The Technology Trap (part 2)

August 10, 2019

Previous | Next

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.

Continued


Democracy and Prosperity (part 3)

July 19, 2019

Previous | Next

I have been discussing the symbiotic relationship between capitalism and democracy as described by Torben Iversen and David Soskice. So far I’ve ignored variations among advanced capitalist democracies. But the authors warn against using any one country–such as the United States in discussions of the “Washington Consensus”–as a model for how ACDs have developed or should develop.  The American version of the emerging knowledge economy is only one version, and one that has its origins in a certain kind of history.

Two paths to capitalist democracy

The symbiotic relationship between democracy and capitalism developed along with the industrial economy. One link between the two was human capital development. Industrialization required a labor force with at least some basic skills, such as reading and writing, and that required some commitment to democratic institutions such as the public school.

How was the political order to be broadened to include the opinions and interests of workers? In some countries, such as Denmark, Sweden, Netherlands, Belgium and Germany, pressure from the working class itself played a major role. In others, such as Britain, U.S., France, Australia, Canada and New Zealand, the initiative came more from modernizing elites who were challenging the power of agrarian interests unsympathetic to industrialization and democracy.

Those differences had their origins in preindustrial patterns of organization:

[T]he countries in which democratization was eventually the result of working-class pressure were organized locally on a quasi corporatist basis both in towns, with effective guild systems, and in the countryside with a widespread socially rooted semiautonomous peasantry, rural cooperatives, and/or dense rural-urban linkages…. [A]ll of these states were Ständestaaten in the nineteenth century—a system in which the different estates (including organized professions) played a direct role in governing. We therefore refer to the preindustrial political economy of these societies as protocorporatist.

The authors do not give any simple definition of corporatism, but I think of it as the opposite of rugged individualism. While classical British and American liberalism celebrates the self-interested individual, corporatism sees people more as representatives of strong group interests, such as guilds or churches. To make a long story short, the protocorporatist countries provided more fertile ground for the emergence of strong worker organizations.

Things were different in Britain and America:

The elite-project societies, in essence Anglo-Saxon (apart from France, which we discuss separately), functioned quite differently: well-developed property markets with substantial freedom of labor mobility, towns with limited local autonomy, and guild systems which had either collapsed (Britain) or had hardly existed (the settler colonies and the United States, minus the South). We refer to the preindustrial political economy of these societies as protoliberal.

In both kinds of countries, some democratization accompanied industrialization, but it took different directions. In the protocorporatist countries like Denmark and Germany, “effective training systems were built on guild and Ständestaat traditions and provided a large pool of skilled workers, which in turn led to unified labor movements with the capacity to extract democratic concessions from elites.” In the protoliberal countries like Britain and America, “the absence of either guild or Ständestaat traditions led to fragmented labor movements with privileged craft-based unions but no effective training system. Here democracy emerged as the result of industrial elites compelling a reluctant landed aristocracy to accept expansion of education and other public goods required for industrialization.”

Political representation

These two paths to democracy had consequences for electoral systems. Where the working class was highly unified and organized, the more socialist left came to be better represented in politics. The elites and other prosperous members of society might resist democratization until the demands of the working class became too strong to ignore. Then they supported a system of proportional representation rather than winner-take-all elections, to protect themselves against the possibility of a working-class majority. Some of these democratic countries (Germany, Austria, Italy) reverted to authoritarian rule for a time in order to counter a perceived threat from the left, but democracy eventually prevailed.

In countries like the United States and Britain, where organized labor was weaker and more politically divided, majority rule worked better for the modernizing elites and other beneficiaries of industrial capitalism.

In these cases industrial elites had little fear of the working class, but they had a strong incentive to expand public goods, especially education and sanitation, required for the development of an effective labor force (in part to circumvent union control over the crafts). The key obstacles to this project were landowners and more generally conservatives who had no interest in an expansion of public goods and who held strong positions politically, especially at the local level. Majoritarian democracy in these cases essentially emerged as a means to force the landed elites to accept major public investments in education and infrastructure needed for modernization. At the same time, a majoritarian system with a strong bias toward the middle classes effectively excluded the radical left from influence over policies.

Iversen and Soskice see a perfect correlation between the alternative paths to democracy and the electoral systems. The “protocorporatist” countries adopted proportional representation systems that gave worker parties more voice, while the “protoliberal” countries adopted majority-rule systems where major parties had to be more-or-less centrist to win a majority.

Inequality and educational opportunity

Democratic governments of different kinds have adopted many of the same policies to support the growing knowledge sectors of their economies, for example by liberalizing trade and investing more in education. All of them have experienced some increase in inequality as technological innovation has rewarded workers with the right skills and penalized those without them. However, they differ markedly in the extent of the inequality and the associated decline of economic opportunity. The U.S. Council of Economic Advisers introduced the term “Great Gatsby curve” to describe the inverse relationship between economic inequality and intergenerational mobility among countries.

In general, the countries with weak worker organization and majoritarian electoral systems now have relatively high economic inequality and relatively low social mobility. This is true of the United States, United Kingdom and France. Canada and Australia are more average in inequality and social mobility.

In contrast, the countries with strong worker organization and proportional representation systems now have relatively low economic inequality and relatively high social mobility. This is especially true of the Nordic countries: Finland, Norway, Sweden and Denmark. Germany is more average in inequality and social mobility.

I think this is an important finding, because it means that even in a world of global, hi-tech competition, countries have choices. Economic growth and global competitiveness do not necessarily require the extravagant executive salaries and tax cuts enjoyed by the American 1%! Nor do they require tossing aside former manufacturing workers without making provision for their economic security or retraining.

One of the biggest factors in economic opportunity is education, and here the international findings reflect badly on the United States. Here the authors use an index of educational opportunity based on such variables as the availability of vocational training, the public spending on preprimary education, the public/private division of higher educational spending, and the age at which students are tracked (since early tracking can restrict opportunity). Among advanced democracies, only Japan and South Korea scored lower than the U.S. on this index. The Nordic countries scored the best.

Many readers may find this puzzling because the U.S. has so many fine schools, especially major research universities. But the quality of individual schools is not the same thing as educational opportunity. A good prep school that serves only the affluent does little to provide upward mobility.

In our majority-rule system, the interests of the downwardly mobile minority are not being well served. Their interests have diverged more sharply from those of more successful workers, making it harder for the traditional party of labor to represent them. This relates very much to the next topic, the threat that populism poses to democracies with high inequality.

Continued


Democracy and Prosperity

July 17, 2019

Previous | Next

Torben Iversen and David Soskice. Democracy and Prosperity: Reinventing Capitalism through a Turbulent Century. Princeton: Princeton University Press, 2019

The authors are professors of political economy, Torben Iversen at Harvard and David Soskice at the London School of Economics. Their focus is the relationship between capitalism and democratic government in the most advanced capitalist democracies (ACDs).

The authors complain that too much of the recent literature describes that relationship too pessimistically, emphasizing the potential of capitalism to undermine democracy by generating too much inequality. In particular, they summarize Piketty’s Capital in the Twenty-First Century as arguing that “the power of capital to accumulate wealth is governed by fundamental economic laws which democratically elected governments can no longer effectively counter. If they try, capital just moves somewhere else.” This may be a little unfair to Piketty, since he does look to democratic government to curb wealth accumulation: “Although the risk is real, I do not see any genuine alternative: If we are to regain control of capitalism, we must bet everything on democracy–and in Europe, democracy on a European scale.” Nevertheless, Piketty does not seem entirely confident that democracy is up to the task, whereas Iversen and Soskice believe that it is.

A symbiotic relationship

Looking back at the last hundred years, the authors argue that “the advanced capitalist democracies, for all their instability and social problems not least at present, have been remarkably resilient and effective over this whole period.” The key to this resilience is the symbiotic relationship between democracy and capitalism. The democratic nation-state pushes advanced capitalism forward, and advanced capitalism reinforces democracy.

The first reason for this symbiotic relationship is that the state has to be strong enough to perform several crucial roles in the economy, if capitalism is to remain vibrant and innovative. The state must require businesses to engage in fair competition, as opposed to tolerating self-serving monopolies. It must require labor to moderate its demands and cooperate with management initiatives. It must invest in such public goods as education, research and infrastructure. It must negotiate changes in the rules to respond to shocks to the system, such as technological change.

A second reason for a symbiotic relationship is that the democratic electorate expects political leaders to manage advanced capitalism effectively. They have a stake in its success, and they expect results that they can see in their own lives. This is especially true of the citizens that the authors call “decisive voters.” These include the employees of advanced capitalist companies, who are usually well-skilled. In addition, they include many voters with aspirations for themselves or their children for upward mobility.

[T]he aspirational vote has a particular relevance in relation to advanced capitalism. By contrast to status-ordered societies, growth in the demand for skilled and educated labor is core to the idea of advanced capitalism as a result of technological change….Hence, while aspirational individuals, parents, and families have always existed to some extent, it is particularly associated with advanced capitalism.

Rather than simply being divided into the opposing interests of capital and labor, advanced democracies have a large middle class of actual or potential beneficiaries of capitalism. They support the system to the extent that they perceive themselves to be benefiting from it. But their incomes are lower than those of the principal owners and managers, and they depend more on public programs and services like public education and Social Security. “Accounting for more than one third of GDP on average, wide-ranging tax-financed middle-class programs ensure that those with high and rising incomes share some of their wealth with the rest of society.” The large middle class is a moderating influence. It doesn’t want the government to radically redistribute wealth from the rich to the poor, but it doesn’t want it to let the rich hog the wealth either.

A third reason for the symbiotic relationship is that capital remains “geographically embedded” within nation-states. A common initial reaction to global electronic communications was that geography might not matter much anymore. Work could be done anywhere, perhaps far from established urban centers. Instead, “knowledge-based advanced companies, often multinational enterprises (MNEs) or subsidiaries…are increasingly immobile because they are tied to skill clusters in successful cities, with their value-added embedded in largely immobile, highly educated workforces.” Skilled workers have many good reasons to locate close to others with similar or complementary skills, especially when skills are acquired through face-to-face interaction rather than from some manual. And companies that depend on multi-skilled workforces cannot easily move their entire operation elsewhere, although they can more easily outsource particular low-skill tasks. The dependence of capital on geographically embedded skilled labor gives national and even local governments some power to regulate capital, as well as some incentive to invest in human capital development for the good of the nation or other geographic territory.

For these reasons, democratic governments promote advanced capitalism, but also try to manage it in the interests of a large class of voters. Capitalism thrives, but democracy also works to the extent that voters get a good return on their political investments.

Challenges to the symbiotic relationship

The symbiotic relationship is not a static equilibrium. Capitalism is inherently dynamic, and democracy has to be flexible in order to manage it in the public interest.

Technological change is an important driver of economic change, but not in a simple deterministic way. The authors see a new technology as a political opportunity, something that can be managed for the good of the many, although not usually the all. How political responses to the revolution in information and communications technology (ICT) have shaped the knowledge economy is a central concern of the book.

Another challenge for democratic societies is the recent increase in economic inequality and the decline in economic mobility, which is especially pronounced in the United States. “We see the division between the new knowledge economy and…low-productivity labor markets as a new socioeconomic cleavage that has crystallized along educational lines and a deepening segregation between successful cities and left-behind communities in small towns and rural areas.” The rich have been getting richer and the poor have been left behind, but the impact on the middle class is more complicated. A modest reduction in their share of national income has been accompanied by an absolute increase in income, especially in the more educated middle class. The ultimate impact on democracy is yet to be determined.

A third challenge is political populism, an anti-establishment reaction from those who feel threatened by economic and cultural change. Whether it is a powerful enough reaction to do serious damage to either advanced capitalism or democracy is another issue to be considered. The authors doubt that it is.

Maintaining the equilibrium

Iversen and Soskice acknowledge the tension between democracy and capitalism. “One is based on a principle of equality (‘one person, one vote’), while the other is based on a principle of market power (“one dollar, one vote”). In practice, what democratic electorates support is neither an absolute economic equality inimical to capitalism nor a monopoly of market power inimical to democracy.

“Democracy has a built-in mechanism to limit anti-systemic sentiments.” Voters with a stake in capitalism support the freedom of capitalists to invest in profitable enterprises and keep a lot of their profits, but voters also have a stake in the extension of opportunity so they can earn a good share of the economic benefits.

The historical experience has been that joining the ranks of the advanced capitalist democracies is not easy. Many countries have gotten stuck in a system with powerful capitalist enterprises but weak governments, in which politicians are paid off to protect firms against market competition. On the other hand, where advanced capitalist democracy has become established, it has so far proved to be highly resilient. A long-run perspective on ACDs supports an optimistic view, one that is not too dismayed by recent increases in inequality and reactionary populism.

The next post will discuss the emergence of the knowledge economy and the role of government in that transition.

Continued


Forty Years of Reaganomics

July 18, 2018

Previous | Next

When he was running for president in 1980, Ronald Reagan used to ask his audiences, “Are you better off than you were four years ago?” If they were tired of high gas prices, double-digit inflation, and the Iranian hostage crisis, then voters should choose him over the incumbent, Jimmie Carter.

Reagan’s primary domestic policy aim was to shrink the size of government by cutting taxes, spending, and regulation. If only the government would get out of the way, so the theory went, the private sector could flourish. Although Democrats haven’t always gone along with this agenda, Republicans have had their way often enough to bring about a new era of low taxes and limited government. Even Bill Clinton agreed that the era of Big Government was over. Despite all the talk about how Donald Trump is somehow less Republican or less conservative than his predecessors, his tax, spending and regulatory proposals are right out of the Reagan playbook.

Now that almost forty years have passed since the “Reagan revolution,” we may well ask, “Are we better off than we were forty years ago?” I would like to make a modest contribution to an answer by looking at some of the macroeconomic indicators I have been discussing in recent posts. In order to make it easier to compare statistics across the years, I will express the various indicators as shares of gross national income (GNI) when discussing income, or as shares of gross domestic product (GDP) when discussing expenditures. The difference between GNI and GDP is relatively small and should not create any confusion in this discussion. (See my previous discussion of macroeconomic indicators, especially part 2 and part 3.)

Taxes

National income can go to pay taxes, to consume goods and services, or to save, as expressed in the equation GNI = T + C + S. Tax cuts increase the disposable income available for consumption and saving. Generally, more of that increase goes into consumption than into saving. Since consumption is the largest component of GDP, tax cuts raise what is spent on production. That effect includes a multiplier effect as the increased GDP creates additional income and consumption.

[One technical note: In the national accounting system, the T stands for taxes net of transfer payments, which are payments from the government to its citizens. Payroll deductions for Social Security are taxes and count toward T, but Social Security checks are transfer payments and count against T.  The “tax cuts” discussed here could include some increases in transfer payments, but those too would increase disposable income.]

Before the Reagan election in 1980, taxes had been taking about 17-20% of national income. That includes all kinds of taxes—income, sales, payroll, property—and all payers, personal or corporate. Congress passed substantial tax cuts during the administrations of Ronald Reagan, George W. Bush, Barack Obama and most recently Donald Trump. The national tax rate dropped from about 18% to 16% by the end of the Reagan and Bush administrations (1992); then to 14% by the end of George W. Bush’s first term (2004). Then came the global financial crisis and the Obama stimulus package, which lowered taxes briefly to 10% of national income. Now the rate is 12%, which reflects the economic recovery and some initial effects of the Trump tax cuts.

The rate of consumption has risen accordingly, whether calculated as a percentage of GNI or of GDP. It was running about 60-61% of GDP before 1980, but it is up to 69% now. That is well above the rate of most wealthy countries. It reflects the fact that we have become a relatively low-tax nation, with a high priority on the purchase of private goods and services.

Some of that increased consumption has gone into imported goods. We were running small trade surpluses in the 1960s, but the higher price of oil helped produce trade deficits in the 1970s. In the era of lower taxes since 1980, imports have grown dramatically. The trade deficit as a percentage of GDP peaked before the global financial crisis of 2007, but has settled back to about 3% recently.

The federal tax cuts have also made the tax code less progressive, so that the wealthy have benefited more than the middle class. Lower taxes give business owners and managers more incentive to claim a higher share of profits for themselves, since the government lets them keep more of their gains. The distribution of both pre-tax and after-tax income has become more unequal during these years.

Government spending

Another goal of Reaganomics was to reduce government spending. That meant especially domestic spending, since military spending was to be kept high. That task proved to be more difficult and contentious.

Although cutting taxes and cutting spending may seem to go together in a program to shrink the size of government, they are quite different matters. Spending changes can actually have a bigger effect on GDP than tax changes, and the effect tends to be in the opposite direction. That’s because government spending has a direct positive effect on GDP. It counts as spending on productive economic activity. Then, by affecting income, it has multiplier effects on consumption as well. Spending cuts lower GDP, other things being equal. Tax cuts raise GDP, but only indirectly through the disposable income that goes into domestic spending rather than spending on imports or saving for the future.

Recall the equation: GDP = C + I + G + NX.
(Gross Domestic Product = Consumption + Investment + Government Spending + Net Exports)

Government spending is a component of GDP. But taxes only effect GDP through their indirect effects on consumption and net exports.

That means that if Americans are willing to incur an additional $100 billion in the annual deficit, increasing spending has a lot to be said for it instead of cutting taxes. The overall effect on GDP should be greater, and the mix of public and private benefits may add to the quality of life. Cutting taxes increases spending on private goods, but raising spending provides public goods (that’s what government spends on) and private goods too (through the effect on income and consumption).

In any case, Republicans wanted to shrink government, not expand it, and they had some success in cutting domestic spending. Before 1980, government spending was running at 21-24% of GDP, but now it is down to 17%. (Part of that drop, but only part, is a consequence of using percentages to measure the changes. If one component of GDP increases its percentage share, others must go down, other things being equal. Here C went up and G went down, but neither change was just a mathematical adjustment to the other.) We know from the increased deficit that taxes have been cut more than spending. And since consumption has risen substantially, it’s safe to say that the big tax cuts increased GDP more than the spending cuts lowered it.

Saving and investment

Another goal of Reaganomics was to increase saving and private sector investment. Tax cuts would give people more money to save as well as consume, and strong consumer demand would encourage the investment of those savings in business expansion. Economic growth should remain strong, since the rising investment component of GDP would offset the falling government component.

Some of the consequences of fiscal policy flow from well-established economic principles, such as lower taxes—>higher disposable income—>higher consumption. But higher investment does not automatically follow from lower taxes. It depends on whether businesses find the economic demand sufficient to justify expansion. For example, airlines will meet the demand for more air travel by filling empty seats before they will invest in new planes. Businesses invest more when they anticipate a strong market for their expanded production.

I do not see in the macroeconomic indicators a surge of saving or investment since 1980. Before then, saving was running at about 19-22% of national income, while investment was in the range of 16-18% of GDP. Reaganomics got off to an auspicious start, with saving up to almost 23% and investment up to 20% by the end of Reagan’s first term. But since then, saving and investment have generally been no higher than they were before. Saving is now at 19% of GNI, and investment is at 17%.

I’m not sure why the desired surge of investment did not occur, but here are a few possibilities. Some of the increased consumer demand has gone to support foreign production, which made domestic expansion less necessary. The Federal Reserve has also been very quick to ward off inflation by raising interest rates whenever rising demand started to push up prices. Higher interest rates discourage borrowing for business expansion. And although new technologies have been emerging, how to utilize them productively and profitably in a largely service economy has remained a question.

Sector balances

The economy consists of three sectors, each with its own financial balance resulting from inflows and outflows. They are the government sector, the domestic private sector, and the external (foreign) sector.

Ever since the Roosevelt administration engaged in massive deficit spending to combat the Depression and fight World War II, government has experienced more budget deficits than surpluses. Before 1980, deficits were running about 2-4% of national income. Since 1980, deficits of 4% or more have been common, except during the Clinton presidency, which ended in a small surplus. The deficit rose again in the George W. Bush and Obama presidencies, first because of the Bush tax cuts, and then because of the global financial crisis and the Obama stimulus package. The deficit was 9% of national income in 2012, but is down to 5% now.

As I discussed in my post on sectoral accounting, one sector’s deficit is another sector’s surplus. When the government experiences an income shortfall by spending more than it receives, some other sector must experience an income surplus by receiving more than it spends. Before 1980, that other sector was the domestic private sector. Households and businesses were saving more than they spent either on consumption or investment in real assets, with the difference showing up as financial assets. But since the 1980s, we have had a balance of trade deficit (and a current account deficit, which is the balance of trade adjusted for other financial flows between countries). Now about two-fifths of our government deficit winds up as surplus dollars in the hands of foreigners. By running such a large deficit, government is enabling both Americans and foreigners to accumulate financial assets.

While our government has been enabling the accumulation of private financial assets for some time, it used to do it in a more egalitarian way, through public-sector job creation, wages and the expansion of public goods. Now we do relatively less of that, and more with tax cuts aimed at corporations and the wealthy. That’s another reason why the distribution of income has become more skewed.

Gross domestic product

To summarize the changes in component shares of GDP, the consumption share is up sharply, government spending is down, investment has remained about the same, and net exports have fallen as the trade deficit has worsened. In the era of Reaganomics, we have been relying primarily on tax cuts to grow the economy instead of on public spending, business investment, or global demand for our products.

How much growth has our fiscal policy helped to achieve? I used data on real (inflation-adjusted) GDP to compute the cumulative growth for two different periods, 1945-1980 and 1980-2016 (the last year in that data series). Then I calculated the annual growth rate that would yield, when compounded, the cumulative result.

For 1945-1980, GDP grew 191%, which implies an annual rate of 3.1% compounded.

For 1980-2016, GDP grew 159%, which implies an annual rate of 2.7% compounded.

This confirms what others have reported, that growth in the Reaganomics era has been on average slower than in the previous postwar era.

This slower growth has also come with other costs: some neglect of public goods and services such as infrastructure repairs, a larger national debt, a larger trade deficit, and greater inequality.

With regard to the inequality, Piketty has argued that slower growth itself contributes to it, since workers rely on economic growth for real wage increases. Big investors rely more on the rate of return on capital. As the rate of growth falls farther below the rate of return on capital, the share of income going to capital rather than labor goes up. This is in fact what has been happening, a trend Piketty describes as a “drift toward oligarchy.” I think the drift toward economic oligarchy is related to the current threat to democracy, of which Donald Trump’s authoritarian tendencies are only one manifestation.

Government fiscal policy is by no means entirely to blame for sluggish growth. Factors such as slower population growth, an aging population and the difficult transition from a manufacturing economy to a service economy are also involved. But going forward, we do need to think about what combination of public and private initiatives can help.

We have probably gone about as far as we can go with tax cuts as the way to prop up a struggling economy. And government spending cuts without tax cuts would almost certainly be worse. The question for economists and policymakers today is how to make the best use of government spending to give the economy what it really needs. Among the things it needs are enhancements to human capital to keep up with changing job requirements, development of cleaner energy sources, and a twenty-first-century infrastructure. And as Modern Monetary Theory advocates, creating public jobs for anyone who wants them is one of the most direct ways of boosting national output and income.

The anti-government philosophy that has dominated the Reaganomics era has outlived its usefulness. I think that Republicans will either have to change their tune, or tone down the anti-government chorus so that new music can be heard. Democrats need to convince voters that their proposals serve the common good and not just the needs of particular constituencies. Warrenomics anyone?

 

 


Viking Economics

June 25, 2017

Previous | Next

George Lakey. Viking Economics. Brooklyn: Melville House Publishing, 2016.

This is a book about the economies of four Nordic countries whose peoples have Viking ancestry–Norway, Sweden, Denmark and Iceland. It focuses especially on Norway, where the author, who was born in the US, has spent the most time. Lakey himself is a sociologist, not an economist. Although he draws on the work of economists, the book is not very technical. Lakey supplements his own reading and observations with many interviews and anecdotes.

For people who feel that US economic policy has been moving in the wrong direction, the Nordic countries are a good place to look for alternatives. They have been accomplishing something we have not been lately–a high level of national income without an extreme degree of economic inequality.

According to rankings by international agencies like the IMF and World Bank, the Nordic countries are among the richest in GDP per capita. Norway ranks higher than the US and the others a little lower. According to a Gallup international survey, Norway, Sweden and Denmark are all ahead of the US in median household income. So much of the income from America’s national production is concentrated at the top that households in the middle do not do as well. The Nordic countries have done a better job of maintaining a thriving middle class at a time when the American middle class has been shrinking.

Among 32 developed countries in the OECD, the four Nordic countries studied in this book rank in the top ten for economic equality. The US and the UK rank near the bottom. The OECD has also surveyed the populations of these countries on their life satisfaction. The same Nordic countries are consistently near the top of the rankings, while the United States is only a little better than average. Lakey also draws on research by Richard Wilkinson and Kate Picket on other social indicators that tend to be associated with wide disparities in income: “They find that inequality highly correlates with negative statistics in physical health, mental health, drug abuse, education, imprisonment, obesity, social mobility, violence, teenage pregnancy, and child well-being.”

Equality, productivity and innovation

Lakey acknowledges the widespread belief that differences in economic reward motivate people to do their best, and especially to devise better ways of doing things that the marketplace can reward. “The belief is that inequality motivates, by increasing both the risk and potential reward, attracting talented people who love adventure. The bold ones make the breakthroughs that propel invention and innovation. It sounds reasonable.”

Yes it does. No modern society pays all economic contributors the same. It hardly follows, however, that the extremes of wealth and poverty we see in the United States are optimal for encouraging productivity and innovation. Lakey reports, “Rates of start-up creation in Norway are among the highest in the developed world, and Norway has more entrepreneurs per capita than the United States….” He suggests a couple of ways that economic equality supports potential entrepreneurs: giving them access to education without burdening them with debt, and providing a stronger safety net so they can afford to take risks. People can leave a job to try something new without worrying about losing their health insurance, since coverage is universal. More equal societies do a better job of developing talent across the economic spectrum, and they have higher rates of social mobility.

Lakey also cites research showing a positive association between high productivity and strong unions. This may be counterintuitive, at least for Americans, since “U.S. unions sometimes defend inefficient labor practices and outmoded organization of work, even though undermining productivity–whatever it takes to keep workers in jobs.” However, Lakey argues that this is because the American system leaves workers so insecure. When union membership is higher, high wages are more universal, and the social safety net is stronger, workers have less to fear from productivity-enhancing innovation. In addition, companies may have to boost profits by increasing productivity, since it is harder for them to do it by cutting wages.

Another feature of social organization that contributes to both productivity and equality is the Nordic tradition of cooperatives. They have industrial co-ops, farm co-ops, consumer co-ops, housing co-ops, even parent co-ops providing child care. People are motivated to contribute because they know they will share in the benefits.

Nordic countries are also noted for developing the talents and productivity of women. Their rates of female employment exceed that of the United States, although women are still underrepresented in the highest managerial positions. Rates of employment for men are also higher than they are here. The Nordic countries do more to support employed parents, by subsidizing child care and providing paid family leaves for parents of both sexes. And although more adults are employed, annual work hours per worker are lower, for example 1,418 in Norway vs. 1,791 in the US in 2012. That’s 373 more hours off the job, or about 10 weeks. National production does not seem to suffer, since productivity per hour is higher in Norway.

Keeping poverty low

International comparisons of poverty rates often use a relative definition of poverty. They determine what percentage of a population lives on less than the national median income. That could be misleading if two countries have very different medians; a very poor country could appear to have little poverty if it had little variation around its very low median. For countries that are all pretty affluent, the relative definition makes for pretty fair comparisons. UNICEF calculated child poverty rates for the Nordic countries in the range of 4.7% to 7.3%. The rate for the US was 23.1%, the second worst among OECD countries. We should all think about the damage to human potential that figure represents, and its impact on our national productivity and well-being.

Lakey wants to correct the impression that Nordic states are just generous “welfare states,” since their strategy for fighting poverty involves much more than just handing out cash and other benefits to poor people. It is, first of all, a strategy emphasizing full employment and good wages. Norway has a pretty good record for holding unemployment down, keeping wages up, and preparing people for jobs with educational and training opportunities. “Free post-secondary schooling is available for technical fields like seafaring, business, engineering, and agriculture; for arts fields like performance and visual arts; and for professions like medicine and law.” Adult education is so common that one-sixth of the population is taking courses in any given year.

When jobs are available and wages are fairly high, the government can provide some cash assistance to families with children without worrying that the payments will destroy people’s motivation to work. That’s especially true when such benefits are universal rather than provided only to the very poor and unemployed. You have everything to gain and nothing to lose by taking a job.

Universal services and taxation

Programs designed just for the poor don’t have a very good track record for actually eliminating poverty. They tend to be inefficient because a lot of administrative effort has to go into determining eligibility, and potential recipients may try to cheat. They tend to be under-funded because popular support for them is limited (especially when there is a longstanding racial divide between the affluent and the needy). They tend to be stigmatizing for the people who participate in them. They tend to be too individualistic, helping one person at a time instead of changing social conditions more generally. “The twentieth-century descendants of the Vikings figured out that the individualistic charity model of the nineteenth century simply could not alleviate poverty. In each country, the designers turned against programs for the poor and created universal systems instead.”

Among the publicly-funded services available to Norwegians are tuition-free higher education, paid maternity and paternity leave, affordable child care, subsidized public transportation, subsidies for family farms, vocational counseling and job training, free health care and universal public pensions.

To pay for such benefits, Nordic countries tax their citizens at high rates, both through individual income taxes and corporate taxes. (In contrast, although US rates may look high on paper, the tax code has so many loopholes that revenue as a percentage of GDP is among the lowest for OECD countries.) Lakey describes the general Nordic attitude toward taxes as “To get a lot, we pay a lot.” The “lot” they get includes not only the benefits they receive personally, but the general benefits of living in a more egalitarian and less divided society.

Do high taxes inhibit economic growth, as is so often claimed by economic neoliberals in the United States? Lakey cites the work of economist Jeffrey D. Sachs, who modified his own neoliberal views after examining the evidence. He compared the Nordic countries with the Anglo-Saxon countries of Australia, Canada, Ireland, New Zealand, UK and United States, countries he characterized as “low-tax, high-income countries that share a historical lineage with nineteenth-century Britain and its theories of laissez-faire.” He concluded, “On average, the Nordic countries outperform the Anglo-Saxon ones on most measures of economic performance.”

Relevance to the United States

Maybe the culture and traditions of the Anglo-Saxon countries are so different from those of the Nordic countries that we are unable to learn much from them. On the other hand, maybe the problem isn’t as much culture and traditions as vested interests standing in the way of the public good. Lakey cites research showing that most Americans want more economic equality than they now have. “In one of the studies, participants were shown two different income distributions, in the form of pie charts. Without saying so, one chart reflected the distribution in Sweden and the second chart that of the United States. 92 percent said they preferred the first.”

Lakey also cites research by political scientists showing that in the US, the wealthy get what they want in political decision-making much more often than any other economic segment of society. He believes that politicians are so dependent on powerful financial interests that voting alone will not move a country in a more egalitarian direction. Only broad social movements featuring nonviolent direct action can bring about the desired changes.

Continued