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.



Are We “Eating the Family Cow”?

January 25, 2019

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Peter Temin, “Finance in Economic Growth: Eating the Family Cow.” Institute for New Economic Thinking, Working Paper No. 86, December 17, 2018.

If you rely on the family cow for its milk (or income from selling the milk), it’s best not to eat the cow. That’s a commonsense basis for the economic idea that future income depends on capital assets. Taking it a step further, long-term economic growth depends on expanding capital assets.

In a manufacturing economy, seeing that expansion is fairly easy. We can see automobile manufacturers building more assembly lines and making more cars. The transition to a service economy has clouded our vision somewhat. Temin describes the new reality: “Agriculture, mining, construction and manufacturing occupied only one-quarter of the labor force in 1990 and fell below one-seventh in 2016. The rest of the labor force is working in services.”

In the service economy, expanding capital assets involves more than buying buildings or equipment. It involves such intangibles as financial assets, knowledge and intellectual property. But our national accounting system does not yet reflect that. The Bureau of Economic Analysis, which produces the National Income and Product Accounts (NIPA), acknowledges the problem: “While all countries account for investment in tangible assets in their gross domestic product (GDP) statistics, no country currently includes a comprehensive estimate of business investment in intangible assets in their official accounts.”

Temin says that this puts economists in the position of tackling 21st-century issues with data designed for the 20th century. “Students are told that the economy has de-industrialized, but they have not been made aware how the growing share of services makes the measurement of macroeconomic variables increasingly difficult.”

This might not be so much of a problem if intangible assets were expanding nicely right along with tangible assets. But Temin doesn’t think they are. His concern is that we may actually be consuming rather than expanding our most important intangible assets, putting our future economic growth at risk, but our national accounting system is not equipped to detect the problem:

Existing NIPA data fail to describe the future path of growth in our new economy because they lack output data on financial, human and social capital investments. They fail to show that the United States is consuming its capital stock now and will suffer later, rather like killing the family cow to have a steak dinner.

Investment in standard accounting

In standard national accounting, Investment (I) is one of the components of GDP, along with Consumption (C), Government spending (G) and Net Exports (NX). It is defined narrowly, however, as spending on plants, equipment and new inventory by firms, and real estate investments by households. It only includes real assets, not financial assets or human capital.

But aren’t you making an investment when you use surplus income to buy assets like stocks and bonds in a retirement account? We certainly do call it investing because the general idea is the same. Like a piece of machinery, a financial asset is a form of wealth that can produce future income. But unlike the machine, your retirement account is not necessarily making anything to add to the Gross Domestic Product. Your financial acquisitions are accounted for on the income side of the economy, as a form of Saving (S). Of course, if the company that issues stocks or bonds uses the money it receives to build a factory, then that does become an investment for purposes of the national accounts. That distinction makes sense, at least within the framework of a manufacturing economy.

Another exclusion from investment is education, although we may think of it as an investment in human capital. In standard accounting, an educational expense is part of Consumption (C) if made by a household, and part of Government spending (G) if made by a government.

The challenge of accounting for intangible investments

While many economists find it reasonable to talk about intangible investments, incorporating them into the national accounting is not easy. Not only are they inherently hard to measure, but sometimes they may seem downright illusory. We can walk into a factory and see what it produces, but how do we distinguish a service from a disservice, or a productive financial asset from a “toxic asset”? This section will focus on financial assets, but similar valuation problems emerge with other intangible assets as well.

If you are just saving for retirement, that “investment” may be reasonably distinguished from those that contribute to future production. On the other hand, that distinction may be harder to justify for a financial firm that acquires financial assets in the normal course of business.

Consider a bank that makes a profit by accepting deposits at low interest rates and making loans at higher rates. It is providing financial services such as facilitating home buying. If it uses some of its profits to expand its operations, surely it is expanding its income-producing assets and thus investing. In standard accounting, only the purchase of tangible assets such as new branch offices would count as investing, but shouldn’t the strengthening of its capital position also count? Doesn’t that also enable it to provide more services and generate more income?

Some economists have found it useful to expand the concepts of capital and investment to include all forms of wealth. That’s what Piketty was doing when he studied how the rich get richer. He concluded that a higher rate of return on capital relative to the rate of economic growth is associated with greater inequality. But that broad a definition of capital doesn’t work for all purposes. Some forms of wealth are clearly not capital in the sense of a “factor of production.” Collectibles like gold coins or art works don’t produce anything, and they may not even appreciate. Some financial assets fluctuate wildly in market value, and so their potential to generate income is hard to evaluate. If we are interested in productive financial assets, they are easier to talk about than to measure.

Perhaps the biggest problem involves assets so overvalued as to be dangerous. That was a huge problem leading up to the 2008 financial crisis. Lenders were making too many risky mortgage loans and selling them off to other financial institutions, which then packaged them as overrated investments to be bought by unsuspecting customers. Building more car factories obviously produces more goods for car buyers, but financial acquisitions don’t always provide more services for financial clients or income for owners. Temin quotes Simon Kuznets, who remarked in 1937, “It would be of great value to have national income estimates that would remove from the total the elements which. . .represent dis-service rather than service. Such estimates would subtract from the present national income. . .a great many of the expenses involved in financial and speculative activities.” Financial wheeling and dealing in the mortgage industry did a disservice to all kinds of people, from the borrowers who were encouraged to buy homes they couldn’t afford and then got foreclosed on, to the insurers who insured the overvalued bundles of mortgages and the investors who bought them. When the future income from the overvalued assets turned out to be illusory, the asset values collapsed and fortunes were lost.

The country has experienced a dramatic expansion of financial services, but we have no straightforward way of measuring the output of services, the increase in productive capital, or the contribution to long-term economic growth. Temin is among the skeptics who doubt that the accumulation of financial capital is doing as much for us as we think.

Investment in America: Tangible capital assets

We turn now to the question of how well the United States is investing in its economic future. We’ll start with investment in tangible capital assets as revealed by standard accounting, and then turn to the more challenging question of intangibles.

Temin refers to private fixed investments as “Keynesian” because of the roots of that concept in Keynesian macroeconomics. He says that “no one disputes the low level of Keynesian investment in recent years.” Here I’m also going to quote myself, since I commented on this investment situation in my recent post on “Forty Years of Reaganomics“:

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.
. . . .
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% [of GDP].

The results are even more disappointing if one considers the tangible investments that are made by government and accounted for within government spending. The U.S. continues to neglect its aging infrastructure, allowing its roads, bridges and transit systems to deteriorate. Failure to mitigate the effects of climate change will damage our infrastructure as well, creating a further drag on economic growth.

Investment in America: Financial capital assets

If we could consider intangible assets along with other forms of productive capital, would that brighten or darken our picture of investment and future growth? Temin believes that we are reducing rather than increasing our stock of productive intangible assets. Here we are not so much investing as disinvesting.

In public finance, tax cuts have damaged the federal government’s financial position, creating a larger liability in the form of the national debt. That will probably inhibit the government’s future ability to contribute to GDP with spending on public goods and services.

In private finance, expansion of the financial services industry appears to be producing diminishing returns. Temin cites cross-national research showing that a growing financial sector contributes to economic growth only up to a point, but tends to reduce growth once it becomes too large. This implies that too little of that sector’s capital is being put to productive use.

Temin’s prime example of the wasteful use of capital is private equity firms:

Private equity firms have grown in recent decades to raise capital from wealthy individuals and institutions to make risky investments that promise high returns. Private equity firms buy companies and use high leverage to make these high returns. The debts, which have fixed interest payments, provide high returns on the capital invested by rich investors since all the profits go to them. And if the company fails, the debts default and investors walk away without loss. Society picks up the tab.

Brian Alexander’s Glass House told the story of the destructive effects of private equity firms on the economy of Lancaster, Ohio. I concluded my review of the book by linking the wasteful use of capital with economic inequality:

The wealthy minority have a lot of capital available to invest. But very weak income growth for the majority limits their ability to spend on new products. Under those conditions, it is not surprising that a lot of capital would go to buy existing enterprises rather than create new ones; nor is it surprising that cost-cutting rather than expansion of production would be a favored route to profit. If this strategy works to make the 1% richer despite hollowing out the middle class, that only reinforces the inequality and sluggish growth, creating a vicious cycle.

Temin’s conclusion is similar: “Recent research finds that finance has grown to the point where it no longer continues to benefit the entire economy, but it instead increases the incomes of the richest Americans at the expense of everyone else.”

Investment in America: Human and social capital

Research on human capital has focused primarily on education.

Macroeconomic thinkers say that education is the key to national success in the world where developing countries like China and Japan challenge the United States’ economic leadership. Letting our human capital decay may be the most important problem for future generations.

Here the picture is also discouraging: States have been cutting support for public universities; teacher pay has been declining relative to other jobs; and “the first education budget of the new administration in 2017. . .cut over ten billion dollars from federal education initiatives. . . .”

With regard to social capital, Temin thinks of it as “a new name for the old idea of community. . . .” Like other intangible assets, “no way has been found to include it in GDP.” But strong communities support economic productivity in many subtle ways. People with strong support groups make better, more productive workers.

An example of how social policy can strengthen or weaken community is the rate of incarceration. Locking criminals up protects the community, but locking too many people up for doing too little undermines community. “Young, poor and dominantly minority men and (to a lesser extent) women cycle through jails, prisons and then back into the community. They disrupt families, weaken social networks and other forms of social support, putting children at risk and promoting delinquency.”

Temin also cites Pearlstein and Wu’s critique of the brand of capitalism promoted by business schools and the business community in recent years. The pursuit of economic efficiency to the exclusion of other goals can also weaken community “by undermining trust and discouraging socially cooperative behavior.”

Temin states his general conclusion this way:

The evidence shown here reveals that we are investing less than before in Keynesian investment of private fixed assets and dis-investing other forms of capital. Financial investment is negative due to rapidly rising government debt and private financial investments that redistribute income toward the top end of the income distribution. Investments in human and social capital–both outside the BEA’s methodology–clearly are negative.

This is a bold thesis. However, the very fact that current accounting practices do not allow us to measure intangible investment with any precision limits our ability to test it. Temin relies on selected studies using unconventional data and impressionistic evidence to make his case, and I think his argument has merit. But economists have their work cut out for them if they are to achieve a comprehensive and realistic assessment of the nation’s investments in its economic future.