Archive

The Dismal Science

The New Leader. 84.6 (November-December 2001): p2.

GEORGE P. BROCKWAY, who initiated the NL column called “The Dismal Science” and presided over it for almost two decades, died on October 5. He was 85 years old.George P Brockway

An imposing figure, Brockway tended to dress conservatively, although you could detect a bit of whimsy in his bow ties, soon confirmed by a quiet sense of humor. His voice was unexpectedly soft, but you also quickly recognized that he knew where he was coming from and where he wanted to go.

Brockway was born and brought up in Portland, Maine; his parents were rock-ribbed New England Republicans. During one of our periodic lunches with him, we wondered how a reputedly tough bargainer who had built one of the country’s major independent publishing houses came to have an unabashedly strong liberal commitment. While a student at Exeter, he explained, he was asked by the school magazine to take the Herbert Hoover side in an exchange on the 1932 Presidential election. Given his family’s politics, he eagerly accepted the assignment. “But after reading what I had written,” he said, “I realized I didn’t believe a damn word of it.”

At Williams College Brockway majored in English and was editor of the literary magazine. The teacher he felt had the greatest influence on his thinking, though, was a philosopher of history, John William Miller, who focused on the interrelation of man and nature. Since a sheepskin and a Phi Beta Kappa key did not automatically open the door to a job in 1936, Brockway spent a year at Yale on a graduate fellowship before joining McGraw-Hill as a trade book salesman.

In 1941 he signed on as William Warder[1] Norton’s assistant at the prestigious, growing W.W. Norton and Company. Besides selling books, in relatively short order he was editing prominent writers, developing the Norton Anthology series, and shrewdly buying up the backlists of other firms. By 1958 he was named president, and in 1976 he became chairman of the now wholly employee-owned company, structured to resist the advances of corporate raiders.

What Brockway did not anticipate was Reaganomics, whose highflying inflation and 21 per cent loan rates threatened Norton’s collapse. Despite discovering that he didn’t really have a friend at Chase Manhattan, he somehow managed to overcome the crisis. Then, on the train home one night, he decided he didn’t want to do what he was doing anymore and would retire at the end of 1983, at age 66. But first he set about carving out a second career. Thus the query we received from him asking if we would consider a regular column “on what used to be called political economy.” Familiar with his writing from several pieces he had done for us over the years, and pleased with two sample columns he submitted, we said yes.

“The Dismal Science” began its 20-year run in the NL of January 11, 1982. Brockway’s relaxed conversational style, and his daring to insist, for example, that an economic recovery with 6 or 8 or 10 per cent unemployment is not a recovery, instantly won him an appreciative audience. Even those infuriated by his central thesis–that “economics is a branch of ethics, not of natural science”–could not resist reading him. In these pages, of course, that will no longer be possible. But we would note that a thoroughly revised, handsome fourth edition of his second book, The End of Economic Man, has recently been issued. His two other books on the subject, Economists Can Be Bad for Your Health and Economics: What Went Wrong and Why and Some Things to Do About It, are also available.

We will miss his demystifying wisdom and his collaboration, but most of all we will miss George Pond Brockway’s friendship.

 

[1] Ed.:  In error The New Leader wrote “Walter Norton’s assistant.”  The name was William Warder Norton, or W.W. Norton

Advertisements

By George P. Brockway, originally published July/August 2001[1]

7-8 2001 Why the Trade Deficit is a Blessing Title

FOR YEARS almost beyond counting we had the budget deficit to worry about and argue over, and for some 30 years we have also had the foreign trade deficit.  Many thought the two went together, like the proverbial horse-and-carriage. But the budget deficit has gone away[2] (with consequences yet to be discovered); the trade deficit is still with us and growing practically every day.

The reason for its robustness is that we import more goods and services than we export-and have done so every year, with few exceptions, since the early 1970s.  We pay for our excess imports by using dollars to acquire the necessary amounts of the exporters’ currencies, or by paying directly in dollars. Consequently, our trade deficit has risen in dollars-a growing total now approaching 1.5 trillon of them.

The countries we are importing from do not buy more of our goods and services with those dollars (that’s how the deficit developed in the first place).  They buy our bonds and stocks and other assets.  If their purchases are wise or lucky, further streams of dollars swell their accounts.  One way or another, our dividend and interest payments to foreigners now run more than $10 billion annually.

In October 1998 Congress appointed a bipartisan United States Trade Deficit Review Commission to study the imbalance.  Last November (2000) the commission issued its report.  All 12 members agreed the trade deficit is a problem of the utmost seriousness that threatens the welfare of the nation and the whole world.

The chairman of the commission (and leader of its six Republicans) wrote, “Large and growing trade deficits are neither desirable nor likely sustainable.” The vice chairman (and leader of the Democratic contingent) wrote, “It is simply irresponsible to ignore the huge threats that the growing trade deficit could pose to our economy.”

Those are pretty strong words; yet I am here to tell you there is exceedingly little chance that the ominous but unspecified disasters will befall us. Indeed, although I believe our trade deficit will continue to grow, I will argue that it is a blessing for us and for the world.  My confidence is based on a simple reality:  All the nations of the modern world need petroleum, and only a few have enough natural supplies to satisfy their needs.

Art Buchwald once wrote that when the petroleum-producing Arabs sent their sons to the United States for higher education, we made the serious mistake of directing them to Harvard Business School instead of Slippery Rock Teachers College, where they might have learned how to play basketball.  As it happened, the second-generation petroleum producers somewhere learned to play OPEC.  It is quite possible that their teachers were the Western oil companies and the Western central banks (including the Federal Reserve), who in the 1950s and ‘60s smugly rebuffed Arab pleas, first for rational drilling and pumping programs, and then (after the Arabs nationalized their oil fields) for rational terms for what their generally arid lands wanted to buy in Western markets.  No doubt they were greedy.  So were we.  In the end they learned how to play the OPEC game very well.

Their smartest move was to agree to sell their petroleum exclusively for dollars.  At first glance this decision certainly seems quixotic, given the coolness between them and us because of our support of Israel.  On reflection we see that making the dollar the petroleum market’s international currency allows them to pose as modern men too business like to hold a grudge, and also enables them to avoid being skinned alive by the international money speculators.

Under an open system, they would be in a continuous frenzy trying to determine how much each of the world’s currencies was worth to them every minute of the day.  Speculators would make (and no doubt occasionally lose) fortunes trying to outmaneuver them. Under the present system, they need worry solely about what a dollar is worth to them, or how many barrels of oil they have to sell today in order to get the dollars they need today.

The dollar is uniquely qualified to play this role because our trade deficit means that there are many billions of dollars sloshing about in the world.  No other currency can or will make that claim.  The two economies large enough to think of doing it are Japan and the European Union (EU), and both are forbidden to attempt it by their economic theories.

Let no one imaging that economic theory is just hot air.  Japan, profusely praised by Wall Street for saving rather than consuming, has saved itself into a decade of stagnation that shows no sign of ending.  As for the EU, it is run by bankers who pride themselves on tightly controlling all sorts of deficits.

IN SHORT, if you want a truly international currency you cannot do better than the United States dollar.  Our supply-siders have tried to charm us into becoming compulsive savers like the Japanese, and the neoclassical economist of the “Washington Consensus” continue to scold that we don’t save enough, but we remain a nation of carefree spenders.  Because we are the largest importers and the largest exporters in the world, dollars circulate widely around the globe.  More to the point, we are the world’s biggest importer of petroleum and possibly the biggest exporter of agricultural produce the petroleum-producing nations need, plus military material they think they must have.

So the dollar was chosen, and the petroleum-thirsty nations found themselves having to harvest it-not merely for their day-to-day purchases, but also as reserves to help protect themselves from sudden assaults on their currencies, and to ensure that they can buy at least their share of petroleum until the Arabian sands run dry.  At the moment the dollar reserves of these nations are slowly and surely reaching $1.5 trillion.

Yes, the figure for our trade deficit is in the same ball park.  In fact, if you add the foreign investments in our real estate and newspapers and book publishing and agribusiness and automobile manufacturing and the rest to the sum of foreigners’ dollar reserves, you will find the total is actually on the same yard line as our trade deficit.

7-8 2001 Why the Trade Deficit is a Blessing Oil Derrick Where else could it be?  Aside from some of the deficit dollars being hidden in mattresses or mislaid in “statistical discrepancies,” there is no place else for it.  The mathematics is simple and indefeasible[3].

Moreover, no country’s finance minister is likely to tamper with his or her dollar reserves at the risk of collapsing the country’s finances altogether. And if they all tried to tamper at once (as the Congressional commission’s scenarios suggest), their mutual competition would result in their getting poor value for their money.

Please note that this story is historically sound.  Our trade deficits were few and insignificant before the 1970s, when OPEC firs showed its power, and they have increased along with the world demand for petroleum, and hence for dollar reserves.

The foregoing is, I submit, a stunning conclusion.  Consider some corollaries:

  1. Our trade deficit is caused by foreigners’ need for dollars, not by our inability to produce goods the world wants at prices it is willing to pay. All the complaining about the alleged failure of our school system, the power of our labor unions, the greediness of our rich, the general fecklessness of our society-and there is much complaining in the commission’s report-is beside the point.  The criticisms may be justified; that is another question. But they are not the cause of our trade deficit.
  2. If we could somehow manage to increase our exports and decrease our imports enough to erase the deficit, we would upset the international economy-and ours. To be sure, the nations of the world are able to get dollars from one another, but because they are all in the same boat, they must, in the aggregate, trade enough of their goods to us for dollars to maintain their reserves and to increase them as their economies expand.
  3. Since the 1970s our bankers and mainstream economists have been saying that we save too little to finance our economy, that we have to attract foreign investors by offering high interest rates[4]. The foreign nations must put their dollar reserves where they will be both safe and liquid, though, an nothing satisfies these requirements so well as U.S. Treasury bonds.  Ergo, the high interest rates are not now, and never have been, necessary to attract foreign capital, that comes to us anyhow. But they have kept our unemployment rate higher than it otherwise would have been and thereby widened the debilitating gap between the haves and the have-nots of our society, not to mention adding to the cost of debt services.

IF WE HAVE high interest rates (and for the past 30 years they’ve been higher than in any other third of a century in our history), it is not because the Federal Reserve Board has been “forced,” as they like to say, to impose them.  Rather, it is because the Reserve has misread the state of the world and its own economic theory.

The theory in question is that of the gross domestic product or the gross national product.  It doesn’t matter which; in both cases exports are a positive factor, while imports are a negative factor.  Accordingly, a trade deficit-that is, and excess of imports-decreases the domestic or national product and should be avoided.

The key word is “product” or output.  The GDP never was intended to be a measure of consumption or satisfaction or quality of life.  For example, petroleum is probably our largest import, would our quality of life be improved if we eliminated it?  In some ways, yes; and perhaps eventually, yes.  But here and now, surely not.  And think of all the natural products we import-bauxite and tungsten and uranium, and tea and coffee and bananas.  Would our quality of life be better without them?  And suppose we could not import unique articles like works of art and antiquities for our museums and our personal pleasure.  In the other direction, would our quality of life be better if we exported all our wheat or all our silicon chips?

As you can see, a trade deficit can be greatly to our advantage, if not a necessity.  The advantage becomes a fortuitous blessing when we realize that all we have to do to enjoy it is to maintain a growing economy and restrain the Federal Reserve from going off in blundering pursuit of a misunderstood theory.

Imports are a disadvantage to us to the extent that they prevent the development of industrial or commercial opportunities we might have exploited ourselves, thus reducing our output by causing underemployment of our capital and labor.  But if our labor and capital are fully employed, every increase in imports can be an increase in our quality of life.

Again, recent history is suggestive.  The latter 1990s seemed like the storybook time of Goldilocks.  Unemployment fell, capital investment rose, and prices were comparatively steady because the interest rate was comparatively steady from 1995 to June 1999.  True, the trade deficit continued to rise, yet we continued to prosper.

TO COVER all the bases, it should be observed that there is also a cultural dimension to the trade deficit.  Many even find its economic aspect less alarming than how much of our economy foreigners have come to own.

Of particular interest to me is book publishing, about 90 percent of which-after the sale of Houghton Mifflin to France’s Vivendi International– is now said to be controlled by six conglomerates, five of them in foreign hands.  Publishers have always been a bit smug about being engaged in an ostensibly cultural endeavor that at least sometimes makes money.  Lately they have been flattered by sociologists who call them gatekeepers of the realm of ideas and values. (I was brought up to believe values are more likely to be solid if ideas circulate freely, but let that pass.) At any rate, some feel that barbarians are currently not only at the gates but in charge of them.

How did the foreigners get to be our gatekeepers?  They bought the gates, of course, and they bought them from Americans with dollars. There is nothing in such transactions to indicate that the buyers are less responsible than, or more corrupt than, or even very different from the sellers.  If the buyers are barbarians, the chances are that the sellers were, too.  Or both may have been praiseworthy.

In the 1930s and ‘40s, it seemed as though almost all the number one bestsellers were published by Doubleday, Simon and Schuster and Macmillan, with occasional assists from Scribner’s, Harper’s, Viking and Little, Brown.  And for a while it seemed as though the number one best-selling fiction writer was Margaret Mitchell, and the number one best-selling nonfiction author was always named Dale Carnegie.  Although the names and numbers are different today, the situation is not dissimilar.  No one has ever pretended that best-sellers were necessarily best by any other standard.7-8 2001 Why the Trade Deficit is a Blessing Margaret Mitchell

It will be noted that all the publishers named above have been sold and resold and conglomerated in one way or another, mostly to Germans, Australians, or Brits.  I’m not one to say that they are worse (or better) gatekeepers than those who sold out, though I have made a case (see the new edition of The End of Economic Man-advt.) that things are better for workers (and for the economy) if their firm is employee-owned.

In a conglomerating world, however, it makes a little difference to workers who their employer is, provided they are treaded decently and paid fairly.  Nor does it make much difference to consumers who produces the commodities they buy, so long as the quality and price are right and child labor is not brazenly required.  The government will be satisfied with any firm so long as it is law-abiding, generally abjures petty fraud, and pays its taxes.  As for investors, they have already indicated by their eagerness for capital gains that they don’t care who the gatekeepers are.

Furthermore, if there actually were some sense to the gatekeeping metaphor-if a gatekeeper undertook to corrupt our society-we could protect ourselves by not paying attention to his (or her) product.  Corruption is like the tango:  it takes two to do it.  A corrupter without a willing corruptee is little danger to anyone.  If there is a problem here, it is our willing corruptees.[5]

None of this should be astonishing.  After all, America was built with foreign investments.  Except for a few months immediately before (yes, before) the onset of the Depression of 1837, we were a debtor nation from 1776 until World War I.  We prospered in those prewar years.  Why should we not prosper now as we become a debtor nation again?

Finally, lets try to put the size of the problem (if anyone still thinks it is a problem) in perspective.  It has take us roughly 30 years to run up a trade deficit gradually approaching $1.5 trillion.  That’s less than a fifth of our GDP.  The stock exchanges can and do lose that kind of money in a couple of weeks, and what is lost on the exchanges is gone and lost forever.  By contrast, our trade deficit is a debt for which we received value, and from which the world economy benefits, but which we may never be asked or even permitted to discharge as long as OPEC pumps petroleum.

The New Leader

[1] Ed: This article was written before there was a Euro, before the US returned to being a net exporter of energy, before the expansion of wind and solar energy, before China grew to the largest economy.  As a result, many of the assumptions here no longer hold.  Someone smarter than I will have to say if the arguments presented are stronger or weaker.

[2] Ed: This article was published at the end of the Clinton Presidency when the annual federal budget WAS balanced

[3] Ed: re: the first footnote, this suggests the arguments still hold (though I haven’t done the research)

[4] Ed: This claim has certainly been undone by the era of “quantitative easing” where interest rates were zero, and in certain places and times, negative.

[5] Ed:  its as if in 2001 the author could foresee Fox News, Laura Ingraham, and David Hogg.

By George P. Brockway, originally published September/October 2000

2000-9-10 New Use for a Bad Idea - title.jpg

IN ECONOMICS no bad idea goes unused. This is perhaps to be expected in a discipline that prides itself on being the science of the efficient allocation of scarce resources. Ideas are hard to come by in the best of times. With many hundreds of doctoral candidates looking for original dissertation subjects, and many thousands of tenure-track assistant professors looking for profound article topics, nothing that looks like an idea can be allowed to waste its fragrance on the desert air. In addition, there are the diurnal needs of business-page journalists and bond salesmen. Not to mention the problems of NEW LEADER columnists.

A subject that has met all the above needs for at least the past quarter century is the productivity index. It is with mixed feelings that I report on a quite new use that has been thought up for this fallacious procedure. Since, as we shall see, the new use is in the very highest reaches of national policymaking, it is in an especially bad place for a bad idea.

The February 8, 1982, column in this space was titled “Productivity: The New Shell Game.” On May 28, 1984, “The Productivity Scam” appeared. The third antiproductivity- index piece had to wait until  May 19, 1993, and the fourth is here and now. Productivity being a protean idea, each column is concerned with a different use of the index.

True to its metaphor of a shell game, the earliest column said that in the new game each of the three shells had a “pea” under it. The first pea, “which always turns up on metropolitan bars and suburban bridge tables,” was that “it just seems people aren’t willing to work the way we did when we were young.”

Next was the “America has gone soft pea.” We let them beat us in Vietnam; investigative journalism got out of hand over Watergate; and now a court has said that creationism isn’t science. It’s hard to tell what the country stands for anymore. It’s no wonder that productivity is down and we have to have this recession to get us back on the track.

Under the third shell was the “archaic industry pea.” Our productivity is down because we don’t invest enough, because we don’t save enough, because we tax business-too much.

In other words, the productivity “peas” were Reaganomic explanations of the recession then stagnating. Regardless of the shell we chose, we got a pea; and regardless of the pea we got, we lost.

By May 1984, the productivity focus had narrowed, with this conclusion: “The uproar about labor productivity is a scam to distract attention from a massive shift in the distribution of the goods of the economy. The share of nonmanagerial labor is being reduced; the share of managerial labor is being increased; and the share of those who do no labor, who merely have money, is being increased most of all. This is what Reaganomics (or, if you will, Volckerism) is all about, and the Atari Democrats have been gulled into going along with it.”

(Those whom the late Robert Lekachman, a wise and witty contributor to this journal, dubbed Atari Democrats called themselves New Democrats. Atari was at one time the leading producer of electronic games, and was early seduced abroad by the promise of cheap labor. What became of it, deponent knoweth not.)

Nine years later (May 19, 1993), the focus had narrowed again. The talk was all about downsizing, a nasty and disgraceful business practice that continues to this day.

The productivity index is thus one of the most powerful ideas of our time. It has malignly affected the lives of millions of men and women, the fortunes of thousands of enterprises, and the economies of nations.  It is a tragedy of almost universal scope.

The basic idea of the index is sound enough. Output is divided by input to determine how many units of input achieve a unit of output. The result is an index number that can be compared with other numbers similarly derived. A single index number, of course, is almost useless; but much can be learned from comparisons, and they are of great and daily use in business management. The current performance of a company’s sales (or any other) department can be compared with. its performance in prior years, or with the performance of corresponding departments of the particular industry as a whole. Banks routinely analyze their customers’ profit and loss statements in this way, and trade associations frequently do the same for their members.

It must be confessed that executives sometimes make unreasonable use of the comparisons. A sales department may be faulted for a falling sales index, while the sales force argues that the quality of the product has declined, or that the advertising has been inadequate, or that the sales representative suffer from stress caused by driving poorly equipped automobiles.

Rumbles from the executive floor suggest that the sales reps are too well paid, or that there are too many of them, or that some territories are not worth covering.  This is the way that downsizing begins.  Every job in every department is ultimately at risk.

Years ago a chapter in a tome on book publishing started this way: “There are two simple principles by which the business thinking of a publishing house should be guided.  They are (1) Reducing costs by $1,000 has roughly the same effect on the profit and loss statement as increasing sales by $25,000.  (2) You have to spend a dollar to make a dollar.

Downsizing tends to forget the second principle, and also the greater principle that the human beings who are so easily hired and fired are not a means to an end but are ends in themselves.  But the ethical objections to downsizing shouldn’t allow us to decide that there are not solid, hard-nosed, business-is-the-only-thing objections to the national productivity index.

THE INDEX numbers are simple fractions:  national output for a certain period in dollars (because we can’t add shoes and ships and sealing wax) divided by the hours worked by everyone engaged in production, whether paid or not.  Fractions, of course, are not unequivocal; you can increase their value either by increasing the nominator or by decreasing the denominator (2/3 and 1/2 are both greater than 1/3).  So you can increase a productivity index number either by increasing “dollars of output” or by decreasing “hours worked.”  As we shall see, the hours present a special problem.  Consider some examples of how the index works.

First, microeconomically:  Think of a journeyman plumber whose output is x, whose hours worked is y, and whose productivity is therefore x/y.  Suppose by taking on a plumber’s helper (a human being) he increases his output 20 per cent.  Being a rational person, you might conclude that such an increase in output would result in a substantial increase in productivity, but you would be sadly mistaken.  According to the formula, his productivity becomes 1.2x/2.0y, or .6x/y, and thus has fallen 40 percent.

We get similar results macroeconomically.  Take the 5.4 million or so people counted by the Bureau of Labor Statistics as unemployed. (There are about 10 million more who aren’t counted because they have a part-time job, or are too discouraged to continue looking for work, or are too turned off ever to have seriously entertained lawful employment).

Let’s accept (for argument only) that the conservative press is correct in saying the 4 percent of our civilian workforce officially designated unemployed are so careless, stupid, uneducated, arrogant, sickly or pregnant that they’re unlikely, if employed, to produce on the average more than a third as much as an equal number of those who are currently employed.  Even at that level, if we could find the wit and will to employ these people on this basis, we could increase our gross domestic product by 1.2 percent, or about $130 billion a year.

Being still a rational person, you might think such a tidy sum would increase our productivity, but again you would be sadly mistaken.  Productivity is still output divided by hours worked or x/y.  After finding jobs for the 4 percent of our civilian workforce that is now unemployed, our productivity becomes 1.012x/1.04y, a fall of 2.7 percent.

So if we really believe in the conventional theory of productivity, we must deny help to our plumber and jobs to the unemployed.  Unfortunately, a large majority of the members of the American Economic Association do believe in the theory.

A couple of other examples may clinch the case.

A young slugger lived up to his promise by hitting a grand slam home run his first time at bat in the majors.  His next time up, there were only two men on base.  His manager yanked him because (aside from drawing a walk or being hit by a pitch, neither of which would count as a time at bat) his productivity could only go down.

Then there was the unsung predecessor of Tiger Woods who hit a hole in one on the first hole of a club tournament, but retired when his drive on the second hole stopped rolling two feet short of the cup. “My productivity could only go down,” he lamented as he gave his clubs to his caddy and took up water polo to sublimate his aggressions[1].

THE THING about “hours worked” is that Gertrude Stein couldn’t have said “hour is an hour is an hour” because they aren’t. I was a lousy salesman, though I worked doggedly at it for almost five unproductive and depressing years. Many years later I became a moderately successful CEO of a small company and worked doggedly at that. I put in approximately the same number of hours a day as a salesman as I did as a CEO. After all, there are only so many hours in a day. But the value of my work as CEO really and truly was vastly greater than the value of my salesmanship, and you may believe I was paid more for it, too. Adding those different hours together in the denominator is less sensible than adding apples and oranges.

Karl Marx[2] faced a similar problem when he was wrestling with his theory of surplus value. He finally declared victory and wrote: “We therefore save ourselves a superfluous operation, and simplify our analysis, by the assumption, that the labor of the workman employed by the capitalist is unskilled average labor.” If this was a valid assumption in his day (and it probably wasn’t), it certainly is not in ours.

John Maynard Keynes also felt a need to devise a homogeneous unit of labor. He wrote: “Insofar as different grades and kinds of labor and salaried assistance enjoy a more or less fixed relative remuneration, the quantity of employment can be sufficiently defined for our purpose by taking an hour’s employment of ordinary labor as our unit and weighting an hour’s employment of special labor in proportion to its remuneration, i.e., an hour of special labor remunerated at double ordinary rates will count as two units.”

The minimum wage (currently $5.15 an hour) may be taken as a homogeneous unit of labor. But why bother? It is merely a multiple of a homogeneous unit we already had ($1.00) and tells us nothing new.

Unless you naturally think like an economist, you may wonder why the denominator of the productivity fraction is “hours worked” rather than “dollars paid for labor.” The deep secret is that economists, like well-bred  characters in an early 19th-century English novel, are with a few exceptions embarrassed by talk about money. General equilibrium analysis, the most fashionable economic theory at the bulk of elite American universities, can find no place for money in its doctrine. Even monetarism, despite its name, is scornful of the stuff we pay our bills with, which it speaks of as “nominal” money, and insists that what it calls “real” money is what matters, although no such thing exists. (If you’ve read much medieval philosophy, you may find such talk familiar.)

There is another problem with the denominator. We learned in school that the factors of production are land, labor and capital. Some add technology, and Adam Smith wrote of a propensity to barter. In any case, labor is merely one of the factors of production; yet the productivity index treats it as the only one.

To be sure, labor may be the largest factor. A quasi-constant of the economy is that the cost of labor currently runs about 60 per cent of GDP. But the cost of capital-the money spent for interest by nonfinancial, nonagricultural businesses -has increased roughly five and a half times in the past 40 years, partly because the Federal Reserve has increased interest rates, and partly because today American business relies much more on borrowed money than it used to. Common laborers, not Protestant financiers, are now the austere actors on our economic stage[3].

This shift in roles may be good or bad or indifferent, but the productivity index, no matter how constructed, will at best only call our attention to the fact that a shift has occurred. It will neither judge the desirability of the shift nor tell us what to do about it. Econometrics-c-playing with statistics-is the beginning, not the end, of economics.

ALL THAT said, we come to the new use of the productivity index mentioned at the start. I’m sorry, but I can’t say who invented the new use. It was a stroke of genius, even though the Federal Reserve Board had already pioneered the implausible idea of using high productivity (according to the index) as an excuse for trying to reduce production. I’m sorry again, but I can’t say, at least with a straight face, why we should reduce production.

The new scheme goes like this: (1) Production is produced by workers exercising their productivity. (2) The population of workers increases about 1 per cent a year. (3) The productivity index, fallacies and errors and all, increases about 1.5 per cent a year. (4) Put them together, and you get 2.5 per cent a year as the rate at which a well-mannered economy should expand. (5) The economy has been expanding at better than that rate in every year except one in the last eight. (The low one was 2.4 per cent in 1993.) Conclusion: Look out! It must be overheating!

Well, I ask you!

I regret to have to add that the Democratic Party Platform Committee listened solemnly to this kind of stuff. I doubt that the Republicans bothered their heads about it. All they need to know on earth is that a tax cut is beauty, and beauty is a tax cut, especially a tax cut for millionaires. I regret further to have to admit that the economics profession is careless about such nonsense. The other day I read a paper by a friend of mine that was decorated by several equations in which a symbol for productivity occurred. I objected that the symbol stood for a fallacy, and that his equations were therefore fallacious.

He laughed. “Everybody does it,” he said. “You’re expected to do it. It doesn’t matter.”

Well, I’ve already asked you.

The New Leader

[1] Ed:  As a similar tale goes, a golfer played at Pine Valley, arguably the best golf course on earth, and in the first four holes had two birdies and two eagles. One eagle was a hole-in-one.  He was 6 under par.  The fourth green is back at the club house.  The golfer walked off the course and into the bar and would not come out as he’d only screw up the round.

[2] Ed:  Though likely not as a salesman….

[3] Ed: emphasis mine

By George P. Brockway, originally published July/August 2000

2000-7-8-a-new-new-theory-titleTWO YEARS AGO, the hope was expressed here that the Federal Reserve Board was on the verge of learning how a modem capitalist economy-call it “the New Economy” if you wish-actually works, or could work (“A Fortunate Experiment,” NL, August 10-24, 1998). But it has become clear that the Reserve was merely adopting another new theory of how a quasi-mercantilist economy functions at least the fifth in Chairman Alan Greenspan‘s incumbency.

The previous new theory of the old economy went like this: Exuberant stock markets are giving rise to a “wealth effect,” whereby wildly successful speculators are using their inflated capital gains as collateral for loans to buy second (or first) homes and automobiles and a variety of other items, some necessary and some simply nice to have. As a result, the economy is in danger of “overheating.”

Now here comes what they call in Silicon Valley the new new thing: The secret cause of our trouble is that our productivity is growing too fast (the year before last it was supposed to be growing too slowly); consequently, the wealth effect is higher than ever. Indeed, it is so great that people’s income from borrowing on their capital gains exceeds their income from working at productive jobs. This situation is said to be unbalanced and unsustainable. We are borrowing on the future,” “living beyond our means,” and violating other 18th century copybook maxims.

Yet that is exactly the virtue of modern capitalism. It is how the company I worked for could expand to give me a better job, how my wife and I could buy a decent home in which to raise our children, how the city could build schools to educate them, and not least, how World War II could be won.

It is also argued that the wealth effect will cause too much money to chase after too few goods, a.k.a. inflation. A moderately rational person might consider encouraging the production of more goods wiser in such circumstances than reducing the amount of available money. The answer to this suggestion is that to produce more goods we would have to hire more people; and since we pride ourselves on having practically full employment (so why not say it’s really full?), we can’t hire more people without starting a wage-price spiral. To be sure, we have some 20 million fellow citizens who are either unemployed, underemployed, uninterested in employment at the going wage, or turned off.

Because of (not in spite of) the Federal Reserve Board’s threat to resume increasing the Federal funds rate, the United States economy is on the launching pad for an interest-price spiral (not a wage-price spiral) that could start spinning tightly upward before the 2000 election and then, before the election of 2004, could collapse in the ninth recession since the end of World War II.

In It Can’t Happen Here Sinclair Lewis’ hero opined that we Americans might one day have fascism but would call it antifascism. True to this heritage, the Federal Reserve Board has adopted an inflationary policy but tells us (and itself) that it is fighting an inflation invisible to ordinary folk like us because it is around the curve.

PERHAPS not altogether coincidentally, the Reserve acted in the same way almost a third of a century ago, in 1969, the last year we had a budget surplus before the current one. It was also the final year of what is now the economy’s second longest expansion. During the following 14 years we had four recessions, the highest unemployment rates since the Great Depression, a series of sensational bankruptcies, and a record breaking 271.4 per cent surge in the Consumer Price Index. The Reserve was serious about inflation the whole time.

Of course, there was a war on in Vietnam then and (as at present) trouble with the Organization of Petroleum Exporting Countries, but raising the interest rate did not stop the war and in truth started the trouble with OPEC. Meanwhile, the costs of living and doing business went higher, and the budget surplus was wiped out.

Money has power-several powers, in fact, as we shall see. The most familiar is its purchasing power. The Federal Reserve Board, in its diurnal struggle with inflation, has long concentrated on restraining money’s buying power. It does this by increasing the interest rate in order to reduce the number of consumers able to buy interest-sensitive commodities (especially cars and houses). This, in turn, reduces the number of workers employed in supplying those commodities, keeping them from buying other commodities they want or need. All of that is supposed to prevent the economy from overheating.

When we return from a shopping (or web-surfing) expedition and say the dollar doesn’t go as far as it used to, we mean its purchasing power is reduced. That is the same as a rise in the general price level, which is the same-as inflation.

THERE ARE two other probable, but presumably unintended, consequences of the Reserve’s actions. The first is a recession. To rephrase “Engine Charlie” Wilson, what is bad for General Motors is bad for the economy. We can’t slow down on the building trades and the automobile industry and their many auxiliaries (steel, lumber, oil, glass, rubber, major appliances, and on and on) without slowing down the whole show. Second, although the Reserve may have only restraint of purchasing power in mind, raising the interest rate simultaneously reduces the borrowing and investing power of money.

A fall in the investing power of money is, of course, the same as a decline in the amount of investing that is done-in other words, stagnation. Assuming that a projected investment is attractive and that the credit of the company wanting to make it is sound, the interest rate determines the limit of investing the company can finance with a given sum.

The range of impacts on investing power is vast, as four historical examples will show. Before the 1951 “Accord” that “freed” the Federal Reserve Board from its World War II commitment to help the Treasury maintain the market prices (and, of course, the interest rates) of government securities (not an unreasonable chore for a central bank in time of war or peace), the prime rate was 1.5 per cent. In December 1980 and January 1981 the prime topped off at 21.5 percent. In June 1999, at the start of the Reserve’s present program, it stood at 7.75 percent. Now it has reached 9.5 per cent (not so long ago, anything over 6 per cent was illegal usury). A corporation that could afford an annual interest expense of $150,000 and borrow at prime, could therefore have borrowed and invested $10 million in the first example, but only $697,674 in the second example, $1,935,484 a year ago, and $1,598,947 today.

Moreover, the effects of a rise (or fall) in the interest rate multiply throughout the economy. When the prime hit 21.5 per cent around Christmastime 1980 and our company’s investment was limited to $697,674, the purchasing power of every dollar of that amount likewise fell 12 per cent. So the firm could actually purchase only $613,953 worth of goods and services for its investment.

The Reserve’s present program (ironically assisted by OPEC) will increase the cost of doing business and will soon prompt or excuse enough price increases to embolden the many inflation hawks on its Board of Governors to push harder for really pre-emptive strikes, whereupon further price increases will begin appearing on the visible part of the curve, and the interest-price spiral will be well launched.

The increasing prices will harden the inflation hawks’ belief that they “must” (as the business press puts it) raise the interest rate to hold prices down. But a capitalist economy is based on borrowing, and the causation runs from the cost of borrowing (the interest rate) to price, rather than the other way[1]. Every firm, before it starts work on a new project, or orders a new production run of an old one, must know its costs to set prices.

The cost of borrowing is established by the Federal Reserve Board when it determines the Federal funds rate. To be sure, that rate is the one banks charge each other for very short-term loans (usually overnight) to allow the borrowing bank to meet an emergency or to take advantage of an exceptional opportunity, but it also sets the floor under the cost of all borrowing.

Today the nation’s business enterprises routinely quote many millions of prices, change some, and establish thousands of new ones. Scores of millions of consumers agree to some of the prices, and sales are made; a few haggle for lower ones, with occasional success. All of these prices are based in part on what the Reserve did at its last meeting. But there is no way on earth that what the Reserve did at its last meeting could have been based on the prices sellers and buyers actually agree to afterward.

This is not a chickenandegg question. Actual prices are based on actual costs, never the other way around. Businesses do not set the floor under interest rates, the Federal Reserve does[2].

In sum, as the Federal Reserve Board continues to raise the interest rate, it will cause stagnation (a decline in investment), stimulate inflation (a rise in the price level), and achieve its perverse intentions (a decrease in demand and an increase in unemployment). It will prick the stock exchanges’ irrational bubbles with consequences that will confirm the wisdom of Marcel Proust, somewhere in whose expansive universe is the observation that our wishes may be fulfilled, on the condition that we not find in them the satisfactions we expected.

IT IS POSSIBLE that the Reserve is already too far in to back out, for to cut rates now would announce to all the Fed watchers that the threat of inflation was past. The bull market would roar ahead, speculators confident that the Reserve would protect them. (Economists call this phenomenon by the odd name of “moral hazard.”)

Yet at the very least stagnation would be avoided if the Reserve did the unimaginable and lowered rates. At the best, new ways might be found to expand the economy and to reverse the fatal trend toward continually widening the chasm between the haves and the have-nots of our society.

Given the Reserve’s blind tradition of “staying the course,” the summer’s growing inflation and stagnation may continue and prove enough to defeat Vice President Gore (as former Reserve Chairman

Paul A. Volcker‘s recession defeated Jimmy Carter 20 years ago). Similarly, 2004’s recession[3] may prove enough to defeat then-President Bush (as Chairman Greenspan’s recession defeated his father eight years ago).

The New Leader

[1] Ed:  my emPHAsis

[2] Ibid

[3] Ed:  Well, it happened in 2007

By George P. Brockway, originally published March/April 2000

2000-3-4-why-free-trade-is-not-fair-title

LET ME SAY at once that aside from a few broken windows, I believe the recent World Trade  Organization (WTO) meeting in Seattle, because of the demonstrations it sparked, was as near perfect as could have been expected. Perfection would have been for the WTO to abolish itself and start over, and with luck we may come to that.

Let me say next that I’m not impressed, and never have been, with the argument that it’s wrong to oppose child labor in India (a nation that deplores America’s crass commercialism and lack of spirituality) on the grounds that if the children didn’t work, their parents would starve. Arguments of that kind have been used since the beginning of time to justify every conceivable example of man’s inhumanity to children, to women and even to other men. If it is impossible to make rugs of the highest-that is, most traditional-quality unless the knots are tied by juvenile fingers, it would be no hardship for us to walk on broadloom carpets.

I am not, furthermore, abashed by the debater’s point that if I want to protect several million American jobs, I can do so only by throwing several million (and probably more) workers out of work on the other side of the world. The late Sidney Weintraub, a longtime contributor to this magazine, had the answer to that one. He asked whether any free-trade publicist or professor ever felt obligated to resign in favor of a jobless scribbler or savant half a world away. If not, why not?

I am willing to entertain, for purposes of illustration (since I am showing, not arguing), the exceedingly remote possibility that American environmentalists thought up dolphin-safe tuna nets and turtle-safe shrimp nets to interfere with the ability of Central American fishermen to compete with ours. Whether the new nets impede trade or not, though, they certainly promote diversity of life and so, in the general interest, should be required by any responsible authority.

On the other hand, I submit that it is none of our business where France buys its bananas (especially since we don’t grow them). It is preposterous to the point of idiocy that we should have the right, because France insists on buying bananas from its former colonies, to impose tariffs of 100 per cent on brie and foie gras and other delicacies I happen to like-whose producers, to the best of my knowledge, do not now have, and never have had, anything to do with bananas.

All such nonsense, and much more, was foreseen by Ralph Nader, Senator Ernest F. Hollings (D.-S.C.) and others who testified against Congressional approval of the World Trade Organization (the new, friendlier sounding name of GATT, or the General Agreement on Tariffs and Trade). Brief hearings were hastily held over a few days around Thanksgiving in 1994. Unfortunately, it was agreed that the question would go to the floor on a “fast track” basis, with limited debate and no opportunity for amendment: just a simple vote up or down. The whole thing was a done deal by December 8. It would not be outrageous to suggest that few legislators had a detailed understanding of what the WTO was about, although it sounded good, and most citizens did not know how their senators and representatives had voted, let alone why.

The fast track was not an altogether bum idea, for tariffs are even more subject to logrolling than military appropriations. The trouble was, and is, not that the WTO has a few sloppily drafted passages of the sort that are almost unavoidable in any large piece of legislation. No, the trouble is that the World Trade Organization is not merely foolish, but dangerous.

Unhappily, what’s done is not so easy to undo, especially in an organization that was conceived in secrecy, does most of its business in secret ad hoc committees, and can overturn its secretly arrived-at decisions only by a unanimous vote. (A vote of 148-to-nothing is hard to achieve in the best of conditions, and is practically certain to prove impossible when the “ayes” must include both the plaintiff and the defendant.)

As I said at the outset, the best thing the WTO could have done in Seattle was abolish itself and start over. Somewhere on the desk before me I have suggestions for an alternative approach. My idea was designed to protect the interests of workers and consumers in both developed and underdeveloped nations. It first appeared in this column about 18 years ago.[1]

WE BEGIN with the workers in the developed countries, for the WTO is taking away something they once had-namely, reasonably decent jobs. At the least, they had much better jobs than many millions of them have today in this prosperous millennium. Let me repeat two dicta that I hold self-evident: (1) The citizen’s right to make an honorable contribution to the common wealth is equal to the state’s right to hold him or her to its laws. (2) No full-time work that does not support a life of honor and decency is worth doing except as a favor or a hobby, as training or punishment, or in defense of the realm.

No American official-nor any official of any other nation-is entitled to take these dicta lightly. Bearing them in mind, I say the way to protect is to protect directly and openly.

First, we recognize that a few of our important (not necessarily our largest) industries are threatened in their home market by severe competition from foreign industries. Second, we determine whether that competition is made possible by wages or working conditions that we should consider exploitative or dangerous. Third, we simply and absolutely refuse admittance to commodities produced under such conditions. We don’t fiddle with the tariff on foie gras or anything else; we simply forbid the importation of offending stuff.

The proposal is not complicated. It does not cover all industries or any other nation (although we would not object if the possibility helps improve conditions in other countries anywhere in the world). It does not dictate where France buys its bananas. It does not require elaborately contentious cost accounting, as do the WTO rules against “dumping.” It turns on straightforward questions of fact. What are the working conditions? Is child labor employed? What are the wage scales? (And don’t try to kid us that the serfs are happy; it’s our happiness that we are protecting.)

The proposal does not interfere with foreigners’ or multinationals’ trade anywhere else in the world. In every respect it is analogous to laws currently in effect that refuse entry to contaminated foods or drugs we consider dangerous (regardless of what anyone else thinks), or automobiles that do not meet our emissions standards, or books that violate our copyright laws, or foreign-made assault rifles. Such laws protect Americans as consumers and citizens. The proposal will protect Americans as workers and as entrepreneurs.

Some will object that it can’t work, because it is impossible to compare foreign wage scales and working conditions with ours. If the comparisons can’t be made, how do the critics of American workers know they are overpaid? The objection misses the point anyhow. The proposal is not trying to change foreigners’ conditions but to protect ours. The WTO tries to run the world in accordance with an archaic economic dogma. The proposal is intended to protect our right to follow our vision of the good life in our own way.

The crucial question is, as the lawyers say, who has the burden of proof? In the present case, we can reasonably ask those seeking access to our markets to prove that their workers are fairly paid and fairly treated by our standards. As the Wall Street Journal might proclaim, we insist on a level playing field for all our home games. American companies and American unions and even committees of American workers would have the right to challenge the proof. No need to make a big fuss over it, any more than a fuss is now made about determining that certain foreign automobiles do not meet our emissions standards, or that certain drugs are legally inadmissible.

There are many who will argue against protecting the American standard of living. Some will be devoted to consumers. Cheap imports, they will say, benefit everyone. If so, how do we repay those who lose their jobs so that the rest of us can be free to choose among low priced commodities? Or don’t we care?

NOW CONSIDER the situation of the underdeveloped countries and peoples of the globe. Today, as in the 18th and 19th centuries, the more developed countries need the less developed countries as sources of raw materials, some of which are not available elsewhere. The multinational corporations also use certain less developed countries as sources of cheap labor and working conditions. The banks of the First World have found the weak nations of the Third World eager borrowers of money at high interest rates. What was imperialism before independence has become neoimperialism.

The social and political domination of imperialism is largely gone, but the economic extraction of neoimperialism grows and festers. The irony is that what is mainly extracted is labor power. This comes about because the goods the multinationals manufacture in the Third World are sold in the First World. Steel produced by Brazilian mills is bought in markets formerly served by Pittsburgh. Plastic frame irons General Electric manufactures in Singapore are sold in American discount stores. American textbooks printed in Hong Kong are studied in British classrooms. California sports shirts stitched together in China are sold in resorts on the Florida Keys.

As a result of all this activity, the Third World has goods to export, but never seems to have enough.  The reason is that the exports to the First World are paid for with imports from the First World. It is at this point that the extraction of labor power shows itself, for many times more labor goes into the exports as into the imports.

The wage differential varies from industry to industry, from country to country, and from time to time, but a rough idea of comparative wage scales can be gathered from the Gross National Product per capita. Today that figure is $2,800 in the Peoples’ Republic of China, $1,350 in Nigeria, and $3,300 in Brazil. In the United States it is about $32,000. On the basis of these figures, we will not be overstating the case if we say that a dollar commands at least five times as much labor in the Third World as it does in the First World.

Thus when the two “worlds” exchange goods, the Third World is the net loser of four-fifths of the labor involved. This four-fifths is extracted and gone forever. The Third World nations will escape from neoimperialism only when they are able to sharply reduce manufacturing things for the First World and increase manufacturing things for trading with one another. For many and obvious reasons, this will not be easy to do. Their situation is only superficially like that, say, of the fledgling United States in the 19th century.

Two differences are crucial. First, although Europe (mainly Britain) invested heavily in the United States, the investments were either in factories for things like sewing thread or pig iron that were largely consumed in the U.S., or for dams, railroads and other infrastructure, which necessarily remained in the U.S. Early on the United States exported agricultural products, but comparatively little else.

Second, the United States was thinly populated, the frontier was open, and the egalitarian tradition was strong; so labor was in great demand, and American wages were the highest in the world (a boast, incidentally, that we can no longer make).

There was, in short, no possibility that Europe might extract American labor power. Any extraction ran the other way. The Third World has been enticed, by faulty economic theory, into producing primarily for export. On such a foundation, they can have little hope of an early escape from neoimperialism.

Providentially they can be helped if we help ourselves. That is to say, they may be nudged into trading among themselves if we reduce our labor-extracting trade with them. It is in our interest to protect ourselves from such trade because it hurts our fellow citizens. The citizens of a nation have, in the grand old phrase, certain rights, privileges and immunities that are denied to foreigners. If we who are citizens are not distinguished in this way from outsiders, of what meaning is citizenship to us? And if national citizenship is without meaning, of what meaning is the nation?

2000-3-4-say-no-to-the-wtoPerhaps we don’t want a nation. Perhaps we reserve our loyalty for those who are very near and very dear to us. Perhaps, as D.H. Lawrence put it in Aaron’s Rod, we “love-whoosh for humanity.” But if we have a nation, then the well-being of our fellow citizens has to be vital to us. We can’t demand respect for our own well-being unless we, at the same time, to the same extent, and for the same reasons, respect theirs.

In contrast, the theory of free trade is concerned only with commerce. Like classical economics, it has no respect for persons, except possibly as consumers. It sees no need for government beyond minimal police protection. As was demonstrated in Seattle, the World Trade Organization is not prepared even to consider questions concerning human rights, labor rights, the environment, or the use of natural resources. Even after the financial debacle of Southeast Asia, no attempt will be made to rationalize the surge and countersurge of money around the globe. In a free trade world, politics stops at the cash register.

Before we pursue policies that deny citizens the right to make a particular contribution to the common wealth, we have a duty to guarantee that they have an actual opportunity to make a contribution in another way. This duty is not satisfied by colorful references to sunset industries or to hoped- for results from research and development that somebody may be undertaking at some unspecified time. This duty is not satisfied by vague programs, even if well-funded (and they seldom are), to retrain people for new jobs that do not yet exist. This duty can be satisfied only with alternatives that are specific, real, and at least equivalent.

And time is of the essence. Since such alternatives are exceedingly unlikely-at least no one has bothered to name one-we have a duty to protect our fellow citizens by regulating our participation in foreign trade, even if it means forgoing an extra sports shirt or a better sports car.

By exploiting their cheap labor to produce things for export to the developed nations, the developing nations condemn themselves to a neocolonial status. By encouraging this sort of exploitation, the developed nations condemn themselves to the stagnation and decline that has been the fate of all imperialisms the world has yet seen.

The New Leader

[1] Ed:  the author isn’t here to ask which article he refers to but this seems correct.

By George P. Brockway, originally published August 23, 1999

1999-8-23-why-we-must-have-a-recession-titlePROBABLY at least once in every one of the 18 years I’ve been writing this column, I have made fun of an obiter dictum[1] of President Calvin Coolidge: “When many people are out of work, unemployment results.” I think it is still good for a laugh, although of course it is undeniably true, and so is my variant: When many people raise prices, inflation results.

I’ll go a step further: It is only when many people raise prices that we (including the Federal Reserve Board) know we have inflation. And I’ll take another small step for man but a momentous step for understanding the economy: Except in time of war or disaster, we have inflation only when the central bank (the Federal Reserve Board) brings it about.

Let’s heed Deep Throat‘s advice and follow the money.

If you (as an individual or a corporation) plan to start anew business, or to expand an old one, or to merely keep an old one going, the first thing you have to do is look for financing. As Iago said, put money in thy purse.

You can get money in lots of ways. You can borrow it from a bank or from a venture fund. You can sell shares or unneeded assets to a more venturesome fund or to a friend or on an exchange. You can use money you have on hand or your company has on hand. It does not make much difference how you finance your enterprise, but you have to do it, and it will cost you. Even money that you or the company may have on hand has an opportunity cost-that is, what you might have made if you had invested it in some other way.

In short, borrowing comes first and its price depends on the interest rate. Interest rates have to be set before the financing of any good or service is agreed to; financing precedes manufacturing; manufacturing precedes delivery to customers; delivery requires prices, which must be set to cover all the previous costs, plus, it is hoped, a profit. This is the way capitalist business runs, and there is no better way to run it.

To be sure, different companies follow different routines to achieve the same result. Many arrange a line of credit with a bank to prepare for the needs of a year or a season or a project. Special projects may be planned all at once. An automobile company may glimpse a chance for a new sports utility maxivan. All that exists at the beginning is a price range, a schedule of standard specifications, and a menu of desired special features. The engineering and design departments see what they can do; the sales department does market research; but the car is not built unless the finance department can be reasonably sure of necessary monetary support at a feasible interest rate.

That is not to say that finance is more important than (or even as important as) engineering or design or advertising or sales. It is simply to say that finance is primary. After all, the name of our system is finance capitalism.

I have been belaboring the obvious because it is essential for understanding one of the crucial problems of our time-the relation of the interest rate to the price level in a modem economy. The interest rate has an effect on prices, because it is a cost, and costs have to be covered by prices. The causation goes only from interest rate to prices, not vice versa. Prices may affect the sensibilities of the Federal Reserve’s governors, and they do in fact set the interest rate. Nevertheless, this is not a chicken-and-egg question.

A chicken makes an egg, and the egg makes a chicken, and that chicken makes an egg, and so on. Leaving aside the Reserve’s sensibilities, prices do not affect the interest rate, because the interest rate is set before prices are.

It is possible to assemble the statistics and plot curves showing the fluctuations of the interest rate and the price level. Depending on where you start, the peaks and valleys of one will necessarily follow those of the other with, as they say, a lag. If you then start with the other one, their roles will be reversed, and the lag will be different. There is absolutely no way of telling from the statistics or the graphs themselves which “really” comes first, the interest rate or the price level.

In this, the question is like that of the three-way colonial trade (guns and calico for slaves, slaves for cotton and rum; cotton and rum for guns and calico). These are not statistical problems; they are analytical problems. We know from our analysis that the interest rate affects prices, but there is no way for prices to affect the interest rate.

Well, I’ll take that, or a little of it, back. Banks and other lenders have to make ends meet, too; so their prices (the interest rates) have to be high enough to cover their labor, capital and rent costs. But the basic price of their product is set by the Federal Reserve Board. Their overheads merely account for the differences between the rates of your friendly neighborhood banker and those of the snobbish bank in the next town. The dictum stands: Interest rates affect prices, but the Reserve, not prices, affects interest rates.

The business press frequently writes that in certain situations (usually good news, like increasing employment and more prosperous businesses) the Reserve “will have to raise rates,” but there is no natural law or legal requirement that forces it to take the specified action. If the Reserve does raise rates, it is because of the governors’ own free will, guided by their own economic theory, which in this case happens to be fallacious.

PLEASE NOTE that it does not matter whether inflation is thought to be demand-pull or cost-push. A strong argument can be made that in a modem economy inflation, when it occurs, is practically always cost-push. For demand-pull inflation to work, supply has to be rigidly limited, and in a modem economy there is practically nothing that cannot be readily and indefinitely replicated within a reasonable span of time.

In other words, while the hallowed law of supply and demand was plausible enough in the isolated market towns of Adam Smith‘s day, it no longer is absolute —except in the narrow confines of Wall Street, where the supply of investment grade securities is strictly limited. Even international cartels controlling natural resources, such as the Organization of Petroleum Exporting Countries, are of bounded effectiveness because of the development of substitutes and the threat of military reprisal.

To be sure, the Federal Reserve worries publicly about the supply of labor, and that is certainly at least biologically limited, although relaxed immigration laws could provide short-run solutions and expanded education could extend the long run. Yet the experience of the last few years should have taught us that neither the wisest statesmen nor the most erudite economists have the faintest idea where or whether there actually is a natural rate of unemployment (that most barbarous notion), beyond which inflation must rage uncontrolled.

However all this may be, the fact remains that the interest rate must be agreed to by each enterprise before the enterprise is able to make a responsible attempt at setting its own prices. Thus the price level, an aggregation of all the prices in the economy, is systematically subsequent to the interest rate. Following the money, we see that when the interest rate goes up so does the price level.

No precise formula guides the process. Some entrepreneurs will hold their prices down and be satisfied with a lower profit. Some will manage to cut other costs technological, administrative, sales, advertising, and so on. In general, though, even a small interest hike will result in a noticeable hike in the price level.

In any case, the country is full of inflation hawks-and that includes many governors of the Federal Reserve Board -who are constantly on the lookout for the most obscure forecast of the inflation they fear. Recently they raised the rate, and they threaten to raise it further, despite their admission that there is no significant evidence of coming inflation. Instead, there is much talk of pre-emptive strikes, and of the importance of being ahead of the curve. Indeed, it is widely said that the Reserve must act now.

What happens in these circumstances? The price level inches up, and actual inflation shows itself. The hawks demand a further interest rate increase. The scene is like Zeno’s paradox of Achilles and the tortoise, except that the Achilles of the interest rate can’t catch up with the tortoise of inflation, because Achilles is carrying the tortoise and even pushing it out ahead of him.

Well, we’ve seen how the story ends. In fact, we’ve seen the ending nine times since World War II.  Raising the interest rate can only slow down inflation if the Reserve keeps raising it until the whole economy is put into reverse-until, that is, millions of men and women lose their jobs, hundreds of thousands of businesses go bankrupt, and public works languish.

We’re on our way. If we keep it up, we must have a recession. When former Federal Reserve Chairman Paul A. Volcker was asked if his policies might lead to recession, he replied, “Yes, and the sooner the better.” He showed how it was done. Why do we have to do it again?

The New Leader

[1] Ed:  Really?  “Obiter dictum”?  Really?

By George P. Brockway, originally published August 9, 1999

1999-8-9-lessons-from-the-depression-titleTHE NEW Congressional committee created ostensibly to reach a nonpartisan solution to the Social Security “crisis” may not really be intended to do anything, except perhaps issue a report calling for further study of the problem. In fact, I think it is probably a device for changing the subject whenever some humorless member of Congress tries to make an “issue” out of Social Security. “We must wait until the committee reports,” will be the ready response. If I’m right, Social Security will be effectively eliminated from the front lines of the November general election campaign, and no one will have to take a possibly unpopular stand either for or against any of the myriad “reform” schemes lurking on the horizon.

My junior high school civics teacher would be saddened to hear of my lapse from her innocent teaching, but I, for one, am enthusiastically in favor of another do-nothing committee on Social Security. A little over a year ago the much larger National Commission on Retirement Policy, made up of presumed experts business leaders, academics, Congressmen- managed to split three ways on which reform should be endorsed; so nothing was done. That was fine, because all of them would have gotten Social Security mixed up with the stock market in one way or another. Since the stock market is still dangerous, our need for a do-nothing committee is still great.

Nevertheless, I have not forgotten all I learned in those dear, departed civics classes, where we were taught to analyze legislation under three headings: (1) the need for the law, (2) the constitutionality of the law, and (3) the proper taxation to pay for it. That continues to strike me as a good, systematic approach, and I hereby suggest that the committee spend its time looking at the existing Social Security Act accordingly. This will give it something to do that no prior committee has done and keep the matter bottled up until after the balloting. Let me demonstrate.

1. Why was the Social Security Act needed? Well, there was a jim-dandy depression on. There being no official or semi-official definition of “depression,” one has to be supplied: A depression is a massive, comprehensive and persisting breakdown of the economic system. The economy does not recover without major changes or a major shock or both.

In the 1930s, millions and millions of people were out of work; the municipal poorhouses and charity soup kitchens were overwhelmed; beggars were everywhere; bands of hobos hitched long journeys on freight trains, tracking the seasons or wandering aimlessly. In most towns, near the freight yards or in the gashouse district, there appeared “Hoovervilles” of shacks made from old cartons and discarded (or stolen) boards, furnished with broken furniture from the town dump. In many cities a portion of the local jail was used as a temporary shelter for the more respectable homeless. I myself spent a night as a guest of the Hudson, New York, jail in the course of a hitchhiking journey to search for a job that I didn’t find.

The Great Depression was not a pretty time. Millions suffered, despite having worked long and hard and faithfully. Their dependents, of course, suffered along with them. So did young people coming fresh to a labor market that had no place for them. The society had failed, not a particular individual or group or class. Thus the Social Security Act was needed to deal with at least one aspect of the collapse of the social system-namely its effects on the elderly, the disabled and the orphaned.

2. Was the act constitutional? That proved to be a tough question for a Congress dominated by Southern Dixiecrats and Northern Republicans, and for a Supreme Court possessed of states’ rights notions that had become obsolete at Appomattox Court House on April 9, 1865. It took six years of depression for Congress and the Supreme Court to follow the election returns and take the general welfare seriously. Follow they eventually did, and our second question was answered in the affirmative.

3. Is the taxation appropriate? That question is still with us. The dispute today concerns the adequacy of the present payroll tax. No one wants to increase the rate. Some want to increase the income by putting a portion of the money in the stock market; others argue that income will be more than sufficient as long as the economy remains robust. The real trouble, however, is in the method of taxation itself.

A payroll tax has nothing going for it. It is comparatively easy to evade, especially by those in domestic or casual work. It also discourages employment. If you have a job, that laudable fact triggers a tax on you or your employer or both. On the other hand, if you are a professional gambler, or if all you do for a living is clip coupons and play the market, you don’t pay any payroll tax.

To be sure, aid for the needy is a responsibility of the state; and all businesses-manufacturing, wholesale or retail –owe their existence to the state. In some cases the state licenses or charters or franchises them; and in every case the state protects the society that is the source both of their work force and their market. Consequently, it is reasonable for businesses to be taxed to help pay for the general welfare of the government that nourishes them.

But a payroll tax is a poor way to do it. It is an up-front cost that must be met with the first employee hired, that increases with each additional employee and each wage increase given, and that continues until the last hour of the last employee’s employment. In his book The Next Left, the late Michael Harrington argued that French President Francois Mitterrand‘s bold, popular and promising social policies resulted in economic stagnation because he financed them by levying payroll tax after payroll tax. Instead of expanding, French industries cut employment to the bone in a largely vain attempt to keep their prices competitive with those of neighboring countries. The failure of Mitterrand’s programs had nothing to do with the fact that he was a Socialist. Their effect would have been the same even if the programs had been private fringe benefits.1999-8-9-lessons-from-the-depression-tight-money

OUR Social Security system, although in many respects the most successful legacy of the New Deal, has twice the vices of an ordinary payroll tax, since both employee and employer are taxed. Wage negotiations are rendered more difficult because the employees’ present value of any wage is reduced by the 6.2 per cent Social Security tax plus the 1.45 per cent Medicare tax, while for employers labor costs are increased by the same 7.65 per cent (called, no doubt to spare their delicate sensibilities, a “contribution”).

In addition, the Social Security tax has the extraordinary effect of being a radically regressive tax on the nation’s workers, especially the working poor. It is, to begin with, a flat tax–even flatter (as far as it goes) than the various flat tax proposals of current Republican politicians. It has no exemptions or credits, and starts with the first penny a worker earns. It continues at 7.65 per cent on both employee and employer until the employee earns $72,600, whereupon only the Medicare portion remains. A Fortune 500 CEO who pulls down $10 million a year therefore pays a rate that is less than one ten-thousandth of the rate paid by the charwoman whose job it is to clean up after him.

Nor are these the only indefensible unfairnesses of the Social Security tax. More important in the long run is the fact that the tax has been used to eliminate the higher brackets of the personal and corporate income taxes, and hence exacerbates the widening gap between the rich and the poor in the United States.

The Social Security system is said to be a pay-as-you-go plan, but of course it isn’t. It is a pay-years-before you go plan. The Trust Fund that is being paid for now will not be used up before 2029, and probably much later, if ever. In next year’s budget, the total of employee taxes, employer contributions, and interest earned by the Trust Fund is $636.5 billion, while the entire cost of Social Security (beneficiaries, bureaucrats and all) is only $408.6 billion. The $227.9 billion Social Security surplus not only goes to make possible the budget balance everyone is so proud of, but also accounts for the entire budget surplus that Congress is squabbling about.

The trouble with Social Security; in short, is the method of meeting the costs. A payroll tax is adverse to national employment and investment, and is unreasonable in its incidence. Moreover, the present payroll tax may be incapable of paying the bills. It is anticipation of the last that has caused today’s uproar. But speculating on the stock exchange, whatever else may be said for or against it, is almost guaranteed to fail at the most critical moment. A booming stock market does not guarantee a booming economy, but a crashing market is sure to bring the economy down with it.

Again I can offer a personal reminiscence. My father put together a satisfactory nest egg by playing the boom market of the 1920s. When the ’30s began he believed President Herbert Hoover and did not “sell America short.” In August 1933 he died broke. As the HMO lobby’s ads say, “There must be a better way.” And there is: The Social Security Act addresses a national need and it should be funded by a national tax. The income tax does not inhibit employment and investment, because it falls only on persons and enterprises capable of sustaining employment and investment.

It is often argued that the income tax is too subject to the cold and shifting winds of politics to be the support for something as vital as Social Security. But the raucous history of the present debate has surely demonstrated that Social Security is in any event buffeted by the very same winds as the rest of our political life.

The New Leader

%d bloggers like this: