A low volume, high quality source from the demand side perspective.The podcast is produced weekly. A transcript is posted on the day of.

Wednesday, October 7, 2009

James K. Galbraith, plus markets, multipliers, recessions, the cruel legacy of the Chicago School, and crowding out

Crowding in or crowding out?
Paul Krugman and others are battling over crowding out and crowding in. Do government deficits steal investment capital or make it more expensive for private borrowers?
Our reading of Minsky suggests that deficits and investment are indeed substitutes for each other, but not competitors. Government deficits keep business cash flow from collapsing altogether. Minsky's equation profits equal investments plus deficits indicates that business, far from suffering from deficits, actually benefits.
Others have suggested that government deficits increase expected inflation and so will help investment, since deflation is death to current investment.
Our reading of Minsky suggests that the drop in demand is the problem. It may lead to deflation among price takers, but even if prices can be supported by market power, pricing power, as demand drops the revenue that would support new investment disappears.

One only needs to reflect on the explosion of investment in a boom. Surely one investor is bidding against another, just as these folks see all investors bidding against the government, yet investment surges in booms.

Another debate continues around the multiplier.

To say the multiplier is a constant number that can be isolated empirically is to ignore the fact that it depends on the savings rate. The higher the savings rate, the lower the multiplier.

To say the propensity to spend a tax rebate is the same as the propensity to spend the income from a new job is also nonsense. Thus the stimulus from the tax cuts of 2008 will be much lower than the stimulus from the job-creating infrastructure spending. The multiplier from the former may well be less than one. The multiplier from the latter is already one when it employs the first person.

And the multiplier works in reverse, as well. So the multiplier effect of the collapse of business investment may well wash away much of that of the stimulus bill.

This is not that difficult for those not entangled in protecting their reputations.

Compare recessions by percentage of job loss

Elsewhere, a comparison of recessions inspired by a chart at Calculated Risk demonstrates that the so-called mild recessions of 2001 and 1990, were not so mild in terms of job losses. True they were not as deep as others, but they were longer and in terms of jobs lost were more severe than the short, sharp recession and recoveries of 1953, 1960, 1969, and 1974. That is percentage terms, so it is not skewed by the size of the workforce. Plus, job growth emerged from the past two recessions at a much flatter angle than earlier, pre-Greenspan recessions. Put bluntly, in terms of jobs, the recessions have not been getting more mild, just longer. No longer V-shaped, these are basin-shaped.

All other recessions pale in comparison to the current one in terms of employment. Each of the others, aside from the 2001 Bush recession and the 1981 Reagan recession reached a trough in job losses by the 13th month. The current recession is still going down sharply in the twenty first month. This is, indeed, the Big One.

And although the employment crisis is continuing to deepen, the original published numbers understate it. As CR says,

Note: The the preliminary benchmark payroll revision is minus 824,000 jobs. (This is the preliminary estimate of the annual revision - this is very large).

Get that link to Calculated Risk in the transcript of today's podcast on the blog at Demandsideblog.blogspot.com.

Link to Calculated Risk

Economists still hiding out in crumbling efficient market theory

One of the principal illusions, or delusions, of the primitive orthodoxy is that markets are efficient. The efficient market hypotheses is, in fact, the core of the Chicago School's error and of -- due to the consequent damage done by those who follow it -- that school's moral liability.

Markets would be efficient, or at least more efficient, if all goods were private goods, or if all costs were included in the price, or (as Joseph Stiglitz has pointed out) if information were symetrical between buyers and sellers, or if market imperfections such as monopoly and monopsony did not exist. Unfortunately, that hypothetical world exists somewhere other than the industrial states in which efficient market zealots preach.

To be fair, the Chicago School concentrated on the efficiency of financial markets, a preposterous proposition to which they still cling despite all evidence to the contrary. Nevertheless the idea of efficient markets has been carried everywhere and so, too, it seems, the perception that somehow markets are working today to maximize benefit.

No better demonstration of the absence of critical thinking in economics exists than the continued deference to the Chicago School and its efficient markets. How absurd, for example, that the outcome now extant in the financial sector might be considered an optimal outcome, or that the proliferation of McMansions and underwater mortgages might be considered the maximum benefit for the whole, or that the degradation and imminent collapse of the environment might be somehow to the advantage of a substantial percentage of the population, or that the shift of wealth to developed countries and native elites in the wake of the opening of Third World markets might be somehow efficient. These are plainly the result of markets let loose to be controlled by the powerful, rather than structured and confined to be efficient.

That may be a lengthy introduction to today's audio clip, but it is just the tip of the iceberg in terms of the vacuous understanding of markets displayed by the primitive orthodoxy and its cathedral the University of Chicago.

Ray Anderson is founder and chairman at InterfaceInc. Anderson sees tax policy as a way of rectifying some of the fatal shortcomings of markets.


That was Ray Anderson on internalizing externalities. Anderson was interviewed here on Bloomberg. He has led his company InterfaceInc into a dominant place in the supply of carpeting to business and industry. He did this with vision and an appreciation for all the costs of production, not just those traditionally internalized.

There is much more to be said about the role and power of market participants and the structure and scope of markets themselves, and we will say it here sooner or later. In their place and structured rationally, markets are great. When entrenched powers dominate others via market distortions and then resist correction in the name of market efficiency, it is the lingering stench of the Chicago School.

Let us take the most extreme example of the nonworking of markets. Suppose there is a market in household goods and there is no police authority. The market in goods is bustling with the contraband of thieves and robbers. It is an efficient activity to go house to house and extract people's wealth to take to the market. The first activity is an externality to the market. Is such antisocial robbery on a large scale possible without the market, the place to sell? No. It is called an externality only because it exists apart from the point of purchase-sale.

This is not too far a step from the degradation and exploitation of the environment. Large corporations with the correct industrial capacity and small dumpers of toxic material both enjoy a capacity to steal from and harm future generations that is inextricable from the market for the goods in question, yet these are considered outside markets. Externalities.

Is the market efficient? Well, it finds the right price considering the subsidies of future generations -- and current -- and the structure and rules of traffic in the particular goods.

James K. Galbraith

In our series looking for the perspective of those who got it right, we turn to James K. Galbraith, son of the great economist John Kenneth Galbraith and apparently invisible to those who say nobody saw it coming.

We've promoted Galbraith's book the Predator State ad nauseum here on the podcast. Let's review a few of the anti-orthodox principles that organize that book.

One, and quoting:

Because markets cannot and do not think ahead, the United States needs a capacity to plan. To build such a capacity, we must, first of all, overcome our taboo against planning. Planning is inherently imperfect, but in the absence of planning, disaster is certain.

Two, and continuing to quote:

The setting of wages and control of the distribution of pay and incomes is a social, and not a market, decision. It is not the case that technology dictates what people are worth and should be paid. Rather, society decides what the distribution of pay should be, and the technology adjusts to that configuration. Standards -- for pay but also for product and occupational safety and for the environment -- are a device whereby society fashions technology to its needs. And more egalitarian standards -- those that lead to a more just society -- also promote the most rapid and effective forms of technological change, so that there is no trade-off, in a properly designed economic policy, between efficiency and fairness.

And three, with a final quote:

At this juncture in history, the United States needs to come to grips with its position in the global economy and prepare for the day when the unlimited privilege of issuing never-to-be-paid chits to the rest of the world may come to an end. We should not hasten that day. In fact, if possible, we should delay it. We should take reasonable steps to try to keep the current system intact. But given the rot in the system, we should also be prepared for a crisis that could come up very fast. The fate of the country, and indeed the security and prosperity of the entire world, could depend on whether we are able to deal with such a crisis once it starts.

Galbraith traces the fall of conservativism from the Reagan Revolution into the more or less overt plundering of the society by the politically well-positioned oligarchs of Big Oil, Big Pharma, Insurance, Finance, Agriculture and Media.

Galbraith in 1981 as a young director of the Congressional Goint Economic Committee organized what he called "a largely futile frontline resistance to Reaganomics." The vapid combination of Supply Side pap and Milton Friedman Monetarism resulted in immediate large deficits and the beginning of hte deindustrialization of America. (Whatever might be contested about the causes of the events, the timing is not debatable.) Earlier Galbraith drafted the Humphrey-Hawkins bill, which generated the dual mandate for the Fed, and other mechanisms that focused on full employment.

The bill was created by Representative Augustus Hawkins and Senator Hubert Humphrey and signed into law in 1978. Its full title is the Full Employment and Balanced Growth Act. As written it was a worthy successor to the most important piece of economics legislation, the Full Employment Act of 1946. As implemented, it has been a way to get the Fed Chairman before Congress a couple of times a year, but otherwise has been limited to creative footnotes. Lip service is a strong description.

In particular, the Act requires the President to set numerical goals for the economy of the next fiscal year in the Economic Report of the President and to suggest policies that will achieve these goals and requires the Chairman of the Federal Reserve to connect the monetary policy with the Presidential economic policy.

The Act sets specific numerical goals for the President to attain. By 1983, unemployment rates should be not more than 3% for persons aged 20 or over and not more than 4% for persons aged 16 or over, and inflation rates should not be over 4%. The Act allows Congress to revise these goals as time progresses. If private enterprise is lacking in power to achieve these goals, the Act expressly allows the government to create a "reservoir of public employment." These jobs are required to be in the lower ranges of skill and pay so as to not draw the workforce away from the private sector.

Coordination between fiscal policy and economic policy has not occurred, of course, and it was actually one of the accomplishments of the Reagan Revolution to drive them as far apart as they have become. Unemployment rates of 3 and 4 percent are now considered the stuff of fantasy. A public employment program?

The Reagan Revolution, whatever its tenets, resulted not in principled conservativism, but in a corporate takeover of the state, as Galbraith has described in his book. By the way, this digression on Galbraith's early work is not from the book, but our contribution with an assist from Wikipedia.

The American economic model in Galbraith's view, is not the free rein to the markets and public be damned approach of Reagan and Bush, but is the structure created by the New Deal. The institutions, Galbraith writes, "are neither purely private nor wholly public. They are not like the socialist welfare institutions of Europe, but neither are they private enterprise."

Some are supported by state spending -- entitlements, but also bank credit, credit guaranetees, and implicit guarantees, and -- Galbraith is writing prior to the massive bailouts when he says -- quote --- the expectation of rescue in the event of trouble. Mortgages, health, agriculture, and the military are some of the other areas receiving massive public subsidies.

And Galbraith is also adamant about the need for standards, which rises from the delusion that markets will produce a competitive market price. Quoting

"As economic theorists know, the real world is necessarily devoid of any such thing [as a competitive market price]. If there is one administered, or controlled, or monopolistic price in the system -- an oil price or an interest rate -- then even if all the other markets are perfectly competitive, all of them will be "distorted" by the presence of that one monopolistic price ...


The fact is that monopoly and market power are not only pervasive, they are at the center of economic life. The very purpose of a new technology is, of course, to create a monopoly where none previously existed.



That being so, prices and wages would serve a quite different function in the real world than the market model assigns to them. Instead of being set so as to maximize efficiency in production, they are set essentially by social relations between groups of workers and by the pattern of prices that are explicitly controlled. They express, in other words, the preixisting matrix ...

... Seen in this light, deregulation of wages and prices ... is nothing more than a rearrangement of social power relations. And the consequences have little or nothing to do with the efficiency whereby a good or service is produced...

p. 179-180

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