The Slack Wire – Page 3

Revisiting the Euro Crisis

The euro crisis of the 2010s is well in the past now, but it remains one of the central macroeconomic events of our time. But the nature of the crisis remains widely misunderstood, not only by the mainstream but also — and more importantly from my point of view — by economists in the heterodox Keynesian tradition. In this post, I want to lay out what I think is the right way of thinking about the crisis. I am not offering much in the way of supporting evidence. For the moment, I just want to state my views as clearly as possible. You can accept them or not, as you choose.

During the first 15 years of the euro, a group of peripheral European countries experienced an economic boom followed by a crash, with GDP, employment and asset prices rising and then falling even more rapidly. As far as I can tell, there are four broad sets of explanations on offer for the crises in Greece, Ireland, Italy, Portugal and Spain starting in 2008.

(While the timing is the same as the US housing bubble and crash, that doesn’t mean they are directly linked — however different they are in other respects, most of the common explanations for the European crisis I’m aware of locate its causes primarily within Europe.s)

The four common stories are:

1. External imbalances. The fixed exchange rate created by the euro, plus some mix of slow productivity growth in periphery and weak demand growth in core led to large trade imbalances within Europe. The financial expansion in the periphery was the flip side of a causally prior current account deficit.

2. Monetary policy. Both financial instability and external imbalances were result of Europe being far from an optimal currency area. Trying to carry out monetary policy for the whole euro area inevitably produced a mix of stagnation in the core and unsustainable credit expansion in the periphery, since a monetary stance that was too expansionary for Greece, Spain etc. was too tight for Germany.

3. Fiscal irresponsibility. The root of the crisis in peripheral countries was the excessive debt incurred by their own governments. The euro was a contributing factor since it led to an excessive convergence of interest rates across Europe, as markets incorrectly believed that peripheral debt was now as safe as debt of core countries.

4. Banking crises. The booms and busts in peripheral Europe were driven by rapid expansions and then contractions of credit from the domestic banking systems, with dynamics similar to that in credit booms in other times and places. The specific features of the euro system did not play any significant role in the development of the crisis, though they did importantly shape its resolution.

In my view, the fourth story is correct, and the other three are wrong. In particular, trade imbalances within Europe played no role in the crisis. In this post, I am going to focus on why I think the external balances story is wrong, since that’s the one that people who are on my side intellectually seem most inclined toward.

As I see it, there were two distinct causal chains at work, both starting with a credit boom in the peripheral countries.

easy credit —> increased aggregate spending —> increased output and income —> increased imports —> growing trade deficit —> net financial inflows

easy credit —> rising asset prices —> bubble and/or fraud —> asset price crash —> insolvent banks —> financial crisis

That the two outcomes — external imbalances and banking crisis — went together is not a coincidence. But there is no causal link from the first to the second. Both rather are results of the same underlying cause.

Yes, in the specific conditions of the late-2000s euro area, a credit boom led to an external deficit. But in principle it is perfectly possible to have a a credit-financed asset bubble and ensuing crisis in a country with a current account surplus, or one with current account balance, or in a closed economy. What was specific to the euro system was not the crisis itself, but the response to it. The reason the euro made the crisis worse because it prevented national governments from taking appropriate action to rescue their banking systems and stabilize demand.

This understanding is, I think, natural if we take a “money view” of the crisis, thinking in terms of balance sheets and the relationship between income and expenditure. Here is the story I would like to tell.

Following the introduction of the euro in 1998, there were large credit expansions in a number of European countries. In Spain, for example, bank credit to the non-financial economy increased from 80 percent of GDP in 1997 to 220 percent of GDP in 2010. Banks were more willing to make loans, at lower rates, on more favorable terms, with less stringent collateral requirements and other lending standards. Borrowers were more willing to incur debt. The proximate causes of this credit boom may well have been connected to the euro in various ways. European integration offered a plausible story for why assets in Spain might be valued more highly. The ECB might have followed a less restrictive policy than independent central banks would have (or not — this is just speculation). But the euro was in no way essential to the credit boom. Similar booms have happened in many other times and places in the absence of currency unions — including, of course, in the US at roughly the same time.

In most of these countries, the bulk of the new credit went toward speculative real estate development. (In Greece there was also a big increase in public-sector borrowing, but not elsewhere.) The specifics of this lending don’t matter too much.

Now for the key point. What happens when a a Spanish bank makes a loan? In the first step the bank creates two new assets – a deposit for the borrower, and the loan for itself. Notice that this does not require any prior “saving” by a third party. Expansion of bank credit in Spain does not require any inflow of “capital” from Germany or anywhere else.

Failure to grasp is an important source of confusion. Many people with a Keynesian background talk about endogenous money, but fail to apply it consistently. Most of us still have a commodity money or loanable-funds intuition lodged in the back of our brains, especially in international contexts. Terms like “capital flows” and “capital flight” are, in this respect, unhelpful relics of a gold standard world, and should probably be retired.

Back to the story. After the deposits are created, they are spent, i.e. transferred to someone else in return, in return for title to an asset or possession of a commodity or use of a factor of production. If the other party to this transaction is also Spanish, as would usually be the case, the deposits remain in the Spanish banking system. At the aggregate level, we see an increase in bank credit, plus an increase in asset prices and/or output, depending on what the loan finances, amplified by any ensuing wealth effect or multiplier.

To the extent that the loans finance production – of beach houses in Galicia say — they generate incomes. Some fraction of new income is spent on imported consumption goods. Probably more important, production requires imported intermediate and capital goods. By both these channels, an increase in Spanish output results in higher imports. If the credit boom leads Spain to grow faster relative to its trade partners — which it will, unless they are experiencing similar booms — then its trade balance will move toward deficit.

(That changes in trade flows are primarily a function of income growth, and not of relative prices, is an important item in the Keynesian catechism.)

Now let’s turn to the financial counterpart of this deficit. A purchase of a German good by a Spanish firm requires a bank deposit to be transferred from the Spanish firm to the German firm. Since the German firm presumably doesn’t hold deposits in a Spanish bank, we’ll see a reduction in deposits in the Spanish banking system and an equal increase in deposits in the German banking system. The Spanish banks must now replace those deposits with some other funding, which they will seek in the interbank market. So in the aggregate the trade deficit will generate an equal financial inflow — or, better said, a new external liability for the Spanish banking system.

The critical thing to notice here is that these new financial positions are generated mechanically by the imports themselves. It is simply replacing the deposit funding the Spanish banks lost via payment for the imports. The financial inflow must take place for the purchase to happen — otherwise, literally, the importer’s check won’t clear.

But what if there is an autonomous inflow – what if German wealth owners really want to hold more assets in Spain? Certainly that can happen. These kinds of cross-border flows may well have contributed to the credit boom in the periphery. But they have nothing to do with the trade balance. By definition, autonomous financial flows involve offsetting financial transactions, with no implications for the current account.

Suppose you are a German pension fund that would like to lend money to a Spanish firm, to take advantage of the higher interest rates in Spain. Then you purchase, let’s say, a bond issued by Spanish construction company. That shows up as a new liability for Spain in the international investment position. But the Spanish firm now holds a deposit in a German bank, and that is an equal new asset for Spain. (If the Spanish firm transfers the deposit to a Spanish bank in return for a deposit there, as I suppose it probably would, then we get an asset for Spain in the interbank market instead.) The overall financial balance has not changed, so there is no reason for the current account to change either. Or as this recent BIS paper puts it, “the high correlations between gross capital inflows and outflows are overwhelmingly the result of double-entry bookkeeping”. (The importance of gross rather than net financial positions for crises is a pint the bIS has emphasized for many years.)

It may well happen that the effect of these offsetting financial transactions is to raise incomes in Spain (the contractor got better terms than it would at home) and/or banking-system liquidity (thanks to the fact that the Spanish banking system gets the deposits without the illiquid loan). This may well contribute to a rise in incomes in Spain and thus to a rise in the trade deficit. But this seems to me to be a second-order factor. And in any case we need to be clear about the direction of causality here — even if the financial inflows did indirectly cause the higher deficit, they did not in any sense finance it. The trade balances of Germany and Spain in no way affect the ability of German institutions to buy Spanish debt, any more than a New Yorker’s ability to buy a house in California depends on the trade balance between those states.

At this point it’s important to bring in the TARGET2 system.

Under normal conditions, when someone wants to take a cross-border position within the euro systems the other side will be passively accommodated somewhere in the banking system. But if a net position develops for whatever reason, central banks can accommodate it via TARGET2 balances. Concretely, let’s say soon in Spain wants to make a payment to someone in Germany, as above. This normally involves the reduction of a Spanish bank’s liability to the Spanish entity and the increase in a German bank’s liability to the German entity. To balance this, the Spanish bank needs to issue some other liability (or give up an asset) while the German bank needs to acquire some asset. Normally, this happens by the Spanish bank issuing some new interbank liability (commercial paper or whatever) which ends up, perhaps via various intermediaries, as an asset for a German bank. But if foreign banks are unwilling to hold the liabilities of Spanish banks (as happened during the crisis) the Spanish bank can instead borrow from its own central bank, which in turn can create two offsetting positions through TARGET2 — a liability to the euro system, and a reserve asset (a deposit at the ECB). Conceptually, rather than the transfer of the despot being offset by a liability fro the Spanish to the German bank the interbank market, it’s now offset by a debt owed by the Spanish bank to its own national central bank, a debt between the central banks in the TARGET2 system, and a claim by the German bank against its own national central bank.

In this sense, within the euro system TARGET2 balances stand at the top of the hierarchy of money. Just as non financial actors settle their accounts by transfers of deposits at commercial banks, and banks settle their balances by transfers of deposits at the central bank, central banks settle any outstanding balances via TARGET2. It plays the same role as gold in the old gold standard system. Indeed, I sometimes think it would be better to describe the euro system as the “TARGET2 system.”

There is however a critical difference between these balances and gold. Gold is an asset for central bank; TARGET2 balances are a liability. When a payment is made from country X to country Y in the euro area, with no offsetting private payment, the effect on central bank balance sheets is NOT a decrease in the assets of the central bank of X (and increase in the assets of the central bank of Y) but an increase in the liabilities of the central bank of X. This distinction is critical because assets are finite and can be exhausted, but new liabilities can be issued indefinitely. The automatic financing of payments imbalances through the TARGET2 system seems like an obscure technical detail but it transforms the functioning of the system. Every national central bank in the euro area is in effect in the situation of the Fed. It can never be financially constrained because all its obligations can be satisfied with its own liabilities.

People are sometimes uncomfortable with this aspect of the euro system and suggest that there must be some limit on TARGET2 balances. But to me, this fundamentally misunderstands the nature of a single currency. What makes “the euro” a single currency is not that it has the same name, or that the bills look the same in the various countries, or even that it trades at a fixed ratio of one for one. What makes it a single currency is that a bank deposit in any euro-area country will settle a debt in any other euro-area country, at par. TARGET2 balances have to be unlimited to guarantee the this will be the case — in other words, for there to be a single currency at all.

(In this sense, we should not have been so fixed on the question of being “in” versus “out” of the euro. The relevant question is the terms on which payments can be made from one bank account another, for settlement of which obligations.)

The view of the euro crisis in which trade imbalances finance or somehow enable credit expansion is dependent on a loanable-funds perspective in which incomes are fixed, money is exogenous and saving is a binding constraint. It’s implicitly based on a model of the gold standard in which increased lending impossible without inflow of reserves — something that was not really true in practice even in the high gold standard era and isn’t true even in principle today. What’s strange is that many people who accept this view would reject those premises – if they realized they were applying them.

Meanwhile, on the domestic side, abundant credit was bidding up asset prices and encouraging investment that was, ex post, unwise (and in some case fraudulent, though I have no idea how important this was quantitatively). When asset prices collapsed and the failure of investment projects to generate the expected returns became clear, many banks faced insolvency. There was a collapse in activity in the real-estate development and construction activity that had driven the boom and, as banks tightened credit standards across the board, in other credit-dependent activity; falling asset values further reduced private spending; all these effects were amplified by the usual multiplier. The result was a steep fall in output and employment.

I don’t believe there’s any sense in which a sudden stop of cross-border lending precipitated the crisis. Rather, the “nationalization” of finance came after. Banks tried to limit their cross-border positions came only once the crisis was underway, as it became clear that there would be no systematic euro-wide response to insolvent banks, so that any rescues or bailouts would be by national governments for their own banks.

Credit-fueled asset booms and crashes have happened in many times and places. There was nothing specific to the euro system about the property booms of the 2000s. What was specific to the euro system was what happened next. Thanks to the euro, the affected governments could not respond as developed country governments have always responded to financial crises since World War II — by recapitalizing insolvent banks and shifting public budgets toward deficit until private demand recovers.

The constraints on euro area governments were not an inevitable feature of system, in this view. Rather, they were deliberately imposed through discretionary choices by the authorities in order to use the crisis to advance a substantive political agenda.

Industrial Policy: Further Thoughts

(Cross-posted from my Substack. If you like this blog, why not subscribe to that too?)

I just returned from Bangalore, where Arjun and I spent an intense 10 days working on our book, and on another project which I’ll be posting about in due time. I’d never been to India before, and it was … a lot. It took me a while to put my finger on the overarching impression: not chaos, or disorder, but incongruity — buildings and activities right on top of each other that, in an American context, you’d expect to be widely separated in space or time. That, and the constant buzz of activity, and crowds of people everywhere. In vibes, if not in specifics, it felt like a city of back-to-back Times Squares. I imagine that someone who grew up there would find an American city, even New York, rather dull.

It’s a city that’s gone from one million people barely a generation ago to 8 million today, and is still growing. There’s a modern subway, clean, reliable and packed, with the open-gangway cars New York is supposed to switch to eventually. It opened 15 years ago and now has over 60 stations — I wish we could build like that here. But the traffic is awesome and terrifying. Every imaginable vehicle — handpainted trucks, overloaded and dangling with tassels and streamers; modern cars; vans carrying sheep and goats; the ubiquitous three-wheeled, open-sided taxis; the even more ubiquitous motorbikes, sometimes carrying whole families; and of course the wandering cows — with no stoplights or other traffic control to speak of, and outside the old central city, no sidewalks either. Crossing the street is an adventure.

I realize that I am very far from the first person to have this reaction to an Indian city. Some years ago Jim Crotty was here for some kind of event, and the institution he was visiting provided him with a driver. Afterwards, he said that despite all the dodging and weaving through the packed roads he never felt anything but safe and comfortable. But, he added, “I would never get into a car with that guy in the United States. He’d be so bored, he’d probably fall asleep.”

Varieties of industrial policy. The panel I moderated on industrial policy is up on YouTube, though due to some video glitch it is missing my introductory comments. Jain Family Institute also produced a transcript of the event, which is here.

It was a very productive and conversation; I thought people really engaged with each other, and everyone had something interesting to contribute. But it left me a bit puzzled: How could people who share broad political principles, and don’t seem to disagree factually about the IRA, nonetheless arrive at such different judgements of it?

I wrote a rather long blog post trying to answer this question.

The conclusion I came to was that the reason Daniela Gabor (and other critics, though I was mostly thinking of Daniela when I wrote it) takes such a negative view of the IRA is that she focuses on the form of interface between the state and production it embodies: subsidies and incentives to private businesses. This approach accepts, indeed reinforces, the premise that the main vehicle for decarbonization is private investment. Which means that making this investment attractive to private business owners, for which profitability is a necessary but not sufficient condition. If you don’t think the question “how do we solve this urgent social problem” should be immediately translated into “how do we ensure that business can make money solving the problem,” then the IRA deserves criticism not just on the details but for its fundamental approach.

I am quite sympathetic to this argument. I don’t think anyone on the panel would disagree with it, either normatively as a matter of principle or descriptively as applied to the IRA. And yet the rest of us, to varying degrees, nonetheless take a more positive view of the IRA than Daniela does.

The argument of the post was that this is because we focus more on two other dimensions. First, the IRA’s subsidies are directed to capital expenditure itself, rather than financing; this already distinguishes it from what I had thought of as derisking. And second the IRA’s subsidies are directed toward narrowly specified activities (e.g. battery production) rather than to some generic category of green or sustainable investment, as a carbon tax would be. I called this last dimension “broad versus fine-grained targeting,” which is not the most elegant phrasing. Perhaps I would have done better to call it indicative versus imperative targeting, tho I suppose people might have objected to applying the latter term to a subsidy. In any case, if you think the central problem is the lack of coordination among private investment decisions, rather than private ownership s such, this dimension will look more important.

Extending the matrix. The post got a nice response; it seems like other people have been thinking along similar lines. Adam Tooze restated the argument more gracefully than I did:

Mason’s taxonomy focuses attention on two axes: how far is industrial policy driven by direct state engagement v. how far does it operate at arms-length through incentives? On the other hand, how far is green industrial policy broad-brush offering general financial incentives for green investment, as opposed to more fine-grained focus on key sectors and technologies?

Skeptics like Daniel Gabor, Mason suggests, can be seen as placing the focus on the form of policy action, prioritizing the question of direct versus indirect state action. Insofar as the IRA operates by way of tax incentives it remains within the existing, hands-off paradigm. A big green state would be far more directly involved. Those who see more promise in the IRA would not disagree with this judgment as to form but would insist that what makes the IRA different is that it engages in relatively fine-grained targeting of investment in key sectors.

My only quibble with this is that I don’t think it’s just two dimensions — to me, broad versus narrow and capital expenditure versus financing are two independent aspects of targeting.

I should stress that I wrote the post and the table to clarify the lines of disagreement on the panel, and in some similar discussions that I’ve been part of. They aren’t intended as a general classification of industrial policy, which — if it can be done at all — would require much more detailed knowledge of the range of IP experiences than I possess.

Tooze offers his own additional dimensions:

The relationship of economic policy to the underlying balance of class forces.
The mediation of those forces through the electoral system …
The agenda, expertise & de facto autonomy of state institutions…

These are certainly interesting and important questions. But it seems to me that they are perhaps questions for a historian rather than for a participant. They will offer a very useful framework for explaining, after the fact, why the debate over industrial policy turned out the way that it did. But if one is engaged in politics, one can’t treat the outcome one is aiming at as a fact to be explained. Advocacy in a political context presumes some degree of freedom at whatever decision point it is trying to influence. One wouldn’t want to take this too far: It’s silly to talk about what policies “should” be if there is no one capable of adopting them. But it seems to me that by participating in a political debate within a given community, you are accepting the premise, on some level, that the outcome depends on reason and not the balance of forces.

That said, Tooze’s third point, about state institutions, I think does work in an advocacy context, and adds something important to my schema. Though it’s not entirely obvious which way it cuts. Certainly a lack of state capacity — both administrative and fiscal — was an important motivation for the original derisking approach, and for neoliberalism more broadly. But as Beth Popp Berman reminds us, simple prohibitions and mandates are often easier to administer than incentives. And if the idea is to build up state capacity, rather than taking it as a fact, then that seems like an argument for public ownership.

I’ve thought for years that this was a badly neglected question in progressive economics. We have plenty of arguments for public goods — why the government should ensure that things are provided in different amounts or on different terms than a hypothetical market would. We don’t have so many arguments for why, and which, things should be provided by the public. The same goes for public ownership versus public provisions, with the latter entailing non-market criteria and intrinsic motivation, with the civil service protections that foster it.

The case for public provisioning. One group of people who are thinking about these questions seriously are Paul Williams and his team at the Center for Public Enterprise. (Full disclosure: I sit on CPE’s board.) Paul wrote a blog post a couple weeks ago in response to some underinformed criticisms of public housing, on why public ownership is an important part of the housing picture. Looking at the problem from the point of view of the local government that are actually responsible for housing in the US, the problem looks a bit different than the perspective of national governments that I implicitly adopted in my post.

The first argument he makes for public ownership is that it economizes on what is often in practice the binding constraint on affordable housing, the fixed pot of federal subsidies. A public developer doesn’t need the substantial profit margin a private developer would expect; recovering its costs is enough. Public ownership also allows for, in my terms, more fine-grained targeting. A general program of subsidies or inclusionary zoning (like New York’s 421a tax credits) will be too lax in some cases, leaving affordable units on the table, and too stringent in others, deterring construction. A public developer can assess on a case by case basis the proportion and depth of affordable units that a given project can support. A third argument, not emphasized here but which Paul has made elsewhere, is that developing and operating public housing builds up the expertise within the public sector that is needed for any kind of transformative housing policy.

It’s telling but not surprising to see the but-this-one-goes-to-11 response to Paul’s post that all we need for more housing is land-use deregulation. Personally, I am quite sympathetic to the YIMBY position, and I know Paul is too. But it doesn’t help to oversell it. The problems of “not enough housing” and “not enough affordable housing” do overlap, but they are two distinct problems.

A somewhat different perspective on these questions comes from this report by Josh Wallack at Roosevelt, on universal childcare as industrial policy. Childcare doesn’t have some of the specific problems that industrial policy is often presented as the solution to – it doesn’t require specialized long-lived capital goods, or coordination across multiple industries. But, Wallack argues, it shares the essential element: We don’t think that demand on its own will call forth sufficient capacity, even with subsidies, so government has to intervene directly on the supply side, building up the new capacity itself. I’ve always thought that NYC’s universal pre-K was a great success story (both my kids benefited from it) that should be looked to as a model of how to expand the scope of the public sector. So I’m very glad to see this piece, which draws general lessons from the NYC experience. Wallack himself oversaw implementation of the program, so the report has a lot more detail on the specifics of implementation than you normally get. Very worth reading, if you’re at all interested in this topic.

One area where Wallack thinks the program could have done better is democratic participation in the planning process. This could be another dimension for thinking about industrial policy. A more political practice-oriented version of Tooze’s bullets would be to ask to what extent a particular program broadens or narrows the space for popular movements to shape policy. Of course the extent to which this is feasible, or even desirable, depends on the kind of production we’re talking about. In Catalyst, Matt Huber and Fred Stafford argue, persuasively in my view, that there is a tension between the need for larger-scale electricity transmission implied by the transition away from carbon, and the preference of some environmentalists for a more decentralized, locally-controlled energy system. I am less persuaded by their argument that the need for increased transmission and energy storage rule out a wholesale shift toward renewables; here as elsewhere, it seems to me, which obstacles you regard as insurmountable depend on where you want to end up.

The general point I would make is that politics is not about a final destination, but about a direction of travel. Whether or not we could have 100 percent renewable electricity — or 100 percent public ownership of housing, or whatever — is not so important. What matters is whether we could have substantially more than we have now.

On other topics.

Showing the inconsistencies between conservative free-market economics and actual conservative politics is, in my experience, much harder in practice than it seems like it ought to be, at least if you want to persuade people who actually hold one or both. So it’s fun to see Brian Callaci’s (excellent) arguments against non-compete agreements in ProMarket, the journal of the ur-Chicago Stigler Center.

Garbriel Zucman observes that the past few years have seen very large increases in the share of income at the very top, which now seems to have passed its gilded age peak. Does this mean that I and others have been wrong to stress the gains for low-wage workers from tight post-pandemic labor markets? I don’t think so — both seem to be true. According to Realtime Inequality, the biggest income gains of the past two years have indeed gone to the top 1 percent and especially its top fractiles. But the next biggest gains have gone to the bottom half, which has outpaced the top 10 percent and comfortably outpaced the middle 40 percent. Their income numbers don’t further break out the bottom half, but given that the biggest wage gains have come a the very bottom, I suspect this picture would get even stronger if we looked further down the distribution.

This may well be a general pattern. The incomes that rise fastest in an economic boom are those that come from profits, on the one hand, and flexible wages that are strongly dependent on labor-market conditions on the other. People whose income comes from less commodified labor, with more socially embedded wage-setting, will be relatively insulated from swings in demand, downward but also upward. This may have something to do with the negative feeling about the economy among upper-middle class households that Emily Stewart writes about in Vox.

I’m still hoping to write something more at length about the debates around “greedflation” and price controls. But in the meantime, this from Servaas Storm is very good.

What I’ve been reading. On the plane to Bangalore, I finished Enzo Traverso’s Fire and Blood. I suppose it’s pretty common now to talk about the period from 1914 to 1945 as a unit, a second Thirty Years War. Traverso does this, but with the variation of approaching it as a European civil war — a war within a society along lines of class and ideology, rather than a war between states. A corollary of this, and arguably the animating spirit of the book, is the rehabilitation of anti-fascism as a positive political program. It’s a bit different from the kind of narrative history I usually read; the organization is thematic rather than chronological, and the focus is on culture — there are no tables and hardly any numbers, but plenty of reproductions of paintings. It reads more like a series of linked essays than a coherent whole, but what it lacks in overarching structure in makes up with endless fascinating particulars. I liked it very much.

Varieties of Industrial Policy

I was on a virtual panel last week on industrial policy as derisking, in response to an important new paper by Daniela Gabor. For me, the conversation helped clarify why people who have broadly similar politics and analysis can have very different feelings about the Inflation Reduction Act and similar measures elsewhere.

There are substantive disagreements, to be sure. But I think the more fundamental issue is that while we, inevitably, discuss the relationship between the state, the organization of production and private businesses in terms of alternative ideal types, the actual policy alternatives are often somewhere in the fuzzy middle ground. When we deal with a case that resembles one of our ideal types in some ways, but another in other ways, our evaluation of it isn’t going to depend so much on our assessment of each of these features, but on which of them we consider most salient.

I think this is part of what’s going on with current discussions of price controls. There has been a lot of heated debate following Zach Carter’s New Yorker profile of Isabella Weber on whether the energy price regulation adopted by Germany can be described as a form of price controls. Much of this criticism is clearly in bad faith. But the broad space between orthodox inflation-control policy, on the one hand, and comprehensive World War II style price ceilings, on the other, means that there is room for legitimate disagreement about how we describe policies somewhere in the middle. If you think that the defining feature of price regulation is that government is deciding how much people should pay for particular commodities, you will probably include the German policy. If you’re focused on other dimensions of it, you might not.

I am not going to say more about this topic now, though I hope to return to it in the future. But I think there is something parallel going on in the derisking debate.

People who talk about industrial policy mean some deliberate government action to shift the sectoral composition of output — to pick winners and losers, whether at the industry or firm level. But of course, there are lots of ways to do this. (Indeed, as people sometimes point out, governments are always doing this in some way — what distinguishes “industrial policy” is that it is visible effort to pick different winners.) Given the range of ways governments can conduct industrial policy, and their different implications for larger political-economy questions, it makes sense to try to distinguish different models. Daniela Gabor’s paper was a very helpful contribution to this.

The problem, again, is that models are ideal types — they identify discrete poles in a continuous landscape. We need abstractions like this — there’s no other way to talk about all the possible variation on the multiple dimensions on which we can describe real-world situations. If the classification is a good one, it will pick out ways in which variation on one dimension is linked to variation on another. But in the real world things never match up exactly; which pole a particular point is closer to will depend on which dimension we are looking at.

In our current discussions of industrial policy, four dimensions seem most important — four questions we might ask about how a government is seeking to direct investment to new areas. Here I’ll sketch them out quickly; I’ll explore them in a bit more detail below.

First is ownership — what kind of property rights are exercised over production? This is not a simple binary. We can draw a slope from for-profit private enterprises, to non-profits, to publicly-owned enterprises, to direct public provision.

Second is the form of control the government exercises over investment (assuming it is not being carried out directly by the public sector). Here the alternatives are hard rules or incentives, the latter of which can be positive (carrots) or negative (sticks).

The third question is whether the target of the intervention is investment in the sense of creation of new means of production, or investment in the sense of financing.

The last question is how detailed or fine-grained the intervention is — how narrowly specified are the activities that we are trying to shift investment into and out of?

“Derisking” in its original sense had specific meaning, found in the upper right of the table. The idea was that in lower-income countries, the binding constraint on investment was financing. Because of limited fiscal capacity (and state capacity more generally), the public sector should not try to fill this gap directly, but rather to make projects more attractive to private finance. Offering guarantees to foreign investors would make efficient use of scarce public resources, while trusting profit motive to guide capital to socially useful projects.

In terms of my four dimensions, this combines private ownership and positive incentives with broad financial target.

The opposite case is what Daniela calls the big green state. There we have public ownership and control of production, with the state making specific decisions about production on social rather than monetary criteria.

For the four of us on the panel, and for most people on the left, the second of these is clearly preferable to the first. In general, movement from the upper right toward the lower left is going to look like progress.

But there are lots of cases that are off the diagonal. In general, variation on each of these dimensions is independent of variation on the others. We can imagine real world cases that fall almost anywhere within the grid.

Say we want more wind and solar power and less dirty power.

We could have government build and operate new power plants and transmission lines, while buying out and shutting down old ones.

We could have a public fund or bank that would lend to green producers, along with rules that would penalize banks for holding assets linked to dirty ones.

We could have regulations that would require private producers to reduce carbon emissions, either setting broad portfolio standards or mandating the adoption of specific technologies.

Or we could have tax credits or similar incentives to encourage voluntary reductions, which again could be framed in a broad, rules-based way or incorporate specific decisions about technologies, geography, timelines, etc.

As we evaluate concrete initiatives, the hard question may not be where we place them in this grid nor on where we would like to be, but how much weight we give to each dimension.

The neoliberal consensus was in favor of private ownership and broad, rules-based incentives, for climate policy as in other areas. A carbon price is the canonical example. For those of us on the panel, again, the consensus is that the lower left corner is first best. But at the risk of flattening out complex views, I think the difference between let’s say Daniela on one side and Skanda Amarnath (or me) on the other is the which dimensions we prioritize. Broadly speaking, she cares more about movement in horizontal axis, as I’ve drawn the table, with a particular emphasis on staying off of the right side. While we care more about vertical axis, with a particular preference for the bottom row.

Some people might say it doesn’t matter how you manage investment, as long as you get the clean power. But here I am completely on (what I understand to be) Daniela’s side. We can’t look at policy in isolation, but have to see it as part of a broader political economy, as part of the relationship between private capital and the state. How we achieve our goals here matters for more than the immediate outcome, it shifts the terrain on which next battle will be fought.

But even if we agree that the test for industrial policy is whether it moves us toward a broader socialization of production, it’s not always easy to evaluate particular instances.

Let’s compare two hypothetical cases. In one, government imposes strict standards for carbon emissions, so many tons per megawatt. How producers get there is up to them, but if they don’t, there will be stiff fines for the companies and criminal penalties for their executives. In the second case, we have a set of generous tax credits. Participation is voluntary, but if the companies want the credits they have to adopt particular technologies on a specified schedule, source inputs in a specified way, etc.

Which case is moving us more in the direction of the big green state? The second one shifts more expertise and decision making into the public sector, it expands the domain of the political not just to carbon emissions in general but to the organization of production. But unlike the first, it does not challenge the assumption that private profitability is the first requirement of any change in the organization of production. It respects capital-owners’ veto, while the first does not.

(Neoliberals, it goes without saying, would hate both — the first damages the business climate and discourages investment, while the second distorts market more.)

Or what about if we have a strict rule limiting the share of “dirty” assets in the portfolios of financial institutions? This is the path Europe seems to have been on, pre IRA. In our discussion, Daniela suggested that this might have been better, since it had more of an element of discipline — it involved sticks rather than just subsidy carrots. To Skanda or me, it looks weak compared with the US approach, both because it focuses on financing rather than real investment, and because it is based on a broad classification of assets rather than trying to identify key areas to push investment towards. (It was this debate that crystallized the idea in this post for me.)

Or again, suppose we have a sovereign wealth fund that takes equity stakes in green energy producers, as Labour seems to be proposing in the UK. How close is this to direct public provision of power?

In the table, under public ownership, I’ve distinguished public provision from public enterprise. The distinction I have in mind is between a service that is provided by government, by public employees, paid for out of the general budget, on the one hand; and entities that are owned by the government but are set up formally as independent enterprises, more or less self-financing, with their own governance, on the other. Nationalizing an industry, in the sense of taking ownership of the existing businesses, is not the same as providing something as a public service. To some people, the question of who owns a project is decisive. To others, a business where the government is the majority stakeholder, but which operates for profit, is not necessarily more public in a substantive sense than a business that isprivately owned but tightly regulated.

Moving to the right, government can change the decisions of private businesses by drawing sharp lines with regulation — “you must”; “you must not” — or in a smoother way with taxes and subsidies. A preference for the latter is an important part of the neoliberal program, effectively shifting the trading -off of different social goals to the private sector; there’s a good discussion of this in Beth Popp Berman’s Thinking Like an Economist. On the other side, hard rules are easier to enforce and better for democratic accountability — everybody knows what the minimum wage is. Of course there is a gray area in between: a regulation with weak penalties can function like a tax, while a sufficiently punitive tax is effectively a regulation.

Finally, incentives can be positive or negative, subsidies or taxes. This is another point where Daniela perhaps puts more stress than I might. Carrots and sticks, after all, are ways of getting the mule to move; either way, it’s the farmer deciding which way it goes. That said, the distinction certainly matters if fiscal capacity is limited; and of course it matters to business, who will always want the carrot.

On the vertical axis, the big distinction is whether what is being targeted is investment in the sense of the creation of new means of production, or investment in the sense of financing. Let’s step back a bit and think about why this matters.

There’s a model of business decision-making that you learn in school, which is perhaps implicitly held by people with more radical politics. Investment normally has to be financed; it involves the creation of real asset and a liability, which is held somewhere in financial system. You build a $10 million wind turbine, you issue a $10 million bond. Which real investment is worth doing, then, will depend on the terms on which business can issue liabilities. The higher the interest rate on the bond, the higher must be the income from the project it finances, to make it worth issuing.

Business, in this story, will invest in anything whose expected return exceeds their cost of capital; that cost of capital in turn is set in financial markets. From this point of view, a subsidy or incentive to holders of financial assets is equivalent to one to the underlying activity. Telling the power producer “I’ll give you 10 percent of the cost of the turbine you built” and telling the bank “I’ll give you 10 percent of the value of the bond you bought” are substantively the same thing.

As I said, this is the orthodox view. But it also implicitly underlies an analysis that talks about private capital without distinguishing between “capital” as a quantity of money in financial form, and “capital” as the concrete means of production of some private enterprise. If you don’t think that the question “what factory should I build” is essentially the same as the question “which factory’s debt should I hold?”, then it doesn’t make sense to use the same word for both.

Alternatively, we might argue that the relevant hurdle rate for private investment is well above borrowing costs and not very sensitive to them. Investment projects must pass several independent criteria and financing is often not the binding constraint. The required return is not set in financial markets; it is well above the prevailing interest rate and largely insensitive to it. If you look at survey evidence of corporate investment decisions, financing conditions seem to have very little to do with it. If this is true, a subsidy to an activity is very different from a subsidy to financial claims against that activity. (A long-standing theme of this blog is the pervasive illusion by which a claim on an income from something is equated with the thing itself.)

Daniela defines derisking as, among other things, “the production of inevitability”, which I think is exactly right as a description of the (genuine and important) trend toward endlessly broadening the range of claims that can be held in financial portfolios. But I am not convinced it is a good description of efforts to encourage functioning businesses to expand in certain directions. Even though we use the word “invest” for both.

Conversely, when financing is a constraint, as it often is for smaller businesses and households, it takes the form of being unable to access credit at all, or a hard limit on the quantity of financing available (due to limited collateral, etc.), rather than the price of it. One lesson of the Great Recession is that credit conditions matter much more for small businesses than for large ones. So to the extent that we want to work through financing, we need to be targeting our interventions at the sites where credit constraints actually bind. (The lower part of the top row, in terms of my table.) A general preference for green assets, as in Europe, will not achieve much; a program to lend specifically for, say, home retrofits might.

This leads to the final dimension, what I am calling fine-grained versus broad or rules-based interventions. (Perhaps one could come up with better labels.) While for some people the critical question is ownership, for others — including me — the critical question is market coordination versus public coordination. It is whether we, as the government, are consciously choosing to shift production in specific ways, or whether we are setting out broad priorities and letting prices and the profit motive determine what specific form they will take. This — and this may be the central point of this post — cuts across the other criteria. Privately-owned firms can have their investment choices substantively shaped by the public. Publicly-owned firms can respond to the market.

Or again, yes, one way of distinguishing incentives is whether they are positive or negative. But another is how precise they are — in how much detail they specify the behavior that is to be punished or rewarded. A fine-grained incentive effectively moves discretion about specific choices and tradeoffs to the entity offering the incentive. A broad incentive leaves it to the receiver. An incentive conditioned on X shifts more discretion to the public sector than an incentive conditioned on any of X, Y or Z, regardless of whether the incentive is a positive or negative.

Let me end with a few concrete examples.

In her paper, Daniela draws a sharp distinction between the IRA and CHIPS Act, with the former as a clear example of derisking and the latter a more positive model. The basis for this is that CHIPS includes penalties and explicit mandates, while the IRA is overwhelmingly about subsidies.¹. This is reflected in the table by CHIPS’ position to the left of the IRA. (Both are areas rather than points, given the range of provisions they include.) From another point of view, this is a less salient distinction; what matters is that they are both fairly fine-grained measures to redirect the investment decisions of private businesses. If you focus on the vertical axis they don’t look that different.

Similarly, Daniela points to things like the ECB’s climate action plan, which creates climate disclosure requirements for bank bond holdings and limits the use of carbon-linked bonds as collateral, as a possible alternative to the subsidy approach. It is true that these measures impose limits and penalties on the private sector, as opposed to the bottomless mimosas of the IRA. But the effectiveness of these measures would require a strong direct link from banks’ desired bond holdings, to the real investment decisions of productive businesses. I am very skeptical of such a link; I doubt measures like this will have any effect on real investment decisions at all. To me, that seems more salient.

The key point here is that Daniela and I agree 100% both that private profit should not be the condition of addressing public needs, and that the public sector does need to redirect investment toward particular ends. Where we differ, I think, is on which of those considerations is more relevant in this particular case.

If the EPA succeeds in imposing its tough new standards for greenhouse gas emissions from power plants, that will be an example of a rules-based rather than incentive-based policy. This is not exactly industrial policy — it leaves broad discretion to producers about how to meet the standards. But it is still more targeted than a carbon tax or permit, since it limits emissions at each individual plant rather than allowing producers to trade off lower emissions one place for higher emissions somewhere else.

Finally, consider the UK Labour Party’s proposal for a climate-focused National Wealth Fund, or similar proposals for green banks elsewhere. The team at Common Wealth has a very good discussion of how this could be a tool for actively redirecting credit as part of a broader green industrial policy. But other supporters of the idea stress ownership stakes as an end in itself. This is similar to the language one hears from advocates of social wealth funds: The goal is to replace private shareholders with the government, without necessarily changing anything about the companies that the shares are a claim on. ² From this point of view, there’s a critical difference between whether the fund or bank has an equity stake in the businesses it supports or only makes loans.

To me, that doesn’t matter. The important question is does it acts as an investment fund, buying the liabilities (bonds or shares or whatever) of established business for which there’s already a market? Or does it function as more of a bank, lending directly to smaller businesses and households that otherwise might not have access to credit? This would require a form of fine-grained targeting, as opposed to buying a broad set of assets that fit some general criteria.³ Climate advocate showing to shape the NWF need to think carefully about whether it’s more important for it to get ownership stakes or for it to target its lending to credit-constrained businesses.

My goal in all this is not to say that I am right and others are wrong (though obviously I have a point of view). My goal is to try to clarify where the disagreements are. The better we understand the contours of the landscape, the easier it will be to find a route toward where we want to go.

At Barron’s: With the Debt Ceiling Deal, the Administration Takes a Step Backward

(I write a monthly-ish opinion piece for Barron’s. This is my most recent one. You can find earlier ones here.)

Since the onset of the pandemic, policy makers in the U.S. and elsewhere have embraced a more active role for government in the economy. The extraordinary scale and success of pandemic relief, the administration’s embrace of the expansive Build Back Better program, and the revived industrial policy of the Inflation Reduction Act and the Chips and Science Act all stand in sharp contrast with the limited-government orthodoxy of the past generation.

The debt ceiling deal announced this weekend looks like a step back from this new path – albeit a smaller one than many had feared. Supporters of industrial policy and more robust social insurance have reason to be disappointed – especially since the administration, arguably, had more room for maneuver than it was willing to use.

To be fair, the agreement in part merely anticipates the likely outcome of budget negotiations. Regardless of the debt ceiling, the administration was always going to have to compromise with the House leadership to pass a budget. The difference is that in a normal negotiation, most government spending continues as usual until a deal is reached. Raising the stakes of failure to reach a deal shifts the balance in favor of the side more willing to court disaster. Allowing budget negotiations to get wrapped up with the debt ceiling may have forced the administration to give up more ground than it otherwise would.

The Biden team’s major nonbudget concession was to accept additional work requirements for some federal benefits. The primary effect of work requirements, with their often onerous administrative burdens, will be to push people off these programs. This might be welcome, if you would prefer that they not exist in their current form at all. But it’s a surprising concession from an administration that, not long ago, was pushing in the other direction.

In a bigger sense this change directly repudiates one of the main social-policy lessons of recent years. Pandemic income-support programs were an extraordinary demonstration of the value of simple, universal social insurance programs, compared with narrowly targeted ones. The expiration of pandemic unemployment benefits gave us the cleanest test we are ever likely to see of the effect of social insurance and employment. States that ended pandemic benefits early did not see any faster job growth than ones that kept it longer – despite the fact that these programs gave their recipients far stronger incentives against work than those targeted in the budget deal.

These compromises are all the more disappointing since there were routes around the debt ceiling that the administration, for whatever reason, chose not to explore. The platinum coin got a healthy share of attention. But there were plenty of others.

The Treasury Department, for example, could have looked into selling debt at a premium. The debt ceiling binds the face value, or principal, of federal debt. There is no reason that this has to be equal to the amount the debt sells for – this is simply how auctions are currently structured. For much of U.S. history, government debt was sold at a discount or premium to its face value. Fixing an above-market interest rate and selling debt at more than face value would allow more funds to be raised without exceeding the debt ceiling.

The administration might also have asked the Federal Reserve to prepay future remittances. In most years, the Fed makes a profit, which it remits to the Treasury. But it can also report a loss, as it has since September. When that happens, the Fed simply creates new reserves to make up the shortfall, offsetting these with a “deferred asset” representing future remittances. (Currently, the Fed is carrying a deferred asset of $62 billion.) The same device could be used to finance public spending without issuing debt. In a report a decade ago, Fed staff suggested that deferred assets could be used in this way to give the Treasury department “more breathing room under the debt ceiling.” (To be clear, they were not saying that this was a good idea, just noting the possibility.)

Another route around the debt ceiling might come from the fact that about one-fifth of the federal debt – some $6 trillion – is held by federal trust funds like Social Security, rather than by the public. (Another $5 trillion is held by the Federal Reserve.) This debt has no economic function. It is a bookkeeping device reflecting the fact that trust fund contributions to date have been higher than payments. Retiring these bonds, or replacing them with other instruments that wouldn’t count against the ceiling, would have no effect on either the government’s commitment to pay scheduled benefits or its ability to do so. But it would reduce the notional value of debt outstanding.

None of these options would be costless, risk-free, or even guaranteed to work. But there is little evidence they were seriously considered. This is a bit disheartening for supporters of the administration’s program. It’s hard to understand why you would go into negotiations with one hand tied behind your backs, and not have a plan B in case negotiations break down.

Tellingly, the one alternative the Biden team did consider was invoking the 14th Amendment to justify issuing new debt in defiance of the ceiling. The amendment refers specifically to the federal government’s debt obligations. But of course, hitting the debt ceiling would not only endanger the government’s debt service. It would threaten all kinds of payments that are legally mandated and economically vital. The openness to the 14th Amendment route, consistent with other public statements, suggests that decision-makers in the administration saw the overriding goal as protecting the financial system from the consequences of a debt default – as opposed to protecting the whole range of public payments.

What looks like a myopic focus on the dangers to banks recalls one of the worst failures of the Obama administration.

In the wake of the collapse of the housing market, Congress in 2009 authorized $46 billion in assistance for homeowners facing foreclosure through the Home Affordable Modification Program. But the Obama administration spent just a small fraction of this money (less than 3%) in the program’s first two years, helping only a small fraction of the number of homeowners originally promised.

The failure to help homeowners was not due to callousness or incompetence. Rather, it was due to the overriding priority put on the stability of the banking system. As Obama’s Treasury Secretary Timothy Geithner later explained, they saw the primary purpose of HAMP not as assisting homeowners, but as a way to “foam the runway” for a financial system facing ongoing mortgage losses.

Geithner and company weren’t wrong to see shoring up the banks as important. The problem was that this was allowed to take absolute priority over all other goals — with the result that millions of families lost their homes, an important factor in the slow growth of much of the 2010s.

One wouldn’t want to push this analogy too far. The debt ceiling deal is not nearly as consequential – or as clear a reflection of administration priorities – as the abandonment of underwater homeowners was. But it does suggest similar blinders: too much attention to the danger of financial crisis on one side, not enough to equally grave threats from other directions.

It’s clear that Treasury Secretary Janet Yellen and the rest of the Biden administration are very attuned to the dangers of a default. But have they given enough thought to the other dangers of failing to reach a debt-ceiling deal — or of reaching a bad one? Financial crises are not the only crises. There are many ways that an economy can break down.

At Substack: The End of Laissez Faire

(I wrote this post about two weeks ago, but then took a while getting the Substack actually launched. Going forward, hopefully the content will be more timely. All substack content is free; you can subscribe to the newsletter version here. Hopefully the content will be more timely in the future!)

Sometimes I think being a normal economist must be like one of those classic office jobs. You drive to work, park in the garage, take the elevator up to your office. You take some papers from your inbox and put them in your outbox. There’s the research frontier; ok, we’ve advanced it a little bit. Then the bell rings, quitting time. Whereas here in the heterodox world, it’s like you’ve let yourself in through a gap in the fence and you’re wondering, is this place a construction site, or is something being demolished, or is it an archaeological dig? I think this is my desk, but it could be some weird art object, or possibly part of the ventilation system. This person in the hallway — are they the boss, or a customer, or maybe someone in need of emergency medical assistance? Am I sure I have a job? Am I even supposed to be in here?

Well then. Back to work!

The question of the moment is industrial policy. Not so long ago, the consensus on climate policy, at the high table at least, was that carbon pricing was it. Government provides the public interest with an abstract monetary representation, and then private businesses (or “markets”) will translate that representation into whatever concrete changes to production are called for. In recent years, though, the debate seems to have been shifting rather rapidly towards what I have called an investment-focused approach. The passage of the Inflation Reduction Act (along with other similar measures) seems to mark a decisive turn toward industrial policy, in the US at least. This is not only about climate — the disruptions to global supply chains during the pandemic and, more worryingly, a renewed sense of rivalry with China, have strengthened the case for support for key sectors of the economy.

(Full disclosure: When someone mentioned to me early in the Biden administration that there was interest in dealing with the chip shortage by fostering a US industry, I thought it was a silly idea that would go nowhere. This was, it seemed to me, about the worst case for policy — a problem that was at once both extraordinarily hard for government to solve, and likely to take care of itself on its own before long. Shows you how much I know! — or perhaps, how much things have changed.)

The case for industrial policy, obviously, involves a reevaluation of the capacity of government and the problems it is expected to solve — what Keynes, in an essay whose title can be repurposed today, called the line between agenda and non-agenda. But it also, a bit less obviously, involves a shift in how we think about the economy. An economy where industrial policy makes sense is not one that can be usefully described in terms of a unique, stable equilibrium toward which decentralized decisionmakers will converge. Industrial policy only makes sense in a world where increasing returns and learning by doing create significant path dependence — what we are good at today depends on what we were doing yesterday — and where an uncertain future and the need for large, irreversible investments, and the prevalence of complementarity rather than substitution, creates coordination problems that markets are unable to solve. I don’t know that the drafters of the IRA were conscious of it, but they were implicitly endorsing a very different model of the economy than the one that one finds in textbooks.

Supply constraints. My big recent publication, coauthored as usual with Arjun Jayadev, is an article in the Review of Keynesian Economics called “Rethinking Supply Constraints.” It addresses exactly this issue. The one-sentence summary is that it makes more sense to think of the productive capacity of the economy in terms of a speed limit — a limit on the rate at which output and employment can grow — rather than an absolute ceiling, as in conventional measures of potential output. This, we argue, fits better with a wide range of empirical phenomena. Equally important, it fits better with a vision of the economy as an open-ended collective transformation of the world, as opposed to the allocation of an existing basket of stuff.

There’s a summary in this blogpost, and video of my presentation of it at the University of Massachusetts is here. (I start around 47 minutes in.) I will try to write more about it in this newsletter soon.

Low rates and bubbles. My latest Barron’s piece (I write one more or less monthly) was on whether the post-2007 decade of low interest rates can be blamed for Sam Bankman-Fried and financial bubbles and frauds more generally. As always, when the headline is a question, the answer is no.

I don’t think I quite stuck the landing with this one. The big point I should have hammered on is that if abundant credit ends up supporting projects that are socially and privately worthless, that’s a problem. But it is a problem with the institutions whose job it is to allocate credit, not with low interest rates or abundant credit as such. If banks and bank-like institutions can borrow at lower rates, it’s easy to see why they’d lend to projects with lower returns. It’s harder to see why they’d lend to projects with negative returns. The idea, evidently, is that for some reason when interest rates are too low financial-market participants will make choices that are not only socially costly but costly to themselves as well. The low rates-cause-bubbles arguments almost amount to a kind of financial terrorism — give us the risk-free returns we were counting on, or we’ll blow up our portfolios, and some chunk of the economy along with it.

The connection to industrial policy? If we don’t trust financial markets to make investment decisions, that strengthens the case for a bigger public role.

Biden, Brenner, and Benanav. Robert Brenner’s frequent collaborator Dylan Riley wrote a piece in the NLR blog Sidecar, drawing on Brenner’s work to argue that industrial policy is hopeless because of global overcapacity; you’ve got to seize the commanding heights or stay home. I don’t agree. I think there are ways that the socialist project can be advanced via Biden administration initiatives like the IRA, and wrote a piece for Jacobin explaining why.

Some people liked it — Adam Tooze gave it a nice mention in one of his newsletters. Others did not. Aaron Benanav wrote a long and rather irritated rebuttal in New Left Review. I disagree with a lot of what he wrote, which is fine; he, as he made very clear, disagreed with what I wrote. As the protagonist of James Salter’s great Korean War novel The Hunters says, “You shoot at them, they shoot at you. What could be fairer?” But I am a little annoyed that my jaunty Hamilton reference, intended to warn against the danger of imagining that you are in a position of power, got turned into evidence that I myself dream of being in the “room where it happens.” That seems unsporting.

I talked about my piece and the larger debate with Doug Henwood on his excellent Behind the News podcast. I will also be writing a piece for NLR that will be in part a response to Benanav but mostly, I hope, an intervention to move the debate in a more positive direction.

Speaking of Korea. I was on an English-language Korean news show recently, talking about the IRA. The video is here; a twitter thread summarized the points I was trying to make is here. An implicit background point, also very relevant to my objections to the Brenner-Riley-Benanav position, is that trade flows respond mostly to income, not relative prices. How much the US imports from Korea is to a first approximation a function of US GDP growth; subsidies (and exchange rates) are distinctly secondary.

What I am reading. I just finished the novel Variations on Night and Day, by Abdelrahman Munif. It’s the third novel in the Cities of Salt trilogy, though the first chronologically. The first novel, also called Cities of Salt, is about people in a fictional Middle Eastern Country (more or less Saudi Arabia) in the early days of the oil boom. It’s an extraordinary book in many ways, including its use of mostly collective protagonists — large parts of the narration are from the point of view of “the villagers”, “the workers” and so on. The second book, The Trench, moves up the social scale, focusing on the various schemers, strivers, climbers and entrepreneurs – business and political – who accrete around the monarchy’s capital. It’s got an ensemble, rather than collective cast, with one central character and an endless number of minor ones – it would make a great tv show. (Think a gulf-monarchy version of Hillary Mantel’s Cromwell novels.) The third book — Variations on Night and Day — moves up the social scale again, and back in time, to the earlier life of the sultan whose death occurs at the very beginning of The Trench. It’s a great book, gripping as narrative and morally serious. It provides what science fiction and fantasy promise but very seldom deliver, an immersive experience of a world very different from our own. Still I have to say, I somewhat preferred the first two books. At the end of the day, sultans are just not that interesting.

ETA: As it happens, I went to graduate school with Munif’s son Yasser. He was in the sociology department while I was in economics and we used to hang out quite a bit, tho I haven’t seen him in some years.

At Substack: Hello World

I barley keep up this blog any more; do I really need a new format for (not) writing online? The problem, from my point of view, is that, these days, the only way people see blogs (or most other things one writes) is via twitter. And relying on twitter does not, at this point, see like a great idea. I’m moderately hopeful that an email newsletter can offer an alternative way.

In any case, my new substack is here. It’s pretty no-frills at the moment. I’ve pasted the first post below. For the moment I plan on cross-posting everything, but depending on how the substack goes I may revisit that.

What is this? This is an email newsletter, delivered through Substack. You probably get some others like it already. This one is from me, Joshua William Mason, or J. W. Mason as I usually write it. It’s called Money and Things. This specific email or post is the first one.

Why am I getting this? Either you signed up for it, or I added you. I subscribed a few people who I thought might be interested in hearing from me now and then. I hope you don’t mind! If you do, there’s an unsubscribe button somewhere. I promise I won’t add you again.

What’s the point of it? My main goal with this is to share things I’ve said or written in other settings, along with some interesting things I have read. I write a fair amount in a fair number of venues, and am in the news now and then. So it seems worth having one place to share it all with people who might like to see it. And then, despite the firehouse of content constantly aimed at each of our heads, it still can be nice to have someone point out something worth reading that you might not have run across otherwise.

The other goal is to have a structure for comments on things that are happening in the world. There are always things going on that I don’t have the time or energy or confidence to write about at length, but might have something interesting to say about in a more informal setting. Will a substack be any better for this than the blog I’ve been keeping for the past dozen years? I don’t know, but it seems worth a try.

So, a lot like a twitter feed, then? Yes, very much. I want to use the newsletter to share material that right now I use twitter for. Not everyone is on twitter, after all. And while I can’t see myself getting off twitter entirely – there are still too many interesting people there – I would like to spend less time on it, for all the familiar reasons.

How often will you be sending these? I’m vaguely hoping for once a week. I’m sure it won’t be more often than that; it could be much less. I will at least try to send one out whenever I publish something.

Why is the newsletter called Money and Things? Well, that captures the range of my interests. I write a lot about money, finance, central banks, credit and debt, inflation and other money-related and money-adjacent topics. But I also write about other things.

Also, Money and Things is the working title of the book that Arjun Jayadev and I are working on. This book has been in progress for longer than I care to think about, but it’s now mostly written and should be coming out from the University of Chicago Press sometime in the next year. So I also want to use this email to share material from the book, and, down the road, to encourage people to read it.

What is the book about? Oof, I hoped you wouldn’t ask that. Well, it’s about money … and things.

Can you be more specific? The book is an effort to pull together some different strands of thinking around money that Arjun and I have been grappling with since we were students at the University of Massachusetts 20 years ago. One place to start is the tendency — both in economics and everyday common sense — to think of money either as just one useful object among others, or as a faithful reflection of a material world outside itself. Whereas to us it seems clear we should think of it as constituting its own self-contained world, a game or a logic, that in some ways responds to external material and social reality, but also evolves autonomously, and reshapes that external world in its turn. Economists like to think that when we measure things in terms of money, that is capturing some pre-existing “real” value or quantity. (Like, when you see a figure like GDP, you assume in some sense it reflects a quantity of stuff that was produced.) But in fact — our argument goes — while money is a yardstick that allows all sorts of things to be numerically compared, it doesn’t reflect any underlying quantity except money itself.

Keynesians have been criticizing the idea that money is neutral, just a veil, for decades. But we think there’s still space to spell out what the positive alternative looks like, and why it matters. You might say it’s an attempt to elevate the argument of our “Fisher dynamics” papers — where we argued that movements in debt-income ratios have more to do with interest rates and inflation than change in borrowing behavior — into a worldview or paradigm.

What we’re mainly interested in is the interface or boundary between money-world and the concrete world outside of it. (One jokey summary is that we’re starting from Keynes’ General Theory of Money, Interest and Employment, and writing about the “and”.) The idea is that by focusing there, we can connect some long-standing theoretical questions around the nature of money with contemporary debates about policy and politics, and with historical developments like the shareholder revolution or the euro crisis. We’re aiming for a spot in intellectual space somewhere between Jim Crotty, Perry Mehrling, Doug Henwood and David Graeber, if that makes sense.

Will you have a better answer to this question by the time the book comes out? I hope so!

Getting back to the newsletter — will there be free and paid versions? No, there will not. If someone wanted to give me money for it, I wouldn’t say no. If I got a little, I’d buy my kids ice cream. If I got a significant amount, which seems unlikely, then I might put more time into writing it. If I get none at all, that’s perfectly fine.

My personal view – which I know not everyone shares – is that if you are a tenure-track academic, it’s a bit unethical to charge money for a newsletter or similar product. The job of an academic is not just teaching; we are being paid to think about the world and share what we learn. So to me – again, I know many people feel differently – when you turn your work as a scholar into a kind of private business venture, that’s almost a form of embezzlement. Perhaps you saw Inside Job, that movie about economists and the financial crisis. Remember how eagerly someone like Frederic Mishkin turned his stature as a big-name monetary economist into big checks for himself? I don’t want to be that guy. Of course I’m not under any illusion that my integrity carries anything like the market price of a Mishkin’s. But it’s still worth something to me.

To be clear, this doesn’t apply to people who make a living as journalists or writers. If you are a professional writer your readers need to be paying you one way or another, and subscriber-only newsletter content is a legitimate way to make that happen. But as an academic, I’m already being compensated for this kind of work.

Does this mean your book will also be distributed for free? Well, no. The publishers will charge whatever they normally do for a book like this, and Arjun and I will get whatever (presumably small) royalties we’re entitled to out of that.

So how is that different? I don’t know. I feel like it’s different? Of course producing a physical book is costly, and the publisher has their own employees, whose services are valuable, and other costs that have to be paid. On the other hand, it would be technically feasible to just put the book up online as a pdf, and let anyone download it. So making people pay is in some sense a choice we are making. Still, if Inside Job had merely caught Mishkin admitting he’d published a book about financial crises, I don’t think that would have been much of a gotcha. Although then again, on the other hand, the textbook-writing business does seem a bit morally compromised. (Personally I try not to assign anything I can’t distribute a free pdf of.) I do hope our book will be used in the classroom. But I wish students could get excerpts of it in xeroxed course packets, they way I did when I was in college.

Anyway. Money and Things, the newsletter, will always be entirely free. Money and Things, the book, will not be.

You seem to have strong feelings on this topic. Do you have anything else to say about it? Yes, I do. I’ve always found it infuriating that so much scholarly work is hidden behind paywalls. It goes against the whole idea of scholarship, especially if you think of your academic work as part of some political project or as otherwise useful. During the six-seven years between my two stints in graduate school, I was intermittently engaged in online economics discussions, and I found it deeply frustrating that there were so many interesting articles that, without an academic affiliation, I was not permitted to read. I hope someday we recognize IP as applied to academic work for what it is, a comprehensive regime of censorship. (And Alexandra Elbakyan, the creator of sci-hub, as one of humanity’s heroes.)

A bit more recently, but still some years ago, I joined the steering committee of the Union for Radical Political Economics in large part to see if I could convince them to convert URPE’s journal, the Review of Radical Political Economics, to open access. Here you are, I thought, doing work that’s supposed to be part of a larger transformative project, that is relevant not just for other academics but for workers and activists. So why are you enlisting the power of the state to stop people from reading it?

As is often the case, what seemed unanswerable in principle turned out to be less straightforward in practice. The leadership of URPE the organization is largely separate from that of the journal; there’s a multi-year contract with the publisher; and even if open access were allowed, URPE’s share of the subscription revenue is basically the organization’s entire budget. If we went open-access, how would we pay the editor, or award fellowships to students in heterodox programs, or fly people out for the steering committee meetings? Maybe, I suggested, allowing people to read the journal is more important than flying people to meetings. Easy for you to say, someone replied, you live in New York; for others, if they can’t come out and meet in person, they won’t be part of this community at all. Besides, are there really so many non-academics who want to read RRPE?

Maybe if I’d pushed harder I could have got somewhere. But the obstacles were real, and no one seemed to agree with me, so I gave up, and eventually left the steering committee. (Life is too short to be on too many committees.) But I still think I was right.

Anything else? No, I think that’s it for now. But don’t worry – there will be another post coming shortly after this one.

At Barron’s: Are Low Rates to Blame for Bubbles?

(I write a monthly opinion piece for Barron’s. These sometimes run in the print edition, which I appreciate — it’s a vote of confidence from the editors, and means more readers. It does impose a tighter word count limit, though. The text below is the longer version I originally submitted. The version that was published is here. All of my previous Barron’s pieces are here.)

The past year has seen a parade of financial failures and asset crashes. Silicon Valley bank was the first bank failure since 2020, and the biggest since 2008. Before that came the collapse of FTX, and of much of the larger crypto ecosystem. Corporate bankruptcies are coming faster than at any time since 2011. Even luxury watches are in freefall.

The proximate cause of much of this turmoil is the rise in interest rates. So it’s natural to ask if the converse is true. Is the overvaluing of so many worthless assets – whether through bubbles or fraud – the fault of a decade-plus of low rates? For those who believe this, the long period of low rates following the global financial crisis fueled an “everything bubble”, just as the earlier period of low rates fueled the housing boom of the 2000s. The rise of fragile or fraudulent institutions, which float up on easy credit before inevitably crashing back to earth, is a sign that monetary policy should never have been so loose. As journalist Rana Foorohar put it in a much-discussed article, “Keeping rates too low for too long encourages speculation and debt bubbles.”

You can find versions of this argument being made by prominent Keynesians, as well as by economists of a more conservative bent. At the Bank for International Settlements “too low for too long” is practically a mantra. But, does the story make sense?

Yes, low interest rates are associated mean high asset prices. But that’s not the same as a bubble.To the extent an asset represents a stream of future payments, a low discount rate should raise its value.

On the other hand, asset prices are not just about discounted future income streams; they also incorporate a bet on the future price of the asset itself. If a fall in interest rates leads to a rise in asset prices, market participants may mistakenly expect that rise to continue. That could lead to assets being overvalued even relative to the current low rates.

Another argument one sometimes hears for why low rates lead to bubbles is that when income from safe assets is low, investors will “reach for yield” by taking on more risk, bidding up the price of more speculative assets. Investors’ own liabilities also matter. When it’s cheap and easy to borrow, an asset may be attractive that wouldn’t be if financing were harder to come by.

But if low interest rates make acquiring risky assets more attractive, is that a problem? After all, that’s how monetary policy is supposed to work. The goal of rate cuts is precisely to encourage investment spending that wouldn’t happen if rates were higher. As I argued recently, it’s not clear that most business investment is very responsive to interest rates. But whether the effect on the economy is strong or weak, “low interest rates cause people to buy assets they otherwise wouldn’t” is just monetary policy working as intended.

Still, intended results may have unintended consequences. When people are reaching for yield, the argument goes, they are more likely to buy into projects that turn out to be driven by fraud, hype or fantasy.

Arguments for the dangers of low rates tend to take this last step for granted. But it’s not obvious why an environment of low yields should be more favorable to frauds. Projects with modest expected returns are, after all, much more common than projects with very high ones; when risk-free returns are very low, there should be more legitimate higher-yielding alternatives, and less need for risky long shots. Conversely, it is the projects that promise very high returns that are most likely to be frauds — and that are viable at very high rates.

Certainly this was Adam Smith’s view. For him, the danger of speculation and fraud was not an argument for high interest rates, but the opposite. If legal interest rates were “so high as 8 or 10 percent,” he believed, then “the greater part of the money which was to be lent would be lent to prodigals and projectors, who alone would be willing to give this high interest. Sober people … would not venture into the competition.”

The FTX saga is an excellent example. At one point, Sam Bankman-Fried—a projector and prodigal if ever there was one—offered as much as 20% on new loans to his hedge fund, Alameda, according to The Wall Street Journal. It wouldn’t take low rates to make that attractive — if he was good for it. But, of course, he was not. And that is the crux of the problem. Someone like Bankman-Fried is not offering a product with low but positive returns, that would be attractive only when rates are low but not when they were high. He was offering a product with an expected return that, in retrospect, was in the vicinity of -100 percent. Giving him your money to him would be a bad idea at any interest rate.

We can debate what it would take to prevent fraud-fueled bubbles in assets like cryptocurrency. Perhaps it calls for tighter restrictions on the kinds of products that can be offered for sale, or more stringent rules on the choices of retail investors. Or perhaps, given crypto’s isolation from the broader financial system, this is a case where it’s ok to just let the buyer beware. In any case, the problem was not that crypto offered higher returns than the alternative. The problem was that people believed the returns in crypto were much higher than they actually were. Is this a problem that interest rates can solve?

Let’s suppose for the sake of argument that it is. Suppose that without the option of risk-free returns of 3 or 4 or 5 percent, people will throw their money away on crazy longshots and obvious frauds. If you take this idea seriously, it has some funny implications. Normally, when we ask why asset owners are entitled to their income in the first place, the answer is that it’s an incentive to pick out the projects with the highest returns. (Hopefully these are also the most socially useful ones.) The “too low for too long” argument turns this logic on its head. It says that asset owners need to be guaranteed high returns because they can’t tell a good project from a bad one.

That said, there is one convincing version of this story. For all the reasons above, it does not make sense to think of ordinary investors being driven toward dangerous speculation by low interest rates. Institutions like insurance and pension funds are a different matter. They have long-term liabilities that are more or less fixed and, critically, independent of interest rates. Their long investment horizons mean their loss of income from lower rates will normally outweigh their capital gains when they fall. (This is one thing the BIS surely gets right.) When the alternative is insolvency, it can make sense to choose a project where the expected return is negative, if it offers a chance of getting out of the hole. That’s a common explanation for the seemingly irresponsible loans made by many Savings & Loans in the 1980s—faced with bankruptcy, they “gambled for resurrection.” One can imagine other institutions making a similar choice.

What broke the S&Ls in was high rates, not low ones. But there is a common thread. A structure set up when interest rates are in a certain range may not work when they move outside of it. A balance sheet set up on the basis of interest rates in some range will have problems if they move outside it.

Modern economies depend on a vast web of payment expectations and commitments stretching far into the future. Changes in interest rates modify many change of those future payments; whether upward or downward, this means disappointed expectations and broken commitments.

If the recent period of low rates was financially destabilizing, then, the problem wasn’t the not low rates in themselves. It was that they weren’t what was planned on. If the Fed is going to draw general lessons from the bubbles that are now popping, it should not be about the dangers of low rates, but that of drastic and unexpected moves in either direction.

At Jacobin: Yes, We Should Support Industrial Policy and the Green New Deal

(This piece was published by Jacobin on April 6, 2023, in response to the Dylan Riley post linked in the first paragraph. The version below adds a few unimportant footnotes and one somewhat important paragraph that I forgot to write before submitting it — the one about halfway through that mentions Oskar Lange.)

A few days ago, Dylan Riley wrote a post on New Left Review’s Sidecar blog that provoked a furious response on twitter. ⁴ Since I largely agree with the criticism made by Alex Williams, Nathan Tankus, Doug Henwood and others, perhaps I shouldn’t add to the chorus. But I want to try to clarify the larger stakes in this debate.

Riley’s piece starts from the suggestion that the failure of Silicon Valley Bank reflects a larger crisis of overcapacity and lack of investment opportunities. SVB, he writes,

had parked a huge quantity of its deposits in low-yield – but supposedly safe – government-backed securities and low-interest bonds. … the bank was overwhelmed by the massive growth in deposits from its tech clients – and neither it nor they could find anything worthwhile to invest in. …the SVB collapse is a beautiful, almost paradigmatic, demonstration of the fundamental structural problem of contemporary capitalism: a hyper-competitive system, clogged with excess capacity and savings, with no obvious outlets to soak them up.

This is an elegant framing but it runs into a problem immediately, involving the ambivalent meaning of ‘invest.” The depositors in SVB were not venture capitalists, but the firms that they had stakes in. The reason SVB had such big deposits was not because finance was unable to find profitable outlets even in the tech world, but precisely because it had done so. (Whether these businesses are doing anything socially useful is of course a different question.) The fact that SVB’s assets consisted of Treasury bonds rather than loans to its depositors reflects the shift in business financing, especially in tech, away from banks toward specialized venture capital funds — an interesting development, certainly, but one that doesn’t tell us anything about the overall population of businesses looking for financing.

Lurking behind Riley’s formulation here seems to be a crude version of commodity money theory, in which money is either out in the world being useful, or being left idle in the bank. But money in the real world is always in the form of bank deposits — that’s what money is — regardless of how actively it is circulating.

To be fair, Silicon Valley Bank is just the hook here. The real argument of the post — the one that provoked such a reaction — is that the ongoing crisis of overcapacity means that Green New Deal-type programs of public investment in decarbonization are a self-defeating dead end. “Imagine,” writes Riley,

that Bidenomics in its most ambitious form were successful. What exactly would this mean? Above all it would lead to the onshoring of industrial capacity in both chip manufacturing and green tech. But that process would unfold in a global context in which all the other capitalist powers were vigorously attempting to do more or less the same thing. The consequence of this simultaneous industrialization drive would be a massive exacerbation of the problems of overcapacity on a world scale, putting sharp pressure on the returns of the same private capital that was ‘crowded-in’ by ‘market-making’ industrialization policies.

There are a number of distinct arguments in, or at least in the vicinity of, Riley’s post. We can of course debate the specific content of the IRA — where does it fall on Daniela Gabor’s spectrum from “de-risking” to the “big green state”? There’s a larger political question about the extent to which activists and intellectuals on the left should attach themselves to programs carried out by the established political actors through the state, as opposed to popular movements outside of it. And then there is the specific question of overcapacity — is it reasonable to think that any boost to investment via public spending will just diminish opportunities for profitable accumulation elsewhere?

I’m not unsympathetic to the first two of these arguments, even if I don’t agree with them in this particular case.

In my opinion, the IRA model passes two key tests: The public money goes to productive enterprises, not to holders of financial assets; and there is affirmative direction of spending toward specific activities. To me there is an important difference between “for each new solar panel you install with union labor, you will get x dollars of subsidies” and “if you hold a bond that fits these broad criteria, the interest is taxed at a lower rate” — even though, at a sufficiently high level of abstraction, both involve subsidizing private capital. But there’s a lot of room for debate here about how to describe specific measures and where to draw the line; a different read of its provisions might plausibly put the IRA on the other side of it.

Similarly, it’s important to remember that winning some specific legislation does not mean that you control the state — there’s a real danger in imagining ourselves “in the room where it happens” when in reality we are very far from it. When Riley writes that “no socialist should advocate an ‘industrial policy’ of any sort, nor have any truck with self-defeating New Deals,” I, obviously, do not agree. But if you wrote a parallel sentence about the humanitarian activities of the US military in various parts of the globe, I would agree wholeheartedly. Over the years I’ve had many disagreements with people with broadly similar political commitments, who thought this particular intervention could was worth supporting. As far as I am concerned, when the instruments of the state are marines and cruise missiles, the only possible engagement from the left is protest and obstruction.

War is different from industrial policy. But one can imagine an argument along these lines that would be worth taking seriously. If you wanted to write a stronger critique of the Green New Deal from the left, you might stress the tight links between industrial policy and nationalism, and the frightening anti-China rhetoric that’s a ubiquitous part of the case for public investment.

Here, though, I want to talk about the specifically economic argument, about overproduction.

Riley’s post draws on a long-standing argument among writers for the New Left Review, that the fundamental challenge for contemporary capitalism is overproduction or excess capacity. In this story, the end of the postwar Golden Age was due to the end of US dominance in world trade. Starting in the 1970s, stable oligopolies in manufacturing gave way to to cutthroat competition as producers from an increasing number of countries competed for a limited market. Because manufacturing is so dependent on long-lived, specialized capital goods, producers are unwilling to exit even in the face of falling prices, giving rise to chronic depressed profits and excess capacity, and a turn to financial predation — what Robert Brenner calls neofeudalism — as an alternative outlet for investment. Even when profits recover, there’s little incentive to accumulate new means of production, given that there’s already capacity to produce more than markets can absorb.

The most influential version of this story is probably Brenner’s book-length New Left Review article from 1998. ⁵ It is clearly compelling on some level – a lot of people seem to believe something like it. It draws on a long tradition of theories of overproduction and destructive competition, going back at least to the underconsumption theories of Hobson, Lenin and Luxemburg on the one side and, on the other, the first generation of the US economics profession, shaped by the pathological effects of competition between railways. Richard Ely, founder of the American Economics Association, described the problem clearly: “whenever the principle of increasing returns works with any high degree of intensity, competition can never regulate private business satisfactorily.” His contemporary Arthur Hadley described destructive competition in capital-intensive industries in very much the same terms as Brenner: at prices

far below the point where it pays to do your own business, it pays to steal business from another man. The influx of new capital will cease; but the fight will go on, either until the old investment and machinery are worn out, or until a pool of some sort is arranged.

(The quotes are from Michael Perelman’s excellent The End of Economics.)

There’s an important truth to the idea that, in a world of long-lived specialized capital goods and constant or falling marginal costs, there is no tendency for market prices to reflect costs of production. Too much competition, and firms will sell at prices that don’t recoup their fixed costs, and drive each other to bankruptcy. Too little competition, and firms will recover their full costs and then some, while limiting socially useful output. No market process ensures that competition ends up at the goldilocks level in the middle.

But while this problem is real, there’s something very strange about the way Riley deploys it as an argument against the Green New Deal. Rather than a story about competition, he — following Brenner — talks as if there was a fixed amount of demand out there that producers must compete for. In a world of overproduction, he says, any public investment will just create more excess capacity, driving down profits and accumulation somewhere else.

In a funny way, this is the mirror image of the Treasury View of the 1930s — which said that any increase in public employment would just mean an equal fall in private employment — or of its modern day successors like Jason Furman and Lawrence Summers. The Furman-Summers line is that the world has only a certain amount of productive capacity; any public spending above that level that will just result in inflation, or else crowding out of private investment. The Brenner-Riley line is that the world has only a certain amount of demand, both in general and for carbon-reducing technology specifically. Try to produce any more than that, and you’ll just have excess capacity and falling profits. Both sides agree that the economy is like a bathtub — try to overfill it and the excess will just run over the sides. The difference is that for first side demand is the water and productive capacity is the tub, while for the other the water is capacity and the tub is demand.

Riley invokes Oskar Lange’s 1930s discussions of electoral socialism in support of his contention that “half-measures are self-contradictory absurdities” — which very much includes any “blather about New Deals.” But the situation facing socialist governments in the 1930s was quite different. Their problem was that any serious discussion of nationalization would terrify capital and discourage investment, sending the economy into a deeper slump and dooming socialists’ prospects for extending their initial electoral gains. This meant that nationalization had to be carried out all at once or not at all — which in practice, of course, meant the latter. (There is a good discussion of this in Przeworski’s Paper Stones.) Keynesian fiscal policy was precisely what offered the way out of this trap, by allowing an expansion of the public sector on terms consistent with continued private accumulation. Riley here is rejecting exactly the solution to the problem Lange identified.

But there’s a deeper problem with the Riley-Brenner vision. In Jim Crotty’s review of Brenner’s long article, he argues that, in response to what Brenner saw as an excessive focus on labor-capital conflict in accounts of the end of the postwar boom, he created an equally one-sided story focused exclusively on inter-capitalist competition. I think this gets to the crux of the matter.

Let’s take a step back.

The development of a capitalist economy is a complex process, which can go wrong at many points. Production on an increased scale requires the expansion of the physical and organizational means of production, with whatever technical and material requirements that entails. Additional labor must be enlisted and supervised. New raw materials must be acquired, and the production process itself has to be carried out on an increased scale. The resulting products have to be sold at a price that covers the cost of production — in other words, there must be sufficient demand. The resulting surplus has to be channeled back to investment. All of this has to take place without excessive changes in relative prices, and in particular without politically destabilizing changes in wages or the distribution of income. The reinvestment stage normally happens via the financial system; the ongoing payment commitments this generates have to be consistently met. And it all must take place without generating unsustainable cross-border payment flows or commitments.

All of these steps have to happen in sync, across a wide range of sectors and enterprises. A business expanding production has to be confident that the market for its products is also growing, as well as the supply of the inputs it uses, the financing it depends on, and the labor it exploits. An interruption in any of these will halt the whole process. When growth is steady and incremental, this can be mostly taken for granted, but not in the case of more rapid or qualitative change, as in industrialization.

This problem was clearly recognized by earlier development economists. It’s the idea behind the “two gap” and “three gap” models of Hollis Chenery and his collaborators, the “big push” of Rosenstein-Rodan, or Gerschenkron’s famous essay on late industrialization.⁶ Everything has to move forward together. Industrialization requires not only factories, but ports, railroads, water, electricity, schools. All of these depend on the others. You need savings (or at least credit), and you need demand, and you need labor, and you need foreign exchange.⁷

At the same time, an essential feature of the capitalist mode of production is that the various steps each involve different decision makers, acting with an eye only to their own monetary returns. From the point of view of each decision maker, the choices of all the others look like fixed, objective constraints. From the point of view of a particular producer, the question of whether there is sufficient demand to justify additional output is an objective fact. For the producers collectively, it is their decisions that determine the level of demand just as much as — in fact simultaneously with — the level of current output. But for them individually, it’s a given, an external constraint.

The problem comes when in thinking about the system as a whole we treat something like destructive competition not as what it is – a coordination problem – but from the partial perspective of the individual producer. From this perspective, it appears as objectively given, as if there were only so much demand to go around. The mainstream, of course, makes the exact same error when they treat the productive capacity of the system as prior to and independent of the actual level of activity. (This is the point of Arjun Jayadev’s and my recent paper on supply constraints.) The fact that when one part of the system moves ahead faster it encounters friction from parts that are lagging imposes genuine limits on the pace of expansion — both supply and demand constraints are real – but we should not treat them as absolute or externally given.

The faster and farther reaching are the changes in production, the harder it is for a decentralized market system to maintain coherence, and the more necessary conscious, more or less centralized coordination becomes. This was one of the main lessons of the economic mobilization for World War II, and a critical consideration for decarbonization. Planning is ubiquitous in real-world capitalism, and more rapid transformations in activity require planning at a higher level.

At the same time, we shouldn’t underestimate the capacity of our system of anarchic production for profit to eventually break through the barriers it encounters — something Marx understood better than anyone. That is why it’s become the world-encompassing system it is. Sustained demand will itself call forth the new labor and improved production techniques required to meet it. Conversely, while Say’s law may not hold in the short run, or as a matter of logic, it is very much the case that improvements in production create new markets, and expand demand qualitatively as well as quantitatively.

Overproduction and excess capacity are not new phenomena. They have been a recurring feature of the great crises that capitalist economies have experienced for the past two hundred years. Here is Jules Michelet’s beautiful contemporary description of the 1842 commercial crisis in France:

The cotton mills were at the last gasp, choking to death. The warehouses were stuffed, and there were no sales. The terrified manufacturer dared neither work nor stop working with those devouring machines. Yet usury is not laid off, so he worked half-time, and the glut grew worse. Prices fell, but in vain; they went on falling until cotton cloth stood at six sous.

We should never forget about the misery and chaos of crises like this. But we should also not forget how this story ends. It is not “and then eventually enough mills were shut down and things went back to how they were before.”

Here’s how the Michelet passage continues:

Then something completely unexpected happened. The words six sous aroused the people. Millions of purchasers — poor people who had never bought anything — began to stir. Then we saw what an immense and powerful consumer the people is when engaged. The warehouses were emptied in a moment. The machines began to work furiously again, and chimneys began to smoke. That was a revolution in France, little noted but a great revolution nonetheless. It was a revolution in cleanliness and the embellishments of the homes of the poor; underwear, bedding, table linen, and window curtains were now being used by whole classes who had not used them since the beginning of the world.

An openness to the possibility of this sort of transformational change is what’s fundamentally missing from both the Summers-Furman and Brenner-Riley views. This is not a system in homeostasis, that if disturbed returns to its old position. It is a system lurching from one unstable equilibrium to another. And this is very relevant, I think, to decarbonization.

Not so very long ago, it was conventional wisdom that photovoltaic energy was never going to be more than a niche power source — useful when you can’t connect to the grid, but way too expensive to to ever be used at utility scale. And now look — solar accounted for nearly half of new electricity generation installed last year. There’s an almost endless scope for further growth in renewable energy, as more of the economy is electrified. The fact that Silicon Valley Bank was holding a bunch of Treasury bonds does not mean that the field of productive investment has been exhausted.

The tremendous growth of renewable energy over the past generation wouldn’t have happened without public subsidies and regulation. At the same time, most of the actual production has been carried out by employees of private, profit-seeking businesses. Riley is absolutely right that no one should be counting on private investment in education or in care work. Explaining why those activities depend critically on the autonomy and intrinsic motivation of the workers carrying them out, and are therefore inherently unsuited to for-profit businesses, is something we need to keep doing. The same goes for many public functions that have been turned over to contractors. But there are many other areas where it is still possible to harness the profit motive to meet human needs.

(I am not, to be clear, saying anything about the virtues of markets or the profit motive in the abstract. I would like to progressively eliminate them from human life. I am simply stating the fact that my house was put up by a private builder, for profit, and yet the roof does keep out the rain.)

There is plenty of scope to criticize the specific content of the IRA and other climate legislation, and the strategic choices of the groups that support them. (Altho a bit of humility is called for with the latter.) But we need to categorically reject the idea that there is some hard constraint such that any program to increase private spending on decarbonization will be canceled out by a reduction in spending somewhere else.

The bottom line, both for the politics and the economics, is that we need to resist thinking in terms of a change in one area while everything else stays the same. Ceteris paribus may be a useful analytic tool, but it’s fundamentally inapplicable to historical processes where one change creates the pressure, and the possibility, for another.

Yes, given the existing productive technology, given existing markets, one country’s support for renewable energy might compete with another’s. But these things are not given. Economies of scale exist at the level of the industry as well as the firm; technological progress in one place quickly spills over to others. As, say, hydrogen becomes practical for large-scale energy storage, it will be come practical to produce green energy in areas where it isn’t today. This is as far as you can get from the Brenner paradigm of a zero-sum competition for shares of a fixed market.

The real problem for the Green New Deal and broader industrial policy program is not scarcity, whether of material or of markets. It is twofold. First, it requires a capacity for public planning that is currently lacking, in the US and elsewhere. Industrial policy means building up and legitimating the state’s direct role in a wider range of activity— a challenge when the biggest existing form of direct public provision, the public schools, are under ferocious attack from the right. Second, to the extent that a rush of public and private spending leads to a sustained boom, that will create profound challenges for a system that is used to managing distributional conflicts through unemployment. We’ve gotten a sense of what the political reaction to full employment might look like from recent inflation discourse, with its fears of “labor scarcity.” It’s reasonable, for now, to respond that it’s silly to worry about a wage-price spiral when labor is so weak. But what happens when labor is stronger?

These are real challenges. But we shouldn’t see them as arguments against this program, only as markers for where the next conflicts are likely to be. That’s always how it is. “Gradualism cannot work,” declares Riley, but all politics is incremental. Socialism is only a direction of travel. Even if the “commanding heights of the economy” could “be seized at once” — Riley’s rather ambitious alternative to the Green New Deal — that would only be a step toward the next struggle.

A program to mobilize the existing bourgeois state to push private spending in the direction of meeting human needs, and the need for a habitable planet in particular, faces many obstacles — that is true. Whatever successes the left has had under the Biden administration have been limited and compromised. Some of the most important, like the expansion of unemployment and family benefits, have already been rolled back — that is also true. But the same could be said for all the socialist programs of the past. We have to just keep going, with one eye on the long run direction of travel and the other on the contingencies of the present. The one thing we can say for certain about the future is that it hasn’t happened yet. If we keep going, we will see things that haven’t been seen since the beginning of the world.

At Barron’s: Do Interest Rates Really Drive the Economy?

(I write a more-or-less monthly opinion piece for Barron’s. This is my contribution for March 2023; you can find the earlier ones here.)

When interest rates go up, businesses spend less on new buildings and equipment. Right?

That’s how it’s supposed to work, anyway. To be worth doing, after all, a project has to return more than the cost of financing it. Since capital expenditure is often funded with debt, the hurdle rate, or minimum return, for capital spending ought to go up and down with the interest rate. In textbook accounts of monetary policy, this is a critical step in turning rate increases into slower activity.

Real economies don’t always match the textbook, though. One problem: market interest rates don’t always follow the Federal Reserve. Another, perhaps even more serious problem, is that changes in interest rates may not matter much for capital spending.

A fascinating new study raises new doubts about how much of a role interest rates play in business investment.

To clarify the interest-investment link, Niels Gormsen and Kilian Huber — both professors at the University of Chicago Booth School of Business — did something unusual for economists. Instead of relying on economic theory, they listened to what businesses themselves say. Specifically, they (or their research assistants) went through the transcripts of thousands of earnings calls with analysts, and flagged any mention of the hurdle rate or required return on new capital projects.

What they found was that quoted hurdle rates were consistently quite high — typically in the 15-20% range, and often higher. They also bore no relationship to current interest rates. The federal funds rate fell from 5.25% in mid-2007 to zero by the end of 2008, and remained there through 2015. But you’d never guess it from the hurdle rates reported to analysts. Required returns on new projects were sharply elevated over 2008-2011 (while the Fed’s rate was already at zero) and remained above their mid-2000s level as late as 2015. The same lack of relationship between interest rates and investment spending is found at the level of individual firms, suggesting, in Gormsen and Huber’s words, that “fluctuations in the financial cost of capital are largely irrelevant for [business] investment.”

While this picture offers a striking rejection of the conventional view of interest rates and investment spending, it’s consistent with other research on how managers make investment decisions. These typically find that changes in the interest rate play little or no role in capital spending.

If businesses don’t look at interest rates when making investment decisions, what do they look at? The obvious answer is demand. After all, low interest rates are not much of an incentive to increase capacity if existing capacity is not being used. In practice, business investment seems to depend much more on demand growth than on the cost of capital.

(The big exception is housing. Demand matters here too, of course, but interest rates also have a clear and direct effect, both because the ultimate buyers of the house will need a mortgage, and because builders themselves are more dependent on debt financing than most businesses are. If the Fed set the total number of housing permits to be issued across the country instead of a benchmark interest rate, the effects of routine monetary policy might not look that different.)

If business investment spending is insensitive to interest rates, but does respond to demand, that has implications for more than the transmission of monetary policy. It helps explain both why growth is so steady most of the time, and why it can abruptly stall out.

As long as demand is growing, business investment spending won’t be very sensitive to interest rates or other prices. And that spending in turn sustains demand. When one business carries out a capital project, that creates demand for other businesses, encouraging them to expand as well. This creates further demand growth in turn, and more capital spending. This virtuous cycle helps explain why economic booms can continue in the face of all kinds of adverse shocks — including, sometimes, efforts by the Fed to cut them off.

On the other hand, once demand falls, investment spending will fall even more steeply. Then the virtuous cycle turns into a vicious one. It’s hard to convince businesses to resume capital spending when existing capacity is sitting idle. Each choice to hold back on investment, while individually rational, contributes to an environment where investment looks like a bad idea.

This interplay between business investment and demand was an important part of Joseph Schumpeter’s theory of business cycles. It played a critical role in John Maynard Keynes’ analysis of the Great Depression. Under the label multiplier-accelerator models, it was developed by economists in the decades after World War II. (The multiplier is the link from investment to demand, while the accelerator is the link from demand growth to investment.) These theories have since fallen out of fashion among economists. But as the Gormsen and Huber study suggests, they may fit the facts better than today’s models that give decisive importance to the interest rate controlled by the Fed.

Indeed, we may have exaggerated the role played in business cycles not just of monetary policy, but of money and finance in general. The instability that matters most may be in the real economy. The Fed worries a great deal about the danger that expectations of higher inflation may become self-confirming. But expectations about real activity can also become unanchored, with even greater consequences. Just look at the “jobless recoveries” that followed each of the three pre-pandemic recessions. Weak demand remained stubbornly locked in place, even as the Fed did everything it could to reignite growth.

In the exceptionally strong post-pandemic recovery, the Fed has so far been unable to disrupt the positive feedback between rising incomes and capital spending. Despite the rate hikes, labor markets remain tighter than any time in the past 20 years, if not the past 50. Growth in nonresidential investment remains fairly strong. Housing starts have fallen sharply since rates began rising, but construction employment has not – at least not yet. The National Federation of Independent Business’s survey of small business owners gives a sharply contradictory picture. Most of the respondents describe this as a very poor moment for expansion, yet a large proportion say that they themselves plan to expand and increase hiring. Presumably at some point this gap between what business owners are saying and what they are doing is going to close – one way or the other.

If investment responded strongly to interest rates, it might be possible for the Fed to precisely steer the economy, boosting demand a little when it’s weak, cooling it off when it gets too hot. But in a world where investment and demand respond mainly to each other, there’s less room for fine-tuning. Rather than a thermostat that can be turned up or down a degree or two, it might be closer to the truth to say that the economy has just two settings: boom and bust.

At its most recent meeting, the Fed’s forecast was for the unemployment rate to rise one point over the next year, and then stabilize. Anything is possible, of course. But in the seven decades since World War Two, there is no precedent for this. Every increase in the unemployment rate of a half a point has been followed by a substantial further rise, usually of two points or more, and a recession. (A version of this pattern is known as the Sahm rule.) Maybe we will have a soft landing this time. But it would be the first one.

New Paper: Rethinking Supply Constraints

I have a new paper on how we conceptualize the supply side of the economy, coauthored with Arjun Jayadev. I presented a version of this at the Political Economy research Institute in December 2022. You can watch video of my presentation here — I come on, after some technical difficulties, around 47:00. (The other presentations from the conference are also very worth watching.) The paper will be published in the upcoming issue of the Review of Keynesian Economics. (The linked version is our draft; when the published version comes out I’ll post that.)

Our fundamental argument is that while macroeconomic supply constraints are normally conceptualized in terms of a level (or level-path) of potential output, in many contexts it would be better to think in terms of a constraint on the rate of change — a speed limit rather than a ceiling.

While this is a general argument, it’s motivate by the experiences of the pandemic and the post-financial crisis recovery of the preceding decade. We think the speed-limit conception of supply constraints makes sense of a number of macroeconomic developments that are hard to make sense of in the conventional view.

First, deviations in output are persistent. We saw this clearly in the wake of the Great Recession, but it seems to be a more general phenomenon. There’s a long-standing empirical finding that there’s no general tendency of output to return to its previous trend. One way we could explain this is the real business cycle way — short-term as well as long-term variation in output growth are driven by changes in the economy’s productive capacity. But of course, there is lots of evidence that business cycles are driven by demand. Alternatively, we could argue that potential grows steadily but actual output may remain far below it indefinitely. I was making arguments like this a few years ago. The problem is that direct evidence on the output gap (unemployment, growth in wages and prices, businesses’ reported capacity utilization rates, etc.) suggest that the output gap did close over the course of the 2010s. So we’re left with the idea that potential output adjusts to actual output — hysteresis. But if we take this idea seriously, it rules out the conventional idea of a level of potential output. In a world where hysteresis is important, a zero output gap is consistent with lots of different level-paths of output; supply constraints only bind the speed of the transitions between them.

Second, there’s no well-defined level of full employment. (Here we have to ding Keynes a bit.) Employment grows steadily over business cycles — there’s no sign of convergence to some long-term trend. Estimates of the NAIRU or natural unemployment rate follow actual unemployment more or less one for one. And if we try to make a bottom-up estimate of full employment — what fraction of the population could plausibly be engaged in paid work — we end up with a value much higher than actual employment even at cyclical peaks.

Third, we observe inflation and other signs of supply constraints in response to changes in the composition of output and employment, and not just in the level. This has been very clear during the pandemic, but there’s good reason to think it’s true in general.

Fourth, increasing returns are pervasive in real economies. This is a bit of a different argument than the first three, since it’s not pointing to a directly observable macro phenomenon. But it’s important here, because it means that we can’t assume that businesses are already using the lowest-cost technique and increasing output will cause unit costs to rise. One way of thinking about this is to imagine a cost landscape that is rugged, not smooth. Moving from one locally low-cost position to another may require traversing a higher cost region, which will appear as supply constraints during the transition. A clear example of this is the transition from carbon to renewable energy sources.

We also argue that this perspective is more consistent with a sociologically realistic view of what “the economy” is. Real economies are not homogeneous “factors” being added to a “production function” which then spits out some quantity of output. They are complex systems of cooperation between human beings, which are embedded in all kinds of other social relationships and the reproduction of households and other social organisms. These relationships cannot be torn up and recreated at any moment — changing them is costly. They evolve only gradually over time. From this point of view, it is wrong to divide the facts about the economic world into a set of long-run, fundamental, exogenous factors and short-run endogenous factors. Who is actually working, and at what, is as much a part of the economic data, no less easily shifted, than the number of people who are potentially available for work.

This way of thinking about the supply side has several implications for policy. First, rising prices and other signs of supply constraints cannot be taken as evidence for the long-run limits on the economy’s productive potential. In general, we should be skeptical of suggestions that recent rises in the prices of energy, food and other essential commodities reflect the “end of abundance”.

On the positive side, our view suggests that the response to positive output gaps should include not only conventional “supply side” measures, but measures to overcome the coordination and information problems and other frictions that limit rapid changes in productive activity. This implies planning of some sort, though not necessarily central planning in the traditional sense. Another implication is that because prices can adjust more quickly than productive activity can (the emphasis on price stickiness is backward in our view), rapid shifts in activity can generate large price spikes that are not informative about long-run production possibilities and produce undesirable shifts in income. This suggests that price regulation has an important role in smoothing the transition fro one pattern of activity to another.

Specific examples and evidence on all these points are in the paper. You should read it! A final point I want to emphasize here is that we are not saying that supply constraints are limits on adjustment speed in an absolute, universal sense. We are saying that insofar as we need a simple, first-cut description of the supply side, we will usually do better to imagine a constraint on adjustment speed rather than on the level of output and employment.