No. 8: We got effeciency here

For some I know this will seem a little too low on the list, but it is low because it really is low. When you are trapped inside GET (general equilibrium theory) reality is your enemy. Inside GET everything is tranquil–like a heroin addict after the needle is in and the payload delivered. In this exotic den of opium everything is tractable (well no really, Nash cooked this dream off like a poet in the night). Take a brave step away and not all that starts well ends well–and here we are not just talking about aggregation problems.

The efficient market hypothesis (EMH) not only claimed that financial markets were narrowly efficient as in they embodied all the relevant information and said information was conveyed in usably due time, but, also, that following Hayek such information was superior to any information that could be gathered and thus regulated by a central authority.

The outside play here was that ay attempt to regulate financial markets was doomed to failure because market participants would necessarily have at their disposal timely and thus superior information than public regulators. This argument got pushed so far that it was even argued that self regulation by private individuals would be superior as private actors would have better information. This logic of course suffered from a begging the question problem as in: if information is rapidly disseminated by market actors why can’t the state access that information and evolve policy and regulations in lock-step? That is to say, if information is efficiently conveyed why can’t regulators access and then use this information to regulate.

Two defences are available to the apostles of EMH. The first would argue that because the state is not a direct player in markets it in fact does not have access to this information. This is likely true, but the problem is that such a defence invites government participation in financial markets precisely so it can monitor and regulate the industry. YET, this conclusion is exactly the one EMH was designed to trounce. EMH was above all about the capacity of markets to auto-regulate. Why after all is the state needed when private markets are already efficient.

The second, and preferred, line of defence is then the argument that markets were efficient but the quality of the information was bad and that in time markets self corrected via what layman have come to call the Great Financial Crisis (GFC). Here the GFC is painted not as a crisis but an updating from poor information to good and is thus a confirmation of the EMF.

This second line of defence of course suffers from the obvious wrinkle that it boils down to the proposition that markets get things hopelessly wrong and that they can do so for such a prolonged period of time that the whole economy (not just finance) gets sucked into the vortex of ignorance. Presented as such the second line of defence is rather effervescent. For if the updating process takes such a long time and is capable of spreading bad information across a whole host of different markets from housing through to food and energy then the case for government regulation would seem strong.

But alas no! No because we only need to default back to defence one which is that the state does not have any better information than markets. But this only begs the question about the role of the state not just in terms of the regulator but in terms of a participant. In principle there is nothing that stops the state from becoming a significant player in financial markets: taking in information and then asking prudential third party questions.

In a nutshell those who would defend EMH via the second stratagem did so to avoid increased state involvement but then they have to defer to stratagem one in order to salvo the second. But stratagem one begs the question.

None of this is gainsaid by the obvious blooper that calling something efficient which demands that entire economies suffer the pain of “updating” is incredibly glib. Auto-regulation ought to imply smooth processes of adjustment. IF what EMH boils down to is that good information is turbulent which is eventually self-correcting after long period of pain then we really are back to the debates which raged before and after the Second World War.

My bet is this: Diamond and Fama will never win the Swedish bank prize but many economists will retain the ontological model in the back of their heads and demand no less from their graduate students.

A pity really.

IMF research paper: “Inequality, Leverage and Crises”

A recently released research paper coming out of the IMF is worth your time. Particularly so if you find yourself making what you take to be a serious argument about the link between inequality and macroeconomic stability but can’t seem to get any respect. Over thirty years of neoliberalism it has been constantly argued that inequality was good for growth and economic stability; this IMF paper argues the opposite and has the neat feature that it is based in evidence rather than in elegant counter intuitive theory.

Below is the abstract for the research paper by Michael Kumhof and Romain Rancière (hat tip to Andrew Jackson over at PEF)

The paper studies how high leverage and crises can arise as a result of changes in the income distribution. Empirically, the periods 1920-1929 and 1983-2008 both exhibited a large increase in the income share of the rich, a large increase in leverage for the remainder, and eventual financial and real crisis.

The paper presents a theoretical model where these features arise endogenously as a result of a shift in bargaining powers over incomes. A financial crisis can reduce leverage if it is very large and not accompanied by a real contraction. But restoration of the lower income group’s bargaining power is more effective.

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.

David Henderson makes one good point on Canada’s budget triumph

Note, if you are pressed for time just scroll to the last paragraph for the punch-line.

Seems like everyone is picking on poor David Henderson of GMU for his working paper Canada’s budget triumph. The thrust of the paper is that Paul Martin Jr’s 1996 budget proves that through austerity you can spur economic growth. Or simply stated, that austerity = stimulus. As Stephen Gordon–and Stephen is no pinko progressive–pointed out, the paper is disingenuous in two major respects.

First, private sector employment had already recovered by 1996. And second, interest rates had fallen nearly 9% from the onset of the recession prior to the 1995-96 budget. This in and of itself probably helps explain why private sector employment had recovered prior to the 95-96 austerity budget. As Stephen also points out interest rates would fall another 500 basis points after the austerity budget to their lowest level in living memory (exaggeration but close given what counts for memory these days). The culmination of which was a massive depreciation in the CAD dollar such that Canadian exporters got a 10% boost in their competitiveness without having to lift an eyebrow. The bottom line is this: Henderson’s paper is wrong because the austerity budget came after the recovery had well begun in Canada and was further helped along by interest rate cuts and a depreciating dollar.

What Stephen does not explicitly remark on unfortunately–although he does implicitly by including public sector employment in his graph–is that the austerity budget and the cuts to the public sector contained inter alia helped keep labour markets very depressed. Indeed, it would take nearly 8 years for unemployment to drop to its post recession levels.

Paul Krugman picks up on Stephens remarks over at his blog which is fitting given that Henderson specifically tries to link the Canadian experience of 1996 to current American problems. As both Stephen and Paul point out the two simply are not amenable: private employment is not back to its pre-recession levels and the FED has no more room to reduce interest rates. It was a little disheartening that neither Stephen nor Paul chose to ask the question if the 1996 austerity budget nonetheless fit with the Canada of today. That is a more interesting question; namely, will austerity today produce the same results as it did (not) back in the mid 90s. My answer would be no for the following reasons.

Canada has been witness to a steady appreciation of its dollar. This means that much of the capacity in the manufacturing export sector is likely not coming back. To the extent that commodity exports will continue to thrive is of little importance from a labour market point of view because as pointed out in a previous post these sectors are employment lean sectors. That is, you need a 5 % increase in total value added, just to get one percent of growth in employment. So unless agriculture fishing and forestry are driving the commodity exports then resources are not going to make up for the loss of manufacturing jobs.

Second, and related to the first. Commodity markets are relatively strong (that is prices are high). This was not the case back in the 90s. Interest rates are already very low (1%) so there is not much stimulus to be gained there either and the BOC is not talking about funky QE tricks either (which probably would not work anyway). The implication on interest rates is doubly bad news for Canada. Not only is there not much room to cut rates, not much evidence to suggest it would but but there is also thus no instrument (politically viable that is) to depreciate the CDN dollar. The Canadian dollar is thus out of the stimulus picture as well.

The Canadian austerians, from the Federal government (and members of the loyal opposition), to the provincial governments, down to the op-ed pages of the Globe and Mail are busy clamouring for both tax cuts and fiscal austerity. And it looks like the corporate tax cuts are a done deal.

And this brings me to the one thing Henderson got right in his paper (pp17-19) but Stephen and Paul failed to note. Namely, Martin RAISED taxes including corporate and capital gains taxes but not personal income taxes in the 93 and 94 budgets. So I guess you can raise taxes on capital and not retard private sector employment growth. Who knew?

Energy and mining: employment lean and dirty

Now do not get me wrong I am all for job growth especially good jobs that pay above average salaries but is Canada’s current hegemonic accumulation strategy (HAS) of a resource hinterland with a financial hub really the way forward? In the graph below I plot the employment intensity (or employment richness) of the major sectors of the Canadian economy.

Notice that Mining, Energy production, and power and water supply are the least employment intense of the major sectors. For example mining and energy production taken together accounted for nearly 19% of total value added (VA) in the Canadian economy but only a paltry .16% of employment in 2005. In case you are wondering the economy wide average ratio *including* these sectors is 1 %VA = .8 % employment. Exclude these sectors and the economy wide ratio would be even closer to parity.

However there are significant reasons outside of employment to doubt the current HAS. As Marc Lee points out in a recently published paper by the CCPA co written with Ken Carlaw, an economist at UBC-Okanagan, called Climate Justice, Green Jobs and Sustainable Production in BC, not only are mining and energy anaemic job creating sectors they are among the most environmentally unsustainable.

For a brief on Marc and Ken’s paper click here

UPDATE: Tom Walker has pointed out that perhaps the whole conversation on unemployment and the environment should probably shift to an adult conversation on work time reduction. I agree. See the comments section at the link to Marc’s post above.

Finance Minister Flaherty beams sunshine out of his cake hole: Labour market tells a different story

So there is this graph of harmonized unemployment rates comparing select advanced capitalist economies:


Click for crisper image

Then there is this quote from the Finance Minister Flaherty:

“We’re punching above our weight – far above our weight. And now the heavyweights are coming to us for lessons,” he said. “Leaders of the world [are] looking at Canada and our economy with envy, saying: ‘We want to be Canadian.’”

Well Jimmy they are not knocking on our door for advice on unemployment and I could drag out equally dis-confirming productivity stats to bring the hammer all the way down on the anvil but that would take thirty more minutes of my time.

More interesting it would be nice to know what advice Jimmy has been giving the heavy weights: engage in premature austerity and celebrate pyrrhic victory? No wonder Jimmy is getting invited over to all the cool finance ministry cocktail parties around the globe.

As an aside, it would be nice if the journalists over at the Globe would at least challenge the veracity of the claim. But I guess that is what unpaid bloggers do for a non-living.

A tale of Two Cities: FIRE and Manufacturing in the US (PII)

Yesterday I took a look at the changing share of value added between the FIRE and manufacturing sector in the US. Today I have thrown up a graph plotting the relative decline in manufacturing employment and the relative ascendency of employment in the FIRE and BS sectors of the US economy. Clearly the two are inversely related but a causal connection between the two remains an open question.

One of the things that complicates the analysis is that many of activities that once were done in-house from accounting, to facilities management, through to recruitment and equipment procurement are now done at arms-length via outsourced contractors.

To illustrate what I am getting at here the following example may help. In 1980 ACME car company decides to contract out for its cleaning services prior to 1980 these cleaning duties were performed by unionised janitors. So, prior to 1980 the cleaning labour would have been included in manufacturing employment and after 1980 in business services.

Nonetheless, the graph on value added shares from yesterday’s post that something more than just redefinitions are at work. In the next post I will drill down into the FIRE and BS sectors to see what is the main driver of employment growth in those sectors.

A Tail of Two Cities: FIRE and Manufacturing in the US

A question came up on another blog about the changing structure of the US economy. The graph below quits just before the “great moderation” ended. What you are looking at is the changing share of selected sectors of the US economy in total value added. What is interesting and I do not think a coincidence is that manufacturing saw a 12% decrease or (50% of its original share) in VA, while FIRE (finance, insurance, real estate and BS) increased its share by 12% to 33% of total VA. The other interesting thing to note is that while 1980 would seem to be the switch point the trend was already cast in the die which fits with the stylised facts that we have about evolution of the financialization of the US economy.


Click on graph for a crisper image.

The open question is what if anything is the link between the rise of Wall Street and the decline of main street?

Matt Taibbi on Class Welfare and the Crime of a New American Century

I encourage people to read Matt’s full blog post. Below I have reproduced what I think to be the most insightful elements: or when Matt hits high dough. Particularly when he argues that the causes of the great financial crisis were in fact legally sanctioned fraud carried out under the watchful eye of a bought and paid for state. And that really is the truth that dare not speak its name.

After the start of the GFC I wrote:

Hedge fund managers were before congress justifying their pay packages and arguing against regulation while pointing the finger of blame at the ratings companies for the crisis; aka scam, aka market failure. So which is it? Everyone agrees that crisis surely fits the bill, but the characterization of the crisis as originating in a scam or a market failure of epic proportions is being ruled out of court.

Here is the dilemma: characterize the crisis as a scam and then people will have to go to jail. The problem is that if this be a scam it involves almost every single major player in the financial and political establishment in the US. In short, call it scam and a huge swath of the US ruling class would be on the hook.

However, if the crisis is characterized as a massive market failure (and massive is no mere hyperbole, perhaps understatement) then 30 years of patient theoretical innovation in the dismal science not to mention the ideological underwriting service it played for the institutional restructuring of the past thirty years will have to be re-thought.


Here is the core of Taibbi’s recent take on the GFC:

What’s so ironic about this is that Brooks, in arguing against class warfare, and trying to present himself as someone who is above making class distinctions, is making an argument based entirely on the notion that there is an lower class and an upper class and that the one should go easy on the other because the best hope for collective prosperity is the rich creating wealth for all. This is the same Randian bullshit that we’ve been hearing from people like Brooks for ages and its entire premise is really revolting and insulting — this idea that the way society works is that the productive ” rich” feed the needy “poor,” and that any attempt by the latter to punish the former for “excesses” might inspire Atlas to Shrug his way out of town and leave the helpless poor on their own to starve.

That’s basically Brooks’s entire argument here. Yes, the rich and powerful do rig the game in their own favor, and yes, they are guilty of “excesses” — but fucking deal with it, if you want to eat.

And the really funny thing about Brooks’s take on populists… I mean, I’m a member of the same Yuppie upper class that Brooks belongs to. I can’t speak for the other “populists” that Brooks might be referring to, but in my case for sure, my attitude toward the likes of Lloyd Blankfein and Hank Paulson has nothing to do with class anger.

I don’t hate these guys because they’re rich and went to fancy private schools. Hell, I’m rich and went to a fancy private school. I look at these people as my cultural peers and what angers me about them is that, with many coming from backgrounds similar to mine, these guys chose to go into a life of crime and did so in a way that is going to fuck things up for everyone, rich and poor, for a generation.

Their decision to rig the markets for their own benefit is going to cause other countries to completely lose confidence in the American economy, it will impact the dollar, and ultimately will make all of us involuntary debtors to whichever state we end up having to borrow from to bail these crimes out.

And from my perspective, what makes these guys more compelling as a journalistic subject than, say, the individual homeowner who took on too much debt is a thing that has nothing to do with class, not directly, anyway. It’s that their “excesses” exist in a nexus of political and economic connections that makes them very difficult to police.

We have at least some way of dealing with the average guy who doesn’t pay his debts — in fact our government has shown remarkable efficiency in passing laws like the bankruptcy bill that attack that particular problem, and of course certain banks always have the option of not lending that money (and I won’t even get into the many different ways that the banks themselves bear responsibility for all the easy credit that was handed out in recent years).

But the kinds of things that went on at Goldman and other investment banks, in many cases there are not even laws on the books to deal with these things. In some cases what we’re talking about is the highly complicated merger of crime and policy, of stealing and government, which is both fascinating from a journalistic point of view and ought to be terrifying from the point of view of any citizen, rich or poor.