Thursday, November 10, 2011

Gathering Clouds – Poverty, Banking, and Debt Limits « Real-World Economics Review Blog

Gathering Clouds – Poverty, Banking, and Debt Limits « Real-World Economics Review Blog

Peter Radford, over at the Real World Economics Review blog, encapsulates nicely my current criticism of Republicons:

"... we are fast approaching doomsday on the US budget negotiations. As you know there is a super secret and totally undemocratic committee studying ways to reduce the US federal budget. This committee consists of twelve members of Congress, six from each party. They have a target of $1.2 trillion in budget cuts to be spread over the next decade.  If they fail to come up with a program to reach that goal by November 23rd a series of automatic cuts come into play slashing away at the budget across the board.
The odds of an agreement coming from this group is close to zero. Although we hear constant rumblings of side deals and temporary fixes.
The problem – no prizes for guessing the answer on this – stems from Republican intransigence.
Oh what a shock.
The GOP has refused to countenance any tax increase as part of the deal. Not a single dollar of an increase. In their view the entire burden of reduction must come from spending. But not offense-defense spending. They are adamantly opposed to any cuts in our bloated offense defense budget. This presents them with a major quandary: the automatic cuts that will come into being if no agreement emerges from the secret committee includes a major cut in that hallowed offense defense budget. The idea of this draconian measure was to force the Republicans into being a tad more flexible over taxes.
So far it hasn’t worked.
Such is their attachment to low taxes for high income taxpayers that the GOP is actually contemplating allowing the automatic cuts to kick in. This is terrifying their own hawks. They imagine all sorts of terrible things happening if we cut so much as a dime from our offense defense budget. Imagine the fits that they are all throwing at the prospect of the 10% cut in offense defense spending in 2013 alone that the automatic cuts imply. Yes 10%. Followed by a further 10% over the next nine years. That’s a lot of plum jobs lost in a lot of Republican leaning Congressional districts.
Oh the dilemma.
In a sensible world – by which I mean one not infested with ideological sharks – the secret committee would be able to conjure up enough cuts mixed with tax increases to hit the target. We could allow the Bush tax increases to come into effect for the wealthiest taxpayers. We could impose a surcharge on higher incomes. There are all sorts of things we could do, most of which the voters tell pollsters they would accept, but which we cannot do because the Republicans have backed themselves, and thus all of us, into a corner.
So, at present anyway, this entire budget cutting effort, which was forced on us unnecessarily in the aftermath of the budget ceiling epic, looks as if it will fail.
America has rarely, if ever, sunk this low in its ability to mange itself."

Tuesday, November 8, 2011

Some Capital-Theoretic Fallacies of Austrian Economics:

Robert L. Vienneau
October 2007

This article demonstrates certain doctrines of the Austrian school of economics are untenable.

The focus is on certain aspects of capital theory undergirding Austrian Business Cycle theory.

Other criticisms of Austrian Business Cycle Theory from Cambridge-Italian economists are briefly surveyed.

This paper demonstrates an entrepreneur may simultaneously classify a capital good into several orders, as orders of goods are defined by Austrian economists. Hayekian triangles are defined. This paper demonstrates that the shape of a Hayekian triangle varies with the interest rate, even if real resources are not reallocated across stages of production. It is demonstrated, by means of an example, that no tendency need exist for entrepreneurs to respond to lower interest rates by reallocating resources from producing low order goods to producing higher order goods, or otherwise increasing the capital-intensity of the structure of production.

This paper poses a challenge to advocates of ABCT (Austrian Business Cycle Theory) – to either recant their advocacy or to retell their story with correct capital theory. In such theory, no presumption exists that entrepreneurs will systematically direct more resources to producing higher order goods and away from lower order goods when the interest rate is lower.
Whether the details of the ABCT can be reformulated to withstand capital-theoretic critiques remains to be demonstrated.

And a full library of criticism of the Austrian School of economic thought can be found at the Critiques of Libertariansim site.
The full article is here.

Some Capital-Theoretic Fallacies of Austrian Economics

Monday, October 31, 2011

BLS: The Productivity-Compensation Gap

This study of the productivity-compensation gap, published by the US Bureau of Labor Statistics, is a non-partisan examination of how workers - and thus the American middle class - have been getting fucked for years.

Read it and weep.

For those less inclined to do the intellectual heavy-lifting, here's a summary from the windyanabasis blog [full text here]:

Compensation was rising above productivity in the first half of the post-war era; after the Volcker intervention, productivity took off whereas compensation stagnated.  There is no plausible theory of wages being equal to the marginal revenue product of labor that can be consistent with this data. It was government policy that drove wages above productivity in the first period, and government policy drove them below productivity in the second period.
To put things into perspective, between 1980 and 2011, output per hour worked increased by a factor of 1.8, but median real earnings were unchanged (they actually declined somewhat) and median household income increased by a factor of 1.13.  The latter due to more women joining the labor force, bolstering total household income.
Consumer expectations of median income growth (taken from the University of Michigan surveys), census bureau measurements of median income growth, and BLS measurements of median wages all show the stagnation, even as real GDP continued to grow.
But if consumers were aware of this income stagnation, why did they continue to purchase output at the current prices?
First, women’s participation allowed total the income of the majority of households to increase somewhat, and second the majority was effectively selling portions of their assets to the top 1%. This was justified because they believed that their remaining assets were appreciating in value sufficiently to maintain their target wealth levels.
To be clear, we are talking about housing, as most households hold an insignificant portion of bonds or equities. As women’s participation began to level out in the early 1990s, mortgage equity withdrawals began to increase, peaking at around 9% of disposable household income. Consumer credit and auto credit also increased, but the dominant source of demand was equity withdrawal.
When the house bubble burst there was no additional source of demand left. In order to increase demand now, the government must either supply it via deficit spending, or real compensation needs to approximately double in order to restore the balance between pay and productivity.  The problem with only using deficit spending is that the underlying wage issues are not addressed — so there is no end to the deficit spending.
Without a class-based interpretation, you will be looking for what accident went wrong in 2008 that we can fix to get “back on track”. A sudden rush of regulatory uncertainty! A liquidity crisis! A shortage of safe bonds! But a class-based interpretation of this crisis is that we are at the end-game of a 30 year period of unsustainable wage deterioration, and the specific triggers of the financial crisis were not the underlying cause. The underlying cause was  a three decade period of market failure in which one imbalance was hidden by another and then another. If the former interpretation is correct, then the provisioning of liquidity or more safe bonds will allow employment to get back to normal. If the latter interpretation is correct, then these interventions wont work. Employment will continue to stagnate and output will continue to be constrained by the level of deficit spending stimulus.
Only a long period of grinding deflation, combined with nominal wage rigidity, or a short period of massive redistribution and substantially higher median wages will allow the economy to continue to grow at its historical rate. Note that we do not require a higher total wage bill, but higher median wages, and lower superstar wages.
We need a new grand bargain, but unfortunately we are not allowed to talk about this bargain, economists do not want to model class conflicts, and the politicians do not want to discuss 30 years of wage stagnation.
It is a silent labor day.
When you're done crying, stand up and join the fight to restore the American Dream.

[Hint: Electing turd-polishers from the right who prescribe ever greater doses of conservative ['neo-liberal' for you Europeans] economic policy, notwithstanding the fact that their foundational theories are both provably wrong on their own terms and demonstrably contrary to the vast preponderoance of empirical evidence, is NOT the solution.]

Saturday, October 29, 2011

RWER issue 57: Michael Hudson « Real-World Economics Review Blog

RWER issue 57: Michael Hudson « Real-World Economics Review Blog

Michael Hudson
Starting from David Ricardo in 1817, the historian of economic thought searches in vain through the theorizing of financial-sector spokesmen for an acknowledgement of how debt charges (1) add a non-production cost to prices, (2) deflate markets of purchasing power that otherwise would be spent on goods and services, (3) discourage capital investment and employment to supply these markets, and hence (4) put downward pressure on wages.

What needs to be explained is why government, academia, industry and labor have not taken the lead in analyzing these problems. Why have the corrosive dynamics of debt been all but ignored?

I suppose one would not expect the tobacco industry to promote studies of the unhealthy consequences of smoking, any more than the oil and automobile industries would encourage research into environmental pollution or the linkage between carbon dioxide emissions and global warming. So it should come as little surprise that the adverse effects of debt are sidestepped by advocates of the idea that financial institutions rather than government planners should manage society’s development. Claiming that good public planning and effective regulation of markets is impossible, monetarists have been silent with regard to how financial interests shape the economy to favor debt proliferation.

The problem is that governments throughout the world leave monetary policy to the Central Bank and Treasury, whose administrators are drawn from the ranks of bankers and money managers. Backed by the IMF with its doctrinaireChicagoSchooladvocacy of financial austerity, these planners oppose full-employment policies and rising living standards as being inflationary. The fear is that rising wages will increase prices, reducing the volume of labor and output that a given flow of debt service is able to command.

Inasmuch as monetary and credit policy is made by the central bank rather than by the Dept. of Labor, governments chose to squeeze out more debt service rather than to promote employment and direct investment. The public domain is sold off to pay bondholders, even as governments cut taxes that cause budget deficits financed by running up yet more debt. Most of this new debt is bought by the financial sector (including global institutions) with money from the tax cuts they receive from governments ever more beholden to them. As finance, real estate and other interest-paying sectors are un-taxed, the fiscal burden is shifted onto labor.

The more economically powerful theFIREsector (Finance, Insurance and Real Estate) becomes, the more it is able to translate this power into political influence. The most direct way has been for its members and industry lobbies to become major campaign contributors, especially in theUnited States, which dominates the IMF and World Bank to set the rules of globalization and debt proliferation in today’s world. Influence over the government bureaucracies provides a mantel of prestige in the world’s leading business schools, which are endowed largely byFIRE-sector institutions, as are the most influential policy think tanks. This academic lobbying steers students, corporate managers and policy makers to see the world from a financial vantage point.

Finance and banking courses are taught from the perspective of how to obtain interest and asset-price gains through credit creation or by using other peoples’ money, not how an economy may best steer savings and credit to achieve the best long-term development. Existing rules and practices are taken for granted as “givens” rather than asking whether economies benefit or suffer as a whole from a rising proportion of income being paid to carry the debt overhead (including mortgage debt for housing being bid up by the supply of such credit). It is not debated, for instance, whether it really is desirable to finance Social Security by holding back wages as forced savings, as opposed to the government monetizing its social-spending deficits by free credit creation.

The finance and real estate sectors have taken the lead in funding policy institutes to advocate tax laws and other public policies that benefit themselves. After an introductory rhetorical flourish about how these policies are in the public interest, most such policy studies turn to the theme of how to channel the economy’s resources into the hands of their own constituencies.

One would think that the perspective from which debt and credit creation are viewed would be determined not merely by the topic itself but whether one is a creditor or a debtor, an investor, government bureaucrat or economic planner writing from the vantage point of labor or industry. But despite the variety of interest groups affected by debt and financial structures, one point of view has emerged almost uniquely, as if it were objective technocratic expertise rather than the financial sector’s own self-interested spin. Increasingly, the discussion of finance and debt has been limited to monetarists with an anti-government ax to grind and vested interests to defend and indeed, promote with regard to financial deregulation.

This monetarist perspective has become more pronounced as industrial firms have been turned into essentially financial entities since the 1980s. Their objective is less and less to produce goods and services, except as a way to generate revenue that can be pledged as interest to obtain more credit from bankers and bond investors. These borrowings can be used to take over companies (“mergers and acquisitions”), or to defend against such raids by loading themselves down with debt (taking “poison pills”). Other firms indulge in “wealth creation” simply by buying back their own shares on the stock exchange rather than undertaking new direct investment, research or development. (IBMhas spent about $10 billion annually in recent years to support its stock price in this way.) As these kinds of financial maneuvering take precedence over industrial engineering, the idea of “wealth creation” has come to refer to raising the price of stocks and bonds that represent claims on wealth (“indirect investment”) rather than investment in capital spending, research and development to increase production.

Labor for its part no longer voices an independent perspective on such issues. Early reformers shared the impression that money and finance simply mirror economic activity rather than acting as an independent and autonomous force. Even Marx believed that the financial system was evolving in a way that reflected the needs of industrial capital formation.

Today’s popular press writes as if production and business conditions take the lead, not finance. It is as if stock and bond prices, and interest rates, reflect the economy rather than influencing it. There is no hint that financial interests may intrude into the “real” economy in ways that are systematically antithetical to nationwide prosperity. Yet it is well known that central bank officials claim that full employment and new investment may be inflationary and hence bad for the stock and bond markets. This policy is why governments raise interest rates to dampen the rise in employment and wages. This holds back the advance of living standards and markets for consumer goods, reducing new investment and putting downward pressure on wages and commodity prices. As tax revenue falls, government debt increases. Businesses and consumers also are driven more deeply into debt.

The antagonism between finance and labor is globalized as workers in debtor countries are paid in currencies whose exchange rate is chronically depressed. Debt service paid to global creditors and capital flight lead more local currency to be converted into creditor-nation currency. The terms of trade shift against debtor countries, throwing their labor into competition with that in the creditor nations.

If today’s economy were the first in history to be distorted by such strains, economists would have some excuse for not being prepared to analyze how the debt burden increases the cost of doing business and diverts income to pay interest to creditors. What is remarkable is how much more clearly the dynamics of debt were recognized some centuries ago, before financial special-interest lobbying gained momentum. Already in Adam Smith’s day it had become a common perception that public debts had to be funded by tax levies that increased labor’s living costs, impairing the economy’s competitive position by raising the price of doing business. The logical inference was that private-sector debt had a similar effect.

You may download the whole paper at:

The Barter Delusion

A lesson in why mainstream, free market fundamentalist economics, based on essentially non-dynamic equilibrium models that fundamentally misrepresent reality, are flawed from Prof. Steve Keen, Assoc. Prof. @ the University of Western Sydney:

The Barter Delusion

Joan Robinson once remarked that Milton Friedman was like a magician who put a rabbit into a hat in full view of the audience, and then expected applause when he pulled it out again.

There is no better instance of this than his influential admonition against analyzing the dynamics of the nominal money stock:
IT IS A COMMONPLACE of monetary theory that nothing is so unimportant as the quantity of
money expressed in terms of the nominal monetary unit— dollars, or pounds, or pesos. Let the
unit of account be changed from dollars to cents; that will multiply the quantity of money by 100,
but have no other effect. Similarly, let the number of dollars in existence be multiplied by 100;
that, too, will have no other essential effect,
goods and services, and quantities of other assets and liabilities that are expressed in nominal
terms) are also multiplied by 100
provided that all other nominal magnitudes (prices of. Friedman (1969, p. 1; emphasis added)
Indeed, if there were a planet on which all nominal magnitudes including debts were perfectly adjusted when inflation or deflation occurred, this statement—and the neutrality of money it supports—could be true. Since Earth is not such a planet, nominal monetary values can and do matter, because they are the link between financial commitments entered into in the past and our capacity to service them today.


And the major way in which nominal debts matter is that, when they generally reach a level beyond which they can be reliably serviced, they can ignite liquidity and solvency crises that lead to a retrenchment in debt. 

Households suddenly "buckle down" and tighten their belts in order to pay down debt, which would otherwise be used for consumption.

Firms, in response to reduced aggregate demand, borrow less to finance production, and lower payroll by laying off workers (which further impairs household's incomes, further reducing funds that otherwise be used for consumption).

Lenders tighten their credit standards, and reduce lending to both households and firms.

And since real economic activity is not just GDP growth, but GDP + the rate of change in debt [another lesson to be discussed in a later blog posting], then mainstream macro economics -- which only recognizes GDP -- generally understates the negative effects and impacts of a debt-deflation recession.

This is [part of] why Obama's stimulus of 2009 did not work as well as his advisers projected, and why this recovery remain jobless:  it was not sized to address the additional drag of shrinking private sector debt. 

Another reason is that the monetary stimulus from the Fed targeted to the wrong part of the private sector:  the funds would have been far more effective at mitigating debt-deflation impacts if it had been given to households and firms, rather than to banks (never mind the unfairness of bailing out the actors who arguably are most responsible for raising private debt to unsustainable levels).

But that's another, longer lesson.

Wednesday, October 26, 2011

Why ‘Occupy Wall Street’ Makes Sense: Lessons Economists Could Learn from the 99% | Steve Keen's Debtwatch

Why ‘Occupy Wall Street’ Makes Sense: Lessons Economists Could Learn from the 99% Steve Keen's Debtwatch

Joe McIvor, guest-blogging over at Steve Keen's DebtWatch, expresses my thoughts exactly (and with far fewer parentheses, brackets, curliqueues, hyphens and similar stream of consciousness tangents):


Why ‘Occupy Wall Street’ Makes Sense: Lessons Economists Could Learn from the 99%

by antifriedmanitejoe
on October 25th, 2011 at 10:54 pm
Posted In: Debtwatch

(guest blog) by Joe Mcivor

Back in May of this year, Austin Mackell wrote in The Guardian that the Arab Spring revolutions represented “a rebellion not just against local dictators, but against the global neoliberal programme they were implementing with such gusto in their countries”. He cited Egypt in particular as an example of a nation which had taken IMF loans and then promptly implemented their recommendations of substantial privatisation and cutting of services, with the usual disastrous results for the well-being of the population. He went on to write that people in the West had so far “failed to see the people of the region as natural allies in a common struggle”.

Some six weeks ago, thousands of people in New York began to try to correct this oversight. Drawing explicit inspiration from the Arab Spring, a Canadian activist group called Adbusters (self-described ‘culture jammers’ involved in exposing corporate wrongdoing and highlighting the problems of consumerism and advertising) called on people in New York to Occupy Wall Street, in an attempt to highlight what they see as the destructive excesses of a financial sector not only out of control but propped up by governments who frequently grant them disproportionate privileges.

The ‘Occupation’ (which didn’t last long on actual Wall Street but remains in surrounding areas) drew thousands of protesters using the slogan ‘We Are the 99%’, highlighting the increasing proportion of wealth going to a small proportion of the population. The ‘Occupy’ brand has now spread throughout the world, with the now even more invigorated European austerity protests expressing solidarity with their American counterparts. Even in Australia, so far mostly unscathed by the ravages of the Global Financial Crisis (though this is likely to soon change), but nonetheless suffering from overpriced housing, unprecedented household debt levels and increasingly insecure employment prospects, protests using the Occupy brand are occurring (and Steve [Keen, Associate Professor of Economics & Finance at the University of Western Sydney] was naturally asked to speak at one such protest in Sydney).

The ‘common struggle’, it would seem, has begun.

The purpose of this guest blog entry won’t be to detail the exploits of the protesters since this all began – for this you can check out for their excellent coverage. Nor will this blog be as rigorous in discussing theory as Steve’s blogs often have been: there won’t be a detailed discussion of endogenous money, or Minsky’s ‘financial instability hypothesis’ [1]. However, in considering the sentiments expressed by the protest movement it occurred to me how often people uneducated in economic theory of any kind, when confronted with the reality of an economic problem, instinctively, intuitively understand the problem and its causes more or less correctly; while economists, who purport to specialise in the area of economic problems (and, it must be said, seem to go out of their way to be counterintuitive), get it fundamentally wrong. Below, I outline why, in a number of areas, economists could learn from the intuitive wisdom of the 99%.

Lesson #1. Unbridled Greed isn’t Good.
The ‘greed is good’ (ie ‘the invisible hand’) idea – that unregulated markets would maximise societal benefit by the heedless pursuit by individuals and corporations of their own self-interests, while government should restrict both its regulatory and fiscal role in the economy as much as possible – should have died out in the wake of the Great Depression. Unfortunately for most of us, Milton Friedman then came along with an explanation for the depression more palatable to the neoclassical mindset than what had come previously. Along with Anna Schwartz, he argued that the Great Depression wasn’t caused by unbridled greed and speculation: it was caused by the Federal Reserve (essentially) not printing enough money and giving it to Wall Street. Yes, really. If the Fed had printed more money and given it to Wall Street, they argued, this would have restored banking confidence and Wall Street would have resumed lending and prevented the worst of the depression – greed would have saved the day [2]. Unbridled greed was now off the hook for what was seen as the worst economic crisis in capitalism’s history.

When the highly sanitised and compromised version of Keynesian theory, which neoclassical economists had initially come to accept as a way of coming to grips with the Depression (without the revolution in economic thinking which Keynesian theory actuallly implied) [3], ultimately couldn’t explain stagflation, this allowed Friedman to step in and successfully argue (despite an absence of any actual evidence) that stagflation was caused by excessive government spending funded by new fiat money creation. Friedman emerged as the new economic messiah, and a new consensus (which was a lot like the old consensus from before the depression) emerged in economics. This consensus had a number of central tenets:

1 - Greed is good and must be left unhindered by regulation which distorts the beneficial effects of greed.

2 - The central bank can and should control inflation (or prevent deflation as the case may be) by means of fiat control of the money supply, and focus on nothing else. The system is basically stable and as long as the central bank does its job little or no harm should come to the economy as a whole.

3 - Fiat money creation to provide liquidity to the financial sector is good and productive; while fiat money creation to pay for fiscal spending on things like social security, health care, education etc is bad, unproductive and causes unnecessary inflation.

4 - Related to 3, government should be frugal, privatise more of its functions, and cut services generally. Private enterprise, because it is driven by greed, is always better at meeting people’s needs than government, which is woefully inefficient. The government should also cut taxes, especially on the rich, who by their greedy actions are the drivers of economic prosperity for everyone.

5 - Government debt is a sign of poor economic management. Private enterprise and individuals on the other hand must spend, spend, spend and private debt is either unimportant or a sign of progress.

6- Inequality doesn’t matter. The rich may get proportionally richer, but their pursuit of wealth lifts everyone up with them.

These theories have become more or less the state of the art in economic thinking, and have been adopted to varying degrees as policy throughout much of the world – most famously in the U.S. under Reagan and the UK under Thatcher. Even before the GFC, though, the results for the majority of citizens were less than stellar. Strangely enough, the beginnings of the implementation of some of Friedman’s theories in the 1980s resulted immediately in what was then the deepest recession since the Great Depression in terms of unemployment in the U.S., but the agenda was pressed forward with the contention that in the long term things would be better. Even before the GFC, the decades since in the U.S. saw stagnant real wages [4], a declining real value of the minimum wage, reduced access to health care (and a higher cost for those with access), increasingly precarious employment, a decimated manufacturing sector, and skyrocketing levels of private debt. The gains in GDP were not shared – did not ‘trickle down’ – but were wholly appropriated by a small minority of the highly paid. Economists, meanwhile, were claiming victory over the problem of economics and economic stability, and spoke of the ‘great moderation’.

Many of this minority of the highly paid were in the financial sector, which engaged in increasingly risky credit behaviour in order to reap higher profits, confident in the knowledge that the Fed would bail them out if they got into trouble. Now, as has been discussed many times on this blog, the debt-driven speculative excesses of the financial sector have resulted in the worst economic calamity since the Great Depression. Their interest in profiting from the proliferation of credit, and their increasing reliance on debt-financed asset price speculation rather than investment in genuinely productive enterprise, inevitably (as Steve Keen predicted) caused a system wide collapse. So many people got into so much debt that they couldn’t afford to service (much less repay) that it reached a saturation point, asset prices stopped increasing, and a process of deleveraging began as people stopped borrowing or even tried to pay down debt. An economy dependent upon expanding debt – as Steve has shown at least the U.S. and Australia to have become – ultimately can’t survive a deleveraging process unscathed (though the deleveraging process hasn’t yet begun in earnest in the latter country). As money is spent on paying down debt, or even if people simply don’t continue to borrow ever more, there isn’t enough money being spent on actual goods and services to keep the economy afloat. In the U.S., official unemployment (U3) has been hovering in the 9-10 percent range since 2009 or so, with the more inclusive (and comparable to Depression-era figures) U6 measure roughly in the 16-17% range for the same period, and this has occurred in spite of Bernanke’s adoption of the Friedman solution through unprecedented base money expansion and bailouts of the Wall Street firms who helped precipitate the crisis. Meanwhile, executives of firms which took massive government hand-outs after helping to precipitate the crisis are still taking bonuses for their trouble.

According to economic theory, none of this should be happening because the system is basically stable, the financial sector are more or less omniscient drivers of economic progress, private debt doesn’t matter, and the central bank can prevent economic meltdown with helicopter drops of money. Some economists are probably still burying their heads in the sand and saying it’s NOT happening. On the other hand, the 99% are all too aware of what is happening, and have a pretty good sense of why. While perhaps not fully understanding Minsky’s ‘Financial Instability Hypothesis’ or Steve Keen’s formal modeling of it, they do at least understand that too much private debt is a bad thing, and that the system is simply not inherently stable. They also understand that unbridled greed is really only good for the greedy.

Lesson # 2. The Problem is not the Solution
There now at least seems to be some understanding among policymakers that Wall Street’s excesses played an important role in creating the crisis (though Big Government is still partly being made a scapegoat). It seems strange, then (and, once again, counterintuitive), that the principal means by which policymakers in the U.S. propose to get out of the crisis is by trying to ‘get banks lending again’. The solution is essentially more Wall Street, more private debt.

Of course, it must be acknowledged that this has ‘worked’ – or at least appeared to work – a number of times in the past. Starting with the 1987 crisis, Alan Greenspan (himself a staunch Friedmanite) responded to successive crises with cheaper money and bailouts for the financial sector. At least partly, it ‘worked’: lending was restarted, and, though frequent, the economic crises during his reign seemed relatively mild.

Never mind that some of the engineered recoveries were ‘jobless’: Greenspan was hailed as a hero. His successor Ben Bernanke, again an avowed Friedmanite, believed that this policy would continue to avert major crises indefinitely.

Even in the wake of the crisis, the Obama administration has been convinced by economists that each dollar spent on monetary stimulus for the financial sector will result in many times that in lending for private consumption and investment through the magic of the multiplier effect in the fractional reserve system.

There are two problems with this. One is that it has probably reached a point (at least in the U.S.) where it simply won’t work any more. The premise is that if you expand base money you’ll get many times that amount in extra lending – the Fed’s control of fiat money gives it effective control of the broad money supply because the ratio between the monetary base and the money supply is assumed to be relatively stable. Unfortunately this ignores the fact that the extra (private) lending which is supposed to make up the bulk of that monetary stimulus is dependent upon the decisions of lenders to lend and borrowers to borrow (the money supply endogeneity Steve so often emphasises).

These decisions are dependent on a range of factors, of which the availability and cost of fiat money from the central bank is but one. In the past, cheap money was enough to get lending happening again. But with debt levels having reached such a high saturation point, and with economic expectations uncertain at best, making money cheap for the banks and expanding the monetary base (the Friedman/Greenspan/Bernanke solution) simply won’t be enough to restart lending: people don’t want to borrow and banks don’t want to lend. Bernanke’s ‘helicopter drop’ of money is effectively sitting in bank vaults doing very little for the economy. In the decades leading up to the crisis , excess bank reserves represented a fraction of a percent of the money supply (M2). They now account for around 16% [5].

The second problem is that restarting lending doesn’t actually fix the problem: it just defers the consequences while simultaneously facilitating the exacerbation of the core cause ( too much private debt). In fact, it amounts to trying to solve a problem of excessive debt by encouraging even more debt. This is what has happened in this case: Greenspan’s recoveries facilitated an accelerated rate of growth for the debt to gdp ratio and the continued creation of a debt super-bubble which only now appears finally to be deflating – as Steve pointed out in “Bailing Out the Titanic with a Thimble”, “each apparent recovery after a debt-induced crisis was really a re-ignition of the fundamentally Ponzi lending that had caused the preceding crisis” (p. 9). What must be made absolutely clear is that the worst possible outcome for the global economy is the successful facilitation of another recovery driven by restarting expansionary lending. If one thinks of how much worse this crisis has been than that in the wake of the bursting of the ‘dotcom bubble’ in the early 2000s, one should imagine that the next crisis will be worse by a similar order of magnitude, with an even higher mountain of private debt still to climb. The proportion of debt in the economy simply can’t expand indefinitely.

Most of the 99% probably don’t fully understand endogenous money or the full implications of an economy dependent on private debt expansion. But they do have an understanding that bailing out Wall Street hasn’t solved the problem and probably never will. They do understand that people can’t just keep burying themselves in ever increasing amounts of debt, and they do have an understanding that Wall Street got them into this crisis and probably isn’t the means of getting out of it. And in this, they are ahead of the bulk of the economics profession.

Lesson # 3. Bail out the people, not the banks.
There was a period in the initial wake of the economic crisis where it looked as though Keynes would make a recovery in economic orthodoxy, and the term ‘stimulus package’ became part of everyday vernacular.

Given the failure of Bernanke’s pledge to get banks lending with monetary stimulus, it seems likely that the fiscal stimulus in the U.S., despite imperfections (and being far from as ambitious as it should have been), has had the greatest effect in slowing the progress of the crisis thus far (given that the level of private debt to gdp at the beginning of the recession was much higher than at the beginning of the Great Depression). Unfortunately, going back to my point about the alleged virtue of money creation for Wall Street and the sin of doing so to finance fiscal spending, Keynesian stimulus has now largely been abandoned throughout much of the world in favour of ‘austerity’ and deficit reduction. The idea that the magic of the free market will suddenly spring to life once Big Government gets out of the way has again pervaded the consciousness of policymakers.

Imposing austerity in an austere economic environment, and cutting government spending when private demand is retreating, will only serve to worsen the depth of the crisis. The European austerity programs have so far been all pain and no gain: job losses, pay cuts and reductions in services; all for zero improvement in the ability of governments to balance their budgets. No one has been made better off by their implementation: not the EU creditors who imposed them, and certainly not the people of the countries which have adopted them. Not that this will stop the economists from pressing forward: it’s rare for them to let a few facts get in the way of what they see as good theory.

This is not to say that fiscal stimulus will get the world all the way out of the crisis. As Steve has pointed out a number of times before, the private debt hole is too big, and the deleveraging necessary for a sustainable recovery will ultimately overwhelm what the government is able to do. Unfortunately, the most effective solution to the debt problem is also in many ways politically least viable (though I dare say that this is reflective more of the disconnect between the governments of representative democracies and their constituents than the genuine will of the people). It involves not a bailout of the banks paid for by tax payers, but an effective bail out of consumers funded by banks, who would naturally suffer profusely in the process. As Steve has proposed, a government mandated partial debt jubilee – involving both interest rate renegotiation and outright debt forgiveness – is the only way to turn back the clock on the level of indebtedness without feeling the full brunt of a decline in demand caused by massive deleveraging. In his address to the Occupy Sydney rally (see the October 23 blog entry for youtube video), he made the point that “dishonourable debt should not be honoured”. Many financial organisations may go into receivership or have to be nationalised, but the debt burden which oppresses so many people would be substantially reduced, increasingly their ability to spend their hard earned money on goods and services rather than servicing or paying down debt.

The 99%’s objections to the idea of bailing out Wall Street on the one hand, while cutting spending on the poor and allowing struggling individuals to go bankrupt and lose their houses on the other, are probably for the most part based more on a sense of fairness, and the knowledge that these things aren’t good for them, than on any sense that they know of alternatives which will be more beneficial for ‘the economy’. However, in their objections alone they have for the most part shown an understanding of the nature of the problem which exceeds that of the economic experts who wish to impose such measures.

If you aren’t an economist, you may know more about economics than you think…

Economists have gone out of their way to convince people that economics is counterintuitive and best left to the experts. Greed is good, inequality doesn’t matter. We HAVE to bail out Wall Street to save the economy; we HAVE to cut services to save the economy. What the 99% show is that very often, intuition and awareness of the economic reality on the ground gives a much better understanding of economics than an education in economics. Perhaps if such concerns as they have raised had been heeded earlier, rather than been shouted down by the ‘experts’, the world would not be in the mess it’s currently in.

[1] For further discussion of these concepts, start with blog posts like Time to Read Some Minsky, The Roving Cavaliers of Credit, and Bailing Out the Titanic with a Thimble, as well as the various lectures on behavioural finance. Steve’s “Debunking Economics” and Minsky’s “Stabilizing an Unstable Economy” are also obviously worth looking at.

[2] See Friedman and Schwartz, “Monetary History of the United States 1867-1960”.

[3] See Steve’s ‘Debunking Economics’ for further explanation of how conventional economists got Keynes wrong. Minsky’s ‘John Maynard Keynes’ also discusses this in some detail. See both also for a better analysis of stagflation.

[4] Median real household incomes grew, but this is only due to increased incomes for women, presumably from greater access to and participation in the paid workforce: median real incomes for males remained stagnant as for wages. See ‘Economic Report of the President’ for real wage data for nonsupervisory workers and U.S. Census Bureau Table P-5 for historical real income data.
[5] See Economic Report of the President and the H3 and H6 statistical releases by the Federal Reserve.

Simply brilliant.

More people need to read and learn this. Pass it on.

Monday, October 17, 2011

Progressive and Regressive Taxation in the United States: Who’s Really Paying (and Not Paying) their Fair Share?

A long-standing political debate in the United States has focused attention on the fairness of taxes. While conservatives, Republicons, free market fundamentalists & Tea Party types claim their tax-cutting reforms make taxes fairer, critics counter that the majority of the tax cuts accrue to the

Conservatives like to portray proposals to raise marginal tax rates on the upper end of the income scale as an effort to "soak the rich".  They cite cherry-picked statistics:  most often, e.g., findings from the non-partisan Tax Policy Center -or-  Congress’ Joint Committee on Taxation that 47% ~ 51% of households did not owe any net personal income taxes in 2009.  Then they use such 'evidence' out of context to convince low-information voters to support regressive tax policies -- e.g., "Flat Tax" & "Fair Tax" proposals, extensions of the Bush tax cuts on the top 2%, proposed cuts to the Earned Income Tax Credit, or Herman Cain's 9-9-9 tax plan -- even when such policies are empirically at odds with such voters rational self-interest. 

Let's purge some of the miasma on the issue... Brian Roach, in this seminal analysis from Tufts University's Global Development & Environment Institute, perhaps sums the issue up best by saying:
While the fairness of the federal income tax is an important issue, little attention has been paid to a more important issue: the fairness of the entire U.S. tax system. The federal income tax is one of the most progressive elements of the U.S. tax system; other taxes are regressive including sales and social insurance taxes. Analysis of any particular tax reform proposal is incomplete without consideration of its impact on the overall distribution of taxes. 
[Brian Roach, Global Development and Environment Institute Working Paper No. 03-10, 2003;  see here.]

The paper goes on to conclude:

The current trend towards a less progressive federal income tax and more regressive state taxes suggests that in the foreseeable future the United States could have a tax system that is regressive overall.

This illustrates that distributional analysis of tax proposals needs to be assessed in light of the entire tax system if inequitable policies are to be avoided. In particular, claims that we are “soaking the rich,” supported with data on federal income taxesare clearly misleading. One could make a comparable claim that we are “soaking the poor” with reference to state sales taxes or federal social insurance taxes. What constitutes a fair overall tax system can not be settled by objective analysis. However, the basis for an honest debate on tax issues must be an accurate and complete perspective on the entire U.S. tax system.
And things have not changed much since Roach's 2003 study.  For instance, see the Center on Budget & Policy Priorities' updated tax fairness analysis entitled "Misconceptions and Realities About Who Pays Taxes" (May 31, 2011; see full report .pdf here), which is summarized below:

A recent finding by Congress’ Joint Committee on Taxation that 51 percent of households owed no federal income tax in 2009 is being used to advance the argument that low- and moderate-income families do not pay sufficient taxes. Apart from the fact that most of those who make this argument also call for maintaining or increasing all of the tax cuts of recent years for people at the top of the income scale, the 51 percent figure, its significance, and its policy implications are widely misunderstood.
  • The 51 percent figure is an anomaly that reflects the unique circumstances of 2009, when the recession greatly swelled the number of Americans with low incomes and when temporary tax cuts created by the 2009 Recovery Act — including the “Making Work Pay” tax credit and an exclusion from tax of the first $2,400 in unemployment benefits — were in effect. Together, these developments removed millions of Americans from the federal income tax rolls. Both of these temporary tax measures have since expired.

    In a more typical year, 35 percent to 40 percent of households owe no federal income tax. In 2007, the figure was 37.9 percent.

  • The 51 percent figure covers only the federal income tax and ignores the substantial amounts of other federal taxes — especially the payroll tax — that many of these households pay . As a result, it greatly overstates the share of households that do not pay any federal taxes. Data from the Urban Institute-Brookings Tax Policy Center show only about 14 percent of households paid neither federal income tax nor payroll tax in 2009, despite the high unemployment and temporary tax cuts that marked that year.

  • This percentage would be even lower if federal excise taxes on gasoline and other items were taken into account.

  • Most of the people who pay neither federal income tax nor payroll taxes are low-income people who are elderly, unable to work due to a serious disability, or students, most of whom subsequently become taxpayers. (In a year like 2009, this group also includes a significant number of people who have been unemployed the entire year and cannot find work.)

  • Moreover, low-income households as a whole do, in fact, pay federal taxes. Congressional Budget Office data show that the poorest fifth of households as a group paid an average of 4 percent of their incomes in federal taxes in 2007 (the latest year for which these data are available), not an insignificant amount given how modest these households’ incomes are — the poorest fifth of households had average income of $18,400 in 2007. The next-to-the bottom fifth — those with incomes between $20,500 and $34,300 in 2007 — paid an average of 10 percent of their incomes in federal taxes.

  • Even these figures understate low-income households’ total tax burden, because these households also pay substantial state and local taxes. Data from the Institute on Taxation and Economic Policy show that the poorest fifth of households paid a stunning 12.3 percent of their incomes in state and local taxes in 2010.

  • When all federal, state, and local taxes are taken into account,the bottom fifth of households paid 16.3 percent of their incomes in taxes, on average, in 2010. The second-poorest fifth paid 20.7 percent.
It also is important to consider who the people are who don’t owe federal income tax in a given year.
  • Some 70 percent of people who owe no federal income tax in a given year are low-income working households. These people do pay payroll taxes, as well as federal excise taxes (and, as noted, state and local taxes). Most of these working households also pay federal income tax in other years, when their incomes are higher — which can be seen by looking at the low-income working households that receive the Earned Income Tax Credit (see next bullet).

  • The majority of EITC recipients receive the credit for only one or two years at a time, such as when their incomes drop due to a temporary layoff; they pay federal income tax in other years. In fact, EITC recipients pay much more in federal income taxes over time than they receive in EITC benefits. A leading study of this issue found that taxpayers who claimed the EITC at least once during an 18-year period paid a net $473 billion in federal income tax over that period (in 2006 dollars). This finding shows that — while in any single year some taxpayers will receive refundable tax credits whose value may exceed their payroll tax liability — EITC recipients as a group pay significant federal income taxes over time in addition to the payroll and state and local taxes they pay each year.

  • The fact that most people who do not pay federal income tax in a given year do pay substantial amounts of other taxes, and also are net federal income taxpayers over time, belies the claim that households that don’t owe income tax will form bad policy judgments because they ostensibly “don’t have any skin in the game.”

  • The federal tax system is progressive overall, but state and local tax systems are regressive and undo a significant share of that progressivity. There is nothing wrong with having one part of the overall tax system shield low- and moderate-income households, who pay substantial amounts of other taxes and who generally pay federal income tax as well in other years.
To significantly increase the share of households that owe federal income tax, policymakers would have to take such steps as lowering the personal exemption or standard deduction — which would tax many low-income working families into, or deeper into, poverty; weakening the EITC or Child Tax Credit, which would significantly increase child poverty while reducing incentives for work over welfare; or paring back the tax exclusion for Social Security benefits, which would subject more seniors with small, fixed incomes to the income tax.
This analysis now explores these issues in more detail.

Oft-Cited 51 Percent Figure Is Temporary Spike Caused by Recession

In a typical year, roughly 35-40 percent of households have no net federal income liability; in 2007, the figure was 37.9 percent. In 2009, however, two factors combined to cause a large, temporary spike in the share of Americans with no net federal income tax liability — the recession, which reduced many people’s incomes, and several temporary tax cuts that have now expired. The 51 percent figure reflects these temporary factors.
  • Recession-induced decline in incomes. In 2009, unemployment was at its highest level in decades and rising sharply, and incomes were falling. Income tax liabilities are designed to adjust to these cyclical factors, rising when the economy is strong and falling when it is weak; this automatic adjustment helps to stabilize the economy by cushioning the drop in people’s after-tax incomes — and thus their spending — during a downturn. One consequence of the economic downturn was a sharp decline in both federal and state tax receipts, as millions of workers lost their jobs or had their work hours reduced. For many Americans, the loss of income meant that while they owed federal income taxes in 2008, they did not in 2009.

  • Temporary tax cuts. Policymakers responded to the deep economic contraction by enacting policies to stimulate consumer demand, including targeted public investments and temporary tax cuts that removed millions more Americans from the tax rolls. Roughly 95 percent of working families benefited from the Recovery Act’s Making Work Pay tax credit, which reduced their federal income tax liability by $400 for individuals and $800 for married couples. For some of these people, the tax credit eliminated their federal tax liability. Other temporary income tax cuts, including the exclusion of the first $2,400 in unemployment insurance benefits and a first-time homebuyer tax credit, eliminated federal income tax liability for additional taxpayers.
In other words, the federal income tax system did what it is supposed to do during the recession — take a smaller bite out of people’s incomes. As the temporary tax cuts expire and the economy and incomes strengthen, people’s tax liabilities will rebound (see Figure 1).

Lower-Income People Pay Considerable Payroll, State, and Local Taxes

The notion that “half of Americans don’t pay taxes” not only overstates the share of households that do not pay federal income taxes in a typical year. It also ignores the other taxes people pay, including federal payroll taxes and state and local taxes.
Policymakers, pundits, and others often overlook this point. At a hearing last month, Senator Charles Grassley said, “According to the Joint Committee on Taxation, 49 percent of households are paying 100 percent of taxes coming in to the federal government.” At the same hearing, Cato Institute Senior Fellow Alan Reynolds asserted, “Poor people don’t pay taxes in this country.” Last April, referring to a Tax Policy Center estimate of households with no federal income tax liability in 2009, Fox Business host Stuart Varney said on Fox and Friends, “Yes, 47 percent of households pay not a single dime in taxes.” None of these assertions are correct. As the Tax Policy Center’s Howard Gleckman noted regarding TPC’s estimate that 47 percent of Americans owed no federal income tax in 2009, “rarely has a bit of data been so misunderstood, or so misused.” Gleckman wrote:
Let me explain — repeat actually — what [the 47 percent figure] means: About half of taxpayers paid no federal income tax last year. It does not mean they paid no tax at all. Many shelled out Social Security and Medicare payroll taxes. In fact, only 14 percent of Americans didn’t pay either income or payroll taxes. Some paid property taxes and, it is fair to say, just about all of them paid sales taxes of one kind or another. So to say they pay no taxes is flat wrong.
The reality is that the income tax is one of a number of types of taxes that individuals pay, both over the course of their lifetimes and in a given year, and it makes little sense to treat it as though it were the only one that matters. Some 86 percent of working households pay more in payroll taxes than in federal income taxes. In fact, low- and moderate-income people pay a much larger share of their incomes in federal payroll taxes than high-income people do: taxpayers in the bottom 20 percent of the income scale paid an average of 8.8 percent of their incomes in payroll taxes in 2007, compared to just 1.6 percent for taxpayers in the top 1 percent of the income distribution (see Figure 2).
In addition, Congressional Budget Office data show that lower-income households pay a significantly larger share of their incomes in federal excise taxes (levied on goods such as gasoline) than middle- and upper-income households do.
When all federal taxes are considered, it is clear that the overwhelming majority of Americans pay such taxes. The poorest fifth of households paid an average of 4 percent of their incomes in federal taxes despite their low incomes in 2007, while the next fifth paid an average of 10 percent of income in federal taxes.
Low-income families also pay substantial state and local taxes. Most state and local taxes are regressive, meaning that low-income families pay a larger share of their incomes in these taxes than wealthier households do. The bottom fifth of taxpayers paid 12.3 percent of their incomes in state and local taxes in 2010, according to the Institute on Taxation and Economic Policy (ITEP) model. That was well above the 7.9 percent average rate that the top 1 percent of households paid (see Figure 3).
Considering all taxes — federal, state, and local — the bottom 20 percent of households paid an average of just over 16 percent of their incomes in taxes (12.3 percent in state and local taxes plus 3.9 percent in federal taxes) in 2009. The next 20 percent paid about 21 percent of income in taxes, on average. In fact, when all taxes are considered, the share of taxes that each fifth of households pays is similar to its share of the nation’s total income. The tax system as a whole is only mildly progressive.
Policy Options to Force People with Low Incomes to Pay Federal Income Tax Are Unsound
Some have implied or suggested that people who do not owe federal income tax are “freeloaders” who don’t have a “stake in the system” and that making them pay federal income taxes would improve the tax code. Yet the vast majority of the people who owe no federal income taxes fall into one of three categories (see Figure 4):

  • Approximately 70 percent are working people who pay payroll taxes. As noted above, even the low-income households in this group pay substantial federal income taxes over time. The main options to force these people to pay federal income tax in years when their incomes are low include cutting the EITC or the Child Tax Credit, which would tend to reduce work incentives and increase child poverty and welfare use, and lowering the standard deduction or personal exemption, which could tax many low-income working families into, or deeper into, poverty.

  • An additional 17 percent of people who did not pay federal income taxes in 2009 are people aged 65 or older. The main option to make these individuals pay federal income tax would be to subject their Social Security benefits to taxation.

  • The remaining 13 percent consists largely of students, people with disabilities, the long-term unemployed, and others with very low taxable incomes. To make these people pay federal income taxes, policymakers would have to tax disability, veterans’, and similar benefits or make full-time students and the long-term jobless individuals borrow (or draw from any available savings) to pay taxes on their meager incomes.
In short, the kinds of policy changes that would impose federal income taxes on these groups of people would make the overall tax system less fair and less sensible, not more so. An examination of the EITC illustrates this point, as the next section explains.

Corporations and Small Business Owners Also Pay No Income Tax During Bad Years

As this report notes, in addition to paying other taxes each year (many of which involve significant tax burdens), most people who do not pay federal income tax in a given year do pay that tax over time. For example, more than half of the tax filers who received the EITC between 1989 and 2006 received the credit for no more than a year or two at a time and generally paid substantial amounts of federal income tax in other years.* In fact, the taxpayers who claimed the EITC during this 18-year period paid $473 billion in net federal income tax over that period (in 2006 dollars) even after taking the EITC payments they received into account.

The tax-paying record of both large corporations and small businesses follows an analogous pattern — in some years no taxes are paid, while in other years substantial taxes are paid. During the years when they have net operating losses, companies that are subject to the corporate income tax generally have no tax liability.

A GAO study found that in every year from 1998 to 2005, approximately 55 percent of large corporations paid no corporate income tax. ** But just 2.7 percent of large corporations reported no net tax liability in all eight of those eight years. This reflects a similar pattern as applies to families and individuals — those who do not pay income tax in a given year often do pay income tax over time.

This pattern also applies to small business owners and others who deduct business losses from their taxable incomes and thereby eliminate their income tax liability in some years.

* Tim Dowd and John B. Horowitz, “Income Mobility and the Earned Income Tax Credit: Short-Term Safety Net or Long-Term Income Support,” Public Finance Review (forthcoming).
** Large corporations are those with at least $250 million in assets or $50 million in gross receipts. Government Accountability Office, “Comparison of the Reported Tax Liabilities of Foreign- and U.S.-Controlled Corporations, 1998-2005,” July 2008,

Cutting the EITC Would Discourage Work and Increase Poverty

From its roots as an idea from conservative economist Milton Friedman several decades ago, the EITC has become an increasingly important tool to make work pay more than welfare and enough to lift people working full time at the minimum wage out of poverty. Research has demonstrated the EITC’s effectiveness. Nobel laureate (and noted conservative economist) Gary S. Becker has written, “Empirical studies confirm . . . that the EITC increases the labor force participation and employment of people with low wages because they need to work in order to receive this credit.” (Becker also has applauded the EITC for being “fully available to families with both parents present, even where only one works and the other cares for their children [i.e., for being available to low-income working families with stay-at-home mothers].”)
Studies of the EITC expansions of the 1980s and 1990s found those expansions induced more than half a million people to enter the labor force. One prominent study identified the EITC as “a particularly important contributor to both the recent decrease in welfare use and the recent increase in employment, labor supply, and earnings” among female-headed families. The creation of the refundable component of the Child Tax Credit, which like the EITC is available only to families that work, has complemented the EITC’s pro-work efforts. Moreover, the EITC and the refundable Child Tax Credit together lifted 7.2 million people out of poverty in 2009, including 4 million children. These refundable credits lift more children out of poverty than any other program or category of programs at any level of government.
Several factors reinforce the importance of these credits in promoting and rewarding low-wage work. In recent decades, incomes in the United States have grown increasingly unequal, with the lion’s share of the economic gains from globalization, advances in technology, and the like accruing to those on the upper rungs of the income ladder. CBO data show that the average income among people in the lowest income fifth was $17,700 in 2007; if all incomes had grown at the same rate since 1979, that figure would have been $6,000 higher. Our economy benefits from globalization and technological change, but there are winners and losers. The refundable tax credits help to offset a portion of the effects of the stagnation of wages at the bottom of the income spectrum.
In addition, the weak labor market is likely to continue exerting downward pressure on wages over the next several years. The unemployment rate remains stubbornly high, at 9 percent in April 2011. CBO projects that it will not drop to under 6 percent until 2015. Taking note of the current bleak employment picture facing out-of-work men, columnist David Brooks recently wrote that “wage subsidies” should be on the list of future policy responses. The EITC is a much-needed wage subsidy for low-income workers (although the EITC for poor workers without children remains very small and could be strengthened).
Finally, over the past several decades, policymakers have essentially relied more on the EITC to supplement low wages and less on the minimum wage, which they have allowed to decline by 19 percent in purchasing power since 1970 (i.e., the minimum wage has fallen by 19 percent in inflation-adjusted dollars).
For all of these reasons, scaling back the EITC in order to require more low-income working households to pay federal income taxes would be a significant step backward, discouraging work and increasing poverty.

Friday, October 14, 2011

Milton Friedman’s Magical Thinking - Dani Rodrik - Project Syndicate

Milton Friedman’s Magical Thinking - Dani Rodrik - Project Syndicate

Again, the theme seems to return to the Delphic Optimalist concept of BALANCE...

The pendulum has swung too far to the right towards the lunatic fringe of laissez-faire free market fundamentalism over the last 30 years, and we all have been paying for it since the Great Contraction commenced -- except for, of course, the Top 1%, who have been doing not just fine [thank you very much], but exceptionally well. The pendulum needs to begin swinging the other way - and soon, lest the delicate clockwork of our democracy and capitalist institutions become utterly broken beyond repair.

Rodrick's latest contribution to Delphic Optimalist BALANCE in a thumbnail:

... But Friedman also produced a less felicitous legacy. In his zeal to promote the power of markets, he drew too sharp a distinction between the market and the state. In effect, he presented government as the enemy of the market. He therefore blinded us to the evident reality that all successful economies are, in fact, mixed. Unfortunately, the world economy is still contending with that blindness in the aftermath of a financial crisis that resulted, in no small part, from letting financial markets run too free.
The Friedmanite perspective greatly underestimates the institutional prerequisites of markets. Let the government simply enforce property rights and contracts, and – presto! – markets can work their magic. In fact, the kind of markets that modern economies need are not self-creating, self-regulating, self-stabilizing, or self-legitimizing. Governments must invest in transport and communication networks; counteract asymmetric information, externalities, and unequal bargaining power; moderate financial panics and recessions; and respond to popular demands for safety nets and social insurance.
Markets are the essence of a market economy in the same sense that lemons are the essence of lemonade. Pure lemon juice is barely drinkable. To make good lemonade, you need to mix it with water and sugar. Of course, if you put too much water in the mix, you ruin the lemonade, just as too much government meddling can make markets dysfunctional. The trick is not to discard the water and the sugar, but to get the proportions right. Hong Kong, which Friedman held up as the exemplar of a free-market society, remains the exception to the mixed-economy rule – and even there the government has played a large role in providing land for housing.

Thursday, October 13, 2011

#OWS & Dani Rodrick Agree: Free Trade/Free Market Fundamentalists Are Fanatical Dumbasses

The revolution has begun, see it here.

The oligarchs & plutocrats, of course, don't like it one bit, and have unleashed their hounds in Congress to criticize the protesters' perceived lack of message clarity.  "Class Warfare!" they bray at the moon... hoping to distract us all from the subtle but pervasive class warfare that conservatives & laissez-faire free market fundamentalists have been engaging in for at least the last 30 years.

Their feigned indignation & superficial critique is hypocritical, disingenuous nonsense, of course.  But, it has had its effect: beyond red meat for blinkered true believers, it has served to further occlude confused, wooly-headed centrists who might otherwise wake up to the realities of what conservative ideology has wrought.

So, I offer a nugget from Dani Rodrick to dispell the fog. 

At least as far back as 2001, Rodrick - a professor of international political economy at Harvard University - has been writing about the failed promises of so-called free trade policies (e.g., here).  More recently, in his latest book "The Globalization Paradox", Rodrick makes the forceful point that:
... open markets succeed only when embedded within social, legal and political institutions that provide them legitimacy by ensuring that the benefits of capitalism are broadly shared.
And THAT is the message that OWS has been sending, loudly and clearly.

In his review of Rodrick's book, Steven Pearlstein gets it right:

It is dogma among economists and right-thinking members of the political and business elite that globalization is good and more of it is even better. That is why they invariably view anyone who dissents from this orthodoxy as either ignorant of the logic of comparative advantage or selfishly protectionist.

But what if it turns out that globalization is more of a boon to the members of the global elite than it is to the average Jose?
What if most of the benefits of the free flow of goods and capital across borders have already been realized, and any gains from additional globalization will be outweighed by the additional costs in terms of unemployment, reduced wages, lost pensions and depopulated communities?
What if global markets, to be widely beneficial, require the kind of global governance structure that does not yet exist and that most people would oppose?
What if it turns out that the countries that have benefited most from free-market globalization are not those that have embraced it wholeheartedly, but those that have adopted parts of it selectively?
In answer, Pearlstein digests & regurgitates Rodrick's thesis thusly:
Defenders of globalization have always noted that the richest countries tend to be those most open to the rest of the world in terms of trade and investment. Rodrik goes a step further by noting that the most open countries are also the ones with the biggest governments, the most extensive and effective regulation, and the widest social safety nets.
The reasons for that should be obvious, says Rodrik. Globalization, by its very nature, is disruptive - it rearranges where and how work is done and where and how profits are made. Things that are disruptive, of course, are destabilizing and create large pools of winners and losers. Any society, but particularly democratic societies, will tolerate such disruption only if there is confidence that the process is fair and broadly beneficial. That's where government comes in: Markets and government, Rodrik asserts, are "complements."
And there it is:  the Delphic Optimalist concept of BALANCE.

I do not hate capitalism, and I do not sbelieve that ALL free market policies are always utterly devoid of any value whatsoever.  But, the pendulum has swung too far - to the right - for too long, and capitalism is in danger of committing suicide.  It needs to be saved from itself.

But I digress... Pearlstein continues:
As Rodrik sees it, globalization began to run off the rails when it got hijacked by the notion that any restrictions on the flow of goods or capital across borders would result in great sacrifice to efficiency and economic growth. Not only was this free-market ideology imposed by the United States on developing countries through the interventions of the World Bank and the International Monetary Fund, but it was also imposed on the United States itself through a succession of free-trade treaties, the deregulation of finance and the retreat from any semblance of industrial policy.
The irony, Rodrik notes, is that the countries that experienced the greatest growth during the heyday of the "Washington consensus" were Japan, China, South Korea and India, which never embraced it. For years, they had nurtured, protected and subsidized key industries before subjecting them to foreign competition. They had closely controlled the allocation of capital and the flow of capital across their borders. And they flagrantly manipulated their currency and maintained formal and informal barriers to imports. Does anyone, he asks, really think that these countries would be better off today if they had played the game, instead, by the Washington rules?
The paradox, as Rodrik sees it, is that globalization will work for everyone only if all countries abide by the same set of rules, hammered out and enforced by some form of technocratic global government. The reality is, however, that most countries are unwilling to give up their sovereignty, their distinctive institutions and their freedom to manage their economies in their own best interests. Not China. Not India. Not the members of the European Union, as they are now discovering. Not even the United States.
In the real world, argues Rodrik, there is a fundamental incompatibility between hyper-globalization on the one hand and democracy and national sovereignty on the other.
But, what to do about it?

There is, of course, no simple solution.  If there were, we would have already implemented it - howling conservativism notwithstanding - and there would be no OWS movement.  Rodrick himself struggles to come up with a new framework for Global Capitalism 3.0.

But here's a few places to start thinking about making it work for the good ol' U.S. of A.:
  1. Nurture, protect and subsidize key industries before subjecting them to foreign competition.
    • Green Energy, among others... Obama's mistake with Solyndra was not [necessarily] the investment decision, per se, but rather the failure to recognize - and then provide - what is needed to provide adequate protection from Chinese competition.
  2. More closely control the allocation of capital and the flow of capital across our borders.
    • Clearly, The Wall Street casino & the shadow banking industry underwrote & executed an enormous misallocation of capital in the last decade [if not longer]:  the Housing Bubble, and before that the Tech Bubble [and before that, the Asian Currency Crisis].  Dodd-Frank is only a start at what is needed to ensure that our financial institutions direct affordable capital towards productive projects that actually grow the real economy, not engage in speculative Ponzi finance.
    • A Financial Transactions Tax - in this case, including on FX currency transactions, as well as investments in other instruments - would not only raise badly needed revenue [to fund TBTF oversight/resolution authority, pay down national debt, and fund redistributional programs aimed at mitigating inequality], but would also throw some badly needed 'sand in the gears' of the hyperspeed, high volume global financial trading activity.
    • Minimum stay requirements might be a good idea, too, to prevent unwanted sudden inflows & outflows of foreign capital during global finacial market meltdowns.
    • A moajor re-write of the tax code on foreign corporate earnings is in order, particulalrly in terms of the complicated transfers of intellectual property that allow large MNCs to avoid much [sometimes all] of their fair share responsibility (while encouraging offshoring of US jobs).
  3. Give up on our long-standing "strong dollar" currency policy, and allow it to gradually depreciate against other major currencies.
    • Letting the dollar devalue would be the fastest way to turn around the chronic US current account imbalance... albeit at the risk of rising inflation, esp. in re: commodity prices (oil).
      • A real commitment to a sustainable, long-term Energy Independence program is thus a necessary corrolary to dollar devaluation.
  4. Maintain formal and informal barriers to imports, and seek ways to affordably & efficiently subsidize exports.
    • Selective tarriffs, especially targeted to mitigate unfair trade practices ~ even if not recognized as such by the WTO ~ would help restore domestic competitivenes while we seek to re-build our manufacturing base.

 None of which will be easy, particularly given the US dollar as the global reserve currency.  But the rest of the world - particularly China & her BRIC brethren - has not played 'fair', and we have done virtually nothing about it.  How long do we just sit there and take it? 

The free trade fundamentalists rub their hands and worry that we'll ignite a trade war, so they insist we remain passive.  So much for American exceptionalism, eh?

Monday, October 3, 2011

Redistribution of national income to wages is essential | Bill Mitchell – billy blog

Redistribution of national income to wages is essential Bill Mitchell – billy blog

Bill Mitchell, an insightful heterodox economist from Australia, points out:

"... a defining characteristic of the neo-liberal period has been the fall in the wage share in national income in most nations. This has come about because real wages growth has dragged behind productivity growth. The gap between the two represents profits and shows that during the neo-liberal years there was a dramatic redistribution of national income towards capital.
This has been aided and abetted by governments in a number of ways: privatisation; outsourcing; pernicious welfare-to-work and industrial relations legislation (designed to reduce the capacity of trade unions); etc to name just a few of the ways. These ways vary by country.
The problem that arises is if the output per unit of labour input (labour productivity) is rising so strongly yet the capacity to purchase (the real wage) is lagging badly behind – how does economic growth which relies on growth in spending sustain itself?"
[Note:  You should first understand is that Mitchell's use of the term 'neo-liberal' is not AT ALL what the casual American reader might assume in knee-jerk reaction to the 'liberal' part of the term.  In fact, outside the U.S., the term 'neo-liberal' is essentially what is known as right-wing movement conservatism (with a few American idiosyncracies thrown in)... 180-degrees opposite of what most non-academic Americans understand as 'liberal'.]

The short answer to the highlighted question is, of course, that economic growth will not and cannot be sustained... if we continue on the path of increasingly conservative economic policies that the U.S. has been on for the last 30+ years [basically, since Reagan].

Mitchell provides some detail:
In the past, the dilemma of capitalism was that the firms had to keep real wages growing in line with productivity to ensure that the consumption goods produced were sold. But in the lead up to the crisis, capital found a new way to accomplish this which allowed them to suppress real wages growth and pocket increasing shares of the national income produced as profits. Along the way, this munificence also manifested as the ridiculous executive pay deals and Wall Street gambling that we read about constantly over the last decade or so and ultimately blew up in our faces.
The trick was found in the rise of “financial engineering” which pushed ever increasing debt onto the household sector. The capitalists found that they could sustain purchasing power and receive a bonus along the way in the form of interest payments. This seemed to be a much better strategy than paying higher real wages.
The household sector, already squeezed for liquidity by the move to build increasing federal surpluses were enticed by the lower interest rates and the vehement marketing strategies of the financial engineers.
The financial planning industry fell prey to the urgency of capital to push as much debt as possible to as many people as possible to ensure the “profit gap” grew and the output was sold. And greed got the better of the industry as they sought to broaden the debt base. Riskier loans were created and eventually the relationship between capacity to pay and the size of the loan was stretched beyond any reasonable limit. This is the origins of the sub-prime crisis.
So the dynamic that got us into the crisis is present again and with fiscal austerity emerging as the key policy direction the welfare of our economies is severely threatened. This is a dramatic failure of government oversight..."

Bill references a UN-sponsored economic report that sheds even more light:

These dynamics are clearly outlined in the recent UNCTAD Trade and Development Report, 2011. Its depiction of root causes of the current economic problems could not be clearer:
The pace of global recovery has been slowing down in 2011 … In many developed countries, the slowdown may even be accentuated in the course of the year as a result of government policies aimed at reducing public budget deficits or current-account deficits. In most developing countries, growth dynamics are still much stronger, driven mainly by domestic demand.
As the initial impulses from inventory cycles and fiscal stimulus programmes have gradually disappeared since mid-2010, they have revealed a fundamental weakness in the recovery process in developed economies. Private demand alone is not strong enough to maintain the momentum of recovery; domestic consumption remains weak owing to persistently high unemployment and slow or stagnant wage growth. Moreover, household indebtedness in several countries continues to be high, and banks are reluctant to provide new financing. In this situation, the shift towards fiscal and monetary tightening risks creating a prolonged period of mediocre growth, if not outright contraction, in developed economies.
They also highlight distributional issues which are usually suppressed by the conservatives in the public debate but should be at centre-stage.
Wage income is the main driver of domestic demand in developed and emerging market economies. Therefore, wage growth is essential to recovery and sustainable growth. However, in most developed countries, the chances of wage growth contributing significantly to, or leading, the recovery are slim. Worse still, in addition to the risks inherent in premature fiscal consolidation, there is a heightened threat in many countries that downward pressure on wages may be accentuated, which would further dampen private consumption expenditure. In many developing and emerging market economies, particularly China, the recovery has been driven by rising wages and social transfers, with a concomitant expansion of domestic demand …
Wage growth that is falling short of productivity growth implies that domestic demand is growing at a slower rate than potential supply. The emerging gap can be temporarily filled by relying on external demand or by stimulating domestic demand through credit easing and raising of asset prices. The global crisis has shown that neither solution is sustainable. The simultaneous pursuit of export-led growth strategies by many countries implies a race to the bottom with regard to wages, and has a deflationary bias. Moreover, if one country succeeds in generating a trade surplus, this implies that there will be trade deficits in other countries, causing trade imbalances and foreign indebtedness. If, on the other hand, overspending is enticed by easy credit and higher asset prices, as in the United States before the crisis, the bubble will burst at some point, with serious consequences for both the financial and real economy. Therefore, it is important that measures be taken to halt and reverse the unsustainable trends in income distribution.

Mitchell discovers more evidence to support his thesis from data provided by the St. Louis Fed:
... in the early stages of the crisis corporate profits slumped as growth came to a halt and you can see the impact of that in both the following graph and also in the rise in the wage share in the graph presented earlier. But as growth has resumed, the corporate profits series has nearly returned to trend while the wage share continues to fall.
In other words, what growth there has been since the downturn has been largely captured by capital. Workers have not shared in that growth much at all which explains why consumption is so subdued. The subdued consumption, in turn, reduces the incentive by firms to invest and so they are “cashed up” more than usual at present.

The major redistribution of national income over the neo-liberal period has been the source of funding for the dramatic expansion of the now (over-sized) financial sector. The reality is that much of the redistributed real income did not return as investment spending but was rather used to buy the gambling chips that the financial sector gambled with.
There will be massive resistance from that sector to government attempts at re-regulation and redistribution of national income back to workers.
The UNCTAD Trade and Development Report is also insightful when it comes to dealing with the financial markets:
Those who support fiscal tightening argue that it is indispensable for restoring the confidence of financial markets, which is perceived as key to economic recovery. This is despite the almost universal recognition that the crisis was the result of financial market failure in the first place. It suggests that little has been learned about placing too much confidence in the judgement of financial market participants, including rating agencies, concerning the macroeconomic situation and the appropriateness of macroeconomic policies. In light of the irresponsible behaviour of many private financial market actors in the run-up to the crisis, and costly government intervention to prevent the collapse of the financial system, it is surprising that a large segment of public opinion and many policymakers are once again putting their trust in those same institutions to judge what constitutes correct macroeconomic management and sound public finances.
And on the need for fiscal policy to support a process of national income redistribution back to workers, the UNCTAD report also has sound advice:
… there is a widespread perception that the space for continued fiscal stimulus is already – or will soon be – exhausted … There is also a perception that in a number of countries debt ratios have reached, or are approaching, a level beyond which fiscal solvency is at risk.
However, fiscal space is a largely endogenous variable. A proactive fiscal policy will affect the fiscal balance by altering the macroeconomic situation through its impact on private sector incomes and the taxes perceived from those incomes. From a dynamic macroeconomic perspective, an appropriate expansionary fiscal policy can boost demand when private demand has been paralysed due to uncertainty about future income prospects and an unwillingness or inability on the part of private consumers and investors to incur debt.
In such a situation, a restrictive fiscal policy aimed at budget consolidation or reducing the public debt is unlikely to succeed, because a national economy does not function in the same way as an individual firm or household. The latter may be able to increase savings by cutting back spending because such a cutback does not affect its revenues. However, fiscal retrenchment, owing to its negative impact on aggregate demand and the tax base, will lead to lower fiscal revenues and therefore hamper fiscal consolidation … Moreover, making balanced budgets or low public debt an end in itself can be detrimental to achieving other goals of economic policy, namely high employment and socially acceptable income distribution.
These are all words that can speak for themselves with no further prompting or intervention from yours truly.