I haven’t been blogging as much as I wanted to be. My problem with my writing is I’m attracted to “high concept” pieces that take a lot of work but often don’t have the time to finish them “in one go”. Then, once I stop working on them, it becomes difficult to return to them. Thus, starting today, I’m going to make sure I post once a week on what I’m reading. I’m always reading papers, articles and dissertations and I go through much more material than I ever comment on publicly.
Recently I finally got around to Cracking open Wallerstein's "Historical Capitalism". I was let down from nearly the first page. Capitalism according to Wallerstein is distinguished from all past social systems by the drive towards expansion becoming the “primary objective” of capitalists (capitalism itself? It’s not clear whether he means this as an objective claim about the system or the motivations of each individual). This is supposedly the “overriding goal”.I think this is completely wrong and that it is a painfully common mistake of leftists to parrot these kinds of ideas from neoclassical microecnomics textbooks..
The capitalist mode of production isn’t “the endless accumulation of capital for its own sake”. It is the endless accumulation of capital for the sake of reproducing on an expanded scale the social position of the elites in control of the production process. It is true that different types of elites (financiers, landlords, CEOs, stockholders, boards of directors, family owners etc) jockey for the dominant position but the essential point is that profit is an intermediate goal to accomplish other things. Making the intermediate goal the end in itself is arbitrary. Further it leans into economists prejudices regarding the lack of social embeddedness of economic decision making. Of course it is true that the capitalist mode of production does involve the circuit M-C-P-C’-M’ but the circuit is a production schema, not actually a theory. Keynes adopts the schema too. Now the choice of starting and ending point is theoretically informed (monetary production economy) but it is not indistinguishable from the theory.
In short, I think it's valid to say that capitalists are profit seeking, but not to say they seek profit “for profit’s sake”. Capitalists are not midas. The defense that the “abstract capitalist” is midas comes to nothing. There is no abstract capitalist. There is only the monetary circuit which includes production. This circuit has no agency in it, no causal mechanisms; as I said, it is just a schema. I just see no validity in projecting onto this schema the “final goal” of profit seeking and then when dealing with capitalism as a historical system erase that and pencil in the actual “final goals” of all actually existing capitalists. The abstract schema adds a lot, the abstract assumption of profit seeking as a final goal adds nothing and is completely unneeded and invalid.
Now of course, the idea that capitalists “maximize profits” in an asocial way is very influential. Understanding that ideological claim is important. But we must separate the empirical reality we see around us from this ideology.
What Wallerstein seems to mean is that in concrete situations encountered in the production process, capitalists encounter situations where some social obligation (say, the local environment) is subordinated to profit seeking. But this defense of profit seeking as a “final objective” is completely invalid! Just because the elite in control of a capitalist business enterprise disregard some social relations, doesn’t mean they are asocial! They are just dismissing social relations and environments they don’t value. They may not care about detroit or the indigenous, but they care about their family, peers, boards etc. They may destroy some social relations, but create others. Hell, they care about having sex with their secretaries sometimes too That’s just to say that “social relations” aren’t necessarily positive. Their goal might even be “beating” another CEO in salary, perhaps one they went to business school with. Having sex with their secretary and beating Rick in salary may be all they think about.
The point is, in the sphere of the firm they may seem to act asocially in many situations, but that is because they don’t care about their subordinates and “losers”! When it comes to their hierarchy of final goals (access to the provisioning process, fame, political power, social climbing daughters, meeting obligations to their social or legal creditors etc.) whichever one they value most will prevail. If dumping toxic waste in the local river will ruin the dominant capitalist’s child’s wedding, they won’t do it. If it destroys a poor African American community, they often will. Socially Embed! Socially Embed! That is Moses and the prophets!
Last night Trump was elected President of the United States. A multitude of ordinary democrats are going through sorrow and grief right now. For them, it is like their only protection was snatched from them. They are feeling vulnerable and afraid. Over the next few months a significant portion of these people who couldn’t hear any of the criticisms of Hillary Clinton will begin to process them and, possibly, accept many of them. The primary reason they couldn’t hear these criticisms before the election, let alone the primaries, is that they were afraid. Fear is a powerful motivating factor. Ultimately the reason so many flocked to Hillary Clinton is because they were afraid and, crucially, they thought Clinton and the democratic establishment could protect them.
Just like Brexit, a right wing famous institution (the European Union in Britain’s case, Clinton in ours) was marshalled as a defense against far right wing reaction and proved incompetent to the task. This has been the most important point that Clinton supporters could most fundamentally not hear. In some narrow sense you might think that Clinton is “better” than Trump but that’s never what the conversation was. As I said in the aftermath of Brexit, “you can ‘prefer’ the status quo over right wing reaction until you’re blue in the face, it doesn’t matter, status quo can’t hold”. Even if Clinton was capable of squeaking out a victory this time around, she would never have had eight years. The right wing ghoul in four years would have been more cunning, more capable and more evil. The democratic party establishment cannot protect anyone from right wing reaction. It is a rotting albatross across the neck of this country, not a protective amulet.
Fear has been the only thing the democratic party has had for a long time. Pure fear cannot win for long. It just can’t be a long term motivation. You may wish otherwise, but that doesn’t change reality. Frankly, I’m not sure we should want a bunch of people to continually sacrifice themselves for the sake of coastal elite liberals. Maybe, just maybe, it is the responsibility of politicians to respond to the concerns of ordinary people. The data bears out the failure of fear as a long term motivation. Tom Ferguson (who will have what is sure to be an absolutely excellent analysis out soon) tried to warn people in 2014. Turnout in many places had fallen to pre-civil war levels in the 2014 midterms. Presidential elections always have a bump but it seems likely that this will be a presidential turnout low for many places. Already we can see that turnout collapsed in Michigan and Wisconsin.
Thus, don’t let anyone say differently- it is a turnout collapse that lost democrats this election and the turnout collapse is because of the democratic party’s complete abandonment of ordinary people. The strategy of supporting our wall street and silicon valley oligarchy to protect people from the rabble is an utter failure and needs to be recognized as such. The democratic party elites won’t learn. They are already talking about how Clinton should have moved to the right on immigration. They will ride this sinking ship to the end. It is up to rank and file democrats to abandon the establishment en mas and say loudly and clearly that they will not support anyone but left wing candidates. As anyone in a negotiation innately knows, the credible threat of exit is the only thing that gives one power.
This will not be an easy move. The world is very scary when you don’t believe democrats can protect you. It will be comforting to run back to them in future years in a moment of panic. This must be resisted. It is not hyperbole to say that the fate of human civilization relies on our ability to smash or reform the democratic party and pull us away from the precipice of fascism and climate catastrophe. It is also not guaranteed that we will win. The arc of the universe does not bend towards justice- and even if it did sometimes that arc can snap into a million little pieces. However, this is our best chance. Nonetheless we have no other choice- we must try. Hope isn’t necessary, action is.
P.S. The interview I did in June, especially 20 minutes to 33 minutes, at the Nostalgia Trap holds up quite well in analyzing this election.
Because of the excellent coverage at MarketWatch - featuring quotes from my partner-in-crime Rohan Grey and the great economist at UMKC Scott Fullwiler- I made myself watch John Oliver’s coverage of third parties. It was as boring and annoying as I thought it was going to be when i stopped watching the video this morning a few minutes in. Okay I lied- I slogged through the automatic youtube transcripts because I couldn’t bear to hear any more marginally informed smarm from him. There are a lot of ways to criticize what he had to say, but to me the important thing was his drive by defense of central bank independence:
...only the Federal Reserve does and it does not take marching orders from the White House because that would be extremely dangerous you don't want to give presidents the power to just create new money whenever they want
He goes on to illustrate how “dangerous” it is using a frivolous example of a stunt presidential candidate “creating” money for his own use. The problem with this should be obvious- we don’t have to choose between the Federal Reserve having complete autonomy and a president unilaterally spending money on whatever he or she desires. That’s why there’s this centuries long thing called administrative law that deals with how authority is delegated to government agencies and the extent to which it is delegated. The idea that the delegation of some spending authority to administrative agencies or the presidency is crazy and allows them to go hog wild but the ability to buy and sell unlimited amounts of a variety of financial assets and change interest rates- to 20%+ ,as actually happened under Volcker, isn’t enormous power is absurd. This kind of thinking shows either an ignorance of monetary policy or a complete and utter servility to the status quo.
The Committee for Economic Development- a business-run center right think tank that is about as mainstream as you can get- even funded research in the late 1950s “... that openly contemplated varying even tax rates within ranges set by Executive decree, bringing it much closer to the progressive Keynesian ideas of the late forties” (Costantini 2015). Giving the president the authority to, say, spend up to 100 billion dollars if he or she has evidence that there is a recession is some discretion but not unlimited discretion. You could limit the types of spending the President could do to particular categories such as “necessary infrastructure maintenance” or community services, higher unemployment insurance etc and then review her or his spending choices over the following year. These are perfectly reasonable ways of delegating fiscal policy powers and not "very dangerous".
I’ll go further- there is no inherent reason why congress couldn't disallow discretionary changes to interest rates by the Federal Reserve and rely on some delegation of fiscal policy authority as the government's primary discretionary stabilization policy. For example, like the CED research above suggests, you could give the IRS authority to change certain marginal tax rates within particular set ranges. In fact, I think this would be much, much less discretionary authority than the Federal Reserve has now. In other words, just because creating fiscal authorities out of administrative agencies as an alternative to Federal Reserve independence isn’t a mainstream policy idea now doesn’t mean it is inherently crazy. I’m all for making green party analysis more technically correct- but it is obvious to everyone that most people who criticize Jill Stein aren’t interested in that. Oliver himself hit her on this point in the context of a general broadside against third party candidates. In other words, if you’re nitpicking on technicalities to justify your own milquetoast liberalism- at the very least be right.
Which brings us to the issue that so much of what he says here is just wrong and not just misleading or disingenuous. He says it would be crazy for the President to be able to get the Fed to buy and forgive the debt. However, he doesn’t discuss at all that the Department of Education may be able to directly forgive debt- or declare a moratorium on payments- and the President could tell them to do so. This isn’t the place to get into the specifics or technicalities of administrative law but the fact that this never seems to occur to him- or that this would be functionally the same thing as a Fed purchase and forgiveness- reveals basic ignorance of the subject, which is frustrating coming from someone posturing as “more knowledgeable-than-thou”. Sometimes being a left wing policy wonk is frustrating because you have to endure all these “serious” criticisms of left wing politicians that are chock full of this kind of nonsense.
Speaking of nonsense, this all skips over the fact that the example he proffers is particularly absurd because the Federal Reserve already does discretionary fiscal policy and isn’t budgeted by congress (Conti-Brown 2015)! No one told the Federal Reserve to run a full employment program for economists-yet it basically does. This year the Federal Reserve Board alone- meaning not including the budgets of the twelve regional Federal Reserve banks- is spending over $136 million dollars on “monetary policy” research and analysis. In 2009 alone a Federal Reserve spokeswoman told the Huffington post that the Federal Reserve overall was budgeted to spend $433 million dollars on research into “monetary and economic policy”.
Even Milton Friedman, in an interview to Bloomberg July 7th, 1993, was reported as saying:
“the Fed’s relatively enhanced standing among the public has been aided ‘by the fact the Fed has always paid a great deal of attention to soothing the people in the media and buying up its most likely critics' Recognizing that the Fed employs ‘probably half of the monetary economists in the U.S. and has visiting appointments for two-thirds of the rest’ he [Friedman] saw few among the academic community who were prepared to criticize the Fed policy.”
I promise you that Federal Reserve spending on economists and economic research is a frivolous expense with a bigger negative effect on how the economy works than a 1000 tiger themed orgies - and hell it probably costs a lot more money too. That isn’t to besmirch the research- a lot of it is quite good in my experience. However, the fact that it is doled out autocratically by the Fed and without congressional review means these economists are under undue influence. Not to mention it completely distorts government research priorities. If all the research money the government spends is put together, I suspect that monetary policy is very over represented given the priorities of most americans. How much necessary research spending was cut and never refunded after the sequester?
Yet very few people are aware of this, let alone debating it. It’s true that if the Federal Reserve just outright started spending tens of billions of dollars congress would notice and reign it in- but that’s precisely the point. If all that’s constraining “frivolous” discretionary spending from the Federal Reserve is Congressional sanction- presumably this is the same thing could constrain the President. Critics of discretionary fiscal authority vested in an administrative agency besides the Federal Reserve and/or an agency under the control of the President need to explain how this is at all consistent. If they don’t think it is and want the Federal Reserve’s operational budget to be congressionally appropriated, they should spend their time on that much more important issue rather than taking pot shots at Jill Stein or third party candidates. Further, they need to explain why unlimited discretionary policy over setting interest rates is a less important power than moderate fiscal policy discretion vested in another independent agency or the President/a dependent agency. As of now, the only method i see here is hippie punching.
P. Conti-Brown, 2015, the Institutions of Federal Reserve Independence, 32 Yale J. on Reg., p. 273, available at http://digitalcommons.law.yale.edu/cgi/viewcontent.cgi?article=1412&context=yjreg
Costantini, O. (2015). The cyclically adjusted budget: history and exegesis of a fateful estimate. Institute for New Economic Thinking Working Paper Series, (24). available at https://www.ineteconomics.org/uploads/papers/WP24-Costantini.pdf
Polish Draft Law Restructuring Foreign Currency Denominated and Indexed Loans and the ECB Counterattack
Periodically I will be posting interesting things that have slipped under the radar. This is one of those posts. Apparently Poland has a “draft law” aimed at getting rid of past and future foreign denominated and indexed private debt. This is important as foreign denominated currency loans have been seen as an important part of many of the crises over the last 40 years (at least) and a crucial risk to financial stability. The lure of lower interest rates helps banks manipulate borrowers into taking much more risk and uncertainty than they realize. The ECB says:
“The purpose of the draft law is to facilitate the restructuring of loans denominated or indexed in a foreign currency (hereinafter ‘foreign currency loans’) that were granted after 1 January 2000 for a period exceeding 60 months, even if such loans have been repaid in full or terminated and settled. The draft law also prohibits granting of any future loans involving settlement in a foreign currency”
Under the law any “natural persons” can request to have their loan restructured. If it is, “Any contractual obligation of the borrower denominated in a foreign currency or indexed to a foreign currency is deemed to be null and void”. The loan is then converted into domestic currency.
“The ECB reiterates its comments regarding risks associated with foreign currency loans made in a previous opinion. In particular, in the case of Poland, such risks do not, at present, appear to be of a systemic nature for the financial system and are not seen as representing a particular risk from a financial stability perspective.”
It of course also notes that if you reduce the burden of foreign denominated loans people were tricked into taking that could reduce bank profits and thus have a “ significant impact on the financial stability of the Polish banking sector”. Thus, the ECB comes out firmly on the side of creditors, as one would expect. These smaller, more obscure incidents are a good example of the insidious power of European wide technocratic institutions. For all the problems with the Federal Reserve, it can be reigned in by congress if need be and especially in a situation of ascendant social democratic/leftist politics. It’s legal commentary really is advisory and the Federal Reserve knows to tread carefully when interfering. It is tolerated to the extent it is perceived as giving informed advice and not trying to overtly control or bully congress.. However, for smaller countries like Poland entities like the ECB are able to “throw their weight around” with a pile of seemingly technical objections and overwhelm local politics. For opponents of the law, the ECB is indeed a powerful ally to have. It is also capable of obliquely threatening Poland with retaliation from the EU as a whole, without particularly strong legal basis for its innuendo. I strongly recommend you read the ECB’s 6 page commentary in full.
A note: I caught this because I read this press release from the ECB. In general press releases and speeches from important organizations like the ECB are great reads
For those uninitiated in the technicalities of NIPA and national accounting logic in general, this comment may seem strange. What's the issue with the Financial sector running a "nonzero" balance? As you'll see though, there are a number of ways where such an approach comes into conflict with the traditional treatment of the NIPA accounts and need readjustment if the approach I would like to take is to be seen as consistent.
As it Happens Ruggles and Ruggles, in their excellent book "National Accounting and Economic Policy: The United States and UN Systems" tackle precisely this issue. The crux of the issue Mason refers to is summarized at the beginning of the chapter:
"The approach of the United Nations System of National Accounts (SNA) to privately funded pensions and insurance is essentially a neo-classical one.Apart from the costs of operation, private pension contributions and life insurance premiums are considered to be a form of household saving, part of the accumulation of wealth by households that should appear as a category of assets on the household balance sheet. But publicly funded schemes- social security arrangements-- are not treated in this way. Entitlements under public programs are not credited to households until such time as the benefits are actually received. "
Thus, in one treatment there are private transfer payments and in the other only the government makes transfer payments. To make the difference between these two approaches clear, the two sets of T accounts below may be of some use. One Note: here subscripts (e.g. HH, MM, C etc) denote the sector making payment
As you can see from the above, by definition Institutional Investors are in financial balance at all times. Any shortfall or excess of cash flow is counteracted by an offsetting change in their obligation to households. Thus what we would otherwise consider to be the financial net worth of institutional investors is counted as part of household wealth.
From the point of view of flow of funds analysis, there are a number of problems with this type of approach. For one one's claim on "future pension obligations" is not transferrable and thus is not a financial asset as such. The fact that I'll eventually have a certain income in some undetermined future has a very different impact on current spending programs than having assets one can sell or pledge. Second, "excess" cash flow into pension funds, insurance companies etc don't guarantee me or even the household sector as a whole future payments. The conditions under which these institutions pay out are very strongly defined in contracts and aren't very sensitive to current financial surpluses. Someone looking at household wealth with these numbers included will get a very misleading picture of what's going on. Ruggles and Ruggles argue that treating them as transfer payments and thus separating out Institutional Investors net worth from household wealth is the best way of approaching this issue and I agree
So to finally get around to answering Mason's question in brief: transfer payments between private sectors change saving rates in such a way as to make Institutional Investor financial surpluses and financial deficits a consistent accounting concept.
UPDATE: I forgot to add the sectoral balance equation with private transfers
Ruggles, Nancy D., and Richard Ruggles. National accounting and economic policy: the United States and UN systems. Edward Elgar Publishing, 1999.
Since I did a post on increasing returns to devoting resources to producing rice, I think it is time to focus on the opposite. That is, it’s time to focus on resource depletion and decreasing returns.
To do this, it may be useful to introduce some concepts from ecological economics. First there is throughput. Throughput is the amount of energy and matter involved in a production process. A big argument of ecological and biophysical economics is that many of what have appeared as “productivity increases” to economists has historically actually been increasing throughput of energy. Regeneration meanwhile is the idea that when natural resources are left unused they start to regain their original characteristics. Thus the essential distinction between non-renewable and renewable resources is their rate of regeneration. Technically fossil fuels, even considering the greenhouse gas effect, do have a rate of regeneration. However since we are thinking in terms of human resource use the time scale for regeneration, and the level of resource unemployment required to get there, these resources can be called non-renewable given how extremely slow their rate of regeneration is. That last point is worth emphasizing, renewability only matters relative to human time scales. No humans and the time it will take for oil to reform in the ground is irrelevant- at least to us.
This leads us to our final concept: the maximum sustainable scale. This refers to the idea that there is a level of employing a natural resource where the rate of throughput, ie the rate at which this material or energetic natural resource is used, is equal to the rate of regeneration. In other words there is a rate of use where the stock of this natural resource remains constant. A scale of production beyond that will deplete the natural resource and, for our purposes here especially important, lead to diminishing returns over time. This can potentially end with the resource being used up all together. Thus, to simplify here we’re only going to be dealing with homogenous nature. In reality of course, there are many different material forms of nature that are important to different production processes and techniques and have different rates of regeneration.
Thus, rather than dealing with increasing returns in rice, I’m going to deal with decreasing returns in grapes. In this example “Monocropping” grapes leads to an overuse of the soil and less returns each year. At maximum production, Friday produces one less grape meal each year. The less resources devoted to producing grapes, the slower the “decreasing returns” are. For simplicity’s sake I’ve not only assumed the midpoint of the production possibility frontier is the point that maximizes utility but that it is also the spot of maximum sustainable production for Grapes. For those not up on the jargon, I’m assuming that the combination of rice and grape Robinson Crusoe or Friday would choose to produce without specialization both leads to them getting the most enjoyment but also involves producing grapes at the maximum sustainable scale. In other words they would be led by their “short run” self interest to choose to produce the level of grapes and rice that leaves their stock of natural resources constant. With all that in mind, let’s go to the data. I’m starting with the same numerical values as i used in the first post and will try to stick to those numerical values for every Crusoe post I do.
So what’s going on here? What happened is that there was a jump to the no specialization “special case”. That is, there is a point at which Crusoe’s absolute advantage is identical for both goods and thus there are no gains from trade. Because of decreasing returns in grape production, the gains from trade were eliminated by changing relative prices . This is a point that never gets discussed enough- the difference in the absolute advantage Robinson Crusoe has and thus the difference between the opportunity costs of production are changed under any situation that isn’t constant returns to scale. This is why the handwaving when discussing the situation where Crusoe’s absolute advantage of both goods in undergraduate economics classes are so misleading. Yes it is a “special case” but in a situation where some fundamental forces are driving changes in relative prices it becomes a point that all models will pass through. Thus as we’ve seen, if you assume “short run” maximization in a situation where relative prices aren’t constant (which is most situations) then eventually short run gains from trade will disappear or explode. As we’ve also seen however, in both cases “short run” optimization is inconsistent with intertemporal optimization.
The reason we get the result that output is actually lower in “equilibrium” even as the decreasing returns end is the nature of “maximum sustainable production”. The jump to no specialization led to production at the midpoint of both Crusoe’s and Friday’s production possibilities frontier. This led to no further decreases in natural resources but also not a return to the original “stock”.
What is truly galling about this result is decreasing returns to scale with regard to natural resources was an essential part of Ricardo’s rent theory. That following static comparative advantage when one good experienced diminishing returns not only eliminated gains from trade but lowers equilibrium output relative to the no specialization case makes discussions of comparative advantage infuriating to those with some knowledge of the history of economic thought and the inherent limitations of this perspective.
The point of this isn’t that professors should be using the Robinson Crusoe analogy to convince their students of protectionism and militate against specialization instead of convincing them of free trade and specialization. The point is, are you sure your students could follow either of these broadsides against the way the usual comparative advantage model is used? If not, and i suspect the answer is no, then this part of every undergraduate economics education is propaganda and not education as such. Students should be able to explain and use economic concepts and because the basic example isn’t intuitive and isn’t really connected to their lived experiences, they generally don’t. Instead they are rushed along to more baroque and mathematically complex versions of the same models that are also not very understandable. This leaves students in a mass of confusion, but they still remember the slogans long after which, to a cynical man, might appear to be the point.
The Comparative Advantage story is famous. It is an essential part of nearly every undergraduate economics education. It’s propagandistic benefit is also well known. To review, I’m going to run through a numerical example.
Here we see that Robinson Crusoe has an absolute advantage in everything. That is, he can produce more of either type of output than Friday can. Oh no! Poor Friday! But wait, David Ricardo is to the rescue! As long as Crusoe’s absolute advantage over Friday is different for producing Rice than producing Grapes, the opportunity cost (what else he could be doing with that time and resources) of Crusoe producing grapes is higher than Friday producing grapes! Boom, gains from specialization and trade.
You can see here that this is precisely what we find. The table is clearly telling us that Friday should produce grapes while Crusoe produces rice. However, what happens if there are increasing returns to scale? Below I run through such an exercise.
Below I’m assuming that for each year Crusoe spends producing rice with specialization he is able to produce 4 more rice meals the next year.Poor friday can only produce the same amount of rice year after year and he just continues producing grape meals. For each year Crusoe spends producing Rice without specialization, he can produce 3 more rice meals the next year. For each year Friday produces Rice without specialization, he can produce 2 more rice meals the next year. Of course you could do these assumptions in all different ways, that is sort of the overarching point with regard to how these models are used.
nonetheless, I chose these assumptions specifically. First, output isn’t growing by some percentage rate of the previous years output because recall that in this model all factors of production are fully employed and constant. There is no investment here. Thus the growing returns are relative to the underlying stock of capital and land and are thus exponential relative to them. There is no reason to think exponentially accelerating returns are possible under these conditions. However, there is reason to suppose that applying all factors of production will lead to returns growing more quickly than just applying some percentage of your factors of production. This is why rice output is growing faster for Crusoe under specialization than without specialization.
Second, Friday does not only start out less efficient but he is also less efficient at expanding output. I made this assumption to show that if you move to increasing returns there is a case against specialization even if Friday starts out less efficient at producing rice and is always less efficient at producing rice even if he focuses on it. I didn’t do the analysis here because it was obvious, but if you had perverse specialization- that is Friday specializes in rice- Friday produces 3 more rice meals every year, leading to the least total rice output of all the cases.
There are a number of interesting things here to say. This does a good job of making Cameron Murray’s point, which I’ve agreed with ever since I took a look at “Robinson Crusoe’s Economic Man”, that the Robinson Crusoe story is a great pedagogical tool for getting across a number of important concepts in economics. Here we have not only increasing returns and time but Baumol’s cost disease, inequality/distribution and intertemporal optimization. Relative prices are shifting in this economy because of labor productivity increases that exist in one good but don’t exist in another. Within an economy, those working in the low/no productivity growth sectors get wage increases to induce them to do these jobs. Hence the “cost disease” is the rising prices in these industries. This example clearly and easily expresses that idea. On the flip side, in other social contexts there may be no inherent reason for productivity increases to be shared.
If I felt particularly inclined to troll economists, I’d say that what they ignore in their arguments over comparative advantage is intertemporal optimization. That is a bit of a dig but it does get at an important truth. At each Individual point the traditional argument for comparative advantage applies. In fact, the gains to trade as conventionally measured are growing along with Crusoe's labor productivity! Yet taken together this is wildly suboptimal. The argument for protectionism in a very real sense has for a long time been about intertemporally increasing output by inducing production and investment decisions that seem perverse given current production possibilities and prices. The model also makes the important point that protectionism doesn’t have to ever give the protected country's protected industries absolute advantages in producing output over other countries for there to be an intertemporal maximization (or at least improvement) case for protectionism.
Then there is the issue of distribution which increasing returns under specialization brings to mind. If Robinson Crusoe and Friday were more conflictual, say because of property rights or because they represent different countries, in the specialization case Crusoe may not share any gains at all. After all Friday was gaining from specialization in the first year and should be willing to specialize for that benefit 25 years later. Of course the cost of not specializing to Crusoe is increasing all the time precisely because of his productivity increases. If the opportunity cost of not specializing for Friday was lowered by some probability of Crusoe giving in and sharing gains not specializing could be an optimal strategy for Friday for a sustained period of time. That is Friday may be well positioned to strike for higher wages and this example could be a case where striking improved overall welfare. After all economists typically say there is declining marginal utility to more of the same kind of output.
I hope you found this as interesting and entertaining as I did. I suspect that the different ways you can use the Robinson Crusoe story to express concepts in economics will become a running series on this blog.
As I reviewed in my first post , the sectoral balance equation for one country is typically written as
One problem with this equation is the definition of (M-X), otherwise known as the external balance. In the world of MultiNational Corporations, is this balance really meaningful? For example the output that corporations transfer between subsidiaries is subject to what is called transfer pricing. It is quite famous that if someone wants to smuggle financial assets out of a company one way is to find a willing partner in another country and who overcharges you while you undercharge him. The output is then sold at market prices and something close to the difference between the “true balance” and the actual transaction values is set aside for the other party. This is of course enormously easier when both parties are in reality the same corporation. As if that wasn’t complicated enough, corporations also transfer intellectual property and financial assets between subsidiaries.
Why would entities systematically charge inaccurate prices to transfer funds out of a country? The primary reasons are capital controls and, in our modern world the most important one, tax avoidance and evasion. It is precisely these sorts of strategies that have made domiciling in another country profitable. This causes some difficulties in doing sectoral balances analysis, particularly in regards to the behavior of the corporation. They also make us systematically misunderstand balance of payments dynamics. It makes an enormous difference whether we are truly running a trade deficit with the rest of the world or whether export and import prices (as well as transfer payments disguised within property, investment good or financial purchases) are being systematically manipulated to hide foreign investment. After all, definitionally a lower current account deficit means a smaller capital account surplus . In recent literature debating the United States Net International Investment Position (the culmination of current account deficits and the revaluation of foreign owned domestic assets and domestic owned foreign assets), this has been referred to as a “black hole”. If the strong form of the “black hole thesis is true”, that the U.S. is actually running something close to trade balance, foreign holdings of treasuries and other low return assets are essentially permitting the continuation of foreign investment. Thus our NIIP may be systematically underestimated. This would help to explain why despite the supposedly large negative NIIP, foreign return on U.S. assets is systematically and greatly lower than domestic return on foreign assets.
Mona Ali, New School Graduate and Assistant Professor at SUNY New Paltz, has two very interesting recent papers on this issue titled respectively "Dark matter, black holes and old-fashioned exploitation: transnational corporations and the US economy." and "Global imbalances and asymmetric returns to US foreign assets: fitting the missing pieces of the US balance of payments puzzle”. She covers many important issues in balance of payments (so please go read both those papers). However, what I want to focus on is her commentary on “systematic” mismeasurement of u.s. trade deficits because of multinational activity:
“These new and rapidly growing types of off-shoring activities may artificially inflate the US deficit. In fact, a declining trade balance might very well be consistent with higher profitability for US multinationals (Milberg 2006; Milberg and Schmitz 2011). Thus, to view the current account balance simply as the ‘passive outcome’ of movements in the capital account – as does a sizable swathe of the contemporary global imbalances literature – is misleading. Godley (1995) debunks financially motivated explanations of the trade deficit because of their disengagement from the disaggregated firm-level decisions that influence the trade balance. However, Godley-type structuralist trade models where a country’s trade deficit reflects a loss of competitiveness also fail to account for international outsourcing.”
This is of course a simplification. There are a great many corporations with a variety of percentages are owned by foreign sectors and vice versa. Ownership of a company’s debt can also involve influence over managerial decisions. Nonetheless there is no satisfactory “shades of gray” definition so here I will be treating plurality or greater ownership of equity shares as a “domestically owned” corporation. If we have to choose between not analyzing domestic ownership of foreign corporations and analyzing them with perhaps an overestimation of the U.S.’s NIIP so be it. Unfortunately, national statistics in a multinational world are always going to be not quite suited to the task at hand.
Nonetheless, there are strong advantages in accuracy this kind of approach provides. First of all, intra-company transfers disappear in this approach. Thus we don’t have to deal with the headaches of trying to figure out the true market value of Disney and Apple’s intellectual property transferred between subsidiaries. Nor do we have to deal with complicated intracompany insurance schemes or, god forbid, financial derivatives. These are still important, however they can no longer affect (at least directly) the financial surpluses or deficits of individual sectors. This also provides a clear why of understanding balance of payments issues. The result of such an analysis for the United States might reveal that
This sort of analysis actually has a long pedigree in post Keynesian economics. In a paper from the 1970s entitled "Financial Interrelations, the balance of payments and our crisis" cites and discusses Victoria Chick’s paper "Transnational enterprises and the evolution of the international monetary system" (this paper appears to have never been published). The strongest statement on this issue comes from foundational Post Keynesian economist Paul Davidson (who also cites Victoria Chick). In a chapter of the first edition of “International money and the real world” entitled "Multinational Corporations and International Transactions." he says:
”In other words, the existence of multinational corporations (MNCs) who maintain production and trading activities in many nations, can affect, via decisions which are internal to the firm, the accounting magnitudes which measure the balance of trade of any nation during any period. These decisions involve accounting transfer pricing transactions among subsidiaries which are chartered in various nations. These transfer prices need not have any equivalent value magnitude in real world markets. Hence, extreme caution must be exercised before interpreting any balance of trade statistics as symptomatic of a fundamental national disequilibrium, rather than an accounting imbalance due, in large part, to decisions of MNCs' comptrollers to take advantage of different regulations or tax laws in various national jurisdictions...National balances of payments have therefore become, in some significant measure, an appendage of MNC decisions on income distribution and liquidity needs within the MNCs”
It is very difficult tell what these modifications to the sectoral balances approach would mean for measurements of balance of payments deficits, surpluses and Net International Investment Positions. This essentially “GNP” conception of balance of payments would certainly reduce the United States NIIP, but by how much is very debatable and is subject to how accurate data on MultiNational corporate activities. It may even be possible, with adequate data, that such a measure would mean a balanced balance of payments. I haven’t yet dug into the data issues so I don’t know how close to such a measure we could get. Michael Hudson’s “Financial Payments Flow Analysis” is a masterful approach to producing a flow of funds balance of payments measure that shares a similarity to what I’m discussing. However, his work shows just how much careful effort needs to be put in such a project and my impression is it has only gotten more difficult since the late 1960s. At the very least, I hope readers keep the complications of MultiNational corporations involved when doing sectoral balances analysis.
The word “real” has an extremely tangled and messy history in economics. Because of economist’s penchants for price level indices and the constant division of monetary sums by price level indices, this is a common implication of the word real. However, economists ALSO love talking about the “veil of money” and looking at the “real” things that are going on. Further, economists have historically been interested in barter economies and the existence of a “neutral money” that would provide a common method of transaction (dealing with the “inconveniences of barter”) without any effects on how the economy functions. This still gets attention (as I’ve written about previously here ) in the notion of a “natural” rate of interest and is if anything having rising policy influence. Thus economists mean by real both the exchange value ie the relative prices of various forms of output that are also sometimes summed together AND the underlying use values and physical structures that underlie the economy. Thus real wages can mean a sum of money a worker receives deflated by a price level OR the basket of output a worker is paid or both at the same time. As the reader can Imagine, this causes enormous confusion (I wrote about this last year here here.
I personally think (as I’ve written before) that deflation by composite price level indices is extremely overused and that ratios of flows to stocks, flows to flows and stocks to stocks should come more in vogue. These ratios do much to contextualize nominal sums in a way that makes sense and does so without having to mess around with price levels. A nominal to nominal ratio has the same value as a real to real ratio and a nominal to real ratio is invalid. Price level indices are also used without any true grasp of what underlies them, as Morten Jervens has shown in his both hilarious, infuriating and depressing work around african national statistics and their abuse by western mainstream economists. For example asking the question of how price level movements could improve the household income to household debt ratio would lead clearly to the notion that it is not inflation that workers need but wage increases and the deflating debt sums is a fun exercise with no practical meaning. It tells you nothing about the worker’s experience. Saying the “real” value of the debt is decreasing or increasing because you’re dividing it by a price level is like saying the temperature value of the debt has risen or fallen because the temperature rose or fell.
For all these reasons I will be using the term biophysical in the places most mainstream economists (and even some heterodox economists) use the term real to refer to underlying input-output relationships, production processes, physical amounts of output etc. I’m attracted to the term biophysical because it is precise, clear and because it reminds the reader that monetary economies where production decisions are made in monetary terms have impacts on the world in which we live and on the consumption of resources, both renewable and nonrenewable. It also is aimed at reminding the reader that any argument in nominal terms which implies impacts on the biophysical world that violate the laws of thermodynamics are prima facie invalid even if the assumptions are all otherwise consistent in balance sheet terms.
I will refer to price level deflated sums as price level deflated sums as economics has not developed an adequate alternative. Alternatively direct payment in biophysical goods will be referred to as a “basket of goods”. If anyone has an alternative pithy word for price level deflated sums please let me know!