The wisdom of Merton Miller

Here he is on the Great Depression:

Responsibility for turning an ordinary downturn into a depression of unprecedented
severity lies primarily with the managers of the Federal Reserve System.
They failed to carry out their duties as the residual supplier of liquidity to
the public and to the banking system. The U.S. money supply imploded by
30 percent between 1930 and 1932, dragging the economy and the price level down with it. When that happens even AAA credits get to look like
junk bonds.

That is from his Nobel Lecture in 1990. Yes, that is indeed the Nobel-winning Miller of Modigliani-Miller fame who spent most of his career at the University of Chicago calling for intervention by the Federal Reserve. Because he gets it: There is no 'non-intervention' by the Fed - monetary policy always is 'something and the market is freest and most efficient when it is predictable with regard to stabilizing the macroeconomic variables of interest.

Ironically, he did not think that Federal Reserve could fail again in similar fashion as it did during the Great Depression:

That such a nightmare scenario might be repeated under present day
conditions is always possible, of course, but, until recently at least, most
economists would have dismissed it as extremely unlikely.

Even Nobel-Prize winners can be wrong, I guess.

The Hunger Games are real...

What place has a capital (Capitol?) that is shut off from visitors from the surrounding districts by its security forces? A capital where the loyal elites get to enjoy games and wear colorful dresses for parades, while the workers in the surrounding districts are close to starvation as they produce the products that the central planners require? That world exists only in the Hunger Games...and in North Korea!

When the money goes down the rabbit hole

I recently read the great essay "Four Futures" by Peter Frase, in which he lays out a Marxian perspective on what kinds of societies might result in the future from the different combinations of resource scarcity or abundance, and egalitarianism or hierarchy. Quite interesting stuff, although I don't agree with most it.

However, I couldn't resist commenting on one part that directly relates to the title of this blog, where the author discusses the flow of money in the economy:

 The bourgeois elite of the present day does not merely enjoy privileged access to scarce material goods, after all; they also enjoy exalted status and social power over the working masses, which should not be discounted as a source of capitalist motivation. Nobody can actually spend a billion dollars on themselves, after all, and yet there are hedge fund managers who make that much in a single year and then come back for more. For such people, money is a source of power over others, a status marker, and a way of keeping score – not really so different from Doctorow’s whuffie, except that it is a form of status that depends on the material deprivation of others. ...But an economy based on artificial scarcity is not only irrational, it is also dysfunctional. If everyone is constantly being forced to pay out money in licensing fees, then they need some way of earning money, and this generates a new problem. The fundamental dilemma of rentism is the problem of effective demand: that is, how to ensure that people are able to earn enough money to be able to pay the licensing fees on which private profit depends.

"Oh, the trouble! Every year one exploits the masses in the production of gadgets and takes their money only to return next year and find out that they have no money left to buy the gadgets!" - That this problem is not actually one encountered in any capitalist societies even though the wealthy earn huge incomes that they don't spend on consumption, should tell us that something is wrong with Frase's idea of how money flows (and many modern Keynesians make the same mistake in their casual writing). Here is the rub: when the rich get all that money every year, there are three things that can happen.

 First, and most common, is putting the money in the bank or investing it. This makes the little green paper vouchers for output owned by the rich available for use by others in the present in exchange for the promise of future output vouchers (interest and principal repayments). No demand problem there.

Second, the rich could put the money under their mattress, where no one can access the little paper rectangles. This will result in a lower money supply in the economy, which will either be countered in the short run by the central bank by printing more money or prices will have to adjust downwards by means of retailers trying to get rid of their stock through discounts, until all of the output can again be sold at its nominal price tag. No aggregate demand problem there either. When the rich at some point in the future decide to take the money out from under the mattress, this whole process reverses, the central bank tightens or prices rise and all is as it was before.

Third, the rich could burn the money (those crazy hedge fund managers are capable of anything!). The result would be the same as in the second method above, without the part where the rich get to use the money in the future.

What is definitely not going to happen is that the money simply goes down the rabbit hole and takes the goods it could have bought with it, thereby somehow leading to "material deprivation" of others. If some money is not used to buy goods, then prices do the work of making sure everything gets sold for the little green pieces of paper that are actually circulating. In the long run, the wealth accumulation by the rich might actually be a boon to the economy as a whole! After all, if the rich are not consuming their share of output, they must be investing it, which raises future output and means that everyone else can consume more now and in the future. If it really were the case that we all "overconsumed" before the financial crisis, we should be grateful to the rich who "underconsume" and "overinvest" for makings sure we nonetheless invest in the future. Of course, that is a big "if" about the true origins of the crisis, but in this post I would prefer not to go down that rabbit hole...

Labor Theories of Value: Zombie Idea Edition

Two weeks ago, John Kay was arguing in the Financial Times that the orthodoxy on wages might be deficient. Here is how he describes the status quo:

Economics 101 teaches that earnings reflect marginal productivity. The wage equates supply and demand for each type of labour, just as the price of other commodities equates their supply and demand...[T]o set the earnings of any group at a level above the market rate is not only to reduce employment for that group but to undermine economic efficiency.

What is the alleged flaw in this textbook approach? The world is so "complex"...:

Complex modern production is undertaken in teams, and the make-up of an effective team is largely fixed by the nature of the production process. It is difficult, perhaps impossible, to attribute output meaningfully to any particular member. Individual rewards are largely determined by custom and hierarchy. And through a political process involving bargaining between shareholders and employees and among different groups of workers.

This is all pretty unsurprising: workers complement one another and politics sometimes intervenes in the wage-setting process. The implication of the first fact should be that it would be hard to determine theoretically what any one worker should earn and that we should leave that determination to the willingness of employers - who get to practically test that worker's contribution in the context of their respective work teams - to bid for the worker's services. Knowledge is complex and decentralized and  prices should therefore be set directly by the market. Conversely, this implies that a political  wage-setting process that sets the same wage across many firms might be unable to fully account for these complexities as it excludes any practical consideration of what the worker's productivity is in the context of the specific team and workplace that he is hired into. Leaving this complex calculation of marginal productivities to the employers most immediately concerned via the market wage for individual workers should get us as close as possible to an efficient allocation of workers into the work teams that Kay mentions.  Thereby we can maximise productivity and then we can use redistribution, perhaps via lump-sum transfers, to ensure that the fruits of this efficient process are given to those we deem deserving in a manner that does the least damage to the underlying productive process, right?

But John Kay, agreeing with UK Labor Party leader Ed Milliband, seems to draw the exact opposite conclusion:

Wouldn’t it be simpler if poor people in work were just paid more in the first place? That is, apparently, predistribution.

To recap: he argues that it is very complex, even for the employers of the workers in question to figure out what their marginal productivity really is and political distortions make this even harder. And the answer is to abandon market wages and rely on an even more politicized process led by people who have even less of an idea what the productivity of the workers is? Oh, and while you're at it, wages can only go up not down as a result of that process! Unless you're a chief executive that is, because although this is all really "complex", we are very certain that those guys have "excessive earnings",  because...well, John Kay says so.

So we would like to make most labor more expensive while making sure that global talent is less well-paid than elsewhere. Sounds like the secret formula for a healthy labor market and strong growth, doesn't it? Just look at Germany in 2003!

Tax evasion as an automatic stabilizer

A short while back, a lot of attention was given to disparaging comments made by Christine Lagarde about tax evaders in Greece. I certainly agree that tax evasion is an issue in terms of fairness, as it shifts the burden of funding the government budget from evaders to those who honestly pay their taxes and might render government attempts to shift behavior into certain directions, by taxing them differently, ineffective.

However, as far as macroeconomic stabilization is concerned, I am surprised that there is not more people who proclaim the virtues of tax evasion during a recession. Let me consider how economist of different convictions might think about tax evasion:

 On the one hand, those old-style Keynesians still out there should think of tax evasion as a kind of automatic tax cut in bad times. Assuming that workers are more likely to try to avoid paying taxes when times are bad or that the unemployed will look for black market jobs, the avoidance of tax in a recession should increase the government deficit and thereby stimulate the economy. At the same time, the marginal propensity to consume out of undeclared income is probably greater than out of declared income, as black market transactions tend to be handled in cash instead of being initially deposited into a bank account.

Supply-siders on the other hand should see this a victory for the Laffer curve: Tax evasion serves as evidence that high taxes might in fact lead to lower tax revenue due to distorting human activities away from the purview of the tax collector. Similarly, tax evasion should be more likely to occur in those parts of the economy where taxes are most burdensome and therefore serve to alleviate part of the distortions introduced by the government.

Even the market-monetarist should find something to delight in it: as workers can receive part of their compensation untaxed, they should be willing to work for lower wages and thus the downward adjustment of sticky wages should be accelerated by the tax evasion. In effect, the social norm that taxes may be avoided in bad times delivers the employer payroll tax cut that Scott Sumner, for instance, has advocated, but without having to go through the slow process of the legislature.

All things considered, the debate about tax evasion should be a lot more lively than it is, with supporters holding their own against detractors. I don't know why that is not the case. Is mood affiliation with the coalition against the thing with the bad name "evasion" the reason?

This all assumes that medium-term government debt stabilization is more easily feasible once the crisis is over and that the central bank does not actively try to sabotage the recovery, but those things are a given, right? Right?

Nobody produces in Shanghai anymore...

I enjoy reading articles that see the same phenomena that I am interested in though a different lens. Recently, I stumbled across just such a specimen in the form of Eli Friedman's essay "China in Revolt". It is an assessment of the current state of the Chinese labor movement, which has entered a new era of empowerment as the Chinese economy bumps up against the limit on growth imposed by increasingly scarce skilled labor:

Minimum wages are going up by double digits in cities around the country and many workers are receiving social insurance payments for the first time.
Labor unrest has been growing for two decades, and the past two years a-lone have brought a qualitative advance in the character of worker struggles.

Friedman supports this thesis with several stories of successful, albeit oftentimes violent, struggles by workers in various parts of China for higher wages, more rights etc. 

While this might sound like a success story for the proletariat, Friedman loses me on the almost comic attempt to paint this relentless march towards prosperity for the working class as just another Pyrrhic Victory:

Perhaps workers can win a wage hike in one factory, social insurance in another. But this sort of dispersed, ephemeral, and desubjectivized insurgency has failed to crystallize any durable forms of counter-hegemonic organization capable of coercing the state or capital at the class level.

...Capital, meanwhile, has relied on several tried-and-true methods to prop up profitability...

Within the factory, the biggest development of the past few years is one that will be drearily familiar to workers in the US, Europe, or Japan: the explosive growth of various kinds of precarious labor, including temps, student interns, and, most importantly, “dispatch workers.”

...But the big story in recent years has been the relocation of industrial capital from the coastal regions into central and western China.

Where Friedman paints the movement by capitalists towards employing more people in the Chinese interior as a desperate attempt to prop up a failing system, I see prosperity spilling over from one region into the next, as increasing wages and productivity in one part of China makes it increasingly worthwhile to complement the increasing focus of coastal workers on high wage and high productivity activities by moving some less-skilled jobs into poorer provinces where they still provide better opportunities to workers than the alternative of subsistence agriculture. 

While the labor movements in many countries often invoke the imagery of locusts moving on after a greedy feast when they speak about the global movement of capital, I think this completely misses the point that factory jobs spill over into other regions because of the high wages they have brought rather than the devastation.

I think the best way to think about the problem with the locus metaphor is through the paradox in the words of Yogi Berra:
"Noone goes there anymore. It is too crowded."

Moving on only makes sense for capitalists if the high wages in a place have made it relatively unsuitable for low-wage tasks required for some aspects of production. This is the result of too many capitalists trying to employ the inhabitants of a certain country or region and can therefore not coincide with capitalists having abandoned that same place to see it drop back into misery.

Why I am glad Facebook didn't create many jobs

Let's start with a good example what I mean when I say that "flows matter". Here is a piece by Ross Douthat on the Facebook IPO:

"By contrast, the more purely digital a company’s product, the fewer jobs it tends to create and the fewer dollars it can earn per user — a reality that journalists have become all too familiar with these last 10 years, and that Facebook’s investors collided with last week...The “new economy,” in this sense, isn’t always even a commercial economy at all. Instead, as Slate’s Matthew Yglesias has suggested, it’s a kind of hobbyist’s paradise, one that’s subsidized by surpluses from the old economy it was supposed to gradually replace."

 What is it that makes people so easily miss the ball whenever they talk about money flowing (or not flowing!) somewhere? I will argue that both, the concern about few jobs and few dollars earned by Facebook are not just inconsequential but in fact get things exactly backwards:

The fewer jobs the better

Material prosperity is the result of high productivity - being able to make a lot more stuff with the people you have or, equivalently, to make the same amount of stuff with less people, releasing some of that labor to do some other useful thing.

So when Douthat says that Facebook entertains hundreds of millions of people while hogging "fewer jobs" of the general economy in the process, I say hooray! Lots of people happy and very little resources used for it!

To put it differently, most economies don't have any trouble creating jobs. The problem is creating productive jobs. To bring in some of my background: East Germany was terrific at creating jobs. Everyone was employed who wanted to be employed (and some even if they didn't). Unfortunately morale, technology, incentives etc. (not the place for the socialism debate right here) were not so great and so East Germany had fallen behind to less than half of West Germany's per capita income at the time of reunification in 1990. To get back to Facebook: it is easy to create jobs where people do nothing productive. It is hard to produce a lot with very few people. Being able to do the latter is the reason many in the Western world live lifes in abundance and Facebook seems to be doing its part.

Making no money is good for society

This point links in with the argument I just made: Facebook seems to take in very little real resources as payments from its consumers for the services it provides. Absent strogn evidence that Facebook is somehow secretly harming   its users, I would say that points to a fairly high consumer surplus. Can you imagine an interactive anything in the 1980s that would allow you and your friends to use it for free 24 hours a day? I would say Facebook definitely created value. The question is whether it is able to capture a large part of it. Low (zero?) marginal cost of adding another user and the competitive nature of the social media market (think Google+) means that Facebook is having to give up a lot of the surplus in favor of its users. Following the flows of money in this calculation is of no import: who cares about the flow green paper if there is happiness to be had?

In conclusion, Facebook offers a free product (I guess one could talk about how we pay with our "attention span" but set that aside for another debate) and uses very little human resources - people - to do so. March on towards utopia, comrades!

It flows...

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