Author: JW Mason

The IMF on Investment since 2008

Vox today has a useful piece by five IMF economists on the behavior of business investment during and since the Great Recession. [1] From my point of view, there are three important points here.


1. The most important difference between this cycle and previous ones is the larger fall and slower recovery of private investment. This has always been my view, and I think it’s an especially important point for heterodox folks to take on board because there has been such (excessive, in my opinion) emphasis on the inequality-consumption link in explaining persistent demand weakness.

This relationship between output and investment is consistent with previous recessions: 

business investment has deviated little from what could be expected given the weakness in economic activity. In other words, firms have reacted to weak sales – both current and prospective – by reducing capital spending. Indeed, in surveys, businesses typically report lack of customer demand as the dominant challenge they face.

In other words, the old Keynesian “accelerator” story explains the bulk of the shortfall in investment since 2008.
2. Historically, deviations in output and investment has been persistent; there is no tendency for recessions to be followed by a return to the previous trend. 
The blue line shows the behavior of output and investment in recessions historically, relative to the pre-recession trend. Note that is no tendency for the gap to close, as much as six years after the previous peak.
The authors don’t emphasize this point, but it is important. If we look at recessions across a range of industrialized countries, on average the output losses are permanent. There is no tendency for output to return to the pre-trend. If this is true, there’s no basis for the conventional distinction between a demand-determined “short run” and a supply-determined “long run.” There is just one dynamic process. Steve Fazzari has reached this same conclusion, as I’ve written about here. Roger Farmer has just posted an econometric demonstration that in the postwar US, output changes are persistent — there is no tendency to return to a trend.
 3. There’s no reason to think that the investment deficit is explained by financial constraints. I should say frankly that the paper didn’t move my priors much at all on this point, but it’s still interesting that that’s what it says. By their estimates, firms in more “financially-dependent” sectors (this is a standard technique, but whatever) initially reduced investment more than firms in less financially-dependent sectors, but as of 2013 investment in both groups of firms were the same 40 percent below the pre-crisis trend. If you believe these results — and again, I don’t put much weight on them, except as an indicator of the IMF flavor of received opinion — then while tighter credit may have helped trigger the crisis, it cannot explain the persistent weakness of demand. Or from a policy perspective — and the authors do say this — measures to improve access to credit are unlikely to achieve much, at least relative to measures to boost demand.
Investment by sector

So these are features it might be nice to incorporate into a macro model — investment determined mainly by (changes in) current output; a single system of demand-based dynamics, as opposed to a short-run demand story and a long-run supply-based steady state growth path; a possibility of multiple equilibria, such that (let’s say) a temporary interruption of credit flows can produce a persistent reduction in output.  On one level I don’t especially trust these results. But on another level, I think they provide a good set of stylized facts that macro models should aspire to parsimoniously explain. 

[1] The European Vox, not the Klein-Yglesias one.

UPDATE: Krugman today points to the same work and also interprets it as support for an accelerator story.

New-Old Paper on the Balance of Payments

Four or five years ago, I wrote a paper arguing that the US current account deficit, far from being a cause of the crisis of 2008, was a stabilizing force in the world economy. I presented it at a conference and then set it aside. I recently reread it and I think the arguments hold up well. If anything the case that the US, as the center of the world financial system, ought to run large current account deficits indefinitely looks even stronger now, given the contrasting example of Germany’s behavior in the European system.

I’ve put the paper up as a working paper at John Jay economics department site. Here’s the abstract:

Persistent current account imbalances need not contribute to macroe- conomic instability, despite widespread claims to the contrary by both mainstream and Post Keynesian economists. On the contrary, in a world of large capital inflows, a high and stable level of world output is most likely when the countries with the least capacity to generate capital inflows normally run current account surpluses, while the countries with the greatest capacity to generate capital inflows (the US in particular) normally run current account deficits. An emphasis on varying balance of payments constraints is consistent with the larger Post Keynesian vision, which emphasizes money flows and claims are not simply passive reflections of “real” economic developments, but exercise an important influence in their own right. It is also consistent with Keynes’ own views. This perspective helps explain why the crisis of 2008 did not take the form of a fall in the dollar, and why reserve accumulation in East Asia successfully protected those countries from a repeat of the crisis of 1997. Given the weakness of the “automatic” mechanisms that are supposed to balance trade, income and financial flows, a reduction of the US current account deficit is likely to exacerbate, rather than ameliorate, global macroeconomic instability.

You can read the whole thing here.

The Greek Crisis and Monetary Sovereignty

Note: This post only really makes sense as a continuation of the argument in this one.

It’s a general rule that the internal logic of a system only becomes visible when it breaks down. A system that is smoothly reproducing itself provides no variation to show what forces it responds to. Constraints are invisible if they don’t bind. You don’t know where power lies until a decision is actively contested.

In that sense, the crises of the past seven years — and the responses to them — should have been very illuminating, at least if we can figure out what to learn from them. The current crisis in Greece is an ideal opportunity to learn where power is exercised in the union, and how tightly the single currency really binds national governments. Of course, we will learn more about the contours of the constraints if the Syriza government is more willing to push against them.

The particular case I’m thinking of right now is our conventional language about central banks “printing money,” and the related concept of monetary sovereignty. In periods of smooth reproduction we can think of this as a convenient metaphor without worrying too much about what exactly it is a metaphor for. But if Greece refuses to accept the ECB’s conditions for continued support for its banks, the question will become unavoidable.

We talk about governments “printing money” as if “money” always meant physical currency and banks were just safe-deposit boxes. Even Post Keynesian and MMT people use this language, even as they insist in the next breath that money is endogenously created by the banking system. But to understand concretely what power the ECB does or does not have over Greece, we need to take the idea of credit money seriously.

Money in modern economies means bank liabilities. [1] Bank liabilities constitute money insofar as a claim against one bank can be freely transferred to other units, and freely converted to a claim against another bank; and insofar as final settlement of claims between nonfinancial units normally takes the form of a transfer of bank liabilities.

Money is created by loan transactions, which create two pairs of balance-sheet entries — an asset for the borrowing unit and a liability for the bank (the deposit) and a liability for the borrowing unit and an asset for the bank (the loan). Money is destroyed by loan repayment, and also when the liabilities of a bank cease to be usable to settle claims between third parties. In familiar modern settings this lack of acceptability will be simultaneous with the bank being closed down by a regulatory authority, but historically things are not always so black and white. In the 19th century, it was common for a bank that ran out of reserves to suspend convertibility but continue operating. Deposits in such banks could not be withdrawn in the form of gold or equivalent, but could still be used to make payments, albeit not to all counterparties, and usually at a discount to other means of payment. [2]

To say, therefore, that a government controls the money supply or “prints money” is simply to say that it can control the pace of credit creation by banks, and that it can can maintain the acceptability of bank liabilities by third parties — which in practice means, by other banks. It follows that our conventional division of central bank functions between monetary policy proper (or setting the money supply), on the one hand, and bank regulation, operation of the interbank payments system, and lender of last resort operations, on the other, is meaningless. There is no distinct function of monetary policy, of setting the interest rate, or the money supply. “Monetary policy” simply describes one of the objectives toward which the central bank’s supervisory and lender-of-last-resort functions can be exercised. It appears as a distinct function only when, over an extended period, the central bank is able to achieve its goals for macroeconomic aggregates using only a narrow subset of the regulatory tools available to it.

In short: The ability to conduct monetary policy means the ability to set the pace of new bank lending, ex ante, and to guarantee the transferability of the balances thus created, ex post.

It follows that no country with a private banking system has full monetary sovereignty. The central bank will never be able to exactly control the pace of private credit creation, and to do so even approximately except by committing regulatory tools which then are unavailable to meet other objectives. In particular, it is impossible to shift the overall yield structure without affecting yield spreads between different assets, and it is impossible to change the overall pace of credit creation without also influencing the disposition of credit between different borrowers. In a system of credit money, full monetary sovereignty requires the monetary authority to act as the monopoly lender, with banks in effect serving as just its retail outlets. [3]

Now, some capitalist economies actually approximate to this pretty closely. For example the postwar Japanese system of “window guidance” or similar systems in other Asian developmental states. [4] Something along the same lines is possible with binding reserve requirements, where the central bank has tight operational control over lending volumes. (But this requires strict limits on all kinds of credit transactions, or else financial innovation will soon bypass the requirements.) Short of this, central banks have only indirect, limited influence over the pace of money and credit creation. Such control as they do have is necessarily exercised through specific regulatory authority, and involves choices about the direction as well as the volume of lending.  And it is further limited by the existence of quasi-bank substitutes that allow payments to be made outside of the formal banking system, and by capital mobility, which allows loans to be incurred, and payments made, from foreign banks.

On the other hand, a country that does not have its “own” currency still will have some tools to influence the pace of credit creation and to guarantee interbank payments, as long as there is some set of banks over which it has regulatory authority.

My conclusion is that the question of whether a country does or does not have its own currency is not a binary one, as it’s almost always imagined to be. Wealth takes to form of a variety of assets, whose prospective exchange value can be more or less reliably stated in terms of some standard unit; transactions can be settled with a variety of balance-sheet changes, which interchange more or closely to par, and which are more or less responsive to the decisions of various authorities.  We all know that there are some payments you can make using physical currency but not a credit or debit card, and other payments you can make with the card but not with currency. And we all know that you cannot always convert $1,000 in a bank account to exactly $1,000 in cash, or to a payment of exactly $1,000 – the various fees within the payment system means that one unit of “money” is not actually always worth one unit. [5]

In normal times, the various forms of payment used within one country are sufficiently close substitutes with each other, exchange sufficiently close to par, and are sufficiently responsive to the national monetary authority, relative to forms of payment used elsewhere, that, for most purposes, we can safely speak of a single imaginary asset “money.” But in the  Greek case, it seems to me, this fiction obscures essential features of the situation. In particular, it makes the question of being “in” or “out of” the euro look like a hard binary, when, in my opinion, there are many intermediate cases and no need for a sharp transiton between them.

[1] Lance Taylor, for instance, flatly defines money as bank liabilities in his superb discussion of the history of monetary thought in Reconstructing Macroeconomics.

[2] Friedman and Schwartz discuss this in their Monetary History of the United States, and suggest that if banks had been able to suspend withdrawals when their reserves ran out, rather than closed down by the authorities, that would have been an effective buffer against against the deflationary forces of the Depression.

[3] Woodford’s Interest and Prices explicitly assumes this.

[4] Window guidance is described by Richard Werner in Masters of the Yen. The importance of centralized credit allocation in Korea is discussed by the late Alice Amsden in Asia’s Next Giant. 

[5] Goodhart’s fascinating but idiosyncratic History of Central Banking ends with a proposal for money that does not seek to maintain a constant unit value – in effect, using something like mutual fund shares for payment.

Causes and Effects of Wage Growth

Over here, a huge stack of exams, sitting ungraded since… no, I can’t say, it’s too embarrassing.  There, a grant proposal that extensive experimentation has shown will not, in fact, write itself. And I still owe a response to all the responses and criticism to my Disgorge the Cash paper for Roosevelt. So naturally, I thought this morning would be a good time to sit down and ask what we can learn from comparing the path of labor costs in the Employment Cost Index compared with the ECEC.

The BLS explains the difference between the two measures:

The Employment Cost Index, or ECI, measures changes in employers’ cost of compensating workers, controlling for changes in the industrial-occupational composition of jobs. … The ECI is intended to indicate how the average compensation paid by employers would have changed over time if the industrial-occupational composition of employment had not changed… [It] controls for employment shifts across 2-digit industries and major occupations. The Employer Costs for Employee Compensation, or ECEC… is designed to measure the average cost of employee compensation. Accordingly, the ECEC is calculated by multiplying each job quote by its sample weight.

In other words, the ECI measures the change in average hourly compensation, controlling for shifts in the mix of industries and occupations. The ECEC simply measures the overall change in hourly compensation, including the effects of both changes in compensation for particular jobs, and changes in the mix of jobs.

Here are the two series for the full period both are available (1987-2014), both raw and adjusted for inflation (“real”).

What do we learn from this?

First, the two series are closely correlated. This tells us that most of the variation in compensation is driven by changes within occupations and sectors, not by shifts in employment between occupations and sectors. This is clearly true at annual frequencies but it seems to be true over longer periods as well. For instance, let’s compare the behavior of compensation in the five years since the end of the recession to the last period of strong wage growth, 1997-2004. The difference between the two periods in the average annual increase in nominal wages is almost exactly the same according to the two indexes — 2.7 points by the ECI, 2.6 points by the ECEC. In other words, slower wage growth in the recent period is entirely due to slower wages growth within particular kinds of jobs. Shifts in the composition of jobs have played no role at all.

On the face of it, the fact that almost all variation in aggregate compensation is driven by changes within employment categories, seems to favor a labor/political story of slower wage growth as opposed to a China or robots story. The most obvious versions of the latter two stories involve a disproportionate loss of high-wage jobs, whereas stories about weaker bargaining position of labor predict slower compensation growth within job categories. I wouldn’t ask this one piece of evidence to carry a lot of weight in that debate. (I think it’s stronger evidence against a skills-based explanation of slower wage growth.)

While the two series in general move together, the ECEC is more strongly cyclical. In other words, during periods of high unemployment and falling wages in general, there is also a shift in the composition of employment towards lower-paid occupations. And during booms, when unemployment is low and wages are rising in general, there is a shift in the direction of higher-paid job categories. [1] Insofar as wages and labor productivity are correlated, this cyclical shift between higher-wage and lower-wage sectors could help explain why employment is more stable than output. I’ve had the idea for a while that the Okun’s law relationship — the less than one-for-one correlation between employment and output growth — reflects not only hiring/firing costs and overhead labor, but also shifts in the composition of employment in response to demand. In other words, in addition to employment adjustment costs at the level of individual enterprises, the Okun coefficient reflects cyclically varying degrees of “disguised unemployment” in Joan Robinson’s sense. [2] This is an argument I’d like to develop properly someday, since it seems fairly obvious, potentially important and empirically tractable, and I haven’t seen anyone else make it. [3] (I’m sure someone has.)

What’s going on in the most recent year? Evidently, there has been no acceleration of wage growth for a given job, but the mix of jobs created has shifted toward higher-wage categories. This suggests that to the extent wages are rising faster, it’s not a sign of labor-market pressures. (Some guy from Deutsche Bank interprets the same divergence as support for raising rates, which it’s hard not to feel is deliberately dishonest.) As for which particular higher-wage job categories are growing more rapidly — I don’t know. And, what’s going on in 1995? That year has by far the biggest divergence between the two series. It could well be an artifact of some kind, but if not, seems important. A large fall in the ECEC relative to the ECI could be a signature of deindustrialization. I’m not exploring the question further now (those exams…) but it would be interesting to ask analogous question with some series that extends earlier. It’s likely that if we were looking at the 1970s-1980s, we would find a much larger share of variation in wage growth explained by compositional shifts.

Should we adjust for inflation? I give the “real” series here, but I am in general skeptical that there is any sense in which an ex post adjustment of money flows for inflation is more real than, say, The Real World on MTV. I am even more doubtful than usual in this case, because we are normally told to think that changes in nominal wages are the main determinant of inflation. Obviously in that case we have to think of the underlying labor-market process as determining a change in nominal wage. Still, if we do compute a “real” index, things look a little different. Real ECI rises 14 percent over the full 1987-2014 period, while real ECEC rises only 5 percent. So now we can say that about two-thirds of the increase in real wages within particular job categories over the past three decades, was offset by a shift in the composition of employment toward lower-paid job categories. (This is all in the first decade, 1987-1996, however.) This way of looking at things makes sense if we think the underlying wage-setting process, whatever it is, operates in terms of a basket of consumption goods.

This invites another question: How true is it that nominal wages move with inflation?

Conventional economics wisdom suggests we can separate wages into nominal and “real” components. This is on two not quite consistent grounds. First, we might suppose that workers and employers are implicitly negotiating contracts in terms of a fixe quantity of labor time for, on the one hand, a basket of wage goods, and on the other, a basket of produced goods (which will be traded for consumption good for the employer). This contract only incidentally happens to be stated in terms of money. The ultimate terms on which consumption goods for the workers exchange with consumption goods for the employer should not be affected by the units the trade happens to be denominated in. (In this respect the labor contract is just like any other contract.) This is the idea behind Milton Friedman’s “natural rate of unemployment” hypothesis. In Friedman’s story, causality runs strictly from inflation to unemployment. High inflation is not immediately recognized by workers, leading them to overestimate the basket of goods their wages will buy. So they work more hours than they would have chosen if they had correctly understood the situation. From this point of view, there’s no cost to low unemployment in itself; the problem is just that unemployment will only be low if high inflation has tricked workers into supply too much labor. Needless to say, this is not the way anyone in the policy world thinks about the inflation-unemployment nexus today, even if they continue to use Friedman’s natural rate language.

The alternative view is that workers and employers negotiate a money-wage, and then output prices are set as a markup over that wage. In this story, causality runs from unemployment to inflation. While Friedman thought an appropriate money-supply growth rate was the necessary and sufficient condition for stable prices, with any affect on unemployment just  collateral damage from changes in inflation, in this story keeping unemployment at an appropriate level is a requirement for stabilizing prices. This is the policy orthodoxy today.  (So while people often say that NAIRU is just another name for the natural rate of unemployment, in fact they are different concepts.) I think there are serious conceptual difficulties with the orthodox view, but we’ll save those for another time. Suffice it to say that causality is supposed to run from low unemployment, to faster nominal wage growth, to higher inflation. So the question is: Is it really the case that faster nominal wage growth is associated with higher inflation?

Wage Growth and Inflation, 1947-2014

A simple scatterplot suggests a fairly tight relationship, especially at higher levels of wage growth and inflation. But if we split the postwar period at 1985, things look very different. In the first period, there’s a close relationship — regressing inflation on nominal wage growth gives an R-squared of 0.81. (Although even then the coefficient is significantly less than 1.)

Wage Growth and Inflation, 1947-1985

Since 1985, though, the relationship is much looser, with an R-squared of 0.12. And even is that driven almost entirely by period of falling wages and prices in 2009; remove that and the correlation is essentially zero.

Wage Growth and Inflation, 1986-2014

So while it was formerly true that changes in inflation were passed one for one into changes in nominal wages, and/or changes in nominal wage growth led to similar changes in inflation, neither of those things has been true for quite a while now. In recent decades, faster nominal wage growth does not translate into higher inflation.

Obviously, a few scatterplots aren’t dispositive, but they are suggestive. So supposing that there has been a  delinking of wage growth and inflation, what conclusions might we draw? I can think of a couple.

On the one hand, maybe we shouldn’t be so dismissive of  the naive view that inflation reduces the standard of living directly, by raising the costs of consumption goods while incomes are unchanged. There seems to be an emerging conventional wisdom in this vicinity. Here for instance is Gillian Tett in the FT, endorsing the BIS view that there’s nothing wrong with falling prices as long as asset prices stay high. (Priorities.) In the view of both Keynes (in the GT; he modified it later) and Schumpeter, inflation was associated with higher nominal but lower real wages, deflation with lower nominal but higher real wages. I think this may have been true in the 19th century. It’s not impossible it could be true in the future.

On the other hand. If the mission of central banks is price stability, and if there is no reliable association between changes in wage growth and changes in inflation, then it is hard to see the argument for tightening in response to falling unemployment. You really should wait for direct evidence of rising inflation. Yet central banks are as focused on unemployment as ever.

It’s perhaps significant in this regard that the authorities in Europe are shifting away from the NAIRU (Non-Accelerating Inflation Rate of Unemployment) and increasingly talking about the NAWRU (Non-Accelerating Wage Rate of Unemployment). If the goal all along has been lower wage growth, then this is what you should expect: When the link between wages and inflation weakens, the response is not to find other tools for controlling inflation, but other arguments for controlling wages. This may be the real content of the “competitiveness” discourse. Elevating competitiveness over price stability as overarching goal of policy lets you keep pushing down wages even when inflation is already low.

Worth noting here: While the ECB’s “surrender Dorothy” letter to the Spanish government ordered them to get rid of price indexing, their justification was not, as you might expect, that indexation contributes to inflationary spirals. Rather it was that it is “a structural obstacle to the adjustment of labour costs” and “contribute to hampering competitiveness.” [4]  This is interesting. In the old days we would have said, wage indexing is bad because it won’t affect real wages, it just leads to higher inflation. But apparently in the new dispensation, we say that wage indexing is bad precisely because it does affect real wages.

[1]  This might seem to contradict the previous point but it doesn’t, it’s just that the post-2009 recovery period includes both a negative composition shift in 2008-2009, when unemployment was high, and a positive compositional shift in 2014, which cancel each other out.

[2] From A Theory of Employment: “Except under peculiar conditions, a decline in effective demand which reduces the amount of employment offered in the general run of industries will not lead to ‘unemployment’ in the sense of complete idleness, but will rather drive workers into a number of occupations [such as] selling match-boxes in the Strand, cutting brushwood in the jungles, digging potatoes on allotments which are still open to them. A decline in one sort of employment leads to an increase in another sort, and at first sight it may appear that, in such a case, a decline in effective demand does not cause unemployment at all. But the matter must be more closely examined. In all those occupations which the dismissed workers take up, their productivity is less than in the occupations that they have left.”

[3] The only piece I know of that makes the connection between demand and productivity variation across sectors is this excellent article by John Eatwell (which unfortunately doesn’t seem to be available online), but it is focused on long run variation, not cyclical.

[4] The ECB’s English is not the most felicitous, is it? The Spanish version is “contribuyen a dificultar la competitividad y el crecimiento,” which also doesn’t strike me as a phrase that a native speaker would write. Maybe it sounds better in the original German.

A Most Violent Year

I just watched this movie.

Oscar Isaacs plays the owner of a fuel oil company in 1981, the peak year of violent crime in New York City. Needless to say, it’s an industry in which organized crime is salient, in real life and of course double in the movies. But he just wants to sell fuel oil. One way of looking at it, is it’s The Sopranos from the point of view of the people they preyed on. Another way, it’s the kind of movie Deirdre McCloskey used to call for, a celebration of bourgeois virtue. I don’t know if McCloskey would like the results in this particular case. What’s very clear here is how much bourgeois virtue depends on, or is constituted by, its dialectical relationship with the liberal order on the one hand, the rule of law; and on the other hand the personal loyalties of family and tribe. Your status as a business owner depends on your relationship to your wife, children, in-laws, on the one hand, and to the agents of the state on the other. The capitalist is always an embodied human being, never the pure personification of capital. (It’s worth noting that Isaacs’ key counterparties are a Hasidic clan and a grandfather-granddaughter operation.)

We also see the void at the heart of the capitalist ethic. Several times, other characters ask Isaacs why it’s so important to him that his business keep growing. His answers range from “Just because” to “I don’t understand the question.” These exchanges reminded me of a line from Nietzsche that Bob Fitch used to describe real estate speculators:

We must not ask the money-making banker the reason for his restless activity, it is foolish. The active roll as the stone rolls, according to the stupidity of mechanics.

Isaacs’ performance is quite affecting, and it’s clear that his character has real human connections to his family, his employees, and his business peers. That only makes it more effective when we see how much his concrete choices come down to “the stupidity of mechanics.”

The depiction of New York back in the day feels real. The dialogue is smart and the camerawork and sound are effective, in my uniformed judgement. It’s a good movie, I recommend it.

A Quick Point on Models

According to Keynes the purpose of economics is “to provide ourselves with an organised and orderly method of thinking out particular problems”; it is “a way of thinking … in terms of models joined to the art of choosing models which are relevant to the contemporary world.” (Quoted here.)

I want to amplify on that just a bit. The test of a good model is not whether it corresponds to the true underlying structure of the world, but whether it usefully captures some of the regularities in the concrete phenomena we observe. There are lots of different regularities, more or less bounded in time, space and other dimensions, so we are going to need lots of different models, depending on the questions we are asking and the setting we are asking them in. Thus the need for the “art of choosing”.

I don’t think this point is controversial in the abstract. But people often lose sight of it. Obvious case: Piketty and “capital”. A lot of the debate between Piketty and his critics on the left has focused on whether there really is, in some sense, a physical quantity of capital, or not. I don’t think we need to have this argument.

We observe “capital” as a set of money claims, whose aggregate value varies in relation to other observable monetary aggregates (like income) over time and across space. There is a component of that variation that corresponds to the behavior of a physical stock — increasing based on identifiable inflows (investment) and decreasing based on identifiable outflows (depreciation). Insofar as we are interested in that component of the observed variation, we can describe it using models of capital as a physical stock. The remaining components (the “residual” from the point of view of a model of physical K) will require a different set of models or stories. So the question is not, is there such a thing as a physical capital stock? It’s not even, is it in general useful to think about capital as a physical stock? The question is, how much of the particular variation we are interested is accounted for by the component corresponding to the evolution of a physical stock? And the answer will depend on which variation we are interested in.

For example, Piketty could say “It’s true that my model, which treats K as a physical stock, does not explain much of the historical variation in capital-output ratios at decadal frequencies, like the fall and rise over the course of the 20th century. But I believe it does explain very long-frequency variation, and in particular captures important long-run possibilities for the future.” (I think he has in fact said something like this, though I can’t find the quote at the moment.) You don’t have to agree with him — you could dispute that his model is a good fit for even the longest-frequency historical variation, or you could argue that the shorter frequency variation is more interesting (and is what his book often seems to be about). But it would be pointless to criticize him on the grounds that there isn’t “really” such a thing as a physical capital stock, or that there is no consistent way in principle to measure it. That, to me, would show a basic misunderstanding of what models are.

An example of good scientific practice along these lines is biologists’ habit of giving genes names for what happens when gross mutations are induced in them experimentally. Names like eyeless or shaggy or buttonhead: the fly lacks eyes, grows extra hair, or has a head without segments if the gene is removed. It might seem weird to describe genes in terms of what goes wrong when they are removed, as opposed to what they do normally, but I think this practice shows good judgement about what we do and don’t know. In particular, it avoids any claim about what the gene is “for.” There are many many relationships between a given locus in the genome and the phenotype, and no sense in which any of them is more or less important in an absolute sense. Calling it the “eye gene” would obscure that, make it sound like this is the relationship that exists out in the world, when for all we know the variation in eye development in wild populations is driven by variation in entirely other locuses. Calling it eyeless makes it clear that it’s referring to what you observe in a particular experimental context.

EDIT: I hate discussions of methodology. I should not have written this post. (I only did because I liked the gene-naming analogy.)  That said, if you, unlike me, enjoy this sort of thing, Tom Hickey wrote a long and thoughtful response to it. He mentions among others, Tony Lawson, who I would certainly want to read more of if I were going to write about this stuff.

Mark Blyth on the Creditor’s Paradise

There’s a lot to like in this talk by Mark Blyth, reposted in Jacobin. I will certainly be quoting him in the future on the euro system as a “creditor’s paradise.” But I can’t help noting that the piece repeats exactly the two bits of conventional wisdom that I’ve been criticizing in my recent posts here on Europe. [1]

First, the uncritical adoption of the orthodox view that if Greece defaults on its debts to the euro system, it will have to leave the single currency.  Admittedly it’s just a line in passing. But I really wish that Blyth would not write “default or ‘Grexit’,” as if they were synonyms. Given that the assumption that they have to go together is one of the strongest weapons on the side of orthodoxy, opponents of austerity should at least pause a moment and ask if they necessarily do.

Second, this:

Austerity as economic policy simply doesn’t work. … European reforms … simply ask everyone to become “more competitive” — and who could be against that? Until one remembers that being competitive against each other’s main trading partners in the same currency union generates a “moving average” problem of continental proportions. 

It is statistically absurd to all become more competitive. It’s like everyone trying to be above average. It sounds like a good idea until we think about the intelligence of the children in a classroom. By definition, someone has to be the “not bright” one, even in a class of geniuses.

In comments to my last post, a couple people doubted if critics of austerity really say it’s impossible for all the countries in the euro to become more competitive. If you were one of the doubters, here you go: Mark Blyth says exactly that. Notice the slippage in the referent of “everyone,” from all countries in the euro system, to all countries in the world. Contra Blyth, since the eurozone is not a closed trading system, it is not inherently absurd to suggest that everyone in it can become more competitive. If competitiveness is measured by the trade balance, it’s not only not absurd, it’s an accomplished fact.

Obviously — but I guess it isn’t obvious — I don’t personally think that the shift toward trade surpluses throughout the eurozone represents any kind of improvement in the human condition. But it does directly falsify the claim Blyth is making here. And this is a problem if the stance we are trying to criticize austerity from is a neutral technocratic one, in which disagreements are about means rather than ends.

Austerity is part of the program of reinforcing and extending the logic of the market in political and social life. Personally I find that program repugnant. But on its own terms, austerity can work just fine.

[1] One of my posts was also cross-posted at Jacobin. Everybody should read Jacobin.

What Has Happened to Trade Balances in Europe?

It has gradually entered our awareness that the Greek trade account is now balanced. Greece no longer depends on financial markets (or official transfers, or remittances from workers abroad) to finance its imports. This is obviously important for negotiations with the “institutions,” or at least it ought to be.

I was wondering, how general is this shift toward a positive trade balance. In the FT last week, Martin Wolf pointed out that over the past five years, the Euro area as a whole has shifted from modest trade deficits to substantial trade surpluses, equal to 3 percent of euro-area GDP in 2013. He does not break it down by country, though. I decided to do that.

Euro area trade ratios, 2008 and 2013. The size of the dots is proportional to total 2008 trade.

Here, from Eurostat, are the export-import ratios for the euro countries in 2008 and 2013. Values greater than one on the horizontal axis represent a trade surplus in 2008; only a few northern European countries fall in that group. Meanwhile, in seven countries imports exceeded exports by 10 percent or more. By 2013, the large majority of the euro area is in surplus, while not a single country has an excess of imports over exports of more than 5 percent. The distance above the diagonal line indicates the improvement from 2008 to 2013; this is positive for every euro-area country except Austria, Finland and Luxembourg, and the biggest improvements are in the countries with the worst ratios in 2008. The surplus countries, apart from Finland, more or less maintained their surpluses; but the deficit countries all more or less eliminated their deficits.

So does this mean that austerity works? Yes and no. It is certainly true that Europe’s deficit countries have all achieved positive trade balances in the past few years, even including countries like Greece whose trade deficits long predated the euro. On the other hand, it’s also almost certainly true that this has more to do with the falls in domestic demand rather than any increase in competitiveness.

This is shown in the second figure, which gives the ratio of 2013 imports to 2008 exports on the vertical axis, and 2013 exports to 2008 imports on the horizontal axis. (This is in nominal euros.) Here a point on the diagonal line equals and equal growth rate of imports and exports. Most countries are clustered around 15% growth in imports and exports; these are the countries that had balanced trade or surpluses in 2008, and whose trade ratios have not changed much in the past five years. Only one country, Estonia, has export growth substantially above the European average. But all the former deficit countries have import growth much lower than average. (As indicated by their position to the left of the main cluster.) It’s evident from this diagram that the move toward balanced trade in the deficit countries is about throttling back imports, not boosting exports. This suggests that it has more to do with slow income growth than with lower costs.

Again, the sizes of the dots are proportional to 2008 trade volumes.

Still, the fact remains, trade deficits have almost been eliminated in the euro area. Liberal critics of the European establishment often say “not every country in Europe can be a net exporter” as if that were a truism. But it’s not even true, not in principle and evidently not in practice. It turns out it is quite possible for every country in the euro to run a trade surplus.

The next question is, with whom has the euro area’s trade balanced improved? Europe outside the euro, to begin with. The country with the biggest single increase in net imports from the euro zone is, surprisingly, Switzerland, whose deficit with the euro area has increased by close to 60 billion. Switzerland’s annual trade deficit with the euro area is now 75 billion, about a quarter of the area’s overall trade surplus. Norway and Turkey have increased their deficits by about 15 billion each. The rest of the increase in net exports are accounted for by increased surpluses with Africa (26 billion), the US (27 billion), and Latin America (35 billion, about half to Brazil), and a decreased deficit with Asia (135 billion, including a 55 billion smaller deficit with China, 30 billion smaller with Japan and 20 billion with Korea). Net exports to Australia have also increased by 10 billion.

Why do I bring this up? One, I haven’t seen it discussed much and it is interesting.

But more importantly, the lesson of the Europe-wide shift toward trade surpluses is that austerity can succeed on its own terms. I think there’s a tendency for liberal critics of austerity to assume that the people on the other side are just confused, or blinkered by ideology, and that there’s something incoherent or self-contradictory about competitiveness as a Europe-wide organizing principle. There’s a hope, I think, that economic logic will eventually compel policymakers to do what’s right for everyone. Personally, I don’t think that the masters of the euro care too much about the outcome of the struggle for competitiveness; it’s the struggle itself — and the constraints it imposes on public and private choices — that matters. But insofar as the test of the success of austerity is the trade balance, I suspect austerity can succeed indefinitely.

UPDATE: In comments Kostas Kalaveras points to a report from the European Commission that includes a similar breakdown of changes in trade balances across the euro area. There’s some useful data in there but the interpretation is that almost all the adjustment has been structural rather than cyclical. This is based on estimates of declining potential output in the periphery that I think are insane. But it’s interesting to see how official Europe thinks about this stuff.

“Disgorge the Cash” at the Roosevelt Institute

I have a working paper up at the Roosevelt Institute, as part of their new Financialization Project. Much of the content will be familiar to readers of this blog, but I think the argument is clearer and, I hope, more convincing in the paper.

The paper has gotten a nice writeup at the Washington Post, and at the Washington Center for Equitable Growth.

UPDATE. And in the International Business Times.

“The Idea Was to Create a Modern Gold Standard”

My view on the euro is that it has become a project to restore the rule of money over humanity. To move us back toward a world where in every sphere of life, and especially in collective choices made through government, the overriding question is, “what is most consistent with the accumulation of money claims?” or, “what will the markets think?” The euro is a project to roll back social democracy and to reimpose the “discipline of the market” on the state — or in other words to restore the logic of the gold standard, whose essential condition was that preservation of money-claims had priority over democratic government. From this point of view, crises are not a failure of the system but an essential part of its functioning, since discipline requires that punishment be sometimes visibly meted out.

This kind of Polanyian perspective is typically found on the left. But it’s increasingly clear that many of those on the other side think this way too. Here is a striking recent op-ed from the FT, by one Thomas Mayer:

Germany relied on the Maastricht treaty to make it possible to share a currency without sacrificing political accountability. The idea was to create an economic framework that was in some ways the modern equivalent of a gold standard. Monetary decisions would be made by the European Central Bank, whose only goal would be price stability. The lack of shared political institutions did not matter, because the ECB was to operate in total independence from all political influence. It would never lend to member states, even ones that were at risk of going bankrupt. 

Despite these provisions, the Germans did not entirely trust their partners’ fiscal discipline, so they imposed strict limits to government budget deficits and debt…. With the benefit of hindsight, it was all rather naive. Germany should have insisted on a procedure for government insolvency, and a way of showing the door to states that were unable or unwilling to respect the rules. 

Mayer, the head of a German think tank, does not mention that in the first decade of the euro Germany was one of the most frequent violators of the “strict limits” on fiscal deficits. But it’s helpful to see the idea of the euro as a new gold standard stated so plainly by a supporter. And he makes another important point, which is that even under a new gold standard, the discipline of the markets is unreliable, and needs to be supplemented with (or simulated by) overt political authority.

From early 2010, when a Greek default was narrowly avoided, until early 2012, Angela Merkel, the German chancellor, attempted to re-establish the Maastricht model … and contemplated the possibility that Greece might leave the euro. But she is risk-averse by nature and, confronted with the incalculable risks, she changed course in the spring of 2012. The Greek debt restructuring, she now said, was “exceptional and unique”. Leaving the euro was out of question for any member country. Since this decision meant markets would no longer pressurise governments into sound economic policies, she built a pan-European “shadow state” — a web of pacts to ensure that countries followed policies consistent with sound money. 

It has not worked. From Greece to France, countries resist any infringement on their sovereignty and refuse to act in a way that is consistent with a hard currency policy. The ECB is forced to loosen its stance. Worse, it has allowed monetary policy to become a back channel for transfering economic resources between eurozone members. This is Germany’s worst nightmare… 

A century ago, Eugen Böhm-Bawerk, the Austrian economist and finance minister, proclaimed laws of economics to be a higher authority than political power. Some Germans say that a hard currency is an essential part of their economic value system. If both are right, politicians will be powerless to prevent Germany’s departure from a monetary union that is at odds with the country’s economic convictions.

The essential points here are, first, that the goal of the euro system to create a situation where markets can “pressurise governments into sound economic policies,” meaning first and foremost, policies that preserve the value of money; second, that this requires limits on national sovereignty, which will be resisted by democratic governments; and third, that this resistance can only be overcome through the threat of a crisis. In this sense, from Mayer’s perspective, the steps that were taken to resolve the crisis were a terrible mistake, and required the use of direct political control by a “shadow state” to substitute for the blunted threat of financial catastrophe. This is all very clarifying; the one piece of mystification still intact is the substitution of “Germany” as the social actor, rather than European wealth owners as a class. 
Mayer is just one guy, of course, but presumably he speaks to some extent for his old colleagues at Deutsche Bank, Goldman Sachs and the IMF. [1] And anyway this kind of language is everywhere these days.

The FT’s review of “Lords of Secrecy,” for instance, acknowledges that we increasingly seem to be subjects of “a vast secret state beyond control.” That sounds bad! But the reviewer concludes on a cheerful note:

The “lords of secrecy” do need to be kept in check, of course. But that may soon happen anyway. After all, principles go only so far in holding the clandestine arms of the state to account; money goes a lot further. But money is one thing that is not quite so freely available in Washington, or many other capitals in the west, no matter how many secrets they have.

Here, subservience to the bond markets doesn’t just require limits on democracy or the rule of law, it makes them superfluous.

Returning to the euro, here, via Bill Mitchell, is Graham Bishop on the “revolutionary political implications” of unified interbank payments in the euro area:

While payments are an intensely technical area, the political implications are immense… SEPA establishes an effective ‘referendum veto’ to be exercised by citizens whose national governments might contemplate leaving the euro. In SEPA, citizens are empowered to embed the freedom and the choices associated with the single market so deeply in the economy to make it impossible for any EU government which adopted the euro to abandon the common currency. It is hard to imagine that citizens and enterprises accustomed to these choices would want to leave the euro once they considered what they individually would give up by way of returning to narrow, national offerings for trade in goods and services. 

With SEPA, any citizen who fears that his home state is about to leave the euro to implement a major devaluation can protect themselves by transferring their liquid funds into a bank in another euro country – in an instant and at negligible cost. In effect, this is a free option for all citizens and amounts to an instantaneous referendum on government policy. Such an outflow of retail liquidity from a banking system would cause its rapid collapse. The quiet run out of deposits in the Irish banks last year demonstrated the power of depositors to force radical political change.

There’s not much to say about that unctuous, preening first paragraph, with its cant about freedom and choices, except to hope that some future novelist (or screenwriter, I guess) can do justice to the horrible people who rule us. (Also, notice the classic bait-and-switch in which the only alternative to complete liberalization of capital flows is autarchy.) But what’s interesting for the argument I’m making here is the claim that the great political innovation of the euro is that it gives money-owners the right to a veto or referendum over government policy — up to the point of forcing through “radical change,” on pain of a bank crisis. And to be clear: This is being presented as one of the great benefits of the system, and an argument for the UK to join the single currency.

(Also, if I’m correct that the effect of a withdrawal of ECB liquidity support for Greek banks would just prevent transfers to banks elsewhere, this suggests the threat is self-negating.)

The masters of the euro themselves talk the same way. The “analytic note” just released by European Commission President Jean-Claude Juncker, “in close cooperation with Donald Tusk, Jeroen Dijsselbloem and Mario Draghi,” begins with the usual claims about the crisis as due ultimately to lack of competitiveness in the southern countries, thanks to their “labor market rigidities.” (They don’t say what specific rigidities they have in mind, but they do nod to a World Bank report that identifies such distortions as minimum wages, limitations on working hours, and requirements for severance pay.) “While the Maastricht Treaty was based on the assumption that market discipline would be a key element in preventing a divergent development of the euro area economies and their fiscal positions, with increasing government bond interest rates having a signalling effect.” But in practice divergent policies were not prevented, as bond markets were happy to lend regardless. Then, “when the crisis hit… and markets reappraised the risk and growth potential of individual countries, the loss of competitiveness became visible and led to outflows.” [2] What’s most interesting is their analysis of the political economy of removing these “rigidities” and restoring “competitiveness”:

The policy commitments of euro area countries, made individually or collectively, to growth-enhancing structural reforms have not been implemented satisfactorily. Often, commitments are strong in crisis times and then weakened again when the overall economic climate has improved. In this sense, the stabilising effect of the single currency has certain counterproductive effects with regard to the willingness of national governments to start and implement the necessary structural reforms…

Naomi Klein couldn’t have said it better. Crises are a great time to roll back “employment protection legislation” and force down labor costs — the unambiguous content of “structural reforms” in this context. If your goal is to to roll back protective legislation and re-commodify labor, then resolving economic crises too quickly is, well, counterproductive.

A couple years ago, Paul Krugman was expressing incredulity at the idea that prolonging the European crisis could be a rational act in the service of any political agenda. Last week, he was still hoping that Draghi would emerge as the defender of European democracy. No disrespect to my CUNY colleague, who understands most of this stuff much better than I ever will. But in this case, it seems simpler to take Draghi at his word. Restricting the scope of democratic government was the entire point of the euro system. And since the automatic operation of bond markets failed to do the job, a crisis is required.

UPDATE: Schauble today: “If we go deeper into the [debt] discount debate, there will be no more reforms in Europe. There will be joyful celebrations in the Elysée and probably in Rome, too, if we go down this path.” Thee is not even a pretense now that this is about resolving the crisis, as opposed to using the crisis as leverage to promote a particular policy agenda. It’s surprising, though, that he would suggest that the Euro zone’s second and third largest economies are on the side of the debtors. Would that it were so.

[1] It’s almost too good that he hosts a lecture series on “The Order of Money.”

[2] The funny thing is that, after talking about the “misallocation of financing” by markets, and describing the crisis as “a crisis of markets in terms of their capacity to price risk correctly,” they go on to recommend the removal of all remaining restrictions on capital flows: “we need to address remaining barriers to investment and the free movement of capital and make capital market integration a political priority.” Reminds me of the opening paragraphs of this Rodrik essay.