How Can a Political Scientist get this and many (freshwater) economists do not

O.k. I wrote this years ago. Maybe 2003, maybe 2005:

And while NKs accept the basic logic of the rational expectations augmented Philips curve (that is, that the NAIRU is semi-fixed in the long run) monetary and fiscal policy can nonetheless be deployed in the short- run so long as the cause of the deterioration in effective demand is not caused by adverse supply shocks such as an unemployment rate below the NAIRU, insufficient capacity or medium to long-run supply constraints.  This essentially amounts to a hawkish policy stance against inflation and support for less than full employment.[1]  Or alternatively stated, outside of a liquidity trap, NKs are almost indistinguishable in terms of macroeconomic policy from their new classical cousins.

[1] As we shall see below Shapiro and Stiglitz (1984) make the argument that unemployment (above its frictional level) is functional to aggregate efficiency.

The economy lab, the dark age of free trade theory, and the naive view on natural resources and economic development

Over at the Economy Lab in the Globe which Failed, which itself has gone from bad to worse, one of the economists they keep in their stable has either produced an extraordinarily naive analysis or a dishonest one.  I am going to go with naive for the sake of professional courtesy.  Not that that is the MO of economists but I am atheist fan of Jesus and not an economist…so here goes.

To be honest I can’t figure out which vintage trade model Gordon is using.  My informed gut tells me something like an off the shelve H-O-S intro text book model of free trade.  That would fit with his own vintage and the fact that he is an econometrician.  Although that creates a paradox because, as surely Gordn knows, the H-O-S free trade theorem preforms dismally–by even economic standards–in econometric work outs.  In layman’s terms: the work-horse model of free trade which is standard in introductory economics texts fails at a predictive level.

There are any number of reasons for this but just for fun here are few in no particular order:

  1. The economies entering into trade were in a state of autarky (self sufficiency) and full employment.  Both of which are patently false.  More often than not nations pursue trade in the search for a remedy to chronic underemployment and unemployment and have already been engaged in trade.
  2. Product and capital markets are perfectly competitive.  Again patently false.
  3. Factors (capital and labour) are perfectly mobile within a national jurisdiction but not between.  You might get me to agree on labour but the whole point of neoliberal globalisation and its animating quintessential core is the free movement of capital.
  4. As a corollary, capital (investors) is made up of 100% domestic nationals.  Extremely dubious assumption with respect to mining, oil and gas and a whole host of other sectors.
  5. There are no firms.  While capital and labour are the only inputs (and resource endowments) there are no firms.  Just one large something or other allocating labour and capital according to their scarcities.  A model without firms that actually do the trading?  Bizarre me thinks.  This becomes particularly important with respect to determining who benefits from the gains of trade.
  6. Capital is a natural endowment.  Which translated means that for the standard model the explanation is that some countries have lots of capital some do not.  Why that is; the model does not care.  But saying that you don’t care is far cry from saying anything remotely interesting.  Capital is after all nothing other than produced means of production in its physical form and its ephemeral and essential form a complex social relation.  Sorry I can’t really simplify that at this time.  But to get a sense of what I am getting at just recall that the origins of Canada is a colonial enterprise in which colonial settlement was driven by the desire to expropriate natural resources from the original inhabitants.  The origins of Canada, and its rich endowment of natural resources is thus the history of politically constituted property and not some “natural” process of economic development.

O.k. so that is that.  Of course the OEM version of free trade theory is going to be a predictive disaster.  Why anybody bothers to teach it outside of using it is an example of what happens when liberal geeks go wild is beyond me.  But let me do a real world work-out.

Let us take Newfoundland and Labrador as a historical case in point.  Here is region that has leaped from one natural resource boom to another and it has always ended in some form of administration.  The failure to develop a modern diversified economy in which resources play a role but not the primary role.  Contrast the fortunes of early diversifiers in the union, who did so via a tariff wall and you get the picture.

In Newfoundland and Labrador Gordon’s advice is being followed as the mining and oil and gas sectors account for around 40-45% of provincial output but only 4-5% of direct employment including temporary construction employment.  Neither the oil, nor the profits touch land (outside of royalties taxes and wage payments which are all relatively low) in that province because of the weak to non-existent processing of raw materials.

Gordon thinks this is the road map to economic success, I think it leads to ruin.  He is willing to bet standard trade theory on it, I am going with history.

Here is why.  Two seconds of reflection will reveal that in Newfoundland and Labrador almost every single assumption built into the standard free trade model is violated: most certainly 1 through 6 outlined above.  Perhaps most interestingly is that Newfoundland and Labrador would not have a comparative advantage in oil and gas had it not been for the federal and provincial governments.  I am sure Gordon was decrying Hibernia as white elephant back in the day.  The problem is today the two levels of government are fighting over the allocation of royalty payments as the project is paid in full and is churning out lucrative profits for all involved.

Maybe Gordon can write something about that in his next post to the Economy Lab.  I won’t hold my breath.  My discipline right or wrong and all that jazz.

How to read economic language for bias: “wage inflation” in Newfoundland and Labrador

Sometimes we read things and we get that gut feeling that we are being subtly manipulated.  Economics is of course full of this subtle manipulation.  Words like “choice”, and “efficiency” and even phrases like “free trade,” “efficient markets” and my favourite “the natural rate of X” have a very specific meaning in neoclassical economics which do not not have much connection to what the layperson might think they mean.  What is curious about the above terms is that they all lead the layperson in the right ideological direction even if they (the layperson) have no idea what the terms really mean in economic practice.

To my mind one of the most egregious ‘tells’ is the phrase “wage inflation.”  Here even the pedigree of the phrase is suspect.  In economics the word inflation is generally reserved to refer to an increase in the price level.  If just one good rises in price what we have is a relative shift in prices.  Sometimes when, for example, we disaggregate inflation data we talk about the relative contribution of specific  items like food, and energy to the overall measure of inflation.  But to talk of wage inflation is just bizarre.  Economists do not talk about profit inflation; so why would we talk about wage inflation?  The only reason I can come up with is that when an economist does talk about wage inflation they are either too ignorant to bother listening to, or too biased to bother taking seriously.  There is the third possibility that they think inflation is anywhere and everywhere a function of wage increases which normally goes by the name of a wage cost push theory of inflation.  So the third is really an expression of the soft bigotry that comes from being too biased.

Lest anyone think I am making up false examples or hitting at straw men just click on this document.  Here an economist talks specifically about “wage inflation” in Newfoundland and Labrador.  Now I am sure he is a fine economist but why would Mr. Locke talk about wage inflation?  If he were simply unbiased but confused about what the word inflation meant why would he choose to not also talk about profit inflation?  Indeed, in 2008 profits as a percent of wages were running at 125%.  The decadal average was over 70% whereas the national average was around 25%.  If anything it sounds more like a case of profit push inflation but then again Newfoundland and Labrador do not have an inflation problem: prices rose on average 2.45.  So why talk about inflation at all?  Even more embarrassingly Mr. Locke’s own graph plots wages in Newfoundland and Labrador as a percent of the Canadian average.  His stellar proof (p.10) that wages are the cause of an almost non-existent general rise in the price level in Newfoundland and Labrador is that wages in the province have risen to less than 95% of the national average.

The only answer I can come up with is that in such a context the use of the word “inflation” after the word “wages” is designed to tell the reader that increasing wages are BAD.  Why is it bad?  Because inflation is BAD.  And not as in Michael Jackson’s Bad, but you know BAD.

In any case when you read the phrase “wage inflation” stop reading and do something more intellectually rewarding like cleaning your toilet.  And as you watch the water rise in your bowl ask your partner to come in and watch the “inflation” in the water level.  At least with specific reference to the general level of water in your toilet bowl you will be on safer linguistic and scientific ground than talking about wage inflation.

Reswitching, relative prices and linearity

Ok so only 1000 people in the world understand this and only 10 care about it: economics for the most part has long since given up its empirical pretensions when it comes to its ontological assumptions.  Still I suspect the heterodox world will be interested in this forthcoming publication by Anwar Shaikh antiseptically titled, The Empirical Linearity of Sraffa’s Critical Output‐Capital Ratios.  Here is the conclusion:

Even though Marx initially develops his analysis in Volumes I‐II under the assumption that prices are proportional to labor values, he is adamant that the two must be systematically different. In his famous (and incomplete) transformation procedure in Volume III, he derives prices of production as linear functions whose deviations from values increased with the rate of profit. The first two components of the Sraffian decomposition can be therefore viewed as the vertically integrated equivalent of Marx’s procedure. The data clearly support Marx’s general hypothesis that prices of production deviate smoothly and near‐linearly from values.

Sraffa’s elegant and elliptical text suggests that prices of production are likely to exhibit more complex patterns. He specifically cites the potentially complex behavior of individual sectoral output/capital ratios as being the source of complicated price movements. But at an empirical level, individual output capital ratios turn out to be virtually linear functions of the rate of profit, so that individual prices of production and the aggregate wage‐profit curve are near‐linear.

Such findings clearly support the structural price theories of Ricardo and Marx. While they do not completely exclude reswitching, they certainly relegate it to a secondary role. This does not mean that they rehabilitate neoclassical economics. First of all, the structural determination of relative prices in equation (1.4) is a far cry from the neoclassical theory of marginal cost pricing. Secondly, the difference between classical and neoclassical theories of profit is most evident precisely when prices are equal to labor values. This is the condition under which profit is exactly equal to the surplus value created in production. Even if we further posit an infinite number of co‐existing techniques, timeless technical change, and a host of other non‐classical assumptions, then equality of standard prices and values is also the condition under which an aggregate pseudo (surrogate) production function obtains, in the sense that frontier techniques corresponding to lower rates of profit will have higher (constant) capital‐labor ratios5. But correlation is not causation: both profit‐as‐surplus value and the profit‐rate‐as scarcity‐price coexist in this abstract space because their real theoretical differences lie elsewhere (6).

Canada: persistently 2nd worst in class

During the last election much was made about Canada’s relatively good performance during the last recession.  What was conveniently left out of the discussion by all political parties is just how dismal Canada’s macroeconomic performance has actually been over the last forty years including the last decade.  Below are two graphs plotting Canada’s relative macroeconomic performance on three metrics: unemployment and inflation, the so-called Misery Index (MI), and productivity. First the MI (click for enlarged and clear image).

Over the forty years Canada has ranked either the worst or second worst of the seven countries plotted in the graph above.  What is most interesting is that for the last two decades most of that dubious distinction has been earned via high unemployment rates as almost all the differences in the scores in the misery index are attributable to differences in unemployment rates as inflation rates clustered into a tight band between 0 and 3 percent.  So top marks for price stability and low marks for employment creation.  That should help to put a fine point on the topic of corporate tax cuts.

But OK you say so unemployment has been high price stability surely helped bolster Canada’s productivity.  Nope.  There the story goes from bad to pathetic.  Canada has consistently trolled the bottom of the pack.

I guess Canadian policy makers and corporates can take solace in the fact that over the last decade Germany and the Netherlands were also pancaking in terms of productivity but as I will show in later post the other two can at least claim very healthy current account surpluses and in the case of Germany a nonetheless very strong manufacturing sector.  As I will also illustrate in yet another post the bright side is that Canadian profits have been very healthy.  This too will help to put a fine point on the subject of corporate tax cuts.

UBC economist Milligan throws cake at educated, unemployed youth

I tuned into a rebroadcast of this morning’s the CBC’s the Current while cleaning the kitchen this evening which had an unusually good documentary on the problem of youth unemployment; specifically, the problem of university undergrads in finding jobs.  As someone who suffered the 90s recession in spades (really you should see my work history I can sharpen your kitchen knives and the teeth on your chainsaw to a fine edge of efficiency*) I was very much in sympathy with these newly minted baccalaureates.  Personally I pursued my education as an end in itself.  If I had become a logger full time I would a least be able to attempt to make sense of something beyond the hill.  That said I can totally understand why so many of those interviewed in the documentary felt let down: they did what they were told; they followed the path as laid out by parents, teachers and councillors; they volunteered; they studied hard and upon graduation the ambitious among them took jobs as servers.

One of the newly minted graduates arrived to a jobs fair with 40 resumes in hand, another paid a months rent to get a professionally designed CV worked-up.  All for nigh.

In any event a very sobering documentary about the problems facing the educated unemployed youth.  That was until they finally interviewed the economist Kevin Milligan from UBC.  In true Victorian form, Milligan’s bottom line was that however this documentary might tempt you to think something can be done for these wayward educated unemployed forget about it:  Denmark tried it in the eighties and it was a disaster.

Let us just forget about the fact the eighties and early nineties brought all kinds of ideas to the rocks of reality and let us similarly forget that Denmark is a small open economy (this will work in my favour below), what Milligan fails to do and what an economist ought to be able to do and suggest the form that public policy could take to ameliorate the situation.  But that is the rub, the mainstream of the profession takes a do nothing position as the default optimal policy stance with respect to unemployment.  As a nod to their objectivity I suppose I should say their glib nature is not particularly directed at the youth: if the 55+ cohort was suffering above average unemployment rates Milligan’s response would be FIF you too.

Ok so those are the preliminaries.  What Milligan fails to mention is that instead of admitting defeat Denmark learned from its mistakes and doubled down and developed a different strategy to combat youth unemployment.  This time they coupled income support with training and an integration of training with private sector demand.  In short they revamped both their retraining regime and welfare state institutions to match incentives and crucially demand.  So at the height of the down turn in 2009 the youth unemployment rate was fully 4% higher (12 vs 16) in Canada with an overall unemployment rate of 7.2 vs 8.6.  What does that mean? It means with some policy effort that both the general rate of unemployment and the youth rate of unemployment can be lower.  In short, instead of throwing cake, you can have your cake and eat it too.  Serious economists would do well to concentrate their efforts on making the world better rather then resting with lame ideological proclivities to leave it as is; and those of us who pay their salaries would be well advised to demand the same.

Cake just don’t cut it any more.

*In the abstract the sharpest blade would have a length but no width.  It would therefore be a line.

Just who are Paul Krugman’s people? And a side dish of MMT

I know Paul thought he was just being relaxed. Moses knows we all have a right to relax de temps en temps but it is a really remarkable slippage. In his latest post he writes:

So: I basically think of asset prices in a Tobin-type stock equilibrium framework (pdf). People make portfolio choices, allocating their wealth among bonds, stocks, etc.. Asset prices – including the famous “q” – rise and fall to match these portfolio choices to the actual asset supplies (emphasis added).

I have never been able to get past the basic misrepresentations of reality that are hard wired into (liberal: both reform and conservative) economists heads. How can a social science do such a violent abstraction? People in general do not allocate their assets into portfolios. I imagine Paul does, as I imagine some retires who do not have retirement plans but nonetheless who have saved must. But these are fleetingly small group of asset allocators. The vast majority of asset allocation is done by a special class of people who work in the FIRE sector for large institutions which in turn attempt to maximize (beat/achieve the average) by any and all means necessary. If there is a mismatch between assets demanded and assets supplied it has nothing much to do with people.

Now none of this really has much to do with Krugman’s post. But it is still incredibly annoying.

At the end of his post Krugman drops this bomb:

Update: Also, if you think that US interest rates are being held down by the fact that in some sense the Treasury hasn’t had to go to the market lately, since the Fed is buying debt — although the Fed isn’t actually buying it direct from Treasury — consider the case of Greeece (sic). Greece isn’t going to the market at all these days, since it’s getting all its funding from the bailout package. That hasn’t stopped the 10-year interest rate on its outstanding debt from reflecting investors’ perception of its underlying solvency:

This is just weird. Paul himself has noted that you just can’t compare Greece to the US–EVER–period. The Greeks do not have currency sovereignty. For all intents and purposes Greece is a province of the EMU. California can go broke the US can’t. Now politically the US federal government can be forced to go marked to market and normally they are but they do not have to as it is a self imposed constraint. That is not to say that there are not consequences to refusing to abide by this solemn constraint it is just to say the US ain’t Greece no matter how many e’s you put in it.

Update: Yes PK is of course right even if the analogy is bad. The point of my post was that loose talk and poorly thought out analogies lead people to think un-rigorously. Specific type of people do asset allocation. California and Greece cand be compared because they are both wards of a larger monetary union. The point is crucial because the discourse on deficits is completely confused at this point and just down right wacky in the US.

Lowered expectations: Canadian Productivity

Pace Stats Can, annual labour productivity was up 1.4% for 2010 which was a level not seen since 2005. In the Canadian context that makes the latest release noteworthy. Sad really. Even more so given the bulk of the gains in the last quarter came from retail which means productivity was not driven by investment but rather by good old fashioned labour sweating or what Marx called absolute surplus vale extraction.

Canadian capitalism same as it ever was.

Never count on economists to defend the public interest

This is something that should always be kept in mind in economic policy discussions: most economists are pro-Market, not pro-Public Interest.

It is especially important to keep this in mind when we read commentary such as this, in which an economist from one of Canada’s smaller economics departments conflates being pro-market with being in the public interest.

This point is sometimes hard to see, especially since many economists hold to the deeply ingrained syllogism that being pro-market is straightforwardly being in the public interest.

But they are a lobby group like any other, and cannot be relied upon to defend the general public interest.*

Economists, particularly academic economists (and like all academics), rely on, for their social status, research funding and a quiet concious, having the public view them as working in the public interest. And given the majority of economists are true believers in the “market” that inevitably gets conflated with being in the public interest

Cloaking oneself as being in the public interest is of course one of the oldest rhetorical stances to take since like wearing the national flag it clearly puts the speaker in the role of the hero and casts those being spoken against in the role of the villains. This is all the more easy to to do when the terms of conversation are being articulated in fuzzy, ill defined concepts such as the “public interest” and “pro-market”. When an economist uses those terms they have very exotic definitions in mind that most lay people would not readily grasp. Perhaps I am being too charitable: I can’t, in fact, find a definition of the public interest in any my economics text-books.

The public interest is a rather fuzzy notion. We can perhaps all agree that it has something to do with public goods but that just raises the thorny issue of what is and what is not a public good. In any case the argument at least has to be made that a specific policy is in the public good and why. Just standing around hands waiving in the air mindlessly chanting pro-market rhetoric like “free trade” or deregulation does not really cut the mustard.

Indeed after a generation of pro-market policies like financial liberalization and deregulation with cascading financial crises of increasingly damaging intensity culminating in the Great Financial Crisis that was 2007 and from which no advanced capitalist economy has yet to emerge; in which whole nations like Iceland, Greece and Ireland were raised; in which untold millions of workers were put and remain out of work; and as a consequence a massive hole was blown in public finances around the world, it should be clear that pro-market policies are not always or even in the majority of cases un-problematically in the public good to say the very least.

Notice that even if you are want to argue that it was bad government regulation in the US which caused the Great Financial Crisis the fact is that decades of financial liberalization and deregulation (pro-market policies) directly led to the formation of global investment and insurance markets which made sure that a “made in the USA” problem had serious global consequences. And it is not just that economists did not foresee these negative consequences they actually argued in favour of these policies on the grounds that such a crisis was less likely to occur and that the consequences would be less severe in the event that it did occur because these pro-market policies allowed risk to be more evenly spread. So much for theory.

That a pro-market economist is given a national soap-box on which to conflate being Pro-market with being in the Public Interest does not bode well for the Public Interest.

* The first four paragraphs are an inverted paraphrase of the linked commentary. I apologize to my readers for reproducing a very clichéd prose style.