The uses and abuses of economics

Alan Blinder wrote a few days ago in the Wall Street Journal that economic theory has been often abused by politicians. He refers to what he calls the Lamppost Theory of Economic Policy, the notion that: "Politicians use economics the way a drunk uses a lamppost—for support, not illumination." His concerns are fairly conventional. He says:

By 2020, higher spend­ing and tax cuts will push the fed­eral bud­get deficit above 6% of gross do­mes­tic prod­uct—higher than it ever was in the Rea­gan years. Even deficit doves like me think that’s far too high ab­sent a re­ces­sion. Pres­i­dent Trump may be tak­ing the U.S. into a mul­ti-­front trade war, against the ad­vice of al­most all econ­o­mists. And Amer­i­ca’s po­lit­i­cal lead­ers refuse to en­act a car­bon tax, the rem­edy for cli­mate change that al­most every econ­omist fa­vors.

If you read the piece, you would think that economists agree on everything, and that the reasons for the consensus is that the subject is highly technical, and in a sense scientific. So fiscal deficits that are relatively large are bad (unless there is a recession), free trade is always good, and a tax can fix a problem with an externality, like climate change.

The reason for politicians misguided behavior is not difficult to understand either, in Blinder's view. It is essentially a problem of time horizons, politicians must by the nature of their trade be impatient. In his words: "Political time horizons are notoriously short, perhaps extending only to the next election—or the next tweet. In contrast, economists’ time horizons can be agonizingly long—far too long for politics."

I have problems with many of those issues, even if I'm also not a fan of Trumponomics. Note that larger fiscal deficits, including a 6% one, even without a recession, might be acceptable, depending on how the government spends and taxes. If the government is borrowing in domestic currency, with low interest rates, taxing the wealthy, and spending to provide a wide safety net for the relatively poor I would be perfectly fine with that. And there would be no risk of debt sustainability issues or default. Note that, the higher spending would probably translate eventually into higher growth and, as revenue increased, lower deficits. As Blinder well knows, deficits are endogenously determined. The point is that my favoring of higher deficits, in some circumstances, is related to the question of who are the winners and the losers of alternative fiscal policies.

My biggest trouble is, probably, with the free trade assumption (and I discussed that recently here). I don't want to repeat the argument, but there should be significant disagreement within the profession on the benefits of free versus managed trade, since the evidence for free trade is incredibly weak. Free trade is simply a particular kind of trade management that favors some groups at the expense of others.

I also would favor a Green New Deal, a significant increase in the spending on green technologies, since I'm skeptical of substitution effects in general and, hence, of a carbon tax (I'm not against it, just skeptical that it would solve our problems). It seems to me that the biggest issue with global warming is that the distribution of its effects (and note that the benefits of the process of industrialization that caused the climate change in the first place were unevenly distributed) will be very unequal. In particular, developing nations would end up paying a higher price.

All of these issues, with fiscal, trade and environmental policies, seem to suggest that the main problem with the political use of economics is not the illegitimate use of economic arguments for political aims associated to the electoral cycle, that is, the short-termism of politicians. The problem is the very legitimate grievances that arise from the social effects of those policies. Trump is not giving tax cuts just to win elections, although that may play a role (yet, most people are for higher taxes on the wealthy), but also, and more importantly, to increase the rents of the wealthy.

That's why I would be very skeptical of Blinder's suggestion favoring a technocratic government, which would reduce the role of politics in economic policy making. In his words:

I have one final suggestion, though its scope is limited: Suppose we took some—certainly not most—economic decisions out of the hands of politicians, and put them in the hands of nonpolitical technocrats instead.

This is the sort of neoliberal argument used by the Chicago Boys in Latin America to suggest that there was no alternative. Market friendly policies were the only game in town, because they were a technical issue, not open to political dissent, instead of a strategy of a political minority to impose very unpopular policies that favored the wealthy. Trump should be defeated, and his policies rolled back, and for that Dems should field a left of center candidate with reasonable ideas favoring the majority (i.e. the working class), rather than propose undemocratic (technocratic) solutions.

On the natural rate and being always wrong

So I saw that someone linked to an old post of mine in a discussion on Jared Bernstein's blog. The discussion is on productivity slowdown.

In that post I quote Alan Blinder on his views (slightly more than a year ago) on the natural rate. He said :

"the 'central tendencies' in the Federal Open Market Committee’s latest published forecasts range from 5.2% to 5.5% for the 'full-employment' unemployment rate, and from 2% to 2.3% for the potential GDP trend."

So unemployment should be below the natural rate now, and arguably that could be seen as a reason for the FOMC hike last month, although I doubt that Yellen thinks we're at full employment. As I note on that post Blinder was wrong in the 1990s too about the potential GDP trend. I don't expect any surge in inflation any time soon. But it is amazing how serious economists can be wrong almost all the time.

Interest rates will go up (almost certain now)

Not a conventional rate

Janet L. Yellen said in her speech at the Economic Club of Washington that rates are going to increase. Perhaps there will be no unanimous decision by the FOMC, but gradual increases should start in December. It must be noted that she did say that: "we cannot yet... declare that the labor market has reached full employment." She is also concerned with the weakness of the global economy, and, hence, of US exports. The forecast in a nutshell:

"I anticipate continued economic growth at a moderate pace that will be sufficient to generate additional increases in employment, further reductions in the remaining margins of labor market slack, and a rise in inflation to our 2 percent objective."

And that means that:

"As you know, there has been considerable focus on the first increase in the federal funds rate after nearly seven years in which that rate has been at its effective lower bound. We have tried to be as clear as possible about the considerations that will affect that decision. Of course, even after the initial increase in the federal funds rate, monetary policy will remain accommodative."

So they will increase, but slowly. On a more theoretical note, if you doubt the actual relevance of mainstream neoclassical economics for policy decisions, the whole thing is informed by what the Fed refers to as the neutral interest rate, which is according to Yellen "a concept closely related to the... 'natural' rate of interest" (Figure above shows the staffs calculations). Alan Blinder says the rate will, eventually (he says in 3 years), reach 3.5%.

I wrote too much on the problems of the concept of a natural rate of interest to repeat myself. Oh well.

The mystery of productivity: what mystery?

Another old one. Trying to catch up after the Thanksgiving break. Mainstream economists seem always puzzled by productivity. It is the source of growth and a mystery (Helpman has a book titled The Mystery of Economic Growth). They refer to trends in productivity as puzzles, in particular the slowdown after 1973.

 

Alan Blinder: reminds us that after the surge in productivity growth, that for a while at least was referred to as the New Economy, associated to information technologies, has collapsed to even lower levels than the 1973-1995 period. He is, as a good mainstream author, quite puzzled. In his words, "quite surprisingly and still somewhat mysteriously, productivity growth plummeted [after 1973]... We are all in the dark."

In Jeon and Vernengo (2008) we suggest that labor productivity is endogenous, explained essentially by the expansion of demand, and old idea, implicit in Adam Smith's vent for surplus, and part of a well established empirical regularity, the so-called Kaldor-Verdoorn Law. In other words, it is the weak recovery, caused by a contractionary fiscal stance, and the slow pace of private spending growth as employment increases, that explains the poor performance of productivity. In this sense, the causes are considerably simpler, connected to macro policy, rather than the long-term pessimism of Gordon and Summers, which now talk about secular stagnation (see also this book).

Perhaps the more interesting stuff in Blinder's piece is his discussion of what the 'serious people' in the mainstream consider the natural rate to be. He says:

"the 'central tendencies' in the Federal Open Market Committee’s latest published forecasts range from 5.2% to 5.5% for the 'full-employment' unemployment rate, and from 2% to 2.3% for the potential GDP trend."

Note that Blinder also thought that the speed limit was around 2% back in the late 1990s (here his debate with Bluestone and Harrison). And yes he is a Keynesian (a New Keynesian). With friends like this...