A Waning of Controversy among Economists

Yves Smith's terrific ECONned, pointed to an ancient 1961 article from Time. The article suggests "a waning of controversy among economists," which meant that the article reflected the milquetoast economics of the leading democratic economists and the less rabid attitude of the Republicans. Galbraith merited a brief mention in which the author noted that most economists reject his view.

Anon. 1961. "The Economy: The Pragmatic Professor." Time (3 March).
http://www.time.com/time/printout/0,8816,897654,00.html


"Walter Heller is usually tagged as a "liberal," but he departs so often from what used to be liberal cliches that the identity tag is a bit blurred. A more descriptive label, one that he applies to himself, is "pragmatist." That is the vogue word among economists today, the term that most of them use to label themselves and one another. When economists call themselves pragmatists, they mean that they are the opposite of dogmatists, that they are wary of broad theories, that they lean to the cut-and-try approach to public problems, and that they believe it is possible to improve the functioning of the economy by tinkering with it."

Heller said, "My awareness of the seriousness of the situation is balanced by a conviction that we can do something about it -- and without interference in the basic freedom of our capitalist system."


"By broadening the areas of fact, the professionalization has narrowed the areas of theory, of disagreement, and blurred the old boundaries between liberals and conservatives."

The article emphasizes:

"One result has been a waning of controversy among economists. Today, says Kenneth Arrow, "you have to find a real crackpot to get an economist who doesn't accept the principle of Government intervention in the business cycle"."

"A decade ago economists identifiable as liberals were automatically prolabor, rejected the idea that wage increases could be economically harmful. Today Heller, like most other economists, holds that "excessively generous wage bargains'' between unions and management can lead to "cost-push" price upcreep."

Romer’s Charter Cities: A Really Witless Approach to Development

One of the great pleasures historians have is going back through the dead-end schemes of long-ago generations, the ideas, hailed as brilliant at the time, that are perfect fodder for can-you-believe-this curiosities today. You know, strange dietary regimes, inventions that run up against the laws of physics, wacko monetary systems. Smart people dreamed this stuff up, but now all we can do is shake our heads and smile. Surely future historians will find similar boneheadedness today.

Surely, and they can start with this utterly bizarre but characteristic puff piece about Paul Romer and his Charter City fantasy in the latest issue of The Atlantic. If this account is correct, it is all quite simple: Economic development depends on having the right rules in place for the economy. The right rules are privatization, free markets, and the protection of property rights. Investors have to believe these rules will be permanent before they are willing to invest. Therefore the formula for successful development is for governments in poor countries to turn over a portion of their territory to be run according to free market rules under the control of a willing rich country. A return to colonialism? Absolutely, but now it would be voluntary on both ends. Take control of some of our cities, the poor country governments would say, and force us to follow the true path to riches. Romer has set up a little enterprise to market this idea, and he says he has some nibbles.

The article in the Atlantic is pure hagiography, so it’s up to the rest of us to ask a few hard questions. Like: why are you so sure that there is only one correct set of rules, and it’s the one with a University of Chicago economics department logo? Safeguards for property rights in China? What planet are you on? And why would you suppose that the western powers that brutalized and robbed their colonies in olden days would be so virtuous today? In other words, do questions of venality and capture not apply to our governments, only theirs?

One could go on. An example crops up repeatedly in the article: kids in Guinea (they don’t say which one, not that the author seems to care) have cell phones but no electricity at home. The reason given is price subsidies, which reduce incentives to extend electricity to more homes. But how do we know this? Did the US, with a history that includes the Rural Electrification Administration and the Tennessee Valley Authority, and with many municipal utilities today, create its system through market incentives? Do countries with rapidly growing electrical grids, like China, all follow this formula today?

Here is something else: if foreigners are running your city, this means you have no political control over them—no democratic rights. Loss of democracy is a bad thing, right? Not for Romer. He points out that people who migrate in search of economic opportunity are voluntarily foregoing democratic rights in favor of income. He want to make his charter cities magnets of migration too. If migrants put more value on livelihood than the right to vote, that’s their choice, and it is their “preference” for democracy rather than yours that should count.

Actually, why go through all the bother and expense of migration? Why not just pay people to give their vote to someone else? There’s a history to that, too, in rich countries like the US. If democracy is essentially a private consumption good, valued according to willingness to pay, why not let the market rule?

Behind it all, and apparently beyond the awareness of either Romer or his chronicler, is the ghost of Friedrich Hayek. The charter cities idea is warmed-over constitution of liberty à la Hayek. According to this view, a liberal, free market economy is the very embodiment of liberty, but it is under threat from the short-sighted passions of planners, populists and other usurpers. Thus societies need to be placed under a constitutional constraint that protects economic liberalism against the threat of majority rule. Hayek, of course, did not see the need for foreigners to impose this constraint. It could be enforced equally well by elements within one’s own country. He preferred a more legitimate constitutional process, but if the country happened to be Chile, the element could be Pinochet.

UPDATE: I woke up this morning thinking about the Northern Marianas. Why settle for charter cities when you can charter whole islands?

John Boehner and the Laugher Curve

John Boehner has dusted off some Laugher Curve nonsense:

“You equate the idea of lowering marginal tax rates with less revenue for the federal government,” Boehner cautioned. “We've seen over the last 30 years that lower marginal tax rates have led to a growing economy, more employment, and more people paying taxes. And if you look at the revenue growth over those 30 years, you've got a prime example of what we've been talking about.”

Michael Ettlinger and John Irons debunked this nonsense about a year and a half ago. I’d like to simply pick up on this statement:

Economic growth as measured by real U.S. gross domestic product was stronger following the tax increases of 1993 than in the two supply-side eras. Over the seven-year periods after each legislative action, average annual growth was 3.9 percent following 1993, 3.5 percent following 1981, and 2.5 percent following 2001.

Part of the Reagan 3.5% per year average increase had to do with the fact that he inherited an economy below full employment. If you take out the Keynesian effect of returning to full employment – which was mainly from a reversal of tight Federal Reserve policy – average long-term growth during the Reagan years was closer to 3%. For the period from the end of World War II to around 1980 (just before the Reagan tax shift) average growth over this extended period was 3.5% per year. Why? Well in part because national savings as a share of income was higher before the 1981 tax cut than afterwards.

Maybe a reporter should ask the Congressman – how does fiscal irresponsibility and a lower national savings rate lead to more long-term growth rather than less?

Estimated Damages from BP Spill

A couple of follow ups to this. My $23 billion number was part of what Credit Suisse had been estimated but that also included $14 billion in estimated claims on top of the $23 billion in estimated clean-up costs. And this estimate is likely now outdated:

The new estimate is 25,000 to 30,000 barrels of oil a day. That range, still preliminary, is far above the previous estimate of 12,000 to 19,000 barrels a day.

With the estimated damages growing ever higher, this is disturbing:

Administration officials suggested that they had no immediate plans to directly block BP from paying the dividend, even as the White House and its allies made clear that they would pressure the company to ensure that it made paying spill-related claims its top financial priority.

If the debt of BP is now reflecting junk bond status, the government as a potential creditor needs to step in unless it is willing to do what Congressman Boehner and Tom Donohue (Chamber of Commerce) were recommending – have the taxpayers foot part of the bill for this mess.

On a related note - Mark Thoma offers some insights into the debate over regulation especially under a system of rules where companies such as BP might be shielded from much of the downside risks its activities create.

Update: BP stock price has gone up in the two days since the release of the news that the estimated amount of oil being leaked into the Gulf is much higher. So what other news would have offset what one would think to be really bad news? Have the chances that BP can keep its share of the costs from this disaster low gone up for some reason?

BP Share Price and the Gulf Oil Spill

Much is being made of the decline in BP’s stock price, which has lowered its market equity from around $200 billion before the Gulf Oil disaster to around $100 billion. Some pundits have wondered how the market value of its equity can be this low given that the book value of its assets is around $235 billion while its stated liabilities are around $135 billion. Of course, the book value of either can understate the true market value. The BP balance sheet implicitly assigns a zero book value for the contingent liabilities emanating from this Gulf Oil disaster. One pundit today claims that the maximum estimated amount for what BP will be held liable for is $23 billion. Given all the underestimates of how much oil has been dumped into the Gulf of Mexico, one has to wonder.

Then again – I’m sure the BP attorneys are working hard to make sure they pay only a fraction of the true damage. Paul Krugman had an interesting point:

the libertarian alternative to regulation — just use tort law to make people pay for the damage they cause — doesn’t work in practice, because when push comes to shove politicians will shield the rich and powerful from paying the real cost ... Well, here’s the thing: regulation demonstrably does work where tort law doesn’t. Consider the environmental issue: in reality, the perpetrators of oil spills never pay most of the cost

While the “drill baby drill” proponents of offshore drilling used to tell us that we had the technology to keep oil spills from happening or once they did happen from becoming environmental nightmares - as we have recently learned, technology has not advanced that much. If oil companies are shielded from paying more than pennies on the dollar for such potential problems, it is no wonder they under-invest in this technology. The stock market seems to be signaling that BP shareholders may indeed pay much more than pennies on the dollar. If that does happen, bravo!

Update: John Boehner voices a very different view than mine:

In response to a question from TPMDC, House Minority Leader John Boehner said he believes taxpayers should help pick up the tab for the clean up. "I think the people responsible in the oil spill--BP and the federal government--should take full responsibility for what's happening there," Boehner said at his weekly press conference this morning. Boehner's statement followed comments last Friday by US Chamber of Commerce CEO Tom Donohue who said he opposes efforts to stick BP, a member of the Chamber, with the bill. "It is generally not the practice of this country to change the laws after the game," he said. "Everybody is going to contribute to this clean up. We are all going to have to do it. We are going to have to get the money from the government and from the companies and we will figure out a way to do that." So today I asked Boehner, "Do you agree with Tom Donohue of the Chamber that the government and taxpayers should pitch in to clean up the oil spill?" The shorter answer is yes.

This sounds like the Congressman wants us to subsidize negative externalities.

Bolivian Lithium Future

Report on Bolivia's Lithium with maps from my student & basketball friend.
http://democracyctr.org/blog/archives/1527

Fred Barnes Must Want a 2011 Recession

Fred Barnes asserts that President Obama is really hoping for a Republican win in the 2010 elections:

If Mr. Obama wants to avert a fiscal crisis and win re-election in 2012, he needs House Speaker Nancy Pelosi to be removed from her powerful post. A GOP takeover may be the only way. Given the deficit-and-debt mess that Mr. Obama has on his hands, a Republican House would be a godsend. A Republican Senate would help, too. A Republican majority, should it materialize, could be counted on to pass significant cuts in domestic spending next year—cuts that Mrs. Pelosi and her allies in the House Democratic hierarchy would never countenance.

Well – we know that a Republican majority would never agree to tax increases. Steve Benen, however, reminds us that having both a Republican White House and Republican majorities in both houses of Congress wasn’t exactly the recipe for fiscal responsibility just a few years ago. But let’s suppose we did get massive reductions in domestic Federal spending. Maybe we should just turn the microphone over to Brad DeLong to explain why “we need bigger deficits” now.

Coming Soon: The Invisible Handcuffs: How Market Tyranny Stifles the Economy by Stunting Workers.

I am happy to report that Monthly Review has announced that the Invisible Handcuffs will appear next January. I am going over Michael Yates excellent copyedits now. Here is the announcement.

http://www.monthlyreview.org/books/invisiblehandcuffs.php

Brief Notes from China

We are getting ready to leave Shanghai. The timing of the trip was fascinating because China seems to be ready to move to a new stage of development.

For example, just today I read that the government is instituting a 5% energy tax in the remote Xinjiang province. The response to the Honda strike and the string of suicides at the Foxconn factory were critical of management. Of course, the ownership of these plants was not Chinese; even so, the China Daily has pushing the line that it’s time to leave the low-wage economy behind. China is also beginning to take more control over the strategic minerals, of which it has large share of the world’s production.

The taxes levied on real estate knocked the Shanghai stock market down quite a bit. The papers have also been taking a critical attitude towards the wanton demolition of neighborhoods to make way for expensive commercial projects.

All of these moves are consistent with intelligent social democratic principles, but I have difficulty in seeing socialism here. At the same time, virtually everybody we encountered treated the Chinese economy and socialist.

I tried to get a feel for the real estate bubble. Real estate construction in Shanghai seems to have calmed down a bit since I was here a few months ago, but the rate of construction Suzhou and Hangzhou was phenomenal.

Manufacturing Discontent

The World Association for Political Economy gave 8 awards for outstanding achievement in political economy in the 21st century. My book, Manufacturing Discontent, received one of them. Here is the brief note, which I wrote for the occasion:

Manufacturing Discontent is a study of social relations, not Marx’s social relations of production, but the social relations — real or imagined — of the people who live and work under the yoke of capitalism. In this sense, the book is meant as a modest supplement to Kapital, which was a deep analysis of the social relations of the extraction of surplus value from the working class.

A longstanding project of capital is to shape virtually every aspect of people’s lives in order to meet its needs. For example, as part of the management of the interaction of social relations inside and outside the workplace, spokesmen of capital tell workers that they should identify themselves as consumers instead of as workers. Rebellion against degrading and debilitating exploitation at the workplace is foolish; instead, intelligent workers should embrace their jobs, by identifying their work as a welcome opportunity to enjoy the benefits of consumption. In effect, the circuits of consumption and reproduction become harnessed to the social relations of production.

These social relations also help to determine the quantity of surplus value. For example, one dimension of this process is the management of the burdens of risk. Today we are reminded that when crises break out, out the same workers are told that their wages, their consumption, or their pensions are problems that must be corrected.

Do All 222 of These Economists Think the Multiplier for Changes in Government Spending is Negative?

John Boehner uses Twitter to claim that economists think reductions in government spending will lead to an economic recovery. He has cited this letter signed by 222 economists as the basis for his absurd claim. Let’s just say this is an opportunity for each of the 222 economists to either distance himself from Congressman Boehner’s absurd remark or to explain why they think the multiplier is negative.

Mandatory Arithmetic

I propose that no one should be allowed to comment on current budget issues, or at least be taken seriously, unless they explicitly deal with the fundamental arithmetic, which looks like this:

GDP * (fiscal balance / GDP + net private deficit or savings / GDP) ≡ Current account surplus or deficit

I don’t care whether you say prayers to Friedrich Hayek before going to sleep at night, or whether you wake up at 3 am to make an offering at your hidden shrine to Chairman Mao, this simple identity has to hold. It is true continuously at each moment and also over any time span of interest.

Suppose your country is running a fiscal deficit, as most are right now. There are calls to reduce it. In order to have an intelligent response, you need to view the situation in light of the compulsory arithmetic. Do you see a way to reduce the current account deficit? Are you assuming that GDP will fall? Or are you expecting, or forcing, private borrowing to increase? You can’t fiddle with one term in an identity without dealing with the consequences for the other terms.

I would now puff up my chest and demand that reporters, politicians and everyone else reacquaint themselves with Econ 101, except, of course, that Econ 101, which say almost nothing about this identity or how it applies in real life, is itself a big part of the problem.

What’s a Flexible Labor Market?

Now that countries like Greece and Spain are being asked to engineer an internal devaluation of 20% or more, a scenario that is quasi-apocalyptic in terms of the implicit fall incomes and rise in unemployment it would entail, we may have occasion to mourn the absence of centralized wage bargaining, as in, say, Austria. Once upon a time economists denounced such systems as “inflexible”, because they didn’t reflect, with pinpoint accuracy, the shifting conditions in each firm. Now, however, it is hard to miss the point that they provide flexibility on an economy-wide level that makes adjustment less excruciating. Just mentioning.

A Political Economy Moment

This is a critical moment for economic policy in the industrialized countries. After a year and a half of emergency rescue, with large fiscal deficits and rock-bottom interest rates, governments are beginning to pull back. Especially in countries with large current account deficits, stimulus spending is being withdrawn, and central banks are under pressure to begin raising rates and tightening money. The threat of deflation and cascading insolvencies in the financial system are so yesterday; today’s threat is said to be inflation and sovereign default.

If you survey the center-to-left economics blogs, including this one—economists who see the world at least in part through Keynesian eyes—you will find howls of protest. It is simply irrational, we say, to allow this slump to run its course. There is no threat of inflation at all, which is actually a problem, since a bit of inflation would be medicine against effectively high nominal interest rates at the zero lower bound. And every indication is that the recovery under way owes its feeble pulse to the lingering effects of last year’s stimulus.

But is this just a problem of economic analysis? Is it only that New, Post and other Keynesians haven’t been persuasive enough? Does economic argument and evidence drive policy?

In a sense yes: those who make the decisions summon economic arguments to justify their actions. But who gets to make the decisions and what arguments they find appealing is not the outcome of academic seminars. What got us into this mess in the first place, and what now threatens to throw us back into the maelstrom, is the political hegemony of the “finance perspective”, the interests and outlook of those whose main concern is maximizing (and now simply protecting) the value of their financial assets.

Within the world of elite interests, this is almost a mass constituency. While the bulk of such assets are held by an infinitesimal few, perhaps the top 10-20% of the population in the industrialized countries have significant financial wealth and actively monitor their returns. Their understanding of how economies work and what priorities policy-makers should adhere to follow from their personal position. Inflation is a constant threat to asset-holders. They fear the laxity of central banks as well as the buildup of government debt, which can serve as an incentive to future inflation. They want their portfolios to have a component of absolutely risk-free government securities, and the very whisper of sovereign default chills them to the core. They believe in the inherent reasonableness of financial markets and believe that anyone who wishes to borrow from them should demonstrate their prudence and fiscal rectitude. They were willing to relax their principles temporarily during the panic, but now that they have caught their breath they want to see a return to “sound” practices. Governments will bend to their wishes not because they have better arguments, but because they hold power.

Don’t get me wrong. I am not making the crude claim that policy is driven directly by interests. In fact, I believe that, if they get their way, holders of financial assets will suffer along with the rest of us. (Not as much, of course: succumbing to a haircut because of debt deflation cannot be compared to losing one’s job and not being able to meet basic needs.) The process is more complicated: where one sits in society and the kinds of problems one typically has to solve leads to a way of thinking, and this manner of thinking then informs politics. For centuries, the finance perspective has played a central role in economic theorizing, and there is ordinarily a body of research to support it. What I am proposing is this: economic orthodoxy is regaining control over policy because it reflects the outlook of those who occupy the upper reaches of government and business.

Up to this point, the Great Economic Event we are passing through has not caused even a hint of political realignment, and that is why policy is returning to the old normal.

The Role of Home Equity Extraction

Daniel Cooper of the Boston Fed has posted a summary of his recent study of household consumption and its relationship to home equity extraction. He uses the Panel Study on Income Dynamics (PSID), because it has detailed information on all the relevant household financial information. What Cooper wants to know is, to what extent did households use their rising home values during the bubble years to finance higher levels of consumption? His study is useful in many ways but ultimately doesn’t answer the question he is asking. The shortcomings are instructive.

First the results. The summary can be seen in this table, a condensed version of Table 8 in Cooper’s original paper.


It appears that at no time was the mortgage ATM machine used to finance more than twenty cents per dollar of equity extraction. This seems to suggest that the housing bubble played a minor role in financing the consumption boom of the 00's, and that the deflation of this bubble should be having little effect on consumer demand during the current period.

There are two significant problems. One is on the household level: Cooper’s analysis tries (not entirely successfully, but that is another matter) to control for the endogeneity of the equity extraction decision—the impact that changes in household income have on the decision of households to pull money out of their homes via refinancing. The idea is to isolate the role of equity extraction as an “independent” decision. From a macroeconomic standpoint, however, this is not appropriate. Even if equity extraction is simply a conduit for economic influences originating elsewhere, its role is still significant. After all, it is the bubble that opened this channel and the deflation of the bubble that is shutting it down.

The bigger problem, however, is that the significance of equity extraction for aggregate consumption cannot be determined by adding up each household separately. Home repairs are a direct component of aggregate demand, for example, and indirectly stimulate the demand of those who get jobs in that line of work. Also, if one household saves the income it extracts from its rising home equity, and if this money is used to finance the consumption of another household, macroeconomically it’s all the same. (As mother used to say when you tried to separate the food on your plate, it all mixes in your stomach.)

The Cooper exercise is interesting from a sociological point of view. His more detailed work uses PSID data to get at the differences in equity extraction across different income groups and according to other demographic criteria. I learned a lot. Nevertheless, it doesn’t alter the systemic significance of the rise and fall of equity extraction for financing domestic demand during a period of aggregate net borrowing (global imbalances).