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!