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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 March 3, 1999

3-8-99-the-love-song-of-homo-economicius-title

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 March 23, 1998

1998-3-23 Moynihan's Social Security Hocus Pocus titleON MARCH 16 Senator Daniel Patrick Moynihan delivered a speech titled “Social Security Saved!” at Harvard’s John Kennedy School of Government. Said to be the Senate’s authority on the subject, he has addressed it many times over the years.

This time he referred to “the magic of compound interest” and presented some figures that surely seem magical at first glance. At second glance, they seem more than magical.

The Senator would cut the Social Security tax rate 1 percentage point and cut the employers’ tax (officially called “contribution”) likewise in order to “get the system back on a pay-as-you-go basis.” That is a worthy objective; unfortunately, the Senator does not say anything more about it.

According to the Moynihan plan, workers would be given a choice: They could take their 1 per cent cut and spend it on riotous living, or they could take both their own tax cut and their employers’ and put them in “voluntary personal savings accounts.” This is where the compound interest comes in, and it comes in with a roar. A table accompanying the text of the Senator’s speech shows that a worker who earns the “average wage” of $30,000 and stashes an amount equal to 2 per cent of it away every year for 45 years in a voluntary savings account compounding at 3 per cent, will wind up with a nest egg of $275,000 at retirement. And that will be on top of his or her Social Security benefits.

It sounds great, but anyone can do better. The present Social Security tax (employee plus employer) is 12.4 per cent. Suppose the whole caboodle were put in the magical voluntary savings account and compounded at 3 per cent. Then the nest egg would be $1,685,000. If the interest were compounded at 5 per cent (a rate sufficiently close to credibility for the Senator to include it in his table), in 45 years the $30,000-a-year average worker would be worth $2,790,000. At age 65 or thereabouts, he or she could retire and, leaving this lordly sum in the magical account, live on the annual interest of $139,500[1].

With astute quasi-legal advice of the sort advertised in many journals, the principal, or most of it, could be sheltered from the inheritance tax and passed along to the worker’s heirs or assigns, who could live comfortably without working at all. Indeed, since on these assumptions even the $12,000-a-year minimum-wage worker would have $1,085,000, we can safely say that after at most another generation, no one would ever have to work again. It might take somewhat longer in Bangladesh.

Now, I am enough of a Yankee to believe that honest labor never hurt anyone and is good for the soul; so I find this outcome appalling, and I would be sorry I brought it up if it didn’t reduce Senator Moynihan’s scheme to the absurd. Why does the scheme wind up in absurdity? Do you remember how, when lRAs were first peddled, banks advertised that they would make us all millionaires? There was and is nothing wrong with the mathematics. Bankers have books of tables that contain such calculations, and I assume the Senator has consulted one.

The trouble here, however, is that there are not enough ways to invest the bags full of money that would theoretically accumulate. The bags of money will therefore not exist, no matter what the mathematics says. They will not be sitting in bank vaults, waiting for a good deal to turn up, or available for some jolly use. They will not exist, tout court. They will never have existed.

If the Senator’s average worker deposits $600 a year every year for 45 years in the bank of his or her choice, and the bank can’t find people willing and able to pay interest for the use of it, the worker will reach retirement with $27,000, which ain’t hay, but is a long way from the $275,000-or $350,000 at 4 percent, or $450,000 at 5 per cent-the Moynihan table promises. Compound interest is truly magical, but the magic won’t work if there is no interest to compound.

We have now reached a point in the argument where John Maynard Keynes parts from Classical and Neoclassical economics. All three agree that saving equals investment. The conventional schools hold that saving creates investment, and they nag us about it every chance they get. In contrast, Keynes observed that entrepreneurs borrow and invest, not for the fun of it (though it may be fun), but to make money by producing things people are willing and able to buy. Accordingly, he wrote, “The propensity to consume will … take the place of the propensity or disposition to save.”

In any case, three current events teach us that there is now no use for the tremendous savings the Senator’s scheme would generate. (I) Major corporations daily announce plans to buy back sizable blocks of their own stock, thus confessing that they don’t know how to put all the money they already have to work producing goods and services. (2) Corporations of every size and shape raise and spend vast sums of money to buy and sell each other. The rash of mergers and takeovers may keep Wall Street busy scratching but ordinarily is intended to result in a contraction, rather than an expansion, of productive activity. (3) The stock market boom, again, mostly concerns Wall Street. The earnings of the companies on the Dow or the Standard and Poor’s 500 are now less than 1.5 percent of their stocks’ market value. Profits, while growing, cannot grow as fast as the market. Many actively traded stocks on the NASDAQ have never earned a profit at all.

As I have remarked before, the law of supply and demand works if, and only if, supply is restricted. The supply of stocks is indeed limited; consequently, as long as-but only as long as-Baby Boomers worried about looming retirement keep pouring their savings into the market, the market will keep rising. That is why Wall Street is eager for the commissions to be earned (“the old-fashioned way”) from handling the Senator’s voluntary personal savings accounts.

The economic sterility of capital gains, it needs to be recalled in the present context, is that they increase the price but not the productiveness of capital assets. The risk with capital gains is that when large numbers of people try to cash in their gains all at once, the market can crash very far and fast. Some day – at the latest when Boomers start cashing in their gains in order to live on them – the music will stop, and many people will find themselves without a chair to sit on.

In the meantime, conservatives hail Senator Moynihan’s scheme and urge him on. James K. Glassman of the American Enterprise Institute proposes, in the Washington Post, cutting “another few points off the payroll tax” as a step toward the happy hunting ground of complete privatization.

Complete privatization is of course what we had before we had Social Security, and it was not pretty[2]. The inadequacy of the unregulated free market was taught to all who had eyes to see in the months following October 29,1929. It was not until August 14,1935, when the Great Depression was almost six years old, that the heart-rending inadequacy of private charity was ground into the public consciousness. Then the New Deal was finally able to break through the barriers to the general welfare that had been thrown up by Republicans, Dixiecrats and a states’-rights-minded Supreme Court.

THE RESULTING Social Security Act was-thanks to the long years of wrangling and compromising-pretty much like the proverbial horse designed by a committee. It was not, and is not, ideally suited to any of its several functions. Nevertheless, it was, and remains, one of the most useful and successful and necessary public laws of the century. It was enacted because there are, in fact, limits-actual limits that we have tested more than once-to the assuredly great capabilities of private enterprise and private charity.

Despite this record, conservatives are likely to push for complete privatization of Social Security benefits. They are not likely to want to eliminate the system, though, and especially not the tax that supports it. Since Social Security accounts for almost a quarter of what makes ours a big government (which conservatives pretend to be scared by), and since the Social Security tax, including the employers'”contribution,” is indubitably a tax (which in principle conservatives object to), it may seem surprising that they wouldn’t want to abolish the whole shebang.

The reason for this inconsistency is simple. The various flat tax schemes that Congressional Republicans are busy devising have for them the charm of being resolutely regressive. Anatole France observed that rich men, as well as poor, could sleep under the bridges of Paris. Flat-taxers boast that they will give poor men the honor of being taxed at the same rate as the rich. Yet regressive as the flat tax is, it is nowhere near as regressive as the Social Security tax.

The two systems are similar in that each taxes only earned income. Malcolm Forbes probably pays himself and his office boy a fair salary. The two of them pay Social Security taxes at the same rate, and they would both be flat-taxed at the same rate, but they wouldn’t pay any tax on their incomes from the fortunes they inherited, no matter how large or small. David Rockefeller and I, being retired, now pay no Social Security tax (except as employers of servants, if any) and would pay no flat tax at all.

But the Social Security tax is more regressive than the flat tax on two counts: (I) The Social Security tax is levied on the first dollar you earn, while the flat tax proposals, like the present income tax, exempt the first few thousand dollars you get your hands on. (2) The Social Security tax does not tax at all earnings over $68,400, while the flat tax goes to the last dollar. (Moynihan proposes to increase the “cap” to $97,500 by 2003, still leaving the top 13 per cent of wages untaxed.) In short, the Social Security tax is a flat tax that is extra hard on the poor and extra easy on the rich.

At least since the Social Security system was “reformed” in 1983 by Senator Moynihan and others, it has been running a surplus that has been used to bring the “unified budget” closer to a balance. Even in this alleged near-balance year for the budget and near-crisis year for Social Security, the near-balance depends on an actual Social Security surplus of about $40 billion.

For reasons I advanced in this space last September 22, I contend that “A zero deficit means failure,” and for reasons I have advanced here many times, I contend that the Social Security Trust Fund is a serious error. Putting these two mistakes together, we have compounded them, for we have been using the proceeds of a most regressive tax to avoid increasing the income tax, which is moderately progressive, to achieve an unnecessary and wasteful balance.

Senator Moynihan’s scheme continues these injustices, as well as his erroneous attack on the Consumer Price Index. Reactionaries will rejoice.

The New Leader

[1] Ed:  I have tried and tried using the financial functions in Excel, and have asked others to do so.  We cannot replicate these numbers.  We’d be happy to see how they are calculated.

[2] Editor’s emphasis

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 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 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.

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