The Parveh Economics of Inequality

“Parveh” : Neutral food, not meat and not dairy ( from the Jewish tradition) is a term used to describe a neutral opinion or position . "Sitting on a fence" 

Prof. Krugman (Nobel Prize 2009) published in his column at the NY Times an interesting post http://www.nytimes.com/2012/05/04/opinion/krugman-plutocracy-paralysis-perplexity.html talking about the relation between Inequality and the Crisis. The line of reasoning of the article reveals the growing understanding that inequality is a factor to be taken into account, but its development goes, as usual to the Partisan arena ( i.e. the Republican bad guys) thus missing the main political and economic conclusions. Put it in other words, a step forward, but still a small one.

The article opens with the following statements ( Note : I make use of one article and one author but the issue is not a personal critique).

“Before the Great Recession, I would sometimes give public lectures in which I would talk about rising inequality, making the point that the concentration of income at the top had reached levels not seen since 1929. Often, someone in the audience would ask whether this meant that another depression was imminent. Well, whaddya know?”….

Did the rise of the 1 percent (or, better yet, the 0.01 percent) cause the Lesser Depression we’re now living through? It probably contributed”.

The statement “probably (“Probably = almost certainly; as far as one knows or can tell”, from the Oxford Dictionary) contributed” is rather “Parveh”, even trivial. We should already know that any social phenomenon is a potential “ contributor ” to a major economic crisis .The really deep interesting question is not the contribution per se but the relative importance of the phenomenon . Was it determinant ? What are the other components that contribute to the recession? And so on ….

Prof. Krugman continues

“But the more important point is that inequality is a major reason the economy is still so depressed and unemployment so high”.

The reasoning here is a bit confusing: When the question was from the “contribution” ( i.e. cause) side, inequality was a just mere probable contributor. Now when we deal with the solution side, inequality becomes a ” major reason” that impedes to return to normal growth. What a change! Common sense indicates that “cause” and “solution” in any question are correlated, in our case if inequality is now a major depressor, shouldn´t we to expect that it may be also a major detonator for the crisis? The answer to the apparent inconsistency appears now, in the text.

From now on , and for the rest of the article the focus of the debate turns from Economics to the partisan arena. Since the political color of the writer is well known, the main attack is against the Republican Party (as if the Democrats were some sort of Social Democrat part y or it members were not also part of the American oligarchy) . So if the writer is not able to throw even a small stone on his own political house, there is nothing really surprising in his words. Now we understand that inequality is a problem because the Republican Party is owned by a small mega rich group that impedes a normal political debate with the good souls, the Democrats.

Finally, when it comes to the solutions, the writer returns to the old Keynesian creeds leaving.

“Many pundits assert that the U.S. economy has big structural problems that will prevent any quick recovery. All the evidence, however, points to a simple lack of demand, which could and should be cured very quickly through a combination of fiscal and monetary stimulus.

No, the real structural problem is in our political system, which has been warped and paralyzed by the power of a small, wealthy minority. And the key to economic recovery lies in finding a way to get past that minority’s malign influence”.

So for the Economy , Keynesianism and for politics to get rid of the malign influence. Once again, the logic is confusing: If the problem is an excessive political concentration of power due to an excessive concentration of wealth, shouldn´t we deal with the cause? Why there is not an explicit call to deal with the root of the problem by reducing inequalities? Why to stick only to the traditional instruments of Keynesianism and not to mention that equality was a major component in the New Deal?

Summarizing, there is a renewed interest in distribution aspects, but mainstream economists are still unable to propose a political economic agenda in that direction in economic terms. Maybe because the Parveh mainstream economists are unable to deal directly with the Taboo? Who knows... the  fence is already too (intellectually) fragile, and Economists should understand that the days that distribution was a taboo are over.

Spanish Roulette - Gambling with OPM

Spain is famous for its lotteries and the devotion of its people for gambling. Therefore, we shouldn´t be surprised if the recent labor reforms ( Essentially deep cuts of social and labor rights) announced by the Spanish government look, more than anything else , as a huge gamble. Yes, a gamble but with a twist : They pay , We win... what is called gambling with Other´s People Money ( “OPM”) or what I would  call " The Spanish Roulette". I will try along the next few paragraphs to explain the lik between gambling and policy 

First of all a few words on Gambling : Gambling does not fit into the traditional definition of a rational economic behavior. Why is that ? The explanation is simple : The chances to win ( a lottery, for example ) are generally too small in comparison to the cost of the ticket. So when facing an unfavorable perspective a "rational" person would prefer not be involved. Some would even claim that gambling is basically an unfair business, but no one would doubt that the “non rational” gamblers are fully aware of the expected losses. Under normal circumstances the bets and the chances to win or loose are transparent and measurable ( for example , the chance to win in a roulette is 1/37).

However, the level of “non rational” behavior can reach new highs. For example when the gambler pays for a lottery ticket without knowing the odds and /or the winning price. I guess that even the most heavy gamblers would avoid such lottery. However there might be one small exception : If the ticket is paid by someone else, while the prize goes into the gambler´s pocket, gambling turns to be the most rational game in town. Playing with OPM ( Other´s People Money) is the most lucrative business.That is the business the Spanish Governemt is developing trough the labor reform.

This OPM gambling game is precisely what the Spanish Government announced : The denominated “Labor Reform” is equivalnet to a "bet" : The reform includes the loss of labor rights such as the lower severance pay, the introduction of an almost arbitrary right to fire, the abolition of collective agreements ( if a company FORESEES lower sales along 9 months..... ) and more. In “Gambling” terms, the cost of the ticket of the national lottery is clear and palpable on particular and collective terms , exclusively on the working class.

Now, any political ( or economic ) decision that involves huge social or economic certain cost should be weighted against future benefits for the Spanish society ( Example : Churchill´s “Blood Sweat and Tears “ was the price, but the reward was Victory) Otherwise, how can we evaluate the Reform? For example, is there any minimal level of unemployment reduction that justifies the reform? What is the timetable to begin to have some positive results? Did the Government elaborate a “Plan B” in case the actual plan does not work ? And so on....

So I looked around to see whether any important politician and / or economist ( BTW most of them supporting the reform) can enlighten our way with clear and measurable objectives. Unfortunately the only thing you can hear from them are pathetically vague slogans such as “ A step in the right direction”, or “The results of the reform will not immediate, it will have a medium term “ or “ The rationalization of the Spanish labor market “ and so on. So the benefits for the huge sacrifices are not so clear , lets say not existing from a practical perspective. An if there are , please show us …..So isn´t it fair to denominate the new gambling scheme “ The Spanish Roulette”?

As a matter of fact such behavior is typical for politicians which always avoid serious commitments to prevent future critics ( if the results are less than expected) and leave room for maneuver. Fair Enough. However, what really surprises is the reaction of the vast majority of my colleagues, the Economists. We are trained to evaluate figures and facts, and in case we deal with uncertain situations ( such as the future) the discipline developed tools ,models and probabilities to assess the benefits of uncertain economic scenarios . Therefore aby automatic support (or disapproval) of a policy measure without clear figures or model is closer to the field of beliefs and religion than to the field of a social ( although inaccurate ) science.

Is the support for vague and not quantified promises the result of a shallow, not critical thinking of my fellow economists ? Or maybe this is not a question of professional competence, but the recognition that the “Spanish Roulette” scheme will be always “rational” as long as the ticket for the lottery is paid by OPM ( especially the working class) ? I will leave these open questions for the reader to answer.

Deleveraging , Debts and Distribution

Most economists are already convinced that years of massive stimulus spilled on the economy yielded just minor economic results: In any case far from what can be regarded as “Recovery”. Why? Many are the obstacles the economy is facing, though it is widely acknowledged that the private sector heavy indebtedness and its "Deleveraging" .....

Worse than the 30, Ms. Lagarde, Worse ! (or “The Crisis” from an Historical Perspective)

A couple of weeks ago we got another public warning about the state of the Global Economy. This time the warning call was launched by a top economic figure,the Managing Director of the IMF ,Ms. Lagarde.

IMF chief warns over 1930s-style threats
The managing director of the International Monetary Fund has warned that the global economy faces the prospect of economic retraction, rising protectionism, isolation and . . . what happened in the 30s (Depression)

http://www.ft.com (By Hugh Carnegy in Paris, George Parker in London and Peter Spiegel in Brussels – December 16th 2011)

Now, is it reasonable to deliver a dramatic warning about our modern economy alluding to events which took place some 80 years ago ? The answer is yes, as long as the events share some common patterns . So, the question is not whether 30 and 2011 are identical (obviously, they are not not) but if they share meaningful similarities.

Most economists would agree that both events share important common patterns : Generally speaking, both crisis were preceded by a period of economic “prosperity” accompanied with an Asset/Debt bubble . Consequently the violent pricking of the bubble turned into a debt crisis ( i.e. Debt suddenly became unpayable) ,which affected aggregate demand and financial stability. The policy response ,in both cases, was a massive support to the financial institutions and injection of "real" demand through expansionary policies (monetary and fiscal as well).

Up to now, I agree with the analysis, though my reading goes a step forward ( to an area that most mainstream economists simply ignore): I claim that the bubble and the following crisis were in both cases the outcome of a distorted income distribution, skewed toward the upper income echelons ( I´ve wrote extensively about it, so whoever is interested in understanding that point is invited to read previous posts).Anyhow, to illustrate my point please look at the below graphs dealing with the US and think for yourself if there is no place for such hypothesis.... . In an Hamletian style we should say “ To Distribute or not to distribute : That is the question...” . Needless to say the solution lies in recognizing that simple message.

Top 10% share in Income US
“

Total Debt - US

The conclusion is that Ms. Lagarde is quite correct by applying an historical perspective when she delivers her warning. However, as “History does not repeat itself, but it surely rhymes” it would be erroneous to confine our understanding to “Similarities” between “Then” and “Now”; a proper historical narrative should draw our attention to the role of dissimilarities as well.

Coincidence or not, last week turned to be the 20th anniversary of the collapse of the USSR. Are Ms. Lagarde statement and the anniversary related ?

Well, for me the answer is YES. The main difference between 1930 and 2011 is in the political arena: The world of 1930, a minute before the spreading of The Plague (Fascism ,Nazism) was obsessed with the new economic and social alternative model represented by the Soviet Union . Regardless our views on the Soviet Regime during its Stalinist phase, the Soviet model was back in the 30 perceived as a serious alternative (or threat) to the Capitalist order. And here lies THE dissimilarity: Ever since the collapse of the Soviet Union 20 years ago, the dialectic challenge to the dominant regime on a global scale has been absent from the political arena. The result : A new wave of Globalization, an accelerated dismantlement of the Welfare State … and so on.. but this is another story for another post.

And how this difference is related to the economic arena? Lets see how the main mentor of the reform policies in the 30 , Lord Keynes and FDR , regarded their work :

"The broad thrust of his (Keynes) efforts, like that of Roosevelt was conservative, it was to endure that the system would survive"( JK Galbraith)
"The Class war will find me on the side of the educated bourgeoisie" ( JM Kyenes)
“Red Russia holds too much which is detestable" ( JM Keynes)

As can be seen, the whole concept of intervention in the economy, seen by many as a "Socialism" was considered by the its main promoters as than an attempt to save the system of private property (i.e. Capitalism). From whom? The main threat was in the East, the USSR , with its fast industrialization, GDP huge growth , and all of that before the Stalinist crimes became widely known ( BTW, THE problem with the USSR was never the lack of freedom: Just remember how the US supported for decades more than one authoritarian conservative regime around the Globe ….). FDR or Keyens were aware of the challenge imposed on the System and reacted accordingly.

As of our modern times , the Economic system lacks any real drive to reform itself as there is no imminent threat around : No Soviets, no reds.... If so, why to bother to reform? Even Keynes and Roosevelt would agree on that . The results of that tragic myopia can be observed in the half baked reforms “imposed” on the financial system (still (!) able to create exteremely wealthy bankers), .... high unemployment rates with no real policy response ....the endless summits in Europe rushing to decide something before the opening of a new trading session… and above all the return of the Austerity talk with its Deficit Hysteria….( if deficit is the problem , why not to raise taxes ???? ) . As we can see, anything is valid as long as it does maintain the current state of affairs, ironically, the very same system that proved to be fragile and unstable.

The problem is that for the mainstream economists and policy makers there is no myopia, as they are in the game for THAT reason, i.e. to protect the system, not to reform it. However it IS a myopia if we agree that the main problem to be resolved is not “Debt” ( which is by definition, other´s people Asset) but inequality and income distribution . It is a myopia for those who remember the 40 .....

Share of Top out of National Income ( OECD Figures)

My conclusion is that under the current state of affairs, absent political threats or serious social alternative, the Elites will not give up upon the privileges gained along the last 3 decades. Without the drive for reforms , the Political and Economic response will be an anti Keyensian / FDR wave i.e. more Orthodox and austere policies to reduce deicits and public budgets. Even Noble prize winners agree that such policies are a certain recipe for disaster in the midst of deleveraging and weak private demand. ("Keynes Was Right" by P. Krugman)

Such tragic path could lead to a permanent recession mode and a worse economic long run consequences than humanity experienced some 80 years ago. And let us not forget that even the relative mild policies of the 30 were not able to prevent by “new” dawn on September 1st 1939….( WWII)

Profit Margins and Crisis

Figures can be interpreted in many ways. Lets take for example the following grap which depicts the evolution of the margin earning in the US:



That picture is reflected in other parameters, especially the shape of the main stock market indices. So many could argue that the graph reveals that the situation is just fine, we are back in business and the crisis is over. Is it so?

First of all, you can notice that the American business sector enjoyed the same extreme margins just before the last financial bubble exploded into the worst recession in 70 years. So the margins by themselves can be hardly regarded as a signal for “ Business as usual”.

As a matter of fact that profit rates are a genuine alarm before the next round of crisis. Let me explain: Business profits are the mirror picture of purchasing power of the average citizens or in simple words, every cent out of the total sale goes to the profit is taken from salaries. Therefore the graph means that the average citizen , the one that may own some shares or funds and predominantly lives from his salary is in nowadays worst shape than in the midst of the crisis .

But that is not just a question of justice and distribution but a very serious economic issue. If the average worker is poorer, then to whom will the business sell their products? That is exactly the very root of t he economic crisis we are still in , the unbalanced growth and concentration of wealth and profits among too few hands that are not able to consume the excessive production. The credit bubble was just a mean to cover that lack of purchasing power until it could not be sustained. As the crisis developed, the public sector stepped in to cover that lack of demand … ( no more taxes… but a lot of debts ). So the imbalance went from private hands into public hands.

So we are once again experiencing an unbalanced growth, though this time the reaction capacity of the governments will be much more limited. Under these circumstances a more intense crisis is just waiting around the corner or for the most a sluggish economic growth.

The Economics of the Schnitzel*

Everyone can surely remember from his/her own past those unique moments in which a phrase, sight or a comment turned a complicated set of ideas into a simple, clear, concept (“How I did Not Think About It Before?” moment…). That personal Eureka experience may be the outcome of an individual “masterstroke” but it is more commonplace to find the origin of such experiences in our immediate environment.

I had many Eureka moments in my life, one of them dates to my early days as an Economics student. During a Micro Economics class , Prof. U.R. tried to explain what “Revealed Preference” is all about ( Note : R.P. is a method to analyze the consumers´ wants and needs from her actual behavior). A student suddenly asked the lecturer why to bother with complicated calculations as it is much easier to ask the consumer directly about her preferences. The Prof. replied with a simple example: A smart grandmother ( in my case the typical Jewish Grandmother, guess it is the same in other cultures) will never ask her grandchildren if they like the Schnitzel she bothered to prepare. She would prefer to know the “real” answer by having a look at the empty/not empty plates when the meal is over….. That is the essence of Revealed Preference, the understanding that even with kids actual behavior can be a better signal than words as people are prone to answer according to prior strategies and interests, ( in less polite words, to manipulate) That lesson remained in my head as “The Schnitzel Theory”.

Back to the present, I´ve got the feeling that the actual economic conjecture is a perfect candidate to apply the old “Schnitzel Theory”. Listen to what Governments, Central Bankers, the Media (with rare exceptions) and other interested parts have to say about the economy and you will hear an optimistic and sweet melody. Does the economic real “plate” ( i.e. actual decisions ) fit with these calm messages?

Lets have a look on the following graph (Evolution of Interest Rates and Inflation in US)

Source : Treasury Yields in Perspective Doug Short August 16, 2010

What does the graph tell us? First of all the official interest rate is being maintained at record low levels (the red line), practically zero. The market rates (Blue Line) which is heavily influenced by the monetary policy and market expectations is also very low. On real terms (the difference between inflation and interest rates) the official short term rate is in negative territory, i.e. Central Banks are running an ultra expansionary policy (app. negative 2-3%). The last time we had a similar experiment, (2001 -2005) the party eventually ended in tears including the prick of a major real estate bubble and a major economic crisis. That is not a secret, even to policy makers.

The most convincing explanation for such unorthodox and risky policy (with possible assets bubbles or inflation) is that reality is still very unpleasant and the economy requires high doses of cheap money in order to maintain asset prices and employment. In other words, the real and concrete policy measures tell us a different story from the official narrative.

To whom should we believe? My answer to that question as an adept of the "Schnitzel Theory" is that we are still far away from a real and sustainable recovery and a lot of problems lie ahead. Policy makers can say whatever they want, but as long as facts tell us a different story I prefer to believe to the later.

In that context I will ask you a favor : Please let me know when the facts fit with words or when you see a clear return to normal macroeconomic policies. That day it will be possible to say that the plate is empty and the time for the sweet dessert arrived… as Granma taught me : Dessert only for those who emptied their plates ... ( Or "The Wall" version : If you don´t eat your meat, you can´t have any pudding ....")



*Schnitzel : Typical Centre European , a thin meat cutlet (usually breaded and fried), Milanesa in Italy

Free Markets and ( free ) Immigration

The phrase “There is no such thing as a free lunch” ( M.Friedman) is for economists an equivalent to the Law of Gravity. However, the first phase of the current economic crisis with its massive injection of public money seemed to defy Friedman´s rules. Policy makers were seduced by the idea that generous outflows are capable to relieve any social pain and even cure the economic malaises without real pain FOR NO ONE. Unluckily, as the dust sets it becomes clearer that Alchemy is unable to replace good Economics.

The prolongation of the crisis is evident or better put, it´s becoming dear experience for some of us. Let’s analyze some of the last week news : The Financial Times website admitted that “US banking sector picked up pace in the second quarter with lenders’ profits rebounding to pre-crisis levels amid falling loan losses”, whilst on Friday August unemployment figures are close to record levels ( August 2010 Jobs report announcing the loss of 54 k jobs in the US was considered as a “ good news …) . Another title from the FT says : ” Former Chancellor of the Exchequer Alistair Darling said the UK's supertax on bankers bonuses he introduced last year amid outcry over bankers' pay failed to correct the industry ….. Well as far as I know HM government is very efficient when it comes to realize deep cuts in social rights. Perhaps M. Friedman´s phrase should be modified to“ There is such a thing as a free lunch as long as you get someone to pay for it”.

As the failure of the “recovery” measures become evident, the task of maintaining the delicate balance between social pressures while maintaining the existing economic power structure becomes an even harder mission than before. It is becoming evident that someone must pay …..

The question who is going to pay is already generating a few interesting answers : One of them is the call to restore the dominance of market forces in the economy, since the only instrument capable to restore the path of sustainable growth and employment is the market . The free marketers offer a menu that includes for “Entree” delicacies as tax cuts, reduction of public expenses, flexibilization of labor markets, surplus budgets etc. True, there is some debate about the tastiness of such menu, though the question whether, how and who will manage to reach dessert is “blowing in the wind”. In any case, the burden will fall on those who benefited less from the pre crisis prosperity, the lower classes.

The second position to be noticed is the resurrection of xenophobic discourse, not as a marginal topic but as another component of mainstream policies of “respected” institutions . The xenophobia is linked to the economic crisis ( for example “to fight unemployment”) : France has already deported thousands of Romanian Gypsies, Italian authorities established anti immigration policies, Arizona´s immigration laws are still debated, Spain hardened its policy on immigration etc. In that case the bill is served to the foreign workers and immigrants (at first phase.... others will come later)

The irony is that both lines are generally held by the same people. Why irony? Because the two lines contradict each other . In the case of market fundamentalism , the economic models that justify them assume a free and unrestricted flow of ALL production factors (Capital, labor, and raw materials), products and services. If the flow of labor is constrained (as the xenophobes want) , the whole intellectual edifice of free markets becomes irrelevant or becomes not more than another ideological instrument applied in accordance to the particular interests.

A few examples should explain the last point : Under a genuine global free market it would be inconceivable that a Brazilian from Sao Paolo is “allowed” to make use (and pay ) for Telefonica´s privatized services ( held by Spanish Capital ) but not allowed to work freely in Barcelona… or an East European working at car making industry , generating profits for American funds but not allowed to offer his work in the US without a Green Card… or an Israeli government which approves generous grants to major enterprises in the name of the free markets but decides to expel Israeli kids just because they were born to illegal foreigners.

The intellectual coherence demands that whoever support free markets should also favor free and unlimited flow of people as well. If the incoherence is explained by the need to impose certain restrictions on markets ( to preserve social cohesion etc...) , than why only limit immigration? Why not to question privatization? Shouldn´t market forces be restrained when social equity or other common values are under threat ? If the challenge presented in these simple questions is accepted, than market economy will be hopefully expelled from its quasi sainthood status and exposed to social scrutiny as it should have been from the very beginning.

Beggar Thy Neighbor OUT, Beggar Thy Roommate IN

“Beggar thy Neighbor” is a term used to describe policy measures aimed to boost the economy of a country at others countries expense . That policy is supposed to improve the competiveness of country through different means , just to mention a few : The formation of economic barriers for foreign competitors, a forced devaluation the currency and so on.

True, such “Win-Loose” strategy can generate some limited economic impact. However, history tells us that things can turn into a ugly story: "A form of this policy, notably the tariff barrier, was attempted at the beginning of the Great Depression with almost no success. A beggar-thy-neighbor policy in the United States caused other countries to follow suit, resulting in a massive decrease in international trade. This made the Depression worse.” Financial Dictionary). Retaliation became the key word in that context.

Was the lesson learnt? Up to a certain point. The calls for protectionist measures heard lately were not ( still) able to bring about a policy change and governments declare their commitment to open trade . But that´s not the whole story: Fearing from the neighbors’ response, countries turned to beggar their own poorer roommates. After all someone should pay for the party ....

The Spanish case will illustrate the last point. Spain is suffering from a combination of deep recession, current account deficit, soaring public deficit and huge unemployment rate (app.20%). Before becoming a full EU member , Spain used to overcome similar episodes by literally beggaring its trade partners, especially devaluating its currency, the Peseta ( and other policy tools as well). It had some limited impact when combined with other policy tools.

Spain membership in the EU brought about the loss of independence of its economic policy. Thus ,as many “experts” claim, the only way open to the country is an “internal devaluation”, or in a less PC parlour , lower salaries. The logic goes like that: Spain should gain competitiveness so the prices of Spanish prices must be lowered. Since such arbitrary reduction cannot be forced, (and companies might ,G-D forbid, lose money), the burden should fall on the regular cannon fodder, the wage earner ( lower salaries = lower cost = lower prices ). Moreover, that theory holds a moral argument : Spanish wages have risen “too much” in the last years, and THAT distortion explains the uncompetitive position of the economy. This position (held by the Nobel Laureate P. Krugman), could sound reasonable…. as long as you don´t analyze the data.

Lets see the data. The following graph shows the relative weight of the salaries in the Spanish economy, in other words how much of what the country goes to the pockets of the wage earners. (until 2009 real 2010 onward Forecast)


Source : Eurostat Data Compensation of Employees percentage of GDP

What is the meaning of the descending line? It means that for each Euro produced by the economy (similar to the price of a product in a private company),the workers received a smaller slice than what they used to receive a few years ago. Even if we accept the “loss of competitiveness” thesis, it is hard to see how it is related to the “growth” of salaries. If Spain suffered from a higher inflation rate than its trade partners, it was probably related to the rising prices and profits of the companies and less to the salaries . Although other European workers suffered from the same problem, in comparison to the European wage earner, the Spanish worker has suffered more .

But governments are not confused by facts. The “Socialist” Government already embraced the narrative that reduced social rights and lower salaries is the key for Spain´s recovery. Under the blessing ( or pressure) of the IMF, EU, Obama…etc…. the Government already marked the path by a 5% cut of wages in the public sector. The next step was the adoption of a set of decrees which overturn essential social rights (some of them dated from the Franco era!) including a dismissal "easy track" and a planned assault on the system of collective negotiation and pensions.

Spain is just a model though the narrative is being noticed in other countries. So from now on say "Beggar your neighbor OUT, your worker IN...." . That is the newspeak we´ll hear from now on from policy makers and the financial media. I humbly dare to foresee that the "beggar" policy is deemed to fail as it failed 70 years ago: it will pres each and every country to a lower salaries policy which will eventually depress consumption and economic activity.

I wish policy makers understand, before it gets really too late, that "beggar" cannot replace genuine and progressive economic policy. Moreover, it is more than the beggary policy is the path toward higher levels of despair and anger.

Green Shots , At Last

The influential “Financial Times” published a week ago an article titled “Time to Plan for a Post Keynesian era“ by the famous Economist Jeffrey Sachs. So what?
Let me skip a large and obscure introduction and go directly to one of the punch lines in that article:

“.....Governments are fighting for market credibility via draconian cuts in spending. This too is the wrong approach. We should avoid a simplistic austerity to follow the simplistic stimulus of last year...... …...Here are some suggested guidelines.....
….Fifth, governments and the public should insist that the rich pay more in income and wealth taxes – indeed, a lot more. The upward re-distribution of the past 25 years has made our economies into extravagant playgrounds for the super-wealthy. Politicians of both the mainstream left and right in the US and UK have fawned over those who pay their campaign bills in return for low taxation. Even playgrounds should collect tolls – when it is billionaires in the sandpit…....

Just in case you are not familiar with the Sachs let me quote Wikipedia “.....One of the youngest economics professors in the history of Harvard University, Sachs became renowned for implementing economic shock therapy throughout the developing world and in Eastern Europe …...” So here we´ve got a mainstream, not only an Harvard Proffessor, but a “shock therapist “ in favour of “more income taxes” ? THAT is a real Green Shot!!

I do not know whether Sach is alone in his approach and what is exactly his diagnosis but Sach´s message is encouraging . I hope more economists would start to adopt a more critic perspective toward the ruling dogmas in order to provide enduring solutions.

A personal note : This blog has been asserting along the whole crisis for the last two years that the crisis should be analyzed from a distribution persepctive : In other words “bailouts” , “quantitative or “qualitative” easing are not more than a curtain of smoke that will eventually proved to be  useless.

This blog still thinks that the current economic crisis is the result of a a the skewed income and wealth distribution int he world ( you are invitd to read previous posts ) . Thus the only human and reasonable solution for the crisis is the construction of mechanism to redistribute income and wealth. Any alternative should be banned from the outset , not only on moral and social grounds, but rejected from a “pure” economic perspective. Sach´s article could be atoner sign that this persepective is being taken seriously .

For those with a bit of patience between the football games I attached the article .... .


Time to plan for post-Keynesian era
By Jeffrey Sachs
Published: June 7 2010 22:22 | Last updated: June 7 2010 22:22

Mainstream Keynesian economics is facing its last hurrah. The global fiscal stimulus championed last year by the Obama administration is coming undone, repudiated by the same Group of 20 that endorsed it last year. Now, against a backdrop of a widening sovereign debt crisis, we need to abandon short-term thinking in favour of the long-term investments needed for sustained recovery.

Keynesian stimulus was premised on four dubious propositions: that it was needed to prevent a global depression; that a short-run fiscal boost would jump-start the economy; that “shovel-ready projects” could combine short-term cyclical and long-term structural agendas; and, last, that the rapid rise of public debt occasioned by stimulus need not be a concern. That these ideas were so widely accepted was a testament to the perennial political attractiveness of tax cuts and spending increases. In fact, the ubiquitous references last year to the Great Depression were glib; the policymakers had panicked. Adroit central banking could and would prevent depression.
 
The hastily assembled stimulus packages were a throwback to naive Keynesianism. The relevant fact was that the US, UK, Ireland, Spain, Greece and others had over-borrowed for a decade, so a decline in consumption after 2007 was not an anomaly to be fought but an adjustment to be accepted.

Certain counter-cyclical spending is vital on social grounds. But stimulus measures such as temporary tax cuts for households or car scrappage schemes were dispiriting wastes of scarce time and money. They reflected a hope that a temporary fiscal bridge would carry us back to consumption and housing-led growth – a dubious proposition since the old “normal” had been financially unsustainable.
The talk of a green recovery, in which the fall in consumer spending would be offset by investments in sustainable energy, made sense and still does. Yet it was quickly undermined by the politicians’ insistence on “shovel-ready” Projects. The shift to sustainable energy systems is a vital but long-term task. It could never be a short-term jobs
programme. Maybe in China there are shovel-ready projects of sufficient scale, but not in. the US.
Taking office in January 2009, President Barack Obama inherited the largest peacetime budget deficit in US history. By increasing it further, he made it his rather than his predecessor’s. He and his advisers ignored one of the key insights of modern macroeconomics: that the result of fiscal policy depends not only on current taxes and spending but also on their expected trajectories in the future.  The US was not in a credible position to raise an already enormous deficit “temporarily” because the prospect for future deficit cutting was and remains extremely clouded.
 
America has absolutely no consensus on how to restore budget balance, as it is trapped between a federal government that provides too few public investments and services and a public that is almost maniacal in its opposition to tax rises. One cannot build a credible long-term fiscal policy by starting off in the wrong direction, with larger rather than smaller deficits. Now we face a world economy with weak aggregate demand in the US and Europe, bulging budget deficits, sovereign debt downgrading and consumers unwilling to borrow. Governments are fighting for market credibility via draconian cuts in spending. This too is the wrong approach. We should avoid a simplistic austerity to follow the simplistic stimulus of last year. 
 
Here are some suggested guidelines.
First, governments should work within a medium-term budget framework of five years and within a
decade-long strategy on economic transformation. Deficit cutting should start now, not later, to achieve manageable debt-to-GDP ratios before 2015.
 
Second, governments should explain, and the public should learn, that there is little that economic policy can do to create high-quality jobs in the short term. Good jobs result from good education, cutting-edge technology, reliable infrastructure and adequate outlays of private capital, and thus are the outcome of years of sustained public and private investments. Governments need actively to promote post-secondary education.
 
 Third, governments must of course also ensure social safety nets: income support for the poor, universal access to basic healthcare and education, a scaling up of job training programmes and promotion of higher education
 
Fourth, governments should steer their economies towards needed long-term structural transformation. External-deficit countries such as the US and UK will need to promote exports over the next few years, while all countries must promote clean energy and new transport infrastructure.
 
Fifth, governments and the public should insist that the rich pay more in income and wealth taxes – indeed, a lot more. The upward re-distribution of the past 25 years has made our economies into extravagant playgrounds for the super-wealthy. Politicians of both the mainstream left and right in the US and UK have fawned over those who pay their campaign bills in return for low taxation. Even playgrounds should collect tolls – when it is billionaires in the sandpit.
 
 We need, in sum, to reset our macroeconomic timetables. There are no short-term miracles, only the threat of more bubbles if we pursue economic illusions. To rebuild our economies, the watchword must be investment rather than stimulus.

The writer is director of The Earth Institute at Columbia University

 

Will 2011 turn into 1938?

" History Does Not Repeat Itself, But. It Sure Does Rhyme"(Mark Twain)

This is not an exercise in mathematics, it´s about Economics and History. Western governments have lately adopted serious measures aimed to reduce the growing deficit of their public accounts. The list is impressing: The governments of Greece, UK, Spain Italy, Portugal Germany and other countries decided to reduce costs and impose austerity measures expected to inflict a serious ( and additional ) economic stress on their ( more modest ) citizens. Just for the record, alternative or complementary measures as increasing the tax burden (which affects the more affluent classes) or improving the tax collection system are inexistent or of secondary nature.

Such measures can be justified only if that their expected benefits exceed the negative impacts of such measures on the economy. Put it in other words the hidden assumption is that economy is already on “the right track” so the demand of public sector is less crucial than before. However, the propagandist effort pointing on the imminent “recovery” (Green Shots, “We saved the world “ and so on) relies upon a not very solid ground : GDP growth figures are still fragile, interest rates extremely low and unemployment rates high. My claim is that such policies the wrong cure for the wrong disease and they could easily exacerbate the economic recession we are still suffering.

That debate resembles the situation along the mid 30 when the Great Depression was still around but growing pressures for “balanced budget” forced the US administration to cut expenses. True, history does not repeat itself, but it definitively “rhymes”, so the lesson in that case could be interesting.

From the Wikipedia

General
"The Recession of 1937–1938, sometimes called the Roosevelt Recession, was a temporary reversal of the pre-war 1933 to 1941 economic recovery from the Great Depression in the United States. Economists disagree about the causes of this downturn. Keynesian economists tend to assign blame to cuts in Federal spending and increases in taxes at the insistence of the US Treasury while monetarists, most notably Milton Friedman tended to assign blame to the Federal Reserve's tightening of the money supply in 1936 and 1937".
Background….
“…….. In June 1937, some of Roosevelt's advisors urged spending cuts to balance the budget. WPA rolls were drastically cut and PWA projects were slowed to a standstill.
The Results ….
"...The American economy took a sharp downturn in mid-1937, lasting for 13 months through most of 1938. Industrial production declined almost 30 per cent and production of durable goods fell even faster”. Unemployment jumped from 14.3% in 1937 to 19.0% in 1938, rising from 5 million to more than 12 million in early 1938.Manufacturing output fell by 37% from the 1937 peak and was back to 1934 levels. Producers reduced their expenditures on durable goods, and inventories declined, but personal income was only 15% lower than it had been at the peak in 1937. In most sectors, hourly earnings continued to rise throughout the recession, which partly compensated for the reduction in the number of hours worked. As unemployment rose, consumers' expenditures declined, leading to further cutbacks in production".

A few Graphs for illustration




2011 = 1938¿

As can be noticed, the 1937 brilliant cut ( it was a cut, not an increase of taxes) wiped out 2 years of unemployment reduction bringing back the figure to the 20% area. The figures beyond 1939 are irrelevant as the mobilization following the outbreak of WWII changed the rules of the game.

The risks of repeating 1937 1938 experiences are high which means social, economic and political devastating consequences. If history can teach us something, how can we explain the risk approach of policy makers? Given the timing and the nature of these measures, I cannot escape the thought that political decision makers are disproportionally prone to respond to any short term oscillations of financial markets. Personal interest? Class interest? Lack of intellectual skills? Opportunism? Just name it. An honest leadership with a longer run and civic perspective, and even with some “historic” touch would probably adopt a more human and economic measures.

Let us hope that 2011 does not turn into 1938, as the real risk is that 2012 would turn into1939.

The New Capitalism

These days financial European headlines are greener than ever : Capital Markets, the ultimate measure of all are once again traded in a relative high, following several weeks of rising prices.

The headlines of the last rally are accompanied with news concerning the lamentable situation of Greek finance, including the downgrade of its national debt to the worst investment category ( From bbb + to bbb - … something like that ) . Naturally a bad new which should remind us the gravity of the situation, so how it comes that a bad new brings the markets to new highs ? Have the markets gone crazy?

The explanation for the apparent inconsistency is our ( still ) deep public pockets as the Greek new “junk” status practically oblige the European Union and other international entities to “rescue” that country. The word rescue is somewhat misleading as we are not talking about an humanitarian cause but the handling of money so Greece can pay its obligations to foreign investors. Therefore the rise of financial markets is a confirmation for the new injection of fresh public money into the financial arena. Politicians are applauded by markets ….

Still, the celebration can be interpreted from a different perspective .Since the result of the rescue would be that the owners of the Greek debt ( which probably made a lot of money from these obligations) are not really punished for their errors , this sort of rescues undermine the foundations of the market economy ( Economists call it “Moral Hazard”) . This is the essence of what I call the New Capitalism , an economic system in which the detachment between risk and reward is bridged with public money. That system involves the allocation of wealth and welfare from the average citizen to the average investor ( and banker) , generally not the same average person. Anyhow it should be noted that Europe is not unique in the application of that distorted system. The inconsistency of those actions is even deeper if we consider that the New Capitalism is applied in a very selective way : The average citizen runs his life according to the the laws of the “Good and Old “ Capitalism of free markets and competition .The identification of the rescue of financial markets , (better put the holders of certain financial obligations) with “saving the economy” is pure demagogy .

The problematic rescue obliged politicians and markets to go through a preliminary “tough” game but by the end of the day the unconditional support or financial markets is clear and beyond any real question. Thus more rescues and public interventions are just a matter of time. Maybe the imminent rescue is a good news for the very short term, but from a wider perspective it allows to preserve the actual and distorted financial and economic practices that are the real cause behind the economic crisis. In a more financial jargon, the political establishment bought time with public funds until the next default/crisis, but the problems of the New Capitalism cannot be ignored forever.

Right Answer for the Wrong Question

Whoever wishes to understand modern politics or economics must stay tuned to America. Despite the fashionable talk about its imminent decline, America is still the most powerful nation on Earth which its influence goes far beyond “hard” power. Visible trends and even underground streams developing in America are the marking paths to be followed by the rest of the world, whether as a vulgar imitation or as a reference point. It´s just impossible to ignore America

Accordingly I think that the annual State of the Nation speech is an event worthwhile to follow. This week ( January 2010) President Obama launched his annual message with some intersting ideas . First of all , the President made the economic worsening situation of millions of citizens the first priority of his administration, in his own words :

“.....But the devastation remains. One in 10 Americans still cannot find work. Many businesses have shuttered. Home values have declined. Small towns and rural communities have been hit especially hard. And for those who'd already known poverty, life has become that much harder...”.

Such a description ( which nobody can ignore ) sounds as the preamble for a major economic initiative. Still, the President was much specific when he turned to deal with a much thorny issue , the balance of public accounts :

“[F]amilies across the country are tightening their belts and making tough decisions. The federal government should do the same. (Applause.) So tonight, I’m proposing specific steps to pay for the trillion dollars that it took to rescue the economy last year. Starting in 2011, we are prepared to freeze government spending for three years. (Applause.) Spending related to our national security, Medicare, Medicaid, and Social Security will not be affected. But all other discretionary government programs will. Like any cash-strapped family, we will work within a budget to invest in what we need and sacrifice what we don’t. And if I have to enforce this discipline by veto, I will. (Applause.)

Beyond the impressive rhetoric, any mainstream observer would notice the apparent incoherence between the two President´s messages : How this administration intends to create jobs while freezing public spending? Is the President adopting the classic laissez faire stance, counting on free market forces to turn around the situation? Is this an admission that the ultra expansionist policy with a record deficit of almost 10% out of US GDP and low interest rates had failed? Hard questions, big dilemmas....

Now, let me make it clear : the above “dilemmas” are typical mainstream questions which are drawn from a wrong analysis. The apparent dilemma between jobs and “fiscal responsibility” is an “issue” for those who consider the crisis as a deviation from a normal path. Under such a pespective , the economic system periodically staggers due to “exogenous shocks” ( such as the predatory habits if Wall Steet ..) and requires a temporal intervention . To put in it in a simple analogy ,the economy system is like an healthy person which suffers from a temporal disease and the job of the Doctor government is to apply the right dose of medicine. The dilemma is between the types of treatments, their intensity and the possible collateral damages.

Those who think that the actual crisis is a natural outcome of our economic system can be divided into two camps : right and left. The “Right” believes that tides are a normal behavior of a market economy and that the system is resilient enough to overcome the crisis. According to that view, public intervention just makes things worse since market is always smarter than bureaucrats. It is like adopting a “natural cure” attitude refusing to visit a doctor because “the body can heal itself”. These guys don´t understand the above “dilemma”. Mainstream observers consider that i the body cannot cure itself, the experiment can bring to a premature death ….what seems to be an interesting view might become a too risky option for the whole society.

The Left doesn´t consider any dilemma situation. view believes that crisis are a normal component of the economic system but not as a temporal “illness” but as a revelation of the inner contradictions and as a signal that things must change. In our case, I believe that the current crisis can accept only a Left interpretation . The crisis caused high unemployment and low capital utilization as a result of deficient demand ( sub consumption) . In simple words, the crisis is not because we, the economy, cannot produce more products but because there is not enough “money” around willing or able to buy what we can produce. How it comes? Doesn´t the market system balance between supply and demand? The economic system tends to concentrate wealth and consumption power too few hands. That creates a situation in which the economy is able to produce vast amounts of products, but since the majority does not have sufficient purchasing power, there is no buyer of these products , unless they are loaded with debt. Since the the only way “not to remain behind” is working harder or amassing debts

This is more or less what happened in the world economy in the last 30 years : a few Gates, Buffets and bankers earned millions and billions that cannot being spent. Their aim is not to spend that money but to accumulate more money ( Buffet is more than 80 years old and still hanging around, looking for new bargains) . The conclusion of such analysis is that only a redistribution of wealth and incomes can generate the demand to turn the wheels of the economy once again. The pathetic attempt to push the economy through bailouts , public spending or reducing interest rates to inflate financial and real assets is just a ideological fixation and will probably bring to a sovereign debt crisis ( the IMF is already warning) . The hole is too deep and the need to finance the public deficit brings back to the arena the cry for “fiscal responsibility”, but the error made by Obama and his Pseudo Keynesian advisors is to try and maintain the health of the public accounts through freezing, while the only available, logical and required step was to increase taxes on those wealthy people. Let us be clear : fiscal responsibility is not a monopoly of conservatives.....

Since US and the global economy are still , unfortunate, far away from such a “radical” idea ( not so radical as it is exactly how the American economy worked for almost 40 years after the Great Depression) , the crisis and its consequences, high unemployment, sluggish growth and poor horizons is what is expected from us , Courtesy from the “Change, Yes We Can “ President .

Income Distribution ,Bubbles and the Finacial Media

An interest comment regarding the link Debt Bubbles -Income Distribution is presented in this post
The text was published last week at the Financial Times (FT) website and it´s not more than an answer from FT Chief economic Commentator (M. Wolf) to a question raised by a reader. I found the text very interesting as it reflects a seemingly stubborn position of avoiding any serious debate on the above link or alternatively the reejction of any alterantive proposal on economic, political, “theoretical” or practical ground. M. Wolf´s text (FT) is followed by my comments to highlight the main issues in the text

FT : “I am not at all sure about the link between inequality and the bubble. I think that the growth of the financial sector played an important role in increasing inequality in the US and UK. It helped a very small proportion of the population to extract a large amount of rent.”

First of all we can notice that the rise in inequality is undeniable but the real denial is the link to bankers´ greed (the preferred scapegoat) rather than referring to a possible systematic flaw. A serious answer should point to the question of WHY the financial sector expanded to a degree it became a danger to the system and what interests that expansion served. Another interesting point is the irrelevant focus on national (“US and UK”) perspective: even FT agrees that the economic system and the crisis are global, so any economic analysis should be done also from a global perspective.


FT : “…But I am not sure about the reverse causal relationship from higher inequality to the bubble. The argument would, I suppose, be that, lacking higher incomes, a large proportion of the population borrowed in order to sustain consumption. This is possible. But I do not know of any convincing arguments for the proposition”.


The FT previous affirmative tone turns to a more skeptic when he refers to “the reverse causal” (from inequality to bubbles) ,Is it because this causation might oblige us to deal with systematic flaws? Anyhow, this causation seems to be treated as some curious and rather exotic perspective “ I suppose… This is possible… “ are expressions of not taking too seriously the argument. The commentator bothers to specify that “there is no convincing argument for the proposition…”, although a coherent exposition should tell the reader if there are also (not convincing) arguments against the proposition: Maybe there are no evidences against the proposition? Anyhow, there is no mention of any real study about the topic, a weird intellectual lacuna for a discipline like economics that investigates extensively almost any human and social phenomena. Very weird indeed.

FT : “…..In any case, whatever the causal relationship, I cannot see how a more equitable distribution of income would now help solve the crisis. I suppose one might argue that it would increase sustainable consumption, though consumption already looks excessive in the US.

Despite the admission of the ignorance about the topic (“whatever…”), there is no doubt about the conclusion, which is declared in an affirmative tone: “An equitable distribution would not help to solve the crisis”….. So we already admitted that we don´t really know (or pretend that we don´t know) ANYTHING about the issue but we DO know that the solution is not that redistribution ? Doesn’t sound very coherent….

FT ” …I think one would have to argue, instead, that greater equality is a good in itself. The big question is how one could achieve it. There are limits, I think, to how much redistribution one can achieve through the redistribution of pre-tax incomes. So the aim should be to alter the distribution of pre-tax incomes themselves. I know of no easy way to do this, certainly not in the short run”


Now we leave the economic arena to the philosophy realm: Even if we agree that a more equitable society is desirable (which is not an economic issue …), the technical obstacle would be a substantial impediment. Were technical considerations relevant when governments rushed to pour trillions of taxpayer money into failing financial institutions creating the worst moral hazard behavior? How it comes that technical aspects become important whenever we deal with distribution policies, even those considered logical ?And if a measure is right for its own merits, should the easiness of its implementation be an obstacle?

As we have seen along that post, the level of the debate got plenty of room for improvement. Anyhow, the evident attempt to avoid a serious debate on that matter is becoming an unsustainable tactic, so I guess the media and the establishment will intensify the arguments against the calls for a more equitable distribution. On my opinion, the income and wealth more equal redistribution is not only justified by moral foundation but is the only way out from the sub consumption crisis we are stuck in.

Financial Crisis and Wealth Distribution

It is commonly agreed that the detonator of the current crisis was the collapse of the credit bubble which have been developing since the 80. During that period the US Credit/ GDP ratio increased from a stable level up to 350% (a level not seen since the 30). The lion share of the debt increase was at financial institutions and households sectors

By definition debt is a temporal transfer of resources between a lender and a borrower .From the borrower side our approach claims that the debt expansion, especially of the American household sector, served to counterweight the detrimental effects related to the stagnation of the median household incomes on consumption (ap. 70% of GDP). The magnitude of the trend is reflected in the widening gap of income distribution since the 80 : just for the illustration , “Top 1% Pre Tax Income Share” ascended from 9% in 1976 up to 21.8% in 2005 ( the previous peak in 2008 was 23.9%). From the lender side, the vast accumulation of wealth among higher income stratus (Fed surveys show a rather high saving ratios among the higher quintile) was channeled to the financial markets and consumption (Corporations apparently did not need finance due to their positive cash position along the last decade). It seemed that the circle was squared: Stagnating labor cost combined with expanding consumption means higher profits.

An additional source of finance was the foreign sector as a result of their own lack of effective demand which obliged them to keep financing the US economy by purchasing American obligations. The case of China is interesting since the country development policy as the workshop of the world is based upon low labor cost , and high saving ratios which means weak internal demand (“Let some people get rich first“ Deng Xiao Ping ) The consequence was an inevitable accumulation of reserves (almost 2 Trillion USD as of 12/2008) much above the real needs of the economy.

At some point the scheme began to be sustained by increasing real estate prices (and low interest rates). The expectations served to guarantee mew mortgages ( which were packed and sold for a commission) and a source of wealth effect for the costumer reflected in wide use of MEW finance scheme which explains up to 3% of GDP growth since 2001 (J. Kennedy and A. Greenspan). Since the real economic yield of that scheme is rather low (analyzing the ROE in contrast ROA of investment banks for example) the huge leverage and lack of regulation was essential to maintain decent yields (and high bonuses for top managers) and to turn dubious debt into respectable stuff. The collapse of real estate values marked the beginning of the debt contraction (deleveraging) which sustained the consumption generator and the value of collaterals.

Public institutions are nowadays engaged in pouring trillions of public money on bailout plans for financial institutions, various industries, consumers, etc, and public projects to reactivate aggregate demand. Leaving aside the question regarding the effectiveness (and fairness!) of these efforts, the extra expense will be financed somehow and here the distribution specter returns to the debate. If we accept the basic lines of the above analysis, the reactivation of the economy must include a major income and wealth redistribution mechanism on global scale ( income redistribution on national scale is a close relative to protectionism) to ensure a lasting demand generation based upon sound economic principles.