Democracy and Prosperity (part 2)

July 18, 2019

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In Democracy and Prosperity, Iversen and Soskice contrast the emerging knowledge economy with the system that preceded it in the mid-20th century.

The “Fordist” political economy

What many economists call the “Fordist” system was dominated by giant manufacturing corporations such as the Ford Motor Company. They performed a range of functions from “production to logistics and sales and marketing,” and usually had a very hierarchical structure of decision-making.

Assembly-line technology featured “strong complementarities in production between skilled and semiskilled workers. The companies needed large numbers of both, and either of them could obstruct production if they were well organized but dissatisfied. By the 1970s, unionization was at a peak in the advanced capitalist democracies, and so was “wage coordination,” the cooperation of large numbers of workers and companies in setting wages and working conditions.

Economic inequality declined during this period, as even workers with limited educations could quickly acquire the skills needed for many industrial jobs. Poverty declined, even for segregated racial and ethnic groups. “The Fordist economy was…by and large a force of integration and equalization of incomes across industries, skill groups, and geographic space.” The most advanced companies were concentrated in big cities, but peripheral areas often supplied them with materials or components for their products.

National governments helped organize and maintain the system. They supported the collective bargaining rights of labor. They provided a safety net of unemployment and retirement benefits, which gave workers a source of security in addition to short-term wage demands. They invested in public goods like infrastructure and education. They often engaged in Keynesian economic policies, using government spending to stimulate the economy and maintain low unemployment. It was a period of rapid economic growth and relative harmony among business, labor and government.

The knowledge economy

Much of this has changed since around 1980. Information and communication technologies have not affected all jobs equally, but have most easily substituted for routine semiskilled tasks. In some ways, this is a blessing, as such work was often deadly dull and uncreative. But, “As less-skilled workers became increasingly segregated into a growing tier of low-productivity service sector occupations–especially in low-end personal and social services–the complementarities between high- and low-skilled workers unraveled.” Inequality generally increased in advanced capitalist democracies, although with important variations to be discussed later.

New technologies can put a lot of computational power into the hands of individual workers, if they have the analytic skills to use it. In organizations of knowledge workers, decision-making becomes less vertical (hierarchical) and more horizontal (network-based), and relational skills also become more important. Knowledge workers benefit by participating in skill clusters, in which they can play specialized roles, and yet find other work within the cluster when and if a particular role is no longer needed.

These skill clusters are also embedded in larger social networks in which educated workers participate. “Big-city agglomerations” of knowledge are the “dynamic drivers” of the knowledge economy. They are usually places that already had a range of professional services and a strong university or two. Fordist-era cities whose prosperity rested on a single manufacturing industry, such as steel, have had trouble adapting, and many smaller cities have been left behind altogether. (Rapid transit between thriving cities and peripheral areas would help, but people who are already doing fine in the city may not have much incentive to support it with their tax dollars.)

The fact that education, urbanization and high incomes tend to go together increases the inequality among both households and places. Educated people live and work with other educated people, and also socialize with them and marry them, often forming affluent, two-income households. By clustering together, affluent households drive up the cost of good schools and housing in the successful cities, creating barriers to entry for the less educated.

The dynamic cities in the advanced economies of America, Europe and Asia compete with one another to attract capital and market their innovations. “Multinationals play a central role in tapping into multiple skill clusters and tying together complementarities of knowledge. The result is a major increase in multinational investment, trade and competition.

The “embedded knowledge”-based political economy

A central point of Iversen and Soskice’s argument is that knowledge within the knowledge economy is geographically embedded in innovative urban centers within the advanced democratic countries. That gives governments some power over activities that cannot easily be moved from where they are. It also gives them an incentive to support the knowledge sectors of their economies, for the good of the nations where they reside.

The availability of information and communication technologies does not automatically transform an economy. The authors believe that the Soviet Union collapsed partly because it resisted the decentralizing power implied by the new technologies. “It was felt necessary to maintain prohibitions on personal computers until the late 1980s.” The lesson to be drawn: “Without politically initiated reforms economies stagnate, even when they possess the necessary technologies and know-how.”

Beginning in the 1980s, advanced capitalist democracies made a number of “strategic choices” to promote the growth of their knowledge sectors. “Knowledge economies have been enabled by a different political economic framework from that which supported Fordism. We describe this framework as “embedded knowledge-based liberalism.” (In Britain and the United States, many of the leaders in this effort–Thatcher, Reagan–are known as conservatives, but they were working to liberate economic activity from what they saw as outdated restrictions. In that way, they were acting in the tradition of classical liberalism.)

Governments generally worked to reduce barriers to competition, free trade and international flows of capital. The authors measure this with an index of regulation covering eighteen regulatory domains, including such matters as trade barriers, differential treatment of foreign suppliers, and administrative burdens on creating new enterprises. The U.S. and Britain led the way toward competitiveness and away from protectionism, and the rest of Europe followed.

Governments also worked to transform the financial and insurance sectors, so that they went beyond their traditional financial products to provide more complex and customized services for knowledge workers and enterprises. Greater access to credit was important for new businesses, but also for workers following more complicated careers, with many changes in jobs, periods of schooling, and shifts in work/family arrangements.

Governments shifted their macroeconomic priorities from fighting unemployment to fighting inflation. One reason for this was the decline of unions and large-scale wage coordination, which had provided a degree of predictability and moderation to wage demands. A tight monetary policy was a more centralized way of curbing wage-price spirals. Another reason was to stabilize the exchange rates among national currencies for purposes of global trade and investment. Other countries would not be eager to invest in America if they couldn’t count on receiving their returns in dollars with a stable value.

And of course, governments continued to work for an educated workforce, again with important variations to be discussed later. Over the past twenty-five years, attainment of higher education has more than doubled in the ACDs.

Such policies have been most responsive to the needs of knowledge industries and knowledge workers, but less so to the needs of less-educated workers displaced or threatened by new technologies. “Unlike the Fordist economy, there is nothing that binds together the interest of the main social classes. A majority gains, and a small minority gains a great deal, but a large minority loses.” Whether that continues to be the case is an important question for the future.

Continued

 


MMT 6: Unemployment and inflation

July 9, 2018

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This is the sixth in a series of posts about Modern Monetary Theory, based on the text by Mitchell, Wray and Watts. If you have not seen the earlier posts, I recommend that you start at the beginning.

The Classical dichotomy

Classical economists gave unemployment and inflation distinct explanations. They weren’t relating the two by focusing on questions like how the government can create more jobs without triggering inflation. Economists have called this compartmentalization the “Classical dichotomy.”

In Classical economics, how many workers were employed depended on the supply and demand of labor, reconciled by the price mechanism. The greater the demand for labor, the higher the price (the wage); but the greater the supply of labor, the lower the price. If wages were too high, the supply of workers willing to work would exceed the demand from employers willing to pay that wage; if wages were too low, the demand for workers would exceed the supply of people willing to work. So in any labor market, there was an equilibrium price point where labor supply equaled labor demand, and that’s how much labor would be employed. Any unemployed workers who remained were those who chose not to work at the going rate. The market had spoken, and everything was as it had to be.

How much was produced with the employed labor depended on the productivity of labor, which depended in turn on the technologies in use.

Inflation had its own dynamic. The general price level for goods and services depended on the amount of money in circulation (and how fast it circulated) relative to the actual output of goods and services. Money was just a medium of exchange. If more money was available to spend on a given level of output, then prices must be higher. “The later Classical economists believed that if the supply of money was, for example, doubled, that there would be no impact on the real performance of the economy. All that would happen is that the price level would double.”

The policy implication of the Classical dichotomy was that government, as the issuer of the currency, could control inflation by managing the money supply, but unemployment was a different matter. The level of employment was set by the invisible hand of the market, and government had little to say about it.

Aggregate demand and the unemployment-inflation trade-off

The massive unemployment of the 1930s forced economists to rethink the Classical position. Unemployment had to involve more than a voluntary decision not to work at the prevailing wage. And as for policy, there had to be something we could do about it. All was not as it had to be. The new Keynesian economics saw the problem as a failure of aggregate demand, and government could take action to alleviate it.

Suppose that businesses decide to cut back on investment because they lose confidence that the market can absorb further increases in production. As I covered in MMT 2, investment is one of the independent variables that determine aggregate demand, national output and income. A drop in investment produces an even greater drop in output and income because of multiplier effects. Each $100 billion drop in investment can easily produce a $200 billion drop in GDP and GNI. Firms lay off workers, unemployment soars, and consumers have less money to spend, encouraging still more cutbacks in investment.

In that situation, lower incomes also mean that the government is collecting less in taxes. That softens the blow for households, but it may encourage governments to cut spending to keep their budgets balanced. That government austerity makes matters worse, since government spending has its own multiplier effect on national income and output. Keynesian theory recommends the opposite policy. Government should increase spending in hard times in order to increase aggregate demand and get the country back to work.

Stimulating the economy with government spending makes the most sense when an economy is suffering from underutilized capacity, as it was during the Great Depression. Once the economy has moved closer to full employment, continued stimulus runs the risk of pushing aggregate demand so high that it presses against a limited supply. That would push prices up, creating “demand-pull inflation.” (In the MMT interpretation, supply can respond to demand and keep prices stable until the economy nears full productive capacity. In graphic terms, the supply curve is seen as pretty flat until prices turn sharply up when that point is reached.)

The policy implication here is that unemployment and inflation are inversely related. Too little aggregate demand creates unemployment, but too much aggregate demand creates inflation. This trade-off was quantified by the introduction of the “Phillips curve” in the 1950s. Policymakers hoped to find a happy medium with neither too much inflation nor too much unemployment.

Stagflation and the monetarist response

In the 1970s, the inverse relationship between unemployment and inflation seemed to break down. The economy experienced both high unemployment and inflation at the same time, a condition that came to be called “stagflation.”

University of Chicago economists under the leadership of Milton Friedman proposed an explanation. He argued that if the government, in its efforts to promote full employment, overstimulated demand, the resulting inflation could end up increasing unemployment as well.

First, he claimed that there is a natural rate of unemployment, which is determined by the underlying structure of the labour market and the rate of capital formation and productivity growth. He believed that the economy always tends back to that level of unemployment even if the government attempts to use fiscal and monetary policy expansion to reduce unemployment.

What would bring unemployment back to its “natural level” was the inflation expectations of workers. Once they came to expect that inflation would keep eroding their purchasing power, they would become less willing to work at the prevailing wage level. This is reminiscent of the Classical idea that unemployment is a personal choice.

Friedman was influential in getting economists to give up fighting unemployment and focus their attention solely on fighting inflation through tight monetary policy.  A certain level of unemployment is natural and government shouldn’t try to change it.

[The] post World War II [Keynesian] consensus was steadily eroded away over the next 40 odd years….Mainstream macroeconomics reverted back to the pre-Keynesian notions of voluntary unemployment and effectively abandoned the concept of true full employment.

A conflict theory of inflation

Modern Monetary Theorists are more in tune with Keynes than with Friedman. As they see it, when government makes fighting inflation the centerpiece of its economic policy, it overlooks policy options that really could reduce unemployment. In effect, it also sides against labor in the class struggle and impedes the efforts of labor to achieve high employment and good wages.

MMT proposes a conflict theory of inflation. Keynes recognized that inflation could be triggered by rising costs as well as rising aggregate demand. MMT acknowledges this “cost-push” inflation and incorporates it into its conflict theory. Increased costs could come from the wage demands of workers, or from the cost of other resources used in production.

Inflation is “the product of distributional struggle over real income shares, reflecting the relative bargaining strength of workers and employers.” Workers want a big enough share of income to maintain or increase their purchasing power. Firms want a big enough share of revenue to cover their costs, including labor costs, and to make enough profit to satisfy their owners or shareholders.

If both sides feel they are benefiting from the shares they have, inflation is avoidable:

If the desired real output shares of the workers and firms is [sic] consistent with the available real output desired, then there is no incompatibility and there will be no inflationary pressures. The available real output would be distributed each period in the form of wages and profits, which satisfy the respective claimants.

If, on the other hand, either side wants to increase its income faster than general economic growth justifies, that cuts into the other’s share of the income. If workers demand wage increases not justified by higher productivity, employers will resist those demands, or else try to pass the costs onto their customers through price increases. General price increases can offset wage increases, leaving workers no better off than before. Price increases that are not matched by wage gains reduce the worker’s share of national income. Inflationary spirals of wages and prices can be initiated from either side. Remember that we are thinking in the aggregate. What matters is what firms and workers are fighting for and getting in the economy as a whole, not just in any one company.

Changes in the relative bargaining power of business and labor may trigger these struggles as well as determine the outcomes. In the early twentieth century, workers responded to the concentration of power in large firms by forming unions to bargain with those firms collectively. “When employers are dealing with workers individually, they have more power than when they are dealing with one bargaining unit (trade unit), which represents all workers in their workplace.” Organized labor made wage gains, but not without a struggle.

Another thing that strengthens labor’s bargaining power is an economy operating at high capacity and employing a lot of labor. Workers can then press their demands for higher wages with less fear of being laid off or replaced. During the postwar economic boom, highly unionized workers were able to obtain a larger share of the national income than they had gotten before, or they have gotten since.

Raw material price shocks such as the 1970s jump in oil prices can both slow the economy and intensify workplace conflict. Workers paying higher gas prices push harder for higher wages. Businesses facing higher costs of production raise prices. If the price shock both slows the economy and generates wage-price spirals, the result is stagflation.

When the Federal Reserve raised interest rates to fight inflation in the 1980s, that raised the cost of borrowing for businesses seeking to expand. That kept the economy operating in low gear, and also increased the resistance of employers to wage increases. The slow economy made workers more vulnerable to layoffs and weakened their bargaining power.

Inflation has been more-or-less under control since then, but workers have faced a perfect storm of sluggish economic growth, competition from cheap foreign labor, declining manufacturing industries, plunging union membership, chronically high unemployment, stagnating real wages, and a declining share of the national wealth and income.

MMT hopes to do better, by identifying a policy that can boost economic growth and achieve full employment, but still keep inflation in check.

Continued


MMT 5: Monetary Operations

July 7, 2018

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This is the fifth in a series of posts about Modern Monetary Theory, based on the text by Mitchell, Wray and Watts. If you have not seen the earlier posts, I recommend that you start at the beginning.

What is money?

In modern economies, money is not a thing, but “a unit of account in which we keep track of debits and credits.” The sovereign state specifies the accounting unit, in our case the dollar, when it issues a currency. It has value not because it is backed by anything tangible, but mainly because the state accepts it as payment for people’s tax liabilities. That forces people to keep records in dollars for any transactions with tax implications. Once people are using the currency to track their transactions, it transcends anything physical. Money includes the paper dollars in your wallet, but it also includes all the accounting entries that record exchanges and show that someone has a dollar-denominated claim on someone else.

The dollar no longer has any fixed value. Since 1971, when the U.S. went off the gold standard, the value of the dollar has fluctuated according to its supply and demand in global financial markets.

According to Modern Monetary Theory, the creation of money is driven primarily by the demand for loans. When Meili extended credit to Thelma to buy stuff at her yard sale (see the previous post), the loan became a financial asset for Meili and a liability for Thelma, whether recorded in an I.O.U., a ledger, or in their respective memories. That kind of personal loan is at the bottom layer of the “pyramid of liabilities” that constitutes the monetary system. At a higher level, when a bank makes a business loan, it creates the money by crediting the business’s checking account. It also records the account balance as a liability for the bank, since it represents the bank’s obligation to accept checks drawn on the account. The loan itself is an asset for the bank, but a liability for the business, since the business is obligated to repay it.

Bank reserves

But doesn’t the bank have to have the money sitting in its vault before it can loan it out? No it doesn’t. It only has to have a small fraction of it in cash reserves, and most of those are held not in its vault but in an account with the central bank, in our case the Federal Reserve. The local bank doesn’t need much cash on hand on any given day, since it has deposits and loan payments coming in as well as withdrawals going out.

Modern Monetary Theory does not accept the notion that the reserves put a limit on the bank’s ability to lend, so that loan activity is limited by the existing supply of money. Banks respond to an increased demand for loans by finding the additional money they need to keep in reserve, whether by selling assets or borrowing from other banks or from the Federal Reserve. They make a profit by borrowing money at an “interbank” rate of interest and then charging their customers a somewhat higher rate.

The Federal Reserve stands at the top of the “pyramid of liabilities.” It is the “monopoly supplier of reserves.” Its operations accommodate the demand for money to lend, but only within limits because of the Fed’s responsibility to control inflation.

Inflation and interest rates

The Federal Reserve tries to control inflation by setting a target for the interest rate on interbank loans. Since the banks mark up this rate to make a profit when they lend to customers, this rate also affects interest rates for mortgages, business loans, and so forth. The Fed’s aim is to set rates high enough to discourage borrowing and spending when prices are rising too fast, and low enough to encourage borrowing and spending when inflation is low and the economy is growing too slowly. The Fed keeps a constant watch on actual interbank borrowing to see if the rates on interbank loans are deviating from the target. That happens because of fluctuations in the reserves held by the banks.

When banks are short of reserves, the shortage may drive the interbank rate up. (Banks are willing to pay more to borrow, or they can charge more to lend.) The Federal Reserve can alleviate the shortage by injecting cash into the system with purchases of bonds or other assets from banks. When an excess of reserves drives the interbank rate below the Fed’s target, it can drain reserves from the system by selling bonds or other assets to banks.

Treasury spending and lending

When the U.S. Treasury spends money authorized by the federal budget, it also creates money for the economy, for example by crediting the account of a building contractor. When it taxes, it removes money from the economy. When it spends more than it taxes, the excess money increases disposable income and boosts aggregate demand.

Deficit spending can be a source of inflation, however, by pushing up the market demand for goods and services without adding to the supply, especially if the economy is already running near capacity. The government spending went to produce a public good, such as a new highway, but it didn’t add to the supply of consumer goods that people can buy. By issuing Treasury bonds, the Treasury drains excess cash from the system and replaces it with I.O.U.s. People who buy the bonds are saving rather than spending.

Notice that I did not say that the government had to issue bonds in order to borrow the money before it could spend it, like a consumer using a credit card. In principle, the sovereign state has the power to create money when it spends without draining that money back out again through taxation or bond sales. Selling bonds is mainly a prudent measure to ward off inflation. For that reason, Modern Monetary Theory considers it a part of monetary policy more than fiscal policy, which is concerned more with taxing and spending.

The Federal Reserve does not buy Treasury bonds directly from the Treasury, but it can buy and sell them on the secondary market. Those buys and sells are an important way of adjusting bank reserves, as described above. Although the Federal Reserve has a degree of independence from the Treasury, in practice they work together to control inflation.

A tight monetary policy keeps interest rates high enough to discourage too much borrowing and spending. Experience has shown that it can be effective in controlling inflation. The downside is that it can slow economic growth and keep the economy running below capacity. The holy grail for economists would be a set of government policies that would promote both full employment and low inflation. Modern Monetary Theory tries to develop such a policy.

Continued

 


MMT 2: GDP and Government Spending

July 3, 2018

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This is the second in a series of posts about MMT, Modern Monetary Theory.

I will now proceed to describe some of the fundamental principles of Modern Monetary Theory, as explained in the text by Mitchell, Wray and Watts. These may seem a little dry and abstract at first, but how they apply to real-world issues should become apparent very quickly.

GDP and its components

Since macroeconomics is interested in aggregate outcomes, especially the goal of using the available labor and other resources to the limit, its central concept is Gross Domestic Product. “GDP is the measure of all currently produced final goods and services evaluated at market prices.” It represents a country’s entire domestic output.

Economists measure GDP in several different ways, the easiest of which is to add up the various kinds of expenditures on goods and services. These fall into several categories:

  • Consumption (69%): spending on new goods and services by households. That does not include personal financial investments, which are considered savings and not goods or services; and it does not include new home purchases, which are part of Investment below.
  • Investment (17%): spending on plants, equipment and new inventory by firms, and real estate investment by households. It includes only real assets, not financial assets like stocks and bonds.
  • Government spending (17%): spending by all levels of government, including investments in long-term real assets like highways. It does not include transfer payments like Social Security checks or food stamps, which are counted in Consumption when they are spent.
  • Net exports (-3%): spending on exports minus spending on imports. Foreign spending on the products we export contributes to our domestic output, while spending on products we import contributes to foreign output. It is negative because our imports exceed our exports.

The percentages indicate the current contribution of each component to U.S. GDP. The first three add up to 103% because the last subtracts 3%.

This is summarized in the formula  GDP = C + I + G + NX

Domestic output and domestic income are two sides of the same coin, since every expenditure by one economic unit is income for another. “The basic macroeconomic rule then is that, subject to the existing productive capacity, total spending drives output and national income, which, in turn, drives employment.”

Modern monetary theory looks at the economy primarily from the demand side. It assumes that supply is usually pretty responsive to demand. If the government wants to order more airplanes, Boeing will be happy to fill the order. Increases in demand can boost GDP as long as the economy is not already running at full capacity, which it rarely is.

Government spending and GDP

Government spending accounts for 17% of U.S. GDP, not nearly as much as consumption but just as much as business investment and new home buying.

The potential benefits of government spending are twofold: first, it creates public goods and services like highways and public education; and second, it provides employment and profits for private sector enterprises, such as construction companies that build the roads and schools.

Although reducing the size of government is a popular conservative goal, cuts in government spending can be expected to reduce GDP because they are not offset by increases in other components of GDP. Reductions in highway construction are unlikely to be offset by increases in automobile purchases. Quite the contrary, since the spending cuts represent lost income to someone, and lower incomes reduce consumption, which is the biggest part of GDP. Spending increases, on the other hand, can increase GDP both directly and indirectly through their positive effects on income and consumption.

Multiplier effects

The indirect effects of spending changes on GDP are called “multiplier effects,” and they have a precise mathematical description.

Let’s say that for every additional dollar of disposable (after-tax) income, people devote 80 cents to consumption. The technical term for that .80 is the “marginal propensity to consume,” designated by c. Some people consume a larger proportion of their income than others (especially if they don’t have very much), but as usual we are interested in aggregating and using an average.

Thus if $1 was injected into the economy, through additional spending, total income would initially rise by $1. If the marginal propensity to consume was 0.8, then this initial rise in income would induce a rise in consumption of 0.8 x $1 or 80 cents in period 1. This initial $0.80 rise in induced spending would further induce a rise in income of $0.80 which would induce additional consumption in period 2 of 0.8 x 0.8 or 64 cents and so on.

The sequence of 1 + .8 + .64 + .512 is called a “power series” in mathematics because each number is a power of c. The sum of all the numbers comes out 1/(1-c), which in this case is 1/(1-.8) = 1/.2 = 5. In theory, a $1 increase in spending could result in a $5 increase in GDP. In practice, there are other variables that complicate things a bit. But in essence, this is the basis for expecting government spending to stimulate and grow the economy. We are asserting that real output has room to grow, that growth in output generates growth in income, and that consumer demand then drives further growth in output and income, in a virtuous circle.

Does that sound too good to be true? If you want to know where that first $1 came from, or whether there’s a catch somewhere, you are asking the right questions. But if you are sure that you can’t grow an economy by increasing spending, the modern monetary theorists have something to tell you.

What’s the limit, tax revenue?

Let’s play devil’s advocate. If growing the economy were so simple, why not let government spending go sky high? The obvious answer is that like a household, the government shouldn’t spend more than its revenue. That’s the wrong answer, as far as MMT is concerned, but let’s go with it for a moment.

If government has to raise taxes to pay for any spending increases, that wipes out the multiplier effect. That’s because the calculation of increases in consumer spending are based on disposable income, after taxes have been removed. If the government increases spending by $1 billion, but raises taxes by the same amount, gross income goes up $1 billion but disposable income doesn’t go up at all. (Of course it goes up for those who got jobs as a result of the spending, but in the aggregate that’s offset by the tax increase.) The increase in spending will expand the public sector and employ some people there, but there won’t be any further expansion in the economy as a whole.

Still, even that is something. G is part of GDP, so if the government can make good use of otherwise underutilized resources, that in itself adds to GDP. If the private sector is under-investing and under-employing, why shouldn’t the public sector take up the slack, especially if it can give people public goods and services that are otherwise lacking?

Suppose you live in a development with some common amenities and a homeowner’s association. The association raises everyone’s dues in order to hire an additional work crew to spruce up the common areas. That adds a service to aggregate output and new income to aggregate income. Your income remains the same, but part of it is allocated to supporting a common good instead of a private good. Aggregate disposable income is unchanged, because the new “tax” reduced yours, but the wages of the work crew increased theirs. The lesson is that reallocating income and labor to a sphere where it can be more fully employed can add wealth. Substitute government for the homeowner’s association, and you have a case for government spending.

Spending beyond revenue

The case for public spending goes beyond the previous example, into the realm of deficit spending. MMT questions the basic assumption that a sovereign government is like a household in needing to limit its spending to its revenue. That’s where aggregate thinking becomes crucial. Assuming that what is true at the individual level is also true at the aggregate level is known as the “fallacy of composition.”

At the individual or household level, living within one’s means is a cardinal principle of financial planning. If you spend less than you make, you can save and invest the surplus. The money you make adds to your income, setting up a virtuous circle that leads to higher net worth and financial security. Spend more than you make and you run up debt. That debt burden on your future income can then send you into a downward spiral of lower net worth and even insolvency.

MMT maintains that a sovereign state that issues its own currency never has to run out of money, although it does have to manage the currency so that it retains its value. Currencies such as the dollar are “fiat currencies,” no longer backed by any finite commodity, such as gold. The dollar’s value depends on the promise of the federal government to accept dollars in payment of taxes, and on the demand for dollars on world markets.

When the federal government spends, it injects money into the economy; when it taxes, it removes money. There is no economic law that prevents the government from injecting more money than it removes, and in modern times that’s what it usually does. The deficit spending boosts the economy by allowing the multiplier effect to work. And as we’ll see later, the excess money spent ends up as a financial asset in the private sector.

Governments without the power to create their own currency, such as state and local governments, or the homeowner’s association thought of as a kind of government, are much more limited in their capacity to stimulate their economies. They have to operate more like households, spending only what they’ve already received in revenue or cautious borrowing.

The real limit–productive capacity

The real limit on spending is not tax revenue, but the productive capacity of the economy. That is limited by the available resources and technologies. It does expand, but not as fast as we would like. Sometimes shortages of specific resources contract it, as in the case of the OPEC oil embargo of 1973.

If aggregate demand increases so rapidly that it starts to strain productive capacity, then the sustained price increases known as inflation can occur.

Once the capital stock is in place, firms will respond to increases in spending for the goods and services they supply by increasing output up to the productive limits of their capital and the available labour and other inputs. Beyond full capacity, they can only increase prices when increased spending occurs.

So when the government wants to build a highway, it may have to bid more for the job because construction companies already have as many jobs as they can handle. Or when it wants to staff a new department, it may have to hire workers away from other jobs by offering higher wages.

Deficit spending when the economy is at or near capacity may end up boosting prices more than GDP. Even if the spending produces a short-term increase in aggregate disposable income (because it wasn’t offset by tax increases), the increased consumer demand will push up prices rather than real private-sector output. A price increase is not the same thing as a multiplier effect on output and real income.

While acknowledging this limit to effective government spending, MMT theorists are far more interested in what can be done when the economy is operating below capacity. They believe that it is usually possible for the sovereign government to stimulate the economy, create employment, and increase domestic output and real income, while at the same time using monetary policy to control inflation and protect the dollar’s purchasing power. They do not believe that inflation fears justify tight monetary and fiscal policies that keep the economy and its workers from achieving their real potential.

Continued


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.

Continued