NAKED KEYNESIANISM

New Journal: Review of Keynesian Economics

2012-03-02T13:12:00.000-08:00

Aims and Scope (for more infor go here)

It is widely recognized that economic crises can sometimes trigger enormous change, both with regard to economic theory and the politics of governance. Today, the global economy is struggling with the fall-out from the financial crash of 2008 and the Great Recession of 2007-09. The economic crisis that these events have generated, combined with the failure of the mainstream economics profession, has again put the question of change on the table.

With regard to the economics profession, it stands significantly discredited owing to its failure to foresee the recession and the financial crash; its repeated over-optimistic forecasts of rapid recovery; and lack of plausibility surrounding its attempts to explain events. Reasonable people do not expect economists to predict the daily movements of the stock market, but they do expect them to anticipate and explain major imminent economic developments. On that score the profession failed catastrophically, revealing fundamental theoretical inadequacies.

This intellectual failure has prompted us to launch the Review of Keynesian Economics. At a time of journal proliferation some may wonder about the need for another journal. We would respond there is a proliferation of journals but that proliferation is essentially within one intellectual paradigm. As such, it obscures the fact that the range of theoretical inquiry is actually very narrow. A journal devoted to Keynesian economics is therefore needed both to correct this narrowness and because events have once again confirmed the profound relevance of Keynesian theory.

Reflection upon the intellectual history of macroeconomics over the past seventy-five years can help to understand the current predicament and need for this new journal. That history traces an arc, which first saw the eclipse of classical macroeconomics by Keynesian macroeconomics, and then saw the eclipse of Keynesian macroeconomics by a revived and re-tooled classical macroeconomics.

The crisis associated with the Great Depression of the 1930s inspired John Maynard Keynes to write The General Theory of Employment, Interest and Money, a book that explained the persistence of unemployment in monetary economies. Keynes’ theory had enormous influence both inside and outside the academy, and his ideas on the importance of effective demand triggered a remaking of macroeconomics that saw Keynesian theory displace classical macroeconomic theory. That displacement was driven by the failure of classical theory to account for the Depression and the corresponding explanatory success of Keynesian theory. Moreover, not only did Keynesian theory provide an explanatory framework, it also offered practical policy recommendations. After World War II, the Keynesian theoretical revolution inspired new policy thinking that contributed to a twenty-five year period of unprecedented prosperity, now widely referred to as “The Golden Age” of capitalism or “The Age of Keynes”.

From 1945 to the early 1970s, the global economy witnessed an unparalleled period of prosperity that came to an end with the collapse of Bretton Woods (1971), the first oil crisis (1973) and the stock market crash of 1973-74. During this period of almost three decades, the world enjoyed rapid growth, low unemployment and reduced inequality, making Keynesian policies a success by most measures.

However, adherents of classical macroeconomic theory never accepted the legitimacy of Keynesian economics and they forged a counter-revolution, centered upon the University of Chicago and the work of Milton Friedman. In the 1960s and early 1970s the counter- revolution took the form of monetarism, and thereafter it evolved into new classical macroeconomics. The intellectual link between monetarism and new classical macroeconomics was animosity to Keynesianism and a dogmatic predisposition to laissez-faire conclusions.

The counter-revolutionaries were successful in their project and recaptured control of macroeconomics in the late 1970s. Their success was driven by a range of factors including their own intellectual imagination and innovation, intellectual staleness among Keynesians; the Cold War, which promoted laissez-faire ideology; and inflation and political conflict triggered by income distribution conflicts fostered first by full employment and then by the oil shocks of the 1970s.

Most importantly, the counter-revolutionaries opportunistically exploited the intellectual confusions created by the oil supply shocks of the early 1970s. Those shocks unleashed a new supply-side phenomenon of stagflation, which the counter-revolutionaries asserted disproved Keynesian macroeconomics. In retrospect, we know those assertions were false and Keynesian theories of conflict inflation gave a good account of developments, but the dispiritedness of the late 1970s initiated an era of reaction, which included reaction in economics.

It is important to emphasize that the demise of Keynesian economics was not caused by profound logical flaws or lack of supportive empirical evidence. Keynesianism (and other paradigms too) was accused of lacking micro-foundations, when in reality it has always had micro-foundations but rejects micro-foundations predicated on the implausible assumptions of homo economicus and Walrasian characterization of market processes. That Walrasian characterization fundamentally misrepresents economic reality, assuming the existence of institutions that do not exist (i.e. the auctioneer) and ignoring institutions that do exist (i.e. money and money contracting). In doing so, it ignores the macro-foundations that for Keynesians are the twin of micro-foundations.

The inflationary pressures of the 1970s, with the concomitant rise of conservatism in the form of the Reagan-Thatcher movements, were instrumental in the revival of classical macroeconomics and the repression of Keynesian economics. These forces have now waned but they have locked-in a legacy that is hard to reverse. That is because notions such as the natural rate of unemployment are entrenched in macroeconomics discussions and, most importantly, in teaching manuals.

The consequences of the return of classical macroeconomics have been enormous. For society it has entailed an era of neoliberal policy dominance that has contributed to wage stagnation and massive income inequality, which is significantly responsible for the Great Recession and the prospect of stagnation. Economic theory and politics often march hand-in-hand, with theory reinforcing politics and politics reinforcing theory. Together, they both drive policy, making economic theory vitally important for society.

In the end, economic theory is a contested terrain that is fought over by different intellectual tendencies, which may reflect different political and ethical values. In the years after World War II Keynesianism was ascendant, but since the late 1970s classical macroeconomics has been ascendant. Such ebbs and flows are reasonable, and even desirable, in an open society. However, what troubles us is that the period of classical re-ascendance has been characterized by what we think is a closing and monopolization of intellectual space, whereas the period of Keynesian ascendancy was marked by intellectual pluralism.

This closing of economics is significantly attributable to the laissez-faire ideological predispositions of new classical macroeconomics. It has also has been driven by economists’ disdain for epistemological concerns, which has fostered intellectual intolerance and over-reach. Competing theoretical paradigms have been framed inappropriately in terms of truth versus error, a frame that inevitably drives exclusion of the paradigm labeled as being in error. This framing is supported by an erroneous belief that science produces a single true answer. Much vaunted mathematical rigor is built on conceptual narrowness and sloppiness, and the use of math is as much a rhetorical device for selective screening of ideas as it is for exploring the logical coherence of ideas.

These flawed practices have distorted the academy, and in doing so have had profoundly negative consequences for society. That concerns us in our dual identities as professional economists and citizens, and it is this concern that motivates the founding of the journal.

As the name signals, the journal is intended to promote research in a particular paradigm -- the Keynesian paradigm. We make no apologies for this. Journals on international economics promote research in international economics: journals on finance promote research in financial economics. We have no objection to journals promoting particular types of economic research or thinking. What we object to is general-purpose and field journals only permitting research in a particular paradigm.

We have intentionally titled the journal Keynesian without any qualifying adjective or prefix. Our aim is to encourage research and discourse in Keynesian economics – be it old Keynesianism, fundamental Keynesianism, neo-Keynesianism, Post Keynesianism, Sraffian Keynesianism, Kaleckian Keynesianism, or Marxist Keynesianism. The journal is open to all forms of Keynesianism, which we define as (1) holding that output and employment are normally constrained by aggregate demand, (2) holding that the problematic of aggregate demand shortage exists independently of price, nominal wage, and nominal interest rate rigidities, and (3) rejecting the claim that the real wage is equal to the marginal disutility of labor.

This openness to all forms of Keynesianism reflects a desire to avoid intellectual sectarianism, which we think has afflicted past Keynesian discourse. In our view circumstance and ability certainly contributed to the success of the classical macroeconomics counter-revolutionaries, but so too did intellectual and sociological failure among Keynesians. Their tendency to apply arbitrary litmus tests and engage in intellectual sectarianism did a disservice to their project, and in doing so did disservice to society. We want to avoid repeating that history.

The contract with the journal publisher, Edward Elgar, was signed in 2011. We, the founding editors, are very happy with this timing as 2011 marked the seventy-fifth anniversary of Keynes’ General Theory. The founding of the Review of Keynesian Economics is a fitting tribute and celebration of this anniversary. It is also part of the deeper response needed to meet these challenging economic times.

The journal will be dedicated to the development of Keynesian theory and policy. In our view, Keynesian theory should hold a similar place in economics to that held by the theory of evolution in biology. Many individual economists still work within the Keynesian paradigm, but intellectual success demands institutional support that can leverage those individual efforts. The journal aims to offer such support by providing a forum for developing and sharing Keynesian ideas. Not only does that include ideas about macroeconomic theory and policy, it also extends to microeconomic and meso-economic analysis and relevant empirical and historical research. We see a bright future for the Keynesian approach to macroeconomics and invite the economics profession to join us by subscribing to the journal and submitting manuscripts.

The capital debates: A brief introduction

2012-03-01T08:01:00.007-08:00

Teaching on the capital debates this and last week. So here are some thoughts, based on my class notes and the required readings (see below). The capital debates remain a puzzling chapter in the history of economic ideas. Nearly everyone accepts that the British (as opposed to the Massachusetts) Cambridge won the debate, something Paul Samuelson acknowledged early on.[1] Yet, no one seems to grasp the full implications and relevance of the debate itself. Typically it is assumed that the capital debates relate simply to problems of aggregation, and that the use of aggregate production functions and aggregative measures of capital are still justifiable, for simplicity’s sake. However, contrary to this viewpoint the capital debates did not rest upon the possibility of building aggregate measures.

The capital debates are associated with the very notion of capital. Classical political economy authors, from William Petty to Karl Marx, including Quesnay, Smith and Ricardo, treated the process of production as a circular one. In this context, capital is a produced means of production,[2] rather than a factor of production used in the process of obtaining final goods. The most important result of the capital debates is that, once capital is defined as produced means of production, there is no direct relation between the relative abundance or scarcity of the means of production and its remuneration. Distribution, in other words, is not governed by supply and demand.

Since the Marginalist Revolution, and the rise of the so-called neoclassical school, the notion that relative prices are determined by supply and demand, and that these reflect the relative abundance or scarcity of all goods and services – including factors of production – became consensual. As a result, the supply and demand for capital became the determination for the remuneration of capital. The more abundant is capital, the lower its remuneration, and vice versa if it is scarce. Conflict has no role to play in the determination of distribution, and social classes vanished entirely from analysis.

Additionally, substitution leads to the full utilization of resources and their optimal allocation. If capital is scarce and expensive, and labor abundant and cheap, economic agents substitute labor for capital and fully utilize labor. Thus, despite the abundance of labor, its relative cheapness, through the principle of substitution, leads to full employment. Indeed, unhampered markets do lead to the veritable best of all possible worlds.

It is the logic of the principle of substitution, based on relative scarcities that the capital debates shattered. Contrary to the neoclassical parable, the capital debates showed that it is not generally possible to obtain a univocal relation between remuneration and relative scarcity. For example, assume that we have two commodities produced with capital and labor, and that one can be said to be univocally more capital abundant than the other. In this case, as capital becomes more abundant the profit-to-real-wage ratio will fall, more capital will be used, and more of the capital-intensive good will be produced. However, it is possible that one good would be more capital intensive at high levels of the profit-to-real-wage ratio, and that the other becomes the capital intensive good at lower levels of the same ratio. That is, we would have factor intensity reversal. In the instance of factor intensity reversals, the conventional relation between factor scarcity and relative prices breaks down.

In this situation, it would be possible that as the profit-to-real-wage ratio falls, more labor will be used, and more of the labor-intensive good will be produced. In other words, there would be reverse capital deepening and a lower rate of profit associated with a reduction in the use of capital. Substitution moves in the wrong direction, so to speak, and more of the scarce factor is demanded. A simple algebraic exercise may help understand the point.

Let’s assume that there are two methods of production, associated to the manufacture of capital (iron) and consumption (corn) goods respectively. The prices are determined by:

(1) pc=wlc+rpkkc
(2) pk=wlk+rpkkk

where the subscripts refer to consumption and capital, l and k are the technical coefficients of production, and w and r are the real wage and rate of profit. Using pc as a numeraire and solving for pk we obtain:

(3) pk=(1-wlc)/rkc

From (3) into (2) we get:

(4) [(1-wlc)/rkc]=wlk+rkk[(1-wlc)/rkc]

Simplifying, and solving for w we find:

(5) w=(1-rkk)/[lc+(lkkc-lckk)r]

If the expression in the small parenthesis in the denominator is equalized to zero we obtain a wage-profit frontier that is linear. This assumption is what Samuelson (1962, p. 225, n. 7) refers to as the equi-proportional assumption. Figure 1 shows the choice of technique under this assumption.

Figure 1

The firm chooses the highest rate of profit for a given real wage, which implies that as the rate of profit falls the firm must choose the more capital intensive (b in this case). In this case, the neoclassical parable works; there is an inverse relation between factor intensity and its remuneration.

Once, the assumption of equi-proportional capital to labor ratios in the machine and consumption sectors (which would mean in Marxist terminology the same organic composition of capital in both sectors) is dropped the wage-profit frontier is not linear anymore. If we assume that the capital goods sector is more capital intensive than the consumption sector then the wage-profit frontier will be concave (as shown in Figure 2).

Figure 2

In this case, we have two switches; at high levels of the rate of profit the firm choose technique a, which is more labor-intensive, and as the rate of profits falls it switches to b the capital-intensive one as prescribed by neoclassical economics. However, at even lower levels of the rate of profit, the firm switches back to the more labor intensive technique. Reswitching and reverse capital deepening, hence, result from the dismissal of the equi-proportionality assumption, which is what one would expect in a world with several goods.

The implications for neoclassical theory cannot be overstated. First and foremost, there is no relation between relative scarcity and the remuneration of factors of production, and, as a result, distribution is not simply the product of market forces. Further, there is no guarantee that all resources will be fully utilized.[3]

It must be noted that, even though the capital debates are fundamentally about the logical coherence of the neoclassical approach, the results of the capital debates have important empirical implications. Neoclassical theory makes strong predictions vis-à-vis substitution effects and the relation between relative scarcity and remuneration. Yet the capital debates suggest that some of those predictions might not be consistent, and, as a result, the absence of those relations might be expected in the real world.

The most obvious prediction is the inverse relation between investment (capital intensity) and the rate of interest (its remuneration). As it is well known, there is little evidence that investment is sensitive to variations in the real rate of interest. In a rare survey of the empirical literature on the determinants of investment Robert Chirinko (1993, p. 1906) argues, “[T]he response of investment to price variables tends to be small and unimportant relative to quantity variables.” In other words, interest rates have little effect on gross capital formation, and the substitution effects that imply that agents use the cheaper factor of production are not operative. Further, the empirical evidence suggests that investment reacts to quantity variables, meaning the level of activity. This suggests that the income effects tend to be larger tahn substitution effects and that a firm facing less demand will not buy capital goods, even if the interest rate is low. These results underscore the empirical relevance of the capital debates.[4]

Similarly, the capital debates highlighted the futility of using the aggregate production function to measure the growth and productivity performance of real economies. The theoretical problems with the aggregate production function, associated to the notion of capital as a scarce resource, are compounded by the impossibility of disentangling it from the identity of income with the structure of the functional distribution of income (Felipe and Fisher, 2003). In other words, if one runs a regression of income on capital and labor, as is often done by those using a production function, it necessarily follows that income grows because capital and labor grow. Furthermore, changes in income distribution also affect income growth, as total income (net of taxes) is by definition the wage multiplied by labor utilized in production plus capital multiplied by its remuneration.

In this way, the capital debates demolished the theoretical foundations of neoclassical economics, and provided significant empirical evidence that those neoclassical models and their resultant policy prescriptions should be viewed with a healthy measure of skepticism.

Faced with the impossibility of using both the notion of aggregate capital and the principle of substitution, neoclassical economics opted to apply the principle of substitution to each kind of capital good taken as a distinct factor of production, by using the Arrow-Debreu model of intertemporal general equilibrium (Garegnani, 1976; Milgate, 1979). Even though the idea of intertemporal equilibrium, in which capital is treated as a vector of heterogeneous capital goods, was first developed by Eric Lindahl and then popularized by John R. Hicks in the 1930s, and used by Arrow and Debreu in the 1950s, it was only after the capital debates that it came to be dominant within the mainstream.

The problem with the use of heterogeneous capital goods is that it implies a change in the traditional method of economics. Normal equilibrium positions are associated to a uniform rate of profit; however, when dealing with heterogeneous capital goods that are not substitutable between each other, it becomes necessary to discard the notion of long run equilibrium. In Arrow-Debreu models all prices are short run prices, associated to differential rentals for each capital good, and any change in the data of the system – preferences, technology, and information for given initial endowments – affects the direction to which the economy adjusts (Petri, 2003).

In other words, the forces of competition that lead capitalists to those sectors with higher remuneration and establish a uniform rate of profit do not operate in the Walrasian world.[5] Hence, the Walrasian models are incapable of ascertaining tendencies in real economies, a defect that is not mitigated with the introduction of imperfections (Stiglitz, 1993, p. 109), which Stiglitz calls the post-Walrasian and post-Marxist paradigm. Far from increasing the realism of the model, the casting about of such lifelines only complicates the results of an exceptionally unrealistic one.

Information imperfections, and other related imperfections like price rigidities or lack of rationality, once introduced leave the Arrow-Debreu model unable to produce Pareto efficient solutions, or even market equilibrium, since some markets may not exist. Additionally, the introduction of imperfections renders the aggregative model prone to suboptimal outcomes. Suboptimal results in the presence of imperfections suggest that in their absence markets would still produce optimal outcomes.[6]

Some authors tend to confuse the imperfectionist arguments, and the implicit support that they provide for policy intervention, as a break with orthodoxy. While it is clear that they provide space for flexibility in policy advice, they remain firmly based on orthodox grounds.[7] The capital debates, in contrast, showed that unhindered markets, free of imperfections of any type, do not lead to market efficiency in general.

Faced with the logical problems that neoclassical aggregative models are riddled with on the one hand, and the irrelevance of general equilibrium models on the other, neoclassical economists did what any rational agent would do: disregard the critiques and in so doing, their deleterious results, and proceed as if nothing had happened. However, an innovative, if not peculiar, development generated a curious division of labor within neoclassical economics. Aggregative models were deployed for the purposes of teaching and policymaking, while the Arrow-Debreu model became the retreat of neoclassical authors when questioned about the logical consistency of their models. In this response, a harsh tradeoff between logical consistency and relevance was cultivated in the very core of mainstream economics.

The degree of fragmentation – as Roncaglia (2005, p. 468) so aptly expresses it – and confusion in the mainstream today is the result of such inconsistency at the core of economics, and not uniquely, as is frequently asserted, because of the demise of the Keynesian consensus. The collapse of the certainties provided by the old aggregative neoclassical model has brought about an often cynical defense of market-oriented policies for their own sake. The return of Vulgar Economics, which “sticks to appearances … [and] believes that ‘ignorance is a sufficient reason’” (Marx, 1867, p. 307) is complete.

Notes:
[1] See Samuelson (1966). A typical position is that of Robert Lucas (1988, p. 36) who notes the victory of the British argument, and yet remains oblivious to the problems of using the aggregate production function in the same paper.

[2] For Marx (1867, p. 189) capital also involved a social relation between the owners of the means of production and those forced to sell their labor power. For him, capital “can spring to life, only when the owner of the means of production and subsistence meets in the market with the free laborer selling his labor-power.”

[3] Both results are important, for example, for the Keynesian possibility of unemployment equilibrium. Keynes’ (1936, p. 243) emphasis on the unimportance of the natural rate of interest not only implies that the supply and demand for capital (loanable funds) do not determine the equilibrium rate of interest, but also that the conventional rate of interest may be set at such a level that brings about persistent unemployment.

[4] In the same way, the empirical evidence seems to contradict the notion that higher wages would lead to substitution of cheaper factors of production for labor. The exemplary case is the well-know study of the fast food industry in New Jersey, which found a positive correlation between the minimum wage and employment (Card and Krueger, 1995).

[5] That GE models do not support the notion that the abundance of a factor of production will be associated with lower remuneration has been pointed out by a survey of those models (Bliss, 1975).

[6] The same is valid for Bowles and Gintis’ (1993, p. 84) notion that market exchanges are usually contested and endogenous enforcement costs are not zero, and, as a result, there are conﬂicts of interest among exchanging parties. Therefore, if enforcement costs were nonexistent the Arrow-Debreu results would prevail. It must be noted that all the literature on post-Walrasian economics presumes continuity between the classical political economy authors and the post-marginalist revolution economics, which would mean that there are no significant distinctions between Smith, Marx, Walras and Arrow.

[7] Colander et al. (2004), for example, seems to suggest that several of the post-Walrasian developments can be seen as breaking up with orthodoxy. For a critique see Vernengo (2010).

Additional Readings:

Bliss, Christopher (1975), Capital Theory and the Distribution of Income, Amsterdam and New York: Elsevier North-Holland.

Bowles, Samuel and Herbert Gintis (1993), ‘The revenge of homo economicus: Contested exchange and the revival of political economy’ The Journal of Economic Perspectives, 7(1), 83-102.

Card, David and Krueger, Alan (1995), Myth and Measurement: The New Economics of the Minimum Wage, Princeton: Princeton University Press.

Chirinko, Robert (1993), ‘Business fixed investment spending: Modeling strategies, empirical results, and policy implications’, Journal of Economic Literature, 31(4), 1875-1911.Journal of Economic Literature, 31(4), 1875-1911.

Colander, David, Rick Holt, and J. Barkley Rosser Jr. (2004), “The changing face of mainstream economics,” Review of Political Economy, 16, pp. 485-99.

Felipe, Jesus and Franklin Fisher (2003), ‘Aggregation in production functions: what applied economists should know’, Metroeconomica, 54(2-3), 208-262.Metroeconomica, 54(2-3), 208-262.

Garegnani, Pierangelo (1976), ‘On a change in the notion of equilibrium in recent work on value: a comment on Samuelson’, in M. Brown, K. Sato and P. Zarembka (eds), Essays in Modern Capital Theory, Amsterdam: North-Holland.Essays in Modern Capital Theory, Amsterdam: North-Holland.

Heim, John J. (2009), ‘Which Interest Rate Seems Most Related to Business Investment?’, American Society of Business and Behavioral Sciences E-Journal, 5(1), February.American Society of Business and Behavioral Sciences E-Journal, 5(1), February.

Keynes, John M. (1936), The General Theory of Employment, Interest and Money, New York: Harcourt Brace.

Lucas, Robert (1988), 'On the Mechanics of Economic Development,' Journal of Monetary Economics 22 (1), pp. 3–42.

Marx, Karl (1867), Capital, NY: International Publishers.Capital, NY: International Publishers.

Milgate, Murray (1979), 'On the origin of the notion of ‘intertemporal equilibrium’,' Economica, 46(181), 1-10.Economica, 46(181), 1-10.

Petri, Fabio (2003), ‘A ‘Sraffian’ critique of general equilibrium theory, and the classical Keynesian alternative’, in F. Petri and F. Hahn (eds), General Equilbrium: Problems and Prospects, London and New York: Routledge, pp. 387-421.

Samuelson, Paul (1962), “Parable and Realism in Capital Theory: The Surrogate Production Function,” Review of Economic Studies, 29(3), pp. 193-206.

Samuelson, Paul (1966), ‘A summing up,’ Quarterly Journal of Economics, 80(4), 568-583.Quarterly Journal of Economics, 80(4), 568-583.

Vernengo, M. (2010), 'Conversation or Monologue? On Advising Heterodox Economists,' Journal of Post Keynesian Economics, 32(3), pp. 389-96.

Wealthy people were more likely to steal candy from children

2012-02-28T18:10:00.002-08:00

This is great!

http://www.marketplace.org/topics/economy/are-wealthy-less-ethical

Heterodox Central Bankers III

2012-02-25T05:50:00.002-08:00

Raúl Prebisch (1901-1986)

Raúl Prebisch on the adoption of foreign exchange controls by the Argentinean central bank in 1943:

“This capital [short-term capital] went to further inflate the categories of goods or assets that were already inflated, and did not translate, except in very rare occasions, in a real increase in the production of the country… the measures adopted by the government permit to make an exception, to allow the inflow of these capitals if it is shown that these are oriented towards the increase in real production…” (Obras, 1919-1949 Vol. IV, p. 183; General Manager, Central Bank of Argentina, 1935-1943).

In other words, short-term speculative flows should be constrained, but long-term flows for productive activities are fine.

Cesaratto on 'Monetary Mercantilism'

2012-02-24T12:20:00.000-08:00

Sergio Cesaratto on what one might term national views on the European crisis, in particular on orthodox German views. Very instructive. He says:

It obviously makes little sense to blame Germany or any other country for the European crisis. Each dominant class joined the European Monetary Union (EMU) in its own interest or pretending to do so for its respective country. If the collective design of the EMU has failed, the responsibility is not of one single country: each national elite has made its own calculations and they should all have known that Europe was not an optimal currency area. We cannot know, of course, what would have happened to Europe or to single members of the Eurozone (EZ) without the EMU. Less excusable is, especially for major countries, not to appreciate and change national policies that are particularly inconsistent with the EMU. Unfortunately this is far from happening.

Read the rest here.

A farewell to growth?

2012-02-23T07:09:00.002-08:00

It has been common for certain progressive groups to suggest that better income distribution and no growth, or even degrowth more recently, would be better than the capitalist driven consumerist growth process [for a critical review of this literature go here]. Several different strands of thought are involved in this view, and it would probably be worthwhile to disentangle them all.

First, there is an obvious Malthusian flavor to this view, going back to the dire predictions by the Club of Rome in the early 1970s, as a result of limited availability of non-renewable resources. Peak oil has been predicted a few times since. And yes it may very well happen in the near future, but somehow I doubt it. Remember that we moved away from coal and steam engines to oil and combustion ones, not because coal disappeared or became truly scarce, but simple because technological change made it less important as a source of energy (and yes we still burn a lot of coal).

In that sense, our problem is less that we have reached the limits of the existence of renewable resources, but more that the consequences, which are associated to Green House Gas (GHG) emissions, will be and already are dire. It is very likely that climate change caused by GHG emissions will lead to increasing costs in terms of food shortages, for example. But the question there is less that we cannot grow [the Malthusian thing, food does not grow as fast as population; the quintessential anti-Malthusian was Ester Boserup, an early feminist economist, that showed that agricultural productivity was determined by population dynamics; in other words, higher population growth led to increasing agricultural productivity], but who bears the costs of growth.

We leave in a world in which many developing countries import food, in part as a result of very high productivity in agriculture in developed countries, and in part as a result of subsidies and trade policies imposed by developed countries. The costs of global warming will fall overwhelmingly over poor and food-insecure countries in dry and tropical regions, that largely depend on rain fed farming, mostly in Sub-Saharan Africa and South Asia.

That means that a more equitable system to redistribute the costs of climate change, and alternative trade and agricultural policies are needed, which provide food security around the globe. Further, to reduce the effects of climate change a huge increase in spending on R&D is necessary.A Green New Deal or environmental equivalent of the space race, and lots of regulation would do a great deal to promote new and cleaner technologies (see for example the 2006 documentary, “Who Killed the Electric Car,” on what a California regulation did for the electric car).

Finally, note that there is no evidence of sustained technological progress (call it division of labor, or productivity, and you see that the wealth of nations might depend on it) with zero growth or negative growth. Productivity is not only pro-cyclical, but also structurally connected to growth. No growth in demand means limited incentives to productivity increases. So only with economic growth there is a hope of getting cleaner technologies. Degrowth also might lead to all sorts of environmental degradation, since it is far from clear that a society with spiraling down output would manage resources efficiently.

Second, there is peculiar view of the relation between income distribution, consumption patterns and economic growth. The notion is that no growth is necessary, since better living conditions can be obtained simply by redistributing income. The presumption seems to be that income distribution will have no effect on patterns of consumption and on economic growth. It is true that the effects of income distribution on growth are ambiguous, but the presumption that they have no effect is very strong.

I have my own views on what is more or less likely under the particular circumstances we are in. It seems reasonable, that if the redistribution towards the less privileged that the no-growth/degrowth crowd want took place that a consumption boom would follow. Particularly in developed countries were wages have been repressed for a while and which the last few years of the recession have made worse. And that would lead to growth, which is the opposite of what they want. But as much as I would favor that sort of redistributive policy, alas it is not in the cards.

Further, although it is true that consumerism is in many respects created by corporations and several elements in the consumption patterns in modern advanced societies are wasteful, one might also be careful about the false moralism of the New Puritans, as James Livingstone refers to those that preach that all thrift is good and all consumption bad. Consumption is associated to growth, and to better living conditions for the poorest among us. After all it has been the consumer society created by the Industrial Revolution that allowed us to obtain several of the benefits that we now take for granted in civilized societies, with longer life expectancy and better quality of life.

Finally, there is a naïve neoclassicism that is also part of the problem with the no-growth/degrowth crowd. It seems that for some, economics is synonymous with a certain view in which supply and demand determine everything, and, hence, the rejection of the consequences of those neoliberal policies must pass through the rejection of growth too.

Of course growth might not be associated to the market forces as suggested in neoclassical theory (and markets might actually work in very different ways than the mainstream thinks they do). Growth might often be the result of limiting the power of markets, and driving economic forces towards alternative goals. And, while it is certainly true that not all growth is good for the environment, an alternative (and Keynesian) perspective of what is behind growth and development processes might open the door for more environmentally friendly economic dynamics. A simple example would be to use the proceeds of say nationalized and heavily regulated oil extraction for investment in research and development of new technologies.

PS: Obviously all of the views discussed above are not held necessarily by any particularly person that believes that no-growth or degrowth is necessary. And I left a few additional views out, e.g. a view that capitalism is doomed and we are on the verge of a new (perhaps better) system (by the way, I don't agree with that one too; capitalism is doing fine, even if workers are not). But all of these propositions are part of the arguments used by different people to suggest that the benefits of economic growth are overrated.

Yanis Varoufakis report on Greece

2012-02-21T04:28:00.000-08:00

MMT and its discontents

2012-02-20T05:21:00.000-08:00

The Washington Post had a substantial profile on what is now termed Modern Monetary Theory (starts with Jamie Galbraith, and then goes on to the Kansas version of post Keynesian economics). A few reactions in the blogosphere. Two worth noticing are by Dean Baker and Jared Bernstein that provide qualified support.

Dean suggests that beyond fiscal deficits stimulus should also come from monetary policy (lower interest rate), and a more depreciated dollar. My guess is that, at least the Kansas MMTers would be fine with both, but suggest that lower rates of interest are not much in play now. But from what I understand a depreciated dollar has been seen as part of a solution by most progressive economists. Randy Wray, for example, is certainly less concerned with the size of a trade deficit than Dean, since the US is the issuer of the key currency [I have less confidence on flexible exchange rates as a way of solving balance of payments constraints in developing countries, but I'll leave that for another post].

My concern with Dean's notion of a more devalued dollar, which is generally fine and will not lead to the demise of the dollar in the near future, is that for the workers with low wages that depend on cheap imports at Walmart it implies higher prices and lower real wages. A boost to increase real wages would be necessary [see Jamie on that here]. So better income distribution should be the most important channel to boost consumption on a sustainable way.

Jared Bernstein fundamentally adds that taxes on the wealthy should be increased. Which he argues from a political standpoint, and I think it is quite reasonable, since that is one way (besides hiking minimum wages, and repealing right to work and other anti-labor legislation) to improve income distribution.

On a more personal level, my problem with the WaPo piece, and the general discussion of MMT, is that for the most part it sees MMT as just a policy program (the Kansas one is, for example, an Employer of Last Resort of some type, which is fine with me, by the way), and does not separate the theoretical discussions from the policy stuff.

Endogenous money, chartalism, and functional finance, are relevant because they fit the theoretical framework of a coherent heterodox alternative to the mainstream based on Keynes' Principle of Effective Demand [for a full alternative you need also long term pricing; in Kansas your man for that would be Fred Lee]. For my views on that go here. I think, hence, that a coherent alternative to the mainstream, beyond Keynesian economics, requires a good dose of the old and forgotten methods of classical political economy.

PS: My point about theoretical versus policy matters is driven by the fact that on certain policy issues, like the need for further fiscal stimulus, New Keynesians like Krugman and DeLong would be fundamentally in agreement with MMTers.

Put down your Sargent textbook and step away from the econometrics!

2012-02-19T21:38:00.000-08:00

The confusion among mainstream economist is amazing. Mark Thoma in his recent post on our under-performing economy highlights this fact. While going through various models illustrating the GDP gap he makes this statement:

“One way to think of these models is that variation in the red line arises from supply shocks, and variation around the red line -- shown by the blue line -- represents demand shocks. Thus, under this interpretation, the first two models assume that all variation in the economy is due to demand shocks. This is clearly incorrect -- certainly supply shocks matter too -- and therefore these models may not give a very good measure of the gap.”

What is simple amazing about this post and statement is that it is wrong on so many levels. The red line (GDP trend) Thoma is referring to is his trend generated from a regression run on the blue line (actual GDP). If the blue line represents demand, the red line is an average of that demand over the whole data set, not supply! Yes! it is a lack of demand in the economy. What supply shock is Thoma so concerned with capturing in his models? Supply is fine; there are 12.8 million people currently unemployed (officially). This is from a guy who is supposed to be “Keynesian”.

His last model attempts a RBC trick of allowing the trend to be stochastic. So the blue line is still the variations in the actual demand in the economy, and the red line is just a more elaborate average of that demand and still not supply. It’s great to see that the mainstream of the profession has such a firm understanding of theory and basic statistics!

Amity Shlaes is a Keynesian after all!

2012-02-16T07:15:00.001-08:00

Amity Shlaes has argued that the New Deal made things worse in the United States, prolonging the Great Depression in her popular book The Forgotten Men (for a devastating critique go here or here). Now she tells us that it was not so. True to her conservative convictions she argues that nation building abroad is a good thing. The explanation of why nation building is actually a good thing is where she gets confused and argues on the basis of Keynesian logic.

She says that countries that were occupied by American troops grew faster, and even uses the multiplier effect to show the consequences of troop withdrawals. She is aware that this is a bit dangerous, and suggests that "the usual explanation for the growth would be the multiplier effect. ... but multiplier effects don’t last, just as stimuli don’t last at home." Hence, even though the multiplier works, it does not work forever.

So her point is that if the multiplier has only limited effects then it is not a Keynesian argument! The notion that the multiplier effect is based on public choice (Mancur Olson) and not on her bête noire John Maynard Keynes – whose ideas she describes as "sheer fallacies" (2008, p. 272) – is farfetched.

The multiplier, developed by Keynes student and disciple Richard Kahn, says exactly that spending generates income, and leads to higher levels of output and employment. And of course it does not imply that the effects are unlimited, but only that they are positive (she used to argue that they were negative reducing growth, as in the New Deal).

Even if you say, like she does, that the multiplier only works in the short run or more precisely for a limited period of time, and then you need confidence or trust to maintain growth, it is still the initial spending that kick started the growth process. And yes she even gets that confidence is the result of the initial spending, and not vice versa. At the end of the day, she basically thinks Military Keynesianism works abroad. Perhaps the United States should invade the United States, and start nation building at home.

Too many things wrong (Sargent and Field edition)

2012-02-16T06:09:00.004-08:00

And not enough time to blog about all of them. Two that seem to be really important and worth noticing in recent debates around the blogosphere among the chattering classes are the idea (subscription required) that State Defaults after the Jacksonian economic crisis were good to establish US credibility, and the notion that Total Factor Productivity (TFP) was essential for the US recovering from the Great Depression.

Very briefly I’ll discuss why these two propositions are just wrong. Sargent argues that by guaranteeing State debts the Hamiltonian system created moral hazard, and that the States defaults of the 1840s, which resulted from this arrangement, were instrumental in creating a credible fiscal commitment to sound finance. In his words: “in refusing to bail out the states in the early 1840s … the federal government reset its reputation vis-à-vis the states, telling them in effect not to expect it to underwrite their profligacy.” The lesson for Europe is let the periphery default, and, by the way, that would lead them to fiscal consolidation by even more austerity (yep he never heard of multipliers). At any rate, this account of the United States experience is pure fiction.

First of all the collapse had nothing to do with profligacy, and all to do with prices of cotton falling, and States defaulting on foreign debt, not domestic debt. In Europe the countries do print the money in which their debt is denominated, the problem is that the ECB is not willing to do it. The crisis is self-made, and if the ECB monetized a bit of debt there would be no danger of inflation, since the economies are really (really) far from full employment.

Further, the US national government at that point had no public debt (Jackson paid it down and caused a financial crash; he also required payments of public lands in specie, that is the crisis was worsened by austerity and sound money), and no national bank or monetary authority. Hence, it could not bail the States out. Only after the Civil War, with greenbacks, a more centralized management of debt and money were created in the US. So there is no possibility that the reputation of something that did not exist until the 1860s was built in the 1840s.

Sargent's anal fixation with austerity in order to pay debts, even those in domestic currency, and his lack of understanding of basic events in the history of the United States are appalling. And this guy got a Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel (yep, it’s not a real Nobel!).

Field is an interesting case. The mistake in his book is not of his making, in all fairness, but the result of the profession's lack of understanding of basic economic principles. His point, well explained by Mark Thoma, is that part of the recovery in the 1930s was caused by rapid growth in productivity (TFP). Nothing against the argument, which might be (and probably is) true, to some extent. Note also that productivity is not only pro-cyclical but also structural and demand-led, which means that some of the increase in productivity was actually caused by the recovery. But the problem is that TFP is not a measure of productivity.

Note that TFP is based on the notion that there is a production function in which output (Y) is a function of labor (N) and capital (K), and forget for a second the problems of using the notion of a quantity of capital. In addition, we know that income (Y) is equal to the payments to labor (N) and capital (K). So we have a theoretical construct and an identity:

Y=f(N, K) and Y=wN+rK

Obviously if you derive Y with respect to time, you must obtain from either equation that the growth of Y over time is a function of growth in labor and capital, and either some additional part, which depends on the technology f(…) in the theoretical construct, and the weighted average of the growth of wages (w) and profits (r) in the identity. And yes the second is an identity and by definition (constructed in the national accounts) true. So TFP is a residual that says something about income distribution. Let’s please use labor productivity, when discussing productivity. For more on that see, for example, Felipe and McCombie (2001; subscription required).

Reviewing the reviewers of the crisis

2012-02-15T05:14:00.000-08:00

From Triplecrisis:

Gary Gorton and Andrew Metrick have just produced a survey on the vast literature on what happened during the last financial crisis (and to a lesser extent why it did) titled “Getting Up To Speed on the Financial Crisis,” to be published by the Journal of Economic Literature. They used only 16 documents, between papers from ‘top journals,’ reports and speeches and congressional testimonies. It must be noted that the objective of the review is to provide “a one-weekend-reader’s guide” to the crisis.

The biggest problem with their paper is not the limited number of documents reviewed, which seem to be fairly representative of conventional views on the financial crisis, but the limitations of what the mainstream of the profession knows about the crisis, and worse, what the profession clearly does not know it does not know, the unknown unknowns, so to speak. And that is why ignoring heterodox and progressive contributions has been very harmful for the profession.

Read the rest here.

Failing grade for econ courses

2012-02-14T06:08:00.002-08:00

From Remapping Debate:

"Until the 1980s, undergraduate students in economics were generally required to take a course in economic history or the history of economic thought, or both. Over the last twenty years, however, those requirements have been dropped from the curriculum in nearly all undergraduate programs, and even many graduate programs do not require them.

This ahistorical view of economics, according to David Ruccio of Notre Dame, deprives students of fundamental knowledge about the field they are studying and how it has developed. “The implication for students is that what exists now has always existed and will always exist,” he said. “It allows for the impression that there is only one perspective on economics and ignores the multiplicity of perspectives that have existed and exist today.”

Julie Nelson, chair of the economics department at the University of Massachusetts Boston, agreed. “Not having those courses removes the context from the theories and makes them seem like they’re divinely ordained,” she said. “There’s no sense that economics is created by people.”

According to Frederic Lee of the University of Missouri–Kansas City, “if you were actually teaching them about the economy, you might have to talk about the rise of capitalism and the industrial revolution,” he said. “You’d need to talk about American history and the plantation economy and the attack on workers in the 1880s and the Great Depression and the military–industrial complex and the Cold War. These are just some examples to illustrate that without the history we have no place to understand what we mean by capitalism, which is essentially what they’re studying.”

Of course there are a few oases in the profession.

Long-term versus short-term debt

2012-02-08T17:47:00.000-08:00

In a previous post I have referred to the Fiscal-Military State, and Brewer's classic book on it. It is worth remembering, for those afraid about debt these days, that public debt in the UK during the Napoleonic Wars peaked at more than 250% of GDP.

One of the important ways in which the British were able to out-finance the other major European powers, fundamentally France, during the 18th century was the ability to borrow long at at low rates. The graph below shows the proportion of unfunded to funded debt (from Brewer's book). The UK rapidly moved from almost 100% of unfunded debt to less than 10%.

Funded debt, was debt for which specific taxes were set aside to service it, and it tended to be long-term, while unfunded debt was usually short-term debt. Debt service consumed a great amount of the budget, but that was simply the result of the incredibly large amount of debt, since interest rates remained relatively low. I guess the lesson is that long term debt in your own currency is okay.

Heterodox central bankers II

2012-02-02T06:16:00.000-08:00

"At the present time we are still in the depths of a depression and, beyond creating an easy money situation, there is very little, if anything, that the Reserve organization can do toward bringing about recovery. One cannot push a string. I believe, however, that if a condition of great business activity were developing to a point of credit inflation, monetary action could be very effective in curbing undue expansion. That would be pulling a string."

Marriner S. Eccles

Chairman, Federal Reserve Board

March 4-20, 1935.

"The factor of unutilized capacity appears to furnish the decisive answer to the argument that if the budget had been balanced the resulting restoration of confidence would in itself have led to recovery. There is nothing in balancing the budget that would lead to an absorption of excess capacity and hence make it profitable for business to increase its disbursements for plant and equipment. On the contrary, balancing the budget, by curtailing the incomes of people receiving money from the Government and by reducing buying power through increased taxes, would heve been expected to decrease demand and hence increase excess capacity."

Marriner S. Eccles

Chairman, Federal Reserve Board

June 8, 1936

Heterodox central bankers

2012-02-02T05:43:00.000-08:00

"Our national debt we will owe to ourselves. The cost of interest service and gradual repayment that is collected in taxes from one generation will be paid to the same generation. The debt will be held wholly within the United States and by our citizens. It will present none of the impossible problems that accompany an external debt. If we fail in the future to make democracy worth while, it will not be the size of the public debt that defeats us. It will be because we have not learned how to use these great resources - human and material - to provide full employment and a high standard of living for all our people."

Chester C. Davis

President, Federal Reserve Bank of St. Louis

November 14, 1942

Europe's suicide (com)pact

2012-02-01T05:54:00.000-08:00

The draft of the fiscal compact, hailed as a masterpiece by Angela Merkel, was released yesterday (see here). Note article 3.1.a. which says that "the budgetary position of the general government shall be balanced or in surplus." This is more stringent than the old Stability and Growth Pact (SGP) that the fiscal compact supersedes. The consequences of fiscal austerity are already dramatic, and the notion that more of the same can actually have a positive effect is simple madness.

Minsky's Papers

2012-01-30T05:54:00.000-08:00

Minsky's papers are available here. Several interesting nuggets for those willing to dig. Enjoy!

Expansionary Austerity - a Guide to Killing Zombie Economists

2012-01-28T15:03:00.000-08:00

Pondering the puzzle of far too many zombie economists, many of European, English, and American fresh-water origin, I started researching how to REALLY kill a zombie.

The recent tragic British recessionary news motivates this research. Britain receded into a recession in the fourth quarter, making the current depression the longest even considering the prior depression. This NIESR chart is from Jonathan Portes, Director, National Institute of Economic and Social Research, previously, Chief Economist at the UK Cabinet Office. Notice that, in Britain, this depression is also almost as deep as the prior one.

Menzie Chinn, of the University of Wisconsin, Madison, also weighs in with his view which highlights the drastic difference that zombie-supporting political ideologues make in the affairs of nations. Here is his chart:

And Chris Dillow, via Mark Thoma, both have the same question I do (minus the zombie part).

So, I feel I am on solid ground in my quest. The best reference so far for killing zombies (not refereed a.f.a.i.k.), seems to be the Zombie Wiki.

The essential step, though there are many, is destroying the brain of the zombie. That sounds about right to me, though I would hope these charts and the recent IMF studies would destroy the offending brain cells. I think it's way past time that expansionary austerity die its deserved death. Waiting for dark, got my high power flash and brain destroying implements. Off to hunt Zombies.

Can anyone identify the economist in the opening picture?

Update: Here is a link to the IMF Working Paper; the conclusion is at page 30, but take a minute to browse their graphs. Austerity is contractionary.

Keynes's General Theory: Seventy-Five Years Later

2012-01-27T07:18:00.000-08:00

This volume, a collection of essays by internationally known experts in the area of the history of economic thought and of the economics of Keynes and macroeconomics in particular, is designed to celebrate the 75th anniversary of the publication of The General Theory.

The essays contained in this volume are divided into four sections. The first section contains three essays that explore the concept of fundamental uncertainty and its unique role in The General Theory. The second section contains five essays that examine the place of The General Theory in the history of macroeconomics since 1936. The third section contains three essays that explore the interrelationships among Keynes, Friedman, Kaldor, Marx and Sraffa and their approaches to macroeconomic theory and policy. The final section contains four essays that provide several new interpretations of The General Theory and its position within macroeconomics.

Keynes's General Theory is intended for those students and scholars who are interested in the economics of Keynes and the rich variety of approaches to macroeconomic theory and policy.

A Note on the Concept of Vulgar Economics

2012-01-26T14:35:00.000-08:00

The concept of vulgar economics, developed by Karl Marx, is often cited, but seldom properly used or understood. In the preface to the second German edition to Capital Marx said that:

"[The] period, from 1820 to 1830, was notable in England for scientific activity in the domain of Political Economy. It was the time as well of the vulgarising and extending of Ricardo’s theory, as of the contest of that theory with the old school."

It is important to note that Marx clearly knew that "the theory of Ricardo already serves, in exceptional cases, as a weapon of attack upon bourgeois economy," in particular, because Ricardo was the first to show conclusively the necessary oposition between wages and profits, and the conflictive nature of the capitalist system. The problem with post-Ricardian economics was that it could not claim to be scientific and at the same time argue that the capitalist system was harmonious. For him:

"Men who still claimed some scientific standing and aspired to be something more than mere sophists and sycophants of the ruling classes tried to harmonise the Political Economy of capital with the claims, no longer to be ignored, of the proletariat. Hence a shallow syncretism of which John Stuart Mill is the best representative. It is a declaration of bankruptcy by bourgeois economy."

So vulgar economics was the dominant, or common, view of Political Economy after Ricardo, which was fundamentally apologetic and dismissed the Ricardian conflictive view of capitalist economies.

Also, it is important to note that, although critical of bourgeois economics (Quesnay, Smith, Ricardo), Marx knew his theory built on their analysis. He says:

"As early as 1871, N. Sieber, Professor of Political Economy in the University of Kiev, in his work 'David Ricardo’s Theory of Value and of Capital,' referred to my theory of value, of money and of capital, as in its fundamentals a necessary sequel to the teaching of Smith and Ricardo. That which astonishes the Western European in the reading of this excellent work, is the author’s consistent and firm grasp of the purely theoretical position."

So the excellent work of Professor Sieber correctly grasps Marx's theoretical position, according to Marx, and says that it is "a necessary sequel to the teaching of Smith and Ricardo." I'll leave for another post the discussion of the current state of economics, and in what sense one can talk of a return of vulgar economics.

Inequality and mobility

2012-01-22T05:58:00.000-08:00

The so-called Great Gatsby diagram that Alan Krueger presented recently shows that there is a positive correlation between inequality and lack of social mobility. The graph below shows a full version.

Note that the only African and the four Latin American countries are on the higher end of the graph, while the four Nordic and the three British off-shoots in the sample are at the other end of the Gatsby curve. The US uncomfortably close to the higher end of the curve. No particular observation. Graph does all the job. The source for the graph is Miles Corak here.

Scope and flexibility of alternative economic paradigms

2012-01-19T18:56:00.000-08:00

Teaching the basics of the surplus approach this week. One important feature of what Garegnani refers to as the core of the surplus approach, shown in the figure below, is the flexibility that it provides for the development of alternative theories.

In the core output, technology and real wages are taken as data of the system. With output and technology one can determine the labor requirements for production. Further, with real wages one can get the necessary consumption needed to reproduce the labor force. Finally, extracting necessary consumption from output one obtains the surplus, and the surplus is what allows for expanded reproduction or accumulation, the main preoccupation of classical political economy authors.

An important thing to emphasize is that the relations within the core do not imply that the theories regarding the data must be similar. For example, while Ricardo accepted Say's Law, Marx clearly rejected it. Hence, the core is compatible with alternative theories of output, and similarly about the determination of real wages and technological change. The core is flexible and capable of encompassing different theories.

Further, nothing precludes the existence of feedback mechanisms and relations between the data of the system in classical analysis. The level of surplus might certainly have a relation to output, and that is central for the theories of accumulation, but those relations lack the generality that is attributed to the core relations. In those, less rigid relations, the role of institutional and historical elements loom large.

In the marginalist approach, in contrast, output and distributive variables (the real wage and profits, which are part of the surplus and, thus, residual for surplus authors) are determined simultaneously by supply and demand. There is no space for alternative views on the determination of output or the real wage. Full employment (a version of Say's Law) is a necessary result with flexible prices (hence, rigidities are necessary to get unemployment).

Suggested Reading:

Garegnani, P. (1984), “Value and Distribution in the Classical Economists and Marx,” Oxford Economic Papers, 36, pp. 291-325. Link here (subscription required).

PS: A complementary post, diagram and suggested reading at Robert Vienneau's Thoughts on Economics.

Perverse dependence on Asia

2012-01-18T08:19:00.000-08:00

By Luiz Carlos Bresser-Pereira

Published originally in portuguese in the Folha de S. Paulo, January 16, 2012

In his last column, Martin Wolf mentioned the fact that, since 2007, the fast-growing Asian countries have grown by 60%, whereas rich countries have grown by 3%, and he pinned the world's economic hopes in Asia. Brazil, in the same period, grew by modest 16%. Brazilians also depend on the increase in Asian demand to achieve their growth. Brazilian economy is not stagnant as the economy of developed countries, but, in terms of growth, it is closer to them than to countries such as China and India.

Read the rest here.

American decline?

2012-01-15T13:19:00.000-08:00

A few readings on why American hegemony is not on the verge of collapse, prompted by a conversation with a graduate student. Note that all come from a group of people that has been influenced by Maria da Conceição Tavares, who wrote in 1985 a classic paper (A Retomada da Hegemonia Norte-Americana; in portuguese), on the rise of US hegemony when almost everybody was going in the other direction.

Fiori, J. L. (ND) "The Global Power, Its formation, its expansion and its limits," processed.

Serrano, F. 2003. “From Static Gold to Floating Dollar,” Contributions to Political Economy, 22: 87–102.

Medeiros, C. A. (2003), "The post‐war American technological development as a military enterprise," Contributions to Political Economy, 22: 41-62. (Subscription required)

Fields, D. and M. Vernengo (2011), "Hegemonic Currencies during the Crisis," Levy Economics Institute Working Paper No 666.

And yes, I did notice the number of the working paper!

Sraffian environmentalism

2012-01-11T10:10:00.001-08:00

It is well known that the surplus approach authors dealt with exhaustible resources when discussing land and rent. The so-called Ricardian theory of rent, discovered by West and Malthus, has important implications for income distribution as it is well known. Landlords benefited from protection, which forced the use of scarce land, and led to higher rents (and for a given output and a fixed wage at subsistence) lower profits. Thus, the existence of an exhaustible resource led to a transfer from the dynamic capitalists to the backward landlords.

The rent paid for the extensive use of land of different quality is significantly different than the intensive case of marginalist (neoclassical) theory. Marx was critical of certain aspects of the Ricardian theory of rent. In particular, he argued that 'absolute rent' would arise even if there were no differences in the levels of land productivity, if owners had a monopoly power over the natural resource. In this sense, the nature of rent is highly dependent on the historical contingencies and institutional arrangements that make one social group or class able to obtain greater bargaining power.

One important conclusion from this approach is that ownership and taxation of natural resources is crucial to determine which groups win or loose with the continuous use of exhaustible resources. Nationalization of natural resources not only might provide a situation in which the benefits and costs of extraction are shared more equitably, but also furnish the funds for the investment needed to promote alternative technologies. Below some readings that might be useful.

Suggested readings:

Bidard and Erreygers (2001), The Corn-Guano model, Metroeconomica 52(3), 243-53.

Burkett (2006), Marxism and Ecological Economics, Leiden, Brill.

Parrinello (2001), The price of exhaustible resources, Metroeconomica 52(3), pp. 301-15 (subscription required).

Ravagnani (ND), Classical Theory and Exhaustible Natural Resources, processed.

Barro, the euro and credibility

2012-01-09T08:36:00.000-08:00

Robert Barro, the cheerleader of dollarization and common currencies, has finally come out of the closet. No, not in that way; he just came out against the euro in his Wall Street Journal column (subscription required). He says:

"The euro was a noble experiment, but it has failed. Instead of wasting more money on expanding the system's scope and developing ever larger rescue funds, it would be better for the EU and others to think about how best to revert to a system of individual currencies."

The interesting thing is that he wants to discard the euro for all the wrong reasons. In his view, the problem is fiscal, and what the new national currencies would allow is for 'credible' fiscal adjustments. Again, in his own words:

"Worries about values of government bonds are rational because it is unclear whether—even with assistance from the center—Italy and other weak members will be able and willing to meet their long-term euro obligations. A new (or restored) system of national currencies would be more credible, because Italy should be able and willing to meet its obligations denominated in new liras."

Forget that the ECB can actually buy bonds (Italian and others), and reduce the burden of interest payments, allowing for more expansionary fiscal policy, which is what you need in a recession.

The Euro Imbalances and Financial Deregulation

2012-01-08T10:06:00.000-08:00

New paper at the Levy Economics Institute. From the abstract:

Conventional wisdom suggests that the European debt crisis, which has thus far led to severe adjustment programs crafted by the European Union and the International Monetary Fund in both Greece and Ireland, was caused by fiscal profligacy on the part of peripheral, or noncore, countries in combination with a welfare state model, and that the role of the common currency—the euro—was at best minimal.This paper aims to show that, contrary to conventional wisdom, the crisis in Europe is the result of an imbalance between core and noncore countries that is inherent in the euro economic model. Underpinned by a process of monetary unification and financial deregulation, core eurozone countries pursued export-led growth policies—or, more specifically, “beggar thy neighbor” policies—at the expense of mounting disequilibria and debt accumulation in the periphery. This imbalance became unsustainable, and this unsustainability was a causal factor in the global financial crisis of 2007–08. The paper also maintains that the eurozone could avoid cumulative imbalances by adopting John Maynard Keynes’s notion of the generalized banking principle (a fundamental principle of his clearing union proposal) as a central element of its monetary integration arrangement.

Read the rest here.

Cold Fusion and Population - Environmental Musings

2012-01-05T16:01:00.000-08:00

The center of gravity on climate change/global warming/... on the left is pretty fairly represented by Dean Baker's recent blog saying it's lights out figuratively and literally if we don't change our profligate energy ways. And this is by far more important inter-generationally than the current aggregate-demand-deficit-led fiscal deficits. Dean's post is here.

And, given mainstream science, he's absolutely right. This leads to the growth-neutral advocates with whom I have a moral problem in that it condemns the poorer nations to less wealth than we living in advanced countries enjoy. If that is to be the outcome, we should be crystal clear sure of our environmental arguments. I do not challenge results like those from the IPCC.

However, there are a couple of mitigating things going on, one in the realm of economics, and one in the realm of heterodox science.

First, for a recent department seminar on environment, I put together some data using the Kaya model and UN population projections to project CO2 emissions. What this clearly shows is that among greening of energy sources, energy efficiency, and population growth, it's population growth, through GDP growth, that has the greatest impact on CO2, by a factor of at least three times.

And, the closer we are to the UN 2010 population low estimate of growth, the better off we are, in fact, my analysis shows we bend down the CO2 curve starting in about 2050. Fertility reduction is what we should focus on. Fortunately, it is clear in the literature that GDP per capita growth and female education both significantly correlate with reduced fertility rates, and those trends are in train around much of the world.

So the best solution for CO2 mediation in the current context is headed in the right direction; we should give it a major shove. Helicopter drops of books and family planning items. You can see my slides here. Make sure to check out the embedded motion chart to visualize the effects of GDP and education growth on fertility by country. There may be hope in the following sense.

Growth of per capita income is not necessarily that bad for the environment, and those defending De-growth (reduction of GDP) might understate the economic, social and environmental effects of their policy suggestions.

Second, I will talk a bit of non-mainstream science, and thereby prove myself crazy for doing it publicly.

Remember cold fusion? In 1989 Professors Pons and Fleischmann, right here at the University of Utah, reported experimental results for an over-unity chemical reaction in a press conference. They were immediately, viciously, humiliated and attacked by the scientific mainstream, especially those whose gored ox was pulling the generously funded hot fusion projects. The cover story was that this violates thermodynamic laws. Case closed.

Except physics has evolved theories in which such results are supported without violating thermodynamics.

And one of the many serious experimenters working in cold fusion since 1989, Andrea Rossi, has announced and shipped an over-unity megawatt heat generator that uses its modern incarnation LENR, which stands for Low Energy Nuclear Reaction. The mainstream science is still out on this, but if its commercially successful, who cares?

Well, Dennis Bushnell, the chief scientist at NASA Langley, cares, and has spoken. He thinks LENR is a revolutionary epoch-changing technology whose time has come, a true game-changer.

I have gone on further than most care to read in one blog, so will stop and not embed more word or links in this post. Depending on the interest and tolerance for these surprising ideas, I will offer to follow up on this and post more sources.

Let me finish by saying, if true, this will put us on the road to virtually unlimited, very cheap, zero pollution distributed and compact energy sources. That would change much that is wrong with our current economies on the physical (but not distributional) side. And Dean Baker would be freed of his inter-generational global warming dilemma, so can get back to creating jobs here and now.

China on the verge?

2012-01-03T07:22:00.000-08:00

It has become increasingly common to suggest that on top of the European debacle and the sluggish recovery in the United States, China might be on the verge of a collapse, and with it the last bastion of economic growth in the world economy would also be gone. Not only the center is stagnant, but also the periphery of the global economy is very fragile. But the probability of a Chinese slowdown is greatly exaggerated.

Paul Krugman, who has been correct about the need for fiscal expansion in the United States, and about the European Central Bank (ECB) mismanagement of the Greek crisis, for example, has suggested that China is in the middle of a housing bubble that can burst at any time (see also Jayati Ghosh and C. P. Chandrasekhar here for a similar, but broader view of the dangers in 2012). This view insinuates that growth in China is fundamentally dependent on domestic demand, but that the sources of the expansion are fragile. It, further, suggests that China now looks very similar to the US before the Lehman Brothers crisis in September 2008.

Read the rest here.

Hyperinflation in Bitcoinland

2012-01-01T17:48:00.000-08:00

There are Gold Bugs and there are Bitcoin Bugs. They all oppose fiat money (hate the Fed and other monetary authorities) and follow some sort of free banking view loosely based on Austrian views. The supply of bitcoins is strictly exogenous controlled by a complex system that cannot be trampled by greedy central bankers and politicians. Wired said in an article last year that:

"Bitcoin required no faith in the politicians or financiers who had wrecked the economy—just in Nakamoto’s elegant algorithms. Not only did bitcoin’s public ledger seem to protect against fraud, but the predetermined release of the digital currency kept the bitcoin money supply growing at a predictable rate, immune to printing-press-happy central bankers and Weimar Republic-style hyperinflation."

A very monetarist view of inflation, as you can see. The problem is that central banks print too much money, and by the way, in the US hyperinflation is around the corner.

The funny thing is that they had hyperinflation in Bitcoinland (a land of people that use this stuff) last year and they didn't understand it. The graph below shows the exchange rate between bitcoins and dollars from inception to the end of last year more or less. As it can be seen (not very well I'm afraid), prices fell from almost US$30 per bitcoin to around US$3 in two months.

Now think about it. If you bought a "I'm Satoshi Nakamoto" T-shirt (the guy that invented bitcoins, and yes they do sell them) say for US$ 30 in mid-June last year it would cost you approximately B$ 1 (B$ is not a bad symbol for them!). By late October, when the exchange rate depreciated brutally, you would have to pay for the same US$ 30 T-shirt around B$ 10. 10 times more. 1000% inflation in two months looks like hyper to me, even though the supply of bitcoins did not increase nearly as much, since it is controlled by a complex computational algorithm.

This should teach these people that hyperinflation is more complicated than just central banks printing money (see this paper). Still Ron Paul may have some support in Iowa, because of popular misperception about the role of money supply and the causes of inflation. Happy New Year!

PS: In my view Nakamoto is the intelligent version of Madoff. He got away with the dollars and dumped the bitcoins.

Olivier Blanchard didn't learn anything from the crisis

2011-12-30T20:16:00.000-08:00

Olivier Blanchard, top economic honcho at the IMF (not the impossible mission force), says things are bleak and here are his four lessons from the crisis (brace yourself):

"First, post the 2008-09 crisis, the world economy is pregnant with multiple equilibria—self-fulfilling outcomes of pessimism or optimism, with major macroeconomic implications. Second, incomplete or partial policy measures can make things worse. Third, financial investors are schizophrenic about fiscal consolidation and growth. Fourth, perception molds reality."

As you can see it all depends on market mood. Apparently markets are not taking their Prozac and that's why we are in this conundrum. Translating into English, bad situations (bad equilibria) may happen if governments take indecisive action, markets are not sure that the fiscal consolidation (which he seems to support, and the IMF is certainly pushing) will work, and this generates perceptions that are self-fulfilling.

No lesson about the problems with fiscal consolidations leading to recessions (no matter what people may think about it). Also, nothing about the need for central banks to buy government debt and maintain interest rates down (irrespective of markets feelings about it, like in the US). No lesson about how a worsening income distribution and a deregulated financial sector push private agents to unsustainable debt positions. And this is the guy rethinking macroeconomics? Here is my New Year resolution: stop reading Blanchard; if this is what he learned, he obviously is clueless.

Blog related syllabi

2011-12-26T02:43:00.000-08:00

Here are a few of my syllabi for graduate courses: Macroeconomics, History of Economic Thought, and Economic History. As you can see we still teach history of ideas and economic history, something that is increasingly rare even in the few heterodox places left in the US. Philip Mirowski describes in this way the reasons for that:

"After a brief flirtation in the 1960s and 1970s, the grandees of the economics profession took it upon themselves to express openly their disdain and revulsion for the types of self-reflection practiced by ‘methodologists’ and historians of economics, and to go out of their way to prevent those so inclined from occupying any tenured foothold in reputable economics departments. [2] It was perhaps no coincidence that history and philosophy were the areas where one found the greatest concentrations of skeptics concerning the shape and substance of the post-war American economic orthodoxy. High-ranking economics journals, such as the American Economic Review, the Quarterly Journal of Economics and the Journal of Political Economy, declared that they would cease publication of any articles whatsoever in the area, after a prior history of acceptance.

Once this policy was put in place, and then algorithmic journal rankings were used to deny hiring and promotion at the commanding heights of economics to those with methodological leanings. Consequently, the grey- beards summarily expelled both philosophy and history from the graduate economics curriculum; and then, they chased it out of the undergraduate curriculum as well."

The whole interview with Mirowski is here.

The risks for Latin America in 2012

2011-12-24T15:24:00.000-08:00

Nope, not a collapse of China, and also, not clear that it would be a severe collapse in the center, in particular Europe, although that one cannot be completely ruled out. The big risk comes from the macroeconomic policies adopted by Latin American economies.

A study by Esteban Pérez and Ramón Pineda, from ECLAC, shows that Latin American economies are, from a regional comparative perspective, good at withstanding the negative effects of contractions and bad at taking advantage of expansions to achieve convergence with the developed world.

While it is true that during this last crisis Latin American economies did recover fast, and pursued counter-cyclical fiscal policy, it is also true that the willingness to maintain expansionary policies has waned pretty fast. The IMF fear about overheating and the obsession with inflationary pressures has become dominant in the region (see my discussion of that earlier this year here).

The graph below shows government spending as a share of GDP in the big four (Argentina, Brazil, Chile and Mexico). As it can be seen only in Argentina spending did not shrink in 2011 (an election year by the way), whereas in the other three the reduction were of 0.3, 0.5 and 1.2 of GDP. With a multiplier of around 2, ceteris paribus, there is a potential for a significant slowdown in the region.

In fact, in Brazil the economy already stalled to almost zero growth in the third quarter of the year (see here). Following Pérez and Pineda, one could hope for 2012 that countries in the region "instead of viewing expansions through the lens of ‘crisis management,’ expansions should be seen and understood as an opportunity to grow and expand and promote greater levels of well-being, employment and equity in the region." That's this blogger's hope for the New Year. Happy Holidays!

PS: Data from ECLAC here.

Fiscal austerity threatens a global recession

2011-12-21T05:47:00.000-08:00

Check out UNCTAD's new publication here. From the conclusion:

"There is a very real risk of new economic crises erupting and, in today’s highly integrated world economy; their impact will not be limited to specific sectors or to well-defined regions. The G-20 initially recognised this fact, but recent actions have not been consistent. In particular, the fiscal restraint in the countries with current account surpluses and very low long-run interest rates in Europe, point precisely in the wrong direction. A fragile global economy has a significant interest in the implementation of expansionary, rather than contractionary fiscal policies in key economies. Only the former can open a path towards lower fiscal deficits and falling public debt ratios. A “lost decade” for the world economy would risk the development gains achieved during the recent years, and throw into question the ability of democratic governments to tackle the most urgent challenges of our age."

Fiscal austerity in the center, not bubbles in the periphery, are the real risk for the global economy.

Krugman is wrong about China

2011-12-19T04:49:00.000-08:00

If you believe Krugman's last column, you would think that China is like the US (or Japan he says; I would add Spain or Ireland), i.e. growing as a result of a housing bubble. His analogy seems to follow from the 'weakness' of consumption, that is, the fact that consumption is only 35% of GDP. He says:

The obvious question is, with consumer demand relatively weak, what motivated all that investment? And the answer, to an important extent, is that it depended on an ever-inflating real estate bubble.

He forgot to check real wages. The graph below shows that, in contrast to the US, Chinese wages have expanded incredibly fast. Since the Asian crisis, real wages have grown at more than 10% per year.

Consumption as a share of GDP remains low simply because a lot of investment is State driven and exogenous, and incredibly large. Even if there is a real ~~state~~ estate bubble, growth is led by government spending and by rising real wages. And by the way, there is no significant foreign debt, so a collapse of a bubble could be handled by domestic authorities without a sweat. Krugman is just wrong on this one.

PS: Data is from the Economics Intelligence Unit (subscription required). Check also ILO's Global Wage Report.

This wealth redistribution business is trickier than I thought!

2011-12-17T12:24:00.000-08:00

December is, and will continue to be, quite slow. But the video above shows the difficulties of redistributing wealth and why Republicans are against class warfare!

Jamie Galbraith on the current crisis

2011-12-13T03:22:00.000-08:00

Here is Jamie's keynote speech at the Associação Nacional dos Centros de Pós-Graduação em Economia (ANPEC) in Foz do Iguaço, Brazil. If nothing else this talk would be worth for the anecdote of John Kenneth Galbraith granting Piero Sraffa authorization to fly, in a US army plane, to the expected Comunist Revoultion in Italy!

Blog related working papers

2011-12-12T06:03:00.000-08:00

All these papers were published this year in the U's working paper series. A holiday treat; enjoy!

Working Paper 2011_07
Title: The Veblenian Roots of Institutional Political Economy
Author: Kirsten Ford Download PDF (221 KB)

Working Paper 2011_08
Title: An Aristotelian View of Marx’s Method
Author: Nathaniel Cline, William McColloch and Kirsten Ford Download PDF (184 KB)

Working Paper 2011_09
Title: Marx’s Appreciation of James Steuart: A Theory of History and Value
Author: William McColloch Download PDF (166 KB)

Working Paper 2011_11
Title:Thorstein Veblen: A Marxist Starting Point
Author: Kirsten Ford and William McColloch Download PDF (139 KB)

Working Paper 2011_12
Title: Easy Balancing Act: Reducing the Balance of Payments Constraint; Improving Export Competitiveness and Productivity; and Absorbing Surplus Labor – The Indian Experience
Author: Suranjana Nabar-Bhaduri Download PDF (374 KB)

Working Paper 2011_13
Title: Portrait of the Economist as a Young Man: Raúl Prebisch’s evolving views on the business cycle and money, 1919-1949
Author: Esteban Pérez Caldentey and Matias Vernengo Download PDF (452 KB)

Working Paper 2011_14
Title: The return of vulgar economics: A Rejoinder to Colander, Holt and Rosser
Author: Matias Vernengo Download PDF (100 KB)

Arestis and Sawyer on the EU fiscal compact

2011-12-12T05:40:00.000-08:00

Philip Arestis and Malcolm Sawyer are guest blogging at TripleCrisis on the so-called fiscal compact. They say:

The European Leaders agreed in principle at their meeting in Brussels on the 8th/9th of December 2011 to adopt tougher sanctions on the euro area countries that break the ‘new’ rules of what used to be the Stability and Growth Pact (SGP), what is now called the ‘fiscal compact’ (FC). The FC requires that tax and spending plans be checked by European officials before national governments intervene. There will be automatic actions against those countries that are deemed to have budget deficits that are too large. In effect the new agreement tightens the rules of the old SGP, but with no apparent improvement, as the FC retains the principles of the previous SGP but with the one addition that breaking the deficit rules may actually be punished in some way.

Read the rest here. Also read Tom Palley's take on the role of the ECB in the crisis here.

Stephen Marglin on Heterodox Economics

2011-12-11T06:00:00.000-08:00

I have lots problems with Marglin's views, not just on heterodox economics, but on the mainstream too. Marginalism (neoclassical economics), the supply and demand story that emerged in the 1870s, is not simply about efficiency. It is about a certain type of efficiency (factors of production are fully utilized). There are different views of efficiency, and certainly that was the case for the authors of the surplus approach (Smith/Ricardo/Marx), for whom efficiency was essentially about capital accumulation, i.e. the wealth of nations. Also, the problem is not that the mainstream ignores income distribution, but that it provides an untenable position on income distribution (to each according to its productive). In contrast, for the surplus approach authors income distribution depends on class conflict.

From my point of view, Marglin is very close to presenting a post-modernist view of critiques of the mainstream, that is, several alternatives to the mainstream are acceptable, as the much as the mainstream is. This is Deidre McCloskey's view that economics is about the rules of conversation, rhetoric. I'm more of a realist, I think there is an external reality independent of my views about it, and that there are, besides logical aspects, facts that allow us to discern between theories that are not correct (the mainstream) and theories that have not been proved wrong (classical-Keynesian). For my view on heterodoxy read this.

PS: Marglin's syllabus here. Thanks to Pedro Américo for the tip.

The Eurocrisis for Whom?

2011-12-09T08:57:00.000-08:00

Here is the link of my interview with Real News Network. Emphasis, as always, on who wins and who looses with the crisis, and its adopted solution, i.e. austerity. This is not about center vs periphery, but about capital and labor. This crisis has been functional, and serves certain interests. The question is what is behind the current neoliberal European project?

Not very old talk on the Euro crisis

2011-12-08T05:58:00.000-08:00

My talk at the University of Texas, Austin, on the Crisis in the Eurozone Conference. I disagree with everything I said!

Brad DeLong on Carmen Reinhart

2011-12-08T05:54:00.000-08:00

Great post by Brad DeLong, about misplaced fatalism. His comments are based on a video (you can see the whole thing in his post) debate between Krugman and Reinhart. He says:

"A word about the content: I continue to find Carmen Reinhart’s fatalist view puzzling. She agrees with me that we’re facing a demand-side problem — but insists that this problem can’t be solved quickly, that we need to go through many years of painful deleveraging that leave millions of potentially productive workers idle.I agree that this is probably what will happen, given the political realities. But surely this is a huge failure of policy, not something we should accept as inevitable. It’s truly bizarre, if you ask me, to say that our economy suffers from too little spending, and that nothing can or should be done to increase that spending."

He then uses a variation of an ISLM to explain his and Reinhart's views. Translating, political fatalism seems appropriate in the US, but theoretical fatalism is out of place. Agreed!

PS: Also worth reading is Cassidy's take on Obama's speech. An antidote to the fatalism above.

Jan Toporowski on Julio López on Kalecki

2011-12-07T12:09:00.000-08:00

EH.net published in their book review series a nice one on Julio López and Michaël Assous book titled Michal Kalecki, just published by Palgrave-Macmillan. Jan says:

"The excellence of Tony Thirlwall’s series for Palgrave on Great Thinkers in Economics is confirmed by this volume on Michał Kalecki, written by Kalecki’s former student, Julio López Gallardo (Professor at UNAM, Mexico City), and Michaël Assous (Maître de Conferences at the University of Paris, Panthéon-Sorbonne). The book is important in part because of the very enigmatic quality of Kalecki’s ideas which, expressed by him in a dry, lapidary style with few references, appear to have come from nowhere to anticipate the Keynesian Revolution that Keynes labored so long to wrest from the legacy of Alfred Marshall. As Robert Solow, quoted in this book (p. 214), remarked: “Michal Kalecki ... seems to have sprung, full-grown, from his own brow; and his important work on macroeconomics is written not in opposition to the orthodoxy of his time, but in utter independence of it."

Read the rest here.

Know what you're teaching

2011-12-07T06:50:00.000-08:00

Greg Mankiw wrote a response to his students, who protested his teaching, in his last New York Times column. He basically blames the students for not knowing enough economics. He goes on to say that the complaints of the Occupy Wall Street (OWS) movement, in support of which the students had boycotted his class, are also a “grab bag of anti-establishment platitudes without much hard-headed analysis or clear policy prescriptions.”

He also suggested that students boycotted the wrong class, since his lecture that day was on inequality. Note that his views on inequality are strictly based on conventional mainstream neoclassical theory. Inequality for him is based on education (see here his critique of Krugman’s views on inequality). So basically the top 1% are more educated, more productive and, as a result, receive more. You cannot protest market forces.

Read the rest here.

Free Trade Again

2011-12-05T09:52:00.000-08:00

So I've been writing a bit more than often on trade issues. One important conclusion of a paper I co-authored a few years ago was that: "absolute advantage, determined ultimately by low costs of production and/or depreciated currencies, seems to be far more important than comparative advantage in the determination of trade patterns. Developing countries that pursue 'neo-mercantilist' policies to enhance the competitive position of their firms may in fact be doing something rational, leading to higher rates of growth and higher levels of productivity that would imply higher living standards for their population. Also, the avalanche of financial crises in the 1990s, shows that the prescriptions of pop liberals were unfounded; and that balance of payments disequilibria are seldom benign and self-adjusting. Crises are cumulative and the costs of adjustment severe. The Asian crisis and the more recent one in Argentina make the point very clear." Interestingly enough since the Argentine crisis in 2001-2, developing countries have grown considerably faster, and rebounded from the Great Recession pretty fast. It has been the advanced economies, that should not have problems with their balance of payments that got stuck. But the causes for that are fundamentally political. The full paper is here (the title should have said only Principle in the singular). Another paper with similar arguments here.

The role of the State in US Development

2011-12-03T10:51:00.000-08:00

As part of Peter Ho's talk yesterday, two graduate students presented some of their research. One of the topics, was the role of the State, the Fiscal-Military State in particular, in the early process of industrialization and development in the US, which was, as noted by Peter, very much in line with his arguments for managed trade. Here is a link to a paper I wrote on the rise of what Schumpeter termed the Tax State. On the Fiscal-Military State read this. The classic book by John Brewer, The Sinews of Power, was essential in the development of some of these ideas, in the sense that it shows the fundamental role of the State for industrialization and the creation of a global empire. The argument put forward, in the talk yesterday, was that the US development can only be understood from a Fiscal-Military Developmental State perspective.

Rethinking Trade and Commercial Policy at the University of Utah

2011-12-02T13:16:00.000-08:00

Peter Ho, from the University of Denver, gave a nice and stimulating talk based on his recently published book. He tries to rethink classical political economics views on trade, reviewing the contributions of Smith, Ricardo and Stuart Mill, and the trade policy advise that derives from it. Without having read the book, the presentation suggests a sort of institutionalist approach to the critique of the mainstream.

One thing that did strike me out as peculiar to the presentation, but which may not be reflected in the book, was the critique of the mainstream view of trade on the basis of Ricardo/Mill rather than the Heckscher-Ohlin (HO) model. Note that comparative advantage in the HO story is associated to full utilization of resources and relative prices determined by scarcity (for a critique see here). That's clearly not the case in Ricardo.

Also, the Ricardian (properly understood as part of the surplus approach) story is less about the benefits of trade in general, and more about which social class benefits and which one loses from protection (see my discussion here).

One last point about the talk, that I would have liked to discuss with Peter (I had to leave for a defense) was on Mill. He was a peculiar author in-between classical political economy and marginalism, and his contributions are more problematic to properly understand than authors like Ricardo and Marshall. In fact, Mill is a key author to understand the break between the surplus approach and marginalism. As noted by Krishna Bharadwaj, what was Ricardian in Mill's theories does not appear in Marshall's work, and what is proto-Marshallian in Mill's ideas was not part of Ricardo's views of political economy. In that sense, while I'm comfortable with a Smith/Ricardo approach to trade, I'm less keen about adding Stuart Mill to the mix.

PS: I should have noted that his discussion of trade policy builds on Hamilton, List, Prebisch, Myrdal, Singer and others, like the work of Ha Joon-Chang. A paper of mine on a similar subject is the entry on Export Promotion for the International Encyclopedia of the Social Sciences, edited by Sandy Darity (here).

It's the ECB stupid!

2011-12-01T10:50:00.000-08:00

So the Fed announced yesterday that they will inject money into European banks if needed. Mark Thoma and Paul Krugman posted about it (here and here). This is not new, since the Fed did lend to European banks after the Lehman collapse. The reason is simple, US banks would be also affected by a collapse of the European banking sector. The point is that this not sufficient to end the euro crisis, for that the ECB must act buying European bonds. No substitute for that. So Bernanke is still asking: what are these guys doing over there?

Reverse Bond Vigilantism -- How is that austerity thing working out for you?

2011-11-24T08:46:00.000-08:00

Let me see if I get this correctly: Monetary and fiscal austerity reigns over Europe like Napoleon. And beyond to the UK. So what is happening to sovereign bond yields? They are down, right?

In rough numbers, and for 10 years unless noted:

Spain 3 month over 5%
German auction fails by 40%, yields rising
Austria 4%
France 4%
Belgium 5%
Italy 7%
Spain 7%
Portugal 12% if I am reading Bloomberg correctly
Greece 30% ibid

While the risk premium is rising surely just because the Euro zone is currently so dysfunctional, clearly the bond vigilantes are not driving up rates because they think the economies will boom, not even the core economies.

Thus, can this be the last time we have to hear about how austerity must be invoked to please the bond vigilantes? Please? And focus on what they care about, which is growth (since they are after all Keynesians). And then we can fight the correct fight, which is over the meme of austerity-led growth. That one is easy to win. Nope, not even Canada. Sorry.

Update: From Tim Duy at Fed Watch, looks like Eurozone industrial production is tanking, leading growth forecasts down. The blue line headed almost straight down is the result of austerity, and doesn't look like growth to me. This chart also indicates US decoupling from the coming Eurozone depression may be difficult.

C02 emissions and fertility rates

2011-11-23T18:56:00.001-08:00

Finally, a short break. I have been working on my main topic, the nexus of energy and development. And eventually of course the implications for the surplus approach. As part of a recent department environmental sustainability seminar centering on the models of Armon Rezai (and Lance Taylor and Duncan Foley), I presented data and (gasp!) forecasts using the Kaya model of carbon intensity. Surprisingly, there is hope in the data.

One of the points that leapt from the data is that population dynamics are a far greater weight on carbon emissions than the greening of the energy supply ("carbon intensity") and efficiency of energy consumption ("energy intensity"). Respectively, population is seven and three times more important in carbon emissions than either of those.

So, fertility becomes an (the?) important issue in climate debates. The data on global GDP per capita growth are among the most stable, and therefore predictable, that I have seen in macroeconomic series. In one hundred years, each of us will be earning $70,000 in 2005 USD (up from $7,000). Every one of us. Place your bets. So how many will that be?

The great news is that global fertility levels are plummeting, headed toward population decreases. One can see that in this Hans Rosling inspired motion chart using mainly World Bank data (with a recent addition of Jamie Galbraith's world inequality data based on Henri Theil indices). For those who may be concerned, I have no data on global coitus rates; I presume they remain healthy.

The data indicate that per capita GDP increases, female education, and more equal income distribution correlate with reduced fertility. This is great news since the first two are clearly "in train" around the world based on the data. Distribution, the great economic problem, jeopardizes climate as it becomes less equal in major economies.

Note that China has a current fertility rate of 1.6, below the 2.1 population sustainability rate. The biggest surprise is India, whose fertility at 2.7 was achieved without autarchy, a powerful endorsement of economic progress in damping fertility rates.

So we can have growth with some hope for climate given declining fertility rates even at current projected levels of carbon and energy intensities. My data intensive slides are here (including a discussion of the Kaya model). I gladly take questions. I will defer policy proposals. I need to refine the idea of global Fed helicopter drops of family planning supplies. (the interrupter of last resort?)

In a future post, with some trepidation, I will investigate the possibility of radical energy regimes and their implications for our economic and respiratory future. Are we approaching the end of the fossil energy epoch? An incredibly interesting question.

Giving thanks for David Ricardo

2011-11-23T11:57:00.000-08:00

Off to New York, where I'll be interviewed about David Ricardo's contributions to economics, for a documentary on capitalism. So here is a recent post by Robert Paul Wolff, an incredibly wise Marxist philosopher, on Ricardo (his book on Marx is quite Sraffian, by the way). Enjoy the Thanksgivings!

A call for a higher minimum wage

2011-11-23T11:47:00.000-08:00

Jamie Galbraith on Bloomberg yesterday (here). That would be something for people to thank!

The European System: Dream or Nightmare?

2011-11-22T07:43:00.000-08:00

This was the title of the first session of the University of Texas at Austin conference on the Euro Crisis organized by Jamie Galbraith. The whole panel is available here. My talk starts at around the minute 33. Before Bruno Amoroso, Terri Givens and Alain Parguez. Links to all the sessions (I liked all, but highly recommend session 5) here.

The political economy of the Euro crisis

2011-11-21T21:40:00.000-08:00

The solution for the euro crisis seems increasingly out of reach. The victory of the conservative Popular Party in Spain, and the promise of more austerity, following the same in Italy and Greece, bodes badly for a more rational solution. Further, the German officials, and the ECB, in particular, its new head, Mario Draghi were very clear that they would not support anything but austerity.

A question that was raised in my talk last Friday was why would anybody favor such a suicidal policy. Think of the US for a second. Why would the Republicans play with the possibility of a self-imposed default (by not raising the debt-ceiling limit last summer)? The point is that the idea that there is a fiscal crisis (yep there isn't), would allow them (and some pro-business Dems too) to cut spending on welfare programs like Social Security and Medicare. And by the way, high unemployment helps to keep workers in line and wages low. The same is true in Europe.

A severe fiscal crisis, that forces adjustment in the periphery, helps to keep workers in line, not just in the periphery, but also in the core countries. And helps if they want to roll back their Welfare State too. Jerry Epstein says essentially the same thing here.

Talk tomorrow

2011-11-17T15:17:00.000-08:00

If you are around Salt Lake and have nothing better to do, you can come to my talk. Tomorrow at 1 I'll present a paper on the Euro Crisis. Flyer below has the info.

New Monetarists, scientists or engineers?

2011-11-17T07:52:00.000-08:00

Back in 1994, when the New Keynesian (NK) label, if not the models, were relatively new, Ball and Mankiw argued that Milton Friedman was closer to the NK approach than the New Classical (NC)/Real Business Cycle (RBC) one. For them (see here, 1994, p. 9):

"although traditionalist are often called 'new Keynesians,' this label is a misnomer. They could just as easily be called 'new monetarists.'"

The whole point was that monetarists believed in the non-neutrality of money in the short run and in sticky prices, like NKs. Now there is an explicit New Monetarist model with sticky prices here, and a growing literature surveyed by Stephen Williamson and Randall Wright here. Williamson has a blog here.

New Monetarists seem to build on ideas developed by Thomas Sargent and Neil Wallace in the early 1980s (here, for example). A simple introductory presentation is given by Champ and Freeman (here). The theoretical framework is in general based on overlapping generations models, in which monetary policy can affect relative prices and, as a result, change the intertemporal consumption, labor supply, and investment decisions of rational maximizing agents.

As Williamson says:

"Monetary policy matters due to distortions in intertemporal prices, for example the anticipation of higher money growth and higher inflation acts as a tax on labor supply and reduces output."

Not sure if he thinks that the current slow growth is to be blamed on the expansion of the money supply after the recession, and higher inflationary expectations, leading to an increase in the demand for leisure time (a reduction on labor supply, that will be taxed by the higher inflation). That would explain why he thinks that the Fed should sell bonds, and raise the interest rate (not a joke!). At any rate, the whole New Monetarist approach is fundamentally, like New Classical authors in general, concerned with microfoundations. In this case, microfoundations in the money market.

This kind of approach reminds me of another Mankiw paper on the nature of macroeconomic research. For him macro, from the Keynesian Revolution until the rise of Lucas and the New Classical school, was dominated by what he calls engineers, that is problem solvers. From Lucas on it has been dominated by scientists, meaning those that search first principles.

So the first group was concerned with empirical regularities, like Okun's Law, while the latter emphasized rational intertemporal maximizing economic agent models, like in the Ramsey model. New Monetarists are clearly in the latter camp. So are we better off with the rise of the "scientific" macroeconomists? Here is why Mankiw's paper is so important. He candidly tells us (p. 19):

"The sad truth is that the macroeconomic research of the past three decades [the 'scientific' micro-founded stuff] has had only minor impact on the practical analysis of monetary or fiscal policy. The explanation is not that economists in the policy arena are ignorant of recent developments. Quite the contrary: The staff of the Federal Reserve includes some of the best young Ph.D.’s, and the Council of Economic Advisers under both Democratic and Republican administrations draws talent from the nation’s top research universities. The fact that modern macroeconomic research is not widely used in practical policymaking is prima facie evidence that it is of little use for this purpose. The research may have been successful as a matter of science, but it has not contributed significantly to macroeconomic engineering."

No kidding, great science that has nothing to say about the reality of how to solve actual economic problems. The rise of sci-fi macroeconomists. Welcome to the Twilight Zone!

The full Monti, and Papademos too

2011-11-16T14:20:00.000-08:00

Mario Monti in Italy and Lucas Papademos have substituted the fragile and questioned prime ministers in their respective countries. Monti was an European Commissioner with great experience with the EU institutions, while Papademos was the president of the Bank of Greece and vice president of the ECB. Both are economists. The notion is that now with serious and responsible technical men in charge the chances for a solution, which is still in the view of European authorities more austerity, have increased.

The only possible logical diagnosis in which that would be true is if this would have been a crisis of "confidence." As that is not the case the crisis will continue, and become more intractable. Today, after the Eurozone bonds of almost all countries, including France, were forced to pay a higher risk premium the chief economist of JPMorgan Asset Management said that "Germany [is] the only functioning bond market left in the eurozone." A zone of one.

Three things you thought you knew about economics

2011-11-14T10:00:00.000-08:00

Great post by Robert Vienneau who correctly claims that the three propositions below are well-established, namely :

"1. Adam Smith did not use the phrase "The invisible hand" to refer to the optimality properties of a static general equilibrium supposedly brought about by the workings of competitive markets.

2. Thomas Carlyle did not coin the phrase "The dismal science" to refer to Thomas Malthus's anti-utopian theory of population. According to that theory, human population responds endogenously to increased prosperity, thereby making impossible any rapidly established, long-lasting general rise in per capita income beyond the custom and habits of mankind.

3. John Maynard Keynes, in The General Theory of Employment, Interest, and Money, did not explain widespread and persistent unemployment by sticky, rigid, or slowly adjusting money wages and prices - a pre-Keynesian theory that, in fact, he opposed. Many economists, I claim, teach the opposite of these propositions.

(...)

It seems to be a quixotic and never-ending task to oppose demonstrably false statements about economics, often made by economists."

It is absolutely true. I would even say the majority of economists teach the opposite. I have insisted more on 3 here, but 1 and 2 are equally true, and 1 at least as important as 3. I should probably use this in my history of thought lectures from now on.

Income distribution in advanced capitalist economies

2011-11-14T09:38:00.000-08:00

Massimo Pivetti has been central for the development of the so-called monetary theory of distribution, which develops the work of Piero Sraffa. The link (here) is to a talk at UNAM, in México last week (intro in Spanish, but Pivetti gives the talk in English starting at around minute 3). A good paper to follow what he says can be found here. You can see all the videos and other good stuff here.

PS: The classic book on the topic here.

Original Sin And The Euro Crisis

2011-11-11T16:24:00.000-08:00

Krugman has now twice argued that Europe faces an original sin problem (here and here). Let me be absolutely clear. Europe does NOT have an original sin problem. The original sin, a term invented by Ricardo Hausmann (see here), is a situation in which the domestic currency cannot be used to borrow in international markets or to borrow long-term in domestic markets. By the way, a new name for an old problem that was well known by Raúl Prebisch and other Latin American structuralists at ECLAC back in the 1950s, who recommended avoiding excessive borrowing in foreign currency.

It is true that there are no European bonds, and that Greece, as the other countries of the euro, do borrow in a currency they do not control. However, the ECB can buy Greek bonds, and does print euros. That is not the case in a developing country that borrows in foreign currency, and does have an original sin problem. In that sense, the problem in the Eurozone is the unwillingness of the ECB to monetize even small amounts of debt. Misplaced monetarism, not the original sin, is the problem in Europe.

Yield curves and recessions

2011-11-09T12:52:00.000-08:00

Let me get back to my discussion of the neo-Wicksellian macro model. One important feature of the model, is that it suggests that the central bank controls the rate of interest, and it should try to flatten the yield curve. That is, the bank rate (short run) should adjust to the natural rate (long run). In many respects this is the general rule behind all conventional stories about central banking. The Taylor Rule or the New Keynesian ideas behind Clarida, Galí and Gertler are basically a variation of Wicksell's story.

One thing that is also important about Wicksell's rule is that if the yield curve is negatively sloped (the bank rate is higher than the natural rate) then a recession (deflationary forces) are to be expected. The graph below uses the Fed Funds for the bank rate and the 10 year Treasury bond rate for the natural rate. In between the gray lines the official NBER recessions are shown.

As it can be seen, after the red line (Fed Funds) moves above the blue line (Treasury bonds rate) a recession always follows. There are many problems with the Wicksellian model, not the least the assumption of a natural rate of interest, that was severely criticized by Keynes in the General Theory. But the empirical notion that an inverted yield curve forecasts a recession seems to survive any possible theoretical critique. More on the critique will be left for other posts.

Mario Draghing the feet on monetary policy

2011-11-08T09:52:00.000-08:00

Central Banks have been at the epicenter of the current crisis, and have been, for good and for bad, fundamental for the policy response mounted to avoid a new Great Depression. Recently Christina Romer argued that the Fed should start targeting nominal Gross Domestic Product (GDP) instead of inflation. As I noted previously (see here), this is strange since it is far from clear that the Fed actually targets just inflation, or that targeting nominal output would make any significant difference.

Further, the idea that a central bank has the ability to actually hit a targeted level of output, or inflation for that matter, under the current circumstances in particular, is wishful thinking. Central banks can ease the credit conditions by reducing interest rates, a range of rates from the short to the long, to stimulate spending, and pump money into the system, fundamentally to avoid systemic crisis caused by bankruptcies. The ability of Ben Bernanke or Mario Draghi, the newly appointed head of the European Central Bank (ECB) that reduced the rate of interest in Europe as his first measure (see here), to further reduce interest rates and with that help the staggering recovery in the US or the free fall in the periphery of Europe is very limited.

Read the rest here.

Neo-Wicksellian macroeconomics

2011-11-07T13:42:00.000-08:00

Modern macro has more to do with Wicksell's Interest and Prices than with Keynes' General Theory. For one, the idea of a natural rate of unemployment derives directly from Wicksell's natural rate of interest, as Friedman noted. So here is a brief explanation of Wicksell's main argument in that book.

Wicksell distinguished between the natural rate of interest (R*) and the monetary or bank rate of interest (R). The former was determined by the marginal productivity of capital (I) and the intertemporal decisions of consumption (leading to savings S), along the lines of what became known as the loanable funds theory. The monetary rate was determined by bank decisions. That is, banks supplied credit (Ms) at the chosen rate of interest (R), according to money demand (Md). Monetary equilibrium occurred when the two rates coincided (see figure below). The natural rate is the gravitational center around which the bank rate fluctuates. Real and monetary shocks could cause deviations of the bank rate from equilibrium.

Wicksell assumes that a positive productivity shock raises the natural rate of interest, and that banks maintain the initial monetary rate. Thus, with a low bank rate, investment exceeds savings and once the system reaches full employment prices would go up. However, continuous lending would reduce bank reserves, and as a result banks would be forced to increase the monetary bank until a new equilibrium was reached. Inflation resulted from a bank rate that was too low, as much as deflation (and temporary unemployment) from a bank rate that was too high.

The low bank rate implies overinvestment, and the need for additional savings. The inflationary process by reducing the ability of consumers to spend provides the additional 'forced savings.' Inflation acts as a tax that provides the additional resources needed to finance investment. The business cycle can be explained by exogenous shocks to productivity (the I curve), changes in consumers preferences (shocks to S), or by the misconduct of the banking sector (shocks to Ms). Wicksell, as much as the modern Real Business Cycle (RBC) School, favored the former.

Walk out on Mankiw

2011-11-06T11:27:00.000-08:00

As has been reported in some blogs (Robert Viennau and Daniel McDonald) students were planning to walk out of Mankiw's class to protest the type of economics he teaches and in solidarity with the Occupy movement (Adbusters has had a campaign for a while here). That's right on the mark. The teaching of economics is a central part of the process by which the mainstream and the liberalization and deregulation policies that led to the crisis have been perpetuated. The Harvard Crimson reports on the protest here. The anti-Mankiw blog is here.

More old debates on the euro

2011-11-05T14:17:00.000-07:00

Someone pointed this link on the The Economist site, about British economists (on the left and right of the political spectrum) that were against the euro. Vicky Chick, a very good post-Keynesian monetary economist, appears here.

"Just as the political opposition to a single currency spans both socialists and the free-market right, says Victoria Chick of University College, London (a self-described “left-wing anti”), so the economic Noes contain both old-style Keynesians and Marxists on the one hand, and monetarists on the other. However, says Ms Chick, left and right have different reasons for opposing a single currency. For instance, she and economists like her think that the ECB has an in-built bias towards being too tough on inflation—which is unlikely to concern the right.
That said, the two wings have some objections in common. The left-wingers say that the ECB lacks democratic accountability. So, from the other flank, does Patrick Minford, a monetarist at Cardiff Business School. “The idea that credibility requires unaccountable central bankers is wrong,” he says. “Central bank independence has been oversold.” Far from making the ECB an exact copy of the German Bundesbank as is often supposed, he says, the new bank’s designers forgot how much the Bundesbank relied on its political legitimacy.
Besides this, the anti camp—left, right and centre—have two main objections to joining the single currency. First, they say, monetary union has imposed a “one-size-fits-all” monetary policy on the euro-zone: in booming Ireland and slumping Germany alike, interest rates are 2.5%. To complicate matters, thanks to variations in the structure of economies, a given change in interest rates may have quite different effects in two different countries. Britain’s housing market, says Andrew Hughes Hallett of Strathclyde University, is dominated by variable-rate debt, making British consumption and housing expenditure far more sensitive to changes in interest rates than elsewhere in Europe. Meanwhile, German corporations’ reliance on debt rather than equity finance makes the supply of capital more sensitive to interest rates than, say, in Britain.
On top of this, there is little scope for fiscal policy to cushion the effects of economic shocks affecting different countries in different ways. The stability and growth pact limits national budget deficits to 3%. And the EU budget is not big enough for international transfers to take the strain instead.
This leads to the second objection: that Europe’s labour and product markets are too inflexible to deal with the strains that EMU will put on them. If interest rates, exchange rates and fiscal transfers cannot be called on to deal with economic shocks, then wages and prices will have to do the job. “The consequence of one-size-fits-all”, says John Flemming, warden of Wadham College, Oxford (and a former chief economist at the Bank of England) “is that the strain is likely to be taken by unemployment.”"

The whole thing is worth reading to remember the 1999 mood, and those that actually saw it coming.

Reuters on Greece's tiny debt load

2011-11-05T14:02:00.000-07:00

Pedro da Costa, from Reuters, in their Macroscope blog, says that:

"No, that is not a typo in the headline. Greece has long been the focal point of Europe’s crisis. It was the first country to reveal some cracks in a monetary union that lacks a fiscal authority to back it. Indeed, Greek politics were dominating the headlines on Friday, with news that the prime minister had survived a confidence vote in parliament restoring a momentary sense of calm to a still very dramatic situation.

However, Greece’s actual debt load is only large relative to its own small and struggling economy. In the larger context of the euro zone, the actual amount of debt being haggled over is rather puny."

The rest of the post here. I can't but agree with him, in particular taking in consideration the expert he cites.

John Cassidy on Wynne Godley

2011-11-02T12:46:00.000-07:00

On my way to the euro conference in Austin. Just read this nice piece on Wynne Godley (for whom I worked back in the 1990s) in the last issue of the New Yorker. Indeed Wynne was for the European Union, but skeptical about the way the common currency was being pushed. Must read. I have also a post here.

The Crisis in the Eurozone

2011-11-01T21:50:00.000-07:00

A conference on the euro crisis at the University of Texas, Austin, organized by Jamie Galbraith, will be held this Thursday and Friday, and a live webcast will be available here. The program is here. The event will focus on “A Modest Proposal for Overcoming the Euro Crisis” by Yanis Varoufakis and Stuart Holland, a plan which would combine the innovation of the Eurobond with a “New Deal” approach to European development.

Nominal output targeting

2011-10-31T21:56:00.000-07:00

Christina Romer wrote this Sunday about the necessity for the Fed to target nominal output. The implication seems to be that so far the Fed had been targeting inflation, which is obviously incorrect. That would be the ECB. Krugman (here) for some reason liked it. By the way the idea is not new, Samuel Brittan had argued for that not long ago (here), and as noted by David Beckworth so have two other prominent FT columnists (Clive Crook and Martin Wolf).

First of all, Romer calls this a Volcker moment, which is from a historical point of view (and she is a macroeconomic historian) preposterous. Volcker is the guy that tried to use nominal monetary targets, as in Milton Friedman's monetary growth rule (now he is much better and is against de-regulation and too big too fail among other things).

Further, it's not clear how a nominal GDP target would be different from what the Fed is already doing, namely acting as a lender of last resort, and keeping interest rates (short and long, the latter through QE) low. Worse, her argument smells to the confidence fairy stuff you hear from ~~the crazies~~ serious people, and that correctly Krugman deplores. She says:

"By pledging to do whatever it takes to return nominal G.D.P. to its pre-crisis trajectory, the Fed could improve confidence and expectations of future growth."

Sure as objective targets come, nominal GDP is better than inflation, but since the Fed does not target inflation what is she fighting? Ben Bernanke is fine, Super Mario (Mario Draghi), the new president of the ECB needs whatever is the reverse of a Volcker moment. The US (and Europe) need more fiscal expansion.

The political economy of flat taxes

2011-10-30T10:25:00.000-07:00

The GOP has revived this season the ghost of the flat tax. Cain is for the 999 plan (whatever that is) and Perry for a 20% flat income tax (see here, for example). I haven't seen any particular analysis of the Perry plan so far, but it won't be much different from the Cain breakup. For example, the Tax Policy Center (here) shows that Cain's plan would increase the federal taxes of the lowest quintile by 18.3% while reducing that of the top 0.1% by 17.9%. And that's not class warfare! You don't need to be a rocket scientist to know that when you hear flat tax it's all about reducing the taxes of the rich.

Taxation was, by the way, always a key concern of classical political economy (it's there in the title of Mr. Ricardo's Principles). One of the most famous tax proposals of the 19th century, Henry George's single land tax, was in fact based on the 'Ricardian' theory of the rent. That is, the idea that landowners derive their income (rent) from ownership, and that their income (for a given level of output) detracts from profits and the possibilities of accumulation, required a tax to transfer income against wealthy landowners.

The interesting thing is that since the old classical surplus approach makes it clear that class conflict is essential for understanding the functioning of the economy, it does not try to disguise the issue of taxation as not having distributive consequences.

Utah is number 1

2011-10-27T13:41:00.000-07:00

A graduate student brought to my attention the study here that classifies universities according to economic freedom (liberty). The Econ Dept at the University of Utah is number one (if you exclude Canadian universities) in the liberty-reducing (see graph below; click to enhance) index. We hate freedom here!

If you read the paper you'll find out that the liberty-enhancing and liberty-reduction indexes depend on what types of petitions the faculty signs. So if you sign a petition for free trade and against protectionism (a Club for Growth thing), to oppose tax hikes (the so-called Death Tax; yes they do use that term in the paper), to warn against the risks to Social Security (i.e. want to cut benefits) then you're for liberty. But if you sign a petition against the Bush tax cuts, to increase the minimum wage, or to show concern about global warming (they call it climate change; I know) then you're against liberty.

I'm proud to be against liberty then. By the way, we beat other heterodox depts, like UMass Boston and Amherst, right after the U, and the New School and UMKC that don't register at all.

PS: I just noticed that they are color blind. The liberty hating lefties should have been blue not red!

Historians and the surplus approach

2011-10-26T12:23:00.000-07:00

An interesting feature of the literature in history, particularly when related to ancient history, is that ideas that are clearly in the tradition of classical political economy, that is the developments from William Petty to Marx including mainly, but not uniquely Quesnay, Smith and Ricardo, are often used in contrast with the dominant supply and demand approach of the literature in economics. The typical discussion of development presumes that it was the surplus obtained with the domestication of plants and animals, and the transition from hunter/gatherer to agricultural societies, that allowed specialization (the division of labor) and the development of social classes.

The figure below comes from William McNeill's classic The Rise of the West, and the essential concept of surplus is at the center of the stage.

In that sense, historians, contrary to economists (even economic historians) do not tend to fall into the trap of describing markets as autonomous institutions that are disconnected from society. Also, historians tend to think in terms of classes, and restrict individual behavior to the kinds of actions that are related to the underlying social class. That is true in several popular books like Jared Diamond's Guns, Germs and Steel.

Galbraith on long term growth

2011-10-25T21:34:00.000-07:00

Link to the interview here, where he says that we need to spend ourselves out of the stagnant economy.

PS: Here link to his upcoming conference on the European crisis.

G20 Meeting

2011-10-23T12:14:00.000-07:00

Yep nothing much will happen. My take here on TripleCrisis.

Commercial Policy in Latin America

2011-10-23T11:59:00.000-07:00

Last week I taught my Raúl Prebisch class, in my Latin American Economic History and Development course, dealing with Import Substitution Industrialization (an annual thing now). The classic paper in English was published in the American Economic Review of 1959. The masters' students have to read the original paper. This follows my two previous posts (here and here) on trade. A few things that are important to notice.

Prebisch clearly says that industrialization (and hence the expansion of domestic production) is an inevitable part of the process of development, something that has been often forgotten as if strategies based on services or intensive agriculture are alternatives to industrialization. We still live in industrial societies (not post-industrial ones), and industry remains the main source for productivity growth (something that was referred to as Kaldor's Second Law of development).

Second, even if there is strong growth of productivity in the primary sector, these tend to be passed to prices and benefit the consumers, mostly in developed countries, whereas at least part of the increases in productivity in the other two sectors are retained by workers in the form of higher wages. So the problem of industrialization is associated to the ability to keep in the developing countries the fruits of technological progress, and not with protectionism for the sake of domestic special interests. Further, the workers expelled from the primary sector (if productivity is to grow there) must be incorporated in the other sectors, and as a result a preoccupation with what he calls (following Lewis) 'surplus manpower' (p. 255).

Last but not least, it's worth again emphasizing on the question of protection (since Prebisch is seen often as the Devil by Free Traders*), that Prebisch (p. 259) notes clearly that: "protection by itself does not increase productivity."

* The typical attitude is I did not read it, and I did not like it. The aversion of the mainstream to Prebisch is so strong that Dani Rodrik confesses in his Prebisch Lecture (see the irony?!) that a month before he had not read any of his works. Basically he found out that Prebisch: "did not favour indiscriminate protection. He anticipated his later critics by recognizing that trade protection on its own would not lead to increased productivity in manufactures, and that it might even resuit in the opposite."

More on "free" trade

2011-10-21T10:01:00.000-07:00

In a recent post I promised to develop the critique of the dominant trade model, the so-called Heckscher-Ohlin-Samuelson (HOS) theory. While the Ricardian concept of comparative advantage is based on the labor theory of value (and is compatible with modern versions of that theory, as developed by Sraffa), and its results hold if the assumptions are realistic (limited capital mobility, and a fixed level of employment, the latter could result from domestic demand policies), the HOS is an application of the marginalist theory of value and distribution and it suffers from that theory's inconsistencies.

The HOS theory says that a country exports the goods that are intensive in the use of the factor of production that is abundant in the country. A country with lots of workers, and according to theory cheap labor, would produce goods that are labor intensive and export them, while importing capital intensive goods. The graph below illustrates the argument.

If there are two goods (a and b), and one (a) is always more capital intensive (bigger capital-labor ratio) than the other (b), and in both goods we have that as capital intensity increases (larger K/L ratio) the rate of interest falls, then as the rate of interest falls the relative price of the capital intensive good with respect to the labor intensive one falls too. In other words, in a capital abundant country, capital intensive goods would be cheap, and specialization would be guided by the relative prices.

The capital controversy showed that there is no reason, in a world with multiple capital goods, to have a monotonic decreasing relation between capital intensity and the remuneration of capital. One way in which that effect could be represented would be with a capital intensity reversal in the production of goods a and b, as shown below.

In that case, as the intensity of capital increases (K/L goes up) at first, as before, a is the capital intensive good, but now there is a switch and b becomes the capital intensive good at lower rates of interest. The consequence is that for a part of the process as the capital-labor ratio increases the price of a with respect to b increases, but after the switch, the other part of the process, it decreases. The relative abundance of capital and labor is not a guide for relative prices anymore, and as a result, neither can it determine patterns of specialization.

As a result it is not generally true that trade depends on comparative advantage based on relative scarcities of factors of production. This suggests (as the critique of the Ricardian version of the model) that absolute advantage, lower costs, might be more important than conventional wisdom suggests. Also, it implies that history and institutions are central to understand patterns of trade specialization.

The seminal work in this area was done by Ian Steedman, extending the ideas of Sraffa to foreign trade. The classic papers have been collected in Steedman's edited book Fundamental Issues in Trade Theory.

Jamie Galbraith on the European crisis

2011-10-19T09:33:00.000-07:00

Here is the link to Jamie's take on the European crisis. Mike Mandel and Dan McCrum two journalists, are also part of the talk. I'm increasingly surprised that there is a concern that the European Financial Stability Facility (EFSF), the bailout fund, is NOT large enough. As I said before, the Greek debt is not that large, and the European Central Bank (ECB) can buy just a fraction of Greek debt and solve all problems (by the way Jamie makes that point very clearly: that the ECB can print as many euros as they wish to). It's difficult to get this whole thing, as Jamie says Greece is being destroyed, and for what exactly? To make an example.

PS: That also explains the media's need to continue lying about Argentina's post-default performance. Not only Greece must be an example, Argentina cannot be a good example of a default country doing well. On that see Dean Baker's post.

Crossing lines

2011-10-19T09:17:00.000-07:00

David Ruccio has a great post on why there are no clear lines between research and policy advice, between advocacy and activism. The post was prompted by Krugman's justifications for not appearing in the Occupy Wall Street protests. I agree with Ruccio that it is possible to provide serious analysis and participate in social movements, and there are lots of examples of public intellectuals that do both well (Noam Chomsky, the late Howard Zinn, and Cornell West, shown above, come to mind). For example, here is the take from Kevin Gallagher and Mark Blyth in Occupy Boston.

Garegnani and the revival of the surplus approach

2011-10-18T08:01:00.000-07:00

(1930-2011)

Last weekend Pierangelo Garegnani passed away in Rome. He was the main disciple of Piero Sraffa, and one of the most important heterodox critics of the mainstream marginalist (neoclassical) approach. A full account of his contributions to economics is well beyond what I can offer in this space, but here are a few highlights.

As early as 1961, while spending an academic year at MIT, he suggested during a presentation by Paul Samuelson that his results depended on the assumption that all sectors use the same capital-labor ratio. The final results of his critique were presented in Garegnani's paper "Heterogeneous Capital, the Production Function and the Theory of Distribution." His paper shows conclusively that the marginalist theory of value and distribution based on an aggregate production function is untenable. This of course builds on Sraffa's work in the Production of Commodities (PC). By 1966, in the famous Quarterly Journal of Economics (QJE) Symposium, Samuelson had admitted that the neoclassical parable was not defensible.

In his 1976 paper "On a Change in the Notion of Equilibrium in Recent Work on Value and Distribution" Garegnani argued that to avoid the problems associated with the aggregative marginalist model, the mainstream had switched to Arrow-Debreu (AD) General Equilibrium models, which did not use aggregative capital, but also did not assume a tendency to a uniform rate of profit, which implies that it can only be seen as a short run equilibrium. Further, Garegnani later argued that, beyond the problem of being stuck with a short run theory, the AD model was still open to the capital critique, since a notion of aggregate capital was still needed for the equilibration of savings and investment (see his 2003 paper "Savings, Investment and Capital in a System of General Intertemporal Equilibrium").

Garegnani was also the central author arguing that the recovery of the classical theory of value and distribution (and hence Marx) was not incompatible with the Principle of Effective Demand (PED), as developed by Keynes and Kalecki. His two papers in the Cambridge Journal of Economics show that a rejection of the marginalist notion that labor and capital markets tend to full employment depends on the rejection of the mainstream theory of value and distribution, and that Keynes' PED is fully consistent with the old and forgotten classical or surplus approach. He also actively contributed to the extension of the PED to the long run until the end of his life (e.g. his paper with Trezzini).

There are several other contributions, in particular his work on the interpretation of Ricardo and his debates with orthodox Marxists, which again follow in the steps of his teacher. His work is essential for those interested in the understanding of the functioning of capitalist economies, and the incapacity of the mainstream to provide a useful tool to analyze reality.

Jamie Galbraith on the jobs plan

2011-10-17T21:41:00.000-07:00

Jamie's take on the plan. Here is the link.

Sims is not Sargent

2011-10-15T10:36:00.000-07:00

Below Steve's comment on Sims. Worth a whole post.

Chris Sims' classic 1980 paper "Macroeconomics and Reality" still echoes, or should, among macro model builders and macro econometricians. He could not possibly be clearer about the "incredible" restrictions that models often impose, and proposed a way forward, the VAR in its many forms.

That method has evolved to the point where, for example, good econometricians can recast a DSGE model in VAR form and see if it survives the data. Often they don't, a recent example being Peter Ireland's DSGE so soundly rejected by Katarina Juselius.

The rub is in the qualifier good. This is not easy stuff to do correctly. But its power is worth the sweat. Sims has been homaged over his prize by Mark Thoma here, and by Jim Hamilton, the time series bible author here.

A very favorite story is when Sims, Robert Litterman, and Thomas Doan, all either at the Minneapolis Fed or U of Minnesota in the 80's, "took on" their big models with a small VAR and outforecast them by a bunch. They soon left, maybe excommunicated? But Sims and Litterman at least landed on their feet...Litterman just retired as head statistician at Goldman Sachs. So the Sims triumph validates a reality first approach, meaning data before theory, and with the tools we now have and careful work, this method will become ever more influential in applied macro. Sims has also contributed to Bayesian approaches to macro modeling.

I totally miss the logic of the pairing with Sargent, but such is academic politics.

I agree.

PS: Links are there in the two here in Steve's post, and in the title of Sim's paper and Juselius name.

Esther-Mirjam Sent on Sargent and more

2011-10-12T09:54:00.000-07:00

As Kevin Gallagher noted, the contributions of Sargent and Sims are quite different and should be analyzed separately. Ester Mirjam-Sent is certainly the most qualified and discerning critic of Sargent's work, and anybody interested in understanding his (Sargent's) contributions to economics should read her extensive research on his ideas. A good start is her paper in the Cambridge Journal of 1997 (here).

Her concerns are more with the evolution of his thinking about rationality, from rational to bounded, which is a central pillar of neoclassical economics. She notes that Sargent's preoccupation with rationality (which should be contrasted with Simon's views) was to strengthen the theoretical foundations of neoclassical economics. I tend to be more concerned with the critique of those foundations, rather than with the question of how rational behavior leads (or not) to efficient market results.

One important area, in which I have done some research, is hyperinflation theory. Sargent basically is responsible for extending the Cagan model (his classic paper is here) and suggesting that beyond a monetary reform, a credible fiscal adjustment was essential for stabilization. In that sense, while Sargent maintained the fiscal fundamentals of hyperinflation, he suggested that expectations did have a role to play. As Carlos Bastos reminded me recently, here is a critique of Sargent's contribution published in the Economic Journal (subscription needed; portuguese version here). For an alternative discussion of inflation/hyperinflation go here, and for a survey of the literature here.

PS: Sent was one of the faculty members that left Notre Dame after the administration dismantled the heterodox program there. For more on that read here.

Re-writing history

2011-10-10T13:44:00.000-07:00

By the way, in the middle of the several comments praising the winners of the Sveriges Riksbank Prize in Economics there will be a lot of misplaced acclaim. Here is one example from the Huffington Post:

"Sargent famously weighed in on the fight against inflation in the early 1980s. Many economists believed it would take years of high interest rates to bring inflation down. But Sargent believed that inflation could be tamed much faster if the Federal Reserve acted enough to break the public's expectations that prices would continue to rise rapidly. That is basically what happened: Then-Fed Chairman Paul Volcker raised interest rates so quickly and so much that inflation expectations were shattered."

So now, if you believe this report, Sargent and Lucas were right about the costless disinflation of the 1980s. Forget that disinflation had to do with falling commodity prices, caused by the hike in interest rates, and with the weakening of the labor force, which faced what was, in the US up to that point, the worse recession since the Great Depression. Unemployment in the US reached 11%, but it was inflationary expectations that mattered. And the Huff Post is a progressive site, isn't it?!

A beautiful blind

2011-10-10T12:59:00.000-07:00

Sylvia Nasar wrote a new book (the old and famous was the one on Nash's mind and life) on the history of economic ideas. Robert Solow is not too happy, since he thinks the book is superficial, and spends too much time on the economists lives and on what he thinks are second rate minds (e.g. Beatrice Webb, and I suspect for him Joan Robinson too). I did not finish reading the book, and hence will not review it here now, but I can comment on Solow's review, which is quite misguided.

In fact, the preoccupation with policy issues and the general context in which theories are developed is one of the good aspects of this book. In this sense, Nasar's book is in the direct line of descent of those, like Robert Heilbroner, that think that economics is (and should be) about the great questions (accumulation and the wealth of Nations, the quintessential themes of classical political economy) and that the economist's vision is as essential as, if not more so, than the analytical tools utilized.

For example, Solow complains that the book does not spend enough time discussing the theoretical achievements of Alfred Marshall. The fact, that somebody, with Solow's credentials, can write that after Piero Sraffa's devastating critique of Marshallian partial equilibrium (still in all textbooks, by the way), as if his technical achievement was not simply incoherent and irredeemably incorrect is a testimony about the poor state of our discipline.

Solow's complaints about Nasar discussion of Keynes are more puzzling, since he should be as neoclassical synthesis Keynesian be very comfortable with the 'developments' of Keynesian theory within the mainstream, which are after all the dominant model (the New Keynesian model with an IS, a monetary rule and a Phillips curve). He was instrumental in the creation of the current macroeconomic consensus, and his growth model (for which he won the Sveriges Riksbank Prize, also known as the Nobel in economics, although it's not one of the original Nobels) is the dominant view on growth. If the profession has failed, Solow is certainly responsible for it to a great extent.

If anything the problem with the book is that it shares with the mainstream (including Solow) a certain view of economics, and progress in the discipline, that has been established since the rise of marginalism in the latter part of the 19th century. In this view, there is a direct line of descent from Smith and Ricardo to Marshall (via Stuart Mill) to modern economics. According to this approach, the critical authors are, not the true heirs to classical political economy (that is from Smith/Ricardo to Keynes/Kalecki, via Marx), but critics of some aspects of capitalism that seem to have more heart than brains.

In all fairness, however, it's not surprising that a journalist/writer that is not an specialist economist buys the conventional wisdom on the history of ideas. The conventional history of ideas texts are fundamentally, like the parable in Bruegel's painting, written by blind professors to guide their blind students.

PS: The Sveriges Riksbank has been awarded to two professors (Sargent and Sims) that most likely believe that government intervention in the middle of the crisis is worse than some version of laissez faire. This is the reason, not the predictions about the end of times, why this is a dismal science.

On 'free' and managed trade

2011-10-07T23:40:00.000-07:00

In one my last posts I promised to talk about "free trade." As I said the name itself is a misnomer, much like "free market." Not just because it suggests that those that oppose it are somehow against freedom, but mostly because it vaguely indicates that trade and markets are like natural phenomena, which would spring out if only government restrictions were eliminated.

In fact, it is well known, at least since Polanyi's classic, that the key markets in capitalist economies (those for land, labor and money) were slowly created by the interplay of social conflicts articulated through the political process and that their very existence results, in part, from the power of the State. Thus, simplistic and manicheistic views on the relation between the State versus the 'free' market miss the point of how States and markets co-evolved historically.

For example, the Bank of England, created in 1694, obtained the monopoly of money creation only after the Bank Charter Act of 1844, something that resulted from the victory of the City (financial interests) over the country banks (closer to commercial interests). The money issuing monopoly would be impossible without the backing of the government (and its monopoly of violence). The same can be said about international trade transactions. For example, it is well known that the period of the so-called first globalization (1870-1914) saw a significant increase in the volume of world trade. However, several regions actually became more 'protectionist,' i.e. increased the tariffs on trade (see Paul Bairoch for a good discussion on the topic).

In Latin America the higher tariffs allowed government revenue to increase, which, in turn, created the conditions for national armies to reduce domestic conflicts, and centralize administration, provide guarantees for foreign lenders, and fund the construction of railroads and ports. Without tariffs and higher government revenue the integration into world markets would not have been possible.

That does not mean that everybody in Latin America (or in other regions for that matter) did benefit from the increase in international trade during the period [it's worth remembering that in Mexico, towards the end of the period, peasants did revolt against the Porfiriato in the so-called Mexican Revolution of 1910]. It was not 'free' trade that produced growth, but the management of trade to produce commodities for the center (a particular project supported by local elites and international financial and commercial groups) that led to growth (with high levels of inequality).

A more logical discussion, for all these reasons, should not be about 'free' trade versus protectionism, but about what type of managed trade a given society wants, and who benefits from the different trade arrangements. For example, in current discussions about bilateral and multilateral trade agreements the issues of investment and property clauses are essential. The dispute is mostly about those that want to protect the interests of corporations (e.g. property rights, access to foreign courts, elimination of financial regulations forbidding sending profits abroad, etc.), and those that might have alternative interests (e.g. protecting domestic jobs, creating national capacity for industrial innovation, the environment, etc). In fact, for specific cases, like defense or sanitary and phytosanitary rules, it is well established that trade should be regulated, i.e. not 'free' but managed (for discussions of some current problems with the 'free' trade agenda see here and here).

But the problems for the defenders of 'free' trade are not limited to the inconsistencies of their policy positions. In fact, despite the general agreement on 'free' trade by academic (mainstream) economists, the theoretical foundations for their position are very shaky. The basis for the argument harks back to David Ricardo's Principles (and also to the parallel work by Robert Torrens). Ricardo argued that if England and Portugal traded without imposing tariffs it would be mutually beneficial, even if Portugal was better at producing both goods being traded, cloth and wine. The reason is simple. Even if Portuguese workers were more productive than their English counter-parts at producing both goods, they might be better at producing one of them (say wine) and would still benefit from putting all their efforts behind the activity at which they excelled.

In other words, the argument for trade without tariff or other restrictions was based on the the idea that trade is equivalent to access to better technology. The Portuguese could specialize in what they are better technologically, and obtain through trade the things that they do not produce. The English would have also access to better wine. Both would get cloth even if the English were less effective at producing it. The message is: specialization is the wealth of the nations.

However, what is often missed in the discussion is that the Ricardian argument for comparative advantage, as it is the case with all economic models, depends upon certain special assumptions, and that those premises responded to Ricardo's own political views. First, Ricardo assumed that all workers that were employed in wine production in England would find jobs in cloth production, and that all workers in the cloth sector in Portugal would be able to work in the wine sector. Say's Law of Markets, that suggests that general demand crisis do not take place domestically was extended to external markets too. Workers are always employed by definition (not necessarily full employment for Ricardo). Further, Ricardo assumed that capital was immobile, that is, even if it was cheaper to produce from Portugal (given its higher productivity and lower costs) and export to England, English capitalists would prefer to maintain their capital in England and produce in the home country.

Note that if any of those assumptions is violated Ricardo's argument falls apart. In other words, if workers in England and/or in Portugal in the displaced sector cannot find jobs in the other sector, it is unclear that all benefit from 'free' trade. Also, if capitalists can and do move from country to country (interestingly enough Ricardo descended from a family of bankers emigrated from Portugal to Italy, then to the Dutch Republic and finally to England) then in his example the lower costs (absolute advantage) of Portugal would determine that both cloth and wine would be produced there. England would be in a difficult situation importing both goods and condemned to grow at a lower pace, which is exactly the opposite of the historical situation (for an analysis of Anglo-Portuguese trade after the Methuen Treaty of 1703 that allowed Portuguese wine to be exported to England free of taxes and the same for English textiles into Portugal see Sandro Sideri's Trade and Power).

The reasons for Ricardo's special assumptions are very well-known. Ricardo represented financial and industrial interests, and was a harsh critic of the Corn Laws, the tariffs on imported grain imposed after the Napoleonic Wars, that favored the landed and aristocratic classes, defended by his friend Robert Malthus. Ricardo assumed that wages were at the subsistence level, and that tariffs on the importation of grain would lead to the use of more and less productive land in England for their production, increasing the rent accrued by the landowners. For a given output, and fixed wages, the higher rent would necessarily reduce profits, and capital accumulation. In other words, the special assumptions (which Ricardo thought relevant for the particular case of England in that particular historical context) were instrumental in his argument for the elimination of tariffs on grain imports. His was a progressive argument for industrialization and against the agrarian aristocracy (for a discussion of Ricardo's political views see Milgate and Stimson's Ricardian Politics).

Generalizations of the Ricardian argument can only be defended if his assumptions (including that displaced workers do find jobs and there is no capital mobility) are also thought to be generally valid. More modern arguments for 'free' trade rest on the so-called Heckscher-Ohlin-Samuleson (HOS) model, that is fraught with logical problems, and even less defensible than the generalization of Ricardian views, but I'll deal with those in another post.

PS: My paper "What Do Undergrads Really Need to Know About Trade and Finance" might provide a more detailed discussion of some of the issues above. Robert Vienneau has posted here elements of the Sraffian critique of the HOS model.

On China and Jobs

2011-10-04T22:13:00.000-07:00

It is true that whenever the economy grows trade deficits tend to become larger, and the United States, which has had persistent deficits since the early 1980s, is particularly prone to those. Dean Baker has been the most vocal defender of a weak dollar (mostly as measure to boost local manufacturing jobs, since a depreciated currency protects local production; here for example a recent piece). Krugman too has recently argued for a more depreciated dollar and also for trade restrictions against China (see here for a recent one).

In all fairness, I have a few concerns with these line of thought, and not because I am (or ever was) a "free trader", like Krugman (by the way Free Trade is a terrible misnomer and there are serious problems with the conventional arguments for it; theme for another post, I guess).

First, in the case of China, the exchange rate has appreciated a lot since the crisis as can be seen in the graph below (Data from the Economist Intelligence Unit).

Further, when measured by changes in wages (labor costs) the real appreciation since 2007 has been of around 27%, 10% more than when measured by prices, since real wages grow relatively fast in China. Further, China has grown since 2007 at an average of 10.5% per year. In other words, China is growing and revaluing its currency; not sure what more can be expected on that front. Blaming China for lack of fiscal stimulus in the US seems, not just futile, but wrongheaded.

Another important point often missed in these discussions of the exchange rate is that a depreciated currency, everything else constant (economists do like a ceteris paribus condition) implies lower real wages, since imported goods tend to be part of the workers' consumption basket. Hence, if you favor a depreciated dollar, but tend to be for workers (which are getting to bear the brunt of this crisis, as is always the case), then compensating measures are needed to increase real wages without reducing competitiveness (other costs must be reduced, or profit margins would have to be squeezed; that's just the algebra).

Finally, my perennial question, raised before here, so if US deficits are larger, but we give the Chinese dollars, and they hold dollar denominated assets, what's the downside again?

PS: Concerned about the dollar? Go here.

La vie en foreclose

2011-10-03T10:48:00.000-07:00

That's right, not through pink glasses (i.e. rose). Randy Wray, Charles Whalen and Stephen Roach, all in the same page, asking for debt relief as essential for recovery, since most consumers are still de-leveraging from the housing bubble.

Both Keynes and Irving Fisher suggested that debt-deflation was at the heart of the Great Depression, and in that case debt relief for households should be at the center of the recovery. In the 1930s, the New Deal did provide a lot of debt relief for farmers, on top of trying to raise the prices of agricultural commodities (in order to help famers). Now more is needed in the housing front. The figure below shows how much the debt of the non-financial sector has fallen since the beginning of the crisis.

From the peak in 2008, it has fallen around US$ 700 billions. It's likely to continue. The problem is that consumer spending was tied to the ability to obtain credit, i.e. of getting indebted. And mortgages were central for consumers.

The euro is not money of account in Greece anymore

2011-10-02T14:47:00.000-07:00

In Argentina, when the crisis got to the worst stage and reduced revenue and spending cuts were at the peak, local governments started using token currencies to pay state workers. The Buenos Aires province started paying its workers in patacónes, which became an alternative to the official currency, the peso, in 2001. In Greece we are already there. Local networks in which transactions take place using an alternative unit of account are taking place. These, if I understand correctly, are private and for the most part electronic networks, rather than public, as in the case of Argentina. No actual currency is being printed (as the 100 patacónes shown above).

At any rate, they go to the heart of the money question, i.e. they serve as alternative units of account. Money is, after all, the unit of account that allows economic calculation to take place and facilitates the creation of credit and debit networks. Keynes said in his Treatise on Money that: “money of account comes into existence along with debts, which are contracts for deferred payment, and price lists, which are offers of contracts for sale or purchase.... [and] can only be expressed in terms of a money of account” (p. 3). This indicates that the euro is not playing that crucial role of money for the Greek people anymore.

More deficits, not fiscal responsibility

2011-09-30T10:18:00.000-07:00

So there is a short review of the Hinckley Forum debate here. Not bad, but the title is misleading, since nobody was for for fiscal responsibility in the way it is usually defined, i.e. fiscal contraction. By the way, fiscal responsibility, like fiscal consolidation, is one of those code words for adjustment, that should be avoided. At any rate, if you missed it, that is a reasonable summary.

PS: I also emphasized that uncertainty is not central for the current weak recovery, lack of demand is and Steve agreed that without more demand there will be no more confidence. In fact, Steve's plea was for public investment in infrastructure. That's a way of recovering confidence that I'm also for.

Lucas in context, Keynes out of context

2011-09-28T19:59:00.000-07:00

Krugman decided to try his hand at history of macroeconomic thought in one of his last posts. That's great, since history of thought is essential to understand how we got here. It's also bad, since Krugman is still very much a mainstream author, and misses the point of Keynes' contributions, and the limitations of neoclassical (or more properly, marginalist) approach. He suggests correctly that the New Classical (NC)/Real Business Cycle (RBC) project was a failure, but both the reasons for that and his interpretation of the Keynesian project are misguided.

The first proposition in Krugman's reassessment of the recent history of macroeconomics, is that Keynesian models were ad hoc, and assumed wage and price rigidity. The whole of chapter 19 of the General Theory (GT) is about the effects of price and wage flexibility, and how it does not produce full employment. It was with Franco Modigliani's PhD dissertation, done at the New School for Social Research under Jacob Marschak, that the sticky wage version of Keynesian theory that would dominate the neoclassical synthesis was concocted.

Keynes is actually quite explicit about the negative effects of wage reductions. He says (GT, ch.19-link above):

"A reduction of money-wages will somewhat reduce prices. It will, therefore, involve some redistribution of real income (a) from wage-earners to other factors entering into marginal prime cost whose remuneration has not been reduced, and (b) from entrepreneurs to rentiers to whom a certain income fixed in terms of money has been guaranteed.

What will be the effect of this redistribution on the propensity to consume for the community as a whole? The transfer from wage-earners to other factors is likely to diminish the propensity to consume. The effect of the transfer from entrepreneurs to rentiers is more open to doubt. But if rentiers represent on the whole the richer section of the community and those whose standard of life is least flexible, then the effect of this also will be unfavourable. What the net result will be on a balance of considerations, we can only guess. Probably it is more likely to be adverse than favourable."

Hence, the fix-wage version of Keynes' thought is the result of misconception, that suggests that if markets worked well, without imperfections, they would move to full employment. Unemployment is a disequilibrium, by definition a short run situation resulting from a rigidity.

The whole point of the neoclassical synthesis was to suggest that one could continue to teach that markets are efficient, and that supply determined the price and quantity of equilibrium in all markets including those of "factors of production" (i.e. the labor and capital markets), and as a result unemployment could only result from rigidities in the labor market. Nothing revolutionary there, and in that case, as Keynes foresaw, people would think he was quite wrong or said nothing new.

By the way Krugman does not believe that rigid wages are behind our current lack of full employment (in his view it is the downward rigidity of the rate of interest; Keynes also did not believe in the liquidity trap as the cause of depressions), which makes it more difficult to understand why he defines Keynesians (Old and New) as pragmatic rigid price and wage modelers. You cannot blame then Laurence Kotlikoff for his confusion (here and Krugman's reply and here; Jamie Galbraith, also implicated, gives a better answer since he never said that Keynes is about wage rigidity; scroll down for Jamie's and Kotlikoff's back and forth).

Krugman's second point is that Friedman and Phelps in the 1960s were trying to provide microfoundations to wage and price rigidity. Actually, the microfoundations agenda had more to do with the theoretical development of theories for consumption (Modigliani, Friedman), investment (Eisner, Tobin) and money demand (Baumol, Tobin) behavior. The Phillips Curve (PC) debate and the Friedman-Phelps notion of a natural rate of unemployment is associated to the idea that there is a supply side constraint to the economy, and stimulating demand would ultimately have only effects on prices and not on quantities. The economy naturally moves to full employment, unless there are restrictions, and what is needed is to eliminate the restrictions not stimulate demand.

In other words, the monetarist approach of Friedman accepts the neoclassical synthesis notion that it is the rigidities that cause unemployment. It just proposes a different policy solution. By pointing out the existence of a natural rate of unemployment analogous to Wicksell's natural rate of interest (which Keynes' criticizes in the GT) Friedman was just emphasizing that if one believes in the neoclassical theory of value and there are no restrictions the system moves to full employment. In fact, Friedman's (1970) theoretical framework, an ISLM cum PC and natural rate model, is remarkably close to the neoclassical synthesis models.

In that sense, the Lucas Revolution and the subsequent move, after Kydland and Prescott's work, of most New Classicals , including Lucas, to the Real Business Cycles camp is a not a break with Friedman, and the New Keynesians (NK) that accept everything (including the natural rate) are part of the same tradition. The difference is that some emphasize the long run neoclassical principles and others the short run rigidities that demand policy action.

The fundamental problem of the neoclassical/marginalist approach, and the importance of Keynes analysis, can ONLY be properly understood in light of the 1960s capital debates (for a good reference go here). The point, for the purposes of our discussion here, is that if there is unemployment and real wages fall, neoclassical theory tells you that according to the principle of substitution, more labor is demanded (the cheap thing that is in excess supply) and less machines (capital) are used, since they are relatively more expensive. However, since labor (which is cheaper) is used in the machine sector too their price should fall too, and is not generally true that there is a tendency for the full utilization of "factors of production" according to their relative scarcities. Further, even if the substitution effects go in the right direction, and more labor is used, the income effect of lower real wages tends to be large and have a negative effect on demand (put simply, workers cannot buy stuff), which implies that less of all "factors of production" are used. In other words, there is no natural tendency to full utilization of labor or capital, and both the natural rate of unemployment and its evil twin the natural rate of interest do NOT exist.

So it is peculiar that Krugman thinks that "NK economics [is] useful, if only as a way to check my logic, although it’s not really clear if it’s any better than old-fashioned Keynesianism." What logic? New Keynesian models assume a natural rate, and that the economy (without rigidities) moves to full employment! The problem with the NC/RBC/Lucas' type of theory is not that it failed to predict the 1980s recession or that they think that most crises are caused by real shocks (although both propositions are obviously wrong), as Krugman seems to believe, but that they do maintain the fiction of an efficient market that clears (in their case too fast for Krugman's taste) and that produces a natural rate. If he wants to move in the right direction Krugman should follow Galbraith and announce that it is time to ditch the natural rate hypothesis.

PS: That means that progress in economics is not linear, and that one can and should learn from old and forgotten traditions (classical political economy did not assume full utilization of resources).

Christina Romer gets it right on the deficit

2011-09-26T15:43:00.000-07:00

Romer's column in the NYTimes, a few days ago, is certainly worth reading. She says among other things:

"Fiscal austerity, not more stimulus, is the answer. This argument makes me crazy. There’s simply no evidence that concern about the current deficit is a significant factor limiting consumer spending or business investment. And government borrowing rates are at record lows, suggesting that financial markets are not worried about the deficit, either... The best evidence shows that fiscal austerity depresses growth and raises unemployment in the near term. That’s the experience of countries like Greece, Portugal and Britain, which have embarked on drastic deficit reduction plans over the last two years. Cut the current deficit and you will raise unemployment, not lower it."

It's high time for Keynesians, of any sort, that may have some influence with the President to be for fiscal expansion.

More on the "New IMF"

2011-09-24T13:44:00.000-07:00

More evidence for the changes in our NIMF (New International Monetary Fund). In the executive summary to the last WEO, it argues that:

"Fiscal adjustment has already started, and progress has been significant in many economies. Strengthening medium-term fiscal plans and implementing entitlement reforms are critical to ensuring credibility and fiscal sustainability and to creating policy room to support balance sheet repair, growth, and job creation."

That is, not only they want continuing fiscal adjustment, but also cuts to entitlement programs like pensions (in IMF-speak its entitlement reform; one more for the English-IMF/IMF-English dictionary). Because fiscal consolidation (they mean austerity, cutting spending and increasing taxes) will lead to growth and job creation. Sounds new, doesn't it?

So does the IMF think that the periphery of Europe should not continue to tighten fiscal policy? Here is what they have to say:

"In the economies of the periphery [of Europe], a major task will be to find the right balance between fiscal consolidation and structural reform on the one hand and external support on the other, so as to ensure that adjustment in these economies can be sustained."

So external support yes, and of course continue with the adjustment. And yes in IMF-speak structural adjustment means cuts in social programs, or entitlement reform. Again nothing like the fresh new approach at the Fund.

And in Latin America? Well no worries they also have a new approach. For them:

"Some emerging market economies are contributing more domestic demand than is desirable (for example, several economies in Latin America); ... [Latin America] needs to restrain strong domestic demand by considerably reducing structural fiscal deficits and, in some cases, by further removing monetary accommodation."

Yes, more contractionary fiscal and monetary policies. The NIMF is full of 'new' ideas! Uhm, that nice smell of new policy measures!

The New IMF and Argentina

2011-09-24T10:03:00.000-07:00

There has been a certain view, that was already quite popular around the time Strauss-Kahn still managed the IMF, that with Christine Lagarde the Fund has become less orthodox, not just regarding capital controls, but now also supposedly on fiscal issues. See for example the article in the NYTimes by Liz Alderman.

In the last World Economic Outlook, the Fund argues (WEO, p. 110) that Argentina's inflation results from excessively expansionary policies (no analysis backs this claim and the effects of a more devalued currency and commodity prices are not discussed) and suggests (p. 42) that monetary tightening is necessary. Also, the report continues the tone of the previous WEO, suggesting that in developed countries fiscal adjustment should continue to reduce the debt burden, and in developing ones, like Argentina, to avoid overheating.

So fiscal and monetary contraction is their policy advice. The IMF forecasts a significant slowdown next year for Argentina (4.6% for 2012 down from 8% this year). The logic is that Argentina's growth is not sustainable and perhaps a crisis is around the corner.

Andrés Velasco, ex-finance minister of Chile, suggests so much in his last column for project syndicate. This notion that Argentina is close to an external crisis is peculiar to say the least. Velasco had published a paper with Ricardo Hausmann after the 2001-2 crisis that recognized that the problems were not fiscal, but related to exchange rate misalignments, export performance and access to international financial markets.

Although shrinking, Argentina still has a current account surplus, has not depended on international financial inflows (but on its own exports), and the ratio of short term external obligations to reserves is relatively small. So if the whole world economy sinks into lower growth, Argentina, that is forecasted to be the second fastest growing economy after China in 2011, will probably slowdown, but there is no reason for the macroeconomic policy to push for a slowdown for fears of an external crisis.

In that sense, it seems that the default position at the Fund, and in mainstream academic circles (Velasco was at Harvard, before returning to Chile) is that fiscal adjustment is needed in Argentina. And apparently almost anywhere in the world. The New IMF looks a lot like the old one to me!

Class warfare

2011-09-23T08:56:00.000-07:00

Only now I saw this great video by Mark Fiori in Marie Duggan's blog.

Complements Krugman's column today. A must read.

The IMF still believes in fiscal austerity

2011-09-22T06:45:00.000-07:00

In May, Olivier Blanchard, the head of the research department at the IMF, said:

"Earlier fears of a double-dip recession—which we did not share—have not materialized... The inventory cycle is now largely over and fiscal stimulus has turned to fiscal consolidation, but private demand has, for the most part, taken the baton."

The lame excuse for this ludicrous forecast now is that:

"the initial U.S. data understated the size of the slowdown itself. Now that the numbers are in, it is clear that more was going on."

In all fairness I criticized that view in May (here) and in July (here), since it was clear that fiscal austerity (Blanchard says consolidation, but he means reduction of spending and increases in taxes, that is austerity measures, which may not lead to a reduction in deficits, i.e. consolidation; one day I'll publish the IMF-English/English-IMF Dictionary) would not work.

Now that he admits that private demand has not taken the baton you think he would admit that fiscal consolidation (austerity really) is not the solution. You would be wrong, of course. He says in the new World Economic Outlook foreword (WEO, Sept, 2011) that:

"Fiscal consolidation cannot be too fast or it will kill growth. It cannot be too slow or it will kill credibility."

Not very different from what Christine Lagarde, his boss, has been saying. That is, we need fiscal austerity, but not too much (see my critique here). The new claim (in the last WEO) is that China has to import more, since the US private demand will not pick up (and fiscal austerity is needed).

By the way, according to the IMF China will grow 9.5% in 2011, and the yuan has appreciated strongly in real terms (particularly when you deflate by the real wage, that grows astronomically in China). So it's unclear how China could, besides growing sufficiently fast to keep a good chunk of the world economy (in particular exporters of commodities) expanding, also get the US out of its recession.

Perhaps, Blanchard and the IMF should revise their views on fiscal policy for developed countries (the IMF could also change it's adjustment programs based on austerity in Europe too!).

If you’re surprised, that means that you were part of the problem

2011-09-21T10:25:00.000-07:00

Back in July, in the midst of the debt-ceiling debate, Paul Krugman argued that those that were surprised by the GOP tactic of blackmailing the administration, threatening a default in exchange for cuts on social spending and the maintenance of the tax cuts for the rich were part of the problem. Normal was already not part of the GOP. I agree.

Now Krugman tells us that in this crisis a "lot of the blame goes to the economists, by the way, who abandoned what they used to know." But the thing is that the mainstream of the profession has been dominated by the academic equivalent of the Tea Party for a very long time. My point is that if you didn't know that economists forgot certain things about recessions, and never learned a few other things, you have not been paying attention and/or you must be part of the problem too.

Krugman knows this well, since he argued that:

“By the early 1980s it was already common knowledge among people I hung out with that the only way to get non-crazy macroeconomics published was to wrap sensible assumptions about output and employment in something else, something that involved rational expectations and intertemporal stuff and made the paper respectable. And yes, that was conscious knowledge, which shaped the kinds of papers we wrote. So you could do exchange rate models that actually had realistic assumptions about prices and employment, but put the focus on rational expectations in the currency market, so that people really didn’t notice. Or you could model optimal investment choices, with the underlying framework fairly Keynesian, but hidden in the background. And so on.”

That is, in order to publish (in 'respectable' journals) you had to wrap your reasonable assumptions in crazy models. So it should have been clear back then that rational expectations, real business cycles, supply siders, and their political counterparts in the Reagan administration were more dangerous that Old Keynesians and New Old Keynesians (or Old New Keynesians for that matter) were willing to admit.

The problem is not just that New Keynesians of all sorts and political affiliations (Ben Bernanke, Brad DeLong, Paul Krugman, Greg Mankiw, Christina Romer or Larry Summers) can be seen as equivalents to the old Neoclassical Synthesis, the modern equivalents of John Hicks and Alvin Hansen, trying to incorporate the Keynesian insights that lack of effective demand was behind the Great Depression (now our Great Recession), and that fiscal stimulus is necessary, while maintaining the contradictory argument that the price and quantity of all "factors of production", including labor, can be determined by the equilibrium in the labor market. [If this is true lower real wages should equilibrate the labor market and involuntary unemployment should vanish].

From a policy point of view this is certainly important, but it misses the more essential question that Keynes theory was not (at least was not intended to be) about imperfections, and arguably the inability of the Neoclassical Synthesis of overcoming that original contradiction is part of the reason of the rise of New Classical economics, and the acceptance by New Keynesians of the Friedmanian notion of a natural rate. Can you blame the profession that believes in the self-adjusting nature of the system towards the natural rate (included in all New Keynesian models) that fiscal stimulus is only needed in the short run and that the economy is on its path to recovery?

Hansen (1938, p. 34), in the book depicted above, said that the profession was: "living in a time when economics stands in danger of a sterile orthodoxy." [The time, by the way, was the 1937-38 recession]. We are in that position again, and people like DeLong and Krugman, as I said before, the best within the mainstream, would miss the opportunity of providing a more solid foundation for economic theory if they do not recognize the importance of the heterodox contributions of the more radical disciples of Keynes and Kalecki. We do not need another Neoclassical Synthesis, and we should try not to miss this new opportunity to complete the Keynesian Revolution.

Further, although we have our Hansens, so to speak, we do not have our Lauchlin Currie or our Marriner Eccles. That is, the real heterodox Keynesians within the administration. Currie, by the way, wrote an unpublished review of the General Theory, for the eyes of the Board only, that is far better than most responses in academia, which did not rely in either interest rate (liquidity trap) or real wage rigidity. In fact, Currie argues correctly that (following chapter 19 of the General Theory) falling wages would make things worse. If respectable economists in the mainstream, like Krugman and DeLong, miss this opportunity this period will be remembered as 'the years of low theory.'

PS: For a discussion of Eccles and Currie see here. The classic book on Currie is by Roger Sandilands here.

Hinckley Forum - Thursday 9/22 at 10:45

2011-09-20T11:17:00.000-07:00

Roundtable on the Global Financial Crisis
Lance Girton, Professor, Economic Department, U of U;

Minqi Li, Associate Professor, Economic Department, U of U;

Steve Reynolds, Professor, Economic Department, U of U;

Matías Vernengo, Associate Professor, Economic Department, U of U;

Tom Maloney (moderator) Chair, Economic Department, U of U

Greek Debt is not that large

2011-09-20T10:32:00.000-07:00

The NYTimes tells us that Greek debt is out of control, and financial markets fear that a default is around the corner. It might be true, but the size is not a big problem. According to the Times:

"Total Greek public debt is about 370 billion euros, or $500 billion. By comparison, Argentina’s debt was $82 billion when it defaulted in 2001; when Russia defaulted, in 1998, its debt was $79 billion."

The point of this is that it is supposed to be large even when compared to Argentina and Russia that defaulted. Note, however, that the GDP of the euro-17 (the 17 countries of the euro currency area) is around 12.3 trillion euros, and as a result Greek debt corresponds to slightly more than 3% of the euro-17 income. It is true that the euro countries, or the ECB, may not want for political reasons to buy Greek bonds, but given its size and the potential risks it is puzzling, to say the least.

In Argentina and Russia that option was out of the table altogether, since debts were in dollars, and no world central bank could stand to actually buy their bonds. So default was the only alternative. At this point, it is as if the ECB and the European elites do not want to save the euro. And the Greek people's patience is running thin.