Household's financial burden

Matt Franko, via Mike Norman, shows that household financial obligations as a share of disposable personal income is at almost the level of the early 1980s. Deleveraging has been accomplished to a great extent. In part, this results from the Fed's low interest rate policy. However, if wages do not go up, or government does not step up spending, then only another bubble will get the economy going. Hope it doesn't come to that.

I'm out of here (for a few days at any rate). Happy New Year to all!

To Failure

The ministry of silly budgets

Philip Larkin was wrong; failure actually does come dramatically indeed. Or so it seems if you look at the failure of the fiscal policies of the Tory cabinet. John Lanchester has a great piece in the new issue of the London Review of Books showing the perverse effects of austerity. Yes the multiplier works, and it is rather large he contends.

As much as the story of the Cameron/Osborne failure [they've promised to reduce the deficit from 4.8% of GDP to 1.9% and delivered after two years a mild hike to 4.9%], or the problems with the 'independent' Office of Budget Responsibility [you have to love the name, it's like they work for the Ministry of Silly Walks] and the additional nuggets on IMF revisionism, there is an interesting take on the history of economic ideas.

Lanchester correctly points out that:

"About thirty years ago, when Keynes was in the depths of economic unfashionability, going up to a group of macroeconomists and trying to start a conversation about the multiplier would have been roughly like going up to a group of astrophysicists and trying to start a conversation about your star sign."

Lucas suggested that if you talked about Keynes at a conference people would giggle. Note that Richard Kahn, the one that formalized the multiplier in 1931, one of the few theoretical concepts that has direct economic policy applications and is passible of empirical falsification, did not win the Sveriges Riksbank Prize (known as the Nobel).

Even better, he actually gets a good definition of what would be essential in economics. In his words:

"Richard Feynman was once asked what he would pass on if the whole edifice of modern scientific knowledge had been lost, and all he could give to posterity was a single sentence. What axiom would convey the maximum amount of scientific information in the fewest possible words? His candidate was ‘all things are made of atoms.’ In a similar spirit, if the whole ramshackle structure of contemporary macroeconomics vanished into thin air and the field had to be reconstructed from scratch, the sentence which packs as much of the discipline into the fewest possible words might be ‘governments are not households’ (Italics added)."

Mine would be 'demand determines income,' but we are splitting hairs. The orthodox would be either 'markets are efficient' or 'supply creates its own demand.' And here lies a crucial problem. These last two are actually quite well known (Efficient Market Hypothesis and Say's Law), but the heterodox ones are not. Not only we have worse PR, but also when the mainstream fails it is very good at avoiding any blame. In fact, even Lanchester, in an otherwise perceptive discussion, falls into the trap that a good one sentence definition of the field of macroeconomics would be "nobody knows anything." Not true, 'the mainstream knows very little' would be better.

Thelma and Boehner or going off the fiscal cliff

Brad DeLong thinks we're going off the fiscal cliff. Brace yourselves then. What to expect, according to him:

"Running up to the explosion time of the austerity bomb has already reduced likely year-2013 real GDP growth from 3.0% to 2.5%. If no deal is reached until June 30 then our likely year-2013 real GDP growth rate will be -0.5%."

Unless I'm confused those look like the estimates of the Congretional Budget Office (CBO), run by

Douglas Elmendorf. According to the CBO:

"if all of that fiscal tightening occurs, real (inflation-adjusted) gross domestic product (GDP) will drop by 0.5 percent in 2013 (as measured by the change from the fourth quarter of 2012 to the fourth quarter of 2013)—reflecting a decline in the first half of the year and renewed growth at a modest pace later in the year. That contraction of the economy will cause employment to decline and the unemployment rate to rise to 9.1 percent in the fourth quarter of 2013."

So the fiscal cliff, which is more or less a decrease of US$ 600 billions in the projected deficit next year, mostly tax hikes with a modest reduction in spending of about US$ 60 billion (not considering feedback effects caused by increased spending as a result of higher unemployment), will lead to a mild recession.

So not the end of the world, but not good. But better than destroying social security for sure. And yes, by February we'll be talking about the debt ceiling again.

PS: Yep, I know, in the cartoon it is the Aztec Sun Stone not the Mayan calendar.

PS': On the broader problems with the fiscal cliff and why the consensus that we need fiscal adjustment of some sort is incorrect read Jeff Madrick's piece at the NYRB.

Joan Robinson on neoclassical economics

Given Krugman's involuntary reopening of the discussion on the capital debates and the limits of neoclassical/marginalist economics, it would be good to hear this audio (here and here; not very good quality) of a lecture given by Joan Robinson (with a brief intro by Don Harris). H/t F*#k Yeah Piero Sraffa.

Technological Progress and the Capital Labor Ratio

So Krugman is again trying to make sense of his marginalist theory of distribution and the choice of technique. He suggests the following graph, which I slightly modified, to express the possibilities available to the firm.

The profit maximizing firm will choose the 'labor-intensive' technique to the left of the intersection level between the two techniques. For example, at L/Y=0.4, where there is a vertical dotted line, now the firm needs less capital per unit of output (around half, approximately 0.3, rather than 0.6) to produce one unit of output. To the right of the intersection the opposite applies.

Note correctly that, as is well known by Krugman, the neoclassical theory of distribution applies here. The slope of the techniques is given by the negative of the capital to labor ratio, and relative remuneration of capital and labor are associated to the intensity of the use of the factors of production. In his words:

"and if you’re worried, yes, workers and machines are both paid their marginal product."

That is why the firm uses the labor intensive technique as real wages fall, and technical progress is associated with worsening income distribution. There is only one problem. The linear technologies of his example presume that all sectors have the same capital to labor ratio. That is a very peculiar assumption (the same needed for production prices to be determined by the amount of labor directly and indirectly incorporated in production, or what Marx referred to as the same organic composition of capital, by the way). If that proposition is dropped the whole thing is incorrect (see here).

Samuelson (1966; subscription required) was well aware of the problems brought about by the special assumption of his Surrogate Production function. It's time Krugman reads some of Samuelson's classic papers.

PS: Note that Krugman's point here is that maybe worsening income distribution was caused by technical progress, something he has been trying to deny in his recent research, suggesting that the increase in inequality was caused by political factors (conflict) and not skill biased technical change (technology). Make up your mind dude!

PS': Might be good to quote Samuelson directly. According to him (1966, pp. 582-83):

"There often turns out to be no unambiguous way of characterizing different processes as more 'capital-intensive,' more 'mechanized,' more 'roundabout,' except in the ex post tautological sense of being adopted at a lower interest rate and involving a higher real wage. Such a tautological labeling is shown, in the case of reswitching, to lead to inconsistent ranking between pairs of unchanged technologies, depending upon which interest rate happens to prevail in the market."

A tautology that may lead to mistakes. That's what marginalism produces when you want to understand income distribution and technical change.

How do you measure economic success II

Follow up on my previous post on Argentina. One of the typical critiques is that the current government has run very large fiscal deficits, spending well beyond its means. Figure below (Ferreres numbers again) shows the primary (without financial payments) and nominal fiscal balances.

Yep, no primary deficits at all until 2009. In fact, no primary fiscal deficit since 1990. And the largest nominal deficit just before the crisis in 2001 was at around 2% of GDP. That is an incredible amount of fiscal restraint. Yes fiscal spending increased, which explains a good part of the boom, but higher income led to higher revenues, with the consequence that the fiscal results have not been unbalanced.

On the state of macroeconomics: fashion versus logic and evidence

Yes there is something rotten in the kingdom of Denmark, and it is macroeconomics; pretty much as in every other country. There has been an ongoing debate on the blogosphere on the topic (see Krugman, Smith, Thoma, Williamson and Wren-Lewis, not in chronological order, by the way). The New Classical versus New Keynesian debate tends to be on two issues the relevance of microfoundations on the theoretical level, and the importance of price rigidities on the empirical side.

Scientists, as Mankiw put it, are the New Classicals that emphasize the microfundations. They have intertemporal maximization models based on rational representative agents. The New Keynesians are the engineers, again using Mankiw's dichotomy, that strive for economic realism. Or so is what you are expected to believe if you read their posts. Of course all of these presumptions are bogus.

Noah Smith correctly points out that they all use the same DSGE models. But Krugman notes that on policy debates the whole difference is based on the assumption of sticky prices. So they use the same models, but reach very different conclusions. Of course the tools are not neutral though. Using DSGE models has hurt the positions that New Keynesian want to take. For example, Krugman has been forced to argue that the reason for the poor recovery is that the natural rate of interest is negative (and hence the current rate is too high to bring investment and savings into equilibrium).

This is a much weaker position than the one taken by heterodox authors that suggest that the crisis is due to lack of demand associated to worsening income distribution over the last three decades, and the consequent expansion of unsustainable private debt to allow for consumption. So the poor recovery is associated to lack of demand, since wages are stagnant and private debt cannot increase (and the GOP is bent in not allowing public demand to grow).

Note that the Godley type models, which follow the heterodox perspective, were much better for understanding and foreseeing the crisis (see here). There is no reason for intertemporal maximization models, and their kind of microeconomics (Sraffians have better stuff for that). New Classicals, Mankiw notwithstanding, are not scientists (or at least not good ones), since their models do have significant logical problems, and you cannot be a good engineer, somebody concerned with practical applications of scientific knowledge, if you share a model that is flawed.

On an interesting note, Krugman's main complain about Noah Smith's position is that he doesn't understand that the New Classicals have basically treated New Keynesians as outcasts. In his words:

"the freshwater [New Classical] types simply didn’t accept the legitimacy of what the New Keynesians were doing — in fact, didn’t even bother to read any of it, because anyone who actually worked with that kind of model would know that fiscal policy can indeed have an effect in that framework."

The problem is that they don't think he is legitimate. In fact, that is true. Williamson says:

"It doesn't surprise me that Paul Krugman isn't up on what is going on in macroeconomic research. Why should we expect him to go to macro conferences, spend time in seminars, and talk to his colleagues at Princeton? He has plenty on his plate, what with delivering two NYT columns per week, blogging, talking to pundits, and giving speeches. But if he's not up on the field, what purpose does it serve to make up outlandish stuff for people to read?"

Indeed Williamson's critique is that Krugman is not up to date, on the cutting edge, Colander would say. So he has missed the last fashion season in macroeconomics. And Wren-Lewis makes a point that he is a Karl Lagerfeld of macroeconomics (not sure if that is a correct fashion quote). Wren-Lewis points out that:

PK [yes, Paul Krugman] was very much at the forefront of analysing the Zero Lower Bound problem, before that problem hit most of the world. While many point to Mike Woodford’s Jackson Hole paper as being the intellectual inspiration behind recent changes at the Fed, the technical analysis can be found in Eggertsson and Woodford, 2003. That paper’s introduction first mentions Keynes, and then Krugman’s 1998 paper on Japan. Subsequently we have Eggertsson and Krugman (2010), which is part of a flourishing research programme that adds ‘financial frictions’ into the New Keynesian model. You would not think of suggesting that PK is out of touch unless you are in effect dismissing or marginalising this whole line of research.

So he is pretty much au courant, according to his New Keynesian friends (and that sounds right to me too, by the way). No fashion problem with Krugman and New Keynesians. They are trendy too. Good for them.

Yet, what it is expected of science is not fashion, but relevance following logic and evidence. And yes Krugman is right, there is evidence for price rigidity, and also no evidence for the sort of theory of distribution implicit in the mainstream neoclassical DSGE models (productivity equals remuneration of factors of production), or for a natural rate for that matter. And that is the problem with Krugman and his New Keynesian friends, too much preoccupation with fashion, not enough with logic and evidence. If the profession remains concerned with fashionable models it will continue to be irrelevant and impractical.

Pimping out Glenn Hubbard

So how much does it take to get Glenn Hubbard's consulting expertise. Matt Taibbi has the scoop.

"So how much does it cost to get the Dean of Columbia Business School to say that Countrywide customers weren't injured by fraud? Well, MBIA's lawyer, David Freeburg, asked Hubbard that very question:

Q. How are you being compensated?
A. I'm being compensated at an hourly rate for my work.
Q. Do you know your hourly rate?
A. Yes, it's $1200 an hour.

For comparison's sake, $1200 an hour is about what Natalia, the woman New York Magazine called "America's #1 escort" in a famous profile many years ago, made early on in her career working for Jason Itzler, the self-described 'King of All Pimps.'"

So the same that a high end, but not top of the line prostitute, according to Taibbi. Seems about right. A must read. The rest here.

Macroeconomics and the financial cycle

Claudio Borio from the BIS has written a widely cited paper. The Economist has linked to it and suggested that so far his advice for including the financial cycle into macroeconomics has only been followed by a few. Besides Borio, Minsky, Godley and Lavoie and Keene are also cited by The Economist. The paper by Borio (he only cites Minsky), which has been a very influential voice suggesting that capital flows were pro-cyclical and more regulation was needed before the financial crisis, is somewhat underwhelming though.

For starters the definition of the financial cycle is based on individual perceptions. In his view, financial cycles result from "self-reinforcing interactions between perceptions of value and risk, attitudes towards risk and financing constraints, which translate into booms followed by busts." Then there is the question of the theoretical features for modeling the financial cycle according to Borio. There are three that are essential according to him. First, that financial cycles have endogenous causes, second, that debt must be present, and last but not least a different measure of the output gap. The last one is really the central theoretical modification in his scheme [note that heterodox models, like Kaldor's 1940 cycle model were endogenous, and Keynes had debt in the General Theory, in chapter 19 it is central, in fact].

The new output gap measure would include financial variables. He correctly notes that output gap measures take into consideration only inflation, when ascertaining whether the economy is above the potential or not, and that "it is quite possible for inflation to remain stable while output is on an unsustainable path" [and you can have inflation without being at full employment too, I would add]. His measure of the output gap would include information about asset price inflation too (property prices and measures of credit booms) and is shown for the US and Spain as the red line below.

Note that the new output gap shows the economy growing way beyond its potential in both the US and Spain before the crisis, more than in the alternative measures using a Hodrick-Prescott filter (green) and a conventional production function (blue). He concludes that: "potential output and growth tend to be overestimated" by conventional methods. Further, his point when arguing that the cycle is endogenous is that excessive booms are the cause of the collapse, so what is needed is to smooth out the boom. The prescription is to grow less and avoid to surpass the potential level, which is supply determined and exogenous presumably (since no word on this is uttered).*

He wants then to constrain booms, and macroprudential policies should be used for that aim. Further, while noting that in balance sheet recessions (following Koo) it is important to deal with agents losses head on, he suggests that "fiscal policy is less effective than in normal recessions" and that as a result of excessive monetary expansion after the bust "the central bank’s autonomy and, eventually, credibility may come under threat." So one really needs to kill booms, since nothing much beyond re-writing debt down and acting as lender of last resort with moderation can be done after.

I have several problems with these views, even if there are some good things, beyond good intentions, in Borio's paper. In fact, I think that there is significant evidence for the notion that potential output varies with demand expansion (Kaldor-Verdoorn Law), so that if a revision of the way potential output is measured it would be in the opposite direction. Mind you, if you check the chart above it means that Spain now is close to its potential level. I guess the natural rate of unemployment in Spain is around 20% or so (slightly below the current level). Note, also, that in Latin America we have been smoothing the boom with the consequence that our crises are not milder than Asia, but we end up growing less (see the paper by Pérez and Pineda linked here).

However, in my view the biggest flaw in the approach to financial cycles proposed by Borio is the absence of any discussion of how debt-deflation (the balance sheet recessions) affect and are affected by income distribution. There is no understanding of how wage stagnation in the center was as instrumental as financial de-regulation for the collapse, as noted by Barba and Pivetti (link here) or Jamie Galbraith's last book, not by chance called Inequality and Instability. This is again something that heterodox economists have known for a while and that the mainstream still has to learn.

* The reasons for the excess in the boom are associated to excessive finance [which he calls excess elasticity of the system], as in Shin's (2011) global banking glut, and not excessive savings, since he correctly points out that "expenditures require financing, not saving."

Where are we on the Fiscal Cliff?

This graph from the Washington Post shows the several proposals so far. As you can see Obama has been moving on Social Security and Medicare/Medicaid cuts in the direction of Boehner.

Don't get me wrong, but even proposal #1 conceded too much.

PS: To be precise US$ 350 billion too much in the #1 offer (i.e. the entitlement cuts). You may give some discretionary cuts, and negotiate how much you increase the taxes on the rich, but you cannot after winning an election, that clearly meant that people want to preserve Social Security and Medicare/Medicaid, cut those very programs.

Krugman and the natural rate again

Krugman again (re-channeling Hicks) restates his argument that the problem with the US economy is that the natural rate of interest is negative. Note that he also admits, as did recently Goldman Sachs or anybody that looks at data, that the accelerator is what determines investment. Not only his stance has serious logical problems, but also it weakens his own arguments about confidence fairies and so on. And there is no empirical evidence favoring the view that in any period, not just now, non residential investment is significantly affected by variations of the rate of interest. But yes we do need more fiscal expansion, even if lack of full employment is not simply a market failure.

PS: Note that Krugman's second graph, showing the equilibrium of I and S with a negative natural rate, implies that either we had a negative shock to I or a positive shock to S. That is, either a negative productivity shock or a change in preferences about present and future consumption. Real shocks. So what, now he is a Real Business Cycle (RBC) guy? Just drop the natural rate already. Evidence and logic require it.

Energy sources in Latin America and Asia

The graphs below (World Bank data) show the sources of energy in a few selected countries in Latin America and Asia. The first thing to notice is that Asia burns way more coal than Latin America, which tends to depend more on hydroelectric and natural gas sources (the US is a natural gas and coal country, by the way).

One reason for the difference is that Latin America does not have a significant share of the global coal reserves. China and India have a reasonable share (the US has the largest reserves of coal, followed by Russia).

In terms of the environment hydro sources are considerably better for emissions (zero) than coal, but do have other impacts, associated with flooding, reduced streams and negative impact on fish migration patterns among the worse. Natural gas is also better than coal. So Latin America is slightly more environmentally friendly. Coal tends to be cheaper (although fracking may be changing that in the US), which gives a competitive edge to Asian countries.

Note that energy is essential for the functioning of the economy. Lenin said that: "Communism is Soviet power plus the electrification of the whole country." Paraphrasing, capitalism is power to the corporations and electrification of the whole world. Note that this implies that sometimes, at least, the constraint to the expansion of demand could come from a supply restriction. Interestingly enough, more often than not, it still manifests itself through an external constraint, since many developing countries are net importers of energy.

New book on fiscal issues

Well not really. My co-edited book The Means to Prosperity: Fiscal Policy Reconsidered is now in paperback, for a third of the price. So buy three copies please.

The natural rate is 6.5%

At least according to the Fed's new press release. The release says:

"the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal."

So if unemployment falls below 6.5% expect higher rates of interest, associated to what would be in Bernanke's view the risk of excess demand.

Note that the inflation target continues to be 2%, so even Blanchard's mild-mannered rethinking of macroeconomics (that Krugman and others having been pushing) for a higher inflation target has not been accepted by Bernanke. Obama should get rid of Bernanke next time he has the chance.

PS: In contrasting news the Reserve Bank of India seems to be suggesting, at least according to The Economist, that it would raise its inflation target above 5%. Good for them.

Goldman and Chinn discover the accelerator

Steve Bannister (where have you gone Joe Di Maggio?) pointed out this nice post by Menzie Chinn on the "puzzle" (sic) of the slow investment recovery during the crisis. Note that it is actually not a puzzle at all. Chinn cites a study by the Vampire-Squid (Goldman Sachs), that concludes that (wait for the surprise) "the accelerator model generally fits well." Chinn also finds that lending conditions and "slow GDP growth (attributable to fiscal drag) are important determinants of low nonresidential fixed investment." Is rain wet?

PS: Lending conditions (which is actually a measure of liquidity) might actually be caused by the level of activity and investment rather than the other way round.

Krugman notes that marginalism doesn't work

This is great, like in his book (homonymous to his blog) Krugman has noted that the idea that technology (the marginal productivity of labor) determines distribution (real wages) is bogus. He says so clearly:

"if you want to understand what’s happening to income distribution in the 21st century economy, you need to stop talking so much about skills, and start talking much more about profits and who owns the capital. Mea culpa: I myself didn’t grasp this until recently. But it’s really crucial."

Kudos for the mea culpa. Now notice that he says that who owns capital is important. In other words, power and conflict are central for the determination of income distribution. This dude is becoming a surplus approach author (next thing he will be reading Sraffa!). Okay, so can you now drop the production function, the assumption of full employment and the natural rate hypothesis. I mean, it would only make the whole thing coherent.

PS1: Note that in the post I criticized here from this week (two days ago) he said that productivity was determined by technology (skills), that is the inclination of the marginal productivity curve, depending on the production function. Today he says: stop talking about skills!

PS2: My review of his book is here, by the way.

More on Hirschman

Several obituaries of Hirschman have already popped up (see here, here, and here for example). Note that both Alex Tabarrok at Marginal Revolution and Rajiv Sethi (who was my econometrics teacher I should note), the economic blogs, emphasize among the many contributions of Hirschman his book Exit, Voice and Loyalty (EVL), his work as a historian of economics (Tabarrok, in particular, praising The Passions and the Interests, PI), and his interdisciplinary work (Sethi, noting his crossing of boundaries of disciplines).

I tend to find exactly that those are the less appealing and more problematic characteristics of Hirschman as a scholar. His analysis of the history of ideas is based on the policy objectives rather than on the theoretical foundations of theories. Hence, classical political economy ideas are treated in terms of their laissez faire component, which would actually make them similar to a lot of the marginalist ideas of a century later.* Note that laissez faire in the period of the rising bourgeoisie is not akin to the same policy once that class is dominant.

Note also that a bourgeois economist like Ricardo could openly suggest that capital and labor had conflictive interests, in a way that only a few years later would be considered unacceptable. Marx, a radical critic of classical political economy, could maintain the core principles of Ricardian economics exactly because of that.

Also, EVL, which shows the breadth of Hirschman's intellectual interests, is a book that emphasizes interdisciplinarity in a way that the material economic preoccupations of agents and social groups are of secondary importance. Classical political economy was in many respects interdisciplinary, in particular because it shed light on the social conflicts inherent in the determination of income distribution.

In my view the more interesting contributions are associated to his early works, in particular his book National Power and the Structure of Foreign Trade (NPSFT), which showed that relationships of dependence and the counterpart, hegemonic power, can arise out of trade relations. For those that follow the aggressive trade policies pursued by developed countries pushing Free Trade Agreements (FTAs) and Bilateral Investement Treaties (BITs) this should not be a surprise. In this context, his analysis of power in NPSFT seems more akin to the preoccupation of the old classical political economists with economic power and social conflict that his analysis in EVL.

Hirschman also wrote one of the first papers, if not the first, showing the contractionary effects of depreciations, and was as a practitioner of development policies for a big push of public investment to kick start the process of industrialization. That agenda for industrialization of the periphery is still open, and his contributions (e.g. linkages) are still relevant. Those are the good things to be remembered, in my view.

* Coherent with his perspective mainstream Tabarrok suggest reading McCloskey's Bourgeois Virtues together with PI. The idea is that capitalism is a cultural phenomenum, that is based on bourgeois values, in Weberian fashion. I have criticized this view in another post (see also Cesaratto's post).

Albert Hirschman (1915-2012)

Albert Hirschman, one of the last pioneers of development, has passed away. News via Monkey Cage and Dani Rodrik.

So? None of your conclusions follow from your arguments

Krugman has a post on the effects of technological change on employment. Here is a very illustrative case of the limitations of mainstream marginalist (neoclassical) economics, which leads a reasonable and intelligent economist to all sorts of mistakes. He says:

"start with the notion of an aggregate production function, which relates economy-wide output to economy-wide inputs of capital and labor. Yes, that sort of aggregation does violence to the complexity of reality. So?"

Implicit here is the incorrect notion that the problem with the aggregate production function is over-simplification. Nope, that is a feature of all theories of course. The problem is far worse; it is that it leads to logical mistakes.* So, as we will see, none of Krugman's conclusions follow from his analysis, and that is kind of a problem. Lack of logical coherence and empirical evidence are after all the two main criteria of demarcation between scientific knowledge and the half-baked notions of ideologues.

His first point, which is based on the marginalist theory of distribution**, is that:

"in competitive economy ..., we would expect the labor force to achieve full employment by accepting whatever real wage is consistent with said full employment."

In other words, wage flexibility guarantees the full utilization of labor. A reduction in the real wage in the case of unemployment would lead to full employment (yes, he actually does not defend this in policy discussions, because he thinks that nominal wage rigidities preclude adjustment; mind you his real preocupation is that the rate of interest of equilibrium is negative, precluding adjustment in capital markets).

Of course this is nonsense. A reduction in real wages, and I'm not even talking about the effects of deflation on demand which were discussed by Keynes in the chapter 19 of the General Theory, may not lead to an increase in the demand for labor. First, it must be noted that if wages go down, since wages are part of the cost of production of produced means of production (i.e. capital), the price of the latter also goes down. There is a priori no reason to say that firms will substitute labor for capital (on capital debates go here; really Krugman should read this stuff).

Second, once the idea that the intensity of the use of a 'factor of production' is inversely related with its remuneration is abandoned (by the way there is no evidence for the notion that real wages are inversely related to employment utilization, in fact, if anything, the evidence points in the other direction, with real wages being slightly pro-cyclical), there is no reason to believe that real wages are connected to productivity (and again there is no evidence for that relation either, which means that when Krugman asks "what is that real wage?" and replies that it is "the marginal product of labor at that point," he is also incorrect). Yes real wages have stagnated, since the bargaining power of the working class has deteriorated, with productivity still growing since the 1970s.

So, what is the problem Mr. Krugman? That your conclusion, that the effects of technical change on employment are ambiguous, does not follow logically from your arguments. Ricardo's discussion of the effects of technical change on employment, in his famous chapter on machinery, is far more interesting and coherent than Krugman's (see the paper here). Not just the idea of a natural rate has to be abandoned, but the essential principle of substitution, which allows for the natural rate, must be dropped too. Logical coherence and evidence require it.

* For a serious discussion of the limitations of the aggregate production function go this paper by Jesus Felipe and Franklin Fisher here.

** The quote of Hicks classic presentation of the marginalist theory of wages leaves little doubt of where Krugman stands, if you had any.

What is new about the IMF's views on capital controls?

I wanted to write about this topic for a while, but didn't have enough time. The IMF has adopted a new institutional view on capital controls, which will inform their policy advice and surveillance of member countries, which they suggest reflects "a very broad consensus" [I'm always a little bit wary of broad consensuses]. Note that the Fund is still in favor of capital account liberalization, as noted in the second key feature of their institutional view, which says that "capital flow liberalization is generally more beneficial and less risky if countries have reached certain levels or 'thresholds' of financial and institutional development."

The question is how to get beyond the threshold, but there is no doubt that liberalization should be ultimately pursued, at least to some degree. They do add a cautionary note that full liberalization might be an impossible goal for many countries. In their words: "countries with extensive and long-standing measures to limit capital flows are likely to benefit from further liberalization in an orderly manner. There is, however, no presumption that full liberalization is an appropriate goal for all countries at all times."

The new institutional view is based on the notion that capital flows will continue to move away from the center, and that developing countries will be faced with a persistent pressure for the appreciation of their currencies. Blanchard says in his post that "looking at the relevant set of investors suggests higher flows to emerging markets are here to stay." He also suggests that the biggest threat from those inflows, the so-called Dutch Disease that New Developmentalist authors like Bresser-Pereira (here, for example) have emphasized, is not that dangerous and the empirical evidence about it is not well established [by the way, I tend to agree with Blanchard on this one, and believe that fears of a Dutch Disease are exaggerated].

My concerns with the new institutional view are twofold. On the one hand, I would rather not accept a general rule in which the IMF has a say on when and why a member country should use capital controls. Right now countries have a right to do it. So this new institutional view actually reduces policy space for developing countries. Note that the IMF, in spite of all the talk about the new macroeconomics is enforcing austerity in the European periphery. So the orderly manner that would lead to benefits from capital account liberalization are basically fiscal asuterity and inflation targets (slightly higher, 4% and not 2%).

Second, the view of the relevance of capital controls is limited to its effects on exchange rates, its volatility, the risk of appreciation, and last the possibilities of depreciations with disruptive outflows (or sudden stops). I tend to see capital controls as an essential tool not just for exchange rate management, but also for industrial policy, since the availability of dollars is often essential for determining which sectors can be promoted by allowing imports of essential goods (e.g. capital and intermediary goods), and which ones would be forced to rely on domestic substitutes. Import substitution and alternative development policies, of course, remain an anathema at the IMF.

Further, exchange rates are connected and do affect income distribution. It is far from clear that the only thing a country wants to do is avoid 'excessive' appreciation and loss of external competitiveness. Higher wages, associated with appreciated exchange rates, might be relevant for demand expansion too. At any rate, the point is that a great deal of discretionary power by domestic authorities should be the norm when it comes to capital controls. The less power the IMF has in this respect, the better.

New and Heterdox Master's Program

In response to an increasing demand for a more open, pluralist approach both in teaching and academic research in Economics a group of heterodox scholars have gathered together to launch a new Master’s Program in Economic Development in Buenos Aires, Argentina. The Program seeks to provide economics students with an alternative curriculum while covering—and seeking for students to master—standard mainstream literature and themes, including advanced quantitative skills, as middle step in the development of an academic career or public service.

Latin American students for the most part lack this type of approach and opportunity. Policy discussion has to some extent shifted in recent times in Latin America due to the progressive turn part of the region has taken at the political level. But despite this shift in debate, policy making remains to a large extent permeated by the orthodox vision and so too, with a few notable exceptions, curriculum design and teaching in the field Economics.

While providing wide-ranging courses on development, macroeconomics, microeconomics, econometrics and history of economic ideas, the program will offer students the possibility of picking between two alternative concentrations —the first, on “Macroeconomics and finance for development”, to be coordinated by Matías Vernengo (Ph.D., New School University); the second, on “Industrial organization and technical change”, to be coordinated by Pablo Lavarello (Ph.D., University of Paris XIII). Martín Abeles (Ph.D., New School University) will be the Program Director, backed by a host of prominent academics.

The Program will be hosted by the National University of San Martín (UNSAM), a prestigious Argentine public university, with great achievements not only in social sciences, but also—and very outstandingly indeed—in natural sciences, and classes taught in downtown Buenos Aires. The Program will begin in 2013 and the deadline for applications is December 27, 2012. For more information go here (in Spanish).

Forget Deficits and the Fiscal Cliff Scam

By James K. Galbraith

What do rich people do with money? They make the best use of it they can, and in times of high growth and strong confidence they take risks and – if they are good and lucky – reap the rewards.

But the situation is different when the outlook is bleak and when real estate (especially) will be cheaper next year than today. Under these conditions, money is safe and gains value even at zero interest. So the idle balances pile up in banks and in low-risk assets like Treasury debt.

Read the rest here.

Also, check the four part interview by the Real News Network on why the fiscal cliff is a scam here.

How do you measure economic success?

So the piece on Argentina at the Guardian got a lot of comments. One suggested that Argentina has not been very succesful. As I pointed out in terms of growth (if you use Levy-Yeyati's numbers, as shown in the figure below; his series is the red line) the average rate of growth has been at slightly more than 6% per year since the default, which constitutes the highest rate in the country's history.

Further, if one looks at the expansion of real wages in the industrial sector (using Ferreres numbers; there is a 2nd edition with more recent data) you have an impressive increase of 8.9% per year since the default (up to 2009; they also grew in 2010 and 2011, even though it is less clear they will in 2012).

Sure real wages are still below the peaks (mid-1950s, early 1970s and the very short lived increase after the Austral Plan in the mid-1980s), but the recovery is impressive nonetheless. So the country grows and workers are doing better. I don't know what you think, but it looks pretty good to me.

PS: Levy-Yeyati and Ferreres' numbers (not the official) are the ones used by the critics to say that the boom was not a success.

Don't comply for me Argentina

By Jayati Ghosh and Matías Vernengo

Argentina is in the news again. The country that successfully managed an external debt restructuring after a major financial crisis in 2001-02, and eschewed the standard austerity package to benefit from a remarkable economic recovery, is being attacked by a combination of court rulings and aggressive moves in financial markets.

Elliott Capital Management, a vulture fund based in the tax haven Cayman Islands owned by conservative financier Paul Singer (a big donor to the Romney campaign), refused to accept the terms of the debt restructuring that was accepted by more than 92% of bondholders in 2005 and 2010. It has demanded payment in full, and has actively pursued its case in different courts across the world. A few months ago, the Argentine frigate Libertad, which ironically means freedom in Spanish, was seized in Ghana after a local judge ruled in favour of Elliott Capital Management. Judge Thomas Griesa has recently ruled in a district court in New York that the Argentinian government must pay $1.3bn to the same vulture fund – the full face value of their holdings plus accumulated interest starting in late 2001 – on the basis of an unusual interpretation of the pari passu clause in debt contracts.

Read the rest here.

Income distribution in the BRICS

If you have any doubts the graph above confirms the obvious. Income distribution is terrible in Africa and Latin America, and slightly better in ex-communist (China too is ex, isn't it?) and Asian countries. Mind you I expected China to be better than Russia.