Ages of American Capitalism (part 5)

July 13, 2021

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Continuing with the last of Jonathan Levy’s four ages, the “Age of Chaos,” I turn now to the present century and the period including the Great Recession of 2007-2009, the worst economic crisis since the Great Depression. Someday, Americans may look back and see it as the start of a new era in economy and government. So far, however, Levy observes mostly continuity since 2009, and not the new “democratic politics of capital” he would like to see. More on that later.

The “Great Moderation”

In 2004, Ben Bernanke, a governor of the Federal Reserve who would later become its Chair, used this term to describe the economic stability he believed had been achieved. (If this sounds familiar, I recently described Binyamin Appelbaum’s take on the “Great Moderation” in my third post about The Economists’ Hour.) At the time Bernanke was speaking, there had been only 16 months of recession in the previous 21 years. He credited this achievement especially to sound monetary policy, tight enough to control inflation but flexible enough to alleviate recessions by lowering interest rates as needed. Bernanke’s views expressed the capitalist confidence of the time—not only in the stability of the currency, but in the continued growth of economic demand and corporate profits.

Profits were growing rapidly in the 2000s; the bad news was that few of the economic benefits were reaching the average worker. Labor’s share of the national income was plummeting. Levy attributes that to another “credit-fueled and asset-priced” expansion, “which distributed, logically enough, more money to the property owners of assets, rather than to working people.”

Levy then provides a global perspective on this uneven expansion. Much of the world was experiencing an economic boom, but with some noteworthy imbalances. Manufacturing was booming in developing countries with historically low wages, led by China. Other developing economies prospered by meeting the increasing global demand for commodities like oil or iron. Countries of the new European monetary union were expanding their global financial services. The United States contributed a boom in housing and consumption heavily fueled by debt.

The relationship between the U.S. and China was pivotal. China’s communist leaders chose to save and invest much of the revenue from manufacturing exports. While holding down wages and consumption at home, they invested heavily in the United States, in effect financing the soaring U.S. trade deficit. (The federal budget also went from surplus to deficit as the George W. Bush administration cut taxes but increased military spending after 9/11)

The Federal Reserve had lowered interest rates as the economy slowed in 2000-2001. Now the combination of lower-cost loans in the U.S. and capital reinvested by the Chinese produced a “liquidity glut.” That fueled a speculative bubble in U.S. assets, especially housing. The moderation described by Bernanke gave way to a period of speculation and volatility, leading in a few years to financial breakdown.

Sources of profit

Levy does not claim that the American economy of the new millennium was based on speculation alone. Real businesses produced real goods and services and earned real revenue. Internet companies—so many of which had failed in the dot-com bust of 2000—were finding ways to become profitable. One way was to collect massive amounts of user data and sell it to marketers, as Google and Facebook did. Another was to gain a huge advantage over the competition by developing an especially powerful marketing platform, as Amazon did. Levy notes that such business concentrations challenge the thinking of the Law and Economics movement, which had weakened antitrust enforcement on “the assumption that short-term, rational profit maximization among firms would always increase competition to the benefit of all consumers.” One reason why labor’s share of national income declined was that big companies in highly consolidated industries had more power to set wages.

The benefits of the new economy were distributed unevenly, not only because of the growing power imbalance between business and labor, but because of the increasing premium placed on education and skills. The wage gap between college-educated and non-college-educated workers widened. Geographical disparities were also evident, as centers of technological innovation like Silicon Valley flourished, while old manufacturing cities and many rural areas declined. Unemployment remained stubbornly high in what was called a “jobless recovery,” since high-tech industries didn’t employ enough people to compensate for the decline in manufacturing employment. What job growth did occur was more in low-wage services.

A serious underlying problem was that the growth in profits was outrunning the growth in investment and productivity. Levy says that “productivity growth in general disappointed because few potentially productivity-enhancing innovations appeared.” Economic rewards flowed to the owners of intellectual capital (“Big Data”) and human capital (education), but not to enough workers. The investments that might have enhanced the productivity of ordinary workers were not, for the most part, forthcoming. But consumption could still grow if those with stagnant wages could compensate by assuming more debt. That’s where the liquidity glut came in, making it easier to extend debt to people at many income levels. That’s how the expansion of the 2000s turned into the great housing boom of 2003-2006.

U.S. housing prices shot up. Through a “wealth effect,” capital gains on leveraged property ownership could translate into new incomes for American homeowners. The housing stock thus became a new personal income flow. The age’s capitalism of asset price appreciation had found a new asset class to concentrate on, as many ordinary homeowners were given the chance to participate in the game of credit-fueled asset price appreciation. As in credit cycles before, it only worked so long as confidence was maintained, and prices kept going up. That was what the Great Moderation had come to depend on.

In booming cities, residential construction and home prices surged because of increased demand and short supply. But they could flourish in more depressed areas too because of riskier subprime mortgage loans (often with initially low but potentially very high rates). President Bush boasted about the “ownership society,” where ownership of a wealth-producing asset was open to all. The financial services industry constructed a $4 trillion pyramid of mortgage-backed securities on shaky ground. The securities became farther and farther removed from the real financial state of the borrowers and the affordability of the loans. Big banks created various classes of mortgage-backed securities, combined them in complicated ways until rating agencies underestimated their true risk, and even had them backed by insurance companies that also misjudged them.

Levy regards the economic expansion of the 2000s as a “wasted opportunity to make broad-based investments in economic life.” Too many dollars flowed into speculative real estate investments, based on the assumption that home prices would continue rising and workers with stagnant wages could make the payments on their subprime, adjustable mortgages. Meanwhile, “the alarm kept sounding that man-made climate change required long-term fixed investments in a new energy system to capture and reduce carbon emissions.” And climate change was not the only pressing national need being neglected.

The Great Recession

I have discussed the 2008 financial crisis and the associated recession many times, most recently in my summary of The Economists’ Hour, part 3. Levy’s interpretation is based on his understanding of the dynamics of capitalism, including the long-term, linear trend of technological advance and the shorter-term cycles of confidence and credit. The crash of 2008 marked the end of a particularly speculative credit cycle, when a liquidity glut suddenly gave way to a liquidity shortage.

The expansion of the 2000s came to depend heavily on the housing boom, which depended in turn on the extension of credit to home buyers whose low incomes limited their ability to repay the kinds of subprime, adjustable-rate mortgages they were getting. The risks were disguised by complex and overrated securities based on those mortgages. As long as buyers kept buying and confidence in rising home values remained high, the boom could continue. When housing prices peaked in 2006 and loan defaults increased, the bubble burst. Mortgage-backed securities suddenly lost value, and investment banks whose balance sheets were loaded with them could no longer raise cash either by selling them or borrowing against them. The collapse of Lehman Brothers in September 2008 triggered a massive contraction of credit.

Nervous, precautionary hoarding among the global owners of capital broke out on a massive scale. Capitalism regressed back to where it was during the Great Depression of the 1930s—mired in a liquidity trap. Across the board, spending of all kinds, whether for investment or for consumption, dropped off. Employment collapsed.

The “ownership society” celebrated by President Bush, in which Americans would prosper together by owning rapidly appreciating assets, had failed. “Due to collapsed housing prices, between 2007 and 2010 median wealth declined 44 percent—back, adjusted for inflation, to where it had been in 1969.” (That large a drop may sound hard to believe, but a family with a $300,000 home and a $250,000 mortgage has only $50,000 in equity, which drops by 44% if the house loses just $22,000 in market value. Many families have little net worth outside of their home.)

What was different in this financial panic was that the federal government quickly intervened to restore liquidity. The standard procedure of cutting interest rates to ease borrowing and expand the money supply was not enough. In addition, the Federal Reserve arranged and subsidized the buyout of investment bank Bear Stearns by JP Morgan. It made a large loan to AIG, the largest insurer of mortgage-backed securities. The Troubled Asset Relief Program (TARP) authorized the Treasury to buy “toxic assets” that companies could not otherwise sell. (Actually, Treasury injected the cash mainly by purchasing non-voting stock in the companies.) In 2009, the new Obama administration got Congress to pass the American Recovery and Reinvestment Act, which stimulated the economy with tax cuts, aid to states, infrastructure projects and government research programs. In 2010. the Federal Reserve adopted its policy of “quantitative easing,” buying up long-term Treasury and mortgage bonds in order to bring down long-term interest rates. (The higher the demand of lenders for bonds, the easier it is for borrowers to borrow at low rates.)

Although these measures alleviated the immediate crisis, economic recovery was slow. Little was done to prevent ten million homeowners from losing their homes to foreclosure. Nevertheless, a new conservative movement, the Tea Party, formed around the complaint that the Obama administration was doing too much to help “freeloaders” and not enough for “hardworking Americans.” Rather than rallying around Obama as earlier generations of Americans had rallied around Roosevelt, a substantial segment of the electorate still wanted less government, not more.

The limits of reform

On the other hand, Barack Obama was no Franklin Roosevelt either. He filled his administration with leaders associated with the moderate Clinton administration—economic thinkers who had trouble thinking beyond the restoration of financial stability. The Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) tightened regulation on the big banks and securities ratings agencies. But unlike Roosevelt, Obama didn’t have the benefit of many years of more sweeping proposals—in FDR’s case from the Populist and Progressive movements—and a public that was willing to try them. Even Obama’s rather moderate proposal for subsidized health insurance stirred up ferocious opposition.

Levy regards the Obama years as another lost opportunity. Because government could borrow money at near-zero interest rates, it was a great time to consider bigger public initiatives:

[M]any productive opportunities for spending cried out: to repair public infrastructure on dilapidated roads and bridges, to lay the foundations of a “green” energy grid, to invest in productivity-enhancing technology, or to support early childhood education to reverse the drastic effects of education gaps in the future labor market, to name some obvious candidates.

After Levy wrote those words, Joe Biden proposed such an ambitious agenda. But what Levy observed in the aftermath of the Great Recession was a “Great Repetition,” another expansion led more by asset speculation than by productive investment. This time it was an expansion of corporate debt that led the way.

Levy observes that each transition from one age of capitalism to another has required some form of state action. The victory of the Republican Party in 1860 and the Civil War ushered in the Age of Capital, as the nation transitioned from an agrarian economy based on land and slaves to a manufacturing economy based on steam-driven machinery. Then in 1932, the New Deal ushered in the Age of Control, as government tried to guide the economy with regulation, income supports, and fiscal or monetary policies to counter extremes of the business cycle. The “Reagan Revolution” of 1980 reacted against the reliance on government in the Age of Control and initiated the Age of Chaos.

A new age of capitalism—which Levy does not name and does not yet exist—would require more than an income politics focusing on the distribution of the benefits from capitalism. It requires a “democratic politics of capital,” giving citizens a voice in directing capitalist investments toward socially useful ends. Traditionally, government has directed investment primarily to wage war and maintain a military-industrial complex. Otherwise it has left major investment decisions to the private sphere and the owners of capital, who waste too much capital on short-term speculation. Now other urgent national needs may call for an expanded conception of public investment. Levy would probably like Biden’s concept of “human infrastructure.”

Readers who are not put off by the length of this book will find it historically informative and intellectually challenging. I highly recommend it.

Ages of American Capitalism

June 24, 2021

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Jonathan Levy. Ages of American Capitalism: A History of the United States. New York: Random House, 2021.

I found this book to be a remarkable work of economics and American history. A lot of economics consists of ahistorical models intended to describe economies in general but no one time and place in particular. Such abstract models are useful tools, but need historical context to bring them to life. On the other hand, many historical accounts do not demonstrate a very good grasp of economic principles. Jonathan Levy is one of those rare scholars with both a fine command of historical facts and great insights into the workings of capitalism. The fact that he has accomplished this at an early stage of his career is all the more impressive.

I cannot do justice to the entire book (over 900 pages long with notes and index), but I will discuss selected chapters. Here I start with the Introduction, which sets forth Levy’s assumptions about the nature of capital and the capitalist economy.

Capital and capitalism

Levy presents three main theses, the first of which is:

Rather than a physical factor of production, a thing, capital is a process. Specifically, capital is the process through which a legal asset is invested with pecuniary value, in light of its capacity to yield a future pecuniary profit.

The first things that come to mind when one hears the word “capital” may be capital goods like the steam engine, which Levy describes as the most important capital good of the Industrial Revolution. But capital is anything that can generate a return greater than its cost. That includes financial capital like stocks and bonds, intellectual capital like software and data, or human capital like educational credentials. In the antebellum South, slaves were the most valuable capital, more costly in total than southern land or northern factories. Many forms of capital produce marketable goods, but capital assets can also appreciate in value while not producing anything at all. What capital assets always have is some “scarcity value” because some people own more of them than others. Those owners are, of course, the people we call capitalists.

Levy defines a capitalist economy as “one in which economic life is broadly geared around the habitual future expectation that capital assets will earn for their owners a pecuniary reward above their cost.” The term expectation is key. A future reward is always uncertain, since it depends on the “flow of historical events.” What drives capitalism is investment, and what drives investment is confidence in some future. Andrew Carnegie could only sink massive quantities of financial capital into steel mills if he believed in the future demand for steel. In the twentieth century, when the economy produced far more consumer goods, business confidence became more dependent on consumer confidence, which depended in turn on consumer income and its security. People can buy more if they have a reliable income and are confident they can make next month’s rent.

Another important form of confidence is faith in the value of the nation’s currency, especially on the part of financial investors. Lenders would like to know that the dollars they lend will come back to them—with interest or dividends, of course—in dollars that have retained their value. They want the government to maintain the scarcity value of money through relatively tight control of the money supply. A challenge for monetary policy is to maintain the confidence of lenders while allowing the money supply to grow along with the expansion of domestic product and commerce. “Because a capitalist financial system is a perpetual leap of faith, over and over again, confidence becomes the emotional and psychological mainstream of economic activity.” The corollary to that proposition is that every financial crisis is a crisis of confidence. That’s why financial crises have often been called “panics”.

I would add that capitalism may require a modern culture that encourages faith in a worldly future, one imagined as better than the present. That view is in contrast to a static conception of life or a preoccupation with an otherworldly afterlife. (Although that is a secular vision, the historical religions of Judaism and Christianity may have prepared the way with their belief in a future “promised land.”) Interest in a worldly future was a feature of the Enlightenment, and one of its proponents was Adam Smith, a major figure in the Scottish Enlightenment and the father of classical economics.

Profit motives in political and social context

The second of Levy’s three theses is:

Capital is defined by the quest for a future pecuniary profit. Without capital’s habitual quest for pecuniary gain, there is no capitalism. But the profit motive of capitalists has never been enough to drive economic history, not even the history of capitalism.

The pursuit of profit, while central to capitalism, is normally part of some larger project. Henry Ford had a vision not only of selling automobiles, but of helping create a society of mass production, consumption and leisure, a vision he got partly by reading Emerson. He also rather heavy-handedly imposed a vision of the ideal worker, characterized by self-discipline, sobriety and frugality and enforced by visits of company representatives to workers’ homes. In an earlier time, southern plantation owners were motivated by white supremacy as well as economic profit. Among the many ill-gotten gains were sexual privileges for white males.

Major developments in capitalist history have been political as well as economic projects. When the Republican Party came to power in 1860, its political agenda included stopping the spread of slavery into the West, thus both striking a blow for free labor and undermining the value of slave capital. Republicans also supported the Homestead Act of 1862, which made 160-acre plots of federal land available for western settlers. Since farmland was also a form of capital, this was a contribution to a democratic “politics of capital.” But that was before the huge concentrations of capital in the latter part of the century. As the nation industrialized and urbanized, and mechanization reduced the need for farm labor, the portion of the population that could own land or businesses declined. Political debate eventually came to focus more on a “politics of income.” The New Deal was a political project with large economic implications, as the Roosevelt administration tried to boost incomes by supporting job creation, labor unions and the ideal of the male breadwinner. The “Reagan Revolution” of 1980 was a very different political and economic project, turning away from the democratic politics of income to provide more support for capitalists in the form of reduced taxes and regulation. These interconnections allow Levy to assert, “The history of capitalism must be economic history but also something more.”

Economic growth and the liquidity problem

Levy describes capitalism as having two different dynamics related to time. The first is a long-term, linear pattern of economic growth, driven by technological improvements and increases in productivity. The second is a cyclical pattern of boom and bust, driven by fluctuations in confidence that affect lending and investment. That brings us to Levy’s third thesis:

The history of capitalism is a never-ending conflict between the short-term propensity to hoard and the long-term ability and inducement to invest. This conflict holds the key to explaining many of the dynamics of capitalism over time, including its periods of long-term economic development and growth, and its repeating booms and busts.

The key concept for understanding these dynamics is liquidity. The capitalist economy needs liquid assets, which are assets that hold value but can also be readily exchanged for other assets. Cash is the best example, but financial assets that are easily traded, like Treasury bills, also qualify. But here’s the other side of the coin, no pun intended. For capitalism to work, someone must invest in “relatively illiquid factors of production,” like factories! Up to a point, liquid and illiquid assets work together in capitalism. One kind of liquidity is transactional liquidity, which means that buyers have the cash to buy the products that a capitalist enterprise produces when it invests in the (illiquid) factory or other capital goods.

In other ways, liquidity can be the enemy of long-term investment. In the case of precautionary liquidity, people hoard capital because of a lack of confidence in the future. They are reluctant to invest because of a fear of losing their money. In the case of speculative liquidity, capitalists maintain a large cash position so they can jump in and out of short-term investments, seeking the quickest return. The day trader buys stocks in the morning and sells them in the afternoon, ready with the cash to repeat the process tomorrow. (That works best when prices are generally rising, but as they say, you should never confuse genius with a bull market.)

Historically, investment booms have usually involved both long-term fixed investment and shorter-term speculative trading. When speculation bids assets up to unrealistic levels, the cycle ends in an economic bust, at which point the loss of confidence discourages investment and encourages precautionary liquidity. At the beginning of a boom, confidence is high, based initially on some realistic expectation of production for profit. But the accumulation of profits finances a speculative frenzy, ending ultimately in a crisis of confidence—a panic—and an economic contraction.

In Chapter 7, for example, Levy describes the railroad boom of the 1860s, which ended in the Panic of 1873. Building railroads for steam-powered trains was a pretty good idea, especially to move agricultural produce from midwestern farms to eastern cities and ports. It was a political as well as economic project, with the federal government chartering railroad corporations and granting them millions of acres of land. Soon, however, railroad entrepreneurs—most notably Jay Gould and Cornelius Vanderbilt—were speculating in railroads as well as building them.

Why go through the time, hassle, and uncertainty of actually building a railroad and running it on a profitable basis when credit was readily available (for these men at least)? If the right rumor gripped the trading floor, they could turn a fast buck through leveraged speculation on a financial asset, without ever having to part with liquidity, and put capital on the ground where it became a fixed, running cost.

Notice that this was “leveraged speculation.” The most lucrative way to speculate is to make money with borrowed money (just as a home buyer can do by making only a downpayment, but immediately getting the right to any appreciation). But when doubts appear that a boom is sustainable, credit dries up, debts are called in, and panic-selling devastates asset values. In the Panic of 1873, which began with a credit crunch and higher interest rates in Britain, railroad stocks lost 60% of their value, and half of American railroad corporations went bankrupt. That same year, by the way, Mark Twain and Charles Dudley Warner gave the era its name when they published The Gilded Age.

Similarly, the “greatest leap forward in productive capacity in world history” occurred when Henry Ford introduced his moving assembly line in 1913—another useful idea, although not much loved by those who had to work on it. But this was quickly followed by the frenzied stock market speculation of the 1920s, the crash, and the Great Depression of the 1930s. Most recently, the housing boom of 2003-2006 turned into the Great Recession of 2007-2009.

The “key economic problem,” according to Levy, is the perennial weakness of investment resulting from the hoarding of capital for purposes of precautionary or speculative liquidity. He sees this as an especially acute problem in our economy today. The assumptions he lays out in this Introduction—a broad definition of capital, a conception of motivation that includes but goes beyond financial profit, a conviction that economics and politics are always intertwined, an appreciation of the importance of expectations and confidence, and the tension between some forms of liquidity and long-term productive investment—enable Levy to tell the story of American capitalism in an exciting and insightful way.

Levy’s main message is that a capitalist economy is not a standalone machine that automatically produces general prosperity if it is left alone, as some economists in the neoclassical tradition still teach. Rather he says:

History does not confirm the belief in the existence of some economic mechanism through which the pattern of capital investment will simply lead to the best possible outcome so long as it is not interfered with. One likely outcome, among others, is that the propensity to hoard will win out, exacerbating inequality and crippling economic possibilities. As the profit motive is not enough, a high inducement to investment must come from somewhere outside the economic system, narrowly conceived. History shows that politics and collective action are usually where it comes from.

In other words, getting the economy to work for all of us is a continuing challenge for society in general, and democratic politics in particular.


The Technology Trap (part 2)

August 10, 2019

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Carl Benedikt Frey uses the distinction between labor-replacing and labor-enabling technologies to explain why industrialization can have quite different short-term effects on jobs, wages, and the demand for labor. The Second Industrial Revolution did more than the first to raise labor demand, create good jobs, and increase labor’s share of national income. Here I will take a closer look at that process for the United States in the twentieth century.

New technologies

Based on the research of Michelle Alexopoulos and Jon Cohen, Frey identifies electricity and the internal combustion engine as the most important general-purpose technologies of the Second Industrial Revolution. Both originated in the late nineteenth century but were widely applied in the twentieth. Both were essential to what became the country’s largest industry by 1940, automobile production.

A distinct “American system” of manufacturing was substantially boosting productivity by the 1920s. The model-T Ford was the first product to be assembled without any hand labor for fitting pieces together, since machine tools could now produce completely standardized and interchangeable parts. Another innovation was “unit drive”–machines with their own electric motors–which “allowed factory workflows to be reconfigured to accommodate assembly line techniques, as machinery could now be arranged according to the natural sequence of manufacturing operations.”

Electricity also enabled the production of new home appliances, “such as the iron (first introduced in the market in 1893), vacuum cleaner (1907), washing machine (1907), toaster (1909), refrigerator (1916), dishwasher (1929), and dryer (1938).” These time-savers made it easier for women to enter the labor force, earning money with which to buy more of the products being made.

The internal combustion engine revolutionized transportation, as the share of households with cars went from 2.3% in 1910 to 89.8% in 1930. The share of farms with tractors went from 3.6% in 1920 to 80% in 1960. The Federal Aid Highway Act of 1956 created better highways for cars and trucks to travel. Economists have attributed over a quarter of the increase in productivity between 1950 and 1970 to spending on highways.

Frey summarizes:

America’s great inventions of the period 1909–49 were predominantly of the enabling sort. Some jobs were clearly destroyed as new ones appeared, but overall, new technologies boosted job opportunities enormously. Indeed, gigantic new industries emerged, producing automobiles, aircraft, tractors, electrical machinery, telephones, household appliances, and so on, which created an abundance of new jobs. Vacancies rose and unemployment fell as the mysterious force of technology progressed.

Wages and working conditions

In general, wages rose along with productivity from 1870 to 1980. Since this hasn’t been true throughout history–and especially not lately–we have to say that rising productivity is helpful but not sufficient to produce wage increases. Frey suggests that concerns about worker turnover were one motive for employers to raise wages. “[T]he assembly line could be slowed if an experienced worker quit and was replaced by someone who could not initially keep pace.” Keeping labor peace in the face of worker organization and agitation was another motive.

A democratic society can also legislate on behalf of workers, especially if middle-class voters identify with their concerns. That was more the case during the Great Depression, when New Deal legislation supported worker interests. The National Labor Relations Act of 1935 guaranteed the right to organize and bargain with management, and the Fair Labor Standards Act of 1938 defined the standard work week as 40 hours and required employers to pay overtime for additional hours.

New technologies also created safer and less physically demanding workplaces. “Machines meant the end of the most hazardous, dirty, and backbreaking jobs,” and disabling injuries were cut in half. “Belts, gears, and shafts [of the pre-electric factory] were the main sources of factory accidents, posing a constant danger to workers’ fingers, arms, and lives.”

The “Great Leveling”

In retrospect, the twentieth century up until about 1980 is noted not only for its greater prosperity, but its reduction in economic inequality. Inequality had increased between the American Revolution and the Civil War, as artisan jobs had been lost to factories, large fortunes were being amassed, and large wage gaps had opened up between the most successful urban workers and the masses of poor people both on the farms and in the cities. The late nineteenth century is, of course, known as the “Gilded Age” for its conspicuous consumption by wealthy capitalists.

The twentieth century was different:

As Americans in the middle and at the lower end of the income distribution became the prime beneficiaries of progress, inequality went into reverse. Along with every other industrialized nation, America saw the share of income accruing to people at the top, fall.

Here, explanations differ. Thomas Piketty has argued that the general trend of capitalism is toward greater inequality, and it takes some unusual shock to the system to interrupt that process. As summarized by Frey:

In Piketty’s world, there are no forces within capitalism that serve to drive inequality down. From time to time, however, macroeconomic or political shocks may disrupt the normal equilibrium. Two world wars and the Great Depression served to destroy the riches of the wealthy.

Without denying that such shocks have played a role, Frey does see forces within capitalism to generate equality, the first of which is investment in labor-enabling technologies. That creates the potential to empower and enrich workers. A high rate of unionization is helpful for realizing that potential. Beyond that, workers must be able to keep up with the skill demands of new technologies.

“The leading explanation for the great leveling comes from pioneering work by Jan Tinbergen that conceptualized patterns of inequality as a race between technology and education….” The enabling technologies of the twentieth century favored more skilled workers. Jobs like mechanic or electrician paid well, but only for those who had the skills to do them. Semi-skilled assembly-line work could also pay pretty well, for workers with the discipline, stamina and dexterity to keep up. That could have created a wide gap between a skilled few and the unskilled many, except for the fact that so many workers were acquiring at least the basic skills they needed for an advanced industrial economy.

[E]ven if technological progress favors skilled workers, growing wage inequality does not have to be the result. The return to human capital depends on demand as well as supply. As long as the supply of skilled workers keeps pace with the demand for them, the wage gap between skilled and unskilled workers will not widen. While a number of short-run events and government interventions contributed to the great leveling, the most pervasive force—and certainly the best documented one—behind its long-run egalitarian impact was the upskilling of the American workforce, which depressed the skill premium.

The percentage of young people who completed a high-school education went from 9% to 40% just between 1910 and 1935, and proceeded upward from there.

The combination of enabling technology and a more skilled population created the largest middle class the country had ever seen. But that made the shrinking of the middle class that occurred after 1980 all the more surprising and alarming. Frey calls this the “Great Reversal,” and that is the topic of the next post.


The Technology Trap

August 9, 2019

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Carl Benedikt Frey. The Technology Trap: Capital, Labor, and Power in the Age of Automation. Princeton: Princeton University Press, 2019

Economic historian Carl Frey deepens our understanding of the current technology revolution by comparing it to previous technology-driven transitions. Although the author is perhaps best known for his estimate that 47% of American jobs are vulnerable to automation, his general view is fairly optimistic. He does not doubt the long-run benefits of the Industrial Revolution, which has doubled per-capita income every 50 years since 1750. He expects similar benefits from the new digital technologies, eventually. But he is concerned about the loss of jobs due to automation and the resistance to change it may generate.

Two sides of technology

For many years, the conventional wisdom in economics was that new technologies create as many jobs as they destroy, and do so fairly quickly. More recent thinking distinguishes two different effects of technology, either of which may dominate.

The extent to which labor-saving technologies will cause dislocation depends on whether they are enabling or replacing. Replacing technologies render jobs and skills redundant. Enabling technologies, in contrast, make people more productive in existing tasks or create entirely new jobs for them.

A classic example of a replacing technology is the early industrial power loom, which replaced the hand loom for weaving cloth and put a lot of weavers out of work. An example of an enabling technology is an X-ray machine, which improves a physician’s ability to diagnose disease.

Which side of technology is more prevalent has implications for labor demand, wages, and the share of national income going to labor as opposed to capital.

If technology replaces labor in existing tasks, wages and the share of national income accruing to labor may fall. If, in contrast, technological change is augmenting labor, it will make workers more productive in existing tasks or create entirely new labor-intensive activities, thereby increasing the demand for labor.

Just because a technology is available does not mean that people will want to adopt it. That depends on how they expect it to impact their income. And since different groups can be affected differently, technological change depends on who stands to gain or lose and the distribution of power among competing interests.

Technology traps

Societies fall into a technology trap when they are unable to implement a potentially useful technology due to social resistance. Frey uses the term mainly in reference to preindustrial societies, although he fears that we could fall into a similar trap today. “One reason economic growth was stagnant for millennia is that the world was caught in a technology trap, in which labor-replacing technology was consistently and vigorously resisted for fear of its destabilizing force.”

During the period that he calls “The Great Stagnation,” the problem was not so much that innovations didn’t appear, but that people lacked the incentive to implement them, especially for purposes of saving labor in economic production. He characterizes the Renaissance as both a cultural movement and “a force of profound technological change,” but a period with “plenty of imagination, but little realization.” One reason why industrialization didn’t occur earlier than it did was that landed elites were living comfortably off cheap labor they controlled, and had no interest in seeing them go to town to work in a factory. In the late eighteenth century, 96% of the world’s population were slaves, serfs, servants, or vassals. Many monarchs also preferred the status quo to the uncertainties of a social upheaval.

The fear among the ruling classes that labor displacement would cause hardship, social unrest, and at worst a challenge to the political status quo meant that worker-replacing technologies frequently were resisted or even banned. This dynamic, in which the politically powerful had more to lose than they could gain from progress, kept the Western world in a technology trap where technologies that threatened people’s skills were forcefully resisted.

Who gained from industrialization?

When the Industrial Revolution did begin in Britain, it was in someone’s interest to make it happen.

The hegemony of landed wealth was challenged by the mobile fortunes of merchants, who came to form a new industrial class with growing political influence. The mechanized factory was deemed critical to Britain’s competitive position in trade and thus to merchants’ fortunes, which its government would do nothing to jeopardize.

The position of the merchants was strengthened by profits from the Atlantic trade, which were not as monopolized by royal trading companies as they were in other parts of Europe. Merchants also got some support from a stronger Parliament, after the Civil War and the Glorious Revolution. “In eighteenth-century England, the polity and judiciary, which had previously supported the cause of workers and guilds and opposed replacing technologies, began to side with the innovators.”

At first, industrialization benefited neither the artisans who had been spinning, weaving and sewing in cottage industries, nor the workers in the early textile mills. The main effect of innovations like the spinning jenny and the power loom was to replace skilled artisan labor with something cheaper. The new factory jobs paid less, required less skill, and were done by children about half the time. It took about seventy years, from about 1770 to 1840, before the British working class started to share the benefits from industrialization. But they were helpless to stop the process because of their weak political position. In 1769, Parliament made it a capital crime to destroy machinery, as some protesters had been doing.

The situation during the “Second Industrial Revolution,” when the United States emerged as the leading industrial power, was very different. Here Frey says that the new technologies, especially electric power and the internal combustion engine, “were predominantly of the enabling sort.” They raised worker productivity and created new jobs more than they replaced workers. He cites the work of another economic historian:

Alexander Field has argued that productivity growth in the period 1919–73 can be thought of as “a tale of two transitions.” The first involved the redesign of the factory to take advantage of the virtues of electricity, whereas the second constituted a shift toward the horseless age, as motorized vehicles revolutionized transportation and distribution.

In this case, the benefits did come to be shared with the workers in the form of higher wages, shorter hours, safer workplaces, and earlier retirement. Although the workers’ struggles to organize were often violent, they were focused on winning a better share of the benefits of higher productivity, not on destroying the machines that made it possible.

Technology in social context

One question that I had throughout the book was how economists make the distinction between replacing and enabling in practice. Since Frey uses those terms as adjectives describing technologies, the reader could easily get the impression that the effect of a technology is readily observable as soon as it is introduced. That may be true for some specialized machines, that either clearly do or clearly don’t replace what a worker is currently doing. More generalized technologies with many applications can have mixed effects, replacing some workers while enabling others, as Frey’s discussion of twentieth-century electrical machines makes clear. “Clearly, technology did cause some occupations to vanish–like those of lamplighters, elevator operators, laundresses and so on–yet these jobs employed only a fraction of the workforce relative to the new machine-aided occupations that emerged.”

Another example of mixed effects is the internal combustion engine. On the one hand, it gave the drivers of motor vehicles the power of many horses, enabling them to cover greater distances, move more goods, or plow more fields. It created the occupation of truck driver, which is still the largest single occupation in many states. On the other hand, the tractor and other farm machinery dramatically reduced the demand for farm labor.

Now as Frey points out, many of the laborers who left farm work in the twentieth century did so more voluntarily than the displaced artisans of early industrial times. They chose to leave because they could get higher wages in manufacturing. In that case, the same workers were replaced in the agricultural sector after they were enabled in another. Similarly, workers who left domestic service for manufacturing were replaced by electrical appliances. But that raises the question of why labor demand was so high in manufacturing. Was it simply in the nature of assembly-line technology to enhance rather than replace labor?  Wasn’t it also because there was now a mass market for manufactured goods, supported by a system that routinely passed along the benefits of high productivity to consumers (as low prices) and to workers (as high wages). Without expanding markets, wouldn’t assembly-line technology replace many workers and not just empower them?

Another factor affecting whether workers are replaced or enhanced is their skill level. “One reason that the horseless age was not accompanied by a jobless age is that human workers, unlike horses, have the means of acquiring new skills, which allows them to take on tasks outside the realm of machines.” If the effect of a machine depends on what happens outside the realm of machines, then classifying the machine as replacing or enabling is no simple matter.

The conclusion I come to is that whether a technology is replacing or enhancing may not be at all obvious when it is first introduced. It depends on how its applications unfold over the course of many years, in a social context that includes things like corporate policies, markets, labor organization, and access to education.

What seems clear is that very early industrial technologies were more replacing than enabling, and that the potential of technology to empower workers was realized only gradually over the course of industrial history. Harnessing the power of nature with such innovations as the steam engine and electrical machinery had a lot to do with this. But rather than seeing technologies as either inherently replacing or enabling, I would call attention to the continued potential for both, as well as to the many decisions that influenced how technologies were actually used. Was it the assembly line itself that made Henry Ford raise wages and reduce car prices, or was it his vision of a path to a prosperous industry?

A new technology trap?

Frey’s concerns about a new technology trap arise from his observation that new technologies are more like those of the First Industrial Revolution than the Second; they are more replacing than enabling. (But again I ask: Is that a feature of the technology itself or of the social context in which we are using it?)

After reviewing many recent technological developments, including in machine learning, machine vision, sensors, various subfields of AI, and mobile robotics, my conclusion is that while these technologies will spawn new tasks for labor, they are predominantly replacing technologies and will continue to worsen the employment prospects for the already shattered middle class.

Like some other economists, Frey sees a similarity between the plight of workers today and that of early textile workers, whose skills and incomes were more replaced by machinery than enhanced by it. That accounts for a lot of the backlash against automation and global trade, which could impede technological change. “The mere existence of better machines is not sufficient for long run growth.” Growth will depend on “policy choices made in the short run.” At the very least, steps must be taken to ease the transition to a hi-tech society for workers who are experiencing dislocations.

Frey remains a long-run optimist, believing that eventually productivity growth will resume–it’s been sluggish lately despite the new technologies–and that more good jobs will be created involving tasks that are hard to automate. These will usually be the more creative, more skilled areas of human activity. Frey rejects as a “widespread misconception…that automation is coming for the jobs of the skilled.” From my perspective, that means that information technologies may not turn out to be as “predominantly replacing” as it now seems.

I will elaborate on many of these points in upcoming posts.



Postcapitalism (part 2)

May 4, 2016

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Paul Mason’s perspective on the current plight of capitalism develops from his understanding of the crises that have occurred periodically in the history of capitalism. The current crisis resembles past crises in many respects, but differs from them in ways that are crucial to his central argument. The current crisis has taken shape more slowly and been resisted more successfully for a time, but will ultimately result in a more profound transformation.

Long cycles of capitalism

The historical part of the book focuses on the “long cycles” of capitalism first described by Nikolai Kondratieff. He discovered a roughly fifty-year cycle of economic activity, divided about evenly between an upswing and a downswing. He described the upswing as a period of technological innovation and high investment, followed by a period of slower growth or contraction, usually ending with a depression. Mason uses these dates for the first four long cycles:

  1. 1790 to 1848
  2. 1848 to mid-1890s
  3. 1890s to 1945
  4. Late 1940s to 2008

Each cycle has its key industries where innovation and growth are centered, such as the steam-powered factory in cycle 1, railroads and machine-made machinery in cycle 2, mass production and electrical engineering in cycle 3, and mass consumer goods like automobiles in cycle 4.

In the late 1990s, a fifth cycle began, “driven by network technology, mobile communications, a truly global marketplace and information goods.” But instead of transforming production, it has stalled out, while the previous cycle has hung on longer than normally expected. Mason’s theory of cycles tries to explain why.

A theory of cycles

In very brief form, Mason’s theory says this: During the upswing of a long cycle, capital that has built up in the financial system flows into new technologies and markets, “fueling a golden age of above-average growth with few recessions.” Because the economic pie is expanding so rapidly, achieving social peace by giving everyone a piece of it is easier. Workers who are displaced by labor-saving improvements can usually find employment in expanding industries.

At some point, the upswing peaks out. “When the golden age stalls, it is often because euphoria has produced sectoral over-investment, or inflation, or a hubristic war led by the dominant powers.” There are limits to how much capital can be invested productively in the same technologies and industries. As for “hubristic wars” I assume he means that nations foolishly squander their wealth trying to grab too large a share of the world’s markets and raw materials. I will add that although military spending can stimulate the economy in times of recession, wars have had devastating effects on many healthy economies, with the impact of World War I on Europe the prime example. “War is good for the economy” is not a very safe bet.

When  dominant industries stop expanding and profits stop rising, employers become more resistant to wage demands, and they may also try to reorganize production to replace skilled workers with lower-skilled workers and machines. Worker resistance increases as displaced workers have fewer alternatives. If profits continue to fall, “capital retreats from the productive sector and into the finance system, so that crises assume a more overtly financial form.” I take that to mean that capital that is not invested productively can only finance debt and inflate the value of stocks and other assets beyond their earnings value. Financial panics and depressions occur when the debtors default and the asset bubbles burst.

Mason thinks that traditional descriptions of long cycles focus too exclusively on waves of technological innovation (not to say those are not important), and not enough on falling profits, class conflict, and the intervention of the state. In the first three historic cycles, businesses tried but ultimately failed to maintain profits by squeezing the workers. When economic conditions and social unrest got out of hand, the state acted to facilitate the transition to the next cycle.

In each long cycle, the attack on wages and working conditions at the start of the downswing is one of the clearest features of the pattern. It sparks the class warfare of the 1830s, the unionization drives of the 1880s and 90s, the social strife of the 1920s. The outcome is critical: if the working class resists the attack, the system is forced into a more fundamental mutation, allowing a new paradigm to emerge….The history of long cycles shows that only when capital fails to drive down wages and when new business models are swamped by poor conditions is the state forced to act: to formalize new systems, reward new technologies, provide capital and protection for innovators.

The issue of falling profits deserves additional attention, but I’ll save that for when I discuss Mason’s theory of value in the next post.

The prolonged fourth cycle

Something different happened during the downswing of the fourth cycle, beginning in the 1970s. As in previous cycles, the growth in productivity slowed. The initial responses were inflationary rather than deflationary. Businesses kept giving in to the wage demands of highly organized workers, and government social spending also increased, although both wages and benefits were eroded by rising consumer prices. As wages went up faster than productivity, profits were squeezed. Business then launched a very successful attack on workers and government, blaming both of them for inflation. Globalization enabled corporations to eliminate high-wage, unionized manufacturing jobs in the developed countries, while finding new sources of revenue in the developing countries.

All this meant that profits could be maintained without transitioning beyond fourth-cycle capitalism. There was a twenty-five-year surge of productivity in the developing world, between 1981 and 2006. But in the developed countries, productivity growth continued to fall, and yet profits remained high because of stagnating wages. Inequality rose to Gilded Age levels, but until recently popular resistance has not been strong enough to force serious systemic change.

So we have been living in a strange time, suspended between an old system that no longer works for enough people and a new one that can’t quite get going. “Alongside higher profits, the overall rate of investment after the 1970s is low.” There is something odd about an economy in which capitalists make so much money while investing so little in the economic progress of their own countries. But another major transition cannot be put off forever.

A fifth cycle?

Twenty-five years ago, I taught a course on Social Change using Daniel Chirot’s Social Change in the Modern Era as a text. Chirot used long-cycle theory as a framework, and he said this about the fifth cycle he saw emerging at the time:

We can expect that the present fifth industrial cycle will gain ground, transform economies and societies, make life ever more materially comfortable, and then come to some sort of end in a half-century or so. Then, a new crisis will come, and a sixth as yet quite unknowable, industrial cycle will begin.

I gave a lecture which began, according to my notes, “Chirot may be right, but I want to raise the possibility that we are coming to the end of an era, not just a transition between cycles.” I based that suggestion on several far-sighted books of the 1980s, such as Christopher Chase-Dunn’s Global Formation: Structures of the World Economy, and James Robertson’s Future Work: Jobs, Self-Employment and Leisure after the Industrial Age.

Mason’s position is basically the same. The new cycle that has begun without yet coming to fruition represents a more fundamental threat to capitalism. That would explain why resistance is so strong, and why capitalists would prefer to export existing forms of production to other countries rather than improve upon them at home.