Posts Tagged ‘economics’

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Mainstream economics presents quite a spectacle these days. It has no real theory of the firm and, even now, more than nine years after the Great Recession began, its most cherished claim to relevance—the use of large-scale forecasting models of the economy that assume people always behave rationally—is still misleading policymakers.

As if that weren’t embarrassing enough, we now have a leading mainstream economist, Havard’s Martin Feldstein, claiming that the “official data on real growth substantially underestimates the rate of growth.”

Mr. Feldstein likes to illustrate his argument about G.D.P. by referring to the widespread use of statins, the cholesterol drugs that have reduced deaths from heart attacks. Between 2000 and 2007, he noted, the death rate from heart disease among those over 65 fell by one-third.

“This was a remarkable contribution to the public’s well-being over a relatively short number of years, and yet this part of the contribution of the new product is not reflected in real output or real growth of G.D.P.,” he said. He estimates — without hard evidence, he is careful to point out — that growth is understated by 2 percent or more a year.

This is not just a technical issue for Feldstein:

it is misleading measurements that are contributing to a public perception that real incomes — particularly for the middle class — aren’t rising very much. That, he said, “reduces people’s faith in the political and economic system.”

“I think it creates pessimism and a distrust of government,” leading Americans to worry that “their children are going to be stuck and won’t be able to enjoy upward mobility,” he said. “I think it’s important to understand this.”

Here’s what folks need to understand: mainstream economists like Feldstein, who celebrate an economic system based on private property and free markets, build and use models in which market prices capture all the relevant costs and benefits to society. And, since GDP is an accounting system based on adding up transactions of goods and services based on market prices, for mainstream economists it should represent an accurate measure of the “public’s well-being.”

Mainstream economists can’t have it both ways—either market prices do accurately reflect social costs and benefits or they don’t. If they do, then Feldstein & Co need to stick with the level and rate of growth of GDP as the appropriate measure of the wealth of the nation. And, if they don’t, all their claims about the wonders of free markets simply dissolve.

Notice also that, for Feldstein, the problem is always in one direction: GDP statistics only undercount social well-being. What he and other mainstream economists fail to consider is that whole sectors of the economy, like financial services (or, more generally, FIRE, finance, insurance, and real estate), are counted as adding to national income.

As Bruce Roberts has explained,

because “financial services” are deemed useful by those who pay for them, those services must be treated as generators in their own right of value and output (even though there is nothing there that can actually be measured as output at all). . .

the standard (neoclassical) approach embedded in GDP accounting means, in concrete terms, that profits in FIRE must be treated as a reflection of rising real output generated by FIRE activities, requiring a numerical “imputation” of greater GDP. And, worse, that *rising* profits in FIRE then go hand in hand with *rising* levels of imputed “output” and hence enhanced “productivity.”

If Wall Street doesn’t add to GDP—if FIRE activities just represent transfers of value from other economic sectors (both nationally and internationally)—then its resurgence in the years since the crash doesn’t contribute to output or growth.

The consequence is that GDP, as it is currently measured, actually overcounts national output and income. Actual growth during the so-called recovery is much less than mainstream economists and politicians would have us believe.

That’s the real reason many Americans are worried they and “their children are going to be stuck and won’t be able to enjoy upward mobility.”

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Apparently, the latest attempt to redefine the role of economists is to encourage them to be plumbers.

Maybe it’s just my age but, when I read plumbers, I immediately think of the covert Special Investigations Unit in the Nixon White House—the operation that began with attempting to stop the leak of classified information (such as the Pentagon Papers) and then branched into illegal activities while working for the Committee to Re-elect the President (including the Watergate break-in).

I don’t think that’s what MIT economist Esther Duflo (pdf) had in mind when, in her Ely Lecture to the American Economic Association meeting last month, she suggested that economists seriously engage with plumbing, “in the interest of both society and our discipline.”

As economists increasingly help governments design new policies and regulations, they take on an added responsibility to engage with the details of policy making and, in doing so, to adopt the mindset of a plumber. Plumbers try to predict as well as possible what may work in the real world, mindful that tinkering and adjusting will be necessary since our models gives us very little theoretical guidance on what (and how) details will matter.

I’ll admit, I have a lot of respect for plumbers (especially when they’re able to fix the mess I’ve made trying to repair an existing fixture or install a new one). And I do think anyone involved in designing new policies and regulations should learn more about how they are actually implemented.

But economists, especially mainstream economists (of the sort Duflo is speaking for and to), are the last people I’d call in to fix the policy plumbing. Me, I’d pay them a large sum of money to learn about how policy formulation and implementation actually works. And then I’d pay them even more not to get anywhere near the process.

I’d much prefer that others—from the people actually affected by the policies to representatives from other academic disciplines and areas (such as anthropology, labor studies, peace studies, and so on)—be the ones who actually engage with the details of policy-making.

A good example of why I would want mainstream economists to be kept as far as possible away from the process of policy and implementation is a recent piece by Laura Tyson and Susan Lund.*

Their view is that capitalist globalization has had “disruptive effects on millions of advanced-economy workers” (and, we should add, on millions of workers—peasants, wage-laborers, and others—in economies that are not so advanced) and has aggravated income inequality within countries. So far so good.

But then they assert, without evidence, that the main culprit is not how globalization has been carried out, but technological change, which “automates routine manual and cognitive tasks, while increasing demand (and wages) for highly skilled workers.”

And because they take technological change as a given (rather than a strategy on the part of employers to boost profits), they recommend that workers (who, they presume, have no say in the development and implementation of new technologies) are the ones who need to adapt.

advanced economies must help workers acquire the skills needed to fill high-quality jobs in the digital economy. Lifelong learning cannot just be a slogan; it must become a reality. Mid-career retraining must be made available not only to those who have lost their jobs to foreign competition, but also to those facing disruption from the continuing march of automation. Training programs should be able to impart new skills in a matter of months, not years, and they should be complemented by programs that support workers’ incomes during retraining, and that help them relocate for more productive work.

Now, it’s true, Tyson and Lund don’t spend any time on the plumbing of creating and implementing lifelong learning programs. But that’s not the problem. Even if they were good economic plumbers, we’d still end up with a situation in which employers set the agenda and workers are forced to have the freedom to scramble to try to keep up.

That’s the plumbing Tyson and Lund leave out of their analysis. It’s what keeps the extra value flowing from workers to their employers. And, if workers are no longer useful for creating that extra value, they’re simply flushed down the drain.

If and when mainstream economists are willing to talk about those parts of the economic system, I’ll be the first to invite them to join the plumbers’ union.

But only, until they prove they can analyze and fix the problem, as plumber apprentices.

 

*This is not to pick on Tyson and Lund. I could have chosen any one of an almost infinite number of essays on economic policy by mainstream economists I’ve read over the years. Theirs just happens to be the latest I’ve run across.

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It is extraordinary that the hegemonic economic theory in the world today—neoclassical economics—still lacks an adequate theory of the firm.

It beggars belief both because neoclassical economics is the predominant theory that is taught to hundreds of thousands of students every year and used to make sense of the world and formulate policy in countless think thanks and government agencies and because the firm (or enterprise or corporation) is one of the central institutions of capitalism. It’s where many (but of course not all) goods and services are produced, value and surplus-value are created, and profits generated for capitalists.

And yet the neoclassical notion of the firm, even when developed by Nobel Prize-winning economists (such as Oliver Hart and Bengt Holmstrom), is not much more than an empty box—without any real history and, as it turns out, without any links to politics.

Daniel Carpenter, the Allie S. Freed Professor of Government in the Faculty of Arts and Sciences and Director of Social Sciences at the Radcliffe Institute for Advanced Study at Harvard University, certainly thinks that’s a problem in terms of making sense of how firms came to be constituted historically and what their effects are on contemporary society.

Q: The neoclassical theory of the firm does not consider political engagement by corporations. How big an omission do you think this is?

 I think it’s an immense omission. For one, we can’t even talk about the historical origins of many firms without talking about corporate charters, limited liability arrangements, zoning, public contracts and grants, and so on. To view these processes as legal and not political is a significant mistake. I’m currently writing a lot on the history of petitioning in Europe and North America, and in areas ranging from railroads, to technology-heavy industries, to extractive industries, to banking, firms (or their investors) had to bring a case before the legislature, or an agency of government, or both. They usually used petitions to do so. 

 Beyond the past and into the present, there are a range of firm activities that we can’t understand without looking at politics. Industrial organization considers regulator-firm interactions, but does not theorize the fact that now most firms have regulatory affairs and compliance offices, or the fact that firms hire not just lobbyists but lawyers to do a lot of political work for them.

 And in the future, the profitability and survival prospects of many firms in the coming years will depend heavily, in a polarized environment, on the political skills of managers. The theory of the firm was developed in an era (1950s – 2000) when globalism was the rule. What might it look like if Trump and Brexit are the new norm?

Today, of course, many citizens are concerned about the corrupt links between the capitalist firms in which they work and the governments that are supposed to represent the people. In my view, that concern was one of the causes of the Brexit vote and Trump’s victory in the U.S. presidential election.

The problem is, neither the post-Brexit British government nor the Trump administration has given any indication they’re going to solve the problem of the firm. Quite the opposite. Both have tied themselves to the very same capitalist firms that have wreaked havoc on society for decades now.

Meanwhile, neoclassical economists continue to build their models based on a theory of the firm that bears no relationship to the way firms operate in the real world, manipulating market rules and political actors to their own ends.

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Now that President Trump has begun carrying out his campaign pledges to undo America’s trade ties, formally withdrawing the United States from the Trans-Pacific Partnership and announcing he will start to renegotiate the North American Free Trade Agreement, it’s time to analyze what this means.

As it turns out, I’d already started to do this before the election, with a series of posts (e.g., here, here, here, and here) on Trump and the mounting criticism of the trade agreements the United States had signed (such as NAFTA) or was in the process of negotiating (the TPP).

It’s clear Trump’s decisions—which he claims are a “Great thing for the American worker”—challenge the view of economic and political elites, as well as those of mainstream economists (such as Brad DeLong), in the United States and around the world that everyone benefits from free trade.*

But, we now know, there has also been a growing counter-narrative, that not everyone has gained from growing international trade and trade agreements, which have generated  unequal benefits and costs. What’s interesting about this alternative story, at least when it comes to NAFTA, is that critics on each side argue the other side is the one that has benefited: U.S. critics that Mexico has gained, and just the opposite in Mexico, that the United States has captured the lion’s share of the benefits from NAFTA.

Here’s the problem: workers on both sides of the border have lost out, and their losses are mostly not due to NAFTA.

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We know, for example, that the wage share of national income in the United States has in fact declined after NAFTA was implemented (in January 1994)—from 45.1 percent of gross domestic income to 42.9 percent. But we also have to recognize workers have been losing out since at least 1970, when the wage share stood at 51.5 percent.

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Much the same has been happening in Mexico, where (according to the research of Norma Samaniego Breach [pdf]), the wage share (the dark green line in the chart above) has been falling since 1978—and continued to fall after NAFTA was put into place. And, as Alice Krozera, Juan Carlos Moreno Brid, and Juan Cristóbal Rubio Badan have shown, economic and political elites in Mexico, much like their U.S. counterparts, have mostly ignored the problem of inequality and resisted efforts to raise the minimum wage and workers’ share of national income.

The fact is, while NAFTA did propel a large increase in trade between Mexico and the United States, it “did not cause the huge job losses feared by the critics or the large economic gains predicted by supporters” (according to a 2015 study commissioned by the Congressional Research Service [pdf]).

The bottom line is, eliminating or renegotiating NAFTA—including in the manner Trump is proposing—is not going to help the working-classes in either Mexico or the United States. It is merely a diversion from the real changes that need to be made, to which the political and economic elites as well as mainstream economists in both countries stand opposed.

 

*The only real debate within mainstream economics is between neoclassical economists who argue free trade generates the most efficient outcomes, within and between countries (regardless of whether countries run trade surpluses or deficits), and their critics (such as Jared Bernstein) who argue that trade deficits lead to a loss of jobs (e.g., in U.S. manufacturing), and thus require interventions of the sort Trump is proposing to change the pattern of international trade.

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In discussing the textbook treatment of the minimum wage, James Kwak provides a perfect example of how contemporary mainstream economics “can be more misleading than it is helpful.”

Kwak refers to the problem as “economism.”* For me, borrowing from a different tradition, it is a case of “vulgar economics.”

The argument against increasing the minimum wage often relies on what I call “economism”—the misleading application of basic lessons from Economics 101 to real-world problems, creating the illusion of consensus and reducing a complex topic to a simple, open-and-shut case. According to economism, a pair of supply and demand curves proves that a minimum wage increases unemployment and hurts exactly the low-wage workers it is supposed to help. The argument goes like this: Low-skilled labor is bought and sold in a market, just like any good or service, and its price should be set by supply and demand. A minimum wage, however, upsets this happy equilibrium because it sets a price floor in the market for labor. If it is below the natural wage rate, then nothing changes. But if the minimum (say, $7.25 an hour) is above the natural wage (say, $6 per hour), it distorts the market. More people want jobs at $7.25 than at $6, but companies want to hire fewer employees. The result: more unemployment. The people who are still employed are better off, because they are being paid more for the same work; their gain is exactly balanced by their employers’ loss. But society as a whole is worse off, as transactions that would have benefited both buyers and suppliers of labor will not occur because of the minimum wage. These are jobs that someone would have been willing to do for less than $6 per hour and for which some company would have been willing to pay more than $6 per hour. Now those jobs are gone, as well as the goods and services that they would have produced.

That’s exactly the argument presented by Harvard’s Gregory Mankiw in his best-selling textbook Principles of Microeconomics. He uses neoclassical economic theory to distinguish (as in the figure above) a “free labor market,” where the market is in equilibrium and there is full employment, and a “labor market with a binding minimum wage,” where there is a surplus of labor or unemployment. In the latter, at a minimum wage above the equilibrium wage, the quantity demanded of labor (by employers) is less than the quantity supplied of labor (by workers). Thus, in his view,

the minimum wage raises the incomes of those workers who have jobs, but it lowers the incomes of workers who cannot find jobs.

Mankiw then supplements his discussion of the negative effects of the minimum wage by asserting it “has it greatest impact on the market for teenage labor.” Low wages, he argues, are appropriate for such workers because they “are among the least skilled and least experienced members of the labor force.”**

Only after presenting the model of unemployment created by a minimum wage and focusing on teenage workers does Mankiw admit that the minimum wage “is a frequent topic of debate” among economists, who “are about evenly divided on the issue.”***

Nowhere does Mankiw discuss the history of the minimum wage nor the determinants of either the supply of or demand for workers who are forced to have the freedom to sell their ability to work for a wage at or below the minimum wage. He is thus content, like many nineteenth-century economists, to “interpret, systematise and defend in doctrinaire fashion the conceptions of the agents of bourgeois production who are entrapped in bourgeois production relations.”

That is the very definition, in our own time, of vulgar economics.

 

*I hesitate to use Kwak’s term economism because, in my view, it signifies something different: the reduction of all social phenomena, in the first or last instance, to the economy (or some part thereof, such as the relations or forces of production). In other words, economism is an economic determinism—the positing of some kind of economic essence. The irony, of course, is that neoclassical economics represents an essentialism but of a different sort: it reduces all economic and social phenomena to a given human nature. Neoclassical economics is therefore a theoretical humanism.

**Later, he adds that such teenagers are “from middle-class homes working at part-time jobs for extra spending money.” Even less reason, then, to worry about such low-wage workers. According to the Bureau of Labor Statistics, minimum-wage workers do tend to be young. But they’re not just teenagers. In 2015, more than 2.5 million workers in the United States received wages at or below the federal minimum wage (3.3 percent of the labor force), of whom 1.4 million were 25 years or older (2.2 percent of the labor force).

***The 2006 survey Mankiw refers to was conducted only among members of the American Economic Association, the main organization of mainstream economists in the United States. It is interesting that the minimum wage is one of the few issues on which there was no consensus, even among mainstream economists. About 38 percent wanted it increased, while 47 percent wanted it eliminated entirely.

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Last year, as I reported the other day, I published over 800 new posts.

I’ve never done this before. However, I decided to look back over the year and choose one post for each month of 2016:

January—Liberal ideology

February—Who are the capitalists?

March—Yea, they’re angry!

April—Life among the liberal econ

May—Letting capitalism off the hook

June—Globalization, inequality, and imperialism

July—Trump and the Prosperity Gospel

August—The Mandibles and dystopian finance fiction

September—What about the white working-class?

October—Nobel economics—or why does capital hire labor?

November—Condition of the working-class in the United States

December—China syndrome

Enjoy!

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There are two sides to the recent China Shock literature created by David Autor and David Dorn and surveyed by Noah Smith.

On one hand, Autor and Dorn (with a variety of coauthors) have challenged the free-trade nostrums of mainstream economists and economic elites—that everyone benefits from free international trade. Using China as an example, they show that increased trade hurt American workers, increased political polarization, and decreased U.S. corporate innovation.

The case for free international trade now lies in tatters, which of course played an important role in the Brexit vote as well as in the U.S. presidential campaign.

On the other hand, invoking the China Shock has tended to reinforce economic nationalism—treating China as an unitary entity, a country has shaken up world trade patterns, and disregarding the conditions and consequences of increased trade with other countries, including the United States.

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Why has there been an increasing U.S. trade deficit with China in recent decades? As James Chan explained, in response to an August 2016 article in the Wall Street Journal,

Our so-called China problem isn’t really with the Chinese but rather our own multinational companies.

As I see it, U.S. corporations have made a variety of decisions—to subcontract the production of parts and components with enterprises in China (which are then used in products that are later imported into the United States), to purchase goods produced in China to sell in the United States (which then show up in U.S. stores), to outsource their own production of goods (to sell in China and to export to the United States), and so on. The consequences of those corporate decisions (and not just with respect to China) include disrupting jobs and communities in the United States (through outsourcing and import competition) and decreasing innovation (since existing technologies can be used both to produce goods in China and sell in the expanding Chinese consumer market), thereby increasing political polarization in the United States.

The flip side of the story is the accumulation of capital in China. Until the development of the conditions for the development of capitalism existed in China, none of those corporate decisions were possible—not by U.S. corporations nor by multinational enterprises from other countries, all of whom were eager to take advantage of the growth of capitalism in China. Which of course they then contributed to, thus spurring the widening and deepening of capital accumulation within China.

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It should come as no surprise, then, that there’s been an upsurge of strike activity by workers in the fast-growing centers of manufacturing and construction within China—especially in the provinces of Guandong, Shandong, Henan, Sichuan, and Hebei.

According to Hudson Lockett, China this year

saw a total of 1,456 strikes and protests as of end-June, up 19 per cent from the first half of 2015

The problem with the China Shock literature, which has served to challenge the celebration of free-trade by mainstream economists and economic elites in the West, is that it hides from view both the decisions by U.S. corporations that have increased the U.S. trade deficit with China (with the attendant negative consequences “at home”) and the activity by Chinese workers to contest the conditions under which they have been forced to have the freedom to labor (which we can expect to continue for years to come).

It’s our responsibility to keep those decisions and events in view. Otherwise, we risk the economic and political equivalent of the China Syndrome.