Paul Ryan -- the 'Sarah Palin' of 2012?

Breaking news late US Mountain time on Friday 8/10/12 indicates that Mitt Romney will name Paul Ryan, representative from Wisconsin, author of the so-called 'Ryan budget,' and Ayn Rand radical,  as his VP pick.

A desperation move given the recent polls - Romney has 'lost the summer.' The Obama campaign, and progressives, should be ecstatic. I would start by framing the Ryan budget as a European-style austerity budget for America which will further eviscerate the lower and middle class social safety net by transferring risk to the less fortunate among us, and point out that the current European unemployment rate is 11.3% and rising under Ryan-style budgets.

Just saying.

Update: Here is an L.A. Times link detailing Ryan's Ayn Randian infatuation.  Another inconvenient truth like Romney's taxes and Bain labor minimizing facts that the Romney campaign would sooner forget; I doubt Axelrod and OFA will let them do so.

A Keynesian Theory of Hegemonic Currencies

By Thomas I. Palley

Several years ago (June 2006) I wrote an article advancing a new theory of why the dollar is the world’s dominant currency and why it is likely to remain so. The article was published in the midst of the last boom and sank like a stone. But now debate about the cause of the dollar’s hegemony has been revived in an interesting paper by Fields and Vernengo titled “Hegemonic currencies during the crisis: The dollar versus the euro in a Cartelist perspective” (also here). Their paper provides an opportunity to revive discussion, so I am posting the article again. Here it is (subject to a couple of word edits):

The U.S. dollar is much in the news these days and there is a sense that the world economy may have become excessively reliant on the dollar. This reliance smacks of dysfunctional co-dependence whereby the U.S. and the rest of the world both rely on the dollar’s strength, but neither is well served by it.

Read the rest here.

Romney's economic plan and the confidence fairy

Romney's economic plan is out, and not surprisingly is all about confidence fairies. Glenn Hubbard, one of the co-authors (with John B. Taylor, Greg Mankiw and Kevin Hassett) argues in the Wall Street Journal that the recession has been caused by uncertainty. In his words:

As a consequence, uncertainty over policy—particularly over tax and regulatory policy—slowed the recovery and limited job creation. ...  the Obama administration's large and sustained increases in debt raise the specter of another financial crisis and large future tax increases, further chilling business investment and job creation.

So too much regulations and spending is what is causing the slow recovery. This is interestingly enough what the manuals of Hubbard, Mankiw or Taylor would say (all are supposedly New Keynesian economists, whatever that means), which still present the simple Keynesian model in which spending determines the level of output (the old 45o degree Hansen model, which encapsulates the logic of the multiplier).

So what is the solution for these GOP New Keynesians? Four points:
growth and recovery first, and it stands on four main pillars:

• Stop runaway federal spending and debt. The governor's plan would reduce federal spending as a share of GDP to 20%—its pre-crisis average—by 2016. This would dramatically reduce policy uncertainty over the need for future tax increases, thus increasing business and consumer confidence.

• Reform the nation's tax code to increase growth and job creation. The Romney plan would reduce individual marginal income tax rates across the board by 20%, while keeping current low tax rates on dividends and capital gains. The governor would also reduce the corporate income tax rate—the highest in the world—to 25%. In addition, he would broaden the tax base to ensure that tax reform is revenue-neutral.

• Reform entitlement programs to ensure their viability. The Romney plan would gradually reduce growth in Social Security and Medicare benefits for more affluent seniors and give more choice in Medicare programs and benefits to improve value in health-care spending. It would also block grant the Medicaid program to states to enable experimentation that might better serve recipients.

• Make growth and cost-benefit analysis important features of regulation. The governor's plan would remove regulatory impediments to energy production and innovation that raise costs to consumers and limit new job creation. He would also work with Congress toward repealing and replacing the costly and burdensome Dodd–Frank legislation and the Patient Protection and Affordable Care Act. The Romney alternatives will emphasize better financial regulation and market-oriented, patient-centered health-care reform.

In short, reduce taxes (the effective corporate income tax is well below 25% and several corporations do not pay much or anything in fact), which mainly helps the wealthy, and has little impact on income, cut spending (contradicting what they teach), cut and privatize Social Security and health programs, and more deregulation. The non sequitur with cutting welfare programs or the craziness (or dishonesty) of arguing for deregulation (eliminate Dodd-Frank) even if they call this disingenuously 'better financial regulation' is astonishing. And yes the idea is that somehow all these measures would create an environment in which job creators would feel safe to invest.

Brad DeLong and Menzie Chinn do a great job debunking this terribly poor and dangerous economic plan.

Hegemonic currencies during the crisis

The paper "Hegemonic currencies during the crisis: The dollar versus the euro in a Cartalist perspective," discussed here before, has been published in the Review of International Political Economy (subscription required). A previous version here. The paper suggests that the dollar is not threatened as the hegemonic international currency, and that most analysts are incapable of understanding the resilience of the dollar, not only because they ignore the theories of monetary hegemonic stability or what, more recently, has been termed the geography of money, but also as a result of an incomplete understanding of what a monetary hegemon does. The paper argues that the dominant view on the international position of the dollar has been based on a Metallist view of money. In the alternative Cartalist (or Chartalist) view of money, the hegemon is not required to maintain credible macroeconomic policies (i.e., fiscally contractionary policies to maintain the value of the currency), but to provide an asset free of the risk of default. Further, it is argued that the current crisis in Europe shows why the euro is not a real contender for hegemony in the near future.

Palley on the crisis and the policies for prosperity

Tom Palley has just published a new book of essays titled “The Economic Crisis: Notes from the Underground.” The book consists of short essays on the economic crisis; the economics and politics of globalization; monetary policy; global imbalances; and policies for restoring shared prosperity.

Phyllis Deane (1918-2012)

Phyllis Deane retired emeritus professor at the University of Cambridge and an authority on economic history, particularly the British Industrial Revolution, and the history of economic ideas, has passed away. Data collection on the British National Accounts led to her volume, with Max Cole, British Economic Growth, 1688-1959, which remains a classic on the Industrial Revolution, and later to her broader volume on the topic depicted above. She also wrote a very readable volume on the history of economic ideas, The Evolution of Economic Ideas.

Davidson on Mitt Romney's Sweatshop Capitalism

By Paul Davidson

Right now, a man whose predatory career has claimed the jobs of countless Americans is trying to wrap himself in the flag and call himself a “job creator” and “wealth creator.”

Does he mean miserable jobs in Chinese factories? Wealth for the 1 percent? Apparently that’s exactly what he means.

Republicans claim that Mitt Romney's entrepreneurial activities at Bain Capital have been good for Americans. The truth is that Romney has spent his career offshoring and outsourcing American production processes -- and associated jobs -- to countries like China where human labor is valued in the market at a very low wage rate.

Mitt Romney’s tenure as Bain’s CEO has long linked him to offshoring and outsourcing. Even today, although he is no longer in that position, Romney still makes a nice profit on undertakings done long after he left the day-to-day management of the firm.

Read the rest here.

The surplus approach and institutions: Diamond vs. Acemoglu & Robinson

By Sergio Cesaratto (guest blogger)

The European crisis absorbs me so much – also politically and personally since our lives are involved – that not much time is left for what now appear as a divertissement, more abstract economic research. So not much time to devote to this post then. Somebody might like, however, to develop this line of research.

If anybody wants to be persuaded of the correctness and fruitfulness of the 'surplus approach' by Sraffa (1951) and Garegnani (1984), a reading of Jared Diamond Guns, Germs, and Steel would be enough to convince herself.[1] What is surprising – but not really at a closer scrutiny – is that Diamond does not quote any classical economist in his book – he does not mention any economist at all indeed. The likely explanation is that he has only been exposed to neoclassical economics and, of course, he could not find anything interesting there.[2] Also Acemoglu and Robinson (A&R) are neoclassical economists. Their neoclassicism is shown by the role that they attribute to the 'right' institutions in setting the correct incentives to individual entrepreneurship. Although in a very diplomatic way, Diamond is very critical of their attempt to explain why some regions developed earlier while other developed later or not at all. In his review of Why Nations Fail in the New York Review of Books Diamond (2012a) aptly summarises A&R’s thesis:

“Different economists have different views about the relative importance of the conditions and factors that make countries richer or poorer. The factors [A&R] most discuss are so-called “good institutions,” which may be defined as laws and practices that motivate people to work hard, become economically productive, and thereby enrich both themselves and their countries… Among the good economic institutions that motivate people to become productive are the protection of their private property rights, predictable enforcement of their contracts, opportunities to invest and retain control of their money, control of inflation, and open exchange of currency. For instance, people are motivated to work hard if they have opportunities to invest their earnings profitably, but not if they have few such opportunities or if their earnings or profits are likely to be confiscated.”

The indictment Diamond moves to A&R is that, although the institutions they refer to are relevant:

“as readers may quickly confirm for themselves, it is indeed a fair characterization of Acemoglu and Robinson’s book to say that their theory is as if institutions appeared at random. Although their letter describes institutional variation today as a systematic outcome of historical processes, much of their book is actually devoted to relating story after story purportedly explaining how institutional variation developed unsystematically and at random, as a result of particular events happening in particular places at critical junctures.” (Diamond 2012b)

“Acemoglu and Robinson’s view of history is that small effects at critical junctures have long-lasting effects, so it’s hard to make predictions. While they don’t say so explicitly, this view suggests that good institutions should have cropped up randomly around the world, depending on who happened to decide what at some particular place and time.” (Diamond 2012a)

As well known, according to Diamond, complex political institutions emerged around 3400 BC in specific parts of the globe where material circumstances related, to the climate and to the availability of domesticable vegetable and animals (there are not so many) made profitable for the humans to transit from populations of hunter/gatherers to sedentary civilisations. With agriculture a surplus of food emerged that unlashed the possibility of creating a class of people not engaged in a daily fight to collect food and survive, but that could dedicate themselves (exploiting the rest, of course) to the political organisation of society, to write legal codes, to philosophy (that includes science and technology) and to war.

Any student of the classical economists will recognize the echo of Petty, Turgot and Adam Smith in this approach. It worth quoting at length:

“it’s obvious that good institutions, and the wealth and power that they spawned, did not crop up randomly. For instance, all Western European countries ended up richer and with better institutions than any tropical African country. Big underlying differences led to this divergence of outcomes. Europe has had a long history (of up to nine thousand years) of agriculture based on the world’s most productive crops and domestic animals, both of which were domesticated in and introduced to Europe from the Fertile Crescent, the crescent-shaped region running from the Persian Gulf through southeastern Turkey to Upper Egypt. Agriculture in tropical Africa is only between 1,800 and 5,000 years old and based on less productive domesticated crops and imported animals.

As a result, Europe has had up to four thousand years’ experience of government, complex institutions, and growing national identities, compared to a few centuries or less for all of sub-Saharan Africa. Europe has glaciated fertile soils, reliable summer rainfall, and few tropical diseases; tropical Africa has unglaciated and extensively infertile soils, less reliable rainfall, and many tropical diseases. Within Europe, Britain had the further advantages of being an island rarely at risk from foreign armies, and of fronting on the Atlantic Ocean, which became open after 1492 to overseas trade.

It should be no surprise that countries with those advantages ended up rich and with good institutions, while countries with those disadvantages didn’t. The chain of causation leading slowly from productive agriculture to government, state formation, complex institutions, and wealth involved agriculturally driven population explosions and accumulations of food surpluses, leading in turn to the need for centralized decision-making in societies much too populous for decision-making by face-to-face discussions involving all citizens, and the possibility of using the food surpluses to support kings and their bureaucrats. This process unfolded independently, beginning around 3400 BC, in many different parts of the ancient world with productive agriculture, including the Fertile Crescent, Egypt, China, the Indus Valley, Crete, the Valley of Mexico, the Andes, and Polynesian Hawaii.” (Diamond 2012a)

The graph (see the original in Diamond 1997) summarises the chain of material circumstances (including the easier communications and similarity of climate in Eurasia) that Diamond advances as an explanation of the variety of growth experiences.

As said, had Diamond been exposed to Classical Political Economy, he would have recognised the ancestors of his theory in Petty, Turgot and Smith. As known, Turgot and Smith shared a “stage theory” of growth very similar to that by Diamond (see Meek 1971; 1976).[3]

Few quotations from “On Universal History” (1750 [2011]) will confirm the similarity between Turgot and Diamond (and Adam Smith, of course) (my italics):

"Without provisions, and in the depths of forests, men could devote themselves to nothing but obtaining their subsistence. (p. 351)

There are animals which allow themselves to be brought into subjection by men, such as oxen, sheep, and horses, and men find it more advantageous to gather them together into herds than to chase after wandering animals.

It did not take long for the pastoral way of life to be introduced in all places where these animals were met with: oxen and sheep in Europe, camels and goats in the east, horses in Tartary, and reindeer in the north.

The way of life of hunting peoples is maintained in the parts of America where these species are lacking. …

Pastoral peoples, whose subsistence is more abundant and more assured, were the most numerous. They began to grow richer, and to understand better the idea of property. (p. 352)

Pastoral peoples in fertile countries were no doubt the first to move on to the state of agriculture. Hunting peoples, who are deprived of the assistance of animals to manure the soil and to facili­tate labor, were unable to arrive so soon at agriculture. If they culti­vate any land at all, it is only a small quantity; when it is exhausted they move their habitation elsewhere; and if they are able to aban­don their nomadic life it is only by infinitely slow steps.

Husbandmen are not by nature conquerors; the cultivation of the land keeps them too busy. But, being more wealthy than the other peoples, they were obliged to defend themselves against vio­lence. Besides, with them the land can sustain many more men than are necessary in order to cultivate it. Hence people who are unoc­cupied; hence towns, trade, and all the useful arts and accomplish­ments; hence more rapid progress in every sphere, for everything fol­lows the general advancement of the mind; hence greater skill in war than in the case of barbarians; hence the division of occupations and the inequality of men; hence slavery in domestic form, and the sub­jection of the weaker sex (always bound up with barbarism), the hard­ship of which increases in proportion to the increase in wealth. But at the same time a more searching enquiry into government begins." (p. 355)

From these quotations the sequence food surplus à complex institutions is clear.[4]

In their reply to Diamond, A&R (2012) argue that:

"Diamond’s theory predicts that the Neolithic Revolution would happen first in Eurasia, but cannot account for differences in prosperity today, which are huge within Eurasia and not explained by the timing of the Neolithic Revolution."

This is the challenge to future research. How the surplus approach may help to explain recent growth episode and differentials? Of course the theory of long-period effective demand is central in this regard. Possibly, the efficiency of the wage-goods sector has had a role in facilitating growth in episodes of strongly export-led growth, by allowing a constant increase of the standard of living of workers in a non inflationary environment. Or, on the other hand, a too big size of the social surplus becomes a problem in advanced capitalists economies as Marx, Rosa Luxemburg and Kalecki taught us. Workers must share a part of it, letting wages to go beyond the subsistence level, to let the system to work. Well, it time to stop and leave the stage to other voices (see the post by Matias Vernengo for a start).

AppendixEGT, Diamond and the surplus approach on population growth and human development

In Cesaratto (2010) on EGT I wrote (inspired, at least partially, by Franklin Serrano):

“According [to the EGT exponent Charles Jones, e.g. 2002, 2004) productivity growth depends on population growth. Jones fervently defends this sort of causality (e.g. 2002, pp.103-104). After all, he argues, humans are the ultimate fuel of the process of research, and it should not be surprising that faster population growth has a positive effect on the generation of new ideas. Jones’ favourite quotation is from Phelps (1968, pp.511-512), according to whom: ‘One can hardly imagine …how poor we would be today were it not for the rapid population growth of the past to which we owe the enormous number of technological advances enjoyed today. …If I could re-do the history of the world, halving population size each year from the beginning of time on some random basis, I would not do it for fear of losing Mozart in the process’. One might certainly argue that halving the German speaking population of the eighteenth and nineteenth centuries would entail the risk of losing many of the greatest musicians ever, but this could be done to other populations of comparable size, in that or other periods, without much fear of losing outstanding talents. Ruling out genetic factors, something therefore seems to be missing from this population-driven mechanics of growth.

Jones (2004, pp. 48-56) discusses these possible objections at some length. Looking at different regions of the world in the very long term (12,000 years or so), some relationship seems to emerge between population size at the beginning of the period and their technological rank measured at the year 1000/1500 or so (before European explorations ended the isolation of various areas). The rationale of this correlation (ibid, p. 56) would lie in the following virtuous circle: at the beginning a small population could only generate ideas over long periods of time. Low productivity levels and subsistence kept the population constant. However, once one idea was produced subsistence levels and fertility rose, leading to a larger population. This in turn facilitated the production of new ideas over shorter lapses of time, and so on and so forth (see also Jones and Romer, 2009, pp. 10, 14, 24-25).

A scholar quoted in this regard is Jared Diamond (1997) who is, however, totally misinterpreted by these authors. In his famous book, Diamond argues that some environmental advantages, in particular the availability of suitable vegetable and animal species, made possible to some luckier populations some 10 thousand years ago to realise a food surplus and to become “large, dense, sedentary, stratified populations” (1997, p.87 and passim). More precisely, the realisation of food surpluses permitted these populations to grow more rapidly and to support a political class that, at the price of the exclusive control of the surplus, provided organisational, institutional, and military leadership. Moreover, the surplus allowed for the sustenance of those who Adam Smith would have called ‘philosophers or men of speculation, whose trade it is, not to do anything, but to observe everything’ (1776 [1979], p.21). It is clear from Diamond that population growth is not and cannot be the original source of “ideas” since both division of labour and population growth both logically and historically originate from the emergence of food surpluses. This is enough to show the closeness of Diamond to the Classical economists’ surplus approach, as well as his distance from the poor growth mechanics of EGT.”

This was what I wrote few years ago. I may add this. Turgot puts the question in a way similar to Smith: given two populations of the same size, it is education (that is the degree of division of labour) that makes the difference:

“The original aptitudes are distributed equally among barbarous peoples and among civilized peoples; they are probably the same in all places and at all times. Genius is spread through the human race very much as gold is in a mine. The more ore you take, the more metal you will get. The more men there are, the more great men you will have, or the more men capable of becoming great. The chances of education and of events either develop them, or leave them bur­ied in obscurity, or sacrifice them before their time, like fruits blown down by the wind.)” (p. 378).

Diamond, as the Classical economists, regards the size of the population, or its concentration in smaller territories towns etc. as an advantage from many points of view. But the material conditions that set off the emergence of a food surplus are the trigger:

“correlations suggest strongly that regional population size or population density or population pressure has something to do with the formation of complex societies. But the correlations do not tell us precisely how population variables function in a chain of cause and effect whose outcome is a complex society. To trace out that chain, let us now remind ourselves how large dense populations themselves arise. Then we can examine why a large but simple society could not maintain itself. With that as background, we shall finally return to the question of how a simpler society actually becomes more complex as the regional population increases. We have seen that large or dense populations arise only under conditions of food production, or at least under exceptionally productive conditions for hunting-gathering. Some productive hunter-gatherer societies reached the organizational level of chiefdoms, but none reached the level of states: all states nourish their citizens by food production. These considerations, along with the just mentioned correlation between regional population size and societal complexity, have led to a protracted chicken-or-egg debate about the causal relations between food production, population variables, and societal complexity. Is it intensive food production that is the cause, triggering population growth and somehow leading to a complex society? Or are large populations and complex societies instead the

cause, somehow leading to intensification of food production?

Posing the question in that either-or form misses the point. Intensified food production and societal complexity stimulate each other, by autocatalvsis. That is, population growth leads to societal complexity, by mechanisms that we shall discuss, while societal complexity in turn leads to intensified food production and thereby to population growth. Complex centralized societies are uniquely capable of organizing public works (including irrigation systems), long-distance trade (including the importation of materials to make better agricultural tools), and activities of different groups of economic specialists (such as feeding herders with farmers' cereal, and transferring the herders' livestock to farmers for use as plow animals}. All of these capabilities of centralized societies have fostered intensified food production and hence population growth throughout history.

In addition, food production contributes in at least three ways to specific features of complex societies. First, it involves seasonally pulsed inputs of labor. When the harvest has been stored, the farmers' labor becomes available for a centralized political authority to harness—in order to build public works advertising state power (such as the Egyptian pyramids), or to build public works that could feed more mouths (such as Polynesian Hawaii's irrigation systems or fishponds), or to undertake wars of conquest to form larger political entities.

Second, food production may be organized so as to generate stored food surpluses, which permit economic specialization and social stratification. The surpluses can be used to feed all tiers of a complex society: the chiefs, bureaucrats, and other members of the elite; the scribes, craftspeople, and other non-food-producing specialists; and the farmers themselves, during

times that they are drafted to construct public works.

Finally, food production permits or requires people to adopt sedentary living, which is a prerequisite for accumulating substantial possessions, developing elaborate technology and crafts, and constructing public works.” (pp.185-6)

References:

Cesaratto, S. (2010), Endogenous growth theory twenty years on: a critical assessment, Bulletin f Political Economy, vol.4, n.1, working paper version Quaderni del Dipartimento di Economia politica, Università di Siena, n.559

ID (con F.L.Serrano) (2002), As Leis de rendimento nas teorias neoclasica de crescimiento: Una critica Sraffiana, Revista Ensaios FEE, vol.23. (English version www.networkideas.org – International Development Economics Association).

ID (1999), Savings and economic growth in neoclassical theory: A critical survey, Cambridge Journal of Economics, vol.23.

ID (1999), New and Old Neoclassical Growth Theory: a Critical Assessment , in G.Mongiovi, F.Petri (a cura di), Value, Distribution and Capital: Essays in Honour of Pierangelo Garegnani, Routledge.

Acemoğlu, D. & Robinson, J. A. (2011) Why Nations Fail: The Origins of Power, Prosperity and Poverty, Profile.

Acemoglu D. and Robinson J.A., reply by Jared Diamond, The New York Review of Books, 16 August 2012.

Diamond J. 2005 [1997], Guns, Germs and Steel: A short history of everybody for the last 13,000 years (London: Vintage).

Diamond (2012a), ‘What Makes Countries Rich or Poor?’, The New York Review of Books, June 7:

Diamond J. (2012), Reply to A&R, The New York Review of Books, 16 August 2012.
Garegnani, P. (1984) Value and Distribution in the Classical Economists and Marx, Oxford Economic Papers, 3: 291–325.

Meek R. (1971) Smith, Turgot and the Four Stages Theory, History of Political Economy, 3, 9-27.

Meek, R.L. (1976) Social Science and the Ignoble Savage. Cambridge: Cambridge University Press.

Jones, C. (2002) Introduction to Economic Growth, New York: Norton.

Jones, C.I. (2004) ‘Growth and Ideas’, NBER Working Papers: no. 10767.

Jones, C.I. and Romer P.M. (2009) ‘The New Kaldor Facts: Idea, Institutions, Population, and Human Capital’, NBER Working Papers: n. 15094.

Phelps, E.S. (1968) ‘Population Increase’, Canadian Journal of Economics 1: 497-518.
Sraffa, P. (1951) Introduction to Ricardo's Principles, in Ricardo, D. (1951-73) Works and Correspondence of David Ricardo,(Cambridge: Cambridge University Press) Vol. I.

Turgot (2011), The Turgot Collection, Writings, Speeches, and Letters of Anne Robert Jacques Turgot, Baron de Laune, Edited by David Gordon, Mises Institute, available at http://mises.org/document/6298/The-Turgot-Collection-Writings-Speeches-and-Letters-of-Anne-Robert-Jacques-Turgot-Baron-de-Laune


Notes:

[1] Franklin Serrano suggested to me to read Diamond many years ago.

[2] On Endogenous Growth Theory (EGT), the most ambitious attempt by the mainstream to explain economic growth, see Cesaratto 1999a, 1999b, 2010, and Cesaratto & Serrano 2002. See also the appendix.

[3] Meek (1976) points out that both Turgot and Smith regarded the protection of property rights as a result of development rather than a cause of it.

[4] True, Turgot as much as A&R dismiss the role of the climate as a determining factor: “A reason for these differences which are found between nations has been sought in differences of climate. This view, modified a lit­tle and rightly restricted only to those climatic influences which are always the same, has recently been adopted by one of the greatest geniuses of our century. But the conclusions which are drawn from it are hasty, to say the least, and are extremely exaggerated. They are belied by experience, since under the same climates peoples are dif­ferent; since under climates which resemble one another very little we very often find peoples with the same character and the same turn of mind” (379-80) But I do not believe that this would change much my argument.

PS: Also read the following post on the same topic here or here where the argument extends to William McNeill and other historians.

Leading nowhere indicators

Leading indicators precede aggregate economic activity and signal policy makers about the state of the economy. Construction spending is usually considered a reliable leading indicator, and the figure below shows that total construction spending fell considerably before the beginning of the Great Recession (the shaded area).

And yes the indicator shows that a very slow recovery is now under way. We are around the levels of spending of 2003. Note that the fall in construction spending in the previous (and milder) recession was almost imperceptible (we were in the beginning of the housing bubble after all). Also, this is one of the problems with the collapse of housing bubbles, not only deleveraging implies that consumers are less capable of spending, but also the overinvestment in housing during the boom implies that a key sector, construction, has a very slow recovery.

Further, today the jobs' numbers were released with 163,000 nonfarm payroll jobs created, up from 64,000 last month. It is hard to see this as a prove of strenght in the labor market, as the Conference Board suggests. We needed to be creating something more like 400,000 for a healthy recovery. Unemployment ticked up to 8.3%.

Lucas in retrospect

I said it before, but it's worth repeating when one discusses the so-called Lucas' Critique and microfoundations. Lucas and the New Classical Rational Expectations (and RBC) School are the intelligent design of economics. In their view, markets work and this must be the result of some sort of high power, with which mere mortals and governments should not interfere. Lucas and his followers should have the same status as defenders of intelligent design in the scientific community (for the original claim go here).

If you have any doubts go check his paper on what should be the priorities of macroeconomic research just a few years before the crisis (Lucas, 2003), when several heterodox economists had already warned about a bubble and impending crisis. In his own words:

"My thesis in this lecture is that macroeconomics in this original sense has succeeded: Its central problem of depression-prevention has been solved, for all practical purposes, and has in fact been solved for many decades. There remain important gains in welfare from better fiscal policies, but I argue that these are gains from providing people with better incentives to work and to save, not from better fine tuning of spending flows."

Yes, business cycles problems have been solved, and there is no need for counter-cyclical fiscal policy. And this guy got the Sveriges Riksbank Prize, sometimes referred to as the Nobel!

But the point I wanted to make really is that there is less than meets the eye to the so-called Lucas' critique. The problem for Lucas was that the parameters of macroeconometric models (mostly of the Cowles Commission, CC, or the Cambridge-Levy stock flow with coherent accounting, SFCA, types) were not invariant to policy changes, and could not, in fact, be taken as parameters. Even if you take the neoclassical/marginalist approach seriously (meaning forget its logical problems revealed by the capital debates), as noted by Ray Fair (2012) (one of the last defenders of the CC approach within the mainstream):

"The Lucas (1976) critique says that the coefficients may not be stable if they are based on expectations that change over time or change when a new policy regime replaces an old one. This problem is part of the larger problem of potential coefficient instability, and it may not be the most serious. If expectations are not rational or if regimes do not change very often or by very much, any instability caused by Lucas-critique related issues may be small relative to instabilities caused by other things, like the changing age distribution of the population."

The fact, is that parameters are to a great extent invariant to policy changes, and there are a lot of parametrical regularities in macroeconomics, e.g. Okun's Law, Houthakker-Magee effect, or relations with changes in size that are not dramatic, like the size of fiscal multipliers, accelerator coefficients and pass-through effects, for example. And you can go on, for example, it's not a new thing that expansionary fiscal policy and higher debt levels have almost no impact on interest rates, that is, also, a fairly established macro regularity. That is why one can talk about macroeconomic stylized facts.

And it should be no surprise then, that models that do not use the mainstream assumptions of reversion to mean (to the optimal levels, by the way, the reason why Lucas thought cycles were solved and no macro policies where needed), and that depend on the macro accounting and the proper Keynesian causalities fared better during the last crisis (see here).

Palley on the Fed’s 2% inflation target trap

Thomas Palley

The Federal Reserve has now openly adopted a two percent inflation target, with both Chairman Bernanke and the Federal Open Market Committee publicly committing to holding inflation at that level. Though not a problem today, this two per cent target represents a policy trap that will undercut the possibility of future wage increases despite on-going productivity growth. That promises to aggravate existing problems of income inequality and demand shortage.

The Fed’s new policy is tactically and analytically flawed. Tactically, at this time of global economic weakness, the Fed should be advocating policies that promote rising wages rather than focusing on inflation targets. Analytically, its inflation target is too low and will inflict significant future economic harm.

Read the rest here or here.

Microfoundations and the capital debates

Steve has commented on the ongoing debates about microfoundations of macroeconomics, mainly between Paul Krugman and Simon Wren-Lewis (for my comments and Simon's reply on his blog go here, and scroll down to the last comments). I just want to further clarify what I think is, from the point of view of the history of ideas, a significant confusion in the debates about microfoundations, and one (oh yes, here he comes again) that is ultimately related to the capital debates (the Rosetta Stone of the history of economics ideas; if you prefer Sraffa's PCMC, as I tell my students, is the Rosetta Stone. To get an idea of what is the meaning of the capital debates go here).

Microfoundations are first and foremost about the determination of relative prices, the core of what we now call microeconomics, and used to be called before the theory of value. Individual behavior, rational or otherwise, is relevant to the extent that one thinks that behavior of individual agents is central for price determination, and that was at the core of the Marginalist Revolution.

The point is that if individual workers (using the figure of a representative rational utility maximizing worker), for example, in the labor market, confronts rational individual profit maximizing firms (again a representative firm), the free play of the market would produce an optimal outcome. Krugman is very clear why he thinks microfoundations are important. He says:

“if the assumption of perfect rationality breaks down even in the most standard of micro settings — if consumers behave in a way inconsistent with full maximization even when doing something as mundane as choosing which type of gas to put in their tank — how absurd is it to insist that, say, Keynesian stories about the economy can’t be right because we can’t fully derive them from intertemporal maximization?”

In other words, if workers say are not concerned with maximizing utility in terms of higher real wages, but in terms of relative wages, or if firms have limited knowledge about the workers willingness to work, and have an incentive to pay wages above the reservation wage (the one that compensates workers for the trouble with parting with leisure time), then the imperfection implies that the labor market will not clear and you might have unemployment. This is basically the efficiency wage story that New Keynesians use to justify unemployment (note that unemployment does result from real wages above the equilibrium level, and not from lack of demand as in Keynes).*

The capital debates show that even if you have workers trying to maximize utility in the normal fashion, and firms too have full information, that is, in the absence of any imperfection, there is no guarantee that lower real wages would imply more intensive use of the labor ‘factor.’ It is actually quite simple, if commodities are produced with commodities, then a reduction in wages also reduces the price of all goods, since they are produced with labor too, and there is a possibility that the fall in the price of commodities that do not use too much labor falls more than proportionally, so the increase in their demand does not lead to an increase in the hiring of new workers. Also, as wages are central for the consumer’s demand, the income effect of any reduction in wages would trump any (if it is positive) substitution effect. In other words, why would a firm hire more workers (even cheap ones) if nobody buys their products?

Further, PCMC does provide a sound way of determining relative prices. Long term normal prices are determined by the technical conditions of production, given one distributive variable (either real wages or interest, or if one prefers, for a given wage-profit frontier). It does take long term patterns of demand as given obviously, since producers would not supply, in the long term, goods and services for which there is no demand. The analysis of the determinants of effectual demand, the long term patterns of demand, are at a lower level of abstraction, and include all the institutional factors associated to fashion, conspicuous display of power, the effects of marketing, etc., that Veblen, Galbraith (father) and other institutionalist authors suggested were relevant.

Also, workers are rationally trying to obtain a fair wage, and to consume according to their tastes and the other social and institutional factors that determine their behavior. But those are taken as given for the determination of long run prices. And firms do maximize profits, and this implies that they add a mark up on their full costs. These models were developed by the authors of the Full Cost Pricing School, and the literature on barriers to entry, e.g. Sylos-Labini, Steindl and others, and the empirical evidence tends to be favorable.

In that sense, heterodox (classical-Keynesian, by which I mean Sraffa’s prices cum Keynes/Kalecki’s effective demand) does have a coherent determination of long run prices, based on rational behavior, as the foundation of the macroeconomic theory. Markets do not produce optimal outcomes and unemployment of productive resources is the normal, long run, position of the economy. In fact, the capital debates not only say that classical political economy (the surplus approach) provides sound microfoundations, but also that it is NOT possible to do so within the neoclassical/marginalist paradigm.***

* Interestingly enough Krugman’s argument for the current recession is not a rigidity in the labor market, but one in the money market, that is, a rate of interest that does not allow for investment at the level of full employment savings, the so-called Liquidity Trap.

** And yes there is empirical evidence in favor of this view, since there is no support for the effect of lower real wages and higher employment. Real wages tend to be pro-cyclical, go down in a recession, and up in the boom.

*** Arrow-Debreu also does not provide a way out of this conundrum.

PS: For the implications of Sraffa's contribution for Keynesian economics see this paper, and this post.

Palley on the ELR in the UK

Thomas I. Palley

The following story, which appeared in The Guardian on Sunday 29 July, was forwarded to me by Malcolm Sawyer:

“Million jobless may face six months’ unpaid work or have unemployment benefits stopped”

In a sense, the UK, under Conservative Prime Minister Cameron, is looking to adopt a quasi-employer of last resort (ELR) scheme in which the ELR wage is set equal to existing unemployment benefits (Note: the Conservative scheme involves compulsory labor for benefits).

Read the rest here.