The Slack Wire – Page 53

The King Street puzzle

Ever since I moved back to Northampton, I’ve been baffled by how sharply bounded the urban part of this town is. Downtown there’s a few blocks of dense, busy, pedestrian-friendly, expensive and, ok (I’ve come to terms with my bougieness) charming and enjoyable city streets, all solid three and four-story mixed-use brick buildings and sidewalks that, on a warm summer weekend, can’t accommodate the crowds. And then turn down King St., and you’re looking at parking lots, gas stations, empty lots, fast food places, more empty parking lots, and no one on the sidewalk at all.

There’s got to be a reason for this.

So why doesn’t Northampton’s successful downtown grow? It can’t be that unused parking is the highest and best use of land two blocks from one of the most successful commercial districts in Western Mass. As Atrios regularly and, rightly points out, land-use rules mostly make small-town downtowns like Northampton’s illegal to build today. But what are the specific legal obstacles here? Parking requirements? Zoning that prohibits mixed use? Floor-area ratio limits? People love downtown Northampton. Business loves downtown Northampton. Why can’t we have more downtown?

Turns out I’m not the only one wondering. Here is a proposal from the Northampton Chamber of Commerce to revise the zoning code for King St. And it looks like a step, if a small step, in the right direction.

For the Central Business Zone (which runs up to Trumbull St., for local folks), the Chamber wants to remove parking requirements; allow mixed uses by right; increase maximum building height from 55′ to 65′; eliminate the 5% open space requirement; and eliminate the minimum rear setback. All of this seems right.

Hard to say how important these specific regulations are in inhibiting dense urban development on King St. To be honest, as soon as one starts exploring this stuff in any detail, it’s hard not to be struck by how brutally complicated it all is. But the Chamber is clearly pulling in the right direction, which I suspect would not have been the case not that many years ago. The interesting question, now, will be who pulls the other way.

Dumenil on Marx

[This past Febuary, a few of us were lucky enough to take part in a discussion of the structure of Capital led by Gerard Dumenil. I just unearthed my notes; for the sake of posterity, here they are.] Marx’s method Marx moves from the concrete, to the abstract, and back to concrete. Concrete reality is unitary, but concepts are necessarily partial. So the definitions of particualr concepts don’t matter except insofar as they form part of a particular science. Marx’s work contains several, at least partially independent systems of concepts. So for instance alienation is not part of the system of concepts, or science, constituted by value, capital, profit, etc. Capital begins with the commondity, builds via money to value, and then builds to capital. The error of idealism is to confuse the production of theoory with the exposition of theory; the latter builds up logicallly from the simplest concepts, while the former cannot. Exposition can follow a deductive method, but the original development of theory cannot. The three volumes of Capital Volume I is of course finished, Volume II is also largely finished, but Volume III is not. Capital is value in a movement of self-expansion. It is necessary, but basically indeterminate, to give one of these eleements priority in exposition. The commodity is the unity of use- and exchange-value, or of utility and value. Volume II is accounting. Volume I is explaining the class anture of capital. That’s why Marx begins with the self-expansion of capital, rather than the movement (circuit) of capital, even though either is equally acceptable logically. In a sense Volume I is all about unemployment. But it’s just as much about exploitation, and about technical-organizational change. It ends with primitive accumulation for political rather than scientific reasons – he wants to conclude with a topic that allows for a harsh condemnation of capitalism. Volume II then is the “movement” part of value in movement of self-expansion. Each “atom” of value moves through various forms, from money, to commodity, to the productive process, to different commodities, back to money – the familiar M-C-P-C’-M’. Volume II is really providing a form of accounting: the distribution of value among its various forms is like the asset side of a balance sheet. Together the discussion of circulation and the reproduction schemes articualt both aspects – movement and self-expansion. The reproduction schemes imagine all the circuits taking place together, in sync. The three sectors – I, constant capital; II, wage goods; and III, luxuries – correspond to the three forms of valorization – c, v and s. (Marx recognized the concept of national income before it was widely understood.) In Volume III the different conponents that have been described separately are integrated into a picture of the cpitalist process as a whole. Marx is no longer discussing basic concepts, but mechanisms. In some sense, the section on the Law of Capitalist Accumulation could better have gone here. Now we no longer assume prices are proportional to values, but introduce prices of production. (Probably not the best name to have used.) The mechanism governing prices of production is that excess supply of a good produces lower prices in the short run; lower output (Marx doesn’t emphasize this, but it is key); and less investment in that industry. In the long run, as this process equalizes profit rates across industries, market prices come into line with prices of production. Crises Marx’s theory of crises does not rely on disproportions, in fact he criticizes Ricardo for his focus on them. There really is no theory of short-run crises in Marx. (The Labor Theory of Value: What happens with long-run prices that are not proportionate to values? Marx should not have spoken of the “transformation” of values into prices.) The tendency of the Rate of Profit to Fall is fundamentally about the character of innovations – capital-saving innovations are rare. Increased competition is the result, not the cause, of the falling rate of profit. (Here we are at the limits of Marx’s analysis.) Historically there have been two main periods of declining profits, the late 19th century and the 1970s. The profit squeeze is part of the story of the 1970s fall – maybe one-third. An explanation based on intensified international competition, as in Brenner, is absolute bullshit. [Dumenil’s words.] Finance Only industrial capital makes the full circuit described above. Commercial capital is limited to the “commodity-handling” and “money-handling” parts of the circuit. All labor in these circuits is unproductive labor. Cases like transportation are tricky and can be placed in either circuit. Interest-bearing capital: this embodies the division between active and inactive capitalists. If the analysis in Volume II corresponds to the asset side of a balance sheet, the analysis of interest-bearing capital corresponds to the liability side, that is, how capital comes into the firm, how the firm is financed. (In Marx’s terms interest-bearing capital includes shares as well as debt.) The active capitalist has the chracter of an owner but also of a worker, pays self a wage. Eventually the active capitalist disappears and is replaced by a salaried manager: this was a very prescient observation by Marx. Banking capital: Banks become adminstrators of interest-bearing capital, while remaining one of the main embodiments of commercial capital. So financial institutions have two aspects: on the one hand, they carry out a specific commercial function, but on the other they are the representatives of the capoitalist class in general. Fictitious capital: This is not value in the movement of self-expansion. All interest-bearing capital is fictitious. Securities issued by corporations are “less fictitious” since they finance productive capital, but they are still not capital, because (1) that would be double-counting [with the productive capital they finance], and (2) their value may fluctuate independently. In any case, we should not fetishize the concept of fictitious capital. The question of how much of the income of the financial sector comes through fictious capital is superficial. Remember, banks are partly one industry among others, but partly the carriers of the status and claims of the capitalist class as a whole. (Over time capital ownership is becoming more collective.) Big financial institutions are the police of capitalism, enforcing capitalist logic on the management of firms. If the capitalist class loses control of finance, it loses control of the productive process. Consider the highest-income 0.1% of the population [in the United States], with incomes of at least $2 million per year. Half of their income takes the form of wages. (Not e however that a larger fraction of capital income than wage income is probably hidden, so the real share of wages may be smaller.) It is as if some part of claims on profits are shifting away from traditional forms of interest-bearing capital, and toward positions within financial institutions. But it is not as simple as saying that the highest wages are really profits or rents. The important point isn’t simply that wages are high, but that they come from control over production. Those who get the most “profit-like” wage income as executive salaries, bonuses, etc., are in the same families that own financial assets – the relationship [between the financial and “traditional” parts of the capitalist class] is now a love affair, not a conflict. The 1970s saw a revolt of the money capitalists, with new discipline imposed on managers, using the language of corproate governance, “shareholder value,” etc. This was very successful – of course top managers were happy to go along in the US. Managers in Europe and Japan were more reluctant. So in the US all those ideas of managerialism, “soulful corporation,” and so on, seemed to disappear. But this shift did not really extend to the inner workings of the firm – production is organized more than ever by professional managers. The difference is that managers no longer think of themselves as standing between owners and the popular classes. This earlier conception had been the result of a history of class struggle. The business cycle Marx’s theory of the business cycle is not found in any one section or chapter. It’s not a theory of disproportion, of the misallocation of capital between sectors. In Marx, a recession is a sudden contraction of activity. There are five phases of the cycle; one is overproduction, which requires a definition of “over” – relative to what? In Volume III, overproduction is over with respect to the supply of labor. This is what produces a short-run fall in the profit rate. In general, there are two short-term mechanisms producing recessions: wages and interest rates. One or both rises in expansions and encroaches on profits. This produces contractions, although how is not explicit in Marx. The phrase that the “ultimate ground of crises is the restricted consumption of the masses” sounds like a story of insufficient aggregate demand. But this is not what marx has in mind. As he says in Volume II, wages usually peak just before a crash. Marx supposes the typical cycle to be ten years long, but this is a vague gneeralization without any sophisticated reasoning behind it. This may be connected to technological factors, but the idea that a lack of real investment opportunities leads to excessive financial investment is total bullshit. [Again, GD’s phrase.] Stability and instability Volume III has a clear story about competition: If profits are higher in one sector, there will be investment there; if the output of a sector can’t be sold, prices will be cut. This can be modeled. It is difficult, but not impossible, to produce Marx’s results. Stability requires some reaction to imbalances, but not too much. The second question, is what determines the overall size of the economy? Imbalances between supply and demand in the goods market are dealt with by quantity (as well as price) adjustments. This “direct control of quantities” is present in Ricardo and of course Keynes but not Marx. Control of quantities makes it easier to get convergence in the model. The overall size of the economy is determined by the supply of credit. Credit creation is procyclical but the money supply is counercyclical. (Kalecki’s model needs a credit mechanism to allow investment to vary independently. It doesn’t have it – Kalecki never considered money.) We [D&L, not Marx] speak of proportions and dimensions. Proportion is investment abd relative prices between industries. Dimension is the overall size of the economy, the growth path. To model capitalism, we need to have stability of proportion and instability of dimension. Capitalism remains at the frontier of stability of dimension. (The price mechanism is slower than the quantity mechanism.) Inventories grow – if the quantity adjustment is too large there is an increase in inventories elsewhere that ouweighs the decrease at the first firm. The short-run dynamics are somewhat Keynesian. The development of the credit system creates the possibility of greater instability of dimension. This in turn invites more active control by the authorities. Take a simple two-factor model. Innovation is local – new technologies are similar to old ones. Innovation is random in the neighborhood of existing technologies. If an innovation raises the profit rate, it is adopted. In addition, Marx believes it is easier to innovate by raising the proportion of capital – technological change is biased in a capital-using direction. Hortatory You need to understand mechanisms. You need a global perspective. You need to know history. You need to be an activist. We absolutely need to get rid of the capitalist classes. You need to get some political culture. Don’t become stupid writing a dissertation. Do not attempt to derive concrete developments from abstract laws of value. Do not fall into idealism. If you’ve only read Capital you know nothing about the contemporary crisis. You need to explain what’s going on. This is not the end of history. Your research agenda will be determined by what happens next. Still, there are some principles: We live in a class society, classes are not going to disappear tomorrow. The basic marxist framework is not absolute, it may evolve, but it still applies. When you are told that your dissertation is too broad, listen with only one ear.

The atrophy of the liberal imagination, a continuing series

My buddy Mark Engler wrote an interesting piece for the Dissent blog on why the left should oppose the Kagan nomination. Interesting, but not convincing, at least not to me. It’s not that I like her, altho I’ve been more or less convinced by people who know the academic-law world from the inside that her publication record is perfectly adequate. On substantive political issues there’s not much to say for her, and that’s on Obama, not the “process”.

What I don’t see, tho, are what are the principled demands being made here. “Liberal justice” is almost an empty signifier; I suspect that beyond the important, but fairly narrow, areas of civil liberties and executive power, most of us on the labor or socialist left will find a wide range of legal issues on which our views and Glenn Greenwald’s sharply diverge. Just as importantly, what is the public debate that this is clarifying or polarizing? Will this fight help develop a left opposition in Congress? Does it mobilize people? Could we win? Looks like no on all counts, to me.

Being on the left can’t just mean bitching about everything, it’s got to mean staking out clear, principled positions, organizing people around them, and having concrete victories to show for it. Opposing Kagan does not seem to meet this test.

Anyway — the reason for this post, or at least its title — I was going to say all this in a comment to Mark’s Dissent post. But it turns out the Dissent blog has no comments section. Yes, Dissent does not allow comments. Doesn’t that say it all?

Killer app

Anyone who pays for recorded music is a sucker. But what about the artists? No one will make music if they don’t get paid! Possibly, this is not the case. But it is a problem that musicians get no money from downloads, perhaps not only because of the moral claims it gives to the parasites in the record industry. Here’s the solution I’d like to see: There should be a system allowing you to make a voluntary payment to the musician whenever you download a piece of music. Set the standard rate at, say, double the royalty the artist gets typically, and I’m sure the payment would still be much lower than what’s charged for downloads now. What’s stopping you from doing this yourself, you ask. The transaction costs are prohibitively high. You need to identify the musician’s paypal account or whatever, decide the right amount (little decisions are very cognitively costly for some of us), and make an affirmative effort to make the payment. And of course, you need to have the idea of paying the musician in the first place – conventions do a lot of work, and there isn’t one for this. But imagine if there were some program that worked with iTunes, Rhapsody, etc. that whenever you added a track to your library, asked you, “Send a standard donation to the artist?” You could even set it to Yes by default. There’d also have to be a service musicians registered with, of course; I don’t think that would be the hard part. And of course in our current IP dystopia you’d have to maintain the fiction that the donation was on top of what you’d already paid to buy the track “legally”. The payment would be voluntary, so you could pick the amount, but as the whole point here is to make the system as seamless as possible defaults would play a big role; personally I like the idea of a standard rate fixed in proportion to the median income of the downloader’s country or region, but that’s not important. The important point is that when you disintermediate the record companies, there is a very large space left where fees are much lower than current costs – low enough that many people would pay them – but high enough to provide a decent income to artists, even taking into account the inevitable freeloaders. And as for freeloaders, don’t underrate the power of norms: People, after all, like the musicians they like, and it’s easy to imagine donations under this system being quickly established as something you just do. Of course, the donation only has a moral force that current payments don’t because the money is going to the artist. If musicians find themselves signing contracts that pledge any donation income to their label, then we’re right back where we started. Which brings me to a larger point. Over at Crooked Timber, they’re discussing the concept of “self-ownership”. Logically enough, they conclude that your personal autonomy can’t be reduced to ownership, since you can’t sell yourself. What they don’t do is generalize this to a broader category of claims – let’s call them moral rights – that can’t be sold or otherwise transferred to someone else. There are obviously a lot of valuable but inalienable claims that fall into this category: degrees and other credentials, membership in a family, citizenship. And most importantly in this context, what the copyright pages of European books call the author’s “moral rights” as creator of an original work. This right is well established in academia: priority in publishing is felt very strongly – it is in some sense the currency of scholarship – and, more important, enforced with strong social sanctions. What’s funny is it has no legal status. More broadly these kinds of rights clearly are legally recognized. For instance, it would be interesting to know what the case law is – there must be some – on the hypothecating of Social Security benefits. Clearly it is not the case that you can sell your future Social Security for a lump sump payment n the present, or there would be various well-established sleazy outfits doing that; but I’d very much like to know the arguments the courts accepted why not. Point is, there clearly is a category of rights that cannot be alienated, and it’s a category that could be usefully broadened, here in the Age of Information.

Sign of the times

Interesting milestone in 2008, according to the BEA. For the first time ever (well, at least since 1947) manufacturing was no longer the largest recipient of US nonresidential investment. The new champ? Mining. $216 billion in new fixed assets in mining (mostly in oil and gas extraction), and only $208 billion in manufacturing.

I don’t remember seeing this written about anywhere, but it seems like it should mean something.

Walking the walk

In Jan Toporowski’s interesting review of Minsky’ recently-published PhD thesis, he mentions in passing that the reason Minsky went to Harvard after serving in World War II, rather than returning to the University of Chicago, was that his Chicago mentors were no longer there. One, the liberal Henry Simons, “had committed suicide in despair at the onset of Keynesianism”; the other, Oskar lange, had returned to post-war Poland to take up a series of senior positions in the new government there; among others, as Poland’s first post-war ambassador to the United States. Both, I guess, deserve credit for following their principles all the way to the end.

It’s the case of Lange that really intrigues me. There doesn’t seem to be a biography of him available in English, but according to this admiring obituary in Econometrica, he was a member of Parliament and of the Central Committee until his death in 1965, and held various other high offices, through the postwar reconstruction through the height of Stalinism and into the post-1956 reform period; he also taught the whole time at the University of Warsaw and published eight books. A full and successful career, in short.

Is there any other figure of comparable stature who made a similar move from a respected, prominent position in the US (or Western Europe) to a respected, prominent position in the Eastern Bloc? I certainly can’t think of any.

What’s wrong with macroeconomics

Really, you could start anywhere.

But let’s take this, from VoxEU:

In a recent paper (Laibson and Mollerstrom forthcoming), my co-author David Laibson and I make further attempts to assess whether the saving glut hypothesis fits with reality. We build a model where one country (the US) receives exogenous capital inflows which are calibrated to match the US current account deficits for the period that Bernanke was focusing on. Our model shows us that such a course of events should indeed lead to increases in US consumption. However, we also find that the investment rate should have risen by at least 4% of GDP. Intuitively this makes sense; if the Chinese government exogenously loaned US households a trillion dollars, those US households should have chosen to invest a substantial share of those funds to help make the interest payments.

What’s missing here? Businesses, one, and the financial system, two. Investment decisions are supposed to be made directly by households. Of course writers like this (a grad student and professor at Harvard, natch) know that firms and banks exist; they just assume that there are no important differences between an economy with them and one without them — the standard approach, despite its seeming self-refuting quality, to macroeconomics today. This will seem trivially obvious to anyone who’s taken a macro course, and astonishing to almost anyone who hasn’t; it’s still a bit astonishing to me. It’s nice to be reminded, though, of why post-Keynesian and Marxist approaches to macroeconomics are still essential.

Another One for the Pessimists

Elasticity pessimists, that is.

Following up on the long post on Krugman and China, here’s some interesting evidence on the non-responsiveness of trade flows to exchange rates. It’s a study of what happens to online book prices in the US and Canada when the exchange rate between the two countries change. In theory, when the exchange rate changes, online retailers should adjust local-currency prices so a given book costs the same in both countries; if they don’t, book buyers should buy from the country where prices are cheaper. As the authors say, online bookselling is “an activity where trade barriers are minimal, information is cheaply available and products are homogenous. If pervasive cross-border arbitrage was ever going to arise, it would be in sectors like online book retailing.” [1]

And if pigs were ever going to fly, it would be the most svelte and limber ones.

In fact, local-currency book prices don’t respond to exchange rate changes, so you get big differences in the price of books bought from, say, Amazon.com and Amazon.ca. (Yes, this takes shipping costs into account.) But people blithely go on on buying from their own country’s site: “The fact that books in Canada become cheaper following an appreciation of the US dollar should be reflected in higher sales for Canadian retailers. Using sales rankings as proxies for quantities, we find no evidence supporting such behaviour.”

Since they are real economists, they conclude that exchange rate movements need to be bigger and more persistent to affect trade. But if you’re some kind of Keynesian freak, you might take this as further evidence that exchange rates just aren’t that important to the current account balance.

[1] Besides these factors, online bookselling is also unusual in that the goods are bought directly from the exporting country. Most traded goods and services are sold, and therefore priced, in the importing country. So there’s the additional step of pass-through to prices further reducing the impact of exchange rates.

Krugman and China

So, what’s he on about?

There’s a lot of heat, but surprisingly little light. Is the objection to the renminbi peg as such, or is it just he thinks a different peg would be better? Better for who — the US, China, the world? Why is he so sure that the current account imbalance between the US and China is due to the peg? And what general principles for currency value and trade flows, if any, underwrite the argument in this specific case?

One thing he’s got right, at least — the US current account deficit with China is big. The US c.a. deficit in January was about $40 billion, or 3 percent of GDP. (That’s down from 5 percent of GDP in 2008, and 7 percent in 2005-06.) China accounted for $18 billion of that ($17 billion if you include Hong Kong, with which the US runs a surplus), or about 40 percent of the total. At the height of the c.a. deficit, in mid-2006, China accounted for about a third of it. The rise in China’s share is largely accounted for by the fall in oil prices; in recent years China has consistently accounted for about half the non-OPEC deficit. So if you are worried about the current account deficit, you should worry about the deficit with China.

But should you worry about the current account deficit? And does worrying about the deficit with China mean worrying about Chinese “manipulation” of the renminbi?

To take the second question first, it’s far from clear that the currency peg is responsible for the deficit. One reason the US deficit with China is so big is that US trade with China is so big — China is by far the largest recipient of US exports outside of North America. Yes, China’s exports to the US are four times greater than its imports from the US, an outlier among major trade partners, but countries like Germany, Japan and India regularly see ratios in excess of two to one, and their currencies float freely. So at the least, it’s clearly not true that laissez-faire in the foreign exchange markets guarantees balanced trade — which would be a strange thing for Krugman to believe in any case.

But of course, it could be true that the vagaries of the foreign-exchange markets, demand for US assets, or government policy can all keep a currency away from its trade-balancing level. So set aside the loaded language of manipulation, which suggests there is something inherently immoral or dishonest about currency pegs — which have, after all, been the norm in international trade for much longer than floating currencies, and are used by lots of other countries beside China today. Is it the case that a higher renminbi would narrow the US deficit with China?

There is a long tradition, going back at least to Keynes, that doubts whether trade flows are sufficiently responsive to exchange rates to make them an effective way of achieving balanced trade.[1] In the short run, the elasticity pessimists are clearly right that income changes, not exchange rates, are the decisive influence on trade — casual examination of the trade statistics shows that exports to and imports from any given country tend strongly to move together, whereas they should move in opposite directions if exchange rates were dominant. Nor is this surprising — in the short run most trade is contractually committed; over the medium run market share is expensive enough that sellers absorb some part of exchange rate movements in profit margins rather than adjusting prices, and even when prices do adjust few close substitutes are available for many traded goods, especially intermediate goods. Thus the familiar J-curve, where the short- or medium-run effect of an exchange rate change is in the “wrong” direction.

But in the long run, surely, prices are decisive? Maybe, maybe not. Krugman brings up “the smaller East Asian nations in the aftermath of the 1997-1998 crisis” as if they were an obvious case of exchange rate effects. It is true that those countries did devalue their currencies during the crisis, and did see sharp improvements in their current account in the following years. But they didn’t just devalue; they also saw dramatic falls in domestic income and consumption. How do we know if it was the devaluations or the contractions that led to the improved trade balances? Well, take Indonesia and Korea as examples (I pick them because they are in the OECD international trade database.) In both, the improvement in the current account balance (from a $250 million to a $2.7 billion surplus 1996-2000, and from a $2.4 billion deficit to a $3 billion surplus 1996-98, respectively) came entirely from declining imports. Indonesian exports were no higher at the end of 1999 than at the beginning of 1997 — but imports had fallen by half. That looks a lot more like an income effect than a price effect to me.

Still, in the very long run exchange rates presumably do have a major effect on trade flows. But it matters how long the long run is. If the problem with the current account deficit is its anti-stimulus effect, and not the broader “global imbalances,” then a solution that only helps five years from now, and makes things worse in the next year or two, is no solution at all. (Someone should ask Prof. Krugman how long he thinks it would take for a renminbi revaluation to have a net positive effect on the US current account.) But set that aside. Let’s say that a change in Chinese policy would lead to a higher renminbi, and that that would narrow the US deficit with China, and fast enough to work as fiscal policy. Should we care? And does the answer depend who “we” are?

The simplest way of looking at the demand effects of the deficit is that every dollar of “anti-stimulus” in the US is balanced by a dollar of stimulus in China. And to be honest, it’s hard to find much beyond that simple level in Krugman’s stuff on China. He seems to be saying the reniminbi should be revalued so that the US gets more, and China less, of a fixed pool of global demand. Now, I am not as allergic to mercantilist-type arguments as most people. But why on the world should China go along with this? And why, from behind the veil of ignorance, should we-in-general want them to? [2]

In a recent blog post, Krugman had an interesting answer to this question — interesting because it’s so clearly wrong. He writes, “the global macro aspects of the situation are reminiscent of the late 1920s, when the US was simultaneously insisting that European nations repay their dollar debts and that they not be allowed to export more to earn the dollars. That didn’t end well.” There are two key differences, ,though. First, China accepts payment in dollars — it doesn’t insist on its own currency.[3] And second, China has no problem exporting capital to match its current account surplus, unlike the US in the 20s, when our surplus was offset by politically contentious loans related to WWI reparations and highly unstable private flows. These two factors mean that while debtors then found themselves forced to accept domestic deflation and contraction, the US is under no corresponding pressure. As long as China is willing to finance the US deficit with low-interest loans to the US, the deficit need have no negative effects for this country; and as soon as they stop financing it, it will go away — as Krugman rightly stresses, China’s trade surplus and capital exports are two sides of the same coin.

Let’s take a step back.

Imagine that China appeared out of the blue one day and began selling stuff to the US. But instead of buying stuff in return, they simply lend their dollar earnings to the US government, i.e. bought Treasury bonds. This reduces demand for producers of US goods. But now suppose the US government increases its total borrowing by the amount of the Chinese bond purchases, and uses the increment for domestic purchases. Supply and demand for bonds among non-China buyers are unchanged, so there is no reason for interest rates to move. The stimulus of the additional government spending exactly offsets the anti-stimulus of the Chinese imports, so there is no inflation. And the offsetting goods and capital flows between the US and China mean there is no pressure on the dollar. At the end of the day, domestic output and employment are unchanged, and domestic consumption is increased by the amount of Chinese imports. In short, to exactly the extent that the imbalance with China reduces private domestic demand, it removes the constraints on expansion of public domestic demand.[4] This is the fundamental difference between the position of the US today and the position of countries on the gold standard or equivalent systems, as in the 1920s. In the latter case there is no mechanism to guarantee offsetting capital flows to trade imbalances, so countries can find themselves facing a foreign exchange constraint on output and growth.

And now we are coming toward the point of this very long post. Krugman calls Chinese capital exports “artificial,” by which he means — well, what, exactly? That they are undertaken by government? that they are not motivated by returns? that they correspond to a big current account surplus? It isn’t clear. Nor is it clear what he thinks a world of “natural” flows would look like. More balanced trade overall? or just a more favorable balance for the United States? And finally, why should we support a policy whose benefits to American workers are offset by costs to (much poorer) workers elsewhere?

Let’s turn back to that previous era of global imbalances, the 1920s and 30s — whose lessons, I think, Krugman gets wrong. It’s well known that when countries left the gold standard and devalued their currencies, their economic performance dramatically improved. But was this from the stimulus of an improved current account,as Krugman imagines the US would enjoy following a renminbi revaluation? Not at all. As Peter Temin and Barry Eichengreen both emphasize, countries that devalued did not, on balance, experience any improvement in their current account at all! Rather, the devaluations allowed them to achieve the same external balance at a higher level of income. Removing the foreign exchange constraint allowed national governments to take much more aggressive steps to boost domestic demand — mainly through looser monetary policy once central banks no longer had to defend the peg to gold. In effect, going off gold enabled a movement from a low-employment to a high-employment equilibrium by allowing countries to reflate one at a time, instead of needing a coordinated expansion; but trade flows at the beginning and end of the process were basically the same.

The key point is that what matters is not the balance of trade between any particular countries, but the presence or absence of a foreign exchange constraint. If a country can offset adverse movements in its current account with expansions of public, or private, domestic demand, i.e. if a worsening current account is reliably offset by capital inflows or if it can settle international claims in its own currency (of course both are true of the United States), then deficits need have no effect on output or employment. But some countries must restrict domestic demand to keep any current account deficit at a level they can finance; adverse movements in those countries’ current account reduce output and employment without any corresponding gains elsewhere. Thus the deflationary bias of the gold standard. This was the decisive consideration for Keynes in the design of postwar international financial arrangements: No country should be prevented from pursuing full employment by a foreign exchange constraint. [5]

So where does that leave us? A new international financial architecture isn’t on the menu (and doesn’t seem to interest Krugman, anyway; for him the problem is all China.) But under the current system, it’s clear that the highest level of output and employment will be achieved if a simple condition is met: current account deficits are run by countries that can most easily finance them. Countries that can easily attract capital inflows and issue liabilities in their own currency should have exchange rates that result in deficits at full employment; countries without those characteristics should have “undervalued” exchange rates so they run surpluses at full employment. This preserves the flexibility of every country to manage domestic demand to preserve full employment. Expansionary fiscal or monetary policy leads to adverse movement of the current account. It’s no problem if this increases the deficit for countries that can finance a deficit, but for others this will rule out expansion unless they start from a position of surplus. And indeed this was one of the lessons of the Asian crisis — countries that found they could no longer count on private capital flows concluded they need to run large current account surpluses to ensure that their growth was not choked off by foreign exchange constraints.
Given that the US issues the global reserve currency, a world with a large US current account deficit will almost certainly see higher and more stable output than one in which the US current account is balanced. And given that the US does not face a foreign exchange constraint, our unemployment can’t be blamed on the Chinese – they’re not holding back domestic demand here.
Krugman is a smart guy: why doesn’t he recognize this? The answer, I think, goes back once again to Keynes. In chapter 23 of the General Theory, he writes:

When a country is growing in wealth somewhat rapidly, the further progress of this happy state of affairs is liable to be interrupted, in conditions of laissez-faire, by the insufficiency of the inducements to new investment. Given the social and political environment and the national characteristics which determine the propensity to consume, the well-being of a progressive state essentially depends, for the reasons we have already explained, on the sufficiency of such inducements. They may be found either in home investment or in foreign investment… Thus, in a society where there is no question of direct investment under the aegis of public authority, the economic objects, with which it is reasonable for the government to be preoccupied, are the domestic rate of interest and the balance of foreign trade.

Before the 20th century, there was “no question of direct investment under the aegis of public authority” simply because the public sector — apart from the military — was very small. Of course that’s not the case today – no technical reason why federal spending couldn’t increase by 10 percent of GDP if need be. The obstacles are political – as Krugman acknowledges when he stipulates that the Chinese surplus matters because in its trade partners, “both central banks and governments are unable or unwilling to pursue sufficiently expansionary policies to eliminate mass unemployment” (my emphasis).
The unwillingness of the US to pursue sufficiently expansionary policies is not a fact of nature. Given that unwillingness, Krugman (and Dean Baker, etc.) may be right that an improvement in the US current account is the most practical way to boost US demand – even if they exaggerate how quickly and reliably exchange rate changes will deliver it. But it’s neither a necessary nor a particularly good way of achieving this. The real problem is the inability of the US financial system to channel savings into productive investment, and the unwillingness of the state to step in in its stead. Too bad folks like Krugman are trying to shift the blame to China.

[1] Formally, Keynes and post-Keynesians like Davidson doubt that the Marshall-Lerner-Robinson condition is satisfied, i.e. that the elasticity of imports and exports with respect to exchange-rate changes sum to at least one.

[2] He actually does answer this question with respect to China, sort of. Might makes right: “Because the United States can get what it wants whatever China does, the odds are that China would soon give in.”

[3] In the real world the problem is that US government borrowing did not increase by as much as the capital inflows from China, with the result that Chinese purchases of Treasurys drove down the yield and forced more return-sensitive investors to look for similar assets elsewhere — thus the demand for asset-backed securities. This point is made by Perry Mehrling and by Daniel Gros. Neither draws the logical conclusion that the financial crisis might have been averted if the federal government had only borrowed more. Topic for another post.

[4] Countries other than the US are in more the gold-standard situation — they face the problem of earning the dollars to cover their deficit with China, or euros for their deficit with Germany.

[5] Since he doubted the effectiveness of exchange rates to provide the needed flexibility, the key goal for him was an automatic mechanism to provide the offsetting capital flows to deficit countries, without depending on either private investors or the governments of surplus countries.

Stein’s law modified

Krugman cites it: If something can’t go on forever, it will stop. True.

Also true:

Even if something can go on forever, it will stop eventually.
Even if something can’t go on forever, it can go on for a very long time.

One might say the difference between these corollaries and Stein’s original is the difference between a real-world, historical approach to macro and the equilibrium approach of the mainstream. Fresh or salty, it’s all water “when the storm is past and the ocean is flat again…”