Should Ontario Become an Independent Country?

Ok just forget how crazy the question sounds.  The recent wrangling between Ontario and Alberta over the value of the Canadian dollar, oil output and the decline of manufacturing in Ontario (and other provinces east of Ontario) raises some reasonable questions about the Canadian monetary and fiscal union, aka the Confederation of Canada, aka, British North America, aka Canada.

Critics have long argued that the Bank of Canada’s single minded attention to price stability, i.e., inflation, and to a single policy instrument, i.e., the interest rate, was both too crude and too cruel.  Too cruel because it makes unemployment the site of dynamic economic dynamic adjustment and too crude because it is both geographically insensitive and structurally daft.

Here I will put the cruel to one side and consider the crude.  Interest rate adjustment is a crude way to attempt to manage the macro-economy.  Think about the regional dimensions.  If you exclude Western Canadian growth the beavers teeth look not nearly so sharp, or as long.  The present interest rate regime is probably too low for western Canada and too high for eastern Canada.  Suggesting that, all things being equal, the Canadian dollar is probably too high and too low.  Too low for the resource sector and too high for manufacturing.

Federal tax policy has not helped either.  The unilateral decrease in corporate income tax rates deprived the federal government of resource revenue while having little if any impact on investment in the manufacturing sector.   The west did not need a GST rebate the east did.  And to add insult to injury, the Federal government has decided to move to an austerian footing.  Again viewed through the lens of the west probably not a totally idiotic position to take (countercyclical one might say).  Viewed from the east, however, a completely counter-productive, pro-cyclical policy.

All of which raises the question if Ontario, or indeed if all of the provinces east of Manitoba, would not be better off with their own federal government and their own central bank.

O.k. time to remember how crazy the question was.  Not that crazy after all.  But it is only a sane question because macroeconomic policy (fiscal and monetary policy) is so cruel and crude.

Delicious and dangerous irony: China to buy Italian bonds

How much of a disaster is the EMU?  Look no further than the spectacle of the Italians going cap in hand to the Chinese for a bail out.  The fact that the Italians are tapping the Chinese is not the issue.  The issue is that they cannot tap the EU or the by now ideologically impotent ECB.  I have always thought of neoliberalism as the ideological gloss on an accumulation strategy.  Me thinks I might have it exactly backwards.

The irony of greed: The end game for Neoliberalism?

The global economy is in the toilet and the Boomers’ representatives are chanting: “flush, flush, flush.”  Me? I am eating cigarettes and wine while admiring the remarkable consistency in the myopia of all of it.

In the name of fiscal prudence the whole of the advanced capitalist zone is in engaged in austerity budgeting and calls for more of the same.  Even Martin Wolf, in his otherwise insightful column in the FT online today, felt the need to tap his hat and nod in the direction of the genteelism of supply.  Exhibit A, the conclusion to his incisive intervention:

Reconsidering fiscal policy is not all that is needed. Monetary policy still has an important role. So, too, do supply-side reforms, particularly changes in taxation that promote investment. So, not least, does global rebalancing. Yet now, in a world of excess saving, the last thing we need is for creditworthy governments to slash their borrowings.

As is widely acknowledged, monetary policy has little outside of conciliatory role to play at this time.  In so far as the CBs should not make the mistake of tightening policy as the ECB and the BoC did.  But apart from the role of spoiler there really is not much left for the CBs to do.  The problem is squarely fiscal.  As Wolf himself went to pains to argue.  Why then the conclusion given that further tax reductions are not only going to make the fiscal positions of governments worse they will also likely have the same effect as lowering interest rates at this time:  Nadda, ziltch, rien, nothing?  The problem is that Wolf has to tip his hat to conventional wisdom.  If not; he has no hope of bending the ears of policy makers.  Oh well, that is his plight not mine.

Here, given none are listening we may speak frankly.  The world economy is in the toilet because free trade, tax cuts, deregulation and above all the liberalization of finance over the last thirty years let loose a Tsunami of forces both economic and political.  The liberalization of finance and production allowed for the national gutting and then global whipsawing of labour.  As the profiteers profited and retired workers slept while the assets they had built were being systematically stripped and the fortunes being amassed were then turned to the seedy business (although a time honoured practice if one cares to actually read Smith) of buying off the government–and it must be stressed the intelligentsia too–broadly understood.

We now have the perfect storm.  A generation of public and private sector functionaries has been trained to believe that the market can do no wrong and the government no good.  As a corollary is of course the proposition that monetary and regressive tax policy is everything.

The irony, of course, is that any credible account of the present crisis would have to admit that we are here because free trade, tax cuts, deregulation, the flexibilization of labour markets  and above all the liberalization of finance brought us here.  How odd it is then that we should be treated to more of  the same as the cure for what ails us.

The love which dare not speak its name

People who would want to avoid reading my dissertation or anything about neoliberalism but nonetheless would like to have some idea about what has been going on in the world of public policy and economic policy in particular ought to read the 24 page special publication by the OECD “Evolving Paradigms in Economic Policy Making.” It is a fairly interesting document given its understated criticisms of macroeconomic policies and downright silences on key policies which it had a hand in crafting and popularizing. The document is filled with tap dancing around the elephants in the room. Here is how they deal with the last crisis:

Indeed, the repetition of bubbles and busts from the late 1980s until the early 2000s, such as the Savings and Loans, LTCM, Asian and dotcom crises, had not only macroeconomic origins, but was also associated with, partly misguided, financial innovation…..With hindsight the dotcom bust in 2000-01 should have been taken as a warning signal that systemic risk was unduly increasing…..Monetary policy appeared to be generally successful in this period, with low and stable inflation and generally well-anchored inflation expectations. But it was not sufficiently recognised that this outcome was helped by globalisation, a positive aggregate supply shock that kept inflation low – at least until oil and
commodity prices surged……Fiscal consolidation also looked successful, but – as has been a recurrent theme in the OECD’s economic history – failure to attain sound underlying public finances was masked by very favourable cyclical developments…..While structural policies had been successful in several countries, there was little international coordination on policy choices, contributing to the persistence of cross-country imbalances in savings and investment and widening global imbalances (Figure 4)…..Finally, the potential for systemic financial risks was not effectively monitored, such risks being viewed as low as long as stability-oriented macroeconomic policies were pursued and micro-prudential regulation was conducted effectively.

OK now pay attention because here is the conclusion drawn from the above:

All this [the above] explains how problems in a small corner of US financial markets (subprime mortgages accounted for only 3% of US financial assets) could infect the entire global banking system and set off an explosive spiral of falling asset prices and bank losses in 2008 and 2009. Consumer and investment demand quickly started to fall in the United States. As the US financial crisis intensified, weakness spread globally. With wholesale money markets freezing up, companies started to liquidate inventories and in late 2008 world trade nose-dived. The sharpest contraction since the Great Depression of the 1930s unfolded (p.12).

Wha? First off, government fiscal policy had nothing to do with it. Even if they had run super macro-prudential budgets that would not have stopped the financial markets from imploding. And why is the OECD arguing that governments should have been running their budgets as though they were in a permanent recession? So that line is just a sop to austerity ville and its citizens. Second, I can’t get to global financial meltdown from their list. If they really believe that just 3% of US financial assets under management were the cause of the global crisis they need a much braver laundry list. In any case, one word you will not read is “neoliberalism”. Instead you will be treated to vague sentences which read: “The prevailing paradigm largely survived the post-dotcom experience” (p. 11). It is odd that a prevailing paradigm should not have name. What prey tell came after Keynesianism?

And here is the problem with this retrospective on changes in macroeconomic paradigms. Namely, it is yet another instance where one of the leading institutional protagonists of neoliberalism is simply dodging its responsibility. Nowhere is there even a hint of contrition that labour market policy was exactly the least significant area that should have been paid attention to. The OECD spent the better part of 10 years focussing advanced capitalist policy makers on the need to flexibilize labour markets to almost the exclusion of all else. Indeed, in Alan Greenspan’s famous phrase, they spent from the mid-1990s to the mid 2000s ‘traumatizing workers’. One would be hard pressed to find any research during that time frame coming out of the OECD cautioning about systemic risk, regulatory capture (corruption is the word we Europeans use for the third world), or the dangers of financial deregulation. If the researchers at the OECD are suppose to be guiding policy makers towards best practice they did a horrible job. Not only did they cut your unemployment benefits they did nothing to help make sure you would not need them.

To add insult to injury, as Paul Krugman notes, in their 89th economic outlook they are pushing for the further traumatization of workers via higher interest rates and fiscal austerity.

For fiscal policy, exiting from crisis measures and restoring sound public finances is likely to continue well into the medium term. The pace of the exit should be commensurate with the state of public finances, the ease of sovereign funding, the strength of the recovery and the scope for monetary policy offsets. It should also take into account that delays in fiscal consolidation might increase interest rates and future growth. A credible fiscal consolidation will likely improve financial market conditions and hence the monetary transmission mechanism.

Furthermore, fiscal consolidations in which expenditure reductions have a high weight are more likely to result in durable retrenchment (Guichard et al., 2007) and more likely to be accommodated by monetary policy once it has departed from the zero-rate bound. Even so, tax increases look unavoidable in view of the size of the consolidation requirements. It is important that consolidation be growth-friendly. For example, raising the retirement age could bring long-term gains while having only limited effects on near-term growth. Priority should be given also to reducing the distortions created by subsidies and tax expenditures, and tax increases should be focused on the least distortive taxes such as on overall consumption and immovable property (p.14).

What is that about never letting a crisis that you helped create go to waste? I am just going to call this tax paradigm what it is (if your under six close your eyes): Fuck the fixed or FIF. Say it with a crappy mob accent and pretend you are an OECD economist acting macho. Next time you see a house or a worker with medium to low portable skills just say FIFem. There is of course never any mention of policies that would arrest mobile factors from playing the arbitrage game. That would of course be downright un-neoliberal and certainly too much to ask of one of the central institutional protagonists of the paradigm which dare not speak its name.

Understanding Corporate Tax Cuts: embracing conventional wisdom and coming to radical conclusions

Warning this post contains scenes of graphic illustration, it is not intended for short attention spans or people who can not locate coordinates in two dimensional space.  Viewer patience is therefore highly advised.

The debate on corporate income taxes brings out a really nice teachable moment in that it provides an occasion to clarify the terrain of past present and likely future debates on macroeconomic policy.  In what follows I will hew closely to the standard story, but what I intend to show is that even within the terms of the conventional collective memory there is an important contradiction that helps clarify what the real debate over corporate cuts ought to be about.  Let me see if I can deliver.

The conventional account of history runs something like this.  By the 1970s and early 80s unions had become too strong, unemployment insurance and welfare programs too generous and together they produced highly distorting macroeconomic outcomes: high unemployment, high inflation and low output (referred to at the time as stagflation).  Let me just accept this account for argument sake because I think it represents the story in the back of the head of most policy makers and economists over forty.  Let us represent this conventional story by line A in the diagram below.  Notice the oscillating line around A.  That represents the economic cycle.  From the vantage point of policy makers and economists over forty  the problem with the Keynesians is that they were preoccupied with stabilizing those oscillations when they should have been preoccupied with moving the economy towards line B.  Line B represents an equilibrium in which both employment creation and output proceed in a balanced manner.

Point Y represents the bad equilibrium that Keynesians were unwittingly fixated.  In their drive to stabilize the macro economy via employment they gave short thrift to output and thus created an inflationary environment which produced increasing high levels of unemployment, low levels of output and high levels of inflation. In time policy makers and economists shifted their attention away from cyclical stabilisation to structural change .  That is, from attempting to smooth the oscillations around line A to moving the macroeconomic trajectory from line A to B.

Notice that point Y does not entail a lower level of employment but rather a higher level of output.  And this was what was so seductive about the supply side arguments of that time.  What they in fact said was that it was possible to maintain employment and increase output provided the appropriate structural reforms were undertaken.  Everybody and I mean everybody wanted lower inflation and higher employment.  And in the face of stagflation the punters got onside and away we went.

My argument is simply this.  After the largely successful attack on trade unions was accomplished, after the reform of both welfare and unemployment insurance programs were completed and within the context of free trade and capital mobility the real impact of he structural changes was to move the economy to line C point Z.  That is to say, even granting neoliberalism was not some radical attempt to reconfigure income and wealth distribution between economic classes the structural reforms were more successful than its antagonists imagined and thus instead of landing on trajectory B point Y we landed on trajectory C, point Z.

When therefore there is the call to cut corporate income taxes it explicitly assumes that the Canadian economy is still stuck on trajectory A point X.  But if in fact we are on trajectory C, point Z; we are thus in fact stuck at a bad equilibrium.  The move to further juice up output without a commitment to juice up employment is like the Keynesians of yore trying to smooth the oscillations around a bad equilibrium. But this time around it is employment which is lacking not output capacity.

What does this have to do with corporate tax cuts?  Corporate income tax cuts are suppose to be a stimulus to increase the output capacity of the Canadian economy over the medium to long term.  But if as is widely recognized output is not the problem but employment why are we even talking about supply side measures (i,e. corporate tax cuts)?

I think economists are still fighting the last war and not the war we are in.  And as any historian of war will tell you an army that does so will loose.

Update: this is not as radical an idea as it may appear: see this article in the business section of the Globe online.  The difference with Canada is that I think are debt growth is papering over the underlying bad equilibrium.

No. 6: Low interest rates anywhere and everywhere cause inflation

Ok this is a bit of pinball intro as I bounced first to the PEF to be greeted by a blog post by Erin Weir recommending we all read Nick Rowe poking at the President of the Minneapolis Federal Reserve with a sharp stick (more on that below).

Erin writes:

The President of the Minneapolis Federal Reserve had warned that unduly low interest rates would cause deflation. Of course, anyone with a handle on basic macroeconomics knows that the risk of leaving interest rates too low is inflation.

Ehhem, as everybody ought to know…ceteris paribus “anyone with a handle on basic macroeconomics knows that the risk of leaving interest rates too low is inflation.”

And what is often left out in inventory (introductory) macro is that ceteris paribus is crucial.

If you were to take Japan as your only data set and regress interest rates on the general price level you might be tempted to agree with the Pres. of the Min Fed. If you took Zimbabwe (interest rates and inflation rates only) as your case you would be tempted to argue the same: high interest rates cause high inflation! Neither of course is right. Back from the extremes; what is the relation between low interest rates in NA and the price level right now? There is a group of economists that have been promising, predicting, and now praying for an acceleration in the general price level since 2001. Ceteris paribus so is Erin if he believes that low interest rates ————> inflation. I do not think he does but it sure sounds like it.

Perhaps if intro to macro started with these real world examples they would be better courses. As everyone knows (don’t they?) both inflation and deflation are anywhere and everywhere decidedly more complex phenomena than simple causal arrows running from interest rates to general price levels. NB. Even the case where interest rates cause inflation or deflation they are going to be particular cases. The causal case (general law level) can only be sustained if and only if the economy being investigated conforms to the model. The theoretical model rarely will (and only loosely) so that too would be a particular case from which no general (———>) covering law can be given. Again the Fed Pres is wrong but not simply because he got the standard Macro 101 ass to front. As Nick Rowe notices and then notes.

I notice he has an undergraduate in maths, then went straight into a PhD in economics. My conjecture: I bet he never took Intro Economics, or anything vaguely similar. I bet he waded straight into the mathematical deep end. And so he never really learned economics. So he took the Fisher identity (nominal interest rates = real interest rates + expected inflation), added monetary super-neutrality (equilibrium real rates are independent of monetary policy in the long run), and ran with it. He never distinguished between the equilibrium thought-experiment and the stability thought-experiment. If you explain this in words, as you have to in Intro Economics, you have to get it right.

We should never, ever, let students do this. Yet we do it all the time.

And this is also why we should never frame monetary policy in terms of interest rates. If this guy can’t understand it, maybe some average people will get it wrong sometimes too, and have things going in the wrong direction

Sometimes I despair of my discipline. And for my economy.

None of which seems to have aught much to do with math save for in one sense; like alcohol, the math does a kind of confidence trick .

Incomplete metaphors

Over at WCI Nick Rowe has a post up about central banks and economic activity. There is a lesson there, but not the one Nick thinks.

If a house has a good thermostat, we should observe a strong negative correlation between the amount of oil burned in the furnace (M), and the outside temperature (V). But we should observe no correlation between the amount of oil burned in the furnace (M) and the inside temperature (P). And we should observe no correlation between the outside temperature (V) and the inside temperature (P).

Let us start with a quibble, a thermostat is fine but a proper building envelope is equally important. That said, my oil stove does not have a thermostat. In fact, I am the thermostat and I can adjust the heat only through a drip valve. In a mild winter I am far too hot (i.e., I am burning more oil than I need). In a cold winter I am capable of making an adjustment in the drip rate to compensate. In a super cold winter even with the drip valve at maximum I am cold. That means the colder it is, to a point, the more control I have over the temperature. But after that point I am too cold. Now throw in the quality of the building envelope.

Now transcribe this into macroeconomic terms. What are the implications?

Rowe V Krugman V reality

Personally I think blood sports are pornographic. Krugman is a persistent pessimist on the future track of US growth. Nick Rowe (the boat) is dipping his oar formally on the optimistic edge of the ram. But surprisingly for apparently Keynesian reasons. Me I am going to err on the side of Krugman’s pessimism because I do not think individuals think like this nor do I think they are homogeneous like this:

Since the actual natural rate has not changed, and since the market rate set by the Fed has not changed, you might think that no individual will want to change his desired savings or investment. But, because each individual (falsely) thinks that the natural rate has increased, relative to the market rate, each individual thinks that every other individual will increase desired investment and reduce desired saving. So each individual expects the Wicksellian/Keynesian cumulative process will cause rising prices and output. And this is what causes each individual to increase his own desired investment and reduce his own desired saving. And so there is a Wicksellian/Keynesian cumulative process of rising prices and output.

Keynesian or not.

Ideological Capture and the Death of the Functionalist Capitalist State

Marx and Engles once famously quipped in an obscure text somewhere that “the executive of the modern state is but a committee for managing the common affairs of the whole bourgeoisie.” In modern theory this economistic and functionalist rendering of the state has been widely rejected for reasons I will not bother to outline here.

As a first cut theory of the modern capitalist state I, however, had always thought it was rather an astute observation. Business owners have collective needs they can not or will not independently provide and yet require these goods and services in order to conduct their affairs. They need independent courts to police and enforce private contracts, they eventually figure out they need a common currency, a reliable system of roads etc, etc. The solution to this collective action problem is the state. Indeed much of the history of liberalism can be read as a conversation about what the proper functions of the state ought to be and how to protect it from being hijacked by the popular classes to provide for their collective needs. That is why in that same obscure text Marx and Engles called for the extension of the vote to non-property owning individuals. What a Radical Idea!

What strikes me, however, about the latest wave of austerity sweeping through the advanced capitalist zone is the degree to which the state is failing to act as the executive committee of the bourgeoisie. When you read Keynes’ General Theory it is palatable the degree to which he was frustrated by the state’s failure to do its job and save the capitalist class from itself. In our contemporary period of growing myopathy economists like Paul Krugman seem gobsmacked on an almost daily basis at the failure of the present administration in the US to act accordingly. What Paul and many others do not seem to be able to figure out is why?

I think the failure of the state to act as the committee for managing the general affairs of the capitalist class is rather simple: both the bourgeoisie and its representatives—politicians—have been consumed by the ideology they have been selling.

Neoliberalism was about making the world a better place to be a capitalist. As such, it was also about getting citizens to internalize the needs of business as their own. Everyone and every institution were asked, prior to making any practical suggestions to ask themselves what would a business person do? So successful was the campaign to get citizens across the world to internalize the needs of capital that even the elites ended up drinking the cool-aid they sold. Put differently neoliberalism moved from being the Noble Lie to the prize winning Noble Truth.

I am going to coin a new term here and call this phenomenon “ideological capture”; which no doubt, in the case of the US is reinforced by an almost complete “regulatory capture.” Indeed so complete has this ideological capture been that it appears as though instead of individual states acting on behalf of the collective needs of the entire bourgeoisie individual states are rather acting as the executive of a single capitalist firm and viewing the societies they govern as one giant business enterprise. This in train is leading to a whole host of jumbled thinking not the least of which is the package of compositional fallacies and outright contradictions masquerading as fiscal prudence.

In another post perhaps I will take the time to catalogue them all. But of course all of this is a rather moot point. Even if the managers of the capitalist enterprise called the modern state woke up and decided that they would save capitalism from and for the capitalists it is not at all clear how they would do it. Let us say for argument sake I agree with people like Krugman and think that fiscal expansion across the capitalist zone coupled with a real effort on the coordination on international imbalances—as opposed to the bizarre spectacle that was the G20 meeting in Korea—would go some way to stop the haemorrhaging. The fact remains the neoliberal growth model is a failed experiment. A reset back to 2005 will not do the trick; nor 1996; nor 1985; nor 1976; nor the summer of 68.

There are in fact three resets and not one that have to be pulled-off. To meaningfully deal with international imbalances we are going to have to deal with both the class and the environmental imbalances (that was euphemistically put). These are all massive problems with very politically complex solutions to be worked out. Neoliberalism has served to hyper accelerate all three imbalances and there is nothing I am seeing from the Very Respectable People (VRP) like Krugman that betrays any sense of what is really required. To make matters worse VRP are on the outside of the debate which gives a good indication of just how far off is a meaningful consideration of the immensity of the tasks at hand given they are only one quarter of the way there and sitting on the benches.

Marx and Engles quipped somewhere in an obscure text second only in obscurity to the Bible that Capitalism creates its own gravediggers. Some good irony then that the state is busy performing this historical mission that was once bequeathed to the working class.

Extend and pretend

It is bad when the most pertinent of commentaries gets no response. What is ironic here is that at the micro level banks are telling their public stop pretending we are not extending even though they face near zero costs or in the case of the US negative costs.

You leave out an important scenario: in a zero interest rate environment, no bank is bad. This is why otherwise insolvent banks like Bank of America or Citi can stay solvent. It doesn’t matter the proportion of non-performing loans on the asset side as long as its cost of funds is minimal. Banks are thus engaged in a race with time to capture a positive return to recapitalize before interest rates rise.

Posted by: Guillaume | November 08, 2010 at 10:48 PM

Yep extend and pretend. That is the future but it is not as yet the present.