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By George P. Brockway, originally published September 22, 1997

1997-9-22 Why a Zero Deficit Means Failure titleI DON’T want to alarm anyone, but I think it important for us to realize that the United States of America is about to sail into unfamiliar waters. What is more, those waters are inaccurately charted.

Many years ago I had occasion to consult charts of the Aegean Sea, the island pocked body of water between Greece and Asia Minor. From 1522 to 1912 the principal southern islands were occupied by the Ottoman Turks, and from 1912 to 1947 by Italy. I used British revisions of charts originally prepared by the Italian Navy. Scores of tiny islands and mid sea rock formations had notations beside them: “Reported 2.6 mi.   north, 1949,” or “Reported 1.9 mi. south, 1948.”

The economic waters we are now entering are at least as badly charted. The years 1947, 1948, 1949, 1951, 1956, 1957, 1960, and 1969 are the only ones since the great Crash of 1929 in which we managed to balance the Federal budget. As we shall see, what happened in those eight years is the diametrical opposite of what is generally assumed, and our misconception is driving us in an unexpected and unhappy direction.

We need to understand this because we are approaching another balanced budget much faster than anyone thought possible. Indeed, the embarrassing fact is that tax revenues are so good in today’s relatively affluent society that the budget would balance itself in a couple of years if Congress just sat on its hands and watched[1].

The universal mantra has been that we must at any cost balance the budget by 2002. We came within two votes of .launching a Constitutional amendment to that effect. I suppose most people have forgotten the reasoning behind the mantra. Forgetfulness, of course, is what mantras, like the Big Lie, are for. No matter.

The various reasons that were given for balancing the budget a couple of years ago appear to have been reduced to one: President Clinton, House Speaker Newt Gingrich and all their economic advisers say that the balancing will lower the interest rate and hence save good citizens money as well as make for prosperity.

Yes, but I seem to remember that six months ago-on March 25, 1997, to be precise-the Federal Reserve Board kicked the Federal funds rate up a quarter of a point, and soon thereafter every other interest rate went up at least that much. What was the budget news then? There was certainly a noisy squabble going on, but was there anyone, inside the Beltway or out, who was proposing to increase the deficit? If no one was even thinking about such a thing, why did the interest rate go up?

We don’t have to reach back as far as March 25 for incongruities. In the midst of the budgeteers’ recent self-congratulations, the Bureau of Labor Statistics of the Department of Labor announced that the official unemployment rate had fallen to 4.8 per cent (it’s since crept up a tenth of a point or two). That prompted a flood of professional prophecies that the Federal Reserve Board would have to (the Board seems never to act of its own free will) raise the interest rate again to keep more people from getting jobs.

And shortly thereafter the International Monetary Fund, well-known for its conventional views, cautioned that “undue delay in tightening monetary policy could undermine the current expansion.”

Look at the crosscurrents we have drifted into:

  • News about an imminent budget balance, which is supposed to presage prosperity.
  • News about falling unemployment, which you might think would be an essential element of prosperit
  • Prophecies about necessarily rising interest rates, which must be bad if it’s good to balance the budget to get lower rates.

While we were being buffeted by these currents, Federal Reserve Chairman Alan Greenspan made his semiannual reports to Congress, partly televised on C-Span.

I always look forward to the televised versions of these reports, because they often include questions by Congressmen and answers by the Chairman. The Times and the Wall Street Journal usually provide little more than a summary of the Chairman’s prepared remarks. Constant readers may remember my excitement two years ago (“What Greenspan Really Told Congress,” NL, July 17-31, 1995), when I scooped the world with the news that Greenspan doesn’t believe in NAIRU (or a natural rate of unemployment), that he doesn’t think we must have high interest rates in order to sell our bonds, and that he does think the increasing inequality of incomes is the most serious economic problem now facing the United States.

No doubt chagrined by my scooping them, the rest of the media have not noticed my reportage (though I have a videotape of Greenspan’s words). Neither were they moved to fully report Greenspan’s latest testimony, although in the course of it he had a wary yet respectful exchange with Congressman Jesse L. Jackson Jr. of Illinois.

Jackson questioned the wisdom of relying on the official unemployment figures, since they count as unemployed only people who looked for work last week. A better number, Jackson suggested, would include those too discouraged to continue looking for work, those too turned off ever to have looked for lawful work, those working part time when they would rather work full time, and those slogging away at jobs for which they are overqualified. If all these people were counted, Jackson said, unemployment would be nearer 20 million than the officially reported 6 million or 7 million.

1997-9-22 Jesse L. Jackson Jr..jpgGreenspan replied that he did not know enough about the people Jackson mentioned to use them as a basis for policy, but he acknowledged that they exist. His acknowledgment is my scoop for this week. For I submit that an economy incapable of providing proper jobs for 15 or 20 per cent of its work force is not an adequate economy. It may be “prosperous,” but it does not come close to doing what an economy ought to do. So we have a fourth crosscurrent to reckon with as we approach the waters whose charts are questionable.

PRESIDENT CLINTON and Speaker Gingrich and practically the entire economics profession, as I have said, are united in steering us toward a balanced budget on the theory that this will reward us with lower interest rates. A look at the records, however, reveals that in every one of the eight post-Depression years with a balanced Federal budget the prime interest rate (to which most rates we pay are related) went up, not down. We must conclude, therefore, that either our leaders or the records (or both) have lost their bearings. Clinton, for instance, claims credit for reducing the Federal deficit and says it has resulted in lower interest rates. Granted, recent budgets have boasted a reduced deficit. The Republicans, not surprisingly, insist they brought about the reductions, but that’s not what is plainly wrong with the President’s story.

What’s wrong is that although the deficit has gone down in all five years of his watch, the interest rate went up in three of them -1994, 1995 and 1997-and the prime rate is now two full points higher than it was when Clinton took office.

In other words, five years of reinventing government-of “it’s the economy, stupid”; of the end of welfare as we know it; of the end of the era of big government-have brought forth, not a decrease, but an increase of 32 per cent in the prime interest rate. The emperor, his advisers and his loyal opposition may have plenty of new clothes; they just have them on inside out and backward. There is no empirical evidence whatever that a falling deficit causes or inspires or favors or even accompanies lower interest rates.

Nor is there evidence for a contrary causation: A high deficit has not automatically produced high interest rates. Consider the famous years 1981 through 1986, when Ronald Reagan was President and Paul A. Volcker was the Federal Reserve Board Chairman. The prime interest rate fell from 21.5 per cent to 7.5 per cent. Was this the result of a falling budget deficit? Hardly. The deficit more than tripled in those years, and the interest rate went down at an equally record breaking pace.

Conventional economics, incidentally, teaches that high deficits cause high inflation, and that high interest rates cure inflation. Consequently, true believers should expect that inflation soared in the Reagan- Volcker years. Again the records belie conventional expectations. In 1981 the annual change in the Consumer Price Index was 10.3 per cent. In 1986 it was only 1.9 per cent.

In short, the economic waters we are now entering are charted to correlate high deficits with high interest rates and low inflation. A realistic mapping, though, shows that low or nonexistent deficits are not associated with falling interest rates, while high interest rates are commonly associated with high inflation.

The discrepancies between the conventional view of the economy and its recent performance lead me to suggest the future may prove Proust was right in observing that our desires may be fulfilled on condition that they do not bring the happiness we expect of them. We may succeed in balancing the budget, but it is exceedingly unlikely that the interest rate will fall as far as our leaders and advisers expect. Even if the rate should drop a point or two, it is unlikely that business will correspondingly expand. If anything, a balanced budget will act as a constraint on business, in the same way that the drive for a balanced budget has constrained expenditures for maintaining our infrastructure, for improving the lot of the disadvantaged among us, and for nurturing progress in the arts and sciences.

Is there no limit to the deficit that we can sustain? Sure there is a limit. My father advised my wife and me always to stretch a little when buying a home for our family. That way we could, and did, steadily improve our standard of living. Naturally, we had to be able to pay the interest on our successive mortgages. It is the same with a capitalist nation. Capitalism is based on borrowing as much as it can from the future in order to build for the future.

A zero deficit is a confession of a failure of faith in the future, especially when 20 million citizens lack proper jobs.

The New Leader

[1] As it happened, over the four years following the publishing of this article the Clinton Administration balanced the Federal Budget four years running: http://www.factcheck.org/2008/02/the-budget-and-deficit-under-clinton/

By George P. Brockway, originally published November 4, 1996

1996-11-4 Deceptively Simple Economics Title

I WANT TO tell you about a new book you probably will not quickly hear about elsewhere. It is not the sort of book most newspapers or magazines notice, because it is a serious work on economics and full of unfamiliar ideas. Nor is it the sort of book professional economics journals review, because it is not narrowly technical and the author is not a professional economist.

The title is Leakage: The Bleeding of the American Economy (368 pp., $39.95). The author is Treval C. Powers. The publisher is Benchmark Press.

Leakage is an extraordinary achievement- a careful, probing, empirical analysis of the American macro-economy and, a fortiori, any free-market economy in the modem world. It is relevant for economic theory and turns a strong light on many dark and murky notions that are today taught in the colleges. It is also relevant for policy and hence for politics.

Powers’ argument is deceptively obvious. What he calls the Composite Producer, or the producing economy considered as a whole, pays people money for the use of their labor and their capital and their land to produce goods and services; there is, ultimately, no other source for money income. The Composite Consumer, or all the people considered as a whole, uses the money (wages, rent, interest, profit) to buy what has been produced; there is no other way the economy can recoup the costs of the goods and services that have been produced.

So far, one might think this is merely another form of Say’s law that production creates its own demand, or of its contemporary version, the supply-side delusion. But the conclusions of Say and Powers are almost diametrically contrary to each other. Say wrote: “It is the aim of good government to stimulate production and of bad government to encourage consumption.” In contrast, Powers writes: “Receipt of income from the nation [i.e., the producing economy] entails a responsibility for the spending of that income. Failure to spend income for goods and services must be seen as a transgression against the weakest and most vulnerable families of the nation.”

Powers notes that the Composite Consumer doesn’t spend all of its income, with the result that the Producer increases prices and reduces expenditures for labor and capital use. Production necessarily drops below the optimum. A freefall, however, does not ensue, because the Composite Producer is continually introducing efficiencies in production processes and creating new products.

Studying a run of the Statistical Abstract of the United States, Powers finds that in the American economy, in good years and bad, the annual cost of producing and maintaining capital goods and services is a quasi-constant, never varying much from 20 per cent of the total cost of production. This quasi-constant and several others, Powers observes, will require further analysis (one of Leakages virtues is that it opens avenues for further research), for substantial reform of the economy is likely to depend on their interrelationships and on the internal organization of at least some of them.

Given present circumstances, it seems evident that aggregate investment will not be increased without increasing aggregate consumption. Thus, the supply side cry of both classical and neo classical economics; that we must curtail consumption in order to save, and that we must save in order to invest, is hopelessly wrongheaded.

Flying in the face of ascetic moralizers since the beginning of time, Powers shows that saving, or non-consuming, not only fails to boost production but actually lessens it. He writes, “When the demand for consumer goods and services is reduced, so also is the demand for capital expenditures. They are not independent variables.”

Saving-both personal saving and undistributed corporate profits-is the main example of what Powers calls “alpha leakage.” A certain amount of alpha leakage, mainly cash balances for routine transactions or as bank reserves, is unavoidable and fairly constant. Ordinary savings by some people for retirement, education and emergencies do not upset the economy, because they are roughly balanced by other people spending previous savings for the same purposes.

The rest is a consequence of maldistribution of income, whereby some people receive more money as wages or capital income from the production of goods and services than they know how to spend on them. So long as domestic (not foreign) goods and services are involved, sumptuous or extravagant expenditures are not economic leakage, but of course they may be deplored on other grounds.

In this connection, Powers makes another observation that flies in the face of conventional wisdom: Because government does not save, but spends its entire income on goods and services, taxation “cannot be a source of leakage and reduction of output.” Aggregate demand (and hence production) is increased by taxation of income that would otherwise have leaked from the economy, whereas taxation of personal or corporate income that would have been spent on goods and services has no effect on aggregate demand, though it certainly affects individual demand.

There is another type of leakage-Powers calls it “rho leakage”-that consists of money lost or denied the economy by constrictive policies of the banking system (in recent decades the Federal Reserve’s misconceived specialty), by bank failures and business bankruptcies, and by stock market crashes. (I’d add bull markets as well as bear markets; see Taking Stock of the Stock Markets,”NL, July 11, 1988.) Rho leakage is much more volatile than alpha leakage.

ANALYZING published government statistics, Powers is able to estimate what the American rate of growth might have been if there had been no leakage, what it actually was at any point since 1900, and over five year periods dating back to the end of the Civil War. You will note that Powers is concerned with the rate of growth, as befits a dynamic economy, whereas conventional economics is generally satisfied with statistics of absolute growth. Because the rate of growth is at issue, Powers gives us a whiff of elementary calculus. At this point some may want to follow the advice of the famous footnote in The General Theory where Keynes writes, “Those who (rightly) dislike algebra [and calculus] will lose little by omitting [this] section of this chapter.” In any event, Powers performs the necessary operations for us and gives the results in 48 useful tables and 32 clear, elegant graphs available nowhere else and alone worth more than the cost of the book. In this space it is possible to suggest only a few of his conclusions:

  • “Virtually every transient feature of economic behavior is a consequence of decisions and actions of persons in control of public economic policy.”
  • “Irregularities of performance are related to maldistribution of income.”
  • “Because they believe that the progress of the GNP over a period of several years reveals the growth capacity of the nation, economists generally underestimate the actual capacity.”
  • “Monetary restraint had no remedial effect on inflation; on the contrary, it always raised the price level.”
  • “Growth never required a relative increase of investment.”
  • “There is no connection between employment and monetary stability”
  • Deficit spending without appropriate taxation is “a way of transferring income from the general population to the wealthiest minority of it.”

The book’s final chapter is an analysis of inflation similar to that of the late Sidney Weintraub, a frequent contributor to these pages. Despite intense union activity during most of this century, the wage share of business income has not substantially changed. The reason is that struck corporations seldom give raises unless they can also raise prices. It is noticeable that the general price level increases most in years of heavy strike activity. Powers’ solution, that strikes be forbidden except for a share of dividends, is probably unconstitutional.

I must confess that Leakage has a special fascination for me because its author took up economics after retiring from an internationally recognized career as a research chemist, while I took up economics as I approached retirement from a background in literature and philosophy and a career as an executive of a small independent corporation largely concerned with the liberal arts. Despite our widely disparate backgrounds and habits of thought, we reached essentially identical positions on point after point. That these positions are, more often than not, identical to those previously taken by Keynes (whose background and habits of thought were certainly different from either of ours) is, at least for me, an additional reason for taking this original book very seriously indeed.

Leakage will prove valuable to anyone actively concerned with economics, politics or recent American history. Highly recommended, as you may have gathered.

The New Leader

By George P. Brockway, originally published July 17, 1995

1995-7-17 What Greenspan Really Told Congress titleTODAY’S LESSON will be in two parts. The first will be an exhibition of a complaint; the second an exhibition of a gleam of hope for better times in this nation and this world and even this dismal science.

The complaint concerns the press, particularly the business press, which is so busy collecting meaningless quotes from pseudo-prominent bankers and brokers that it fails to notice the story it is presumably covering. For example, on July 19 Chairman Alan Greenspan of the Federal Reserve Board, who is as entitled as his predecessor to be called “the second most powerful man in America,” appeared before a subcommittee of the House of Representatives in accordance with the provisions of the Full Employment Act of 1978, otherwise known as Humphrey-Hawkins.

Now, Humphrey-Hawkins has not had a good press. In his excellently useful Presidential Economics, Herbert Stein says that its “goals are so unrealistic and inconsistent that they are not taken seriously by anyone.” Still, it is the law of the land, so Greenspan duly appeared on the Hill, surrounded by advisers and armed with a prepared statement plus supporting documents. At least some of the Washington press corps came to pick up the handouts and perhaps lend an ear to part of the subsequent testimony. It was a routine assignment.

The shape of a Greenspan news story is now well established. The question always is, will-he-won’t-he raise (or lower) the interest rate? The Chairman always answers it, to the delight of his audience, in his personal version of Casey-Stengelese. Thereupon the reporter interviews a clutch of brokers’ economists for their differing interpretations of what he said, and offers the thoughts of a smaller clutch of Congress people or government officials.1995-7-17 What Greenspan Really Told Congress Joseph Kennedy

And so it was with the New York Times account of the latest Humphrey-Hawkins affair. Three brokers’ economists were interviewed – one from Minneapolis (thus showing that the Times is a national newspaper), one from New York, and Allen Sinai. Sinai is from New York, too, but he is quoted in almost every story and I assume must be considered universal. Of the Congress people, the Times made do with a mildly querulous comment by subcommittee member Joseph Kennedy II (D.-Mass.) and a reverential tribute to the Reserve and its leader

By House Banking Committee Chairman Jim Leach (R.-Iowa). All in all, the 28-inch Times story (counting picture and headlines) did not do much more than, as the saying goes, keep the advertising columns separated (a problem we rarely have at THE NEW LEADER).

As it happened, however, Chairman Greenspan interspersed among his answers to questions from the Congressional panel several profound, profoundly astonishing and profoundly hopeful observations. The Times missed them all, and so did the Wall Street Journal. That’s the complaint I promised.

But fortunately for you and posterity, I was channel-surfing[1] the next day and came upon CNBC, which was using clips of the Humphrey-Hawkins hearings to keep sections of its Money Wheel separated. The first clip I heard stopped me short.

“I don’t believe,” Greenspan was saying, “that any particular unemployment rate – that 5 per cent or 5.5 per cent or whatever numbers we’re dealing with is something desirable in and of itself. I don’t believe that.”

Well, you may be sure that I stopped surfing and anchored myself to CNBC. At considerable trouble and expense I also now have the whole thing on videotape. If you want a good journeyman definition of the barbarous notion of a natural rate of unemployment, you can do worse than settle on “a particular unemployment rate that is something desirable in and of itself.” In his December 29, 1967 speech that named the cruel notion, Milton Friedman put it as follows: “At any moment of time, there is some level of unemployment which has the property that it is consistent with equilibrium in the structure of real wage rates.”

During the 28 years since Friedman made his speech, one or another of several theories of a natural rate of unemployment has swept through the economics profession. Some of the theories depend on productivity rankings; some on a distinction between nominal wages and real wages; some on both; some on neither. But all agree that the rate of unemployment is so linked to the price level that as one goes up, the other goes down. The linkage is not explained; it goes without saying. Everyone presumes that a fall in unemployment will “force” the Federal Reserve Board to damp the “inevitable” inflation by raising the interest rate. In fact, this presumption explains most of the gyrations of the interest rate during Greenspan’s tenure. (For a detailed refutation of the linkage, see the September issue of the Journal of Economic Issues self-advt.)

Now we have heard Chairman Greenspan repudiate the natural rate nonsense. If the second most powerful man in America can do that, there is hope for the rest of us.

From December 29, 1967, to date, economic thought in the United States has been stopped dead because the fundamental economic problem was solved. To be sure, it was solved the way Ko-ko explained the solution of his problem to the Mikado: “Your Majesty says, ‘Kill a gentleman,’ and a gentleman is told off to be killed. Consequently that gentleman is as good as dead-practically, he is dead and if he is dead, why not say so?”

In the same way, Paul Krugman, self-proclaimed spokesman for mainstream economics, writes: “Most of the 5 million or so unemployed are either unskilled or part of the inevitable ‘frictional’ unemployment.” In other words, there are no employable unemployed; hence there is no unemployment problem. Furthermore, says Krugman, “adding 2 million jobs, if we could do it, would drive the U.S. unemployment rate down to about 3 per cent. But that isn’t possible, or at any rate not for very long. At that low unemployment rate, inflation would begin to accelerate rapidly.”

Having grossly underestimated the number of unemployed and having arrogantly dismissed as useless their fellow human beings who make up that number, mainstream economists have embraced the theory of the natural rate of unemployment and simply declared joblessness a non-problem. This has left them free to spend the past quarter century pondering such weighty concerns as “Games with Incomplete Information” (the lead article in the current American Economic Review). Perhaps Greenspan can guide us to a fairer land.

INDEED, the Chairman took another step in that direction as the Humphrey-Hawkins hearings wore on. He was asked if it would be possible to lower interest rates and still have our bonds attractive to German and Japanese investors. Greenspan’s reply was short and to the point: “I’m not aware that we have had very many difficulties selling the debt – the Federal debt – at low interest rates.”

It was very brave of Greenspan to make that statement. Not only does it give the lie to his six-foot- four predecessor – who claimed the budget deficit forced high interest rates that crowded entrepreneurs out of the credit market – it undercuts his own words regarding the deficit. He is for balancing the budget (but no constitutional amendment) because, he said, “there is no doubt, in my judgment, that the net result of moving to budget balance will be a more efficient and more productive U.S. economy.” In forming that judgment he can scarcely have considered what is going on in Washington today or what will happen throughout the nation thanks to these “revolutionary” goings-on.

Nor can he have considered his own power over the deficit. The interest bill on the national debt is at present roughly equal to the budget deficit. A fraction of the debt is rolled over every year. If the new loans were issued in accordance with the “patterns of rates” followed by the Reserve and Treasury during World War II, the reduction in the interest bill alone would practically eliminate the deficit by the mystic year 2002 -and not a single welfare family would have to camp on the public sidewalk while the mother begged for a nonexistent job.

I don’t suppose you are willing to bet anything like that will happen. (It would be a good “derivative” to have the other side of.) You’re right, but it is not some esoteric economic law or some superhuman market that will prevent the happening. The reason, rather, is that we the people of the United States of America care more about money, and individuals with money, than we do about our fellow citizens and ourselves.  We should at least recognize that we are in the deficit mess (if it is a mess) not because too few people are unemployed, but because for the past 40-odd years relatively high interest rates have transferred money from the many who do the work of the world (including the government) to a comparatively few bankers,  rentiers and speculators.

The transfer has not escaped Greenspan’s attention. In response to a question from Congressman Kennedy he said, “Evidence suggests in recent years that income is being dispersed rather than concentrated [that is, the rich are becoming richer, the poor poorer, etc.]. … There has been a regrettable dispersion of incomes that goes back to the later ‘60s…. What’s the major threat to our society? I’d list this as a crucial issue. If it divides the society, I do not think that is good for any democracy of which I am aware.”

Unfortunately, Greenspan did not see that there was anything the Federal Reserve Board could do to change the situation. He did not mention anything anyone else could do either, beyond the new obligatory red herring of higher education for competing in the coming world economy.

Nevertheless Greenspan had a vital three-part message: First and most important, there is no such thing as a natural rate of unemployment, therefore there is work aplenty for economists eager to grapple with real problems of the real world. Second, Federal Reserve policies based on the alleged crowding-out concept can now be forgotten. Third, we should embrace policies that unite us, because policies that divide us may well prove ruinous.

Greenspan’s message permits the gleam I mentioned at the beginning. Put into practice, it would make a better nation, a better world and a better economics. It’s a pity the Times, the Wall Street Journal and the rest missed it.

The New Leader

[1] Ed. – many who knew the author well are reeling, shocked, that he knew how to spell “channel-surfing” much less had a concept of what it was… God forbid he did it!  Oh!  How delicate the façade!

By George P. Brockway, originally published May 9, 1994

1994-5-9 Unemployment Japanese Style Title

1994-5-9 Unemployment Japanese Style Reuters

I REPRODUCE above in its entirety a news article that appeared on page D4 of the Business Day section of the New York Times for Friday, April 29, 1994. Don’t feel badly if you can’t recall seeing the story in tile paper. It was easy to miss. It ran in the gutter at the very foot of the page and was surrounded at its top and left by an article from a stringer headlined “Denver Airport Date Firm” (on Sunday the date turned out for the nth time not to be firm). If you were the editor of what you proudly and properly referred to as a newspaper of record, and you had a story you wanted to kill yet had to print in order to complete the record, you would handle it in just this way.

I leave to others the task of speculating why the Japanese unemployment story was in fact buried; why, given its explosively dramatic contrast with American and European unemployment records, it was not run as the lead on the first page of the Business Day section, if not on the front page of the entire paper; why the bare numbers were not accompanied by a backgrounder explaining how the Japanese manage such a low unemployment rate even in the midst of a recession; why nothing about the story has appeared among the concerns of the editorial page or the Op- Ed page; why the Times economics columnists have found nothing to remark on in a report that renders suspect the barbaric but fashionable theory of a natural rate of  unemployment, a smattering of whose arcane details they dazzle us with now and then.

Although I will not speculate, I am interested in that last point. For as I have said often enough, I follow Keynes (and indeed everyone at all capable of empathy with a fellow human being) in holding that an outstanding fault of the economic society in which we live is its failure to provide full employment. The theory of a natural rate of unemployment, subscribed to by almost every conventional economist in the United States, argues that this outstanding fault cannot be corrected without igniting an inflation that would destroy the economy.

The news from Tokyo tells us that the current unemployment rate in Japan, while the highest in six years, is nevertheless lower than the lowest unemployment rate the United States has posted since World War II. I do not have at hand Japanese figures earlier than 1967, but after that date Japan’s unemployment has never been higher than 2.9 per cent and U.S. unemployment has never been lower than 3.4 per cent. The American low was registered during the Vietnam War. Our present rate (achieved during a sluggish peacetime recovery that has scared the Federal Reserve Board silly with nightmares of future inflation) is almost three times the present Japanese rate (achieved during a persistent recession).

These facts strongly suggest that the so-called natural rate need not be accepted as immutable. What the Japanese have done is surely within our capabilities; and given the freedom, not to say volatility, of American life, a 2.6 percent rate would be as near full employment as never was.

The natural rate theory has from the beginning allowed that the rate is not really natural but depends on “market characteristics” that are, as Milton Friedman has said, “man-made and policy-made.” What man and policy make they presumably can unmake. The chief market characteristic complained of by natural rate theorists is a minimum wage law. Emboldened by my recent adventure in investigative reporting (see “Ending Welfare As We Know It,” NL, March 14-28), I phoned six Japanese agencies (four of them official) and one American labor union to find out whether Japan has a minimum wage law. No one knew offhand, but the consulate called me back a couple of hours later to report that indeed Japan has such a law. It is a national law, and it specifies minimum wages for different trades and different localities. I doubt that natural rate theorists, who are firm believers in market discipline, would think it an improvement on the American law.

Let us therefore consider the reaction of conventional theory to a 2.6 per cent unemployment rate. Without doubt the prescription would be for a high-very high-interest rate to contain inflation. Has that been prescribed in Japan? Indeed it has not, nor has such a regimen been followed. Rather the contrary, the interest earned by a 1O-year government bond in Japan is now 4 per cent; with us, the corresponding rate is, as I write, 7.10 per cent and will go higher before you read this, if the present majority of the Federal Reserve’s Open Market Committee has its way.

Well, then, since Japan has comparatively low unemployment and comparatively low interest, it must, according to conventional theory, have comparatively high inflation. But Japan’s price index changed 0.0 per cent in April and, at least from 1967, has never climbed as fast as ours.

IT IS OF COURSE possible that other elements contribute to the differences between Japan and the United States. I can name three that may: import policy, productivity and saving.

We all know about Japanese import policy. It is difficult, devious, protectionist, and successful. Twelve years ago I wrote the first of several columns arguing for a protectionist policy for the United States (“America’s Setting Sun,” NL, June 14, 1982). I don’t propose to repeat myself now, except to remark that Japanese protectionism has obviously not prevented the success of Japanese policies directed toward low unemployment, and may well have been a factor in their success.

Productivity is another question I have addressed several times (first in “Productivity: The New Shell Game,” NL, February 8, 1982). In the present context all that need be said is that American productivity is now, and as far as I have been able to discover has always been, greater than Japanese. In fact, among the leading industrial nations, only British productivity has generally been outranked by the Japanese.

On the other hand, Japan’s GNP has, until the last couple of years, grown faster than ours.  Conventional economic theory, though, is possessed of the altogether unintelligible notion that productivity is more desirable than production. It may work out that way in a mathematical model, but it certainly doesn’t on the dinner table[1].

I have also written about saving and shall do so again, but the problem with respect to Japan is special. In the first place, a 1990 study by Fred Block in the Journal of Post Keynesian Economics demonstrated that the figures usually published overstate Japanese saving and understate American. In the second place, as Block showed, an extraordinary amount of Japanese saving, however defined, goes into speculation rather than production. The real estate (land and improvements) of Japan, a nation whose area is no greater than that of Montana, is, at today’s prices, more valuable than the real estate of our 48 contiguous states (a not inconsiderable amount of which is owned by Japanese). The Japanese stock exchange is notoriously volatile, with daily spikes (or spike holes) of 5 per cent or more not uncommon. Keynes thought Americans were addicted to gambling, but the Japanese seem to have it worse.

1994-5-9 Unemployment Japanese Style Unemployment Office

All of their speculation absorbs enormous amounts of money, but it does nothing for the economy. The money is saved in the sense that although it was earned in the producing economy, it is withheld from use in the producing economy. The withholding is achieved by underpaying large classes of workers, especially women, and by underfunding social services. Because of its hierarchical distribution of wealth and its systematic maldistribution of income, Japan cannot consume all it produces and must sell overseas; thus when foreign markets falter, Japan suffers recession.

In short, neither Japanese import policy, nor Japanese productivity, nor Japanese saving can account for Japan’s low unemployment coupled with low inflation. So is there nothing we can learn from the Japanese record? There are, I think, a couple of things. In the circumstances, the actual virtues (as opposed to the theoretical vices) of some sort of protectionism are very hard to deny, as are the virtues of a steadily low interest rate.

Regarding the latter point, we are told that we cannot afford a low rate because it would stimulate a flight of capital to the Bahamas or the Caymans or perhaps some more exotic land farther overseas. I don’t know about that. Even in the early ’80s, when the prime rate here hit 21.5 per cent, and the Japanese rate was as low as it is now, only a small proportion of the yen flew here. Why did most of it stay home? For the good and simple reason (as Tom Swift used to say) that with a low interest rate Japanese industry could be happily profitable, while the “strong” American dollar caused by high American interest made it easy to penetrate our unprotected market.

A high interest rate (and our recent supposedly low rate was exceedingly high by Japanese standards, as well as by our own pre-1960 standards) is a market characteristic that makes for a high “natural” rate of unemployment. A low rate, contrariwise. The news was barely fit to print. Still, we’d be wise to pay attention to it.

The New Leader

[1] Ed.:  I can’t help but wonder what the author would have thought of Clayton Christensen’s concerns with corporate focus on margins instead of profits as in the Innovator’s Dilemma, and his more recent thoughts on The Capitalist’s Dilemma.

By George P. Brockway, originally published June 29, 1992

1992-6-29 The Last Chapter on Keynes Title

ONE OF THE saddest pieces in modern literature is the last chapter of John Maynard KeynesThe General Theory of Employment, Interest and Money. It was not meant to be sad. It was written in exultation by a man of 52 at the height of his powers. He had been editor of the Economic Journal, the most prestigious publication in his field, for 25 years. He was the author of several influential political pamphlets and four major books, one of them an international best-seller, another a ground-breaking two-volume Treatise on Money. He was active and known and listened to in Cambridge, Manchester, Whitehall, and the City of London.

As he wrote the final chapter, he could look back with satisfaction on five years of hard work on a book he was frank to say he expected would change the world. The people with whom he had discussed his ideas and to whom he had submitted proofs of the work in progress encouraged him in that expectation, though he scarcely needed encouragement. He was self-confident to the brink of arrogance. At the same time, he had a saving wit (those who felt its occasional sting were not so sure it was “saving”) that was often turned toward himself. How else can we interpret the title he gave his great book? The General Theory, indeed! Did he rank himself with Einstein? Of course he did. Did he find it amusing that he should be so pushy? Yes, that too.

The heart of the whole work is in the last chapter’s first sentence: “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.” I can only think that most economists reading that sentence have shrugged as they shrug when, let us say, a politician makes obligatory declarations in favor of school and family – two institutions everyone believes in and no one proposes to do anything substantial about. Then they probably have skimmed lightly to the famous peroration concerning “ideas, not vested interests, which are dangerous for good or evil,” and have returned contentedly to the construction and deconstruction of their mathematical models.

Keynes, however, intended his ideas to be “dangerous for good.” The economy’s faults were dangerous for evil” – not inconvenience, but evil. The economy would not work properly unless they were corrected. Every aspect of The General Theory depended upon and was directed toward that correction. Few noticed.

At a crucial point in Chapter 6 Keynes shows the fallacy of the classical theory that saving drives the economy. He writes: “Saving, in fact, is a mere residual.” At the end of the chapter he announces that” the conception of the propensity to consume will, in what follows, take the place of the propensity or disposition to save.”

Okay, say mathematically trained economists, wherever S appears in our equations we’ll substitute C. But they pay no attention to the distribution of incomes. Indeed, their procedure is one of deduction from axioms, with all reference to actual situations rigorously excluded. The result is confusion.

In the modern economy of mass production, while it may not make much difference who does the saving, it makes all the difference in the world who does the consuming. Affairs might be so badly skewed that only one person did all the saving, and the system could creak along reasonably well. But the system would not work if one person did all the consuming (a manifest absurdity); and it will not work very well when 20 percent of the people do a mere 4.3 percent of the consuming (which is the way we try to run things in the United States today [in 1992]).

In a mass-production economy, consumption is a chore that cannot be delegated. A feudal economy can do everything it has to do when one-tenth of 1 per cent of the people dine on pate of reindeer tongue, and 99.9 per cent get along on carrot soup. A modern economy falters whenever a sizable percentage of the population is denied its output. If the output isn’t fully consumed, there is no point in producing so much; and if there is no point in producing so much, there is no point in employing so many people, whereupon things start to unravel – rather, many things are not knitted up in the first place.

In talking about “arbitrary and inequitable distribution of wealth and incomes,” Keynes wasn’t ritualistically endorsing motherhood; he was pointing to the heart of the problem. This was so obvious that he didn’t think it needed much emphasis. The solutions, too, were obvious, and a few of them had been in partial use: nearly confiscatory death duties, steeply progressive income taxes, possibly a cap on incomes. What would be necessary at a particular stage in a particular society might not be appropriate in another, One wouldn’t know until one tried. It is also very likely, as he wrote in a previous chapter, that “the duty of ordering the current volume of investment [to achieve full employment] cannot safely be left in private hands.” Again, one could not say in advance exactly how this should be organized.

Keynes taught himself probability theory, and wrote a fat book about it, to satisfy himself that, as regards the future, “We simply do not know.” Unfortunately, some of his most skeptical critics and some of his most enthusiastic supporters undertook to supply the unavailable knowledge. The result was what several generations of bemused undergraduates have learned to call the IS-LM curve, which is supposed to show “the simultaneous determination of equilibrium values of the interest rate and the level of national income as a result of conditions in the goods and money markets.” That’s what The MIT Dictionary of Modern Economics says; don’t look at me[1].

And don’t let it fret you. It’s all a game of let’s-pretend. But it distracted the economics profession from Keynes’ message and sent the majority off on a treasure hunt for equilibria to make graphs and journal articles of. (Physics, the source of the idea, equates equilibrium with entropy, or the end of change, a.k.a. death. But let that pass.)

KEYNES, TO BE sure, was not above trying to peer into the future himself. The peroration of The General Theory may even be taken as an example. I want to shift here, though to an essay he wrote six years earlier. It is called “Economic Possibilities for Our Grandchildren.” He advanced two propositions: First, the “economic problem” would be solved in about a hundred years, provided there were no major wars and the population did not expand too much. Second, the process would depend on the steady accumulation of capital, and that would come about by means of incentives then in force. “For at least another hundred years,” he wrote, “we must pretend to ourselves and to everyone that fair is foul and foul is fair; for foul is useful and fair is not. Avarice and usury and precaution must be our gods for a little while longer still. For only they can lead us out of the tunnel of economic necessity into daylight.”

The man who said, “In the long run we are all dead,” should have known that things seldom if ever work out as envisioned. Only 62 of his prophecy’s 100 years have run [in 1992.  84 years as of the day this is put on-line], and we certainly have not avoided major wars or population explosions. Nor have we seen recent signs of the sort of capital accumulation that Keynes expected to lead us into daylight. As for the interest rate, which he expected to trend steadily downward and effect “the euthanasia of the functionless investor,” it is (even at today’s supposedly low rates) higher than it ever was in his lifetime.

Two contemporaries, Bernard Shaw (whom he admired) and Lenin (whom he did not), had visions similar in form to his. In the Preface to Major Barbara, Shaw wrote “that the greatest of our evils, and the worst of our crimes is poverty, and that our first duty, to which every other consideration should be sacrificed, is not to be poor.” In the play proper, Cusins asks: “Excuse me: is there any place in your religion for honor, justice, truth, love, mercy, and so forth?” Undershaft replies: “Yes: they are the graces and luxuries of a rich, strong, and safe life.”

Lenin, foreseeing the establishment of the Communist state, wrote in The State and Revolution: “Capitalist culture has created large-scale production, factories, railways, the postal service, telephones, etc., and on this basis the great majority of the functions of the old ‘state power’ have become so simplified and can be reduced to such exceedingly simple operations of registration, filing, and checking that they can be quite easily performed by every literate person.”

These three visions all rely on a situation or change of one sort to effect a change of another. In each case, foul or death-dealing or self-serving motives are supposed to be led, one might almost say by an invisible hand, to lay the foundations of the good life. Assume the foundations at last to be laid. Why should the original motives cease to be effective? Why should men and women who have succeeded with “avarice, usury, and precaution” now abdicate? Undershaft obviously enjoys his religion of being a millionaire and his control of money and gunpowder. Why give it all up for “graces and luxuries” he already has? Even in the Lenin example, where the same people may be involved first and last, one wonders why self-serving bureaucrats become dedicated and efficient public servants (for surely that was Lenin’s expectation – and we have lived to see it disappointed).

More important, how can you and I and Keynes himself – understanding the difference – renounce the fair and embrace the foul? What an obscene pretense is asked of us!

Well, “Economic Possibilities for Our Grandchildren” is perhaps a playful aberration in Keynes. His steady theme elsewhere is that economics is one of the “moral sciences” (a phrase he no doubt learned from his Comtian father). His formal ethics was heavily influenced by the hedonism of G. E. Moore and thus was a far cry from that of, say, the American National Conference of Bishops – as both his and theirs are from mine. Yet he and I could have agreed with the bishops when they wrote, “Every economic decision and institution must be judged in the light of whether it protects or undermines the dignity of the human person.” (See ” Bishops Move Diagonally,” NL, March 23, 1987.)

Keynes’ initial disagreement with classical economics was that it denied the existence and even the possibility of involuntary unemployment. Today the economics profession either accepts a “natural” rate of unemployment, which may be as high as 6 or 7 per cent, or rejects the relevance of ethics altogether. The high road surveyed in The General Theory, and described in its last chapter, was not taken.

It might have been[2].

The New Leader

[1] The author also refers here to a college prank of his.  In his senior year he had a course taught by a professor with a never admitted to or publicly used nickname, “Birdy,” and whose ideas were generally thought little of.  On a final exam the author says he wrote a complete and accurate response as the professor would have wanted, no arguing with the professor, but his last sentence, which resulted in a trip to the dean, was “That’s what Birdie says; don’t look at me!”

[2] It might still be

By George P. Brockway, originally published April 6, 1992

1992-4-6 Where Schumpeter Went Astray Title

 

 

 

 

 

 

 

 

 

 

 

I N PREPARATION for my previous column I reread the passages I had underlined long ago in Joseph A. Schumpeter‘s Capitalism, Socialism and Democracy, a book whose first edition was published in 1942. The second edition appeared five years later, and the third in 1950. My copy is from the 22nd printing of the paperback edition. All that adds up to sales in six figures.

It is a curious book. Its display of scholarshiplis casual and impressive. It contains less economics than history and what the Europeans call sociology (a more humane discipline than ours). Its style is informal, worldly-wise, and generally good natured, though a bitterness lurks behind several references to John Maynard Keynes and comes forward harshly in criticism of Schumpeter’s Harvard colleague, Alvin H. Hansen, who is often meant but never named. (Hansen was a leading expositor of Keynes in America, and many now say he got it all wrong, but his possible mistakes about Keynes are not what bother Schumpeter.)

I don’t propose to review either the work or the author’s academic in-fighting. The book does, however, advance three propositions on which I would like to hang a tale or two. Number one comes at the opening of Part II: “Can capitalism survive? No, I do not think it can.” Number two is at the opening of Part III: “Can socialism work? Of course it can.” These propositions don’t look particularly plausible today, and they are not helped by Schumpeter’s reiterated disclaimer that he is not talking about the then-immediate future, but about a 50-year trend that has now run. The third Schumpeter proposition is never explicitly stated but is a two-part assumption, or definition, that underlies his whole argument. The first part of the assumption is that economics, and capitalism in particular, is about the production of physical things. The second part is that physical things are produced most abundantly when entrepreneurs are allowed or encouraged to compensate themselves at the rates roughly prevailing before the First World War. Taking account also of Schumpeter’s notions about the family, it might not be too extreme to say that the world he celebrates, and whose passing he foresees, is the world of Thomas Mann‘s Buddenbrooks.

That world has indeed passed; yet capitalism is today the survivor in its struggle with socialism. It has not, to be sure, survived unchanged. It used to be said that America’s Norman Thomas brand of socialism never came close to succeeding at the polls because the Democrats, and sometimes the Republicans, stole its best ideas. (Thomas himself once told me he thought many thousands of his votes simply weren’t counted.) But that’s not what I have in mind.

I refer instead to a change in the meaning of private property, surely a central concept in capitalism and in economics generally. In the United States the change as a matter of law was accomplished when the minority in an 1872 Supreme Court case became the majority in another case some 18 years later, or just over a century ago.

The first instance was the Slaughter House Cases, in which the minority argued that the State of Louisiana had deprived New Orleans butchers of their property without due process of law by requiring them to use a subsidized slaughter house at high fixed fees. The majority upheld the state, relying on the common-law definition of property as physical things held exclusively for one’s own use. Since the butchers still had their shops and hooks and cleavers, they were not deprived of their property, even though the high fees made pursuit of their calling impracticable. The minority contended that property necessarily included its exchange-value, or the right to use it for economic gain. Their definition of property began to appear in other state and Federal courts, and finally prevailed in the first Minnesota Rate Case of 1890.

The story is elegantly told in John R. CommonsThe Legal Foundations of Capitalism, a truly great book I’ve had occasion to mention several times in the past. As Commons points out, there is nothing in the common law or in the Constitution to support the new view. But Adam Smith could be cited on the primacy of labor and on the distinction between use-value and exchange-value; and The Wealth of Nations already had an odor of sanctity about it. More important, business practice was coming to depend almost exclusively on exchange-value. Property was no longer a datum – merely a thing. It became an idea – what you could do with it to make money.

This fundamental shift in the meaning of property was a historical turning in the development of modern capitalism – and Schumpeter missed it, or missed most of it. For when property became an idea production, too, became an idea. What distinguishes an idea is criticism. In fact, an idea demands criticism, for one idea thus leads to another. A mere thing, in contrast, is like Popeye: It is what it is. The point here is that a hundred years ago the meaning of property in the United States changed to embrace exchange-value, and that correspondingly not only the economic meaning of production changed but the function of entrepreneurship as well.

Schumpeter’s entrepreneur became obsolete, as he himself saw to some extent. “The entrepreneurial function,” he wrote, “does not essentially consist in inventing anything or otherwise creating the conditions which the enterprise exploits. It consists in getting things done.” Increasingly, Schumpeter continued, “Technological progress is … becoming the business of trained specialists who turn out what is needed and make it work in predictable ways …. Bureau and committee work tends to replace individual action.”

That is true enough. What Schumpeter does not see, however, is that a collegial enterprise can be a far more fulfilling place to work and a far more responsible producer for the common weal than anything built around his quasi-military entrepreneur. It ain’t necessarily so, but it can be so.

The second Schumpeter assumption concerns the distribution of wealth and income, or who gets what and why. The last chapter of his book is an address he delivered to the American Economic Association 10 days before his death on January 8, 1950. In it he said, “Capitalism does not merely mean that the housewife may influence production by her choice between peas and beans; or that the youngster may choose whether he wants to work in a factory or on a farm; or that plant managers have some voice in deciding what and how to produce: It means a scheme of values, an attitude toward life, a civilization – the civilization of inequality and of the family fortune.” Well, he doesn’t mince words, does he?

Three years earlier, in the second edition of his book, Schumpeter made a forecast of the likely state of the economy in 1950. As was only prudent, he protected his forecast with many provisos, the chief of which were that 1950 would be a peak year in the business cycle, and that New Deal (by then, Fair Deal) interference with business (especially price controls and labor legislation) could be curtailed. As it turned out, the second proviso was satisfied, but not the first; and he was right on the mark with one of his predictions, but far off the mark with two others.

The accurate forecast was more demographics than economics: He expected the 1950 labor force to be “something like 61 million,” and the currently accepted figure is 60.8 million. But concerning that force (and now we’re back in economics), he wrote, “I do not see that the number of statistically unemployed men and women can possibly be, in that year, below five or six million ….” Relying on similar statistics, we find the actual unemployment total to have been 3.3 million. Schumpeter went on to say, “On an average of good and bad years (statistical) unemployment should be higher than 5 or 6 million- 7 to 8 perhaps.” In fact, we didn’t hit 8 million until 30 years later, in 1981, when the labor force was over 110 million, though we grazed it in 1975, when the labor force was 95 million.

Schumpeter’s forecast of the GNP was way off in the other direction: $200 billion in 1928 dollars, as opposed to the actual $153 billion. One would, of course, expect lower unemployment to result in higher GNP, but we have a contrary picture. Can we account for the contrariness?

THE KEY IS the distribution of income. Schumpeter points out that, after a disgraceful period ending around the middle of the 19th century, the condition of the masses steadily improved. After all, capitalism is a mass-production system, while elite families’ consumption goods are custom made. “The capitalist achievement,” he writes, “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 problem, though, is that the proportionate shares of the national income remained essentially the same – as Schumpeter insisted they ought to.

Capitalist industry is far more productive and efficient than Schumpeter gave it credit for. Whether run by swashbuckling entrepreneurs or by committees of colorless technicians, industry can turn out the stuff. The question is, Who will buy?

Certainly his 7 or 8 million unemployed (then about a fifth of all wage earners) on the dole wouldn’t be much of a market. Nor would the next three quintiles, whose income would be low because (according to the theory) their contribution would be low. The contribution of the entrepreneurs would be very great, but their numbers would be very small and, besides, they would not be substantial consumers of mass-produced goods. That leaves those just below the elite-say about a fifth of the population-as the only full-scale market for all of industry.

When you take Schumpeter’s figures apart and scrutinize them, you can see why his projected GNP was so far off. The stuff wasn’t turned out because there weren’t enough buyers with enough money. The actual unemployment figures were much better than his estimates, but the distribution of income was not much better, and it is not much better today.

In the world of economic models, it doesn’t matter whether the supply side or the demand side stimulates the economy. But in the real world of existing industry capable of high production, effectual demand (Adam Smith’s phrase) is primary. Schumpeter’s vision of a prosperous world led by entrepreneurial families never came to pass, because too many had little or no share in the prosperity. There was no justice in the shares, and no good economics, either.

 The New Leader

By George P. Brockway, originally published January 13, 1992

1992-1-13 Mister Bush Meet Mister Hoover Title

 

 

 

 

 

 

 

 

 

 

Mister Herbert Hoover
Says that now’s the time to buy;
So let’s have another cup o’ coffee
And let’s have another piece o’pie

.

THE ABOVE text for today’s lesson was composed (words and music) by that universal philosopher of the American way of life, Irving Berlin. The song was the high point (or perhaps more accurately, the sardonic point) of Face the Music, a Broadway hit of 1932- just 15 presidential terms ago.

It all came back to me as I gazed in wonder at the TV coverage of President Bush‘s Thanksgiving demonstration of the propensity to consume, during which he showed how to buy four pair of sweat socks for $8.00.  I suppose the President’s handlers meant the sweat socks worn by some working stiffs inside metal-toed boots and by all preppies while jogging or playing racquet ball-to remind us that the President is a regular guy as well as a consumer doing his part to get the economy going again. But it reminded those who didn’t laugh at the spectacle that Mr. George Bush’s economic policies have a lot in common with Mr. Herbert Hoovers. That is to say, he has practically no policies at all.

Not only are President Hoover’s and President Bush’s policies similar, but so are their depressions (and ours). For what we are now mired in is something quite different from the half dozen or so recessions we have gone through since World War II.

Economists persist in calling our present experience a recession, and they are puzzled by its failure to perform like the others. Even the fact that business is bad puzzles them, because the “indicators” they take seriously have not been ominous. Their biggest worry has been that inventories might get out of hand. “The current downturn is expected to be short and shallow,” wrote the Council of Economic Advisers a year ago.

“Most firms have kept inventories low relative to sales, reducing the need for a sharp cut in production to work off excess inventories. Such inventory corrections accounted for much of the decline in output in earlier postwar recessions.”

The smallest mom-and-pop novelty store today boasts a computer at the cash register that scans bar codes, not simply to generate sales slips but also to indicate when and how much to reorder. At the other end of the spectrum, most manufacturers have long since learned how to order “just in time. Inventories have been lean and clean for several years now; yet the downturn came, and it refuses to go away.

S. Jay Levy and David A. Levy, respectively chairman and vice chairman of the Jerome Levy Economics Institute of Bard College, have a simple yet comprehensive explanation: This downturn is not a recession at all, it is a depression.  To be sure, it is a new sort of depression. They call it a “contained depression. Because Mr. Bush’s depression is “contained,” it is not likely to be so deep as Mr. Hoover’s, but it may well last as long, or even longer.

To the Levy’s, a depression is not, as it is in ordinary speech, merely a very severe recession. They agree with the majority of other economists that a recession is essentially an inventory glut, which comes about in a quasi-natural fashion in the modern economy. In the ancient and medieval worlds, most nonagricultural goods were made to order. If you wanted a pair of boots, you didn’t go to a store

And buy them off a shelf, the way Oliver North picked up revolutions. You went to a cordwainer, who would run up a pair to fit your last. In such a system there might be a glut of agricultural produce (though there seldom was), but manufactured goods were never oversupplied.

In addition, of course, few economies of scale were available; production was slow, expensive and weak. In the modern world, where most production is for sale, not for use, economies of scale are everywhere, and output is exponentially increased, as Adam Smith showed with the manufacture of pins.

But time is necessarily introduced between the start of production of goods for sale and the purchase and use of those goods by the eventual consumer. In that time, many things can go wrong (and some can go surprisingly well), because the future is unknowable.

Among the things that can go wrong is an inventory glut. This starts slowly, as optimistic producers expand output to take advantage of economies of scale. Stepped-up orders gradually push manufacturers to capacity, heighten competition for time on the machines, and result in ever larger orders (see “What Happened to Jimmy Carter,” NL, November 27, 1989, for the way  this “defensive buying” works). The increases in plant utilization naturally require increases in employment. Newly employed workers have new money to spend and encourage greater production.

At this point, manufacturers are likely to seize the opportunity to raise prices, thus depressing demand. Banks will see inflation and raise the interest rate, thus intensifying the inflation, further depressing demand, and perhaps throwing he cycle into reverse. Even without inflation an inventory glut will develop, for our irrational income distribution and usurious interest rates guarantee that workers cannot earn enough to buy what they produce.

Manufacturers participate in the buildup in self-defense as well as in search of profit. Those that don’t participate find themselves squeezed out by their more aggressive competitors. In any case, the buildup is necessarily blind and eventually overleaps itself, whereupon it recedes by stumbling down the up staircase.

According to the Levy’s, a depression, like a recession, is cyclical, and proceeds in a similar manner. It is a capital goods glut, however, rather than an inventory glut. Since capital goods typically are expensive and take a long time to produce, more money is tied up in them, and the tie up lasts longer. The Levy’s argue that what we have now is a depression. Factories, warehouses, office buildings, stores, motels, apartment buildings – all are overbuilt. The banks and insurance companies and pension funds that financed the construction are in trouble – unless they have already failed.

NOW, FASHIONABLE commentators say our problem is that we no longer compete successfully in the world market, partly because our interest rates are too high (they still are), and partly because, all of a sudden, our educational system has fallen apart. Michael Boskin, chairman of the President’s Council of Economic Advisers, testified the other day that we spend more on elementary and secondary education than any other industrialized country, except maybe Switzerland, and that our kids still perform toward the bottom. That sounds enough like the state of our medical services to be true; but if true, it is clear that we will not be able to correct the situation in the present century. In the unlikely case that Mr. Bush’s scheme of making schools compete for students were to be immediately successful, it would take 12 years for the full effects to be realized and then there would still be the problem of the colleges and graduate schools.

1992-1-13 Mister Bush Meet Mister Hoover Herbert Hoover

I’m not opposed to doing something about education (though I am opposed to Mr. Bush’s scheme), but it won’t make us internationally competitive overnight. As I have said before (“The Productivity Scam,” NL, May 28, 1984), I don’t take seriously the underlying notion of productivity. More to the point, the United States of America is not the only nation that is smothered in overcapacity. Every industrialized and partially industrialized country in the world is, too. Plants everywhere are standing idle because plants everywhere are capable of choking us to death with steel, automobiles, TVs, cameras, toaster ovens, and sweat socks. Indeed, they are already choking us with them.

This worldwide overcapacity means that there is no quick solution to our depression. Nevertheless, our depression will, as the Levy’s put it, be contained. In the United States, banks fail and will fail, but there will be no runs on them, as there were in the Great Depression, because the Federal Deposit Insurance Corporation exists. Businesses as remarkable as Pan Am will fail, but there will be no panic selling of assets, because big government will, budget agreement or no, prevent a free fall.

In Mr. Hoover’s day, the government accounted for less than 3 per cent of GNP; in Mr. Bush’s, it accounts for almost 25 per cent. Mr. Bush thinks his 25 per cent too much (as Mr. Hoover thought his 3 per cent), but it is our true safety net. With that high percentage of GNP assured, plus its multiplier effect on the rest of the economy, we will not drop to the lowest depths.

On the other hand, we may be truly depressed for years or decades to come. The glut of capital goods that caused the Great Depression was not absorbed until World War II. There is no reason to expect our present glut to be more tractable. The American oversupply is probably greater now than it was then, and the worldwide oversupply is certainly greater.

Yet I detect a glimmer of hope. Today the richest 1percent of American families have as much income as the poorest 40 per cent. That’s outrageous. But in 1929, on the eve of the Great Depression, the richest 0.1 per cent had as much as the bottom 41 percent. We are, in a manner of speaking, 10 times better off now. The way to put the oversupply of capital goods to use is to draw the bottom two-fifths of us into full participation in the economy. That will not be easy, especially since we have, for the past 15 years, been going hell-bent in the opposite direction. The tentative appeals to “fairness” that the Congressional Democrats made in the budget debate are only a faint promise of a beginning, as are some proposals now coming before the Joint Committee on Taxation. Yet all are opposed by Mr. Bush and his men.

In another column I’ll try to suggest some specific things to do about our predicament. In the meantime, be sure you have plenty of sweat socks.

 The New Leader

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