not discussed in any detail — that both parameters are on the order of 0.4: An additional one percent growth in output, or in wages, will lead to an 0.4 percent growth in labor productivity.

This is a very simple structure but it allows them to draw some interesting conclusions:

– Low wages may boost employment not through increased growth or competitiveness, but through lower labor productivity. (They suggest that this is the right way to think about the Dutch “employment miracle of the 1990s.)

– Conversely, even where demand is wage-led (i.e. a shift to labor tends to raise total spending) faster wage growth is not an effective strategy for boosting employment, because productivity will rise as well. (Shorter hours or other forms of job-sharing, they suggest, may be more successful.)

– Where demand is strongly wage-led (as in the Scandinavian countries, they suggest), profits will not be affected much by wage growth. The direct effect of higher wages in this case could be mostly or entirely offset by the combination of higher demand and higher productivity. If true, this has obvious implications for the feasibility of the social democratic bargain there.

– Where demand is more weakly wage-led or profit-led (as with most structuralists, they see the US as the main example of the latter), distributional conflicts will be more intense. On the other hand, in this case the demand and productivity effects work together to make wage restraint a more effective strategy for boosting employment.

It’s worth spelling out the implications a bit more. A profit-led economy is one in which investment decisions are very sensitive to profitability. But investment is itself a major influence on profit, as a source of demand and — emphasized here — as a source of productivity gains that are captured by capital. So wage gains are more threatening to profits in a setting in which investment decisions are based largely on profitability. In an environment in which investment decisions are motivated by demand or exogenous animal spirits (“only a little more than an expedition to the South Pole, based on a calculation of benefits to come”), capitalists have less to fear from rising wages. More bluntly: one of the main dangers to capitalists of a rise in wages, is their effects on the investment decisions of other capitalists.

What Recovery: Reading Notes

My Roosevelt Institute paper on potential output came out last week. (Summary here.) The paper has gotten some more press since Neil Irwin’s Times piece, including Ryan Cooper in The Week and Felix Salmon in Slate. My favorite headline is from Boing Boing: American Wages Are So Low, the Robots Don’t Want Your Jobs.

In the paper I tried to give a fairly comprehensive overview of the evidence and arguments that the US economy is not in any meaningful sense at potential output or full employment. But of course it was just one small piece of a larger conversation. Here are a few things I’ve found interesting recently on the same set of issues. .

Perhaps the most important new academic contribution to this debate is this paper by Olivier Coibion, Yuriy Gorodnichenko, and Mauricio Ulate, on estimates of potential output, which came out too late for me to mention in the Roosevelt report. Their paper rigorously demonstrates that, despite their production-function veneer, the construction of potential output estimates ensures that any persistent change in growth rates will appear as a change in potential. It follows that there is “little value added in estimates of potential GDP relative to simple measures of statistical trends.” (Matthew Klein puts it more bluntly in an Alphaville post discussing the paper: “‘Potential’ output forecasts are actually worthless.”) The paper proposes an alternative measure of potential output, which they suggest can distinguish between transitory demand shocks and permanent shifts in the economy’s productive capacity. This alternative measure gives a very similar estimate for the output gap as simply looking at the pre-2008 forecasts or extrapolating from the pre-2008 trend.  “Our estimates imply that U.S. output remains almost 10 percentage points below potential output, leaving ample room for policymakers to close the gap through demand-side policies if they so chose to.” Personally, I ‘m a little less convinced by their positive conclusions than by their negative ones. But this paper should definitely put to the rest the idea (as in last year’s notorious CEA-chair letter) that it is obviously wrong — absurd and unserious — that a sufficient stimulus could deliver several years of 4 percent real growth, until GDP returned to its pre-recession trend. It may or may not be true, but it isn’t crazy.

Many of the arguments in my paper were also made in this valuable EPI report by Josh Bivens, reviving the old idea of a “high pressure economy”. Like me, Bivens argues that slow productivity growth is largely  attributable to low investment, which in turn is due to weak demand and slow wage growth, which blunts the incentive for business to invest in labor-saving technology. One important point that Bivens makes that I didn’t, is that much past variation in productivity growth has been transitory; forecasts of future productivity growth based on the past couple of years have consistently performed worse than forecasts based on longer previous periods. So historical evidence gives us no reason see the most recent productivity slowdown as permanent. My one quibble is that he only discusses faster productivity growth and higher inflation as possible outcomes of a demand-driven acceleration in wages. This ignores the third possible effect, redistribution from from profits to wages — in fact a rise in the labor share is impossible without a period of “overfull” employment.

Minneapolis Fed president Neel Kashkari wrote a long post last fall on “diagnosing and treating the slow recovery.” Perhaps the most interesting thing here is that he poses the question at all. There’s a widespread view that once you correct for demographics, the exceptional performance of the late 1990s, etc., there’s nothing particularly slow about this recovery — no problem to diagnose or treat.

Another more recent post by Kashkari focuses on the dangers of forcing the Fed to mechanically follow a Taylor rule for setting interest rates. By his estimate, this would have led to an additional 2.5 million unemployed people this year. It’s a good illustration of the dangers of taking the headline measures of economic performance too literally. I also like its frank acknowledgement that the Fed — like all real world forecasters — rejects rational expectations in the models it uses for policymaking.

Kashkari’s predecessor Narayan Kocherlakota — who seems to agree more with the arguments in my paper — has a couple short but useful posts on his personal blog. The first, from a year ago, is probably the best short summary of the economic debate here that I’ve seen. Perhaps the key analytic point is that following a period of depressed investment, the economy may reach full employment given the existing capital stock while it is still well short of potential. So a period of rapid wage growth would not necessarily mean that the limits of expansionary policy have ben reached, even if those wage gains were fully passed through to higher prices. His emphasis:

Because fiscal policy has been too tight, we have too little public capital. … At the same time, physical investment has been too low… Conditional on these state variables, we might well be close to full employment.  … But, even though we’re close to full employment, there’s a lot of room for super-normal growth. Both capital and TFP are well below their [long run level].  The full-employment growth rate is going to be well above its long-run level for several years.  We can’t conclude the economy is overheating just because it is growing quickly.

His second post focuses on the straightforward but often overlooked point that policy should take into account not just our best estimates but our uncertainty about them, and the relative risks of erring on each side. And if there is even a modest chance that more expansionary policy could permanently raise productivity, then the risks are much greater on the over-contractionary side. [1] In particular, if we are talking about fiscal stimulus, it’s not clear that there are any costs at all. “Crowding out” is normally understood to involve a rise in interest rates and a shift from private investment to public spending. In the current setting, there’s a strong case that higher interest rates  at full employment would be a good thing (at least as long as we still rely on as the main tool of countercyclical policy). And it’s not obvious, to say the least, that the marginal dollar of private investment is more socially useful than many plausible forms of public spending. [2] Kashkari has a post making a similar argument in defense of his minority vote not to raise rates at the most recent FOMC meeting. (Incidentally, FOMC members blogging about their decisions is a trend to be encouraged.)

In a post from March which I missed at the time, Ryan Avent tries to square the circle of job-destroying automation and slow productivity growth. One half of the argument seems clearly right to me: Abundant labor and low wages discourage investment in productivity-raising technologies. As Avent notes, early British and even more American industrialization owe a lot to scarce labor and high wages. The second half of the argument is that labor is abundant today precisely because so much has been displaced by technology. His claim is that “robots taking the jobs” is consistent with low measured productivity growth if the people whose jobs are taken end up in a part of the economy with a much lower output per worker. I’m not sure if this works; this seems like the rare case in economics where an eloquent story would benefit from being re-presented with math.

Along somewhat similar lines, Simon Wren-Lewis points out that unemployment may fall because workers “price themselves into jobs” by accepting lower-wage (and presumably lower-productivity) jobs. But this doesn’t mean that the aggregate demand problem has been solved — instead, we’ve simply replaced open unemployment with what Joan Robinson called “disguised unemployment,” as some of people’s capacity for work continues to go to waste even while they are formally employed. “But there is a danger that central bankers would look at unemployment, … and conclude that we no longer have inadequate aggregate demand…. If demand deficiency is still a problem, this would be a huge and very costly mistake.”

Karl Smith at the Niskanen Center links this debate to the older one over the neutrality of money. Central bank interventions — and aggregate demand in general — are understood to be changes in the flow of money spending in the economy. But a lon-standing tradition in economic theory says that money should be neutral in the long run. As we are look at longer periods, changes in output and employment should depend more and more on real resources and technological capacities, and less and less on spending decisions — in the limit not at all. If you want to know why GDP fell in one quarter but rose in the next (this is something I always tell my undergraduates) you need to ask who chose to reduce their spending in the first period and who chose to increase it in the first. But if you want to know why we are materially richer than our grandparents, it would be silly to say it’s because we choose to spend more money. This is the reason why I’m a bit impatient with people who respond to the fact that, relative to the pre-2008 trend, output today has not recovered from the bottom of the recession, by saying “the trend doesn’t matter, deviations in output are always persistent.” This might be true but it’s a radical claim. It means you either take the real business cycle view that there’s no such thing as aggregate demand, even recessions are due to declines in the economy’s productive potential; or you must accept that in some substantial sense we really are richer than our grandparents because we spend more money. You can’t assert that GDP is not trend-stationary to argue against an output gap today unless you’re ready to accept these larger implications.

The invaluable Tom Walker has a fascinating post going back to even older debates, among 19th century anti-union and pro-union pamphleters, about whether there was a fixed quantity of labor to be performed and whether, in that case, machines were replacing human workers. The back and forth (more forth than back: there seem to be a lot more anti-labor voices in the archives) is fun to read, but what’s the payoff for todays’ debates?

The contemporary relevance of this excursion into the archives is that economic policy and economic thought walks on two legs. Conservative economists hypocritically but strategically embrace both the crowding out arguments for austerity and the projected lump-of-labor fallacy claims against pensions and shorter working time. They are for a “fixed amount” assumption when it suits their objectives and against it when it doesn’t. There is ideological method to their methodological madness. That consistency resolves itself into the “self-evidence” that nothing can be done.

That’s exactly right. When we ask why labor’s share has fallen so much over the past generation, we’re told it’s because of supply and demand — an increased supply of labor from China and elsewhere, and a decreased demand thanks to technology. But if it someone says that it might be a good idea then to limit the supply of labor (by lowering the retirement age, let’s say) and to discourage capital-intensive production, the response is “are you crazy? that will only make everyone poorer, including workers.” Somehow distribution is endogenous when it’s a question of shifts in favor of capital, but becomes exogenously fixed when it’s a question of reversing them.

A number of heterdox writers have identified the claim that productivity growth depends on demand as Verdoorn’s law (or the Kaldor-Verdoorn Law). For example, the Post Keynesian blogger Ramanan mentions it here and here. I admit I’m a bit dissatisfied with this “law”. It’s regularly asserted by heterodox people but you’ll scour our literature in vain looking for either a systematic account of how it is supposed to operate or quantitative evidence of how and how much (or whether) it does.

Adam Ozimek argues that the recent rise in employment should be seen as an argument for continued expansionary policy, not a shift away from it. After all, a few years ago many policymakers believed such a rise was impossible, since the decline in employment was supposed to be almost entirely structural.

Finally, Reihan Salam wants to enlist me for the socialist flank of a genuinely populist Trumpism. This is the flipside of criticism I’ve sometimes gotten for making this argument — doesn’t it just provide intellectual ammunition for the Bannon wing of the administration and its calls for vast infrastructure spending,  which is also supposed to boost demand and generate much faster growth? Personally I think you need to make the arguments for what you think is true regardless of their political valence. But I might worry about this more if I believed there was even a slight chance that Trump might try to deliver for his working-class supporters.

 

[1] Kocherlakota talks about total factor productivity. I prefer to focus on labor productivity because it is based on directly observable quantities, whereas TFP depends on estimates not only of the capital stock but of various unobservable parameters. The logic of the argument is the same either way.

[2] I made similar arguments here.

 

EDIT: My comments on the heterodox literature on the Kaldor-Verdoorn Law were too harsh. I do feel this set of ideas is underdeveloped, but there is more there than my original post implied. I will try to do a proper post on this work at some point.

The Big Question for Macroeconomic Policy: Is This Really Full Employment?

Cross-posted from the Roosevelt Institute’s Next New Deal blog. This is a summary of my new paper What Recovery? The Case for Continued Expansionary Policy, also discussed in Neil Irwin’s July 26 article in the Times.

 

“Right now,” wrote Senator Chuck Schumer in a New York Times op-ed on Monday, “millions of unemployed or underemployed people, particularly those without a college degree, could be brought back into the labor force” with appropriate government policies. With this seemingly anodyne point, Schumer took sides in a debate that has sharply divided economists and policymakers: Is the US economy today operating at potential, with enough spending to make full use of its productive capacity? Or is there still substantial slack, unused capacity that could be put to work if someone — households, businesses or governments — decided to spend more? Is there an aggregate-demand problem that government should be trying to solve?

It’s difficult to answer this question because the economic signals seem to point in conflicting directions. Despite the recession officially ending in June 2009 and the economy enjoying steady growth for the past eight years, GDP is still far below the pre-2008 trend. If we compare GDP to forecasts made before the recession, the gap that opened up during the recession has not closed at all — in fact, it continues to get wider. Meanwhile, the official unemployment rate — probably the most watched indicator for the state of aggregate demand — is down to 4.4%, well below the level that was considered full employment even a few years ago. But this positive performance only partially reflects an increase in the number of Americans with jobs; mostly it comes from a decline in the size of the labor force — people who have or are seeking jobs. The fraction of the adult population employed is down to 60 percent from 63 percent a decade ago (and nearly 65 percent at the end of the 1990s).

Is this decline in the fraction of people employed the inevitable result of an aging population and similar demographic changes, or is it a sign that, despite the low measured unemployment rate, the economy is still far short of full employment? The Federal Reserve — one of the main sites of macroeconomic policy — has already indicated its belief that full employment has been reached by raising interest rates 3 times since December 2016. Fed Chair and Janet Yellen are evidently convinced that the economy has reached its potential — that, given the real resources available, output and employment are as high as can reasonably be expected.

Other policymakers have been divided on the question, in ways that often cut across partisan lines. Senator Schumer’s statement — that the decline in employment is not an inevitable trend but rather a problem that government can and should solve — is a sign of new clarity coming to this murky debate. Along with his call for $1 trillion in new infrastructure spending, it’s an important acknowledgement that, despite the progress made since 2008, the country remains far from full employment.

In a new paper out this week, we at the Roosevelt Institute offer support for the emerging consensus that the economy needs policies to boost demand. The paper reviews the available data on where the economy is relative to its potential. We find that the balance of evidence suggests there is still a great deal of space for more expansionary policy.

We offer several lines of argument in support of this conclusion.

GDP has not recovered from the recession. GDP remains about 10 percent below both the long-term trend and the level that was predicted by the CBO and other forecasts prior to the 2008–2009 recession. There is no precedent in the postwar period for such a persistent decline in output. During the sixty years between 1947 and 2007, growth lost in recessions was always regained in the subsequent recovery.

The aging population does not explain low labor force participation. It is true that an aging population should contribute to lower employment, since older people are less likely to work than younger people. But this simple demographic story cannot explain the full fall in employment. Starting from the employment peak in 2000, aging trends only explain about half the decrease in employment that has actually occurred. And there are good reasons to think that even this overstates the role of demographics. First, during the same period, education levels have increased. Historically, higher education has been associated with higher employment rates, just as a share of elderly people has been associated with less employment; statistically, these two effects should just about cancel out. Second, the post-recession fall in employment rates is not concentrated in older age groups, but among people in their 20s — something that a demographic story cannot explain.

The weak economy has held back productivity. About half the shortfall in GDP relative to the pre-2008 trend is explained by exceptionally slow productivity growth — that is, slow growth in output per worker. While many people assume that productivity is the result of technological progress outside the reach of macroeconomic policy, there are good reasons to think that the productivity slowdown is at least in part due to weak demand. Among the many possible links: Business investment, which is essential to raising productivity, has been extraordinarily weak over the past decade, and economists have long believed that demand is a central factor driving investment. And slow wage growth — a sign of labor-market weakness — reduces the incentive to adopt productivity-boosting technology.

Only a demand story makes sense. The overall economic picture is hard to understand except in terms of a continued demand shortfall. If employment is falling due to demographics, that should be associated with rising productivity and wages, as firms compete for scarce labor. If productivity growth is slow because there aren’t any more big innovations to make, that should be associated with faster employment growth and low profits, as firms can no longer find new ways to replace labor with capital. But neither of these scenarios match the actual economy. And both stories predict higher inflation, rather than the persistent low inflation we have actually encouraged. So even if supply-side stories explain individual pieces of macroeconomic data, it is almost impossible to make sense of the big picture without a large fall in aggregate demand.

Austerity is riskier than stimulus. Finally, we argue that, if policymakers are uncertain about how much space the economy has for increased demand, they should consider the balance of risks on each side. Too much stimulus would lead to higher inflation — easy to reverse, and perhaps even desirable, given the continued shortfall of inflation relative to the official 2 percent target. An overheated economy would also see real wages rise faster than productivity. While policymakers often see this as something to avoid, the decline in the wage share over the past decade cannot be reversed without a period of such “excess” wage growth. On the other hand, if there is still an output gap, failure to take aggressive steps to close it means foregoing literally trillions of dollars of useful goods and services and condemning millions of people to joblessness.

Fortunately, the solution to a demand shortfall is no mystery. Since Keynes, economists have known that when an economy is operating below its potential, all that is needed is for someone to spend more money. Of course, it’s best if that spending also serves some useful social purpose; exactly what that should look like will surely be the subject of much debate to come. But the first step is to agree on the problem. Today’s economy is still far short of its potential. We can do better.

Links for July 17, 2017

The action is on the asset side. Arjun Jayadev, Amanda Page-Hoongrajok and I have a new version of our state-local balance sheets paper up at Washington Center for Equitable Growth. It’s moderately improved from the version posted here a few months ago. I’ll have a blogpost up in the next day or two laying out the arguments in more detail. In the meantime, here’s the abstract:

This paper … makes two related arguments about the historical evolution of state-local debt ratios over the past 60 years. First, there is no consistent relationship between state and local budget deficits and changes in state and local government debt ratios. In particular, the 1980s saw a shift in state and local budgets toward surplus but nonetheless saw rising debt ratios. This rise in debt is fully explained by a faster pace of asset accumulation as a result of increased pressure to prefund future expenses… Second, budget imbalances at the state level are almost entirely accommodated on the asset side – both in the aggregate and cross-sectionally, larger state-local deficits are mainly associated with reduced net asset accumulation rather than with greater credit-market borrowing. …

 

What recovery? One of the central questions of U.S. macroeconomic policy right now is whether the slow growth of output and employment over the past decade are the result of supply-side factors like demographics and an exhaustion of new technologies, or whether — despite low measured unemployment — we are still well short of potential output. Later this month, I’ll have a paper out from the Roosevelt Institute making the case for the latter — that there is still substantial space for more expansionary policy. Some of my argument is anticipated by this post from Simon Wren-Lewis, which briefly lays out several ways in which a demand shortfall can have lasting effects on the economy’s productive capacity — discouraged workers leaving the labor force; reduced investment by business; and slower technical progress, because a slack economy is less favorable for innovation. He concludes: “There is no absence of ideas about how a great recession and a slow recovery could have lasting effects. If there is a problem, it is more that this simple conceptualization” — textbook model in which demand has only short-run effects — “has too great a grip on the way many people think.”

Along the same lines, here is a nice post from Adam Ozimek on the “mystery” of low wage growth. The mystery is that despite low unemployment, annual wage growth (as measured by the Employment Costs Index) has remained relatively low – 2 to 2.5 percent, rather than the 3 to 3.5 percent we’d expect based on historical patterns. (Ozimek doesn’t mention it, but total compensation growth — including benefits — is even lower, less than one percent for the year ending March 2017.) But, he points out, this historical relationship is based on measured unemployment; if we use the employment-population ratio instead, then recent wage gains are exactly where you’d expect historically. So the behavior of wages is another piece of evidence that the official unemployment rate is underestimating the degree of labor market slack, and that the fall in the employment-population ratio reflects — at least in part — weak demand rather than the inevitable result of worse demographics (or better video games).

 

The bondholders’ view of the world.  Matthew Klein has a very enjoyable post at FT Alphaville taking apart the claim (from three prominent academics) that “The French Revolution began with the bankruptcy of the ancient regime.” This is, of course, supposed to illustrate the broader dangers of allowing sovereigns to stiff bondholders. But in fact, as Klein points out, the old regime did not default on in its loans — Louis XVI went to great lengths to avoid bankruptcy, precisely because he was afraid of the reaction of creditors. Further: It was the monarchy’s efforts to avoid default — highly unpopular taxes and spending cuts, then the calling of the Estates General to legitimate them — that set in motion the events that led to the Revolution. So the actual history — in which a government was overthrown after choosing austerity over bankruptcy — has been reversed 180 degrees to fit the prevailing myth of our times: that good and bad political outcomes all depend on the grace of the bond markets. As Klein says, this might seem like a small mistake, but it is deeply revealing about how ideology operates: “ Whoever introduced it must have been working off what he thought was common knowledge that didn’t need to be checked. There is no citation.”

Klein’s piece is also, in passing, a nice response to that silly Jacob Levy post which argues that democracy and popular sovereignty are myths and that modern states have always been ruled by the bondholders. Levy offers zero evidence for this claim; his post is of interest only as a signpost for where elite discourse may be heading.

 

Don’t blame Germany. Here is a very useful paper from Enno Schroeder and Oliver Piceck estimating the effects of an increase in German demand on other European economies. They use an input-output model to estimate the effect of an increase in spending in Germany on output and employment in each of the other 10 largest euro-area countries. One of the things I really like about this is that it does not depend on either econometrics or on any kind of optimization; rather, it is simply based on the observable data of the distribution of consumption spending and of intermediate inputs by various industries over different industries and countries, along with the fraction of household income consumed in various countries. This lets them answer the question: If spending in Germany increased by a certain amount and the composition of spending otherwise remained unchanged, what would the effect be on total spending in various European countries? Yes, they ignore possible price changes; but I don’t think it’s any less reasonable than the conventional approach, which goes to the opposite extreme and assumes prices are everything. And even if you want to add a price story, this approach gives you a useful baseline to build on.

Methodology aside, their results are interesting and a bit surprising: They find that the spillovers from Germany to other European countries are surprisingly small.

Our main finding suggests that if Germany’s final demand were to exogenously increase by one percent of GDP, then France, Italy, Spain, and Portugal’s GDP would grow by around a 0.1 percent, their unemployment rates would be reduced by a bit over 0.1 points, and their trade balances would improve by approximately 0.04 points. The spillover effects on Greece are significantly smaller.

Given how much larger Germany is than most of these countries, and how tightly integrated European economies are understood to be, these are surprisingly small numbers. It seems that a large proportion of German demand still falls on domestic goods, while imports come largely from the euro area — particularly, in the case of intermediate goods, from the former Warsaw Pact countries. As a result, even

if a German demand boom were to materialize, France, Greece, Italy, Spain, and Portugal would not benefit much in terms of growth and external adjustment. The real beneficiaries would be small neighbors (e.g. Austria and Luxembourg) and emerging economies in Eastern Europe that are well integrated into German supply chains (e.g. Czech Republic and Poland).

Of course, this doesn’t mean that more expansionary policy in Germany isn’t desirable for other reasons. (For one thing, German workers badly need raises.) But for the balance of payments problems in Southern Europe, other solutions are needed.

 

Today’s conventional is yesterday’s unconventional, and vice versa. Here is a useful NBER paper from Mark Carlson and Burcu Duygan-Bump on the conduct of monetary policy in the 1920s. As they point out, much of today’s “unconventional” policy apparatus was standard at that point, including large purchases of a range of securities — quantitative easing avant le lettre. As I’ve written on this blog before (here and here and here) discussion of monetary policy is made needlessly confusing by economists’ habit of treating the policy instrument as having a direct, immediate link to macroeconomic outcomes, which can be derived from first principles. Whereas anyone who reads even a little history of central banking finds that the ultimate goal of control over the pace of credit expansion has been pursued by a wide range of instruments and intermediate targets in different settings.

Also on the mechanics of monetary policy, I liked these two posts from the New York Fed’s Liberty Street Economics blog. They do something which should be standard but isn’t — walk through step by step the balance sheet changes associated with various central bank policy shifts. In my experience, teaching monetary policy in terms of balance sheet changes is much more straightforward than with the supply-and-demand diagrams that are the basic analytic tool in most textbooks. The curves at best are metaphors; the balance sheets tell you what actually happens.

At the Left Forum: What’s the Alternative to Neoliberalism?

At the Left Forum last month, I was on a panel with Miles Kampf-Lassin, Kate Aronoff and Darrick Hamilton, on “What Would a Left Alternative to Neoliberalism Look Like?” My answer was that neoliberalism is a radical, utopian project to reshape all of society around markets and property claims; if you want an alternative, just look at the world around us. This is an argument I’ve also made in Jacobin and The New Inquiry.

The panel was recorded by someone from Between the Lines. At some point there’s suppose to be a transcript. In the meantime, the audio is here:

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Posts in Three Lines

I haven’t been blogging much lately. I’ve been doing real work, some of which will be appearing soon. But if I were blogging, here are some of the posts I might write.

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Lessons from the 1990s. I have a new paper coming out from the Roosevelt Institute, arguing that we’re not as close to potential as people at the Fed and elsewhere seem to believe, and as I’ve been talking with people about it, it’s become clear that your priors depend a lot on how you think of the rapid growth of the 1990s. If you think it was a technological one-off, with no value as precedent — a kind of macroeconomic Bush v. Gore — then you’re likely to see today’s low unemployment as reflecting an economy working at full capacity, despite the low employment-population ratio and very weak productivity growth. But if you think the mid-90s is a possible analogue to the situation facing policymakers today, then it seems relevant that the last sustained episode of 4 percent unemployment led not to inflation but to employers actively recruiting new entrants to the laborforce among students, poor people, even prisoners.

Inflation nutters. The Fed, of course, doesn’t agree: Undeterred by the complete disappearance of the statistical relationship between unemployment and inflation, they continue to see low unemployment as a threatening sign of incipient inflation (or something) that must be nipped in the bud. Whatever other effects rate increases may have, the historical evidence suggests that one definite consequence will be rising private and public debt ratios. Economists focus disproportionately on the behavioral effects of interest rate changes and ignore their effects on the existing debt stock because “thinking like an economist” means, among other things, thinking in terms of a world in which decisions are made once and for all, in response to “fundamentals” rather than to conditions inherited from the past.

An army with only a signal corps. What are those other effects, though? Arguments for doubting central bankers’ control over macroeconomic outcomes have only gotten stronger than they were in the 2000s, when they were already strong; at the same time, when the ECB says, “let the government of Spain borrow at 2 percent,” it carries only a little less force than the God of genesis. I think we exaggerate power of central banks over real economy, but underestimate their power over financial markets (with the corollary that economists — heterodox as much as mainstream — see finance and real activity as much more tightly linked than they are).

It’s easy to be happy if you’re heterodox. This spring I was at a conference up at the University of Massachusetts, the headwaters of American heterodox economics, where I did my Phd. Seeing all my old friends reminded me what good prospects we in the heterodox world have – literally everyone I know from grad school has a good job. If you are wondering whether your prospects would be better at a nowhere-ranked heterodox economics program like UMass or a top-ranked program in some other social science, let me assure you, it’s the former by a mile — and you’ll probably have better drinking buddies as well.

The euro is not the gold standard. One of the topics I was talking about at the UMass conference was the euro which, I’ve argued, was intended to create something like a new gold standard, a hard financial constraint on governments. But that that was the intention doesn’t mean its the reality — in practice the TARGET2 system means that national central banks don’t face any binding constraint , unlike under the gold standard the central bank is “outside” the national monetary membrane. In this sense the euro is structurally more like Keynes’ proposals at Bretton Woods, it’s just not Keynes running it.

Can jobs be guaranteed? In principle I’m very sympathetic to the widespread (at least among my friends on social media) calls for a job guarantee. It makes sense as a direction of travel, implying a commitment to a much lower unemployment rate, expanded public employment, organizing work to fit people’s capabilities rather than vice versa, and increasing the power of workers vis-a-vis employers. But I have a nagging doubt: A job is contingent by its nature – without the threat of unemployment, can there even be employment as we know it?

The wit and wisdom of Haavelmo. I was talking a while back about Merijn Knibbe’s articles on the disconnect between economic theory and the national accounts with my friend Enno, and he mentioned Trygve Haavelmo’s 1944 article on The Probability Approach in Econometrics, which I’ve finally gotten around to reading. One of the big points of this brilliant article is that economic variables, and the models they enter into, are meaningful only via the concrete practices through which the variables are measured. A bigger point is that we study economics in order to “become master of the happenings of real life”: You can contribute to economics in the course of advancing a political project, or making money in financial markets, or administering a government agency (Keynes did all three), but you will not contribute if you pursue economics as an end in itself.

Coney Island. Laura and I took the boy down to Coney Island a couple days ago, a lovely day, his first roller coaster ride, rambling on the beach, a Cyclones game. One of the wonderful things about Coney Island is how little it’s changed from a century ago — I was rereading Delmore Schwartz’s In Dreams Begin Responsibilities the other day, and the title story’s description of a young immigrant couple walking the boardwalk in 1909 could easily be set today — so it’s disconcerting to think that the boy will never take his grandchildren there. It will all be under water.

Links for May 5, 2017

Some economics content, for this rainy Friday afternoon:

 

Turbulence. Over at INET, Arjun Jayadev has posted the next in our series of “rebel masters” interviews with dissenting economists. This one is with Anwar Shaikh, who is, I’m sure, familiar to readers of this blog. Shaikh’s work resists summary, but the

broad thesis revolves around the idea that there is an alternative tradition-embedded in the classical approach of Smith, Ricardo and Marx which insists on understanding the world on its own terms rather than from an idealized economy from which the real world deviates. This approach focuses on what is termed “real competition” wherein competition between firms, each seeking to get the highest price they can, leads to a “turbulent gravitation” of prices around values. As such, there is never an equilibrium, but a dancing around some key deeper parameters.

As with all these interviews, there’s also some discussion of his own political and intellectual development, as well as of the content of his work.

I haven’t made a serious effort to read Shaikh’s big new book Capitalism. Given its heft, I suspect it will function more as a reference work, with people going to specific sections rather than reading it from front to back. (I know one person who is using it as an undergraduate textbook, which seems ambitious.) But if you want an admiring but not uncritical overview of the book as a whole, this review in New Left Review by John Grahl could be a good place to start. It’s written for people interested in the broad political economy tradition; it’s focused on the broad sweep of the argument, not on Shaikh’s position within current debates in heterodox economics.

 

The rich are different from you and me. [1] At Washington Center for Economic Growth, Nick Bunker calls attention to some new research on income inequality over the past 15 years. The key finding is that since the end of the 1990s, the rise in income inequality is almost all due to income from S-corporations (pass-through companies, partnerships, etc.) at the very top of the distribution. As a result, rising inequality shows up in tax data, but not in Social Security data, which captures only labor income. What do we take from this? First, the point I’ve made periodically on this blog: Incomes at the top are mainly capital income, not labor income. But there’s also a methodological point — the importance of constantly walking back and forth between your theoretical construct, the concrete social reality it hopes to explain, and the data (collected by somebody, according to some particular procedures) that stands between them.

 

What are foreign investors for? At FT Alphaville, Matthew Klein has a very interesting post on capital controls. As he notes, during the first decade of the euro, Spain was the recipient of one of “the greatest capital flows of all time,” with owners of financial assets all over Europe rushing to trade them for claims on Spanish banks. This created immense pressure on Spanish banks to increase lending, which in the event financed a runup in real estate prices and an immense quantity of never-to-be-occupied houses and hotels. (It’s worth noting in passing that this real estate bubble developed without any of the securitization that so mesmerized observers of the American bubble.) Surely, Klein says,

if you accept the arguments for regulating cross-border financial movements in any situation, you have to do the same for Spain. The country raised bank capital requirements and ran large fiscal surpluses, but none of that was enough. Plus, it didn’t have the luxury of a floating currency. Both the boom and bust would clearly have been smaller if foreigners had been prevented from buying so many Spanish financial assets, or even just persuaded to buy fewer bonds and more stocks and direct equity.

This seems right. But we could go a step farther. What’s the point of capital mobility?  If you don’t in fact want bank balance sheets expanding and shrinking based on the choices of foreign investors, what benefit are those investors providing to your economy? They provide foreign exchange (allowing you to run current account deficit), they provide financing (allowing credit to expand more), they substitute their judgement of future for domestic actors’. These are exactly the problems in the Spanish case. What is the benefit, even in principle, that Spain got from allowing these inflows?

 

There’s always a first time. Also from Matthew Klein, here is a paper from the Peterson Institute looking at historical fiscal balances and making the rather obvious point that there is little historical precedent for the surpluses the Greek government is expected in order to  pay its conquerors creditors. It is not quite true that no country has ever sustained a primary surplus of 3.5 percent for a decade a more, as Greece is expected to do; but such episodes are exceedingly rare.

My one criticism of Klein’s piece is that it is a little too uncritical of the idea that “market rates” are just a fact about the world. The Peterson paper also seems to regard interest rates as set by markets in response to more or less objective macroeconomic variables. Klein notes in passing that the interest rate Greece pays on its borrowing will depend on official choices like whether Greek debt is included in the ECB’s bond-buying programs. But I think it’s broader than this — I think the interest rate on Greek bonds is entirely a policy choice of the ECB. Suppose the ECB announced that they were fixing the interest rate on Greek bonds at 1 percent, and that they’d buy them as long as the yield was above this. Then private lenders would be happy to hold them at 1 percent and the ECB would not have to make any substantial purchases. This is how open market operations work – when a central bank announces a policy rate, they can move market rates while buying or selling only trivial amounts. If the ECB wished to, it could put Greece on a stable debt path and open up space for a less sociocidal budget, without the need for any commitment of public funds. But of course it doesn’t wish to.

 

Capital with Chinese characteristics. This new paper on wealth and inequality in China from Piketty, Zucman and Li Yang is an event; it’s a safe bet it’s going to be widely cited in the coming years. The biggest contribution is the construction of long-run series on aggregate wealth and the distribution of wealth and  income for China. Much of the paper is devoted, appropriately, to explaining how these series were produced. But they also draw several broad conclusions about the evolution of the Chinese economy over the apst generation.

First, while the publicly-owned share of national wealth has declined, it is still very high relative to other industrialized countries:

China has ceased to be communist, but is not entirely capitalist; it should rather be viewed as a “mixed economy” with a strong public ownership component. … the share of public property in China today is somewhat larger than – though not incomparable to – what it was in the West during the “mixed economy” regime of the post-World War 2 decades (30% in China today vs. 15-25% in the West in the 1950s-1970s). … Private wealth was relatively small in 1978 (about 100% of national income), and now represents over 450% of national income. Public wealth [has been] roughly stable around 250% of national income.

It’s worth noting that the largest component of this increase in private wealth is housing, which largely passed from public to private hands, The public sector, by Piketty and coauthors’ measures, continues to own about half of China’s non-housing wealth, including the majority of corporate equity, and this fraction seems to have increased somewhat over the past decade.

Second, income distribution has become much more unequal in China over the past generation, but seems to still be more equal than in the United States:

In the late 1970s China’s inequality… [was] close to the levels observed in the most egalitarian Nordic countries — while it is now approaching U.S. levels. It should be noted, however, that … inequality levels in China are still significantly lower than in the United States…. The bottom 50% earns about 15% of total income in China (19% in rural China, 23% in urban China), vs. 12% in the U.S. and 22% in France. For the time being, China’s development model appears to be more egalitarian than that of the United States, and less than Europe’s. Chinese inequality levels seem to have stabilized in recent years (the biggest increase in inequality took place between the mid-1980s and the mid-2000s)

The third story — much less prominent in the article, and of less important, but of particular interest to me — is what explains the observed rise in the ratio of wealth to national income. Piketty et al. suggest that 50-70 percent of the rise can be explained, in accounting terms, by the observed rates of saving and investment and their estimate of depreciation, while the remaining 30-50 percent is due to valuation changes. But in a footnote they add that this includes a large negative valuation change for China’s net foreign wealth, presumably attributable to the appreciation of the renminbi relative to the dollar. So a larger share of the rise in domestic wealth relative to income must be accounted for by valuation changes. (The data to put an exact number on this should be available in their online appendices, which are comprehensive as always, but I haven’t done it yet.)

This means that a story that conflates wealth with physical capital, and sees its growth basically in terms of net investment, will not do a good job explaining the actual growth of Chinese capital. (The same goes for the growth in capital relative to income in the advanced countries.) The paper explains the valuation increase in terms of a runup in the value of private housing plus

changes in the legal system reinforcing private property rights for asset owners (e.g., lifting of rent control, changes in the relative power of landlords and tenants, changes in the relative power of shareholder and workers).

This seems plausible to me. But I wish Piketty and his coauthors — and even more, his admirers — would take this side of the story more seriously. If we want to talk about the “capital” we actually see in public and private accounts, a theory that sees it growing through net investment is not even roughly correct. We really do have to think of capital as a social relation, not a physical substance.

 

On other blogs, other wonders.

Here’s a video of me chatting with James Parrott about robots.

Who’d have thought that Breitbart is the place to find federal government employment practices held up as an ideal?

At PERI, Anders Fremstad and Mark Paul have a nice paper on the distributional impact of different forms of carbon taxes.

Also at PERI, another whack at the Reinhart-Rogoff piñata.

I’ll be speaking at this Dissent thing on May 22.

 

 

[1] This phrase has an interesting backstory. The received version has it that it’s F. Scott Fitzgerald’s line, to which Ernest Hemingway replied: “Yes. They have more money.” But in fact, Hemingway was the one who said the rich were different, at a lunch with Maxwell Perkins and the critic Mary Colum, and it was Colum who delivered the putdown. (The story is in that biography of Perkins.) In “Hills like White Elephants,” Hemingway, for reasons that are easy to imagine, put the “rich are different” line in the mouth of his frenemy Fitzgerald, and there it’s stayed.

At Dissent: A Cautious Case for Economic Nationalism

I have an article in the new issue of Dissent, arguing that “As long as democratic politics operates through nation-states, any left program will require some degree of delinking from the global economy.”

My piece is part of a special section on “Capitalism Today.” There will be an accompanying event at the New School on May 22, with Jamie Galbraith, Julia Ott, Mark Levinson and me.

I’ve made similar arguments to this article’s in a number of posts on this blog:

Capital Mobility as Trojan Horse
Only the Debt Is National
How to Think about the Balance of Payments
What Is Foreign Investment For?
Lessons from the Greek Crisis
Prices and the European Crisis, Continued

One thing that’s probably not as clear as it should be in the Dissent piece, is that the case for delinking is much stronger for most other countries than for the United States. For most countries, free trade and, even more, free capital mobility, drastically reduce the choices available to national governments. (This “disciplining” of the state by foreign investment is sometimes acknowledged as its real function.) For the US, I don’t think this is true – I don’t think the threat of capital flight meaningfully constrains policy here. And in particular I don’t think it makes sense to see a more positive trade balance as necessary or even particularly desirable to boost demand, for reasons laid out here and here.

 

Links and Thoughts for March 15, 2017

Do you guys know The Death Ship? B. Traven’s first novel, the only one not set in Mexico? It begins with an American sailor who goes ashore in the Netherlands, gets distracted as you do, his ship leaves. The Dutch don’t want him, they send him across the border to Germany. The Germans don’t want him, send him to Belgium, the Belgians send him to France. The French send him back to the Netherlands, where he ends up on the eponymous ship. It’s a good book. I was just thinking of it the other day, for some reason.

 

Against the sonderweg. Here is a fascinating article on the pre-history of Swedish social democracy. Contrary to claims of Swedish “sonderweg”, or special path, toward egalitarianism, Erik Bengtsson convincingly shows that until the 1930s, Sweden was not especially egalitarian relative to other West European countries or the US. Both economically and politically, it was at the unequal end of the European continuum, and considerably less equal than the US. “In 1900, it was one of the countries in Western Europe with the most restricted suffrage, and wealth was more unequally distributed than in the United States. …The more likely explanation of Swedish twentieth-century equality, rather than any deep roots, is the extraordinary degree of popular organization in the labour movement and other popular movements” in the 210th century. Income and wealth distribution were similar to France or Britain, while the franchise was more restricted than in any other major West European country. Up through World War One, Swedish politic was dominated by the same kind of “iron and rye” alliance of feudal landowners with big industrialists as Bismarkian Germany. “The exceptional equality of Swedish economy and society c. 1920-1990 did not arrive as the logical conclusion of a long historical continuity”; rather, it was the result of an exceptionally effective mass mobilization against what was previously an unusually inegalitarian state.

More speculatively, Bengtsson suggests that it was precisely the exceptionally strong and persistent domination by a small elite that created the conditions for Swedish social democracy: “the late democratization of Sweden” may have “fostered a liberal-socialist democratizing alliance … [between] petit bourgeois liberals and working-class socialists … unlike Germany, where the greater inclusion of lower-middle class men meant that middle class liberals and haute bourgeois market liberals could unite around a program of economic liberalism.”  It’s a neat inversion of Werner Sombart’s famous argument that “the free gift of the ballot” prior to the appearance of an organized working class was the reason no powerful socialist party ever developed in the United States. Bengttson’s convincing claim that Swedish egalitarianism was not the result of a deep-rooted history but of a deliberate political project to transform a previously inegalitarian society, has obvious relevance for today.

 

High productivity in France. While we are debunking myths about social democracy, here is Thomas Piketty on French productivity. “If we calculate the average labour productivity by dividing the GDP … by the total number of hours worked … we then find that France is at practically the same level as the United States and Germany, … more than 25% higher than the United Kingdom or Italy.” And here’s a 2014 post from Merijn Knibbe making the same point.

 

Against Hamilton. In The Baffler, Matt Stoller argues that Hamilton is overrated. Richard Kreitner makes a similar case in The Nation, with an interestingly off-center focus on Paterson, New Jersey. Christian Parenti (my soon-to-be colleague at John Jay College) made the case for Hamilton not long ago in the Jacobin; he’s writing an introduction to a new edition of Hamilton’s Report on Manufactures. This is not a new debate. Twenty years ago, as the books editor of In These Times, I published a piece by Dan Lazare making a similar pro-Hamilton case; it was one of the things that Jimmy Weinstein fired me for.

My sense of these arguments is that one side says that Hamilton was a predecessor of today’s Koch brothers-neocon right, an anti-democratic militarist who believed the country should be governed by and for the top 1 percent; his opponent Jefferson must therefore have been a democrat and anti-imperialist. The other side says that Jefferson was a predecessor of today’s Tea Party right, an all-in racist and defender of slavery who opposed cities, industry and progress; his opponent Hamilton must therefore have been an abolitionist, an open-minded cosmopolitan and a liberal. I am far from an expert on early American politics. But in both cases, I think, the first half of the argument is right, but the second half is much more doubtful. There are political heroes in circa-1800 America, but to find them we are going to have look beyond the universe of people represented on dollar bills.

 

Against malinvestment. Brad Delong has, I think, the decisive criticism of malinvestment theories of the Great Recession and subsequent slow recovery. In terms of the volume of investment based on what turned out to be false expectations, and the subsequent loss of asset value, the dot-com bubble of the late 1990s was much bigger than the housing bubble. So why were the macroeconomic consequences so much milder?

 

Selective memory in Germany. Another valuable piece of political pre-history, this one of German anti-Keynesianism by Jörg Bibow. Among a number of valuable points, he describes how German economic debate has been shaped by a strangely selective history of the 20th century, from which depression and mass unemployment – the actual context for the rise of Nazism — have been erased. Failures of economic policy can only be imagined as runaway inflation.

 

The once and future bull market in bonds. Here is an interesting conversation between Srinivas Thiruvadanthai of the Levy Center and Tracy Alloway and Joe Weisenthal of Bloomberg, on the future of the bond market. Thiruvadanthai’s forecast: interest rates can fall quite a bit more in the coming decades. He makes several interesting and, to me, convincing points. First, that in an environment of large balance sheets, we can’t analyze the effects of things like interest rate changes just in terms of the real sector. The main effect of higher rates today wouldn’t be to discourage borrowing, but to raise the burden of existing debt. He also makes the converse argument, which I’m less sure about — that after another round or two of fiscal expansion and unconventional monetary policy, public sector debt could make up a large share of private balance sheets, with proportionately less private debt. Under those conditions, an increase in interest rates would be much less contractionary, or even expansionary, creating the possibility for much larger rate hikes if central banks continue to use conventional policy to stabilize demand.

More generally, he points out that, historically, the peacetime inflation of the 1970s is a unique event over the hundreds of years in which bond markets have existed, so it’s a little problematic to build a whole body of macroeconomic theory around that one episode, as we’ve done. And, he says, capitalism doesn’t normally face binding supply constraints — the vast majority of firms, the vast majority of the time, would be happy to sell more at their current prices. And he expresses some — much-needed, IMO — skepticism about whether central banks can in general hit an inflation target, reliably or at all.

 

Positive money? Here is a vigorous critique of 100 percent reserve backed, or positive, money. (An idea which is a staple of monetary reformers going back at least to David Hume, and perhaps most famous as the Chicago Plan.)  I don’t have a settled view on this idea. I do think it’s interesting that the reforms the positive money people are calling for, are intended to produce essentially the tight link between public liabilities and private assets which MMT people claim already exists. And which Thiruvadanthai thinks we might inadvertently move toward in the future.

 

Captial flows: still unstable. Here’s a useful piece in VoxEU on the volatility of capital flows. Barry Eichengrreen and his coauthors confirm the conventional wisdom among heterodox critics of the Washington Consensus: free movement of finance is the enemy of macroeconomic stability. FDI flows — which are linked to the coordination of real productive activity across borders — are reasonably stable; but portfolio flows remain as prone to sudden stops and reversals as they’ve always been.

 

Killing conscience. Over at Evonomics, Lynn Stout makes the important point that any kind of productive activity depends on trust, norms, and the disinterested desire to do one’s job well – what Michelet called “the professional conscience.” These are undermined by the creation of formal incentives, especially monetary incentives. Incentives obstruct, discourage, even punish, the spontaneous “prosocial” behavior that actually makes organizations work, while encouraging the incentivized people to game the system in perverse ways. under socialism, to speak of someone’s interests will be considered an insult; to give someone incentives will be considered an act of violence.

It’s a good piece; the one thing I would add is that one reason incentives are used so widely despite their drawbacks is that they are are about control, as well as (or rather than) efficiency. Workers’ consciences are very powerful tools at eliciting effort; but the boss who depends on them is implicitly acknowledging a moral claim by those workers, and faces the prospect that conscience may at some point require something other than following orders.

 

The deficit is not the problem. Jared Bernstein makes the same argument about trade that I made in my Roosevelt Institute piece a few months ago. The macroeconomic-policy question posed by US trade deficits should not be, how do we move our trade towards balance? It should be: how do we ensure that the financial inflows that are the counterpart of the deficit, are invested productively?

 

We simply do not know. Nick Rowe has always been one of my favorite economics bloggers – a model for making rigorous arguments in a clear, accessible way. I don’t read him as consistently as I used to, or comment there any more — vita breve and all that — but he still is writing good stuff. Here he makes the common-sensical point  that someone considering investment in long-lived capital goods does not face symmetric risks. “A recession means that capital services are wasted at the margin, because the extra output cannot be sold. But booms are not good, because a bigger queue of customers does nothing for profitability if you cannot produce more to meet the extra demand.” So uncertainty about future economic outcomes — or, what is not quite the same thing, greater expected variance — will depress the level of desired investment. I don’t know if Nick was thinking of Keynes — consciously or unconsciously when he wrote the post, but it’s very much in a Keynesian spirit. I’m thinking especially of the 1937 article “The General Theory of Employment,” where Keynes observes that to carry out investment according to the normal dictates of economic rationality, we must “assume that the present is a much more serviceable guide to the future than a candid examination of past experience would show it to have been hitherto.”

 

The health policy tightrope. The Republican plan health care plan, the CBO says, would increase the number of uninsured Americans by 24 million. I don’t know any reason to question this number. By some estimates, this will result in 40,000 additional deaths a year. By the same estimate, the Democratic status quo leaves 28 million people uninsured, implying a similar body count. Paul Ryan’s idea that health care should be a commodity to be bought in the market is cruel and absurd but the Democrats’ idea that heath insurance should be a commodity bought in the market is not obviously less so. Personally, I’m struggling to find the right balance between these two sets of facts. I suppose the first should get more weight right now, but I can’t let go of the second. Adam Gaffney does an admirable job managing this tightrope act in his assessment of the Obama health care legacy  in Jacobin. (But I think he’s absolutely right, strategically, to focus on the Republicans for the Guardian’s different readership .)

 

On other blogs, other wonders.

I’m looking forward to reading Ann Pettifor’s new book on money. In the meantime, here’s an interview with her in Vogue.

Towards the Garfield left.

The end of austerity is perfectly feasible in Spain.

“Underfunded” doesn’t mean what it sounds like. Based on the excellent Sgouros piece I linked to earlier.

Uber is doomed.

The decline of blue-collar jobs. I admit I was surprised to see what a large share of employment manufacturing accounted for a generation ago.

Perry Anderson: Why the system will win. Very worth reading, like everything Anderson writes. But  too sympathetic to anti-immigrant politics.

The ECB should give money directly to European citizens.

Manchester by the Sea is a good movie. But Margaret is a great movie.

Saving and Borrowing: A Response to Klein

Matthew Klein has a characteristically thoughtful post disagreeing with my new paper on income distribution and debt. I think his post has some valid arguments, but also, from my point of view, some misunderstandings. In any case, this is the conversation we should be having.

I want to respond on the specific points Klein raises. But first, in this post, I want to clarify some background conceptual issues. In particular, I want to explain why I think it’s unhelpful to think about the issues of debt and demand in terms of saving.

Klein talks a great deal about saving in his post. Like most people writing on these issues, he treats the concepts of rising debt-income ratios, higher borrowing and lower saving as if they were interchangeable. In common parlance, the question “why have households borrowed more?” is equivalent to “why have households saved less?” And either way, the spending that raises debt and reduces saving, is also understood to contribute to aggregate demand.

This conception is laid out in Figure 1 below. These are accounting rather than causal relationships. A minus sign in the link means the relationship is negative.

 

We start with households’ decision to consume more or less out of their income. Implicitly, all household outlays are for consumption, or at least, this is the only flow of household spending that varies significantly. An additional dollar of household consumption spending means an additional dollar of demand for goods and services; it also means a dollar less of savings. A dollar less of savings equals a dollar more of borrowing. More borrowing obviously means higher debt, or — equivalently in this view — a higher debt-GDP ratio.

There’s nothing particularly orthodox or heterodox about this way of looking at things. You can hear the claim that a rise in the household debt-income ratio contributes more or less one for one to aggregate demand as easily from Paul Krugman as from Steve Keen. Similarly, the idea that a decline in savings rates is equivalent to an increase in borrowing is used by Marxists as well as by mainstream economists, not to mention eclectic business journalists like Klein. Of course no one actually says “we assume that household assets are fixed or nonexistent.” But implicitly that’s what you’re doing when you treat the question of what has happened to household borrowing as if it were the equivalent of what has happened to household saving.

There is nothing wrong, in principle, with thinking in terms of the logic of Figure 1, or constructing models on that basis. Social science is impossible without abstraction. It’s often useful, even necessary, to think through the implications of a small subset of the relationships between economic variables, while ignoring the rest. But when we turn to  the concrete historical changes in macroeconomic quantities like household debt and aggregate demand in the US, the ceteris paribus condition is no longer available. We can’t reason in terms of the hypothetical case where all else was equal. We have to take into account all the factors that actually did contribute to those changes.

This is one of the main points of the debt-inequality paper, and of my work with Arjun Jayadev on household debt. In reality, much of the historical variation in debt-income ratios and related variables cannot be explained in terms of the factors in Figure 1. You need something more like Figure 2.

Figure 2 shows a broader set of factors that we need to include in a historical account of household sector balances. I should emphasize, again, that this is not about cause and effect. The links shown in the diagram are accounting relationships. You cannot explain the outcomes at the bottom without the factors shown here. [1] I realize it looks like a lot of detail. But this is not complexity for complexity’s sake. All the links shown in Figure 2 are quantitatively important.

The dark black links are the same as in the previous diagram. It is still true that higher household consumption spending reduces saving and raises aggregate demand, and contributes to lower saving and higher borrowing, which in turn contributes to lower net wealth and an increase in the debt ratio. Note, though, that I’ve separated saving from balance sheet improvement. The economic saving used in the national accounts is quite different from the financial saving that results in changes in the household balance sheet.

In addition to the factors the debt-demand story of Figure 1 focuses on, we also have to consider: various actual and imputed payment flows that the national accounts attribute to the household sector, but which do not involve any money payments to or fro households (blue); the asset side of household balance sheets (gray); factors other than current spending that contribute to changes in debt-income ratios (red); and change in value of existing assets (cyan).

The blue factors are discussed in Section 5 of the debt-distribution paper. There is a much fuller discussion in a superb paper by Barry Cynamon and Steve Fazzari, which should be read by anyone who uses macroeconomic data on household income and consumption. Saving, remember, is defined as the difference between income and consumption. But as Cynamon and Fazzari point out, on the order of a quarter of both household income and consumption spending in the national accounts is accounted for by items that involve no actual money income or payments for households, and thus cannot affect household balance sheets.

These transactions include, first, payments by third parties for services used by households, mainly employer-paid premiums for health insurance and payments to healthcare providers by Medicaid and Medicare. These payments are counted as both income and consumption spending for households, exactly as if Medicare were a cash transfer program that recipients then chose to use to purchase healthcare. If we are interested in changes in household balance sheets, we must exclude these payments, since they do not involve any actual outlays by households; but they still do contribute to aggregate demand. Second, there are imputed purchases where no money really changes hands at all.  The most important of these are owners’ equivalent rent that homeowners are imputed to pay to themselves, and the imputed financial services that households are supposed to purchase (paid for with imputed interest income) when they hold bank deposits and similar assets paying less than the market interest rate. Like the third party payments, these imputed interest payments are counted as both income and expenditure for households. Owners’ equivalent rent is also added to household income, but net of mortgage interest, property taxes and maintenance costs. Finally, the national accounts treat the assets of pension and similar trust funds as if they were directly owned by households. This means that employer contributions and asset income for these funds are counted as household income (and therefore add to measured saving) while benefit payments are not.

These items make up a substantial part of household payments as recorded in the national accounts – Medicare, Medicaid and employer-paid health premiums together account for 14 percent of official household consumption; owners’ equivalent rent accounts for another 10 percent; and imputed financial services for 4 percent; while consolidating pension funds with households adds about 2 percent to household income (down from 5 percent in the 1980s). More importantly, the relative size of these components has changed substantially in the past generation, enough to substantially change the picture of household consumption and income.

Incidentally, Klein says I exclude all healthcare spending in my adjusted consumption series. This is a misunderstanding on his part. I exclude only third-party health care spending — healthcare spending by employers and the federal government. I’m not surprised he missed this point, given how counterintuitive it is that Medicare is counted as household consumption spending in the first place.

This is all shown in Figure 3 below (an improved version of the paper’s Figure 1):

The two dotted lines remove public and employer payments for healthcare, respectively, from household consumption. As you can see, the bulk of the reported increase in household consumption as a share of GDP is accounted for by healthcare spending by units other than households. The gray line then removes owners’ equivalent rent. The final, heavy black line removes imputed financial services, pension income net of benefits payments, and a few other, much smaller imputed items. What we are left with is monetary expenditure for consumption by households. The trend here is essentially flat since 1980; it is simply not the case that household consumption spending has increased as a share of GDP.

So Figure 3 is showing the contributions of the blue factors in Figure 2. Note that while these do not involve any monetary outlay by households and thus cannot affect household balance sheets or debt, they do all contribute to measured household saving.

The gray factors involve household assets. No one denies, in principle, that balance sheets have both an asset side and a liability side; but it’s striking how much this is ignored in practice, with net and gross measures used interchangeably. In the first place, we have to take into account residential investment. Purchase of new housing is considered investment, and does not reduce measured saving; but it does of course involve monetary outlay and affects household balance sheets just as consumption spending does. [2] We also have take into account net acquisition of financial assets. An increase in spending relative to income moves household balance sheets toward deficit; this may be accommodated by increased borrowing, but it can just as well be accommodated by lower net purchases of financial assets. In some cases, higher desired accumulation of financial asset can also be an autonomous factor requiring balance sheet adjustment. (This is probably more important for other sectors, especially state and local governments, than for households.) The fact that adjustment can take place on the asset as well as the liability side is another reason there is no necessary connection between saving and debt growth.

Net accumulation of financial assets affects household borrowing, but not saving or aggregate demand. Residential investment also does not reduce measured saving, but it does increase aggregate demand as well as borrowing. The red line in Figure 3 adds residential investment by households to adjusted consumption spending. Now we can see that household spending on goods and services did indeed increase during the housing bubble period – conventional wisdom is right on that point. But this was a  spike of limited duration, not the secular increase that the standard consumption figures suggest.

Again, this is not just an issue in principle; historical variation in net acquisition of assets by the household sector is comparable to variation in borrowing. The decline in observed savings rates in the 1980s, in particular, was much more reflected in slower acquisition of assets than faster growth of debt. And the sharp fall in saving immediately prior to the great recession in part reflects the decline in residential investment, which peaked in 2005 and fell rapidly thereafter.

The cyan item is capital gains, the other factor, along with net accumulation, in growth of assets and net wealth. For the debt-demand story this is not important. But in other contexts it is. As I pointed out in my Crooked Timber post on Piketty, the growth in capital relative to GDP in the US is entirely explained by capital gains on existing assets, not by the accumulation dynamics described by his formula “r > g”.

Finally, the red items in Figure 2 are factors other than current spending and income that affect the debt-income ratio. Arjun Jayadev and I call this set of factors “Fisher dynamics,” after Irving Fisher’s discussion of them in his famous paper on the Great Depression. Interest payments reduce measured saving and shift balance sheets toward deficit, just like consumption; but they don’t contribute to aggregate demand. Defaults or charge-offs reduce the outstanding stock of debt, without affecting demand or measured savings. Like capital gains, they are a change in a stock without any corresponding flow. [3] Finally, the debt-income ratio has a denominator as well as a numerator; it can be raised just as well by slower nominal income growth as by higher borrowing.

These factors are the subject of two papers you can find here and here. The bottom line is that a large part of historical changes in debt ratios — including the entire long-term increase since 1980 — are the result of the items shown in red here.

So what’s the point of all this?

First, borrowing is not the opposite of saving. Not even roughly. Matthew Klein, like most people, immediately translates rising debt into declining saving. The first half of his post is all about that. But saving and debt are very different things. True, increased consumption spending does reduce saving and increase debt, all else equal. But saving also depends on third party spending and imputed spending and income that has no effect on household balance sheets. While debt growth depends, in addition to saving, on residential investment, net acquisition of financial assets, and the rate of chargeoffs; if we are talking about the debt-income ratio, as we usually are, then it also depends on nominal income growth. And these differences matter, historically. If you are interested in debt and household expenditure, you have to look at debt and expenditure. Not saving.

Second, when we do look at expenditure by households, there is no long-term increase in consumption. Consumption spending is flat since 1980. Housing investment – which does involve outlays by households and may require debt financing – does increase in the late 1990s and early 2000s, before falling back. Yes, this investment was associated with a big rise in borrowing, and yes, this borrowing did come significantly lower in the income distribution that borrowing in most periods. (Though still almost all in the upper half.) There was a debt-financed housing bubble. But we need to be careful to distinguish this episode from the longer-term rise in household debt, which has different roots.

 

[1] Think of it this way: If I ask why the return on an investment was 20 percent, there is no end to causal factors you can bring in, from favorable macroeconomic conditions to a sound business plan to your investing savvy or inside knowledge. But in accounting terms, the return is always explained by the income and the capital gains over the period. If you know both those components, you know the return; if you don’t, you don’t. The relationships in the figure are the second kind of explanation.

[2] Improvement of existing housing is also counted as investment, as are brokers’ commissions and other ownership transfer costs. This kind of spending will absorb some part of the flow of mortgage financing to the household sector — including the cash-out refinancing of the bubble period — but I haven’t seen an estimate of how much.

[3] There’s a strand of heterodox macro called “stock-flow consistent modeling.” Insofar as this simply means macroeconomics that takes aggregate accounting relationships seriously, I’m very much in favor of it. Social accounting matrices (SAMs) are an important and underused tool. But it’s important not to take the name too literally — economic reality is not stock-flow consistent!