Tag Archives: Adam Smith

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 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 March 3, 1999


T.S. ELIOT sang of “Songs[1] that follow like a tedious argument! Of insidious intent! To lead you to an overwhelming question …. ” Economics

sometimes seems like that-tedious as well as dismal. Economics is also very like the next line of The Love Song of J. Alfred Prufrock”: “Oh, do not ask, ‘What is it?”’

For the characteristic economics essay or book lays out-“Like a patient etherized upon a table”-an account of the economy, or some part of it, demonstrating how it works, or doesn’t work. Often the putative truths contained therein are unpleasant, like the iron law of wages in the 19th century or the natural rate of unemployment in the 20th. Nonprofessionals are frequently prompted to ask, not “What is it?” but the truly overwhelming question, “What should we do about it?” Professional economists have tended to brush that question aside. They are, they say, scientists, not humanists; and science concerns what is, not what ought to be.

But there is another reason for the posture of most economists, and that is the problem posed by the first sentence of the last chapter of John Maynard KeynesGeneral Theory of Employment, Interest and Money: “The outstanding faults of the economic society in which we live are its failure to provide for full employment and its arbitrary and inequitable distribution of wealth and income.” One would have to be extraordinarily deficient in empathy for one’s fellow human beings not to recognize the justice and urgency of Keynes’ dictum. One would also have to be exceptionally ignorant of the ways of the world to imagine that the problem will simply solve itself. Indeed, anyone with empathy and knowledge must find it acutely uncomfortable to deny that confronting those “faults” is the special responsibility of economists.

Yet starting with Adam Smith in 1776, the history of modem economics has instead been the story of a search for an automatic polity, a mechanism that, whether it makes all well or not, at least makes everything inexorable. With Smith, of course, it was the invisible hand. With Jeremy Bentham it was the felicific calculus, supposed to operate like Newton’s laws of motion. With Jean-Baptiste Say it was production creating its own demand. With John Stuart Mill it was supply and demand. With Karl Marx it was dialectical materialism. With William S. Jevons, Leon Walras and Carl Menger it was marginal utility. Among our contemporaries, equilibrium is the chosen control-metaphorical with John Hicks, mathematical with Gerard Debreu and Paul Samuelson, quasi-psychological with Frank Hahn and Edmund S. Phelps.

All those I have named are honorable men, as I believe almost every economist to be. I am sure none would dispute the truth of Keynes’ pronouncement. Faced with the enormity of the problem, though, all, with the possible exception of Marx, have found in pseudoscience an excuse for denying the need or ability to do anything substantial, and hence for refusing their responsibility.

The first thing to note about the problem is that originally it was a double pronged affair, but by now the prongs have joined together. In the ancient world, the feudal world and the mercantilist world, you could have full employment along with unconscionable disparities of wealth and income. Perhaps even in Keynes’ day, over half a century ago, it was possible to consider the two great failures of the economy separately. Today, however, we shall not be able to solve unemployment without at the same time solving maldistribution.

An explanation for the intertwining of the two problems was suggested by Joseph A. Schumpeter in an observation of the sort he made so casually and so tellingly. “The capitalist achievement,” he wrote, “does not typically consist in providing more silk stockings for queens but in bringing them within the reach of factory girls in return for steadily decreasing amounts of effort.” The modem economy, unfortunately, may not be quite so good to factory girls as Schumpeter suggests.

The reason lies with the opportunities the wealthy have to dispose of their income. In most cases, their money derives from mass production, but they do not spend much of it on the products of the assembly line. This is not merely a matter of taste. It would be flatly impossible to do so. You can buy a top-of-the-line Mercedes, the archetypal expensive, mass-produced commodity, for about $145,000. If you were a senior officer of a Fortune 500 corporation, or a partner in a major financial house, you could pay cash for a brand-new Mercedes the first of every month, junk it at the end of the month, and still have more money than you and your family could conveniently spend.

Traditionally the wealthy have invested their surplus, a practice generally considered to return it to the producing economy it came from. And, like Prufrock’s Yankee contemporary, Miniver Cheevy, they think they “have reasons” to believe they are doing something good. Theoretically, for example, their investment would make more silk stockings available at lower prices by increasing productivity. But in common with the romantic notions Cheevy holds so dear, the idea is largely spurious.

This is because, regardless of what distinguished economists say, the producing economy is, in general, overcapitalized. As things stand, it could very easily, without investment in another machine or machine tool, increase its output by 15 or 20 per cent. It has that capacity right now. More investment will not lead to greater productivity.

Increased demand would. But Chairman Greenspan still hopes to restrain the “exuberance” of the stock market-in which case its upper middle class “wealth effect” will disappear. And far from trying to stimulate consumption, credit card companies can’t wait to put fear of a new bankruptcy law into their lower-middleclass clients.

These actions reduce the nonwealthy to relying on what they earn by working, and what they earn necessarily falls short of being able to buy what industry produces: Schumpeter’s silk stockings (or their millennial equivalent) become less affordable. The shortfall is equal to the earnings and other withdrawals of the wealthy. Its correction must also come from that source.

LEFT TO THEIR own devices, how do the wealthy spend their money? After buying several Andy Warhols and subscribing to tables at a couple of dozen charity balls, it is all too easy to become frustrated by the attempt to consume one’s income and turn to speculation. So the money the wealthy take out of mass production industry stays out, and the money devoted to speculation becomes a flood.

A “moderate” session of the New York Stock Exchange today sees half again as many shares traded as were thrown on the market in the frenzy of the crash of October 1987. And still there is not enough to meet the demand. Besides the NASDAQ and the Amex and the mercantile exchanges and exchanges abroad (including way stations all over the new global village), there are $85 trillion worth of derivative “products” invented by clever bankers and brokers to facilitate betting on almost anything you can think of. In comparison, numbers running is child’s play.

Also in comparison, trying to make money by operating an enterprise that turns out actual goods and services is a mug’s game. As fortunes are made in speculation, the opportunity cost of productive enterprise rises. To keep those who have invested in industry from selling out, they have to be promised increased profits; and the fashionable way of doing that is for lean and mean companies to become leaner and meaner, thereby narrowing the already narrow market. Where once there was a spreading wage-price spiral, heading upward, the economy has slipped into a constricting lean-mean spiral, heading downward.

3-8-99-the-love-song-of-homo-economicius-ts-elliotThe wealthy are not the only ones contributing to this trend. The middle class is the beneficial owner, through what are called “institutions” (especially mutual funds and pension funds and insurance policies), of between one-third and one half of all the shares on the current exchanges. By being funded rather than treated as current expenses, these institutions soak up purchasing power and weaken aggregate demand. The funds’ speculating deprives the producing economy of efficient financing. The resulting shrinkage of the producing economy raises the rate of unemployment, accelerating the erosion of the middle class the institutions were created to protect, and exacerbating the polarization of society.

That is how we are approaching the turn of another century: The nonwealthy are unable to buy the products their industry can produce; industry consequently has fewer opportunities for expansion; the wealthy consequently have fewer opportunities for productive investment; the nonwealthy consequently have fewer job opportunities and more of them become unemployed (“naturally”).

It is easy to convince yourself that looking to the government to fix the situation is hopeless. President Franklin D. Roosevelt couldn’t get a cap on stay-at home incomes even in the midst of World War II, when millions of young men and women (and middle-aged ones, too) were risking their lives for their country. President Richard M. Nixon, despite being re-elected by the second largest percentage of the popular vote yet recorded, couldn’t enlist a Congressional majority for a negative income tax. The current tax law, whose top rate is less than half the top rate of 25 years ago, does not assess even the present top rate against capital gains. And who can imagine the Federal Reserve Board maintaining an interest rate that is either low or steady, let alone both?

Some (if not all) of these things should be done to mitigate the polarization of our society. If they can’t be done in the current political climate, what can economists be expected to do about it? Well, if economists can’t suggest answers, the least they can do is get out of the way. Certainly no solution will succeed if no one has the will to work for it, and certainly those most responsible are the people claiming professional status.

In the meantime, the outstanding “faults” of our economic society, albeit forged into one, are substantially identical with those of Keynes’ day. But the degradation, despair, and (in the words of the late Erik Erikson) negative identity are worse. Will human voices wake us before we drown?


The New Leader

[1] Ed. Well, I’ll be damned.  The author, uncharacteristically, has the quote wrong.  Eliot wrote of “streets”, not “songs” that follow like a tedious argument ….

By George P. Brockway, originally published May 4, 1998

1998-5-4 Learning From Japan titleTHE ECONOMICS profession and the military are similar in many ways, but they differ in one important respect. Generals are notorious for planning and training for the last war, while economists, who do not believe in history, have only one basic prescription for whatever problem may befall.

I don’t mean economists deny that Caesar crossed the Rubicon, or that Columbus sailed the ocean blue, or that Paul Revere went for a ride. What they deny is that economics was any different in those years from what it is today or will be tomorrow. They recognize, to be sure, that people in prior eras had different ideas concerning the economy, but they regard these ideas as wrong or irrelevant and not worth bothering about. They note that the laws of physics and chemistry and other such proper sciences are understood to have worked in the days of Aristotle whether he knew it or not, and assert that the same is true for the laws of economics- which, they claim, were not properly formulated until a half century ago, or after the death of John Maynard Keynes.

As a consequence, Japan is now having a rough time. We are likely to have a rough time, too, if we don’t watch out.

At the end of the Good War, General MacArthur explained to the chastened Japanese that it was not polite to steal things from other countries, and that in the future they would have to make or buy whatever they wanted. Economists pointed out to them that in order to buy things from foreign countries they would have to sell things to foreigners. So they set to work to export textiles (the United States had sent warships under Commodore Matthew Perry in search of silk back in 1854), but soon decided to put what they had learned in the Good War to good use.

One important lesson they had learned was how to organize themselves. Everyone was prepared to make sacrifices. Since their land was not rich in resources (it especially lacked oil), they did not waste time and energy on producing items for local consumption and pleasure. Even their captains of industry led relatively modest lives-far more modest than those of their conquerors. As the country gradually recovered, everyone continued to live unpretentiously, and to save famously. Japanese saving became proverbial, the envy of Wall Street and MIT economists.

In fewer than 20 years they supplanted the West Germans as the wonder workers of the postwar world. Japanese radios and television sets took over the American market. Then came a great stroke of luck. The OPEC inflation and oil embargo of the 1970s hit the United States just as the Japanese were trying their compact and subcompact cars on the American market. Ford and General Motors and Chrysler relied on earlier market research indicating a strong American preference for long, heavy, powerful, chrome-encrusted gas-guzzlers. Recent experience has shown the market research was basically not far wrong[1], but the tiny Japanese cars were immediate hits, and their agile manufacturers have not lost their share of the American market.

For another 20 years Japan’s foreign trade balance grew, and still the country maintained its-parsimonious domestic life. To some extent the parsimony was cultural, but in any event, it was enforced.

We are so imbued with Ben Franklin’s ethics of a penny saved equaling a penny earned that we may mistakenly imagine Japan is the second coming of Tocqueville’s America. Indeed, it is not. Bribery of government officials and extortion by government officials are commonplace. Ordinary business is lubricated by expense accounts that put American extravagances to shame. Furthermore, the class distinctions are so strong that there is little protest when the cost of living (not to be confused with the rate of inflation) puts many conveniences and amenities beyond the reach of ordinary citizens. Japanese cameras are notoriously more expensive in Tokyo than in New York[2].

Those who read this column in the issue of June 14, 1982 (16 years ago, I ask you to remark), learned then that Japan was far from the ideal society being described by the Western business press. In particular, the “lifetime employment” the press continues to talk about covers only workers in the largest companies (less than 30 per cent of the total employment in the automobile business) and “runs only to age 55, whereupon the worker is either demoted, farmed out to a supplier of the giant firm, or turned loose with a couple of years’ severance pay. In each case he faces old age without a pension.” Although women were 36 per cent of the Japanese work force, they had none of the foregoing perks.

I went on to explain that “the Japanese economy is hierarchical in an idiosyncratic way.” Operations that in the U.S. would be performed by divisions of a company are performed in Japan by satellite companies that are technically independent but actually at the mercy of the giant firms. As a result, the employees of the satellite firms are paid low wages and are subject to sudden layoff and dismissal.

The vaunted “productivity” of Japanese automobile companies came from dividing the value of the finished cars by the number of employees of the major companies, excluding those of the parts suppliers[3]. “In spite of all of Japan’s ‘sunrise’ industries in steel and shipbuilding and textiles and electronics and optics as well as in automobiles, the Japanese GNP per capita is still well below ours.”

I also noted: “As Gus Tyler has shown (in ‘The Politics of Productivity,’ NL, March 22,1982), the notion that the Japanese are ‘catching up’ is a statistical flim-flam.”

In short, some Japanese may live abstemiously because of their upbringing; some may live abstemiously because they have to; and some may live abstemiously because consumption is discouraged in other ways. Jean-Baptiste Say, who wrote, “It is the aim of good government to encourage production and of bad government to encourage consumption,” would have loved modern Japan.

The trouble with good government as defined by Say is that you soon have more money than you know what to do with. The citizens have their little nest eggs, and the big businesses have their big profits, and the government has an enormous “favorable” balance of trade. Modern economists nod their heads approvingly because exports are a positive factor in the Gross National Product, while imports are a negative factor. Nevertheless, this is not an unmixed blessing.

Japan became (and remains) very rich by almost any definition; yet despite its riches, the economy began to go sour with the worldwide recession that set in after the Gulf War. In fact, Japan’s success in exporting all over the world led to its present weakness. Building its economy completely on the world market, Japan necessarily faltered when the world market faltered.

At this point, a feature of the Japanese economy that has captured the admiration of American observers came into play. Japanese banks, which are not restricted and regulated the way American banking is, naturally became the depository of industry’s enormous profits. Lists of the 10 or 20 largest financial institutions in the world were therefore dominated by Japanese banks. American bankers were (and are) envious of how intertwined giant industries and giant banks were. Banks owned and speculated in common stocks and real estate, and thus owned industrial corporations. The latter owned bank stocks and speculated in them. From time to time the central bank joined in the fun.

As world trade languished, and as Japanese forays in foreign investment from Radio City in New York to the Pebble Beach Golf Course[4] in California proved disappointing, bankers and indeed the whole of the Japanese economy devoted all available wit and energy and money to speculating in domestic securities and real estate. The stock market shot up faster and farther than Wall Street has ever managed, and the newspapers were filled with stories of lots 10 feet square in central Tokyo selling for a million dollars. Memberships in fashionable golf clubs also were said to cost a million dollars. Besides playing the markets for their own account, bankers lent vast sums to other high rollers. Speculation spilled over to Korea and bubbled around the Pacific rim.

THE HOME BUBBLES burst first, years before the current debacle in Southeast Asia. Japan’s economy has been essentially flat for most of the present decade.

Economists know what to do in such situations: increase saving, control consumption, raise the interest rate, cut taxes, balance the budget, and deregulate. As we have seen, however, Japan was already very much the sort of state advocated by Jean-Baptiste Say.

At the same time there were puzzling differences in details. Unemployment remained well under 3 per cent, yet inflation was close to zero (a situation similar to the one in the United States that is currently bewildering the Federal Reserve Board). The interest rate was below 2 per cent-as it had been in America in the decade ending in 1951-yet there was so much money around that raising the rate proved to be difficult. The regulations that the U.S. most objected to were those that made imports difficult and hence restrained consumption.

Well, it’s a long story and includes political plots and subplots and dark tales of gangsters (for some reason not known as the Japanese Mafia), but here I merely want to mention one detail. Evidently to appease sternly anti consumption economists, Japan introduced a national sales tax a couple of years ago. The latest “reform” package included extensive corporate and personal income tax cuts, but the sales tax was left intact.

There is, I think, very little chance that Japan will recover from its extended stagnation without a fundamental change of policy. Japan had a brilliant postwar run from destruction and demoralization to the second largest economy in the world. As we observed at the beginning, modern economics has a one-track mind, and Japan followed it. The economic advice that enabled the country to achieve riches is now hampering the recovery. It is as successful a supply-side economy as the modern world has seen, and as such its difficulties should be a warning to the United States.

A one-sided economy is unjust and, in the end, is inefficient. Adam Smith was a true citizen of the Enlightenment. He wrote, “Consumption is the sole end and purpose of all production, and the interest of the producer ought to be attended to only as far as it may be necessary for promoting that of the consumer.”

Keynes had a broader understanding of the needs and purposes of modern life. He wrote, “The outstanding faults of the economic society in which we live are its failure to provide for full employment and its arbitrary and inequitable distribution of wealth and incomes.” Japan came close to correcting the first fault, and we are nearer to it than we have been in modern times. But Japan has overlooked the second fault and is checkmated, and we are increasingly in danger of the same fate.

The New Leader

[1] Ed:  An example of what Steve Jobs, among others, hated about “market research” in that it echoed what people already knew about cars not what was possible about cars…

[2] Ed: “Yodobashi Camera is two blocks south of the Kamiyachō station on the Hibiya subway line.  Yodobashi Camera means BIG savings!”

[3] Ed:  Note that this is exactly paralleled in the US practice of using outsourcing to reduce headcount vs revenue thus presenting productivity gain by not counting the now, outsourced, jobs.

[4] Ed:  A great place to shoot 79 by playing the last 5 holes in one under par…

By George P. Brockway, originally published September 6, 1996

1996-9-6 Caught in a Boom Market Title

ON OCTOBER 15, 1929, less than two weeks before the worst crash in the history of any stock market anywhere, one of America’s most renowned economists, Professor Irving Fisher of Yale, announced that stock prices would be “a good deal higher … within a few months.”

Fisher’s prophecy is as good today as it was on the eve of the Depression. All it took to make the market go up then was an influx of money, and that is all it takes now. Per contra, without an influx of money nobody, not even the wisest professors in the land, can induce the market to levitate.

The stock exchanges are, after all, among the few remaining places where the law of supply and demand still runs according to script. Brokers, bankers and publicists who operate in the shadow of the exchanges come to feel the law obtains always and everywhere, imposing market discipline as it goes. But as anyone who has noticed the programmed gyrations of prices in malls and supermarkets knows, this is not the case.

For the law to work, supply must be limited. It no longer is limited in most transactions of daily life. When a bookstore runs out of a bestseller today, it can have fresh stock tomorrow. If you want a new automobile, there are, as my Vermont father-in-law once remarked, plenty of people ready to sell you one.

Supply used to be limited in isolated provincial markets of the sort familiar to Adam Smith, and it is still limited in the narrow confines of Wall Street. Only the issues of a certain number of companies, and only a certain number of shares of each, are admitted for trading on the exchanges. When millions of people with money in their fists start demanding to purchase some of the finite supply, the old law comes into play and prices go up. We have a bull market.

The 1920s upsurge was generated by what may be called exuberant greed. The Great War had liberated and greatly enlarged the middle class. Wall Street promised more liberation. Today greed is certainly just as crucial, but the mood is noticeably different, more desperate than exuberant. For a moment, it seemed like morning in America, but the Baby Boomer generation has grown up and begun to worry about its retirement years, because suddenly they bode to be less golden than those of its parents.

The problem is, at least initially, demographic. Generation X (or whatever it may ultimately be named) is substantially less numerous than its parents’ generation. It is said, therefore, that the Social Security and Medicare trust funds will be depleted, and that the burgeoning costs of these “entitlements” will fall on a smaller number of taxpayers. Much as they love their folks, the young are expected to revolt. Boomers are advised to start looking out for themselves.

Where to look is the question. Many financial advisers answer that, over the years, the stock market has out-performed all other kinds of investment – Treasury bonds, foreign currencies, real estate, collectibles, gold, pork bellies, the lot. The difficulty that few citizens are qualified to play the market seems solved by the existence of 7,000 or more mutual funds whose comparative performances are widely rated. It is unlikely there are 7,000 fund managers more qualified today than Irving Fisher was in his day, but let that pass: The 7,000 funds now manage close to $3 trillion.

Unfortunately, this astronomical sum must be multiplied many times if it is to do the job expected of it. The Boomer objective, after all, is a decent retirement income. Not to be too ambitious, let us say something around $35,000 a year, which is somewhat more than the present median family income. This will certainly not be enough if Medicare is privatized any further, or if the Social Security COLA is eliminated. Nor will it be enough if inflation continues at its current “optimal” rate of 2.5 per cent, since over 10 years this will raise the price level 31 per cent. We can’t, however, allow for every contingency, or we would give up at once.

So let’s assume $35,000 a year, and let’s assume further that Social Security will somehow be good for $10,000, leaving our typical Boomer with $25,000 a year to coax from Individual Retirement Accounts (IRAs), 401(k) schemes and other available fliers. Right now the average stock’s dividend is running at not much more than 2 per cent. At this rate, to rake in $25,000 a year in dividends, our Boomer’s portfolio would have to be worth roughly a million and a quarter.

Although I am no Irving Fisher, nor was meant to be, I think I shall not go far wrong in prophesying that the market will continue climbing, because the desperate Boomers are going to have to put their retirement money somewhere; and regardless of what Bob Dole’s new supply-side friends say, the country isn’t full of enterprises crying for new capital. As long as the Boomers’ annual contributions to IRAs and 40 1(k)s go into the market faster than other people take their money out, the weary bull is bound to keep scrabbling upward, at least for a while.

BUT ALL good things come to an end, and we have already received intimations of the mortality of this one. There are, to begin with, the worries about our corporations’ abilities to compete in the new global village, plus the uneasy suspicion that the information superhighway may turn out to be a curiosity, like the English Chunnel[1]. The principal sign of danger, however, is the 2 per cent dividend rate previously mentioned. Stocks paying only 2 per cent are an acceptable gamble as long as capital gains keep piling up. When they start falling (or turn negative), the stodgy 6 or 7 per cent yield of the Treasury long bond looks like an increasingly desirable port in what could develop into an unpleasant storm.

In 1983, when the present bull market began, the dividend yield of the Standard & Poor’s 500 was more than 6 per cent. When (post hoc and probably propter hoc) the dividend rate fell below 3 per cent, we had the “corrective crash” of 1987. Four years later, the rate had worked its way back to 4 per cent. Now, ominously, it is the lowest it has ever been.

It is by no means certain that even a 2 per cent dividend rate can last. The economy is strong enough to frighten the Federal Reserve Board, and all that, but the rate of profit has been maintained to a considerable extent by downsizing, and the thing about that is it frequently means exactly what it says. For when a company cuts staff, it cuts output, too-unless it has previously been unlucky or unbelievably inefficient or surprised by overwhelming technological change.

The trick is to cut jobs and wages faster than output. If a firm can manage that, its “productivity” will rise, though its production will probably fall. The lower cost per item produced may delight its economist and please its cost accountant; nonetheless, its total profits are likely to fall with its total output. Indeed, a company can be the most “productive” outfit in an industry (as Nissan’s and Toyota’s American automobile plants were rated last year), yet operate at a loss (as the Nissan and Toyota factories did).

For the nation all the time, and for the stock market in the medium and long run, what counts is production, not productivity. Production-goods and services created-can be used and enjoyed, and if so, can yield profits. Productivity which is merely an index number, a ratio of output to hours worked, nothing tangible – is not good to eat and pays no dividends.

The way things stand, if dividends fall much lower, capital gains will dry up as cautious money leaves stocks for bonds; the bull market will 1996-9-6 Caught in a Boom Market Nissanapproach its end. At some point before the end, or soon after, fall. Ever mounting capital gains would be a thing of the past, and to the extent that market and economic troubles are due to vanishing profits in relation to stock prices, an interest rate hike would have the wrong effect. The case for lowering the rate is not much happier, given the present temper of the Reserve Board. The initial consequence would naturally be to raise the price of bonds and, almost simultaneously, of stocks. The price/earnings ratio would stabilize, but again without encouraging capital gains. On the other hand, costs, sales and the profits of ordinary businesses would gradually improve. Up with this the Board could not put, so back up would go the interest rate.  Therefore, for the Boomer generation to enjoy a reasonably comfortable retire there will no doubt be calls for the Federal Reserve Board to intervene, and the Board will be tempted to comply. Besides wringing its hands, it will have two choices: to raise the interest rate, or to lower it. It will be leery of raising it, because someone on its staff may remember that in 1929 and 1930 the Reserve’s tight money policy was blamed for triggering the Crash and then turning it into the Depression.

In any event, raising the interest rate would lower the price of bonds; and almost immediately the price of every income-earning asset, including common shares, would follow. In other words, the stock market would fall, or at the minimum be impeded in its climb. In addition, the costs, and hence the prices, of ordinary businesses would sooner or later increase, and their sales and profits would fall. Ever mounting capital gains would be a thing of the past, and to the extent that market and economic troubles are due to vanishing profits in relation to stock prices, an interest rate hike would have the wrong effect.

The case for lowering the rate is not much happier, given the present temper of the Reserve Board. The initial consequence would naturally be to raise the price of bonds and, almost simultaneously, of stocks. The price/earnings ratio would stabilize, but again without encouraging capital gains. On the other hand, costs, sales and the profits of ordinary businesses would gradually improve. Up with this the Board could not put, so back up would go the interest rate.

Therefore, for the Boomer generation to enjoy a reasonably comfortable retirement, as every generation should, it can no longer consult its narrow self-interest. Instead, it must look forward to, and participate in, and help organize, a great surge in the gross domestic product. This can be accomplished in only one way in a free society. It is not enough for goods to be manufactured and services to be made available. To contribute to private profits and common wealth, commodities must be sold, and someone must be both willing and able to buy them. Otherwise, sensible producers will cut output and make up for the resulting drop in profits by laying off employees.

Mass industry requires mass consumption. But that will require a more generous and hopeful and responsible attitude toward the distribution of income than has been seen, in this country for many long years.

The New Leader

[1] Ed – so much for prognostication, neither turned out to be “merely a curiosity.”

By George P. Brockway, originally published January 29, 1996

1996-1-29 The Assumed Employment Virus Title

I SEE BY THE PAPERS that big corporations are downsizing their economics departments. IBM and GE have eliminated theirs altogether. Others are keeping a few people on for special projects, but still are outsourcing from one think tank or another when they want to know about the economy.

There is poetic justice in this, for economists have not been bashful about claiming credit (if that is the right word) for developing the theory of productivity. That allows the sensitive readers of the Wall Street Journal to call their brokers and take a position in the stock of any company announcing its intention to fire 10,000 or more employees, particularly those with 20 years of service or better.

I do not mean to gloat. Some of my best friends are economists; moreover, intellectual life in America is thin enough without sending more PhDs down to swell the ranks of telemarketers anxious to interact with me during my happy hour about a new exercise machine or a new insurance policy. No, I don’t mean to gloat, but I do intend to seize the day to fret a bit about the state of the profession.

I became concerned about the profession when I sent my brother a copy of my first book. He thanked me in due course, and congratulated me, but he didn’t pretend he had read it, nor did he promise to read it. “After all,” he wrote, “I doubt that I’ve ever in my life read an economics book straight through. You can hardly expect me to break that record now, even for my kid brother.” So far as I know, he never did.

My brother was not a dope. He was far from adopting what James Truslow Adams a half century ago called “the mucker pose.” He held both the baccalaureate and a doctorate from Harvard. He traveled widely and read widely. All his life he was involved in community affairs. But he couldn’t be bothered with economics. When I pressed him for an explanation, he said, “You people claim to be scientists, but you disagree with each other about everything. No two of you speak the same language. Some of you seem not speak any language.”

Although my brother was not a dope, I’m inclined to think that in this case he was almost precisely wrong. Economics is not a science, and the discipline’s practitioners tend to agree too much. Especially about the wrong questions.

One of the puzzles of contemporary economics is the number and variety of theories – including those most prominent in the universities today – that trace their origin to sensationally different journal articles, yet all end up advocating laissez-faire or something remarkably close to it. The puzzle is of course the greater because, not so long ago, the Great Depression and World War II seemed to have laid laissez-faire permanently to rest.

General Equilibrium Analysis, Monetarism, the Neoclassical Synthesis, and Rational Expectations are among the schools affected. In computer jargon, one might say that a virus has attacked them all, disrupting programs, infiltrating compositions, corrupting data bases.

We didn’t use to think of mathematics or logic in such highly charged terms. We were well aware that an error at any point in an exercise would render all that followed suspect; but our exercises used to be more insulated from each other, so that our assumptions were more frequently considered.

Be that as it may, I believe it can be demonstrated that something like a virus has indeed infected most contemporary models of the economy. We may give the virus a name: the Assumed Employment Virus.  For it is an assumption or presumption that the economy is operating either actually or effectively under conditions of full employment.

The Assumed Employment Virus appeared almost contemporaneously with The Wealth of Nations in 1776, but no one noticed for a century and a half. It was not until the Great Depression that providing employment was recognized as an economic problem. Adam Smith, for example, devotes a few pages to the comparative wages of different “employments” and to the “price of labor” generally. Yet the only unemployment he takes notice of is the seasonal one of bricklayers and masons. He pays some attention to the “Poor Laws” (which for 400 years were a staple of British fretfulness, the way “welfare as we know it” continues to occupy us), but seems not to have considered the possibility of, and need for, regular employment for the poor.

The “classics,” or most economists from Smith to the middle of the 20th century (except Karl Marx), presumed that all laborers could get jobs, no matter how bad the times, if they merely lowered their wage demands to what entrepreneurs offered. It was not suggested that in bad times (or at any time) entrepreneurs should pay a living wage at the expense of the going rate of profits. Bob Cratchit was a fortunate man, even though he couldn’t afford adequate medical attention for Tiny Tim. In modern jargon, entrepreneurs were forced by market discipline to cut wages. Laborers were free to accept jobs that would allow them to starve to death. As Phil Gramm and Dick Armey taught undergraduates only the other day in Texas, those who lacked jobs were unemployed because they didn’t want to work. There was no such thing as involuntary unemployment.

It remained for John Maynard Keynes to demonstrate why involuntary unemployment is a fact of laissez-faire life. He observed “that men are disposed … to increase their consumption as their income increases, but not by as much as the increase in their income.” If the resulting weakness in demand is not countered by investment (sooner or later by government investment), production will be decreased, and workers will become unemployed – involuntarily.

Laissez-faire theorists have tried to refute Keynes’ demonstration by presenting arguments that unemployment cannot be reduced to zero. The Monetarist Milton Friedman came up with the first of these -the Natural Rate of Unemployment (whatever is natural is ipso facto involuntary), now usually referred to as the Non-Accelerating-Inflation Rate of Unemployment, or NAIRU. It has also been called the Normal Rate, the Warranted Rate, and (in a triumphal oxymoron) the Full Employment Rate.

There is a sort of reason behind even that last name. All of the involuntary unemployment arguments maintain either that unemployment cannot be reduced below the mentioned rate, or that if it is temporarily reduced (and it can only be reduced temporarily), it will be followed by some unacceptable consequence, usually inflation without limit. If at some point policy forbids, for whatever reason, further reductions in unemployment, why not call that point Full Employment?

The Rational Expectationists, whose leader was recently crowned with a Nobel Memorial Prize, make the problem easy for themselves. It is, they say, rational to expect the economy to behave as the classics would have it; so involuntary unemployment doesn’t exist, and laissez-faire does.

In effect, then, for most contemporary economists both voluntary and involuntary unemployment amount to full employment. Distinguishing among the three terms would saddle scholars with two extra variables that could enormously complicate their equations. The obvious course is to simplify by using one term for three. It is with this simplification that the Assumed Employment Virus enters today’s models.

ONCE THE VIRUS is in the models, two things happen. First, since full employment is now an unequivocal term in an equation, the equation can be solved for it. Full employment is no longer a mere possibility or desideratum or dream but an eventuality, if not a determinate actuality – just as in General Equilibrium Analysis the “proof” of the possibility of an equilibrium quickly entails proof that an equilibrium exists, and that it is optimal. Second, since full employment is at last one of the prime objectives of any modern economic policy, any model containing the virus has apparently proved the achievability of the objective, and it can therefore be assumed. Whatever still remains for the economy to do can be done with comparative ease. In other words, take it easy: laissez-faire.

As might be expected, the Assumed Employment Virus, having successfully infected models of the economy as a whole, has had equal success in confusing more restricted models. Thus the proofs of Keynes and Michal Kalecki that saving equals investment have been used, and are still used, to justify the constant cries for decreased consumption and increased saving. (The proofs merely mean that whatever is invested has been saved; they do not mean that whatever is saved is invested.)

More to our present point, in the absence of truly full employment, too much saving can actually be, as Keynes was at pains to emphasize, a bar to investment as well as to consumption. Because what is saved cannot be consumed, saving reduces demand; and when demand is reduced, prudent entrepreneurs are not emboldened to invest in new production to satisfy it. Consequently, the recurrent schemes to encourage saving are generally either unproductive or counterproductive. In the 1993-94 debates over NAFTA and GATT,   Ricardo’s Law of Comparative Advantage was similarly cited regularly without acknowledgment or recognition of its dependence on the assumption of full employment.

It is obvious enough that a nation is neither enriched nor strengthened if substantial numbers of its citizens lose their jobs and are kept unemployed while the nation imports some product these citizens once made or could now make. This manifest truth is, however, rendered irrelevant by the Assumed Employment Virus.

Those who have been downsized into joblessness (including the economists we mentioned at the start) are likewise victims of the Virus. The standard productivity index is derived by dividing the Gross Domestic Product (GDP) for a period by the number of hours worked during that period. The index is a common fraction, so it will naturally rise if the denominator (“hours worked”) is reduced; hence the rush to downsize everything from the Federal government to the local supermarket.

“Productivity” may thereby be improved, but production (which is not an index number but actual goods and services produced for actual people to use and enjoy) falters. The victims of downsizing, being now unemployed, necessarily reduce their consumption, that is, the demands they make upon the economy. Entrepreneurs, faced by this reduction in demand, reduce production, which of course leads to a reduction of the GDP.

It would be different if full employment were the actuality rather than a deluded assumption caused by a “virus” in economists’ models. As long as there are unemployed workers, though, the first mission of macroeconomic policy should be to increase “hours worked”-that is, employment. This is not to say that we need a return of the Luddites. It is to say that we need economists dedicated to devising policies that will make full employment a hard reality instead of an easy assumption.

The New Leader

By George P. Brockway, originally published October 9, 1995

1995-10-9 Japan Does It Again TitleTHE TEXT for today’s lesson comes from the second act of The Mikado, where Ko-Ko, Nanki-Poo and Yum-Yum sing in unison, “Here’s a pretty how-de-doc!”

For Japan has done it again. Last year

I reported in “Unemployment Japanese Style” (NL, May 9-23, 1994) how Japan has given the lie to the most awesome and awesomely barbarous-notion of American economics. I mean the theory of the “natural rate of unemployment,” or, in proper academic gobbledygook, the “non-accelerating inflation rate of unemployment,” or, in a fashionable acronym, NAIRU.

As you will remember, NAIRU says that if unemployment falls below a certain level, inflation will accelerate without limit until the central bank (a.k.a. the Federal Reserve Board) raises the interest rate high enough to cause a recession. In the United States, the “desired” rate of unemployment is said to be about 6 per cent. At present it is hovering around 5.5 per cent, and the inflation rate is about 3 per cent. We maintain it all with a 9 per cent prime, and are expected to make a soft landing (from where to where no one says).

The Japanese, however, have already landed. Their unemployment rate has not been higher than 3 per cent for decades, and their inflation rate is lower than ours. In short, they have made the natural rate of unemployment and its advocates look foolish.

And now they have done the same thing to the second most hallowed doctrine of contemporary American economics productivity theory. The dogma of productivity is among the most widely invoked in economics, especially when practical policies are at issue. It is dominant at all levels, from microeconomic downsizing to macroeconomic competitiveness in the new global economy. It is central in labor and environmental disputes. Along with NAIRU, it guides the deliberations of the Federal Reserve Board. It is brought to bear on matters not strictly economic, from education to highway design.

How have the Japanese made this sublime theory (and its practitioners) look foolish? Well, it tums out that the assembly plants in the United States of two major Japanese automobile manufacturers, Nissan and Toyota, have higher productivity ratings than those of any American manufacturer. So what’s new? What’s new is that both Japanese plants lost money last year, while American automobile manufacturers were rolling in it.

There are, to be sure, plenty of reasons for the poor profit showing of the Japanese plants. First is the “strong” yen, which renders anything made of Japanese parts expensive in comparison with the same things produced in countries with “weak” currencies. Second is the Japanese determination to use only their own parts, no matter where they are assembled (a casus belli in the trade dust-up last June). Third is the evident Japanese decision to accept the losses for the sake of maintaining or improving their share of the American market. Fourth could be a Japanese preference for losses rather than paying corporate taxes in the United States (since Nissan as a whole lost ¥166.1 billion or $1.86 billion-last year, this is not a probable motive). Fifth is the Japanese policy of slighting their home market in favor of their export market, with the result that a sluggish world economy has been translated, these past three or four years, into a stagnant or recessive Japanese economy.

All these reasons for poor profits would be even more forceful if Japanese plants were less efficient and less “productive.” And American automobile manufacturers would very likely increase their profits by becoming more efficient. The point, though, is this: You can be “unproductive” yet profitable and stay in business. But you can’t stay in business forever, no matter how productive you are, if you don’t make ends meet. (Of course, the American assembly plants of Nissan and Toyota are scarcely noticeable elements of their businesses; these factories could probably be run at a loss indefinitely without much hurting long-term corporate profits.)

In a free economy, productivity may sound nice (at least if you haven’t been downsized), but profitability is essential. This being the case, one must wonder why the economics profession is enthralled by the idea of productivity. You can produce a table and chairs, knives and forks, plants and food, and sustain yourself, but productivity for its own sake is, as Midas found gold to be, not good to eat. Productivity is a less important concept than profit. It is also a slipshod, if not flatly fallacious, idea[i].

I have, over the years, worked up examples of the absurd consequences of applying standard productivity theory to micro-economic and macroeconomic problems, and (you may not believe this) I’m tired of repeating myself. If you missed those lessons, I would advise you to rush to order the third edition of The End of Economic Man, due at your bookseller’s in January.

In the meantime, I will repeat a baseball example, since that sport may again be the national pastime. Once upon a time, the Washington Senators got a rookie centerfielder by the name of Joe Hardy. On Hardy’s first time at bat in the majors (as I heard the story), he hit a grand slam home run. When he was due up next, there were only two men on base; so the manager[1], who had majored in economics, yanked him for a pinch hitter. Otherwise Hardy’s productivity (the number of runs he knocked in per at bat) would have had to go down-unless he drew a base on balls or got hit by a pitch, and neither could be counted on. I forget the manager’s name; I think M.I.T. snapped him up to coach their entry in the Neoclassical Synthesis League.

I know our baseball analogy reeks of metaphysics. So does productivity theory, and I’m sorry, but we’re going to have to think about it.

Productivity is defined as output divided by input. The output part presents no particular difficulty. It can be as definite as the 48,000 pins produced in a day by the “small manufactory” Adam Smith tells us about; but usually it is as diffuse as the Gross Domestic Product, and so has to be reduced to dollars, as the GDP is.

You might think that the input part would also be reduced to dollars, for it, too, is pretty diffuse, including at least land, labor and capital. The fact of the matter, however, is that economists tend to be embarrassed by money. Victorians thought it vulgar to talk about it. Today’s economists, like medieval scholastics and contemporary analytic philosophers, think money is merely nominal-unreal. Mathematical economists who fancy general equilibrium theory can’t find a place for money in their model. Unreal.

The obvious way to avoid using money in the denominator of the productivity fraction is to select the largest factor of input and make it a surrogate for the whole. Very well. Labor is today the single largest factor in the U.S., year after year amounting to close to 60 per cent of total costs. You will have noticed that total costs have to be stated in terms of money, and therefore that 60 per cent of the total also has to be stated in terms of money. (We’re going to have to let that pass, or this column will become a book.)

ANYWAY, the Productivity Index prepared by the Bureau of Labor Statistics of the Department of Labor divides the Gross Domestic Product of a period by the number of hours worked by all persons “engaged” in the period, including the hours of proprietors and unpaid family members. “Hours worked,” especially by unpaid workers, certainly is not money, and the category presents other problems. Most important, the hours are not homogeneous. Lee Iacocca’s hours, or some of them, undoubtedly yield a greater output than do a machinist’s, and a machinist’s hours yield a greater output than do a floor sweeper’s; but they’re all the same to the Department of Labor. Indeed, when you stop to think of it you realize that land and capital also work hours, probably more hours than labor, because they never sleep, and therefore might be thought more suitable than labor as surrogates for all inputs.

There is also an Employment Cost Index, which divides the total annual compensation of all employees of private business, from handyman to CEO, by the annual total of hours worked for pay. This gives us a figure that I frankly can see only cynical use for. Since it combines rapidly growing executive salaries with slowly falling common laborer wages, it has almost doubled from 64.8 in 1980 to 123.5 in 1994, and so can be used by readers of the Wall Street Journal to prove to their seat mates on the commuting train that labor never had it so good.

The conclusions drawn from the Productivity Index are similarly not remarkably reliable or even useful. During our autumn of discontent, mainstream economists recommended single-minded devotion to productivity to prepare us for the explosive competitiveness of the brave new global village. We learned that to become more productive, we must reduce “hours worked,” and to reduce “hours worked,” we must downsize.

Well, you don’t need a productivity index to know that you could make more money if you could turn out the same quantity of commodities with fewer employees. I could do that one with my eyes closed. With my eyes open, I can see that you make more money by producing the same output while borrowing less and paying lower interest on the sum borrowed, or paying lower taxes, or reducing advertising, or having fewer three-martini lunches, or organizing your business more rationally.

What I see with my eyes open as well are a lot of situations where input and output are stated in terms of money. That is not as strange as modern economists seem to think. When we divide total output in dollars by total input in dollars, our answer is the rate of profit, which is not an esoteric new idea at all. Business managers seeking to compare their firm’s current operations with those of their competitors, and with their own in other years, have used such ratios for generations. It’s nothing to them how many hours are required to make their product; what they’re after is the minimum cost.

For years the Japanese have demonstrated that you don’t have to have unnaturally high unemployment to maintain low inflation. Now Nissan and Toyota offer empirical proof that although yours may be the most “productive” outfit in the village, it may profit you nothing. Thus the Japanese have cooled off the two hottest tickets of modern American economics.

What will they think of next?

The New Leader

[1] Benny Van Buren

[i] Shades of Clayton Christensen and, among other things “When Giants Fail”

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