Some brief thoughts on the Great Shutdown

First GDP numbers of the Great Shutdown were out yesterday. As it can be seen in the graph, GDP shrunk by about 4.8%. The data reflects only the first weeks of the stay at home lockdown of the economy in March, as the BEA report points out. Numbers will get considerably worse.

You must add to this the increase in unemployment insurance claims, which since the crisis started has gone up by more than 26 million, as reported by the Labor Department. Note that the unemployment rate is still at 4.4% and that it would take a while for numbers to reflect the collapse in jobs. Also, the series are measured in different ways, so many that lost their jobs, and filed for benefits (and might not even have received them) will not look for jobs (what would be the point), and, as a result would not count as unemployed. Expect the participation rate to fall. At any rate, the true unemployment rate as we speak, 26 plus another 5 million or so unemployed before the crisis, would be closer to about 19%. This is a crisis of biblical proportions.

But that is not my main concern. There are many ways in which fiscal and monetary policy could mitigate the worst effects of the crisis. The problem for me is that almost nobody is talking about the size of the effort that would be required for the economy to get out of this deep hole. Imagine that unemployment does get to something like almost a third of the labor force, as suggested by some Fed officials.

I've been playing around with some scenarios. This is not forecasting, which I don't consider a particular useful approach. This scenario is based on very simple assumptions using a simple Keynesian (yes, as in Keynesian cross) model, and some simple stock-flow accounting definitions, even though I don't have a fully consistent accounting model (on that and Godley and stock-flow models see this old post). I also assume certain parameters and sizes of shocks (even though I played with different numbers; on Godley and his view of the role of parameter estimation and model architecture see this other old post). Other than the simple multiplier (in this scenario of 1.2) and Okun's Law (3:1 ratio in this case), there are only assumptions about autonomous spending (government in this case, with some assumptions for this year at least informed by current events), and my concerns are essentially about what those mean in terms of the political economy of fiscal policy.

So, in my scenario output falls by about 8% next year, and recovery starts immediately, but GDP only surpasses the previous level in 2022/23, in the third year of the crisis. That's with a lot of fiscal stimulus, by the way. And in part the result of that is that the debt-to-GDP ratio goes to, in this scenario, about 180%, after 9 years (I had others with considerably more). Japanese levels of debt. I see no problem, but not everybody agrees, and, of course, that's the problem. Since the social forces that push for austerity are still around.

The scenario also implies that unemployment spikes (less than the number I gave above; so I guess a lot of discouraged workers and disguised unemployment), and it takes almost a decade to come down to reasonable numbers.

As with Godley, my interest in this is NOT to make predictions. I have no clue if this is going to happen or not (most likely not). My point is that in all my scenarios, huge fiscal stimulus was followed by moderate stimulus (not austerity*), and yet in all the debt-to-GDP ratio would go considerably up. It shouldn't be a surprise. In a crisis with a collapse in demand, that destroys jobs and income, and that workers and corporations are heavily indebted, it is unavoidable that the federal government would be required to pick up the tab, run higher deficits, and accumulate debt.

But are we prepared for that scenario? Republicans already called for less government, less taxes, and reduction in all types of spending (particular social spending, which is frankly nuts in the context of a pandemic). More surprisingly, Mitch McConnell seems to want States and municipalities to go bankrupt, that is, not do the normal thing in federations, which is to make the only entity with ability to borrow in its own currency to borrow (at zero rates really) and transfer resources. He basically wants the US to look more like Europe, and not the more social spending part, but the absence of a federal fiscal pact part. That's dangerous. And a Biden presidency (oh man, this hurts!), if it happens (consider the alternative; is it too early for a beer?), would have to deal with that and discussions about the debt ceiling (am I glad a grabbed a beer?). Oh well.

* In my scenarios, austerity makes things worse, making the recovery slower, and tax revenue growth too, btw.

PS: The other post on Godley's approach to macro modeling here.

Das Adam Smith problem

A short lecture on Adam Smith's problem for a Principles class. This might be of more general interest, and perhaps something to watch during the quarantine. The book I used for the lectures on history of economic ideas was Heinz Kurz's Economic Thought: A Brief History, a book that I highly recommend. The discussion here is heavily influenced by Tony Aspromourgos' book The science of wealth: Adam Smith and the framing of political economy, another one you should read if you have the opportunity.

The Economic Consequences of Covid-19 in Latin America

For more information go to their website.

COVID-19 Crisis: More Like the 1920-1921 Recession

By Ahmad Borazan, Fresno State (Guest blogger)

Economic commentators are struggling to find a historic precedent to the current COVID-19 caused economic crisis and the possible path of recovery. Majority of economic downturns are dominantly an aggregate demand driven phenomenon. But with the current crisis there is an imposed constriction in both supply and demand sides of the economy. Looking at the aggregate supply and demand forced contraction there is a compelling analogy between the current crisis and the Federal Reserve induced recessions such as that of 1920-1921.

During a recession caused by a Fed’s hike of interest rate both the supply and demand sides of the economy are brought to a halt. The higher cost of borrowing impedes spending resulting in a chain reaction of contracting production and spending. Similarly, social distancing measures curb spending and production as people stay home, unemployment rises, and non-essential businesses closed.

The Fed increased interest rate in 1920 to bring down inflation and attract gold inflows to restore the gold standard. The hike started in January 1920 and caused severe contraction of industrial production, consumption, and investment. Combined with government spending cuts due to WWI defense spending demobilization, the interest rate hike was high enough to cause the unemployment rate to go up from 2.3% in 1919 to 11.3 in 1921 and nonfarm unemployment rate rose up to 16%. With the economy in a deep recession and unemployment high, prices declined in the biggest deflation of the American economy in the last 120 years.

Then as the high interest rate attracted gold inflows and the price level significantly declined, the Federal Reserve started cutting interest rate in mid-1921. Soon enough the economy recovered through spending booms of debt-driven consumption and residential investment. Usually, the recovery out of recession takes long, hence the argument for government intervention. But as Keynes explained in the General Theory, under extraordinary circumstances that “could only be accomplished by administrative decree and is scarcely practical politics under a system of free wage-bargaining.”

When there is an anchor of expectations that raise the expectation of higher income, then recovery of spending can follow swiftly. During the early 1920s recession, we could argue, this anchor was the Federal Reserve monetary policy. The Fed’s interest rate cut raised expectations of higher future income and an end to the monetary-tightening caused recession. Furthermore, as I argue in a forthcoming paper, the increase in demand was also facilitated by a jump in private spending that was pent-up due to WW-I rationing and the subsequent recession.

As the management of the economy was still in the era of laissez-faire, the high unemployment rate was tolerable and forced as a fair price to purge the economy of inflation. Benjamin Strong, the chairman of New York Federal Reserve refused to cut of interest rates before wages had gone down as much as prices. In the post New Deal era, a high unemployment rate around 10% is less tolerable.

Similarly, we could argue that loosening up social-distancing measures would kick in an increase of spending though as reports from China show this will not be fast as people would still be worried about going back to pre-crisis spending level. The last few days we saw protests in multiple US cities with crowds demanding to reopen the economy. Although the drivers of these protests could vary from legitimate economic pain to partisan politics, the US government should enhance its fiscal measures to sustain households’ incomes and jobs. Paycheck protection program for workers in small businesses should be expanded and extended to workers in large enterprises, in addition to state and local governments.

Government spending expansion when social-distancing measures are enforced and when relaxed would help us avoid a drastic depression as it would ensure sustained demand during the recovery. Furthermore, public deficit driven recovery would enable us to avoid risky private debt-driven rebound which characterized the era of the Roaring Twenties and contributed to the severity of the Great Depression.

Any concerns about expanding the debt are unjustified. The US debt to income ratio is currently less than half that of Japan which is capable of borrowing at extremely low cost while it has a smaller economy and lesser role in global financial markets compared to that of the US. If the Japanese experience proves anything it is that we have ample room for more debt to fund expansionary fiscal policy and avoid a depression. There is no reason to repeat the policy mistake done with the American Taxpayer Relief Act of 2012 which cut discretionary government spending when the unemployment rate was 8%. More generous European economic fiscal and monetary reactions to the current crisis prove the capacity of advanced economies governments in relieving its citizens of economic hardship. One hopes these responses would bring the order of mythological fiscal scarcity to an end.

Donald Trump commenting on rescuing affected workers, kept saying we will help them so they "don’t get penalized for something that’s not their fault.” As if in normal times being unemployed or working for below a living wage is usually an individual’s choice and fault; not a result of the "naturally optimal" markets and other human-made structures.

My talk on the Great Shutdown (in Spanish)

For those that understand Spanish my talk on the crisis (Keynesianism versus Socialism) organized by the university in Puebla (BUAP) by Juan Alberto Vázquez. Link to a piece published in an Argentinian newspaper on the topic here. My part goes up to minute 29 or so, then it's the talk by good friend Ignacio Perrotini on "Milton Friedman and the Plague."

At the Rick Smith Show on the Corona Crisis

I appear between minutes 39 and 59 approximately. Rick's show is always worth listening to.

Virtual Forum: Economics Perspectives and Challenges in the Current Context

Virtual seminar in México, and in Spanish. To attend go to the Zoom page and register. And, yes, it should be Vernengo, with e.

New issue of ROKE is out

The April Issue of the Review of Keynesian Economics is now out. The issue contains a collection of articles covering a spectrum of important issues. It opens with a debate over New Developmentalism which pits development relying on macro prices (especially the exchange rate) against historical state-led development policies. Next, there is an article on the role of the wage share in determining exchange rates. Thereafter, there are several articles on Post Keynesian growth theory. One addresses the evolution of income and wealth inequality, while others empirically assess alternative approaches to theorizing demand growth.

Two paper are open: "A Structuralist and Institutionalist developmental assessment of and reaction to New Developmentalism" by Carlos Aguiar de Medeiros and "Making sense of Piketty's ‘fundamental laws’ in a Post-Keynesian framework: the transitional dynamics of wealth inequality" by
Stefan Ederer and Miriam Rehm.

World War II, not the New Deal, is the model for COVID-19 macroeconomic policies

Central planning (Socialism?) in democratic societies

There is a lot being written on the causes and cures for the economic consequences of the Coronavirus (COVID-19). The predictable distinction is among those that think that this is essentially a demand shock, mostly to services, and those that are concerned with the disruption to supply chains. And to some extent both are correct. But that is not the more relevant problem here, which is whether we need just more government or a change in the nature of the governmental interventions.

Neil Irwin, from the New York Times, provides a suitable and simple explanation of the demand shock story. Note that a demand shock often goes together with significant financial implications, as agents with reduced revenue tend to default on loans or payment streams to any liabilities. The Economist noted the risk associated with excessive corporate debt, and the possibility that the virus might trigger a debt-deflation type crisis in financial markets. On the fragility of corporate balance sheets see also this insightful piece by Michalis Nikiforos. Many economists have talked in favor of this interpretation, and certainly there is a lot to be said about this view, which I tend to agree with, by the way.

The fiscal expansion plans put forward by the administration have been mostly seen through the lens of a regular demand shock version of the recession. They include things like a bailout of certain sectors hit hard by the sudden decline in demand, like the airlines, and checks to those that have lost their jobs, besides the Fed injecting liquidity to reduce the financial effects of the demand shock. In that sense, not very different from the fiscal package and financial rescue of the 2008 crisis.

Of course, macroeconomic policies in 2008, even though they did preclude a fall in unemployment of the magnitude that had occurred in the 1930s during the Great Depression, were flawed in many ways. They did rescue banks, but left many to lose their houses for one (and Obama's Justice Department did not prosecute in any significant way the many financial excesses of Wall St); it was also probably on the smaller side, leading to a prolonged, but very slow, recovery, in which labor market conditions remained relatively poor for many workers, even with low levels of unemployment by the end. All things that increased the problems at the bottom of the income distribution and helped explain Trump's political victory in 2016. Hence, there is reasonable fear that these policies might not work well this time around again. Besides, there is a case to be made that this crisis is not fundamentally a demand shock.

A prominent defender of the latter is Dean Baker. He says: "Our problem is not creating demand in the economy, the problem is keeping people more or less whole for a possibly extended period in which much of the economy is shut down." And as he notes, sending checks to people directly will fall short of a solution. Checks will be irrelevant for many, that have secure jobs, and insufficient for many, since it will be too little, or because some people might be directly excluded from such programs, like undocumented immigrants with US born children. Dean's alternative is to send money directly to companies that would keep workers employed and inactive, helping in the recovery too. Of course this solution deals fundamentally with those in the labor market, and not with those in more precarious situations.

I see the problem as being essentially a demand shock, note that the increase in unemployment insurance applications was marked last week, to a great extent associated to Coronavirus layoffs. Obviously nobody would deny the supply side effects of the crisis, even though these are less disruptive in the short run, in my view. Nobody is being laid off because the company is unable to obtain intermediary goods for production, or at least not on significant numbers. It is the sudden collapse of demand that matters. But that misses the point of the kind of demand and supply shocks that have hit the economy. These are localized, uneven shocks and an efficient policy reaction requires targeted interventions. The kind of intervention we need is one that one the demand side tries to maintain the ability of families with cash flows problems (the ones laid off and those that were already outside the formal job market), and on the supply side that redirects production to the sectors that would experiment a surge in demand.

The most typical analogy in times of macroeconomic crises is the Great Depression, and progressives, not incorrectly go searching for ideas in the New Deal tool box. However, the New Deal was mostly about regulation, in its first phase, and about spending, in particular after the Roosevelt Recession. The kind of intervention we need is more akin to World War II, one in which government agencies have ample powers to requisite, produce or fund private corporations to produce what is needed as vital effort for survival, as alluded by Jamie Galbraith in his recent piece on the virus. For example, we need to reconvert the economy to produce more ventilators, which are in short supply, and also to ration the ability of families to hoard certain key central consumer goods, to preclude localized scarcity of essential items like hand sanitizer. We need planning, not just more government spending. And, yes, that means Socialism (or Social Democracy). This was something that no US citizen would have been surprised about, in particular after the incredible collapse of the market economy in the early 1930s, and it should not be a surprise that Socialism is somewhat more popular now. COVID-19 makes it clear why markets cannot cope with global crisis like a pandemic.

Another central element of the World War II effort was the generous and strategic concern with the global impact of US policies. Lend-lease, even before the US entry in the war, was central for allowing the UK resist the Nazi onslaught, and the subsequent program with the Soviet Union was crucial for them to be able to resist, and eventually win the war in the European front. In order to defeat Nazism, the US authorities were willing to cooperate with a Communist government, and provide significant resources. A similar approach should be used to deal with nations that are not seen as allied (like the Soviets then), but that in a particular context should be helped, like Iran, and Venezuela, which are and will be under extreme duress during the pandemic. The negative effects on the US image associated to the tightening of the sanctions, and the impediments to IMF loans under these circumstances, will be hard to reverse.

Finally, some think that this would be a short lived V-shaped recession. Meaning that once the main social distancing policies are lifted, the economy will recover swiftly. Note, however, that the duration of the measures is contingent on its own success. The more successful we are at flattening the curve, meaning reducing the contagion rate, to avoid overwhelming the health system, the longer the economic disruption will be, and the more we would need a planned economy.

PS: Portuguese translation here.

From Truncated Developmental State to Failed State in Latin America

I gave a talk last year in Argentina that forced me to think about the notion of the developmental state and its limits for Latin America. I discussed it in Mexico too, and I added a bit more about the notion of failed states, also discussed in my first presentation. This week I presented at Boston University, for the first time for a mostly English speaking audience. This is a brief summary of some of my ideas, based on those presentations.

National state formation in Latin America, during the last quarter of the 19th century, in what has been termed in the more conventional literature the 1st globalization, was related to the incorporation of the region in the networks of trade, finance, in particular in relation to the United Kingdom and the United States, and the European migratory flows.  On the other hand, the disintegration of the national states in the neoliberal period, starting with the collapse of the so-called Golden Age of Capitalism, is the result of the same necessity to promote the integration of the region in the global economy. Strong or weak state, but with the same objective, to promote the subordinate integration of the region into the global economy. It must be emphasized that it is NOT a Latin American phenomenon, and that the Failed State in the region corresponds to what James Galbraith has called the Predator State in the case of the US, which implies the use of the state to promote the private gains of corporations and the wealthy.

Neoliberalism is NOT a right-wing phenomenon, since the existence of progressive neoliberals, as denominated by Nancy Fraser, referring to left of center, or more appropriately centrists like Clinton and Obama. Right-wing and left-wing populism are to a great degree a reaction to Neoliberalism.

The concept of the developmental state is often used, but seldom analyzed more carefully. The narrative is often associated with the Asian experience in the post-war period, from Japan to China, including in particular South Korea. Conceptually the work of Chalmers Johnson, and his followers (e.g. Amsden, Chang, Evans, and Wade, to cite the most prominent) is central, building on a tradition that harks back to Friedrich List. But the logic of the developmental state is actually related to the American experience, and to the legacy of Alexander Hamilton, who was the inspiration for List, as noted by Cohen and DeLong, discussed here before. In my view, that should be extended to the British case in the 18th century, which was the ultimate inspiration for Hamilton in his 'Report on Manufactures.'

It seems reasonable that what John Brewer called the British Fiscal-Military State  (old post on that here) is the original developmental state. In my view, the central characteristic of the developmental state is its ability to borrow more or less without limit and also without the possibility of default. It is true that the British currency was effectively tied to gold from the early 1700s, but convertibility was suspended in periods of crisis like the Napoleonic Wars. At the core of the developmental state is the ability to spend, without external restrictions. It must have the hegemonic currency, or it must not have a significant shortfall of it.

Charles Tilly famous dictum according to which “war made the state, and the state made war” is correct. It must be complemented by the work by Jan Glete, which extends to the work by Roberts and Parker on the Military Revolution, and the role of a permanent navy and naval warfare in the formation of the state. Nicholas Rodger refers to the Fiscal-Naval State. War matters, but control of the sea matters even more. What is missing in Tilly, and his followers, is the peripheral state, and the relation of the latter with the developmental state. In this case, if we take the Asian case as paradigmatic, we could say that the state lost the war, and the loss made the developmental state.

The developmental state in the periphery appears in the post-war period, with the establishment of American hegemony. The reasons for the collapse of the 1st globalization are complex, but at a deeper level Charles Kindleberger suggested that the roots of the inter-war crisis, including the Great Depression, and the wars too, were associated to the decline of British hegemony and the slow emergence of the American one. But it is not the collapse of the British hegemony, neither the rise to dominance by the United States, that allowed for the appearance of a developmental state in the periphery, and arguably in Latin America too.

The crisis per se opens space for new policies, without a doubt. But it is ultimately the Russian Revolution, and the Cold War, which provides an alternative to capitalism, that opens up space for both alternative policies in the periphery, but additionally for support by the new dominant hegemon in promoting development and lifting the external constraint, that I suggested was at the core of the possibility for a developmental state. In the Asian case, the very existence of the developmental state was to some extent tied to the special relation with the US within the geopolitical situation that included, not only the Soviet Union, but also communist China, North Korea, Vietnam, and the domino theory, according to which Asian economies would fall and become communist if a neighboring country also did. And that is without considering India, Indonesia and the non-aligned movement.

This generated the conditions for an American procurement policy for Asian firms. Daniel Immerwahr argues that Toyota, the firm famous for ‘just-in-time’ or flexible production methods that superseded Fordist mass production, was virtually broke at the beginning of the Korean War. The firm was saved by Pentagon purchases, which guaranteed demand, and the same time that it enforced standards, and transferred technology. In Latin America there was nothing similar to this. Volta Redonda, the first steel mill in Brazil, which depended on US technology transfer and resulted from the US military base in Natal during World War II, would pale in comparison. It was assumed, not completely incorrectly, that our elites would align themselves with the West, and that a communist revolution could not take roots in the region. When it occurred the long and harsh embargo on Cuba was imposed, and a similar one now on Venezuela. Sticks rather than carrots were used in the backyard.

In the case of Latin America, the legacy of the Monroe Doctrine, implied that the benevolent policy referred to as “development by invitation” by Immanuel Wallerstein, following the ideas of Arthur Lewis and revived more recently by Carlos Medeiros and Franklin Serrano, was never really a possibility.

The limited impact of the developmental state in the region, when compared with the Asian experience, should not be seen as a complete failure. The economies of the region grew relatively fast, and even an incomplete or developmental welfare state was created, as noted by Sonia Draibe and Manuel Riesco. Nor should the debt crisis of the 1980s, which closes the cycle, be seen as the result of state-led industrialization. In fact, it is the debt crisis that leads the region more decisively into neoliberalism, even if neoliberalism had started before with the Southern Cone at the forefront.

What has not been discussed in more detail is the role of the United States opening of China, and the role of development by invitation in Asia for the Latin American periphery. In the case of Latin America the end of the developmental period, and the opening up of China, has gone hand in hand with a reprimarization of production and exports in South America, and with a maquilization – which implies higher dependence on imported components – in Mexico and Central America. The new integration implies a peripheral integration with the Southern periphery. But the decision to open up Asia did not come from Latin America. It was an American decision, based on geopolitical calculations, isolate the Soviet Union, back then, and also to discipline the labor force in the center.

It is in this context that the failed state starts to take a hold in the region. But the failed state, defined broadly as one that is incapable to intervene coherently in the economy, or unable to maintain the monopoly of violence, is by no means a mistake. It is functional and necessary for the integration into the global economy. In contrast to the relatively strong state of the late 19th century needed to integrate our economies into the global markets, now, in the 2nd globalization, a weak state, incapable of defending the rights of the working class, is necessary. In the same sense that American elites abandoned their working class, and have weakened and promoted the destruction of the welfare state institutions, the same has taken place in Latin America, but in more dramatic fashion, since in the region the welfare state was already incomplete or truncated, to use Fernando Fajnzylber’s expression about our industrialization.

The protests in the region, and in the center, have opened the possibility for alternatives to neoliberalism, but it would be a mistake to presume that the latter is dead. In general, when left of center governments manage to get elected they must contend with managing the failed state left by neoliberalism.

Obamacare With a Public Option: Fool Me Twice Shame on Me

By Thomas Palley

There is an old saying “Fool me once shame on you, fool me twice shame on me.” That saying is relevant for the current healthcare debate in which former Vice-President Biden and elite Democrats are touting a reheated version of Obamacare with a public option. It is a case of trying to fool the American public twice.

Adding an Obamacare public option will not solve the healthcare problem. Worse yet, it misses an historic opportunity to heal the festering wound of healthcare via a single-payer system as proposed by Senator Bernie Sanders.

Read rest here.

Housing and Inequality in Utah

From the recent report, written to a great extent by David Fields:

Rising housing costs and stagnating real wages are the primary causes of worsening housing affordability in Utah. From 2009 to 2016 real income only grew at 0.31% per year while rent crept upward at a rate of 1.03% per year in 2017 constant dollars. Now, more than 183,000 low-income Utah households pay more than half their income for rent, becoming more likely to be evicted and moving closer to homelessness.

Housing has not received as much coverage in the discussions about inequality, and this is well wroth reading. 

Bernie Sanders: Nothing to Fear Except Fear Itself

By Thomas Palley

“The only thing we have to fear is fear itself.” Eighty-seven years ago those were the words of Franklin Delano Roosevelt in his 1933 inaugural speech. Today, they resonate with Senator Bernie Sanders’ presidential campaign, which confronts a barrage of attack aimed at frightening away voters.

Fear is the enemy of change and the friend of hate. That is why both sides of the political establishment are now running a full-blown campaign of fear-mongering against Sanders.

The Democratic Party establishment likes the economy the way it is and wants to prevent change. Donald Trump and the Republicans have made themselves the party of hate. Both therefore have an interest in promoting fear, which explains the strange overlap in their attacks on Sanders.

Read rest here.