Monday, April 30, 2012

Globalization and development

UNCTAD's Globalization and Development: Facts and Figures, 2012 has been published. You can read the whole report here.

Friday, April 27, 2012

From Financial Crisis to Stagnation

By Thomas Palley

Marshall McLuhan, the famed philosopher of media, wrote: “we shape our tools and they in turn shape us”. His insight also applies to the economy which is shaped by economic policy derived from economic ideas, and it is the theme of my recent book which argues the global economic crisis is the product of flawed policies derived from flawed ideas.

Broadly speaking, there exist three different perspectives on the crisis. Perspective 1 is the hard-core neoliberal position, which can be labelled the “government failure hypothesis”. In the U.S. it is identified with the Republican Party and the Chicago school of economics. Perspective 2 is the soft-core neoliberal position, which can be labelled the “market failure hypothesis”. It is identified with the Obama administration, half of the Democratic Party, and the MIT economics departments. In Europe it is identified with Third Way politics. Perspective 3 is the progressive position which can be labelled the “destruction of shared prosperity hypothesis”. It is identified with the other half of the Democratic Party and the labour movement, but it has no standing within major economics departments owing to their suppression of alternatives to orthodox theory.

Read the rest here.

Thursday, April 26, 2012

The inflation expectations fairy

There are confidence fairies and there is the inflation expectations fairy. It's a 4% fairy apparently. I'll explain. So Krugman correctly points out always that the more fundamentalist neoclassical economists (the Talibans that love price flexibility and instantaneous adjustment to full employment, not the moderates that also believe in a natural rate, but think it takes a while to get to it like Krugman himself) believe that the economy would recover if only a proper environment for investment was created. Hence, if confidence returned we would have a recovery.

They obviously invert causality between confidence and recovery. As noted by Marriner Eccles long ago: "confidence itself is not a cause. It is the effect of things already in motion. (...) What passed as a 'lack of confidence' crisis was really nothing more than an investor's recognition of the fact that new plant facilities were not needed at the time." Investment is the result of a growing economy, in which firms tend to adjust their capacity to demand. No demand for your goods no need to invest to create capacity to produce more. Plain and simple.

Now a dispute on what is the appropriate policy for the Fed, and what has been Bernanke's role has developed between Krugman and Bernanke (see here and here) [Ball has a more academic paper saying basically the same as Krugman here]. They argue that Bernanke has been correct in pursuing quantitative easing -- the buying of long term Treasury bonds to keep not just short, but also long term interest low -- and saving banks, but he has been reluctant to increase the inflation target to 4%. Blanchard has said pretty much the same about the need for a higher inflation target (this was hailed as new thinking in macroeconomics; with that criteria when Greenspan disregarded the 6% natural rate of unemployment level, believing it was somewhat lower, he was a radical innovator!). [I’ll leave for another post the question of why are we even talking about an inflation target in the US if the Fed supposedly doesn’t have one].

Krugman notes that Greg Mankiw actually has sent a veiled (or not so veiled threat, as he is the advisor to Romney, which may or may not have something to do with Bernanke’s reappointment in the future), saying that “if Chairman Bernanke ever suggested increasing inflation to, say, 4 percent, he would quickly return to being Professor Bernanke” (originally published here, yep Mankiw also writes regularly for the NYTimes).

So what is the mechanism according to Krugman (and the ‘progressives’ like the IMF chief economist Blanchard) by which a higher inflation target would lead to a recovery? In Krugman’s own words:
"If the Fed were to raise its target for inflation — and if investors believed in the new target — expected inflation over the medium term, say the next 10 years, would be higher. … [and] higher expected inflation would aid an economy up against the zero lower bound, because it would help persuade investors and businesses alike that sitting on cash is a bad idea. "
So if the Fed says it’s willing to accept a higher level of inflation – without doing anything concrete and objective like intervening and forcing banks to refinance the mortgages of people in foreclosure – then if investors are persuaded they may be confident enough to spend more. And that’s not a fairy?! The problem with any theory, including the New Keynesian, that believes [or says it does in order to get published] that there is a tendency to full employment, is that it must end on some sort of confidence for spending story, since under normal conditions the system would actually do it anyways. The confidence fairy is dead; long live the inflation expectations fairy!

Tuesday, April 24, 2012

Shift happens indeed

The Chronichle of Higher Education has a very good piece on the 50 year anniversary of Thomas Kuhn's classic The Structure of Scientific Revolutions (SSR). It is worth remembering that the official methodology in economics remains Popperian.

The conventional history of ideas in economics, as represented by Schumpeter’s monumental History of Economic Analysis or by Mark Blaug’s work is one that emphasis the continuity and growth of knowledge. Hence, the frontier contains the set of accepted truths and the past is a history of how true knowledge was achieved. Knowledge progresses in a twofold process, first conjectures are made. Conjectures are not the ultimate truth, but are accepted while not proven incorrect. Then, tests are designed to falsify the conjectures. Hence, in Popperian terms theories can never be proven true or verified, but they can be accepted while they are not refuted. In other words, there is rational progress in science, including economics. Falsification is, then, the instrument to measure progress, since it provides the demarcation criteria to define what is and what is not scientific knowledge, and also to determine whether a theory is superior to the other.

Thomas Kuhn provided and alternative to the conventional approach. The evolution of scientific knowledge is tied to history and to the sociology of the scientific community. A paradigm can be described as the set of rules and methods accepted by a scientific community. Scientific knowledge is for the most part the result of normal science, that is, the work of scientists within the confines of their paradigm. However, normal scientists are sometimes confronted with critical anomalies that put in doubt the validity of the whole paradigm (Kuhn’s model of paradigmatic change is the Copernican revolution). An accumulation of anomalies leads eventually to a paradigmatic crisis, and to the emergence of new paradigms.

New paradigms explain the anomalies unexplained by the old one. More importantly, new paradigms often provide a new vision of the object of study. Hence, new paradigms imply that hypotheses are incommensurable in terms of the old paradigm. The methods of testing hypotheses are no longer accepted. Progress is then only possible within the paradigm. Comparisons between paradigms involve the values of the scientific community and the persuasive ability of scientists.

The Kuhnian model was developed to discuss scientific progress in the hard sciences, so a reasonable question is whether it applies to soft sciences too, admitting that economics is a soft science. In economics several paradigms co-exist for long periods, something that should happen only in periods of crisis. Also, the Marginalist Revolution took place even though there was no evident anomaly unexplained by the dominant paradigm (classical political economy; in all fairness Ricardian economics had been abandoned in the 1830s, and vulgar economics dominated the profession). Ideological reasons seem more important in that case. Further, the Keynesian Revolution, that occurred as a result of the high levels of unemployment (an anomaly if there is one for the normal marginalist science) that could not be explained by the dominant paradigm, was to a great extent aborted, and the idea of a natural rate of unemployment was reinstated.

A. W. Coats (1969; subscription required) notes that anomalies and critical experiments are not common, but still the concept of scientific revolutions may serve in economics as an ideal type to clarify the sociological elements in the development of economic ideas. SSR remains vital for economic methodology, in particular after the last crisis has shown, once again, the limitations of the self-adjusting marginalist paradigm.

Monday, April 23, 2012

Argentina is right

By Luiz Carlos Bresser-Pereira

There is no sense in leaving to a foreign company the control of a sector that is strategic for a country's

Argentina once again became the target of the North, of the “common sense” that comes from Washington and New York, and decided to retake State control of the YPF, the country's major oil company, formerly under control of a Spanish company. The Spanish government is indignant, the company protests, both swear to take all legal measures to protect their interests. The Wall Street Journal states that “the decision will damage Argentina's reputation even further with international investors”. But I ask: does the development of Argentina depend on international capital, or is it the owners of that capital who cannot agree when a country decides to protect its interests? And, as for oil industry, is it reasonable for the State to be in control of its most important company, or should it leave everything under the control of multinational corporations?

It seems today that developing countries have little doubt regarding the second question. Almost all of them decided to assume this control; in Latin America, all except Argentina. There is no sense in leaving to a foreign company the control of a sector that is strategic for a country's development such as oil, especially when this company, instead of reinvesting its profits and increasing production, remitted them to its Spanish headquarters. Besides, the days are past when a country that decided to nationalize the oil industry would go through what Iran experienced in 1957. Great Britain and France immediately overthrew the democratic government that then existed in the country and replaced it with the Shah, who promptly put himself at the service of the imperial powers.

But what will happen to Argentina in view of the decrease in the investments of multinational corporations? Is it not a “greater evil”? This is what tell us every day those companies, their governments, their economists and their journalists. But a country like Argentina, with a moderate Dutch disease (like the Brazilian one) does not need foreign capital by definition, that is, does not need nor should have a current account deficit; if it has a deficit, it is because it did not adequately neutralize the chronic overvaluation of the domestic currency, one of the causes of which is the Dutch disease.

The best proof of what I am saying is China, that grows with huge current account surpluses. But Argentina is also a good example. Since 2002, when it devaluated the exchange rate and restructured its external debt, it has had current account surpluses. And, thanks to these surpluses, that is, thanks to this competitive exchange rate, it grew much more than Brazil. Whereas Brazilian GDP grew by 41% between 2003 and 2011, the Argentinian GDP grew by 96%.

Those most directly concerned with direct investments in developing countries are the multinational corporations themselves. They are the ones that capture those countries' domestic markets without offering their own domestic markets in return. To us, investments from multinational corporations are only interesting when they bring about technology and share it with us. We do not need their capital that, instead of increasing total investments, appreciate the local currency and increase consumption. Their capital would be interesting if it were intended for export, but, since this is unusual, it usually represents just a permanent seigniorage on the national domestic market.

Published in Folha de S. Paulo, April 23, 2012 (in Portuguese here)

Sunday, April 22, 2012

The reform of the central bank charter was necessary for growth and stability

By Sergio Cesaratto, Marc Lavoie and John Weeks

“Give me a one-handed economist! All my economists say: on the one hand… on the other…” once famously said the U.S. President Truman. In his interview to La Nación professor Lance Taylor provides the perfect example of a two-handed economist: he supports growth, but he warns of the dangers of inflation; he approves of a central bank that cooperates with fiscal authorities, but he warns of excessive public spending; he gives his support to import controls, but he warns of their possible “micro-inefficiencies”. Professor Taylor thus plays the two-handed game of criticizing whatever the Argentineans could possibly do, even if we are not completely convinced that he actually said in the interview that he is in favor of an Independent Central Bank, as the headline would make you believe.

Of course we share, and we are sure that the Argentinean government shares, some of these preoccupations – although we are less concerned with the idea that import controls only protect domestic inefficient sectors. To begin with, comparing Argentina with Europe, where the inability of the Central Bank to cooperate with the national treasuries has created the crisis, Argentina looks pretty good, with a central bank that is mandated to cooperate with the democratically-elected government to pursue growth and employment rates that are consistent with the lowest possible inflation rate. In Europe, a non-cooperative European Central Bank has let interest rates on sovereign debt jump to unsustainable levels. In that respect the Argentinean central bank acts more like the North American Federal Reserve.

In addition, European central bankers and political leaders have advocated austerity measures that are causing a serious recession and that exacerbate the public budget problems caused by the financial crisis, very much like Argentina did during the Convertibility period, in which the former Central Bank Charter was imposed. By contrast, in Argentina now, there is a pro-growth central bank that carefully uses its foreign exchange reserves to reduce the needs of the government to borrow on international financial markets, and that wishes to sustain domestic investment through a public investment bank. This can only be good news.

Nobody would deny the importance of a competitive real exchange rate to sustain exports and favor the development of a competitive manufacturing sector. We believe that the reliance of exports on the vagaries of soya prices and harvests is a preoccupation of the Argentinean authorities too. Many Argentinean economists are however skeptical about the positive effects of currency depreciation on manufacturing exports; instead they are more concerned about the inflationary effects that exchange depreciation might have in a country like Argentina, with its strong tradition of labour militancy in defending real wages. They also warn that a policy of real wage compression through a depreciating exchange rate, if successful, would depress domestic consumption, growth and unemployment, with little compensation from an unlikely export-led boom. So, in any case, the objective of a competitive exchange rate should not be accompanied by restrictive fiscal and monetary policies, but rather should be accompanied by income policies that would preserve real wages.

Finally, the government with the support of many economists, in its attempt to diversify the export sector and reduce the import dependence, is relying on a pro-active industrial and trade policy, rather than relying on the real-exchange-rate-depreciation cum fiscal-contraction model proposed by critics. One cannot forget that Brazil has public control of long-term finance through BNDES, and that given Argentina’s higher GDP growth rate, the Argentinean government might have legitimate reasons to impose imports controls. As to the inefficiencies allegedly brought about by import substitution policies and import controls, the de-industrialization outcomes of decades of neo-liberalism are a much worse heritage. We do favor, in general, a more depreciated exchange rate to reduce the external constraint, but because devaluation is inflationary, on the cost side, and there often is wage resistance, one must be moderate. Exchange rates are only one price, and the notion that there is a perfect level that would solve everything, leading to growth, stability and sustainable current account by itself, might be a chimera.

Originally published in Página/12 (in Spanish).

Friday, April 20, 2012

The IMF with a thorn on its side

By Martin Khor

A serious impasse emerged in the preparatory committee of UNCTAD XIII, which is tasked with preparing the draft outcome document that Ministers are scheduled to adopt at the end of UNCTAD XIII in Doha on 21-26 April.

While the previous two or three conferences were rather tame affairs, it looks like UNCTAD XIII (whose general theme is development-centred globalization) will be more difficult, with the organisation’s future scope of work and influence at stake.

UNCTAD was set up in 1964 to support developing countries to strengthen their weak position in international economic structures, and to design national development strategies.

It became a kind of secretariat on behalf of developing countries, providing a small pro-development balance to the huge organisations dominated by the developed countries, such as the OECD, the IMF and World Bank.

Read the rest here.

Also read this piece by Martin Khor too.

Galbraith on inequality

Here an interview with Jamie Galbraith on his new book. An important point about inequality is that it peaked around 2000 and in the first decade of this century it has improved. That is often missed by economists. According to Galbraith:

"Worldwide, inequality rose sharply from 1980 to 2000. This is a pattern you find in my data, which measure pay inequalities within countries, and also in measures of inequality between countries and in measures of the profit share in the rich countries. It's well-confirmed at this point. The pattern closely tracks the evolution of the global debt crisis: first in Latin America and Africa, then in Central and Eastern Europe, finally in Asia.
Worldwide, as in the U.S., the peak appears to have come in 2000. Since then, with lower interest rates and rising commodity prices, conditions have improved, especially in South America where inequality has declined quite a bit. Even in China we observe a peaking of inter-regional inequality in the mid-2000s, although inequality between sectors (for example, inequalities related to the rising power of the banks) continued to increase."
Prices of commodities and higher growth in the periphery are a crucial element of the reduction in inequality in certain parts of the world. The burst of the bubble too reduces inequality in developed countries, but of course it remains (both in the center and in the periphery) at very high levels.

Just prices, elephants and kings

Well I'm not going to get medieval on your rear ends. Yep just price is the old scholastic idea that there is a fair or ethical price that can be charged for a commodity, and beyond that the producer is obtaining unfair earnings. It was the basis for the attacks on usury. David Friedman (1987), in the old New Palgrave (the one edited by Eatwell, Milgate and Newman) argued that the dominant view suggested that the just price was "the price which allowed the producer to maintain his proper place in society."

I wouldn't expect The Economist to come on the side of ethics in market relations, but that's what they have done. The Economist already has a fair price for YPF (see here), the oil company that was partially nationalized by the government of Argentina.
"Argentina could presumably mollify Spain by paying a fair price for YPF—which would most likely be half of the $15 billion or so the company was worth before the Argentine government began harassing it."
Fairness is a strange argument to use in favor of Repsol (the Spanish firm that owned most of YPF). They bought it for $13 billion in 1999, made $15.7 billion in in dividends over the whole period, plus $6.2 billions for the selling of part of the assets. So they made approximately $8.9 billions. And the fair or just price would be another $7.5 billion according to The Economist.

Of course, this price is not connected to the value of the assets, or how well the firm was managed, which says how much it can produce (output in 2011 was at 61% of the 1999 level). It must be a way for Spain to maintain its proper place in the world. Or at least the King, who is apparently incapable of maintaining his elephant hunting hobby. God save the King, then.

Thursday, April 19, 2012

Recovery with a human face

There have been many fora for discussions about the crisis, and its consequences on the more vulnerable around the globe. The electronic debate moderated by United Nations was among the more interesting. Topics ranged from the impacts of the crisis to policy responses and alternative options for socio-economic recovery. Now a summary of the debates is avaliable here:

A Recovery with a Human Face? Summary of a UN e-discussion

A more thorough analysis of the issues debated can be found in the recent publication A Recovery for All: Rethinking Socio-Economic Policies for Children and Poor Households, which can be downloaded for free here.

Thanks go to Isabel Ortiz for sharing the information, and for her commitment to the whole project.

Monday, April 16, 2012

In the news

Two big news today.

The US, as expected, managed to keep the presidency of the World Bank. Kim was chosen over more qualified and progressive alternatives (José Antonio Ocampo, in particular). See more here.

And Argentina has nationalized the oil company (YPF) that had been privatized during the neoliberal period. By the way, notice that neither Brazil nor Mexico, the other two large countries in Latin America, had privatized their oil companies. See more here.

Useless European austerity

By Sergio Cesaratto*

The European financial crisis is not over, it has just begun. In the long run, the Greek tragedy will appear just as one minor episode. It is not difficult for the Argentineans to understand the origin of this crisis, as I shall shortly explain, although they will still be surprised as to why one of the richest regions in the world and a world reference for growth with social fairness is committing suicide by adopting austerity measures that aggravate, rather than solve, the crisis.

The European Monetary Union (EMU) was born out of a French political design of linking for good the post-unification German destiny to Western Europe. The greater Germany would have otherwise looked East - as the facto it has anyway later done by becoming the manufacturing hub of Central and Eastern Europe where it has decentralized her low-value added productions. By participating in the EMU, Italy and the other Southern countries aimed to import the German fiscal, monetary and labor discipline.

The American economists alerted the Europeans that the EMU was not an “optimal currency area”, too heterogeneous, economically, culturally and linguistically. The European elites cried about an U.S. plot to avoid the birth of a new international currency along the dollar. Be as it may, what happened during the EMU from 1999 and 2008 is a story that the Argentinean public, mutatis mutandis, can well understand. Financial liberalization and exchange rates fixed for good led to huge financial flows from the European “core” (Germany, The Netherlands, Austria, Finland) to the “periphery” (mainly to Spain, Greece, Ireland). France and Italy do not strictly belong to either group - the Italian manufacturing sector is second only to Germany and this marks the main difference between Italy and Spain. The capital flows generated a construction boom in Spain and Ireland and encouraged government profligacy in Greece. This led to an ephemeral growth in these countries accompanied by a relatively high inflation and consequent lose of competitiveness. Their foreign accounts became negative and they accumulated a huge foreign debt mainly with Germany.

Asymmetrically, from the late 19990s under the social-democrat Chancellor Schroeder, Germany adopted a mercantilist policy of wage and fiscal moderation and of labour flexibility. So Germany was, on the one hand, compressing domestic demand and inflation and, on the other hand, financing aggregate demand in the periphery. This became the débouché for the German export-led model. The only problem is that the periphery accumulated a huge foreign debt without being able to get eventually out from the imbalances by devaluating the national currency, as Argentina did in 2001 or Italy did in a similar situation in 1992, after the imbalances created by the European Monetary System in the 1980s.

In late 2009, after the explosion of the American financial crisis and the discovery that the Greek centre-right government (a good friend and client of Angela Merkel) had concealed the true level of the public debt, the financial market begun to have doubts about the solvency of the peripheral economies. The crisis affected Greece, Ireland, the Portugal in 2010, and the fourth and third largest EMU economies, Spain and Italy (and marginally Belgium and even France), in 2011. As a consequence of the fall in the fiscal revenues and of the public bail out of the banking sector in countries like Ireland and Spain, the private debt problem became also a public debt problem. (The huge Italian public debt was much older and sustainable, but for a country used to defend her manufacturing competitiveness by devaluing the lira, the EMU was a clear disaster, so markets begun to doubt also about the Italian solvency).

The European reaction has always been characterized by being systematically “too little, too late”. European emergency funds have been created to avoid the default of the peripheral governments. There is a problem, however: a conspicuous part of the cash comes from the same countries that need support, a vicious circle. Against the German will, the European Central Bank (ECB) has timidly intervened to sustain the periphery sovereign debts, but just in order to avoid a sudden collapse of the EMU and not to keep at sustainable levels the interest rates on those debts (both the two German members of the top board of the ECB resigned in protest during 2011). The Germans oppose that the ECB acts as the lender of last resort for States and banks, the main reason why central banks have been created. The idea of a central bank that democratically cooperates with fiscal policy has, for instance, informed the recent Argentinean reform of the central bank.

Indeed German’s leaders, both the ruling Christian Democrats and the opposition Social-democrats, consciously or not, share a wrong diagnosis of the European crisis. In the name of a non-existing inflation fear they oppose a firm action of the ECB to calm down the markets acting as the ultimate guarantor/warrantor of the peripheral sovereign debts. Moreover Germany has imposed fiscal austerity measures on the periphery with the wrong argument that fiscal profligacy was responsible of the crisis. The result is that the economic situation is getting worse, while the social situation is deteriorating.

Germany likely hopes to outlive in spite of the fall of the European periphery markets, by looking at the emerging economies’ markets. The only effective action has been taken in December 2011 by the President of the ECB Mario Draghi, again with the German opposition, by lending European banks 1 trillion Euros at an interest rate of 1% for three years expecting that part of this money to be used to sustain government bonds. The operation brought some short-term relief, but now peripheral banks are even more plenty of domestic treasury bonds, a not very reassuring situation given that the underlying imbalances that generated the crisis are still there and the confidence on sovereign solvency is, as the result of the austerity measures, getting worse, as shown by Greece, Portugal and Spain.

European countries are in Kafkian situation: damned if they stay, damned if they leave. On the one hand, a Euro-break would likely leave the global financial system devastated, given that any indebted country will in practice default at the same time, Italy included. On the other hand Germany opposes the most reasonable solution: let the ECB to sustain the European sovereign debt; support domestic demand in Germany by letting wages and fiscal spending to grow; implement a great European Marshall plan for the periphery financed by issuing Eurobonds.

As I said at the beginning, this is the sad final of a beautiful European story of building a reasonably fair and efficient society. Perhaps once things get worse, including in Germany, the failure of the austerity policies might lead to more progressive actions. This would not compensate, however, the useless suffering that the present policies are imposing on millions of Europeans. Pressure by the U.S. and by the emerging countries on Germany to assume regional and global leadership and not to behave like small Switzerland would clearly be helpful.

*Published originally in Spanish in Página12 (Thanks to Sergio Cesaratto for providing the English version).

Friday, April 13, 2012


Last week, guest blogger Robert Wade sounded the alarm about efforts on the part of some developed country governments to severely restrict the mandate of the UN Conference on Trade and Development (UNCTAD) at the organization’s April 21-26 ministerial conference in Doha, Qatar. We follow up on that post with a sign-on letter from former UNCTAD senior staff members urging that the institution’s broad mandate be maintained, as a critical source of heterodox economic thinking and policy analysis. We reprint their letter and signatories below.

Read the letter here.

Prices and quantities

Mainstream economics suggests that prices and quantities should be treated simultaneously, as it should be if market prices as determined by supply and demand are at the center of the analytical framework. With supply and demand, it must be the case that the quantity produced, and the equilibrium price, both are determined simultaneously. Further, it is the case that, with price flexibility, the quantity produced is optimal from the perspective of the utilization of resources and the preferences of the agents. And if that is true for bananas, or any other commodity for that matter, it must be true too for labor and ‘capital.’

As I discussed before, in particular with respect to capital, this approach (supply and demand or marginalist), which contrasts with the surplus approach, has serious problems. Even if we dismiss, for simplicity sake, the subjective part (about preferences) and concentrate just on supply conditions, the difficulties are insurmountable. Producers only supply more at higher prices, which means that they must encounter increasing costs (diminishing returns). It cannot be the case that they are only willing to supply more at higher prices (higher remuneration) even if costs are not higher, since if one producer obtained higher remuneration free entry of new producers (attracted by the higher remuneration) would imply that more would be produced. So the supply curve depends on diminshing returns.

And diminishing returns are a highly improbable proposition, as Sraffa argued back in the 1920s. Not many producers, if any, would tell you that they don’t produce more because their costs would go up (and that would reduce demand as prices get higher). Most simply would reply that, although they could produce more at the same price, they don’t have enough demand. But the diminishing returns fetish dominates the profession (I won’t say anything here about imperfect competition, but Franklin Serrano noted here that this would be related to barriers to entry).

In the surplus approach, that concerns itself with the way in which societies reproduce themselves (usually in an amplified scale and with accumulation), prices and quantities are treated separately. Since costs of production, for a given technology, seem to be independent from the quantity produced (i.e. the cost would be the same if you produced slightly more or less), then the quantity can be taken as given for the discussion of the determination of prices. It is well know that, in that case, prices depend on the technology, which must allow for reproduction (including of the labor force) and by the way in which the surplus (what is left over, above and beyond the needs of reproduction) is divided between classes.

This separation between prices and quantities has been called by Garegnani the 'method of given quantities.' Note that it does not imply that the quantities are determined by supply or given at a level that is optimal from the point of view of utilization of resources. And that is why it is perfectly compatible with Keynes’ notion of a demand determined level of activity (yes you can, and should, add Sraffa to your Keynes, or Kalecki). Also, it does not mean that there is no technical change or that distribution does not affect output (all propositions that have been discussed here in the blog).

Be that as it may, I’m more interested in the macroeconomic implications of the mainstream views about prices and quantities. Since the late 1960s, these views have coalesced around the notion that, whereas there is a short run tradeoff between prices and quantities (the so-called Phillips Curve, PC), in the long run the tradeoff vanishes. Put simply, if you push demand too much (through fiscal and monetary policy), output would increase, unemployment fall (as per Okun’s Law: higher output implies lower unemployment) and inflation would accelerate. In the long run, however, the economy is self-adjusted and output cannot be above the optimal level, so the only effect of the expansionary policies would be inflation (Friedman dixit).

By the way, the same (the mainstream loves symmetry) is true for deflation. Yes it may cause some problems, but the system returns to full employment, even in the face of contractionary policies (the Greek should not worry about contraction, because markets would produce full employment if they are allowed to work; hence, the need of labor market flexibility). In the long run contractionary policies only would affect prices. In sum, supply and demand would lead to the optimal price and quantity, so if you get off my market (cranky old neoclassical guy would say), and stop expanding demand, there would be no inflation.

The evidence for a natural rate or for a PC is incredibly weak. In order to argue that there is a natural rate, the mainstream has basically suggested that it moves around all the time. So in the 1980s the natural rate was higher (in the US), when the actual unemployment was higher, than in the 1990s (particularly towards the end of the decade), when the actual rate was also lower. The ad hoc nature of the solution is evident. They tell you that the natural (which they measure as an average of the actual) is the attractor of the actual rate, and not the reverse.

The continuous ad hocery of the mainstream is on display now too. This is evident in discussion about the fears of inflation in the US, according to which the tripling of the monetary base would lead to hyperinflation (Krugman criticizes that here, and in several other places). Inflation does not take place, but it must be that expectations of inflation are low.

Also, it is evident in the IMF, the Bank for International Settlements (BIS) and other international institutions (since last year at least) arguments for fiscal and monetary contraction in the periphery (which is still growing faster than the center). The IMF believes fiscal expansion is no longer needed since “private demand has, for the most part, taken the baton” (IMF, 2011: xv). Moreover, the BIS argues that inflation is presently the main risk in an otherwise recovering world economy, and therefore suggests “policy [interest] rates should rise globally” (BIS, 2011: xii). According to this view then, if demand is controlled then prices would stop growing fast, and inflation would be under control.

Brazil actually did that last year, that is, fiscal contraction (with some monetary easing, but from a very tight stance, since it still maintains very high real interest rates). Output decelerated from 7.6% growth in 2010 to a mere 2.7% growth last year. A reduction of almost 5%. Did inflation then fell significantly as it should according to the mainstream? The Consumer Price Index (CPI) of the Fundação Getúlio Vargas increased from 6.24% to 6.36% in the same period, that is, it was almost constant. Something similar took place in Argentina between 2008 and 2009, when output decelerated around 10% (from high growth to negative growth), and inflation remained at high levels (fell perhaps around 6% or so, in an year that commodity prices collapsed). The mainstream argument is that the policies were not credible and as a result inflation expectations remained high.

In other words, it is not that the theory does not work, even though facts show that their predictions are false. It's a problem of the complexity of the phenomenon, and the need to account for expectations (anything can enter here, and no hypothesis can be tested if you take this seriously).

A simpler solution would be to admit that prices have little to do with demand (at most weaker demand and lower employment reduce the bargaining power of workers and reduce wage resistance). In other words, get rid of the notion of natural rate of unemployment and of a PC for which there is no reliable evidence (as should be done by any serious scientist). The contractions demanded by the IMF and the BIS led to recession (they affect quantities), and prices in Brazil did not fall because costs (which include imported goods and wages) did not fall. No need to suggest that expectations are responsible for inflation not falling. [Keen on his debate with Krugman has also referred to these subterfuges to keep theory in the face of lacking evidence; epicycles if you will]. By the way, expectations have been traditionally a way to argue that anything can happen, and allow theories that are not consistent with facts to get away with the incoherence. But I'll let that for another post.


BIS (2011). 81st Annual Report. Basel, Bank for International Settlements, June.

IMF (2011). World Economic Outlook. Washington, DC, April.

Thursday, April 12, 2012

Buffett rules

Brief comment by Jamie on Buffett's rule, that is a minimum tax of 30% on millionaries (annual income above a million). His point is that it would be only symbolic, from the point of view of additional revenue, but it would be important for pushing the debate on income distribution. Hey, anytime we talk about millionaires rather than 'job creators' I'm happy!

PS: More here, where he also talks about his proposal to increase the minimum wage to US$ 12.

Monday, April 9, 2012

Inequality and economic instability

Jamie Galbraith's new book  is out. The main thesis in the book is that the inequality of the past three decades, driven fundamentally by financialization, led inexorably to boom and bust instability. A recent interview about his book and the current economic situation can be found here.

Is China the new #1?

The coming of the Chinese century and the final demise of American hegemony have been announced frequently as a sure thing. I have dealt with several of the issues associated with that, from the misconception of the fears about the dollar as the key currency (yep, will continue to be the unit of account in international affairs for a long time) to the question of the global imbalances (the problem is not that they are big, but the fact that they are not big enough; if the US grew decently and pushed the world economy its trade deficits would be larger).

Here I want just to point out a recent study that looks at corporations. The study shows that a small number of financial institutions basically controls the overwhelming majority of transnational corporations (TNCs). To be precise "only 737 top holders accumulate 80% of the control over the value of all TNCs." These, mostly financial, institutions "are at least in the position to exert considerable control, either formally (e.g., voting in shareholder and board meetings) or via informal negotiations," still according to the same paper.

How many Chinese groups are part of these elite institutions? Well, below the list of the top 20.

4 AXA (France)
9 UBS AG (Switzerland)
14 CREDIT SUISSE GROUP (Switzerland)
17 NATIXIS (France)

The first Chinese corporation is at number 50, the China Petrochemical Group, a resource based State firm. Oh yes, the evil giant vampire-squid is only number 18, but it is on the list. The Chinese economy, like the economies of almost any peripheral country, is partly owned and managed by a network of firms that are fundamentally from developed countries (in the top 20 above, from the US, the UK, France, Germany and Switzerland). The reverse, that is Chinese control of firms in developed countries, is minimal. Yes, sure, China is number one!

Wednesday, April 4, 2012

Not so Keen on Krugman

I have been critical of the theoretical positions held by Krugman for a while now, even if he and DeLong, and even Summers, have been useful for policy reasons. Now a lengthy debate between Krugman and Steve Keen, a very pragmatic and reasonable post-Keynesian (and I guess part of MMT tradition) that understands endogenous money has developed [a good summary with all the links here].

First, and foremost endogenous money implies that the rate of interest is exogenous and determined by monetary authorities. That per se is not necessarily in contradiction with a neoclassical/marginalist view according to which the rate of interest equilibrates investment to full employments savings, as Krugman clearly believes. Wicksell [see here] certainly did not think so either.

For Wicksell in a giro system, in which all transactions were recorded as debit/credit relations, credit could expand indefinitely, but in the real world, bank reserves would vanish and lending would eventually collapse if the bank rate remained below the natural rate for a long period. That is fundamentally the reason why Krugman does not understand the notion that banks can create reserves, and that loans cause deposits. In other words, what regulates the bank rate is, ultimately the natural rate of interest.

Further, the natural rate of interest is NOT a banking phenomenon in marginalist analysis, and, as a result, cannot be exogenous to the system. It results from the marginal productivity of capital and the intertemporal decisions of consumers. Krugman is in fact very clear that he supports the loanable funds theory of interest.

Hence, Peter Cooper is correct to point out that ultimately the debate with Keen must revolve around a notion of a long term normal rate of interest that is institutionally determined by the central bank independent of the marginalist notion of the natural rate. That can only be obtained with the proper critique of the neoclassical notion of capital.

Tuesday, April 3, 2012

The Economist and Argentina

Central Bank Independence is the rallying cry of the Economist againts Argentina's new law regulating the functioning central bank. Argentina will use the central bank as a piggy bank for the government, and that will lead to inflation. This is a bit ironic since it comes after the worse crisis in capitalism since the Great Depression and during the worst European Crisis after the launching of the euro, which threatens the very existence of the currency, and both should at least lead to some revision of central bank practices. Also, one should note the independence of the European Central Bank is part of the problem in the case of Europe, since if the ECB bought small amounts of Greek debt the draconian adjustment would be unnecessary.

The only thing worth about the piece is the brief objective description of what the central bank' new charter does, namely:
"It can now be required to transfer to the treasury cash equal to 20% of government revenues plus 12% of the money supply; to use its reserves (of $47 billion) at will to pay government debts; and to play a more active role in regulating banks and in steering credit to favored industries."
They mock the president of the bank, for suggesting that the bank will not print more money than needed. Mind you that is an old idea, going back to the anti-bullionists, the Banking School, the Radcliffe Committee, and many post-Keynesian authors that defended endogenous money (what is now referred to as MMT). Also, something accepted by any central bank that follows an interest rate rule, since they lend any amount at that rate of interest.

Bernanke would probably reply that the incredible increase in the monetary base, from around US$ 850 billion to around US$ 2.5 trillion in the 2007-2011 period, was what the market needed. The Economist obviously believes that hyperinflation is around the corner in the US too.

The use of reserves, which continues a policy already in place, just with more flexibility, is a way of reducing the need for borrowing in international financial markets. And since the current account is near balance, the only other alternative would be to borrow. Note that borrowing in international markets in foreign currency, has no connection with printing money and financing domestic spending in domestic currency, other than the fact that imports increase with the level of activity. By the way, the government is reducing spending and cutting subsidies, and, hence, promoting a fiscal adjustment and as one should expect the economy seems to be decelerating, so it is very unlikely that there will be overissue, whatever that is.

By the way, historically that is what central banks did. The Bank of England entire initial capital was lent to the government. And one thing that is generally agreed is that the ability to borrow money at relatively cheap rates was essential to explain the British rise to power in the XVIII century, and for the eventual defeat of the French hegemonic pretensions. Inflation, when it occurred was caused by changes in costs of production, and as Thomas Tooke, an often neglected author, suggested, in his monumental History of Prices, that bank issue responded to the needs of trade.

But given the ironic tone of The Economist, let me ironically finish by quoting Milton Friedman, who also opposed Central Bank Independence, albeit for different reasons than I do: ‘to paraphrase Clemenceau, money is too serious a matter to be left to the Central Bankers.’

Podcast with about the never ending crisis in Argentina

Podcast with about the never ending crisis in Argentina with Fabián Amico, and myself and interview by Carlos Pinkusfeld Bastos and Caio Be...