Trumponomics and the next recession

Progressives for balanced budgets and free trade

It was the best of times; it was the worst of times. Or that is what you would think if you follow the economics press lately. Sebastian Mallaby has a column on Trumponomics a while ago, suggesting Trumponomics is not working. I wouldn't disagree with the verdict, but the explanation is far from correct, and that is a common feature of discussions of Trumponomics in the media, and frankly by many progressive (not just liberal, in the US sense of the word) economists. On the other hand, you can expect a lot of praise in conservative circles (and bragging from the Trumpsters) about the unemployment level reaching 3.7%, the lowest since the Kennedy/Johnson boom of the 1960s. Many would say we are at full employment, and in a sense they might not be wrong (I think it's debatable; more on that below).

The question is then how things can be both good and bad. First, let me explain the more obvious, the labor market story. The recovery from the 2008 crisis has been long and slow, as it is well-known. And it is unclear what impact Trump's tax cuts will have, but it is highly unlikely that they would lead to any significant acceleration of growth, if past evidence is a good guide. So the current low unemployment level is the result of a process that started with the Obama fiscal package and has proceeded at a slow pace pushed essentially by consumption (after the initial fiscal stimulus). And that's why it has not been a more robust recovery (it remains very slow, even in the two Trump years).

This is reflected in an employment to population ratio that is still below the previous peak, even if now recovering. In other words, the participation rate in the labor market remains relatively low. And, hence, wages have not yet started to pick up significantly, and inflation remains subdued, which casts at least doubts about the meaning of full employment.

This suggests that we would need more fiscal stimulus, and not austerity. That's one concern I have with some critics of Trumponomics. That they presume that fiscal deficits and Trump's tax cuts are both bad. I would suggest that the latter is certainly bad, for distributive reasons. But deficits in the current situation in which the recovery has not raised all boats is far from a problem. I think it was Barbara Bergmann (citing Alvin Hansen) that said that the full employment deficit was the fiscal deficit necessary to bring the economy to full employment. We are probably not there yet. Btw, this is what used to be called functional finance and Trump's critics should learn about it.

Some critics, like Mallaby, are concerned with the trade wars. Here too I'm a bit worried about the positions taken by critics. Progressives have complained about Free Trade Agreements (FTAs) for a long while now. And also criticized the concept of Free Trade (see here for a list of entries in this blog). Mallaby, for example, suggests that the trade war with China, and the new version of NAFTA (USMCA now), which is worse for him than the original (the name for sure, Moreno-Brid suggested at a conference in Mexico this week MEXCUSA, a good pun in Spanish), would reduce productivity and growth.

I still don't have a full picture of the USMCA deal, but it seems that beyond the clauses about North American content and percent being produced with higher wages in the auto industry (both clauses that seem to favor the US and not Mexico), the liberalization of Canadian dairy industry, and tighter restrictions on generic medications (all of which seem to favor US corporations against Canadian citizens), the most important is the one that allows any member country to essentially veto free trade agreements with non-member countries. That is, most likely, a clause for the US to veto FTAs with China.

In that sense, USMCA is just an extension of the trade war with China. I don't want to write much on this, but it seems to me that the US finally decided to revert the opening policy towards China, that harks back to Nixon, and to take the Chinese challenge (and at this point it's just that; I don't see a Sinocentric world any time soon) seriously. In all fairness, it seems to make a lot of sense, from an American security position to make it difficult for Chinese firms to go about the process of catching up, which includes acquiring companies, reverse engineering, violations of copyrights and patents, industrial espionage and more. And yes, there will be disruption of the commodity chains. For example, maybe Apple will move some of its i-Phone production out of China into other developing countries in the region (don't think many manufacturing jobs will return to the US though). But productivity won't suffer much.

If you're concerned with productivity, fiscal policy and its impact on growth should be a greater concern to you. Expansion of demand is what pushes labor productivity (productivity is not the cause of growth, but the result; search the entries on Kaldor-Verdoorn Law in the blog). The slow recovery is the problem.

Finally, I'm still unsure about when the recession will come, but neither the fiscal or trade fronts, which are the ones attacked mostly by Trump's critics seems to be the crucial problem. Monetary policy might be though. If the Fed continues to raise rates, something they suggested they would do, then there is a serious possibility of a crisis ahead. Higher rates would affect the already overextended American consumer, and lead to a recession. Nothing like the last one, I think. And the Fed would be forced to reverse course pretty soon. But the Fed remains independent, also something that old critics of the concept have embraced in the Trump era.

John Cochrane on economic growth

There are three kinds of lies, "lies, damned lies, and statistics," supposedly said Benjamin Disraeli. This applies to John Cochrane piece in the Wall Street Journal today. Cochrane says that:

"Sclerotic growth is America’s overriding economic problem. From 1950 to 2000, the U.S. economy grew at an average rate of 3.5% annually. Since 2000, it has grown at half that rate—1.76%. Even in the years since the bottom of the great recession in 2009, which should have been a time of fast catch-up growth, the economy has only grown at 2%. Last week’s 0.5% GDP report is merely the latest Groundhog Day repetition of dashed hopes."

That is all true, and I myself complained about slow growth last week. However, this gives a false impression that the slowdown is a very recent thing, of the 2000s. In all fairness there has been a slowdown in growth going back to the 1970s or at least the 1980s. Growth since 1973 has been around 2.8%, and 2.6% since 1980, the years of the first oil shock and the productivity slowdown, and the beginning of the Reagan revolution respectively.

Yes, it is true that growth has further slowed down since the last recession (1.8% since 2000, and 1.2% since 2008), but growth has not only been slower over the last three decades (which, by the way go hand in hand with worsening income distribution), but also it has been more dependent on financial bubbles. And the last three recessions have been associated to the burst of a bubble. And given the structural conditions of the US economy, it seems that only with a bubble we will have healthier growth again.

The point is that an economy that depends on excessive accumulation of private debt, and debt-driven consumption bubbles is more volatile and prone to crisis. And that is associated both to financial deregulation and worsening income distribution. Certainly not to what Cochrane sees as the main American problem: "that the U.S. economy is simply overrun by an out-of-control and increasingly politicized regulatory state. If it takes years to get the permits to start projects and mountains of paper to hire people, if every step risks a new criminal investigation, people don’t invest, hire or innovate."

The notion that further deregulation would lead to a spurt of growth is preposterous. Yeah, because deregulating the financial sector has worked so well.  By the way, investment is a result of growth (accelerator) as well as innovation (Kaldor-Verdoorn). The problem is not enough spending on a sustainable basis, because party politics impedes public investment, and income inequality makes private spending more unstable. Austerity and inequality, not excessive regulation are behind low growth. But at least he is right that growth did not slowdown because of lack of innovativeness or a savings glut.

Causality and the new World Economic Outlook (WEO)

I often say that causality is the main, but not the only, difference between mainstream and heterodox approaches in macroeconomics. It's true for differences between Say's Law versus the Principle of Effective Demand, for discussions of exogenous/endogenous money, and also for interpretations of the relation between growth and productivity.

The new WEO is out (here). This one the first under Maurice Obstfeld, who substituted Oliver Blanchard. The explanation for lower growth in Obstfeld's intro says the following:

What underpins forecasts of moderating growth? First, the ongoing experience of slow productivity growth suggests that long-run potential output growth may have fallen broadly across economies. Persistently low investment helps explain limited labor productivity and wage gains, although the joint productivity of all factors of production, not just labor, has also been slow.*

So low productivity growth causes low output and employment growth, rather than vice versa. Further, lower investment is what causes low labor productivity, which is actually a plausible mechanism. No new machines, no increase in labor productivity.

But as the IMF has recently noticed, the accelerator is the mechanism that explains investment behavior (see here on the previous WEO rediscovery of the accelerator, and also Obstfeld says in the following line: "low aggregate demand... discourages investment"), and that implies that growth is what determines investment and, as a result, labor productivity. So low growth is caused by low growth. Good job!

* I'll leave out the problems with total factor productivity, which have been extensively discussed in the blog before.

Is labor productivity still pro-cyclical? Okun's Law is still fine

So there has been some talk about productivity not being pro-cyclical anymore. This is based on the notion that labor productivity increased during the last few recessions. Robert Gordon is the main source of this view. That is, it would seem that labor productivity is now anti-cyclical. Note that pro-cyclical productivity is what is behind Okun's Law. So below the data, from Fred. Labor productivity, the difference between real GDP growth and civilian employment growth and real GDP growth itself.

It is hard to look at the graph and suggest that the two variables are not positively correlated, even for the post-1980s period. But it is true that if you look at the shaded areas, which represent recessions, it seems that productivity fell before, and was already recovering in that period, at least since the Bush senior recession. This is more about the timing of the recessions, and how these are measured by the NBER, than about the strength of the pro-cyclical relation between productivity and output.

There are a few additional problems with Gordon's views. Note that Gordon does not explicitly deal with the structural relation between labor productivity and growth, the so-called Kaldor-Verdoorn effect, and that's why he finds that the Okun effect is weaker overtime. I had written before on this here (or here), and noted that the Okun coefficient has always been around 2 (by the way, with updated data still is; more on that on a latter post).

The inability to separate the cyclical and structural components of the relation is what causes the change in the short run coefficient (the Okun one). It is still true that as economies grow, productivity picks up, since producers try to adapt to increasing demand by utilizing more effective methods of production.

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...

Elise Gould on Why America’s Workers Need Faster Wage Growth

In the previous post, see here, Matias shared an EPI video on the need for significant wage growth to curb inequality, specifically starting with raising the minimum wage. As a follow up, below is from a briefing paper by EPI economist Elise Gould.

By Elise Gould

The last year has been a poor one for American workers’ wages. Comparing the first half of 2014 with the first half of 2013, real (inflation-adjusted) hourly wages fell for workers in nearly every decile—even for those with a bachelor’s or advanced degree. Of course, this is not a new story. Comparing the first half of 2014 with the first half of 2007 (the last period of reasonable labor market health before the Great Recession), hourly wages for the vast majority of American workers have been flat or falling. And even since 1979, the vast majority of American workers have seen their hourly wages stagnate or decline—even though decades of consistent gains in economy-wide productivity have provided ample room for wage growth. The poor performance of American workers’ wages in recent decades—particularly their failure to grow at anywhere near the pace of overall productivity—is the country’s central economic challenge. Indeed, it’s hard to think of a more important economic development in recent decades. It is at the root of the large rise in overall income inequality that has attracted so much attention in recent years. A range of other economic challenges—reducing poverty, increasing mobility, and spurring a more complete recovery from the Great Recession—also rely largely on boosting hourly wage growth for the vast majority.

Read rest here.

If you care about inequality, raise the minimum wage

From the Economic Policy Institute (EPI). Yes wages in general should grow, starting with the minimum wage. A no brainer.

Labor productivity comparisons

A simplified graph with the GDP per worker employed in 2013 (i.e. labor productivity) in US dollars converted to Purchasing Power Parity (PPP) is shown below.

Note that it is better than per capita income (which is more of a measure of living standards) as a measure of the economic potential of an economy, and that labor productivity avoids the pitfalls of Total Factor Productivity (TFP). The measure in PPP rather than market exchange rates distorts things a bit (but that is another issue). The graph with all the countries, and the link to the Conference Board data set here.

PS: Picture changes a little with productivity per hours worked, which is also available. For example, Norway would be slightly more productive if we used the labor productivity per hour measure.