Income versus Wealth

One way to think about the political economy of macropolicy is to divide people into two camps, those who are motivated primarily by threats to income and those by threats to wealth.  (I will emphasize threats rather than enhancements for simplicity, and in recognition of the force of loss aversion.)

Threats to income take the form of unemployment, wage loss and the loss of public benefits (the social wage).  The policies attractive to this group are generally Keynesian: looser fiscal and monetary policy, measures to increase wages, and other interventions to prevent the economy from producing below its potential due to insufficient demand.

Threats to wealth take the form of inflation and default.  The policies these people are drawn to are what we usually call orthodox: tight monetary policy, restrictions on new borrowing (particularly by the public sector) and hostility to measures that would reduce the profitability seen as underlying asset and credit markets.  The latter often comes dressed as labor market flexibility.

Note that I am not passing judgment (here) on what is right or wrong, good or bad, from an economic standpoint.  I am only attaching particular policy constellations to particular (perceived) interests.  I also recognize potential inconsistencies; in particular, those concerned to preserve the value of their wealth might lean toward Keynes if they fear that insufficient demand will lead to declining profits, lower share prices and higher default rates.  (My modeling hypothesis: this effect is nonlinear in the rate of change in the output gap.  If the output gap is approximately stable or falling, wealth-holders will put this concern below the others mentioned earlier.  If the output gap is rising, perhaps beyond some threshold rate, the Keynesian threat to wealth takes center stage.)

Do these perspectives correspond to class interests?  Yes and no.  Clearly wealthier individuals are likely to be more concerned with wealth rather than income, and the reverse holds for those with little wealth.  Nevertheless, it is not a strict mapping.  There are high income individuals, for example in upper-level management positions, whose vulnerabilities arise far more from their future employment prospects than their portfolios.  Similarly, many middle class retirees are highly dependent on the performance of their savings.  In fact, this last example reminds us that there is a life cycle aspect to this divergence of interests as well as a class aspect, although the class influence is probably larger overall.

How do these perspectives reveal themselves in economic policy discourse?  We know about orthodoxy: it defends itself explicitly on the grounds of wealth effects.  Inflation is always just around the corner, and any additional public borrowing puts the state on the slippery slope to insolvency.  People must learn to live on less and to repay all their debts in full.  The one interesting twist is that, recognizing that wealth preservation is not a widespread concern, those arguing for orthodoxy have tried to present inflation as primarily a threat to income: “the cruelest tax of all”.  To do this, of course, they have to put aside the identity between incomes and expenditures (as adjusted by the current account), meaning that their appeal is based on sowing confusion.  The fact that this particular falsehood cannot be put to rest by rational argument suggests that political economy plays a more powerful role in shaping discourse than economics.

On the Keynesian side, much is made of the threat of demand shortfalls to profits and markets in claims on profits, and arguments are made that concerns regarding inflation and public insolvency are overblown.  Perhaps the reason these arguments are only sporadically effective is that they do not address the very different weights wealth-holders place on income versus wealth threats, nor their perhaps justifiable concern (from their perspective) over tail risks.

There is an emotive side to this dispute.  Keynesians, by emphasizing the potential, even in the near term, for future wealth production, express optimism—a can-do attitude.  Follow the right policies and we can advance together to a higher quality of life.  The orthodox, who want to protect the accumulation of past wealth, express a sort of dourness.  Adjust to the hard times, tighten your belt, and eventually we will get through this.  In pointing to this, I am trying draw out the implications of the difference between the two perspectives in their orientation toward time.

How well does this model capture the current debate in Europe and the US?

ADDENDUM: I left out the confidence argument that is so important to the orthodox side.  In public debate, they want to portray threats to wealth as equally threats to those without wealth.  The way they do this is to argue that wealth-holders play a decisive role in investment, and investment is the key to protecting incomes.  If threats to wealth can be removed, they say, the resulting peace of mind (confidence) will set off an investment boom.  The essential role that the confidence trope plays in selling wealth protection to an income-preoccupied public explains why so much stress is placed on a claim that, by its nature, is almost incapable of reasoned support ex ante.

Europe: Ignorance Does Not Even Remotely Resemble Bliss

The public debate over European austerity, so long overdue, is now breaking out.  The baby steps of Hollande in France, the double dip in England, the difficulty in assembling an austerity coalition in the Netherlands and the first big anti-austerity demonstration in the East (Czech Republic) are all signs that fiscal orthodoxy is under siege.  The backdrop, of course, is the descent of much of Europe into recession when the recovery from the financial crisis has barely begun.  Given that officials have postponed a reckoning with the losses amassed by the banking system, this is a recipe for an even greater disaster.

What stands out at this point is the extraordinary ignorance displayed by the defenders of austerity.  Whether this is honest ignorance or the cynical kind is difficult to say, but in either case it should be shown for what it is.

Let’s take two comments culled from this morning’s New York Times coverage.  First we hear David Cameron, the British PM, in what has become the mantra of the austerians: “More debt and more spending is what got us into this problem. It can’t be the solution of the problem.”

1. Except for Greece, public sector deficits were modest and generally declining in the runup to 2008.  In what sense did public spending provoke the collapse of the global financial sector in the fall of that year?

2. Fiscal deficits ballooned in response to the crisis; they were a symptom rather than a cause.

3. It was actually private debt that got us into this mess.  Public debt has expanded to limit defaults and partially take up its role in sustaining spending.

4. Lack of spending is surely the core issue at present.  Demand for goods and services is depressed, workers are out of work, and investment is anemic.  Borrowing is how spending expands in advance of income.  Either the private sector has to take on more debt or it’s the public sector’s job.  But the private sector is justifiably deleveraging.  Governments that can print money need to take up the slack.  When income growth revives, public borrowing can recede.

Not a single word of this quote is defensible.  That includes “and” and “the” (both of them).

Now listen to Draghi.  Arguing against fiscal stimulus, he says, “If one thinks you can increase demand by increasing deficits, then how come we don’t have higher demand?”

1. Again, the fiscal deficits are a symptom of the slump.  We got drastically lower demand, and then we got deficits.  Draghi might as well ask, if crutches are so good for getting around, why don’t we see more people on crutches in the Olympics?

2. The austerians are demanding that deficits shrink.  This will decrease demand and intensify the slump.

3. The deficits are doing less than they should to stimulate demand because a portion of government spending, especially in places like Ireland and Spain, is going to bail out the financial sector.  With no EU-level plan to either bail out or resolve finance, it is left to individual countries to do this.  Since Draghi is not doing the job a real central banker should be doing, at least he can stop criticizing those who are trying to do some of it for him.

Just as irrationally, Draghi goes on to say that growth can come only from structural reform that makes economies more efficient.  Huh?  That’s about the growth of supply, not demand.  True, if an individual country gains in efficiency relative to the others, and if its exchange rate doesn’t adjust (perhaps because it has given up its own currency), then, yes, it can boost its demand through an increase in net exports.  But this is a zero-sum game overall.  Rebalancing is important for averting the structural forces that create unsustainable debts, but that has little to do with aggregate demand across the system.

So what I propose is this: expose the absurdities of austerian arguments every day.  Don’t let any of it pass.  Let’s get to the point where denying basic economics is like denying climate change, where ordinary people can see that the controversy is an expression of who is paid to say what, not the underlying science.

Education: Low Interest Student Loans – A Very Small Step

Mitt Romney apparently agrees with President Obama on extending the 3.4% interest rate on student loans, which puts both of them at odds with Republicans in Congress. Of course, we will have to wait and see if Mr. Romney shows any real leadership in helping the President overcome the opposition in Congress from his own party. I would humbly submit that this is only a very small step in restoring the recent damage to our education system. Our chart shows the decline in real government spending using data from this source (see Table 3.15.6. Real Government Consumption Expenditures and Gross Investment by Function). Phil Oliff and Michael Leachman documented how state and local government support of elementary and high school education has been declining since the recession. Diane Epstein discussed what the Ryan budget would mean to education spending a month ago. Pell Grants, which already have seen declining values relative to college costs, are slated to be drastically reduced. Head Start funding will also be reduced. Of course, most of what public commitment to education comes from state and local governments, but the Federal government can reverse these recent cuts with a greater commitment to Federal revenue sharing. And the bonus would be that we might avoid doing further damage to the economic recovery ala austerity. In other words – if Mr. Romney wants to really lead, then he will insist that we reject this Ryan budget.

Keynes was right and the Austerians are wrong

Via Paul Krugman comes a report from Henry Blodget that a few European leaders have finally figured out: Keynes was right and the Austerians are wrong. And BBC reports that the UK economy has seen real GDP decline for two consecutive quarters. BBC also notes:

Prime Minister David Cameron said the figures were "very, very disappointing". "I don't seek to excuse them, I don't seek to try to explain them away," he said at Prime Minister's Questions. "There is no complacency at all in this government in dealing with what is a very tough situation, which frankly has just got tougher." He said it was "painstaking, difficult" work, but the government would stick with its plans and do "everything we can" to generate growth.

Does he mean sticking to austerity, which likely caused the economic downturn?

The Precautionary Principle and the Iraqi WMD Test

My emeritus colleague, John Perkins, asks a deep question about proposed justifications for a precautionary principle: would they, in early 2003, have provided a basis for the US invasion of Iraq despite, or even because of, uncertainty about the existence of Iraqi weapons of mass destruction?  The stylized decision situation is this: the US has suspicions that horrible chemical or biological weapons are being stockpiled in Iraq, but there is no firm evidence.  Indeed, the likelihood of WMD’s is small, but the negative consequences if they actually exist are severe.  Suppose further that decision-makers are honest (this is a purely hypothetical test) and want to act rationally so as to minimize the harm of either launching or not launching military action.  In other words, this is a make-believe scenario, but one that nevertheless captures an important aspect of the meaning of precaution: if being precautionary in such a situation makes you more likely to want to invade Iraq, you have a problem.

So is there a version of the precautionary principle that passes this test?  Intergenerational equity arguments (irreversibilities justify low or zero discount rates) are at best a wash, since the costs of under- or overestimating the likelihood of WMD’s have approximately the same time profile.  (The main problem with intergenerational equity is that, while it is a fine concept, it has little relevance to most situations that might require precaution; precaution is about coping with uncertainty, not valuing immediacy versus delay.)  Fat tail aversion à la Weitzman would seem to fail the test, since it would place greater value on insuring against catastrophic WMD risk.  According to this principle, it’s better to accept the certain devil we do know (invasion) than run the risk of the less likely but even worse devil we don’t.  You could argue for a different type of precaution: don’t mess with nature.  This would avoid WMD dilemmas by defining precaution as being about only environmental questions, but at the cost of being either grossly impractical or incoherent.  Example: agriculture, even the most organic kind, is absolutely messing with nature, as are many of the other essential practices of the human race.  Green-is-good is an attitude, not a rational basis for a decision principle.

I think my version of precaution does pass the test.  To recap (OK, not “re” for most readers), I propose that metadata—the history of how we have learned in the past—is relevant to evaluating our ignorance in the present.  If a company had a record of underperforming its earnings target quarter after quarter, you would take this into account even if you had no current information regarding the likelihood of its meeting its next target.  Similarly, what distinguishes the emergence of ecological understanding over the past century or so is that we systematically discover that species, including our own, are more interdependent than we thought, and more sensitive to alterations in their natural environment at lower exposure thresholds.  It is rational to expect that the larger part of our current uncertainty regarding environmental impacts will resolve itself in similar ways in the future; hence precaution.

Here is why I think it passes Perkins’ test.  On the one hand, there has been a long series of manipulated intelligence reports used to justify policies favored by those in power in Washington; foreign threats usually turn out to be less threatening than initially reported.  (Intelligence pertaining to Japan pre-1941 might be an exception, maybe.)  On the other, invasions of foreign countries have typically turned out worse than expected: more resistance, more repression in response to resistance, more cruelty, more overall economic and human cost.  On both counts the metadata should be incorporated into the decision process, and both counsel precaution as I understand it.

My golden rule of precaution: make the decision today that, based on everything you know up to this point, you will be most likely to have wished you had made in the future, when you will have more information.  Assess the likely bias of your ignorance.

Inequality: Finance and Geography

I’ve just finished watching Jamie Galbraith’s INET talk on inequality (thanks, Yves) and was struck by his geographic discussion toward the end.  Most of the increase in US inequality in the last decade or two has been concentrated in just a handful of counties, particularly Manhattan, San Francisco, King (Seattle) and a few others.

Let’s suppose the explosion of high incomes in the financial sector accounts for about a fourth of the increased share claimed by the top 1%.  (Does anyone out there have a real number for this?)  Given geographic concentration, we should look also at the services consumed by the financial elite.  A rough law has it that the earnings of a service provider are proportional to the income of his or her clients.  A dog walker to the rich makes more than a preschool teacher in a low-income neighborhood.  We can therefore propose a sort of inequality multiplier associated with the initial bounty bestowed on those in finance: much more prosperous decorators, physicians, restauranteurs, etc.  These spillovers would be concentrated in close geographic proximity to the location of financial centers. The point is that there are both direct and indirect effects of finance’s grip on profits, much of which would not be captured by existing empirical methods.

Could a Strong Union Movement Save Social Security?

Pear, Robert. 2012. "Social Security’s Financial Health Worsens." New York Times (24 April): p. A 13.


http://www.nytimes.com/2012/04/24/us/politics/financial-outlook-dims-for-social-security.html?hp



"The Obama administration reported a significant deterioration in the financial outlook for Social Security on Monday, while stating that the financial condition of Medicare was stable but still unsustainable."



"The Social Security trust fund will be exhausted in 2033, three years sooner than projected last year, the administration said."



"In explaining changes in their Social Security projections, the trustees cited slower growth in average earnings of workers and the persistence of unemployment in the slow recovery from the recession. They lowered their projection of average real earnings in the future, primarily because of a surge in energy prices and “slower assumed growth in average hours worked per week after the economy has recovered.”



Let's see if we can get this straight. For 40 years wages have gotten hammered by the "job creators". People become increasingly reliant on Social Security, but the system is in trouble because people do not earn enough to get enough taxes taken away to cover social security. The obvious answer is to destroy social security.

The Not-So-Secret Weapon of the Campaign to Destroy Social Security: Cynicism

First, read these two articles, one from the Harvard School of Journalism, the other from the New York Times, back to back.  A match made in heaven, no?

Now that you’ve done your homework, here is my take.  For the past thirty years we have seen repeated campaigns to eviscerate Social Security—to privatize it, siphon off its finances, drain it of its essential social insurance character.  These have failed, not because of the brilliance or commitment of its defenders, but simply because it fulfills a vital social function and is wildly popular.  Even those who, in their heart of hearts, want to crush it to bits, claim to be in favor of “saving” it.  So what’s the strategy of the anti-SS minions?

Cynicism.  Convince younger voters, whose benefits are still decades away, that the program is dying a slow but certain death, and that politicians are too myopic or pandering or just stupid to do anything about it.  From time to time I poll my students, and by a big majority they always tell me that SS will not be around to support them in their retirement.  (Not that this has provoked a big Feldsteinesque spike in their personal savings....)  As this mindset takes hold, it becomes easier to simply tune out the debate over SS.  After all, it’s not like it’s actually going to be there when I’m old, no matter what they say, right?  At some point, it goes from being a third rail to a footnote to just background noise, to mangle a bunch of metaphors.

What I’d like to see are news stories that say something like, “Social Security has had its ups and downs, but it’s in better financial shape now than it was a generation ago, and unless its enemies prevail, it will be there for you when you need it.”

Pareto's Law: Understanding Inequality

Economists, always intent on making their work into a science, like to transform their ideas into a "scientific" law. Accordingly, the Fascist Italian senator, Vilfredo Pareto is credited with discovering Pareto's Law, which explains why inequality is a natural outcome. Pareto suggested that 20% of causes create 80% of effects. He argued that this law explains why 20% of the Italian population owned 80% of the wealth. Sadly, the U.S. experience calls Pareto's data into question, but then, those lazy Southern Europeans wallow in socialism.




There is a second Pareto Law, which offers a more accurate explanation inequality. In his Manual of Political Economy, he explained:


"In all periods of the history of our country we find facts similar to the practices we have just pointed out, permitting certain persons to use stratagems to appropriate to themselves the goods of others; hence we can assert, as a uniformity revealed by history, that the efforts of men are utilized in two different ways: they are directed to the production or transformation of economic goods, or else to appropriation of goods produced by others. War, especially in ancient times, has enabled a strong nation to appropriate the goods of a weak one; within a given nation, it is by means of laws and, from time to time, revolutions, that the strong still despoil the weak."


Pareto, Wilfredo. 1906. Manual of Political Economy, Ann Schweir, tr. (New York: Augustus M. Kelley, 1971): p. 341.


The final phrase about the strong despoiling the weak offers an excellent insight into the way that capitalist countries, led by the United States have been repealing Pareto's first law.

So What is Romney’s Plan for Medicare?

Brian Beutler notes another piece of Romney mendacity:

in an official statement reacting to the reports, Romney declined to describe the details of his plan. “Today’s report reminds us that Medicare must be reformed and strengthened or it will soon collapse,” he said. “President Obama has offered no serious plan of his own, preferring instead to attack and point fingers over problems he refuses to address. Mitt Romney has a comprehensive plan to preserve Medicare for today’s seniors while ensuring that it remains strong for future generations.”

Did you catch that? Romney says he has a comprehensive plan but it’s a big secret! But that’s not the mendacity that I’m referring to. President Obama did pass ObamaCare (or was that RomneyCare)? And Brian’s reporting also noted:

The good news is that the trustees believe the Affordable Care Act strengthened Medicare — and project, as they did last year, that the program won’t exhaust its hospital insurance trust fund until 2024.

Yes – there is uncertainty:

The Board assumes that the various cost-reduction measures — the most important of which are the reductions in the payment rate updates for most categories of Medicare providers by the growth in economy- wide multifactor productivity—will occur as the Affordable Care Act requires. The Trustees believe that this outcome, while plausible, will depend on the achievement of unprecedented improvements in health care provider productivity.

And we have heard that Romney as President will repeal ObamaRomneyCare which will worsen the Medicare situation. Are you thoroughly confused on Romney’s position now?

Romney as Surgeon?

Pema Levy watches Rudi Giuliani on Fox & Friends so we don’t have to:

This reminds me of, you know, going to a surgeon, right? If I’ve got a terrible cancer or something to be operated on, when I had to be operated on for prostate cancer, I didn’t go to the nicest doctor, I went to the best doctor. The guy could have a great personality and tell jokes [and he] put the knife in the wrong way. On the other hand, if he’s a great doctor, that’s my guy.

While a doctor does need to know how to ably control the knife, he also has to know how to diagnosis the ailment as well as ascertain the right procedure. And let’s just hope that the next time Mr. Giuliani has to go under the knife that his surgeon does not change his mind mid-operation.

Honoring Duncan Foley

On April 20-21 at the New School for Social Research there was a symposium held in honor of Duncan K. Foley at which he was presented a festschrift. It was organized by his now retired colleague, Lance Taylor, along with former student and coauthor Armon Rezai, and his coauthor on Growth and Distribution, Tom Michl. Duncan is now part-time at NSSR and about to turn 70. The symposium was a fascinating collection of people from his past discussing many ideas that Duncan has worked on over his career, from his orthodox work on general equilibrium theory, through his work on money in Marxian theory, his work on growth and distribution, econophysics, history of thought, financial markets, public goods, global climate, and other matters. He made a long personal commentary on his career at the end, and on Friday evening letters of admiration were read and many colleagues and students spoke about Duncan's work and influence on them most praisingly. I shall list who presented and then discuss some ideas of particular interest. The first session was on him personally. After the NSSR president presented him the festschrift, Michael Piore reminisced about their time at MIT together after Duncan finished his PhD in two years at Yale. Then I spoke about his role in the development of complexity economics. The second was on growth and distribution, with papers by Amitava Dutt, the French Marxist Gerard Dumenil, and Tom Michl. An idea pushed by both Dumenil and Michl is that a more useful short-run equilibrium condition for a macroeconomy is the rate of capacity utilization, arguing that unemployment rates are poorly measured, and that the natural rate of unemployment is an empty concept useless as an equilibrating condition. Then Duncan's major professor, Herbert Scarf, still very on top of things at 81, chaired a session on Decentralized, Dispersed Exhange, with his student now a philosopher, A.J. Julius proposing a catallactic adjustment to GE process, Graciela Chichilnisky discussing her role in writing into the Kyoto Protocol the cap and trade article, and arguing in favor of her idea of a green golden rule in which the present does not exploit the future and that the future does not exploit the present. She identified this as the meaning of sustainability. Then there were two papers on econophysics, Joe McCauley speaking on financial markets and Victor Yakovenko speaking on income and wealth distribution dynamics and patterns. The final session of Friday was on Value, Distribution, and Capital, chaired by his colleague, Ed Nell. Simon Mohun argued that the labor theory of value can be used to analyze shares of income between different categories of labor, counting supervisory workers wages as returns to capital. Ed Wolff discussed downsizing between 1967 and 1997, reporting that firms downsizing experienced falling profits and share prices, and that downsizing was linked to de-unionization. Anwar Shaikh dscussed how different categories of capital are treated in US national and income accounts, and Duncan's student from Stanford, Tracy Mott followed up on the themes of the earlier talks. On Saturday morning, K. Vela Velupillai spoke on Duncan's PhD thesis and how he had independently discovered a method of studying shadow prices for public goods due to Negishi. Peter Skott spoke on how accounting for positional concernsn by people increases the return to acting to slow global warming. The final session was the most stimulating. Perry Mehrling spoke about the hierarchy of money and how the current global system of credit and debt is operating. He posits that there is now an effective global lender of last resort, the C5. This group is the key group of the five most important central banks, the Fed, the ECB, the Bank of Japan, the Bank of England, and the Swiss central bank. Curious that the Bank of China is not part of this group, despite the increasing importance of the Chinese economy in the world. Phil Mirowski spoke on his ideas of markets as markomata or information processing mechanisms and argued a Minsky view that the financial markets inevitably destabilize themselves. Finally, Rajiv Sethi spoke on how algorithmic trading is destabilizing world financial markets. There were some heated discussions in this session, all very stimulating.

What's the Mythology For, Anyway?

What's the Economy For, Anyway?: Why it's time to stop chasing growth and start pursuing happiness, by John de Graaf and David K. Batker, 2011. Bloomsbury Press.

Here's something Sandwichman didn't know: "Hoover and Roosevelt (and their predecessors) had one thing in common. None entered office with a model or theory of how a national economy works."

Another Casualty of the Hitler-Did-It-Too Gambit

Others, like Brad DeLong and Mark Thoma, have gone after Acemoglu and Robinson for their “argument” that, because Hitler used massive stimulus to extricate Germany from the Depression, there is nothing intrinsically progressive about Keynesianism.  I want to make a different point.

Hitler and his minions were evil and did unspeakably awful things on a massive scale.  Are we clear?  Now, let’s talk about the complications of real history.

The Nazis did not descend on Germany sprouting horns and hooves.  True, reasonable people knew from the start they were very bad news, but there were aspects of the Nazi program that were attractive as well.  High on the list was a realistic program to restore economic growth, including large-scale stimulus, capital controls and renunciation of the Versailles debt.  Remember that, before Hitler, there was Brüning.  It should also be mentioned that the Nazis had an exceptionally progressive environmental and public health agenda, including restrictions on smoking, pesticide-free agriculture, workplace safety and improvements in diet.  If you doubt this, read The Nazi War on Cancer, an extraordinary, mind-bending book by Robert Proctor.

Again, none of this justifies a regime that committed such colossal crimes—but that’s not the issue.  Hitler was not an incarnation of pure evil, just an exceptionally destructive but in some ways normal political leader.  He rose to power by addressing real needs of real people.  You don’t prove that vegetarianism or organic agricultural are reactionary by showing that they were sponsored by the Third Reich, and the same goes for Keynesian stimulus.  Repeat: it’s about seeing Hitler not as a slogan or comic book villain, but as a real life historical figure with layers of complexity.

And once again, since I will probably be misunderstood: yes, the racism, militarism, totalitarianism and genocide were unspeakably horrible.

The Utter Failure of EU Structural Funds

Maybe this is a hot topic of conversation in other venues, but has anyone here noticed that the imbalances crisis of the Eurozone is exactly what the structural/cohesion funds were supposed to forestall?  Billions spent, and what to show?  I run each morning on an EU-funded trail, for which I am supremely thankful, but I would gladly forego it to somehow, magically rescue the good people of Europe from the maw of austerity.

Was it destined to be thus?