Welcome to “A Civil American Debate”

(This welcoming page was initially posted in March of 2011. It was updated in early 2014 to reflect our recent concentration on the economics of wealth and income distribution.)

The Economics of  Wealth and Income Inequality  

Go here for a chronological list of all posts addressing the economics of America’s most fundamental problem: the continuing and accelerating growth of income and wealth inequality, the decline of the “middle class” and the entire bottom 99%, and inequality’s causes and solutions. These posts describe and develop the essential features of the dynamic causes and effects of income and wealth redistribution in a modern market economy, with a primry focus on the U.S. economy. 

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Our Executive Summary on economics (April, 2011) contains an early look at our views on the American economy. These views have expanded considerably, are now more refined, and are accounting in more detail for changes in the field of economics that have taken place over the last two centuries. The essential features of America’s economic problems have not changed, but our intent has been to expand on the failure of the economics profession to comprehend how market economies really work.

Our discussions of other topics are listed on the Contents Topics page. We have left the following introduction unchanged from when it was first posted in March of 2011.

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Introduction 

When we started this project after the Tucson tragedy, we were determined to chronicle America’s past, identifying and discussing major problems, and hoping to help America find ways to work its way out of the current crisis.  By then, we were already gravely concerned about the results of the mid-term elections and a rapidly deteriorating situation.

Our plans to conduct a relatively leisurely series of fact-based discussions and debates quickly gave way, with the facts we are discovering and the current events that are unfolding, to a sense of urgency.  We now intend to provide a broad, fact-based information and analysis service.  We want to join others who are encouraging all Americans to get involved and stay involved in the political process.  Our primary focus for now will be on detailing the stunning economic and social facts and analysis that explain how we arrived at this crisis situation, and what can be done to turn things around.

Most Americans are probably unaware of how dangerous the current situation is for everyone but the very wealthy.  Large corporations and very wealthy people mostly have it their way in Washington, and through control of the media they are able to shape public opinion in ways that serve their interests.  We will show how they are hurting the American middle class and all Americans in the economic bottom 99% , and explain why major concepts in their self-serving ideology and propaganda are wrong.

Today the middle class is shrinking, unemployment hovers around 10%, housing foreclosures and bankruptcy rates remain extremely high, and adequate health care and education are falling more and more out of the reach of middle class Americans.  The middle class is in decline, and poverty is on the rise.  In September of 2010, CBS News Reported that one in seven Americans (43.6 million people) were living in poverty, up 8 million from August of 2004.  In sharp contrast, the rich have been steadily getting richer, and the top 1% holds the majority of America’s wealth.  This is nearly the same inequality in wealth distribution that existed in 1928, just before the beginning of the Great Depression.   Within the top 1%, a small group of multi-billionaires has achieved astronomical wealth, and they are now working to expand their control of federal, state, and local governments.  Their agenda amounts to an all-out attack on what is left of a dwindling middle class.  This grew out of disastrous policies started 30 years ago in the “Reagan Revolution,” but it is not what Reagan wanted.

The Last Two Years

After the Bush Administration ended with an economic collapse into the Great Recession and a massive Wall Street bailout, we could only share America’s guarded hopefulness that the newly elected President Obama could turn things around.  His administration appeared to stem the tide of economic collapse, stemming job losses and avoiding a deeper recession or depression.  Despite his party’s majorities in both houses of Congress, however, Obama was unable to achieve any real Wall Street reform or even produce much health care reform.

Chillingly, Congressional Republicans had become the party of “no,” openly opposing the President’s recovery efforts with filibuster after filibuster and revealing a political strategy of blaming him for the failure of those efforts. We would have expected everyone in Congress to want and to work for economic recovery, but we were sadly disappointed.

When in January 2010 the Supreme Court decided in Citizens United v FEC that corporations had constitutionally protected speech permitting them to spend as much as they desired in election campaigns, a whole new level of concern set in.  Sure enough, in the November elections corporations and billionaires spent millions of dollars, often anonymously, in support of Republican and tea-party candidates.  Consequently, voters provided the party of “no” and its new tea-party allies with a House majority and gains in the Senate, insuring that Obama would not be able to advance his recovery and jobs creation agenda in the next two years.

Exit polls revealed that voters were mainly concerned about economic recovery and jobs.  Many had been persuaded that Obama’s policies were failing and that the new members of Congress they voted for would do a better job of accomplishing his goals.  The voters had been seriously misled: the radical right has no intention of accomplishing these goals.

Instead, the radical right immediately pursued its agenda of advancing the interests of America’s most wealthy people, in opposition to those of all other Americans.  Currently (March of 2011) the radical right seeks to slash spending for federal programs that benefit ordinary Americans by some $60 billion,  including funding for low-income housing, early childhood, Low Income Home Energy Assistance grants, community health centers, and other services for the poor, asserting a politically false and economically impossible “goal” of thereby eliminating deficit spending and reducing the growing federal debt.

These cuts would be counterproductive, serving only to eliminate 700,000 to a million more jobs, worsening the economy and increasing the deficit.   Closing the deficit, however, is not the radical right’s real concern.  They served notice in December of their indifference to budget deficits and the federal debt when they forced renewal of the Bush tax cuts for the wealthy.

Our  Mission

Too many people in the middle class and below, we believe, are not yet sufficiently aware of the dramatically increased consolidation of wealth and income within the top 1% of Americans over the past 30 years, and this group’s steadily increasing control of government and the media.   Nor,  we suspect,  do they yet realize how significantly that consolidation of wealth has hurt them economically.  We were not aware when we started studying these issues of how incredibly serious the economic situation had become, but we believe we have identified and explained the major economic consequences of the last thirty years of the “Reagan Revolution,” and they are stunning.  Nobel prize-winning economist Paul Krugman and Robert Reich, among others, have convincingly argued that the radical right is leading America into another depression, destroying the prosperity and freedom of everyone in the economic bottom 99%.  We too believe that a serious depression is imminent,  but can be avoided if America changes course now.  But there is no margin remaining for political error.

Today a minority group of right-wing radicals within the wealthiest top 1%, which as noted has been given the right to buy elections, seeks to advance a very radical political agenda of privatization and corporate control of government.  This threat has emerged suddenly this year in states like Wisconsin, Michigan and Ohio, where democracy and democratic self-government are now themselves under direct attack.

This site is dedicated to demonstrating the true gravity of the current situation. Within the various categories on this site you will find analyses and findings presented in bite-sized chunks, and we will be continuously adding more details and facts.

You will find this Welcome note both as a page and as a post.  A  Summary post, also posted on the menu bar as a page, summarizes our major conceptual conclusions.   We have also prepared an Economic Summary which contains our stunning conclusions about the effect of the “Reagan Revolution” on the economy over the past 30 years, cross-linked to the relevant posts.

We provide a Resources category listing recommended reading, action groups, and information sources.  Finally, we will develop a Recommendations category where we intend to post suggestions and discussions (our own and from others) about what the bottom 99% can do to turn things around.

Our most important purpose right now is to encourage everyone to get involved and stay involved until our lives, our democracy, and our American way of life are safe from the corporate attack.  We urge everyone to organize, join political action groups, learn about what is happening in America, learn the truth and broadcast it far and wide, as we are trying to do.  We can’t do this alone.

The Future Is at Stake

We especially encourage young people, the so-called “lost generation” that is finding it progressively harder to get a good education as funding and programs evaporate from elementary school all the way up to graduate school.  You are fully aware of what is happening to you: Most students like you are finding it increasingly difficult to get higher education without incurring huge debts it may take a lifetime to repay, and even to find jobs once they have their degrees.  Increasingly, only the very rich can afford high quality education.

We graduated from high school fifty years ago, and you can take it from us:  It hasn’t always been this way.  What is happening today to education in America is outrageous.  Among the most important freedoms in America are your freedoms to get a quality education, to provide economic security for yourselves and your families, and to find fulfillment in life.  Now you must work hard to preserve those freedoms. You all are the keys to regaining your freedoms and making sure that you will have a real future, so please get started.

Here is a recent tape of a political action by Coffee Party USA  that took place at Wesleyan University, to which all young people can (and should) relate.

The huge push-back in Wisconsin against the overt attack on public-sector workers and their unions shows that once they became aware of the sinister hidden agenda of the tea-bagger plutocrats, Wisconsin citizens reacted immediately and decisively.  Here is a video of a Wisconsin farmer explaining how Scott Walker’s tax-cuts-for-corporations and spending-cuts-for-people agenda will devastate Wisconsin communities.

All Americans in the bottom 99% must continue to support the people of Wisconsin as they struggle for justice and attempt to recall legislators and a governor that won election on false pretenses.  It’s not just about unions, and it’s not just about Wisconsin.  What happens in Wisconsin, Michigan, Ohio, and Florida – anywhere in America – affects us all.

There is no doubt that the American people can defeat the power of the radical right, their wealthy patrons and their corporations, once they are aware of the truth and are galvanized into action.   Many progressive organizations and unions are fighting these suddenly very extreme attacks, and they are gaining in strength.

To be sure, the right-wing media has the ability to cause many people to act against their own interests.  But these people are in the minority, and we all have the power to ignore the radical media and disregard their propaganda and their distortions.  If we remain calm and confident, through hard work we can win this class struggle.  It is up to us.

As Michael Moore pointed out recently in Madison, Wisconsin, the 400 wealthiest people in America have as much wealth as the entire lowest half of the population, 155 million people!  But we all need to remember and stay focused on this: They don’t have anywhere near as many votes.  It’s the top 1% against the bottom 99%, so make democracy work and take back your country.

Please send our link to everyone you can.  And bookmark it for our updates! Constructive comments, questions, and information are welcome.

(We invite you next to read our Summary page, where we outline our major conceptual conclusions so far, and our Economic Summary.  Mike’s initial post, The American Bad Dream, reflects on the major developments that have affected his views and concerns over the past 50 years.)

ARC, JMH – 3/16/11

(Contents Topics)

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Inequality Made Easy: The Basics of Redistribution

In my last post, I set forth what I called “the Quantity Theory of Inequality.” Looking it over, I see that it may seem too technical for many people to focus on, so I decided to summarize how inequality works, and in effect how the economy works, in one post that everyone can understand. I’ll also put this in the historical contest of the development of economic ideas.

This is hard-won information – I did a lot of work to get to this point. Later this year, the book I am writing with all of the necessary proof will be published, one way or another! Meanwhile, here is a straightforward summary of the inequality problem, without citations. It’s a bleak prospect, but all is not lost — yet. The U.S. can correct its economic backslide, but if we keep favoring the rich and corporations, the economy will eventually collapse, and perhaps not too far in the future.

I. Mainstream economics, which subscribes to Paul Samuelson’s “neoclassical synthesis,” has basically everything wrong. Its idea of macroeconomics is an aggregation of microeconomic ideas, fashioned around the goal of maximizing personal gain and satisfaction. It imagines — an idea that came from the creators of the neoclassical tradition, especially Alfred Marshall (1842-1924), A.C. Pigou (1877-1959), and the American J.B. Clark (1847-1938) — that economies are self-correcting and will always return to “full employment” equilibrium. The idea of a naturally stable, efficient economy, popularized by Arthur Okun (1928-1980) and by Milton Friedman (1912-2006) is no more than wishful thinking. Okun expressly and incorrectly attributed the idea to the “invisible hand” metaphor used in 1776 by Adam Smith (1723-1790), and Friedman simply likened the market economy to a lottery in which government regulation and taxation defeats the whole purpose of economic “freedom.” Neoclassicism has never been more than a house of cards.

II. Classical economics were effectively rejected, not enhanced, by neoclassical theory. The best of the early classical philosopher-economists – Adam Smith, T.R. Malthus (1766-1834), David Ricardo (1772-1823) – began their “principles of political economy” texts with discussions of “economic rent” or the charges landowners added to the cost of production without themselves contributing to output. They developed principles of value, and of supply and demand, but they had no illusions about efficiency. Except for Ricardo, who was a wealthy man, they were avowed socialists; and they all regarded the objective of “political economy” to be maximizing the welfare of the entire society. The Ricardian School was perfected by J.S. Mill (1806-1873), who was, with the possible exception of Smith, the most passionately outspoken socialist of the group.

III. Basic classical ideas were extended by three economists – the German Karl Marx (1818-1883), the American Henry George (1839-1897), and the Englishman J.M. Keynes (1883-1946). Marx believed (correctly, it turns out) that inequality would grow in capitalist economies as profits accumulated, and George believed (correctly, it turns out) that the problem of poverty amidst plenty was largely due to rent-taking by landlords. Each had identified a piece of the puzzle. Keynes, however, attributed poverty to unemployment, and developed a full employment model. He had brilliant insights respecting interest and investment, but perhaps his greatest contribution was “the theory of effective demand,” which was a direct refutation of Marshall’s neoclassical ideology. Like the neoclassical economists, however, Keynes failed to account for the distribution of wealth and income, which he considered “arbitrary.”

IV. Another American economist, Irving Fisher (1867-1947), was a contemporary of Keynes who went off in another fruitful direction. He perfected the old concept known as the “Quantity Theory of Money” (QTM). The QTM was expressed in his “equation of exchange”: PY = MV. This is a definitional equality, a tautology, reflecting two sides of the same coin: Over a year, the total of goods and services sold (Y) times the average price level (P) equals the total money supply times the velocity of money. E.g., if M = 50, and PY = 100, then V=2. All money is spent twice in the year. Fisher may be better known for his “Debt-Deflation Theory of Great Depressions.” His debt-deflation model is dubious, at least in current circumstances. As the American economy gradually becomes more stagnant today, it is not proving out: There’s been plenty of debt, and a major housing debt bubble burst in 2009, but where is the deflation? Regardless, just as the neoclassical model and Keynes’s full employment model failed to do, Fishers’s formulation of the QTM failed to take into account distribution, and the growth or decline of inequality. 

V. The QTM holds the key, I suggest, that ties all of these loose ends together. As I attempted to explain in my last post, the average annual amount of money in circulation is exactly correlated with the average price level, as both are reflections of total income (GDP). If we hold everything else equal, hypothetically, it is clear that doubling the money supply simply doubles prices. But it is the corollary of that fact that is critical to understanding how the economy works: If we, hypothetically, hold prices and the money supply constant, and let everything else change, what changes in the QTM is the velocity of money, and what changes in the real economy is the distribution of money. Hence, massive inequality growth, both logically and mathematically, reduces the velocity of money. This means that our perception that inequality depresses growth, which is borne out by the income statistics of the 20th and 21st Centuries, is not merely a statistical observation: It is the direct consequence of the mathematical relationships reflected in the QTM. It is necessarily true.

VI. It can be quickly and easily verified that Friedman’s depression theory, which says that a more aggressive Fed policy could have prevented the Great Depression, was based on the presumption of a constant velocity of money. But that is not true when income inequality is growing rapidly, and wealth is concentrating high on the distribution ladder. Similarly, as I attempted to show in the last post, “monetarism,” or the idea that pumping more money into the money supply can revive a sagging economy, fails if the slowing velocity of the money shuts down the ability of monetary infusions to stimulate recovery or growth. It’s like trying to inflate a leaking balloon.

So here’s the upshot: The wealthiest Americans are making too much money – taking in way too much rent and excess profits – and paying too little in taxes. In fact, this whole thing started in the Reagan Administration when taxes on top incomes were cut, and today they are far too low. Corporations are paying fewer and fewer taxes each year. The interest on the exponentially rising national debt is, in the words of J-B Say (1767-1832) “a perpetual annuity” that in a few years will overrun the federal budget. Because of Reaganomics, we have over $18 trillion of un-repayable debt.

As we approach the next fiscal crisis, America is oblivious to this reality because it does not understand the economics of inequality and the consequences of redistribution dictated by the QTM. It’s not just a matter of “fairness” for the rich to pay more taxes: It’s a matter of payback, and more importantly, a matter of survival. We need to tell Bill Gates and Jeffrey Immelt and other billionaires who want government to pay the common costs without impacting their profiteering that they are on the wrong side of history, along with all of the other mega-billionaires, the GOP, and all of those Representatives and Senators, on both sides of the aisle, who believe the “trickle-down” fantasy that making the rich richer benefits everyone. It is a mathematical certainty that it does not.

My message to anyone who believes the economy can grow back on its own, without a complete reversal of the government policies (especially regressive taxation) that got us in this mess, is this: Don’t believe it.

JMH – 4/2/2015

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The Quantity Theory of Inequality

For the last several years, I have been among a small group of economic professionals arguing that income and wealth inequality is America’s most pressing problem, and beyond that, the way the economy works, that the distribution of income and wealth throughout the population is the primary determinant of prosperity and stagnation. Since 2013, more and more economists are moving in the direction of that conclusion, but I have seen no one else, as yet, put it that bluntly.

All of the evidence has pointed to this conclusion, but the theoretical underpinning has been lacking. The evidence has shown that rising income inequality suppresses overall income growth. When income inequality becomes excessive, slowing growth turns into ever-longer recessions and, eventually, a depression. This perception conflicts with the mainstream theories of growth and depression. It is not, however, a matter of conjecture. Now I have the missing theoretical underpinning, and it is found in “The Quantity Theory of Money.” 

The Evidence

uneven ditribtion of gains

Persuasive evidence was provided several years ago in a report from the Center on Budget and Policy Priorities (CBPP) [“Top 1 Percent of Americans Reaped Two-thirds of Income Gains in Last Economic Expansion,” Avi Feller and Chad Stone, September 9, 2009, here.]

This chart shows the cumulative growth of U.S. aggregate income over two consecutive 30-year periods, 1946-1976 and 1976-2007, as well as the cumulative growth over these periods of the top 1% and the bottom 90% income shares. This comparison reveals a pronounced, inverse relationship between income concentration and the aggregate income level.

The difference in the patterns of U.S. income growth between the two periods is extraordinary: The ability to realize income – to make money – shifted substantially to those higher on the income ladder. In the second of those two periods, in other words, household income had become more “concentrated.” Moreover, the phenomenal cumulative growth of top 1% income in the second period was accompanied by a severely stunted income growth for the bottom 90%. Thus, in the second period the top 1% was claiming so much of the new income growth for itself that very little growth was left for the bottom 99%.

The net effect of this trend was about a 25% lower cumulative growth of aggregate (per capita) income in the second period, and that is the key point: The extraordinary inequality growth since the late 1970s has reduced the overall growth rate, depressing the U.S. economy. All of this, it must be emphasized, took place before the Crash of 2008. The economic changes of the early 1980s abruptly terminated a long period of stable growth, which had been distributed more evenly among the income quintiles, and the economy commenced a gradual but relentless decline toward the Crash of 2008 and an incipient depression.

This reality is only gradually dawning on the mainstream economic community, which is accustomed to thinking of income inequality only from a subjective, qualitative perspective. Neoclassical economics has for more than a century denied that income and wealth distribution has any macroeconomic significance. The relationship of income inequality to growth has gained increasing attention, however, in the years since the Crash of 2008 and the advent of “The Great Recession.” IMF economists published studies in 2011 and 2014 which tested the statistical correlation of income (GDP) growth with income inequality, along with a variety of exogenous variables. [“Redistribution, Inequality, and Growth,” by Jonathan D. Ostry, Andrew Berg, and Charalambos G. Tsangarides, IMF Staff Discussion Note, February, 2014 , here; and “Inequality and Unsustainable Growth: Two Sides of the Same Coin?,” by Andrew G. Berg and Jonathan D. Ostry, International Monetary Fund, IMF Staff Discussion Note, April 8, 2011, here.] Their studies found income inequality to be the most highly correlated factor, and to be a consistently “robust and powerful” determinant of growth. 

A few months later in 2014, Standard & Poor’s (S&P) issued a report unequivocally concluding that “too much inequality can undermine growth.” This report seemed to have been prompted mainly by the IMF studies, but it surveyed other information as well. [“How Increasing Income Inequality is Dampening U.S. Economic Growth, and Possible Ways to Change the Tide,” S&P Capital IQ, August 5, 2014, here.] Primarily, firms like S&P rate the earnings prospects and riskiness of securities. It is therefore noteworthy for Wall Street securities analysts to sound such an alarm, especially since it repudiates the neoclassical presumption that distribution lacks macroeconomic significance. That S&P reached this conclusion should not be surprising, however, for there is no other reasonable explanation for the facts. The explosive growth of top 1% real incomes and the steady decline of bottom 90% real income fr more than 30 years necessarily implies a steady transfer of money to the top.

The Dynamics of Redistribution

To date, income inequality has rarely been explained in terms of money transfers. The macroeconomic impacts of inequality cannot be properly understood, however, without taking into account the redistribution of money. It is true that the income gap will vary considerably with changes in qualitative supply-side factors, such as labor union strength, technological change, globalization of markets, trade agreements like NAFTA and the Trans Pacific Partnership (TPP), education, skill development, and so forth. Inequality increases when factors such as these enhance corporate profits, export jobs, or restrain the growth of wages.

Income and wealth inequality by definition, however, are characteristics of the overall distribution of an economy’s money supply throughout the population. These various direct “causes” of inequality determine and direct the flow of an economy’s money, but it is the total redistribution of the money supply in all of these flows which determines whether an economy is growing or declining. The IMF economists phrased it nicely when they suggested that income growth and the redistribution of income are “two sides of the same coin.”

The Quantity Theory of Money (QTM)

Economic historians have traced the QTM back to the 16th Century, and more recently to the Scottish philosopher/economist David Hume (1711-1776) and the British economist Henry Thornton (1760-1815), but more recently the development of the concept has been attributed to the British economist Alfred Marshall (1842-1924) and especially the renowned American economist Irving Fisher (1867-1947). The basic principles are rather straightforward — indeed the fundamental proposition states a tautology. However, major difficulties in its application have led to untenable conclusions, leaving this valuable tool in limbo for many years. An underlying reason for that, I would argue, is the fundamental problem the QTM shares with the neoclassical and Keynesian income models — it has failed to take into account the distribution of wealth and incomes. 

The starting point is the “Equation of Exchange,” today generally attributed to Irving Fisher, which says:

(1)    MV = PY

Where: M is money, V is velocity, P is the average price level, and Y is real income (GDP). [This formulation can be found in the summary of lecture 15, “The Demand for Money,” by Yamin Ahmad, here, Econ 354 – Money and Banking, posted at the University of Wisconsin – Whitewater, 2011 ff., here.] The “equation of exchange” is an expression of the exact correspondence between the value assigned to all transactions in a year (PY) and the nominal value of the money used to compensate for these transactions (MV). This relationship is a tautology, because the value assigned to the transactions is defined as the amount of money expended.

Velocity (V), as Ahmed puts it, is “the number of times per year that a dollar is used in buying the total amount of goods and services produced in the economy”:

(2)   V = P x Y /M

This equation expresses the number of times the money supply “turns over” in a year, as money circulates in exchange for goods and services. Similarly, annual income is expressed as:

(3)   Y = M x V /P

Of course, statistics exist for all four of these variables, and as Fisher opined a century ago, they are fairly precise statistics.  [“The Purchasing Power of Money, its Determination and Relation to Credit, Interest, and Crises,” by Irving Fisher (1911), Preface to the First Edition, the Online Library of Liberty, here.] Despite the tautological, definitional nature of the basic formulation, however, the framing and use of the QTM creates some problems: 

Problem #1

To understand the consequences of the QTM, much depends on what is understood to be the nature of “Y”: I have pointed out in this blog that neoclassical theory is based on the presumption of a long-run “equilibrium” in which all money saved is fully invested and put to use.  To heterodox economists, however, the “long run” never arrives. GDP overstates “goods and services produced in the economy,” because it also includes great quantities of excess profits and economic rent, which are compensation paid above and beyond the real production and capital costs of purchased goods or services. There is never a state of full employment equilibrium, but instead a continuous state of disequilibrium. The implications for the QTM of this perspective are clear: Equation #3 will always produce an inflated impression of how well an economy is actually doing. 

This perspective can be visualized hypothetically: In the extreme hypothetical case that (Y) consists of 90% rent, the result would clearly be the depression from hell. Consumers would only be getting 10% of the goods and services they ostensibly paid for, money would be rushing to the top, and Irving Fisher’s nightmare scenario of a “debt-deflation depression,” if his theory is sound, would be in full swing. [Irving Fisher, Booms and Depressions: Some First Principles, 1st published, Adelphi Company, 1932, Kindle edition, 2011.] Regardless of how the depression played out, in any event, income inequality would have exploded to inconceivable levels. The QTM assumes zero rent, so it would be oblivious to this outcome.   

Problem #2

Sometimes “Y” is denoted as “T,” representing the total “volume of transactions” or, variously, the “number of transactions” [“What is the Quantity Theory of Money?,” by Reem Heakal, Investopedia, here]. This gives rise to a conceptual issue that must be guarded against: It is erroneous to think in terms of anything other than GDP, or other suitable measure of national income, for “Y” in the QTM.  Heakal’s formula is specified as follows:

(1)    MV = PT

Any definition of “T” that represents “the number of transactions,” however, would improperly introduce an index of the number of transactions as a proxy for the dollar amount of all transactions (GDP). Of course, for M, P, and T must all be comparable (measured in dollars) or the formula becomes meaningless. More importantly, specifying the income variable as some sort of index nullifies the velocity factor, reducing the equation to the observation that the purchasing power of the money supply is the reciprocal of the average price level. But that fact is a tautology — true by definition — so the QTM has no explanatory value if the actual velocity of money is factored out. (The velocity of transactions is a meaningless concept.)

Problem # 3

The typical assumption has been that the velocity of the money supply is fairly constant over time. To assume a constant velocity has the same effect as introducing an index of income (T) instead of its actual value (Y): it reduces the formula to the underlying proposition that the price level is directly determined by the volume of money. As Heakal puts it:

The quantity theory of money states that there is a direct relationship between the quantity of money in an economy and the level of prices of goods and services sold. According to QTM, if the amount of money in an economy doubles, price levels also double, causing inflation (the percentage rate at which the level of prices is rising in an economy). The consumer therefore pays twice as much for the same amount of the good or service.  

Basically, I would submit, that part of the QTM is a tautology, a mathematical certainty. This formulation makes no reference to the key variable — velocity; and ignoring the implications of velocity leads immediately to mischief, as Heakal reports:

In its most basic form, the theory assumes that V (velocity of circulation) and T (volume of transactions) are constant in the short term. These assumptions, however, have been criticized, particularly the assumption that V is constant. The arguments point out that the velocity of circulation depends on consumer and business spending impulses, which cannot be constant.

If we presume that velocity is constant, the formula is modified as follows:  

(1)    MV = PY

(2)   Y = M x V /P

                      and, if V = k, then             (3)  Y = k (M/P)

Removing the velocity as a variable makes income a function entirely of the money supply and the price level. Whether it is mainly income or prices that rise in response to increasing the money supply was the “great debate” between the Keynesians and the Austrians (Friedrich Hayek) in the early 20th Century: The Austrians argued that increasing the money supply would increase prices, not income. I always thought the Austrians had a decent argument, but that’s beside the point: Plainly, understanding how the velocity of money changes with changes in the money supply would greatly influence the outcome of that debate. To merely presume a constant velocity of money erroneously over-simplifies the QTM.  

Problem #4

This leads directly to an even bigger problem: The reality is that the velocity of circulation depends upon, and in fact is an inherent characteristic of, income distribution. We get into immediate trouble if we imagine, as Haekal’s discussion implies, that the velocity of money is somehow equivalent to the velocity of an index of transactions. All transactions are not equal in terms of their effect on velocity, and hence, on income. Transactions involving larger amounts of money, by definition, represent higher levels of income: But they also, by definition, create greater increases in the velocity of money. 

The reason it is erroneous to think of the number of events (T) as a proxy for total income (Y) in the QTM,  although perhaps not obvious, is straightforward:

Velocity is determined not just by the number of events, but also by the size of events. And the size of events is integrally related to the distribution of income.

For example, if $3 million is used to purchase 100 new automobiles, its velocity is much greater than if it is only used to purchase 100 cans of soup. Therefore, to compute the aggregate velocity of the money supply it is not enough just to count the number of “events.” 

You might object: “So what? People are always buying soup and cars, and many other things as well: Why isn’t the number of events a reasonable proxy for the total of aggregate economy-wide expenditures?” It probably would be a reasonable approximation if income distribution was more or less constant, but with income transferring to the top, more and more money has been rapidly concentrating in the hands of fewer and fewer people. The assumption made by Irving Fisher and Milton Friedman and others has always been that the velocity of money is relatively constant; but by making that assumption, economists have effectively presumed a reasonably constant distribution of income, thus assuming away the implications for income growth of inequality growth.  

This brings us to a very significant, and (so far as I know) previously overlooked, observation:

The degree of inequality in the distribution of money throughout the population controls the velocity of its circulation, thereby constraining the growth of income and the ultimate allocation of resources and products.

This point can be pinned down to a logical certainty:

  • Varying the amount of money, that is, the size of the money supply, affects the value of the money because the amount of money, all else equal, directly determines the average price level;
  • However, that is the only consequence of varying the amount of money. Doing so does not affect velocity: Hypothetically doubling the money supply while holding all else unchanged simply doubles all prices; and halving of the money supply merely cuts all prices in half. Only the value of money changes, not its velocity;
  • Apart from the volume of money, the money supply’s only other characteristics are its distribution and its velocity;
  • Therefore, if we change the money supply without holding everything else constant, which is what happens in the real world, we are introducing redistribution of the money supply, and changing its velocity;
  • Even if there is no change in the money supply, the velocity of money must be entirely determined by its distribution. Thus, the distribution and velocity of money that are “two sides of the same coin.”

Put another way, a changing money supply not only changes the amount in circulation, but also redistributes money among the population; and it is that redistribution of money that determines the velocity of money, as well as the nature and the amount of human activity. 

Distribution, it should now be clear, is the controlling factor in an economy’s performance. Statistically, growing income inequality has been consistently shown to depress growth. Now we know why: The properly specified QTM shows that result to be a mathematical certainty. The more any given amount of money is distributed among lower-income groups, the faster its velocity necessarily becomes: For example, $1 million dollars in the possession of one thousand people, each with $1,000, will tend to circulate more quickly than $1 million dollars in the hands of a single individual, for it can be spent one thousand times more quickly on goods and services within comparable price ranges, necessarily increasing the growth of aggregate income. Conversely, government policies that enhance corporate profits and redistribute money to the top necessarily reduce the velocity of money and reduce income growth.

Correctly specified, the QTM shows that these conclusions can no longer be considered a matter of conjecture: Of course, an example can be constructed of a few individuals that are circulating money more quickly than a different, larger group of people; but for the entire population and the entire money supply, such a result would be mathematically impossible.

The fact that redistribution of the money supply changes its velocity can reasonably be understood to be the core macroeconomic trait of income distribution.

More Evidence

As discussed above, the QTM requires that any increase in the concentration of income at the top will reduce the velocity of money and the growth of income. Following the Crash of 2008, the data shows, the velocity of the active money supply declined significantly. This graph from the St. Louis Fed shows the trends in the velocity of M2 money since 1950. [“The Velocity of Money In The U.S. Falls To An All-Time Record Low,” By Michael Snyder, The Economic Collapse, June 1, 2014, here.]

M2V_1-30-14-1.566

The M2 category includes most liquid forms of money, including cash and checking deposits (M1) plus “near money,” which includes savings deposits, money market mutual funds, and other time deposits, which can be quickly converted into cash or checking deposits. [“Definition of ‘M2,” Investopedia, here.]  As shown in the next graph from the Fed Board of Governors, the upward trend in the supply of M2 was scarcely affected, implying from the QTM equation that rate of income growth was substantially curtailed in the years following the 2008 Crash:

m2_max_630_378

Another graph from the same period showing the “monetary base” reveals the relative futility of the monetary policy that has followed in the years after the crash. [“Monetary Base Definition,” by Tejvan Pettinger, Economics Help, August 16, 2011, here.]

base-money-supply

As Pettinger explains: “The Federal Reserve created money to buy bonds from commercial banks. Banks saw a rise in their reserves. However, commercial banks didn’t really lend this money out. Therefore the growth of the broader money supply didn’t change much.” So long as inequality continues to rise, the velocity of money will continue to decline as will the growth of income.

Conclusions

A proper understanding of the QTM substantially changes everything:

(1) Milton Friedman’s theory that the Great Depression was the result of the Fed failing to pump enough money into the economy soon enough must be thoroughly reconsidered in light of its failure to reflect the declining velocity of money and the depression’s increased income inequality;

(2) The failure of the QTM to perform as expected since the 1980s, which caused its abandonment by monetarists, now has a rational explanation;

(3) No longer will opponents of the trickle-down mythology be limited to arguing, a la Hillary Clinton, “We tried that and it didn’t work.” Cutting taxes at the top necessarily increases inequality and reduces growth;

(4) The 2015 Republican budget plans would destroy what is left of our economic growth, ensuring the collapse of the federal government and the economy, and possibly not too far into the future;

(5) Taxes must be quickly raised on the highest incomes, on the largest estates, and on all forms of economic rent, and the revenues productively recirculated down into the economy, if we want to recover and grow properly. 

And so forth. We already knew, or at least suspected, many or most of these things. The QTM tells us that they are a mathematical certainty.

JMH – 3/28/2015 (revised 3/29/2015)

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Profitability and Progress: Capitalism’s Achilles Heel

“Blowing the Roof off the Twenty-first Century: Media, Politics, and the Struggle for Post-Capitalist Democracy,” the latest book by Robert W. McChesney, the Gutsgell Endowed Professor in the Department of Communication at the University of Illinois, is a must read for those of us concerned about our ability to survive the crises of economics and democracy now plaguing the United States. More than most writers, in my view, McChesney grasps the true nature of the economic mechanisms that constrain us. None of us, as yet, appreciates the full gravity of the distributional effects of those mechanisms, and the full impact of the growing inequality problem: That is a gap in our knowledge I am working on and endeavoring to fill. McChesney does, however, display an accurate perception of the history of inequality growth, and a sensational appreciation of the overriding importance of economic factors and ideas in shaping our democracy, our culture, and our world.

McChesney describes his perspective as “radical,” but his ideas are reality-based, and radical only in the sense that they contradict conventional wisdom. As I have been arguing, the conventional wisdom about neoclassical, mainstream economics is contrived and mostly wrong, and designed to serve the interests of the rich and powerful. To my way of thinking, what is truly radical is the increasing tendency of conventional wisdom to ignore the facts of the real world. 

McChesney’s message is certainly straight-forward: “In the coming decades we are going to see a society the likes of which has never existed, and can scarcely be imagined. I argue in this book that if the new society is going to be one in which we want to live, it will require fundamental change in the political economy.” (p. 15) McChesney defines himself as a “socialist,” and he explains what he means by that as follows:

I prefer the term post-capitalist democracy to the term socialism, though for me they point essentially the same direction. I have considered myself a socialist since I was eighteen or nineteen years old, and I still do. The term has always signified to me the creation of genuine political democracy, its extension into the economic realm, and having the wealth created by society directed to social needs. (pp. 21-22) 

In short, I propose post-capitalist democracy as a big tent to cover everyone who wants democracy and leaves out only those who put their blind faith in the wealthy, giant corporations, and the profit motive regardless of the evidence or social costs. There are a lot more people in group A than group B, fortunately. (p. 23)

The Profit Motive

Mainstream, neoclassical economics, as I have explained in previous posts, is a paradigm designed to explain how society can maximize its profits. We rarely stop and really think through how much the pursuit of profits determines the allocation of society’s resources and the balance between the satisfaction of common needs and private desires. We are becoming increasingly aware of the circumstances in which the profit motive follows perverse incentives, contrary to the broader public interest, in such areas as private law enforcement, privatized detention and prison systems, privatized health care and health insurance, private control of public communications systems, and privatized secondary education. Ownership confers privilege, and there is nothing radical about recognizing that the monopolization of the essential economic and social aspects of our existence leads to inequality and economic injustice.

There is major evidence of the conflict between public and private agendas in news reports every day. I chose today to write this short post on the distortions created by the “free” market because of several news reports in the last two days, and in particular two reports in today’s paper which I will get to shortly, that illustrate the key difference between a “capitalist” approach to solving the problems of civilization and the “socialist” approach.

Reviewing this post on Wednesday morning, I feel compelled to add this paragraph: As the world’s habitable environment becomes increasingly saturated with the growing human population, resource scarcity and environmental impacts are, in my view, the two most serious issues civilization faces. There is an urgent need to reduce our reliance on fossil fuels as the impacts of extracting marginal supplies increase, and the global warming caused by burning fossil fuels is now approaching the point of no return. Planning for an eventual obsolescence of internal combustion engines and the use of fossil fuels to generate electricity are high priorities. In the interest of maintaining their high level of profitability, however, giant energy companies keep us moving in the wrong direction.  

Energy, Pollution, and Climate Change

There is no mystery about the enormity of the cost of environmental externalities caused by economic activities: oil spills in the Gulf of Mexico and off the coast of Alaska; polluted water supplies in Montana and West Virginia; the long history of air pollution caused by the use of fossil fuels to generate electricity, and so on. It costs a great deal to prevent accidents and minimize pollution, and when producers must pay these costs, it eats into their profits. They cannot always recover such costs through higher prices, even for price-inelastic services like electricity. Huge corporations like BP fight hard against potential liabilities, settle adverse claims, then gloss over the adverse impacts of their activities with public relations campaigns and TV advertising that avers a staunch commitment to the environment. What we do not typically see from energy companies, however, are policies designed to minimize the initial damage.

Oil producers are not backing off on the hell-bent removal of oil from the tar sands of North Dakota and Canada, and there will no doubt be such a high environmental cost that, some day soon, a serious question will be raised about whether the corporate profits involved come even close to offsetting the enormous environmental costs, and whether corporate profits in, say, solar or wind power might be far more consistent with the public interest. There have been months of controversy over the Keystone Pipeline project, intended to move vast quantities of tar sands oil from Alberta right across America’s breadbasket states, and the critical mid-western aquifers. Alleged societal benefits boil down to the assertion that the economy will benefit from temporary construction jobs.

The alternative is moving this oil by rail. Just yesterday we were alerted to extremely disturbing predictions from the U.S. Department of Transportation, predictions made last July and only now being revealed:

According to federal authorities’ own predictions, potentially deadly oil train accidents are likely to be commonplace in the United States over the next two decades, with derailments expected to occur an average of 10 times a year, costing billions of dollars in damage, and putting a large number of lives at risk. The grim projection was revealed exclusively by the Associated Press, which cites a previously unreported analysis by the Department of Transportation from last July. The disclosure comes in the wake of two explosive crude-by-rail disasters in the U.S. and Canada this month alone, including wrecks and explosions in West Virginia and Ontario. (“Get Used to It: DOT Predicts Oil Train Derailments Will Be Commonplace Over Next Two Decades,” by Sarah Lazare, Common Dreams, February 23, 2015, here; see also “More Oil Train Crashes Predicted, AP, Albany Times Union, February 22, 2015, here.)

The avoidance of potentially 200 oil train derailments and the incalculable total cost in lives and environmental damage they would entail, it should go without saying, requires society to abandon the project entirely and throw its resources into “green” energy resource development, especially  since not removing the tar sands and other costly shale oil from the ground will avoid the impact that burning it would have on the pace of global warming.

I do not believe the full costs of global warming can, as yet, be appreciated; but the information available so far is alarming. Reports warn of irreversible damage to ecosystems, including (almost unbelievably) the end of life in the oceans in less than a half century. (See “Death of the Oceans – Horizon – Discovery Science History Nature” (full documentary), YouTube, September 5, 2014, here“The Disaster We’ve Wrought on the World’s Oceans May Be Irrevocable,” by Alex Renton, Newsweek, July 2, 2014, here). Yet it is climate change deniers like Oklahoma’s Senator Inhofe who control our public policy debates and determinations:

Inhofe claimed in 2003 that global warming might help humanity. It’s also important to question whether global warming is even a problem for human existence. Thus far no one has seriously demonstrated any scientific proof that increased global temperatures would lead to the catastrophes predicted by alarmists. In fact, it appears that just the opposite is true: that increases in global temperatures may have a beneficial effect on how we live our lives.”  (“Congratulations, Voters. You Just Made This Climate Denier the Most Powerful Senator on the Environment,” by Rebecca Leber, New Republic, November 5, 2014, here.)

This is anything but an objective view, and in the scientific community it is an extreme minority view. For example, as reported by Skeptical Science (Copyright 2015, by John Cook, here):

  • That humans are causing global warming is the position of the Academies of Science from 80 countries plus many scientific organizations that study climate science. More specifically, around 95% of active climate researchers actively publishing climate papers endorse the consensus position;
  • Surveys of the peer-reviewed scientific literature and the opinions of experts consistently show a 97–98% consensus that humans are causing global warming. 

Just a few days ago, moreover, the New York Times reported that one of the minority scientists most cited by global warming deniers, Wei-Hock Soon of the Harvard-Smithson-ian Center for Astrophysics, “has accepted more than $1.2 million in money from the fossil-fuel industry over the last decade while failing to disclose that conflict of interest in most of his scientific papers.” (“Deeper Ties to Corporate Cash for Doubtful Climate Researcher,” by Justin Gillis and John Schwartz, The New York Times, February 21, 2015here.)

The profit motive, clearly, lacks the heart, soul, and conscience of humanity. It is capable of driving people into the most myopic frames of mind, and presiding over the demise of, yes, even the planet.

Which reminds me: How much longer can democracy survive under the horrendous Citizens United holding that corporations are people, too, entitled to the First Amendment’s protection of free speech, and that spending money is equivalent to speech? As McChesney aptly put it:

When you compare the resources of progressives to the resources of the largest corporations and their allies, you feel like you are lining up for the Indianapolis 500 on a tricycle. (McChesney, supra, p. 26)

I would add that this metaphor may even be conservative, for the ratio of the top speed of a tricycle to the top speed of an Indy car may be considerably less than the ratio of the trillions of dollars of excess profits available to corporations and their principals for influencing elections to the savings available to progressives; and “progressives” in this instance should be interpreted as the broad category of people interested in saving the planet.

The American Energy Innovation Council

This brings me to today’s news. As we know, billionaires are people too, and many have a social consciousness that their for-profit corporations lack. According to an article in today’s New York Times, there is a small group of very wealthy business leaders who appear to meet that definition of “progressive”:

The government is spending far too little money on energy research, putting at risk the long-term goals of reducing carbon emissions and alleviating energy poverty, some of the country’s top business leaders found in a new report.

The American Energy Innovation Council, a group of six executives that includes the Microsoft co-founder Bill Gates and the General Electric chief Jeffrey R. Immelt, urged Congress and the White House to make expanded energy research a strategic national priority.

The leaders pointed out that the United States had fallen behind a slew of other countries in the percentage of economic output being spent on energy research, among them China, Japan, France and South Korea. Their report urged leaders of both political parties to start increasing funds to ultimately triple today’s level of research spending, about $5 billion a year. (“Bill Gates and Other Business Leaders Urge U.S. to Increase Energy Research,” by Justin Gillis, The New York Times, February 23, 2015, here).

Stressing the importance of new technologies to America’s “economic growth, competitiveness, and environment,” the Introduction to this report (February 2015, here) argues:

Since 2010, support for government energy research, development, and demonstration has languished, with appropriations remaining depressed when adjusted for inflation. In essence, we have been eating the seed corn of decades past. This matters because, even amid a surge in domestic production, the country’s energy challenges are more critical today than ever: though oil and gas prices have declined recently, affordable energy is out of reach for many households and businesses; oil and gas development requires renewed focus on sustainability; the electric grid is at risk from physical and cyber attacks and faces greater pressures to integrate growing renewable and distributed sources, even as demand growth is flat; global energy market volatility makes diversification from existing sources much harder; and climate change and international competition for energy resources become more threatening with each passing day. The provision of safe, clean, affordable, and sustainable energy is one of the most important missions for the United States. Fortunately, the nation’s opportunities are vast—if we invest in them.    

These are certainly worthy objectives, but unfortunately, climate change is not nearly high enough on the list of cited concerns. Some initial observations seem mandatory: These are leaders whose companies are not in the energy sector, and their appeal for progress is not to the energy sector itself, but to the government. There is no reason to assume that they are not thinking along the lines of the government support for corporations that has made them and the CEOs of major energy companies very wealthy. Does Bill Gates, possibly the wealthiest man in the world, look to the American taxpayers (who will soon be borrowing nearly $1 trillion per year to balance the federal budget) to fund these programs? Here is what they say:

The council’s fundamental finding is this: the scale of federal energy R&D investment is still just one-third of what is necessary. Federal funding remains the only viable avenue of support for energy technology research and large-scale demonstration projects.

But there is no hint in this Introduction of proposals for tax increases for the most wealthy Americans, such as themselves, or for corporations. The national debt has reached $18 trillion, and these wealthy leaders are content, apparently, to keep on doing what our government has been doing for decades, namely subsidizing corporations and enabling their empires to flourish.

And here is an equally important, if not more important, point. On p. 12 of the report we find this quotation from Bill Gates:

To solve the world’s energy and climate challenges we need hundreds of new ideas and hundreds of companies working on them. That is not going to happen without the U.S. government’s continued tradition of leadership in R&D.  Everyone has a role to play — from the private sector, to philanthropy, to the academy — but we will not be able to find the type of energy miracle we need without investing in the programs that support that innovation.  

Leaving philanthropy aside, his vision seems clear: Companies must have the incentive to work on and implement the “new ideas.” In short, the private sector must see the potential for profit, or they cannot be expected to invest in solving any of the cited concerns. This group is not interested in “socialism” in the sense we have been discussing it here, as a system concerned with the interests of society, but only in “socializing” the continuing advance of capitalism. The question is, what conviction would these business moguls need that the future of the planet is seriously threatened by global warming before they would recommend even the slightest modification to the economic system that enabled their enormous success?

And I feel compelled to make this additional Wednesday morning addition: What will it take to persuade these gentlemen that the threat of deep depression is real, and that growing economic inequality threatens their own empires? How do they expect companies like Microsoft and General Electric to survive after the push for profits, especially energy profits, has siphoned so much wealth to the top that our bankrupt federal government will be forced to default on the national debt? How do they justify continuing to support the robust growth of energy company profits, and the continuing avoidance of taxation by large corporations? At this point, their narrow focus on research and development suggests that they harbor the desperate hope that the miracle of innovation will suffice, all by itself, to sustain progress and prosperity and to protect their interests.   

Implementing “Green” Energy

President Obama has expressed a firm commitment to doing everything possible to reduce greenhouse gas emission and slow the pace of global warming. The U.S. and China reached a historic accord last November on pollution limits:

The landmark agreement, jointly announced here by President Obama and President Xi Jinping, includes new targets for carbon emissions reductions by the United States and a first-ever commitment by China to stop its emissions from growing by 2030. Administration officials said the agreement, which was worked out quietly between the United States and China over nine months and included a letter from Mr. Obama to Mr. Xi proposing a joint approach, could galvanize efforts to negotiate a new global climate agreement by 2015.

A climate deal between China and the United States, the world’s No. 1 and No. 2 carbon polluters, is viewed as essential to concluding a new global accord. Unless Beijing and Washington can resolve their differences, climate experts say, few other countries will agree to mandatory cuts in emissions, and any meaningful worldwide pact will be likely to founder. (“U.S. and China Reach Climate Accord After Months of Talks,” by Mark Landler, The New York Times, November 11, 2014, here.)

Of course, in order to reduce carbon emissions, there must be an increase in conservation and green energy in both countries. Here in the U.S., this will entail more than just lip service to the idea from the energy producers. But it also requires commitments from state governments to subsidize green energy that is not yet fully competitive with fossil-fuel sources on electric grids, and from the general population to adopt conservation measures and alternative energy sources. Also in today’s news was a report warning that changes in New York State’s government policies could threaten the growth of already commercial green power:

Advocates are warning Gov. Andrew Cuomo that two sudden changes in policy could undermine state efforts to promote clean solar energy and energy efficiency. Changes made in December by the state Public Service Commission and New York State Energy Research and Development Authority, cut how some large solar farms are paid for power and imposed income guidelines for property owners to qualify for state-subsidized clean energy loans. The changes prompted 30 alternative energy companies and advocates from across the state to write to the governor last week.

The changes “are undermining the growing clean energy market at a critical time by reducing incentives far too rapidly … and leave most large-scale solar projects upstate not financially viable,” the letter stated. “These actions regarding large-scale solar are undermining your signature policy of assistance to boost the upstate economy by hampering the development of well-paying green jobs.” (“Curb in Aid Hurts Solar,” by Brian Nearing, Albany Times Union, February 23, 2015, here.)

The specific issues here involve NYSERDA’s recently announced cutback on its five-year-old Green Jobs-Green New York subsidized loan program that helps property owners pay for alternative energy like solar panels, or energy efficiency retrofit programs. “Starting this year, NYSERDA will impose income guidelines on residential property owners, and bar apartments, small businesses, and not-for-profit groups from qualifying.” This means that potential investors in solar alternatives will have to borrow at market interest rates. Simply put, profitability to lenders will take precedence over the social objective of reducing carbon emissions.

The issue involving the PSC, my former agency, involves premiums paid by utilities for solar energy:

In the Capital Region, the owners of Rensselaer-based Monolith Solar said changes imposed by the PSC in December to end a premium that utilities pay for power produced by certain types of solar farms could threaten hundreds of its projects. The change would affect off-site solar farms for universities, school districts and municipalities, which can make money selling power back into the grid in a practice called remote net metering.

Melissa Kemp, of Renovus Energy, an alternative energy installation firm from Ithaca, said that change could cost a solar farm a third of its annual revenue. The PSC is scheduled to decide Thursday on whether to revisit its decision. Groups urging the PSC to reverse course include three major solar industry associations, Cornell and Binghamton universities, and Wal-Mart.

As income and wealth inequality grows, it becomes increasingly difficult for state governments and their agencies to accomplish green energy goals. Thus, it’s not just a question of increasing R&D efforts and finding new technologies, as maintained by the American Energy Innovation Council.

Conclusions

An economic system owing its allegiance to the profit motive, i.e., a “capitalist” system, is loaded with perverse incentives, and leads to badly allocated resources. It leads as well to denial of the facts of reality, when necessary to promote opportunities for profit. The result has been to prevent timely action to prevent global warming and its dire consequences, including mass extinctions, and the possibility of the death of ocean life.    

This post has focused on the energy sector. There is enough here, I suggest, to verify McChesney’s argument that “if the new society is going to be one in which we want to live, it will require fundamental change in the political economy.” We will have to step back from our all-out commitment to an economic philosophy of promoting personal gain and profit maximization and seriously consider other means of providing for the common good.

Bill Gates and Jeffrey Immelt must live here on this planet with the rest of us, and are just as reliant on interdependent economic systems as everybody else.  The sooner they realize that, the better.

News flash: Today President Obama vetoed the Keystone Pipeline! I can’t wait to read about it tomorrow.

JMH – 2/24/2015 (ed. 2/25/2015)

Postscript (added 2/27): Yesterday at its regularly scheduled session, the New York Public Service Commission (PSC) responded favorably to the complaint of Monolith Solar, and other solar energy producers that eliminating the premium utilities pay them for their excess power — for resale to electricity consumers — would threaten “the future of hundreds of large-scale projects across the state.” (“PSC lifts solar shadow,” by Larry Rulson, Albany Times Union, 2/26/2015, here)  This was the lead story in today’s paper.

The PSC is on the horns of a dilemma. I know very little about Audrey Zibelman, the PSC’s new Chairman, who arrived a decade after my retirement from the agency: She appears to be an effective leader, sensitive to the conflict between reducing the amount of fossil fuel generation on the electric grid and protecting consumers from exorbitant rates (the traditional role of the PSC) by keeping the price of electricity as low as possible. As today’s article explains, eliminating the 30% price premium paid by utilities for solar power will be delayed, under yesterday’s decision, to avoid harming the budding solar industry.   

In the long haul, it seems to me, New York should consider using public authorities such as the New York Power Authority (NYPA) and Long Island Power Authority (LIPA) to manage the development and distribution of solar and wind power. NYPA has provided clean, inexpensive hydroelectric power for decades (here). Before I retired, a big part of my job was presiding over proceedings for the certification of new power plants, at the time mostly natural gas-fueled plants, with a minimum of adverse environmental consequences. Perhaps the effectiveness of that approach has waned.   

If we are going to respond effectively to the urgent need to reduce carbon emissions,  and avoid the drastically increased environmental harm discussed above, it might well be best (maybe even essential) to return to public provision of green power, rather than leaving our future up to the arbitrariness of profitability. Note that Gates and Immelt have already concluded that public investment in R&D is the most effective avenue for progress. If the private sector cannot get the job done on its own, perhaps public ownership of a significant share of this segment of the means of production is the answer. The use of public authorities has been a time-honored tradition in the United States, always considered an acceptable form of “socialism.”  

 

   

        

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Dynamic Scoring: Delusion, Danger, and Disaster

On the very first day of the 114th Congress, U.S. House leadership adopted a new, hyper-partisan and hyper-political rule that has the potential to add billions on top of billions to the federal deficit with every bill that passes.

So-called “dynamic scoring” completely invents a future where unlimited and unpaid-for tax cuts and loopholes for large corporations and the very wealthy create a more prosperous environment for us all — simply to circumvent the nonpartisan Congressional Budget Office that Republican and Democratic majorities in Congress have used since 1974. This rule passed with only Republican support, 234-172.

This strategy gives complete leeway to the Republican House majority to “pretend-then-spend.” They’re allowing the author of any bill for at least the next two years to invent an outcome where massive giveaways to special interests help everyone — with no budgetary, economic or historic evidence to back up their claims. When you couple this strategy of dynamic scoring with recent laws and Supreme Court cases that allow big corporations and the nation’s wealthiest to flood Washington with money to get their way, we are entering very dangerous territory.  — U.S. Congressman Paul Tonko, 20th Congressional District, New York (“Viewpoint,” Albany Times Union, January 14, 2015, here).

On this blog in recent months I have followed the federal budget situation with growing alarm, and attempted to clarify the extreme danger it poses to our country and its economy. Rep. Tonko has accurately described the problem posed by the new “dynamic scoring” rule: The rule further enables the dangerous Republican agenda. The continuous deficit spending since the Reagan Administration, interrupted only by brief surpluses in the Clinton Administration, has finally brought the country to the brink of economic disaster, and this is indeed “very dangerous territory.”

Dynamic Scoring

The dynamic scoring rule requires the Congressional Budget Office (CBO) and the Joint Committee on Taxation (JCT) to include “the economic effects of legislation . . . in a bill’s official cost to the Treasury” (“House Republicans Change Rules on Calculating Economic Impact of Bills,” by Jonathan Weisman, The New York Times, January 6, 2015, here). This rule underscores the fact that only the proposed amounts of changes in budget proposals are normally accounted for. CBO produces a ten-year “forecast,” but the forecast is not changed to reflect the estimated effects of legislation, as I have verified in my recent posts on CBO “forecasts.”   

The official argument for dynamic scoring is this: “To predict the budgetary impact of a major federal policy accurately, analysts should take into account the policy’s potential macroeconomic effects.” (“Accurate Budget Scores Require Dynamic Analysis,” by Salim Furth, The Heritage Foundation, December 30, 2014, here.)  That sounds sensible, but as the Center on Budget and Policy Priorities (CBPP) points out:

In reality, however, the House would be asking CBO and JCT [Joint Committee on Taxation]  for less information, not more, and the new rule could facilitate congressional passage of tax cuts that are revenue-neutral only on paper.

CBO and JCT already provide macroeconomic analyses of some proposed bills as a supplement to the official cost estimates they produce.  These analyses typically present a range of estimates of the legislation’s impact on the economy.

The new House rule, in contrast, asks for an official cost estimate that only reflects a single estimate of the bill’s supposed impact on the economy and the resulting revenue impact. (House “Dynamic Scoring” Rule Likely Will Mean More Tax Cuts — Not More Information” (PDF), by Chye-Ching Huang and Paul N. Van de Water, January 5, 2015, here.)

The concern is that this rule will be used to enable a one-sided point of view on the potential effects of legislation:

If highly optimistic economic and fiscal assumptions . . . are included in official cost estimates but then fail to materialize, the result will be higher deficits and debt.  And as CBO, JCT, and other analysts have warned, tax cuts that ultimately expand deficits can slow economic growth, rather than increase it, because the higher deficits can create a drag on saving and investment (Id.).

And CBPP adds this understated caveat:

Dynamic scoring could facilitate congressional passage of large rate cuts in tax reform by making the rate cuts appear — on paper — less expensive than under a traditional cost estimate.  That’s because some of the models of the economy and related assumptions used to produce a dynamic cost estimate might show some tax reform packages boosting economic growth and thereby generating additional revenue (Id.).

But these objections state the case far too mildly, and far too politely. Alas, this polite conversation about how dynamic scoring is really about trying to enable more tax cuts, which might lead to higher deficits and debt, simply avoids a very unpleasant truth: Our plutocrats have used our government to enrich themselves, and a close look reveals that the well has nearly run dry — but they keep scraping and gouging for more. It does not appear that they have made a calculation of when, if ever, they will have to stop. 

The Delusion

Unfortunately, the “trickle-down” idea that tax cuts will even partially pay for themselves is entirely wrong-headed, and it is traceable, ultimately, to the rejection by mainstream economics of the Keynesian principle of effective demand. So is the “austerity doctrine,” which posits that cuts in government spending will create growth to make up for the lost revenues caused by reduced taxation. I won’t go back over my discussions of the disproof of the austerity doctrine accomplished by the correction of the Reinhart/Rogoff study “Growth in a Time of Debt” (GITD), which had been Paul Ryan’s sole “economic” support for the claim that the massive spending cuts in his 2012 and 2013 budget proposals would, somehow, stimulate growth and produce deficit-reducing tax revenues. (See “Reinhart, Rogoff, and Reality,” May 30, 2013, here; “Reinhart, Rogoff, and Ideology,” June 6, 2013, here; and “Reinhart, Rogoff, and Redistribution,” June 30, 2013, here.)

The bottom line is that reduced government spending is a direct contraction of the economy, the exact opposite of growth. Doing that to reduce budget deficits, instead of increasing taxation of corporations and the wealthiest Americans, has exactly the wrong macroeconomic result: It reduces growth, instead of increasing it.

Similarly, the “trickle-down” notion that still more tax cuts for the wealthiest Americans and corporations will somehow stimulate growth and increase tax revenues has been repeatedly disproved. The incredible idea that such tax reductions might even somehow pay for themselves is, quite frankly, absurd. In an earlier post (“Amygdalas Economicus: Perspectives on Taxation,” originally posted January 24, 2013, here) I included a report on the Heritage Foundation’s delusional trickle-down forecast for the “dynamic” effects of the Bush tax cuts:

In their April 27, 2001 report “The Economic Impact of President Bush’s Tax Relief Plan” (The Heritage Foundation, Center for Data Analysis Report #0101, April 27, 2001, here), D. Mark Wilson and William Beach predicted that the Bush plan would significantly increase economic growth and family income while “substantially reducing federal debt.” In fact, they predicted, the Bush plan would greatly increase government revenue, so much so that “the national debt would effectively be paid off by FY 2010.” In other words, they argued that the Bush tax cuts would more than pay for themselves, by an incredible amount.

What actually happened, however, is that the federal debt, which was at about $6 trillion in 2001, increased to about $13.6 trillion by the end of 2010 (Treasury Direct, here).  The Heritage Foundation’s estimate of supply-side “stimulation” was off by almost $14 trillion, nearly one year’s GDP.  In those years the economy suffered stagnation, not growth, climaxing with the Crash of 2008 and the Great Recession.  So, whatever the actual isolated effects of the Bush tax cuts were, the Heritage Foundation’s prediction that they would more than “pay for themselves” was pure fantasy.

It is alarming to see this same Heritage Foundation, only a few years later, arguing for dynamic scoring on the ground that we need to improve the accuracy of macroeconomic predictions. The Republican agenda of massive tax cuts for the rich and corporations hasn’t changed, and neither has the nature of reality. Whatever the Heritage Foundation’s agenda for the future of America and its economy may be, it does not depend on the accuracy of macroeconomic projections.

The underlying problem lies in the gimmicky, static nature of supply-side forecasting, which is based in neoclassical supply-and-demand economics. The CBO and other mainstream forecasters can not realistically predict growth based solely on supply-side forecasting, because it only attempts to emulate optimal productive capacity. That is essentially a “static” model, completely ignoring the effects of demand on growth; so trying to make it more “dynamic” is like putting lipstick on the proverbial pig. To put it more politely: It involves nothing but subjective guesswork; it is a fertile field for biases and fantasies.

Demand factors, which create drags on growth, are excluded from direct consideration in supply-side models, and are unlikely to be considered in any supplemental macroeconomic analyses.  The biggest deficiency of forecasting at this point is the failure to comprehend, much less reflect, the continuously growing inequality of incomes and concentration of wealth in America. Any serious “dynamic scoring” would have to reflect the effects on growth and tax revenues of the continuous concentration of wealth at the top, a concentration that has averaged more than $500 billion annually since 1979-80. It is now apparent that the demand-side effects of inequality growth materially depress the rate of income growth:

Of course, CBO’s underlying forecast does largely incorporate these effects, as experienced so far, by predicting only about 2.1% annual growth through 2025 — although it remains on the optimistic side, for growth since the crash has averaged less than 2% per year. 

Moreover, given that the high level of inequality growth is a consequence of the tax cuts on top incomes and corporate earnings that created the national debt — now over $18 trillion (Information Station, December 5, 2014, here; Economic Research, Federal Reserve Bank of St, Louis, here) — any accurate scoring of proposed additional tax cuts would have to include a careful analysis of the resulting increase in wealth transfers to the top. Wealth concentration is an ongoing, dynamic process, continuously reducing the growth of tax revenues, and increasing deficits. In other words, the negative effects of failed trickle-down policy would have to be taken into account. The current dynamic scoring proposal is a one-sided affair which, as Congressman Tonko properly points out, only further obscures our perception of danger.  

The Danger    

The national debt now exceeds $18 trillion. If it were increasing only by the amount of the interest payments on the outstanding balances, the debt would simply be naturally compounding, in an exponential growth. However, the debt is growing even more rapidly than that, because tax revenues remain insufficient not only to cover the interest payments, but also to cover current expenses. 

The consequences were fully displayed in CBO’s February 2014 presentation of “The Budget and Economic Outlook: 2014 to 2024″ (here), which was extended through 2039 in the “Long-term Budget Outlook,” July, 2014, (here). The February 2014 report revealed a rapidly increasing danger posed by the exponential growth of the interest on the national debt.  Here is CBO’s table from that report, showing that debt held by the public is projected to grow from $12.7 trillion in 2014 to $21.3 trillion in 2024, nearly doubling (government-held “internal” debt, e.g., the Social Security balance, will also grow, but the interest it accrues is not immediately payable): 

CBO budget outlook 45010-Outlook2014_Feb

This $8.6 trillion increase in debt held by the public is the accumulation of annual deficits which are projected by CBO to grow to $1 trillion per year by 2024, as reported by The Wall Street Journal (“Deficit Forecast Trimmed as Rates Stay Low,” by Damian Paletta, WSJ, August 27, 2014, here):

federal deficit projections 8-27-14 wsj- cbo

As the debt grows, the interest increases commensurately; the following table from the February 2014 report shows the CBO projections of interest costs, along with all other federal outlays,  over the next decade:

CBO budget outlook 45010- outlays

These data reveal how much faster debt interest is projected to grow than any other expense category through 2024:

  • Total mandatory outlays are projected to increase from $2.1 trillion in 2014 to $3.7 trillion in 2024, a 77% increase;
  • Total discretionary outlays are projected to increase from $1.2 trillion in 2014 to $1.4 trillion in 2024, a 16% increase;
  • The defense budget portion of discretionary outlays is projected to increase from $604 billion in 2014 to $719 billion in 2024, a 19% increase;
  • Interest on the national debt is projected to increase from $233 billion in 2014 to $880 billion in 2024, a 278% increase.

Growing debt interest is steadily swamping the entire budget. Stunningly, debt interest is projected to surpass the entire defense budget by 2021, at which point defense spending is projected to be 52% of all discretionary spending. And by 2024, interest paid on publicly-held debt is projected to have grown to $880 billion, an incredible 39% of the total of interest and all discretionary spending ($1.383 trillion)! And, of course, inter-governmental debt is also growing and accruing interest, a major unresolved problem. A default on the national debt would crush Social Security, Medicaid, and Medicare, the so-called “entitlement” programs, the contributions to which have been replaced with interest-bearing government debt.    

It’s a Distributional Problem

CBO has casually stated from time to time that this trend cannot be allowed to continue indefinitely. It has failed to evaluate, however, how much longer the U.S. government might be capable of continuing on with these perpetual deficits, and paying out debt interest as a perpetual annuity to bond holders. CBO blandly charts budget trends out to 2039, as if somehow it might be possible to get that far.

Wikipedia gives us this common, and commonly understood, definition of “bankruptcy”:

Bankruptcy is a legal status of a person or other entity that cannot repay the debts it owes to creditors. In most jurisdictions, bankruptcy is imposed by a court order, often initiated by the debtor.

By this legal standard, our federal government has been bankrupt for many years, unable to generate enough revenue from its taxpaying “customers.” But the creditors in this instance, at least those on this side of the Pacific Ocean, are not interested in repayment. They are content with a perpetual annuity paid for by those U.S. taxpayers who do not own government bonds.

This munificence has not been voluntarily permitted by taxpayers; it is enforced by the plutocrats that run our government.  No corporation would dream of continuing on such a basis. A few days ago, for example, Target announced that it was shutting down its entire Canadian operations, closing 133 stores, having lost $2 billion in less than two years of Canadian operations. (Kavita Kumar, The Star Tribune, January 15, 2015, here). American taxpayers have no such easy way to cut their losses. 

Tragically, the debt itself is a major benefit to the plutocracy, because with its unduly low tax burden, it is allowed to keep its ever more highly concentrating wealth. The wealthy elite that has requested “dynamic scoring” is not interested in being more precise about macroeconomic impacts. Rather, its financial interest lies in continuing to increase the debt as much as possible, because interest is paid on the debt in a perpetual annuity. That is why they perpetuate the “trickle-down” myth; and that is why, given the expanded opportunity offered by “dynamic scoring” to imagine that there will be fantasy growth from Republican austerity and tax cut proposals, they can be counted on to attempt to use this device to its fullest advantage.      

Of course, the federal banking system has in the past been able to print more money when needed to feed this insatiable desire. But the $18 trillion of debt is the cost to all Americans of money “printed” so far to finance the increasing net worth of the wealthiest Americans. Including off-shore accounts, as I estimated more than a year ago, the net worth of the top 1% of America’s wealthiest households has increased by some $22-25 trillion since 1980, indicating that the economy is structured to reduce the wealth and incomes of lower income and wealth classifications.  

That is where the money went, and that is why we have an intractable inequality problem. Our plutocrats have used our government to enrich themselves, and it does not appear that they have made a calculation about when, if ever, to stop. We can only wonder how much longer the rest of the world will tolerate this continuing abuse of its prime currency, the U.S. dollar, and when the next major collapse of the dollar will come. Obviously, the well has nearly run dry, and our nation has nothing to show for it but vast inequality, a rising depression, and a hopelessly bankrupt government. 

JMH -1/19/2015 (ed. 1/21/2015)

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Inequality and Growth: Two Sides of the Same Coin

[Note – This article was originally published on 3/29/2014.]  

Two-sides-of-the-Same-Coin

In a cogent and extremely relevant article posted on January 16, 2014 (here), Neil Buchanan asked: Where Have the Academic Experts Been Hiding? Here’s the part I want to talk about:

The Role of Scholars in Economics in Downplaying Inequality

What is surprising is that, especially among economists (even nominally liberal economists), there has long been a tendency to treat inequality as an unworthy subject of discussion. This is not a matter of the conversation simply being hijacked by academic conservatives.  There are plenty of conservative economists in top-tier economics departments.  (Harvard’s Economics Department alone is the home to four of the most high-profile conservative economists in the world.)  The interesting dynamic has been the complicity of mainstream economists in taking inequality off of the agenda of “respectable” research.

Why would they do this?  The innocent (and, I think, mostly accurate) explanation is that economists, after the 1970’s, wanted to focus on how to get the economy as a whole to grow.  At that point, distribution of wealth and income was not much of an issue, as described above, because it seemed that the fruits of growth would automatically be spread widely. The analytical move by academic economists was to say that growth and equality were simply different issues, and that the issue driving the conversation should be how to maximize growth.  That did not require that the conversation would never return to the question of inequality, but that is the way it turned out.

I certainly observed many situations, among both economists and legal scholars whose research is modeled on mainstream economic reasoning, in which anyone who even raised the question of equality was all but laughed out of the room.  The mockery was not always (or even most of the time) an attack on someone for caring about inequality; rather, it was instead a condescending statement that the offending party “just doesn’t get it.” In other words, the ideologically neutral form of the conversation was, “Let’s talk about growth, and set inequality aside to discuss later, in a different conversation.”  Unfortunately, that quickly became “You’re talking about the wrong thing if you try to talk about inequality,” and then, “Talking about inequality is not allowed.”

In short, even the non-conservative parts of academia have helped to feed the “centrist” obsession with repressing any discussion about inequality and redistribution.  Happily, that has started to change over the last few years, with more and more economists and legal scholars noting that the growth/distribution divide never made all that much sense, and that the social problems that are associated with gross inequality have reached crisis proportions.  (Emphasis added)

The ideological problems are far deeper than Buchanan’s discussion reveals. The issue of whether and how inequality is related to growth is itself deeply steeped in ideology (let’s call it “level 1″ or “L1″ mythology), and our difficulty understanding the full extent of the problem, or even with understanding how the economy works, is almost entirely due to our failure to understand that fundamental point. If you are conservative, as opposed to “non-conservative,” you extend your ideology to a more extreme, and more obviously faulty level (which I’ll call “level 2″ or “L2″ mythology). This post will explain the difference between these two levels of ideology.   

Level 1 Mythology

I have been saying ever since I began to focus extensively on inequality, about three years ago, that growth and inequality are “two sides of the same coin.” For most of the that time, it seemed like only Robert Reich, among the few economists who were speaking up about inequality, shared that perspective. Then, in July of 2012, Joseph Stiglitz published his book The Price of Inequality, and I had another ally. Highly unequal societies are highly unstable, he has been saying, and that is exactly what “unstable” means: Inequality depresses growth. 

Most economists, among them notably Paul Krugman, didn’t agree. This disparity of views is explained by a difference in perspective: Today’s mainstream economists are raised in the “neoclassical” school of economics, and those in the mainstream like Krugman who consider themselves Keynesians are actually to a large extent “neo-Keynesians,” which is considerably different from the true Keynesian perspective. The neo-Keynesian perspective emphasizes Keynesian theory in connection with policy matters, but is locked into the neoclassical perspective of how the economy works, a very awkward position to be in. Together, the neoclassical and neo-Keynesian schools of economics constitute the vast bulk of what Buchanan refers to as “mainstream economics” today, and that includes nearly all of the economics taught since I learned economic theory in the early 1960s.

Both of these schools are based on solely on an ideology — the L1 mythology — which is fundamentally wrong (by 180 degrees) about how market economies work. Put simply, it is bottomed on a “supply-side” vantage point in its conception of growth: Make it, this point of view insists, and people will buy it. But this perspective turns out to depend on a whole host of assumptions (e.g., perfect competition, perfect knowledge, perfect efficiency, full employment equilibrium) that are not, and have never been, true. Thus, the argument that growth results from expanding investment is like the argument that you can push a piece of string in a straight line across a table. It confuses cause and effect.

Consequently, forecasts or retrospective analyses of growth designed to reflect supply-side assumptions, as frequently discussed on this blog, are fraught with confusion and contradiction. I have reviewed reports on studies involving growth or inequality as I learn about them, and I have routinely found timidity and candid admissions of confusion from the analysts that the studies did not produce the results they expected.   

John Maynard Keynes taught us that investment responds to demand. Keynes’ “demand-side” perspective, put simply, reminds us that people need money (from income, wealth, or debt) before they can buy anything. A piece of string must be pulled across the table. Conceptually, this understanding was the basis of his General Theory of Employment, Interest and Money (1935). It was all but abandoned by mainstream economics after the 1960s, however, because it implied that instability and decline were natural developments in market economies, and therefore that central governments would have to step in and stimulate demand throughout the economy. The L1 myth developed around a rejection of Keynes’s General Theory.

The Keynesian Logic

The General Theory focused on how much demand would be generated by a given (initial) level of “income” (GDP), defined essentially as the total of all transactions, including all payments for labor, capital or consumption. Keynes specified three independent variables in his model: The interest rate, the propensity to consume, and the marginal efficiency of capital. These three factors, acting independently, Keynes argued, determine income and growth. The cyclical level of economic activity revolves initially around the propensity to consume; i.e., as people decide to reduce current spending and increase deferred spending (saving) current economic activity declines, resulting in an initial decline of GDP, compounded (as money circulates) by a bounded multiplier effect.    

This was Keynes’s major contribution to theory. Classical (hence neoclassical) theory ignored the demand function, and therefore had no way to explain growth or decline. The neoclassical model (as developed via Ricardo, Walrus, Marshall and eventually Paul Samuelson, among others) erred by assuming that “supply creates its own demand,” essentially treating the economy as a static aggregation of transactions. Because the interest rate is independent of the other two variables and is not an equilibrium of the supply and demand for money, and because a decline in current consumption does not automatically imply an increase in future consumption, Keynes famously reasoned, an increase in saving, instead of resulting in more investment, results in increased unemployment. No, this was not intuitively obvious to many, though Keynes said it was, which is why it was such a major theoretical development. The upshot, however, is that a market economy is inherently unstable, and that because investment depends on expectations of future demand, an economy’s current level of demand must be stabilized as it rumbles along by infusions of government spending.

The point is that the entire basis for neoclassical economics is itself a myth: As James Galbraith has pointed out, most economists take it as a matter of faith that economies will return on their own to full employment after brief down periods, that is without the stimulation Keynes demonstrated was necessary; but when an economy is always declining, that cannot happen, and eventual collapse into deep depression is inevitable. That is the ultimate reality revealed by Keynesian demand-side economics.

Mainstream academic economics was destined to be controlled, however, not by science but by philosophy; in particular, the philosophy of Milton Friedman, who wanted to keep government from interfering with the “free” economy. So he argued that economies will grow and prosper even while wealthy people are making and keeping as much money as a “free” market will allow. Ignoring considerations of social utility, Friedman made it clear that he opposed interference with the natural distribution of wealth and income established by the free market, which he analogized to the operation of a lottery:

Consider a group of individuals who initially have equal endowments and who all agree voluntarily to enter a lottery with very unequal prizes. The resultant inequality of income is surely required to permit the individuals in question to make the most of their initial equality. Redistribution of the income after the event is equivalent to denying them the opportunity to enter the lottery. (Capitalism and Freedom, U. Chicago Press, 1962, 2002 ed. p. 162)

Note that, from the outset, the underlying issue was distribution, and a separate elaborate line of argument was subsequently constructed by the “conservative” economic community to the effect that income and wealth distribution has no macroeconomic significance, and should be ignored. That line of argument forms the basis of L2 mythology.

Level 2 Mythology

The best example of that argument, “Reducing poverty, not inequality” (here) was offered in 1999 (here) by the former chairman of Ronald Reagan’s Counsel of Economic advisers, Harvard professor Martin Feldstein, who asked us to imagine that a “magic bird” made a small award that would not affect anyone else’s “material well-being.” The truth, however, is that many trillions of dollars of wealth have transferred to the top 1% over the last 30-40 years, both from the bottom 99% and the proceeds of America’s escalating national debt. So the “material well-being” of the bottom 99% has been drastically reduced by redistribution:

productivity veresus inflation-adjusted-wagesThis chart, published by Gus Lubin (November 12, 2013, here), shows that since the advent of the Reagan Revolution presided over by Martin Feldstein and other ideologues, America’s productivity continued to grow, but the gains have remained with the producers while median wages have fallen.   

By now, nearly all informed Americans should be clear on the bankruptcy of the “magic bird” myth. Paul Krugman is getting more serious recently in attacking this issue (“That Old-time Whistle,” New York Times, March 17, 2014, here):

But over the past 40 years good jobs for ordinary workers have disappeared, not just from inner cities but everywhere: adjusted for inflation, wages have fallen for 60 percent of working American men. And as economic opportunity has shriveled for half the population, many behaviors that used to be held up as demonstrations of black cultural breakdown — the breakdown of marriage, drug abuse, and so on — have spread among working-class whites too.  

Meanwhile, media reports continue to amaze us. Detroit is in bankruptcy, its residents wallowing in third-world poverty. Syracuse, NY and many other cities face intractable fiscal problems. Just yesterday, I heard a PBS radio news report that a hospital in northern Massachusetts actually shut its doors because it cannot afford to stay open; sufficient funding could not even be found to keep the ER open. It is becoming increasingly evident that America’s economic woes are attributable to a fundamental shortage of money in the active money supply available to the bottom 99%. This is the stuff of stagnation, of depression.

The “Invisible Hand”

The sum and substance of the L1 mythology, finding no support in scientific economics, was eventually propped up by “the doctrine of the invisible hand,” a mythical and wholly false attribution of Friedman’s alleged “free market” philosophy to Adam Smith. (See my post “The Cult of the Invisible Hand,” December 22, 2013, here.)

Hang on to your hats: The fallacies behind the L2 myth (that distribution is macroeconomically insignificant) and the L1 myth (that an economy will always return to full employment “equilibrium” on its own) are virtually identical. L1 is like believing in the tooth fairy: the money needed for growth will magically appear under our pillow, as needed. L2 is the converse: growing income and wealth concentration does not have a negative impact on the active money supply, or put another way, the lottery winners can gather in money without restraint without hurting anyone else, without violating the so-called “Pareto Principle.” The latter idea has been stretched into the “trickle-down” argument, an idea that may have even pre-dated Adam Smith: This is the claim that the more money concentrates at the top, the better off those below will be; growth at the top causes growth at the bottom. 

In all these instances, when money is needed, it’s simply assumed to be there. That’s a fraud – the money supply is finite, so people really are hurt by inequality growth. Joseph Stiglitz recently weighed in on this point in his excellent discussion of the globalization of inequality (“On the Wrong Side of Globalization,” Opinionator, March 15, 2014, here):

In this series, I have repeatedly made two points: The first is that the high level of inequality in the United States today, and its enormous increase during the past 30 years, is the cumulative result of an array of policies, programs and laws. Given that the president himself has emphasized that inequality should be the country’s top priority, every new policy, program or law should be examined from the perspective of its impact on inequality. * * * And this brings me to the second point that I have repeatedly emphasized: Trickle-down economics is a myth. 

Here’s the real kicker: The impacts of redistribution on growth are vastly more significant than changes in Keynes’s propensity to save, the relatively minor trade-off between current and future consumption. Distribution of wealth and income  encompasses the entire money supply. We now know that since the Reagan Revolution began, the rate of growth was depressed in all five income quintiles, so growing inequality, while it was demolishing the bottom 80%, on a net basis even reduced the rate of growth of the top 20%. Worse, there has been no income growth, Thomas Piketty and Emmanuel Saez have demonstrated, outside of the top 5%. The problem has been consistently getting worse for decades, and now 95% of all income growth is going to the top 1%. The middle class and small businesses are evaporating. 

Needless to say, the “invisible hand” has been called into service to justify, and lend an appearance of inevitability to, the perpetuation of inequality. In fact, it was so used almost from the start, I have been surprised to learn, dooming Adam Smith to eternal misinterpretation just because he chose to use a religious metaphor once in Wealth of Nations, and once in The Theory of Moral Sentiments. 

Okun’s “Efficiency” Argument 

Here’s an important case in point: Back when Friedman and Feldstein were in their heyday forty years ago, another highly respected economist, Arthur Okun, who was Chairman of Lyndon Johnson’s CEA, floated the proposition that trying to correct inequality would likely reduce growth, not increase it, because it would decrease economic “efficiency,” or the ability of the economy to produce (Equality and Efficiency: The Big Tradeoff, The Brookings Institution, 1975). That could be rephrased: Trying to increase incomes of working people is likely to reduce total work. If that sounds absurd, don’t be alarmed: it is a real beauty. (In fact, the idea is apparently inconsistent, in a demand-side universe anyway, with his own more sensible “Okun’s Law,” the assertion he reportedly made of “a clear relationship between unemployment and national output, in which lowered unemployment results in higher national output.”)

According to Paul Krugman (“Liberty, Equality, Efficiency,” The New York Times, March 9, 2014, here) most economists have believed in “the big tradeoff” ever since:

Almost 40 years ago Arthur Okun, chief economic adviser to President Lyndon Johnson, published a classic book titled “Equality and Efficiency: The Big Tradeoff,” arguing that redistributing income from the rich to the poor takes a toll on economic growth. Okun’s book set the terms for almost all the debate that followed: liberals might argue that the efficiency costs of redistribution were small, while conservatives argued that they were large, but everybody knew that doing anything to reduce inequality would have at least some negative impact on G.D.P.

But it appears that what everyone knew isn’t true. Taking action to reduce the extreme inequality of 21st-century America would probably increase, not reduce, economic growth.

There’s no “probably” about it. We’re in a bottom 99% depression, not just a post-recession depression-like period as described by Krugman in his last book. 

Two Sides of the Same Coin

The relationship between inequality and growth is gradually sinking in with the economics profession, but understanding it requires jettisoning the supply-side world view that dominates the discipline. Both growth and inequality are statistics representing measures of income. The annual rate of growth is reflected in the amount of reported income accumulating over a year. Inequality is a measure of the distribution of that income. The factors that increase income and wealth concentration also reduce growth. So growth and distribution are literally two sides of the same coin.

It’s a bit more complicated than this, but here are the two main factors:

1. The demand-side factor: This one is easy for Keynesians, and both Reich and Stiglitz have emphasized it.  People with top incomes have a lower propensity to consume (percentage of income spent on consumption) than middle class people, or poorer people, who can save little or nothing and, at or near the bottom, are running up debt. So, as wages and jobs decline and income shifts to the top, the aggregate consumption (spending, GDP) is by definition declining. Two sides of the same coin by definition;

2. The supply-side factor: All profit is a form of economic rent, payment above and beyond the cost of production. As a career regulator of utility rates, I am intimately familiar with this one. The task of rate-setting is to prohibit the taking of monopoly rents by big corporations providing essential services. Most prices in the economy, even for essential products and services like health care, vehicle fuel, food, shelter, and clothing, are set under conditions of monopolistic control by huge corporations. Thus, these prices not only gradually reduce real incomes through inflation, they also attempt to maximize profit, which entails limiting supply below the point where the price would clear market demand. This too simultaneously compresses growth and increases inequality, compared to the result under competition.   

These two factors alone, together with the clear history of substantially reduced growth since the Reagan Revolution began, really should be dispositive of this issue.  Still, supply-siders don’t get it. Krugman’s article reported two recent studies by IMF economists trying by statistical correlation to test the relationship between growth and income inequality, both as against other social factors and across countries. (“Inequality and Unsustainable Growth: Two Sides of the Same Coin?,” by Andrew G. Berg and Jonathan D. Ostry, International Monetary Fund, IMF Staff Discussion Note, April 8, 2011 (here), and “Redistribution, Inequality, and Growth,” by Jonathan D. Ostry, Andrew Berg, and Charalambos G. Tsangarides, IMF Staff Discussion Note, February, 2014 (here).) 

Note that these researchers had an inkling of the true nature of their variables, as they revealed in the subtitle for their initial 2011 study. Nonetheless, their supply-side perspective cautioned timidity and restraint. In their first study, although they found inequality to be “one of the most robust and important factors associated with growth duration,” (pp. 13-14)  they timidly concluded: “The main contribution of this note may be to push slightly the balance of considerations towards the view that attention to inequality may serve both equity and growth at the same time.” (p. 18) The report on the second study led them to acknowledge a significant connection between inequality and growth. Still, they showed continued supply-side influence in a report that revealed more surprise than timidity:

First, inequality continues to be a robust and powerful determinant both of the pace of medium-term growth and of the duration of growth spells, even controlling for the size of redistributive transfers. Thus, the conclusions from Berg and Ostry (2011) would seem to be robust, even strengthened. It would still be a mistake to focus on growth and let inequality take care of itself, not only because inequality may be ethically undesirable but also because the resulting growth may be low and unsustainable.

And second, there is surprisingly little evidence for the growth-destroying effects of fiscal redistribution at a macroeconomic level. (pp. 25-26)

These two studies turned out to provide substantial corroboration of the fact that income inequality and growth are two sides of the same coin, despite a relatively poor potential correlation among the variables actually tested, yet the surprise these analysts professed was only that their results did not validate Okun’s big tradeoff.  

I checked to see what Okun himself had said: After extolling the virtues of capitalism as compared to state socialism (communism), he presented the source of his efficiency argument:

The case for the efficiency of capitalism rests on the theory of the “invisible hand,” which Adam Smith first set forth two centuries ago. Through the market, greed is harnessed to serve social purposes in an impersonal and seemingly automatic way. (p. 50)  

That was it: His “authority” was the falsely alleged viewpont of Adam Smith. Of course now we know for sure that trickle-down is a myth: Greed is not harnessed to serve social purposes; greed avoids social responsibility. In fact, greed has successfully avoided progressive taxation, which by definition is taxation that stops the further concentration of income and wealth.  The basic point of trickle-down, of course, is to avoid paying taxes. I’ll include again the Piketty/Saez graph charting the top 1% income share, along with capital gains, together with the top income tax and capital gains rates.

DP8675a

The wealthy classes today steadfastly avoid discussing the issue of increasing their taxes, occasionally advancing the Laffer curve argument that even attempting to increase taxes on top incomes would be counter-productive (disproved by Piketty/Saez/Stantcheva’s 2010 study of the income elasticity of the top income tax rate), while their spear-carriers in Congress continue to propose further reducing their already wholly inadequate tax contributions.  

We must now add Arthur Okun to the list of those who, like Milton Friedman and Martin Feldstein, wanted an economy that served only the rich. He was opposed to progressive taxation, but in 1975 he freely admitted, having no reason to try to deny it, that “[t]he progressive income tax is the center ring in the redistributive arena, as it has been for generations.” (p. 101) 

Coincidentally, in his latest Op-ed (“America’s Taxation Tradition,” New York Times, March, March 27, 2014, here), Paul Krugman has begun to develop this point, quoting Teddy Roosevelt’s famous 1910 “New Nationalism” speech, where Roosevelt argued that “[t]he absence of effective State, and, especially, national, restraint upon unfair money-getting has tended to create a small class of enormously wealthy and economically powerful men, whose chief object is to hold and increase their power” and called for “a graduated inheritance tax on big fortunes … increasing rapidly in amount with the size of the estate.” Krugman added:

The truth is that, in the early 20th century, many leading Americans warned about the dangers of extreme wealth concentration, and urged that tax policy be used to limit the growth of great fortunes.

Of course, estate taxation and income taxation are both crucially involved, because great wealth accumulates from excessive incomes. However, the larger point is that there is really no mystery here anymore: We’re facing the same old class warfare, and the entire “science” of “neoclassical” economics has sunk ever more deeply into an age-old mythology tailored only to serve the interests of wealth. 

The American economy will require much reform to survive, but first and foremost progressive taxation of incomes and wealth must be reinstated. Will that happen? I worry that corporations, because they are not really people, probably lack a survival instinct. Mankind has painted itself into a seriously dangerous corner.

JMH – 3/29/2014 (ed. 3/30/2014)   Reposted 12/18/2014

  

Posted in - FEATURED POSTS -, - MOST RECENT POSTS -, Economics, Wealth and Income Inequality | Leave a comment

Saez and Zucman: Telling the Truth About Wealth Inequality

It was high in the beginning of the twentieth century, fell from 1929 to 1978, and has continuously increased since then. The rise of wealth inequality is almost entirely due to the rise of the top 0.1% wealth share, from 7% in 1979 to 22% in 2012—a level almost as high as in 1929. The bottom 90% wealth share first increased up to the mid-1980s and then steadily declined. The increase in wealth concentration is due to the surge of top incomes combined with an increase in saving rate inequality. — “Wealth Inequality In the United States Since 1913: Evidence From Capitalized Income Tax Data,” by Emmanuel Saez and Gabriel Zucman, NBER Working Paper No. 20625, October 2014 (here)

The Saez/Zucman working paper is easily, in my opinion, the most significant development in inequality economics this year. Income inequality has been suggestive of a major problem for about a decade, and the best information we have on that score has been presented by Saez and fellow French economist Thomas Piketty. The problem with income inequality has been that it is far too easily rationalized away, and it has been. The proof of the problem lies in wealth inequality, which is the consequence of transfers of wealth to the top from lower down.

To be sure, they do not quite come right out and say that: There are allusions in this report to the inadequacy of taxation. But the political climate in America right now is extremely destructive. Mr. Zucman is with the London School of Economics and Mr. Piketty is with the Paris School of Economics, but Mr. Saez is on the faculty at Berkeley, and may face some uniquely American constraints. The findings of this study challenge some core underpinnings of “neoclassical” economics, which has been the mainstream ideology in the United States for over a century. He and Zucman are sensibly building a body of scientific evidence that will make the macroeconomic impacts of growing inequality undeniable. They are not contesting ultimate or political conclusions.

With this study, these two are pointing the way to real progress. Piketty published Capital in the 21st Century early in 2014, but unfortunately he could not overcome the constraints of supply-side modeling. He unveiled two “fundamental laws of capitalism” which revived outmoded production function-based growth models that, as he acknowledged, required a long-run equilibrium of savings and investment (a circumstance that never occurs) to be true. His paradigm was subjected to a great deal of criticism, but at least he deserves much credit for calling public attention to the problem of wealth inequality and for his discussion of income inequality in the United States. (See my three posts on Piketty, the second of which analyses the “laws of capitalism” from the perspective of Gardner Ackley, author of Macroeconomic Theory, the leading textbook in the early 1960s, here).

One thing seems certain: The details of this paper will be under attack by the powerful top 0.1% of wealth holders, whose wealth concentration is determined to be of paramount importance. They continue to hold fast to the trickle-down illusion with which they have misled nearly everyone (and by now, most likely, fooled themselves) into believing that their own tax avoidance is good for the economy.

The latest evidence of this is in this morning’s New York Times under the byline “Wall Street Wonders about Hillary Clinton,” and also on-line as “Hillary Clinton’s Comment About Corporations and Job Creation Raises Wall St.’s Eyebrows,” by Andrew Ross Sorkin, New York Times, October 27, 2014 (here). On the campaign trail in Boston, Ms. Clinton said this:

Don’t let anybody tell you that it’s corporations and businesses that create jobs. You know that old theory, trickle-down economics. That has been tried, that has failed. It has failed rather spectacularly.

She also said: “I love watching Elizabeth give it to those who deserve to get it.” Sorkin’s reaction:

Mrs. Clinton didn’t explicitly say who deserved to get it, but she appeared to be directing her ire at Ms. Warren’s favorite target, Wall Street banks. Within the world of finance, Mrs. Clinton has long been seen as a friend of Wall Street — or at least not an enemy. She has rarely engaged in the kind of vitriol that has made Senator Warren a hero of the progressive left.

Just about every time I hear an Elizabeth Warren speech, I hear her declare that trickle-down is a myth. It has, in fact, been repeatedly disproved since 1912. So, when people like Sorkin maintain that arguing for correct economics is “vitriol” and makes you an “enemy of Wall Street,” to me that reflects the powerful lock that economic ideology has on American politics and minds, and certainly on the mainstream media.

This is the atmosphere into which Saez and Zucman have published their NBER Working Paper for peer review and NBER approval. I looked for, but did not find, media coverage of the release. Frankly, without a free and open internet on which studies like this can be posted for people like me to find, important truths about our world might never be revealed. One of the main things this study does, in spades, is provide still more (and overwhelmingly conclusive) refutation of the trickle-down theory.

The 20th Century Growth of Wealth Concentration

Here is Figure 9 in the Saez/Zucman Appendix:

one percent 90 percent smallThere has been a common misconception that wealth inequality has not been growing much. However, Saez and Zucman concluded:

On the basis of new, annual, long-run series, we find that wealth inequality has considerably increased at the top over the last three decades. By our estimates, almost all of this increase is due to the rise of the share of wealth owned by the 0.1% richest families, from 7% in 1978 to 22% in 2012, a level comparable to that of the early twentieth century (Figure 1). The top 0.1% . . . includes about 160,000 families with net assets above $20 million in 2012.

The huge reduction in lower 90% wealth share after the crash of 2008 reflects the huge drop of home values, which constitute the largest portion of lower 90% wealth. Since then, there has been rapid growth of top 1% wealth while bottom 90% real average wealth has declined.  

This chart traces the growth of top 1% (not top 0.1%) wealth, but I want to make a few points based on this fractile share. First, compare the growth of top 1% income over the same period (“Optimal Taxation of Top Labor Incomes: A Tale of Three Elasticities,” by Thomas Piketty, Emmanuel Saez, and Stefanie Stantcheva, NBER Working Paper 17616, November 2011, here) :

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The income inequality comparison is with the bottom 99%, not the bottom 90%, but the similarity between the two charts is striking: The trends have nearly identical turning and crossover points. This underscores the fact that wealth accumulates fairly quickly from income, as well as from the compounding of existing wealth. Saez and Zucman reached this conclusion:

Rising income inequality does matter a lot for the dynamics of the top 1% wealth share. The share of income earned by families in the top 1% of the wealth distribution has doubled since the late 1970s, to about 16% in recent years. This increase is slightly larger (in relative terms) than the increase in the top 1% wealth share, suggesting that the main driver of the increase in the top 1% wealth share is the upsurge of their income. (p. 31)

There may be a major effort to discredit the Saez/Zucman study, both its approach and results, once it gets more publicity. Their basic approach was to develop savings estimates from “capitalized income” data, instead of relying on wealth survey data, such as the Survey of Consumer Finances. They needed to do this, they explained, because the dependability of survey data breaks down  in the case of very wealthy people, like the top 0.01 percent and the top 0.001%. They compared their results to survey results for SCF data, which showed considerably lower concentrations for the top 0.1%, both baseline and adjusted, since 2002.

From the standpoint of macroeconomic impacts, however, it is the the magnitude of the wealth transfers into the top 1% that is important, not how far up into the top 0.1% the highest concentration extends. My own study of that issue provides additional corroboration of the accuracy of the Seaz/Zucman approach:

my graph 1952-1982 c

My estimation of wealth transfers into the top 1%, shown in this graph (the purple line) which I prepared almost a year ago (see “Inequality and the National Debt.” posted April 9, 2014, here), is based on the application of Edward Wolff’s wealth distribution factors to the Census Bureau’s wealth (net worth) data. The trend line is nearly identical to the Saez/Zucman trend line, and that provides important corroboration for both of our results, which were based on different sources of wealth estimates.

There is an important difference between their estimate of the growth of total top 1% wealth and mine since 1980. My estimate is that top 1% wealth grew from $4 trillion in 1980 to $20 trillion in 2012, which is the last year of available data. I added a conservatively estimated $2-5 trillion of unreported offshore American wealth, based on the following:

There was an estimated $21-32 trillion of global wealth held in offshore accounts in 2012 (Tax Justice Network). U.S. GDP was $16.7 trillion, almost 20% of the Gross World Product (GWP) of $85 trillion, so a reasonable estimate of the amount of off-shore money coming from U.S. depositors would be $4-6 trillion. (“Inequality and the National Debt,” April 9, 2014, here)

I further adjusted my estimate of wealth transfers to the top 1% to account for massive wealth transfers to the to 1% in the first half of 2013. (Aggregate net worth had grown by $3 trillion in the first half of 2013, according to the Census Bureau, and Saez had reported that 95% of income growth was going into the top 1%, so most of the 2013 net worth growth, I reasoned, must have gone to the top 1%.) For comparability to the Saez/Zucman data, that adjustment must be excluded here.

The reported Top 1% net worth in 2012 was  $20 trillion in 2005 dollars (about $21.8 trillion in current dollars), according to Edward Wolff’s wealth distribution figures and the Census Bureau’s net worth data.  A rough estimate in 2010 dollars would be $21 trillion plus $2-5 trillion offshore wealth, resulting in a range of wealth of $23-26 trillion for 2012, or a growth from 1980 of $19-22 trillion.

The Saez/Zucman graph above presented estimates of the average wealth of individual taxpayers, not total wealth levels. To convert the 2012 amounts to total top 1% wealth, I’ll use the 2010 estimate of about 116.7 million households. This generates a figure for top 1% wealth in 2012 of $16.3 trillion; the 1980 population was 226.5 million, so we can estimate (on the assumption that the ratio of households to population remained the same between 1980 and 2010, there were 85 million households in 1980) that the total top 1% wealth implied by the Seaz and Zucman average was $3.4 trillion in 1980. The end result is a rough estimate of about $12.9 trillion increase in top 1% wealth from 1980 to 2012, compared to my estimate of top 1% wealth growth of $19-22 trillion.

Obviously a lot of work needs to be done here. One explanation for the difference may be in the Census Bureau’s use of households, rather than taxpayers, and my understanding is that converting the Census-based estimate to a taxpayer-based estimate would reduce the range to about $15.2-17.6 trillion, but I am uncertain about that. Beyond that, it may be important that Saez and Zucman, as I understand it, only capitalized income from revenue producing assets, and excluded from their definition of wealth a number of categories of assets into which income can be invested. (For example, they excluded wealth from non-profit institutions, “which amount to about 10% of household wealth” – p. 4.) Piketty and Saez, moreover, have acknowledged that their U.S. income database may have significantly understated top incomes. In any event, a thorough review will be needed to explain the discrepancy with the Census Bureau’s published net worth data. It is no easy matter to gather wealth data, and it is possible that all of these numbers are understated. The fact remains that all sources of “earned” income, as well as all money generated by preexisting assets, can be saved and converted into wealth. 

What would ultimately be useful are figures for per capita growth of top 1% wealth over this period. Why is this important? We know a few things for sure about the macroeconomic implications of these wealth increases at the top:

(1) Even the low estimate of a $13 trillion increase in top 1% wealth since 1979 is an unimaginably huge amount, representing more than $41,000 for every man, woman, and child in the entire U.S. population;

(2) That wealth did not just materialize out of thin air. It was generated by reduced incomes and savings in the bottom 99%, and from money created by federal borrowing to compensate for the tax reductions that allowed the top 1% to save so much more of its income; and

(3) the top 1% is continuing to evade its former tax responsibility, so the public debt burden continues to grow, income and wealth continue to concentrate, and the bottom 99% economy continues to decline.

The whole truth about the cost of inequality may well be a bit too frightening for a population used to thinking in ideological terms to absorb. Many will simply turn away and bury their heads in the sand. But we should all grab at least one piece of low-hanging fruit:

TRICKLE-DOWN IS A FRAUDULENT MYTH  

The wealth has stayed up, in numbers far greater than Hillary Clinton or Elizabeth Warren or other “progressives” on the “left” have so far even dared to imagine. The minions of the right, when this is all over (and it will end, sooner rather than later) will be known as “radicals,” not “conservatives.”      

Saving

The Saez/Zucman paper is far more sophisticated than my brief report reveals. The authors develop “synthetic savings rates” from the income data. Joseph Stiglitz and Robert Reich are among those who have (correctly) argued the Keynesian point that inequality reduces growth because rich people save much more than others, idling money that would be spent if left in the hands of those below them. That point is fully borne out by this study:

These results underscore that the key drivers of the rise in wealth inequality have been the surge in income inequality combined to an increase in saving rate inequality — and in particular the collapse of the saving rate of the bottom 90%. (p. 31)

And they explain further:

First, saving rates tend to rise with wealth. Bottom 90% wealth holders save around 3% of their income on average, the next 9% save about 15% of their income, while the top 1% save about 20-25% of their income. The main exception is the decade 1930-1939: during the Great Depression the top 1% saving rate was negative, because corporations had zero (or even negative) profits yet still paid out dividends, so that they had large negative saving. This decade of negative saving at the top greatly contributed to the fall in top wealth shares during the 1930s (see below). . . . [T]he fact that saving rates sharply rise with wealth implies that long-run top wealth shares will be substantially higher than long-run top income shares (when ranking individuals by wealth).

Second, saving rate inequality has increased in recent decades. The saving rate of bottom 90% families has sharply fallen since the 1970s, while it has remained roughly stable for the top 1%. The bottom panel of Figure 11 zooms in on the annual saving rate of the bottom 90%, which fell from around 5%-10% in the late 1970s and early 1980s to around -5% in the mid-2000s, and bounced back to about 0% after the Great Recession. The long period of negative saving rate for 90% of the population from 1998 to 2008, due to massive increases in debt (in particular mortgages) fueled by an unprecedented rise in housing prices (see e.g. Mian and Su_, 2014), is particularly striking. Even more striking is the fact that while bottom 99% saving fell a lot in the years preceding the Great Recession, top 1% families continued to save at a high rate. (pp. 29-30)

figure 11 savings

Figure 11 shows, in the top panel, how much more the top 1% is saving relative to the next 9% — the former middle class — and the bottom 90%. The alarming bottom panel shows that the bottom 90% has been accumulating debt since 1996. The interest on that debt just enriches the top 1%, exacerbating inequality, and creates debt “bubbles,” which like the housing bubble in 2008 eventually burst. This chart does not show the elimination of bottom bottom 90% negative savings because of an actual rise in saving or income; rather, the debt was wiped out by the loss of assets — their homes. Positive savings will not be established, even in the top 10-1%, with the expanding student debt bubble.

Conclusion 

There is much more in this study that I could discuss here, but my purpose was to alert readers to this major development. Readers would do well to go directly to the working paper and reach their own conclusions. Those who do will find much more there than first meets the eye. My perspectives on the mechanisms of inequality growth, and the bases for my conclusion that income and wealth distribution are the primary factors determining prosperity or decline, are set forth in my recent article “The Economics of Inequality,” published in The Torch Magazine, Fall 2014  (here).

Wealth concentration is an inevitable, persistent, long-run phenomenon. John Maynard Keynes once famously said, “In the long run we are all dead.” True enough, but it’s also true that for wealth concentration, the long run is much shorter than Keynes might have imagined, as Saez and Zucman reveal. We have an inequality cycle that has become critical in just over three decades. It will likely take longer for economic research to catch up than there is time available. We must act immediately to enact sufficiently progressive taxation to avoid a major collapse.

It is a hopeful sign that Emmanuel Saez and Gabriel Zucman are working hard to uncover the truth, but the mountain that rises before them is high and steep. A new scientific understanding of how market economies work is badly needed, and much work remains to be done. This new study of wealth inequality in the United States, the first of its kind, is a welcome and important step in the right direction.

The mid-term elections are just a week away. In the worst case scenario, the powers of ideology will take complete control of Congress, and the ultimate disaster will be that much closer at hand. Emmanuel Saez and Gabriel Zucman will keep working hard, I am certain, and we all must do the same.

JMH — October 28, 2014 (ed. October 29, 2014)

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Climate Change and the Economy: Facing Reality

(Canada Geese – Eric Kraft)

I denied climate change for longer than I care to admit. I knew it was happening, sure. But I stayed pretty hazy on the details and only skimmed most news stories. I told myself the science was too complicated and the environmentalists were dealing with it. * * *

A great many of us engage in this kind of denial. We look for a split second and then we look away. Or maybe we do really look, but then we forget. We engage in this odd form of on-again-off-again ecological amnesia for perfectly rational reasons. We deny because we fear that letting in the full reality of this crisis will change everything.

And we are right. If we continue on our current path of allowing emissions to rise year after year, major cities will drown, ancient cultures will be swallowed by the seas; our children will spend much of their lives fleeing and recovering from vicious storms and extreme droughts. Yet we continue all the same.

What is wrong with us? I think the answer is far more simple than many have led us to believe: we have not done the things needed to cut emissions because those things fundamentally conflict with deregulated capitalism, the reigning ideology for the entire period we have struggled to find a way out of this crisis. We are stuck, because the actions that would give us the best chance of averting catastrophe – and benefit the vast majority – are threatening to an elite minority with a stranglehold over our economy, political process and media. — Naomi Klein, “The hypocracy behind the big business climate change battle,” The Guardian,  September 12, 2014 (here).

Naomi Klein is a potent force in economic journalism. In The Shock Doctrine (2007), she provided a detailed account of how predatory “disaster capitalists,” tied to Milton Friedman’s “Chicago School,” have taken advantage of natural disasters like Hurricane Katrina and conflicts like the war in Iraq, and even engineered man-made disasters such as revolution in Chile, for privatization and profit. Now her new book, This Changes Everything: Capitalism vs. the Climate, is justifiably making headlines. In this book, I suspect, Klein chronicles the record of corporate opposition to the fight against global warming.  

She published another article a week after this one (The Guardian, September 20, 2014, here,), on the eve of the climate demonstrations in New York City and around the world, which was head-noted with this:

The truth about our planet is horrifying, but the true leaders aren’t the ones at the UN – they’re in the streets. This is why the People’s Climate March matters.

This is a more direct answer to Klein’s question, “What is wrong with us?”: Many of us who are not in denial about science, or even about economics, still find the reality of climate change hard to confront because the truth about global warming, and the pace of extinctions, is indeed quite terrifying. And the bad news keeps getting worse. In today’s New York Times, the article “Global Rise Reported in 2013 Greenhouse Gas Emissions,” by Justin Gillis, September 21, 201 4 (here) reported:

Global emissions of greenhouse gases jumped 2.3 percent in 2013 to record levels, scientists reported Sunday, in the latest indication that the world remains far off track in its efforts to control global warming.

Over the last decade, Gillis reports, emission growth has averaged 2.5 percent annually. So what this means is that greenhouse gas emissions are more than 130% of the level they were at just a decade ago. This is a perilous trend, certainly, but what does this imply about the amount of danger we face and how quickly we need to take decisive action? According to Secretary of State John Kerry, in today’s opening remarks at NYC Climate Week (U.S. Department of State, September 22, 2014, here) :

When we began this discussion a number of years ago, we were warned by the scientists that you had to keep the greenhouse gas levels about 450 parts per million in order to be able to hold to the 2 degree centigrade possible allowable warming taking place. Then, because of the rate at which it was happening, the scientists revised that estimate and they told us, “No, no, no, you can’t do 450 anymore. It’s got to be 350 or we’re not going to meet the standard.” And I, unfortunately, tell you that today not only are we above 450 parts per million, but we are on track to warm – having already warmed at 1 degree – we’ve got 1 degree left – we’re on track to warm at at least 4 degrees over the course of the next 20, 30, 40 years, and by the century, even more.

So this is pretty real. And what is so disturbing about it is that the worst impacts can be prevented still – there is still time – if we make the right set of choices. It’s within our reach. But it is absolutely imperative that we decide to move and to act now. You don’t have to take my word for it. You don’t have to take Al Gore’s word for it. You don’t have to take the IPCC’s word and the Framework Convention, all those people who are sounding the alarm bells. You can just wake up pretty much any day and listen to Mother Nature, who is screaming at us about it.

As Klein reminds us, there are deniers and, critically, “the actions that would give us the best chance of averting catastrophe – and benefit the vast majority – are threatening to an elite minority with a stranglehold over our economy, political process and media.”  Actually, no one can escape this fate, not even them, if we don’t prevent it. So what does this imply about the economic interests that are in denial? Doesn’t the survival of the planet matter to everyone?

The interests most directly involved, of course, are the giant conglomerates hugely benefiting from the extraction and sale of carbon from the ground (e.g., Exxon/Mobil, BP, Koch Industries). It is utter insanity not to be on the safe side, if we are concerned about the survival of human civilization, but the evidence shows we are no longer on the safe side. There will be significant damage. Only corporations, for which profit is their sole objective, could be in denial about the extent of this threat, intransigent in the face of overwhelming evidence. Corporate charters rule, and corporations will not necessarily act even to save themselves and, although our Supreme Court has declared them to have the constitutional protections and freedoms of actual human “people,” this lack of human judgment and conscience is a critical difference, especially when their executives take on the responsibility of fighting against anything that threatens the corporate interest.

So I would be a bit more precise than Klein: Many of us are simply in denial about the reality of global warming because we cannot face the terror of it. But “we” are not in denial about the corporate deniers or their reasons for blocking corrective action. About them, we are dismayed and angry, and we feel helpless — but we are not in denial.

That distinction is important because there is something else that nearly all of us are actually still in denial about, and that is that unfettered capitalism threatens not only the future of the planet, but independently threatens itself as well. This blog has explained in detail how inequality grows in market economies, and how the inequality reduces income growth, in a vicious cycle of decline that can only end one way. Since 1980, income concentration in the top 1% has increased by over 20%, and the wealth (net worth) of the top 1% has increased by well over $20 trillion. Average annual aggregate income growth has fallen from 4% in the post-WW II prosperity era to about 1.5% over the past decade. 

Naomi Kelin, like the rest of us, is as yet unaware of the full implications of the facts of inequality, and that is because mainstream “neoclassical” economics has been in denial about them for over a century. Some argue that the neoclassical “denial” is actually hypocracy, designed to protect the interests of wealth. Intentional or not, that is exactly what it has done.

It may well be that, as Kerry asserts, we can all see the effects of global warming in our daily lives. My wife and I think so. But there is substantial evidence as well that we are feeling the effects of growing inequality and economic decline, especially as America learns the facts about income and wealth distribution. Today’s news stories are informative on that score as well:

(1) Today. the editorial board of the Albany Times Union, my hometown newspaper, formally rejected “trickle-down” ideology and put the blame for shrinking state and local tax revenues squarely where it belongs, on the lack of a nationwide system of progressive taxation. This is the first time, so far as I am aware, that the TU editorial board has reached this important conclusion. (“Tax Policies Need Review,” the TU Editorial Board, Albany Times Union, September 22, 2014, here);

(2) A new Siena poll was released indicating that a majority of New Yorkers, as did most Americans last year, believe the economy is getting worse, not better. It is becoming clearer that people are retiring later, taking fewer vacations, and generally spending less in order to have enough money to sustain themselves in retirement. (“Stagnant outlook tarnishing the golden years, Siena poll finds,” Albany Times  Union,  September 22, 2014, here).

(3) In  “Those Lazy Jobless” (The New York Times, Op-ed, September 22, 2014, here) Paul Krugman  discussed Speaker of the House John Boehner’s recent claim, in a speech to the American Enterprise Institute, that “laziness” is holding back employment in America:

People, he said, have “this idea” that “I really don’t have to work. I don’t really want to do this. I think I’d rather just sit around.” Holy 47 percent, Batman!

It’s hardly the first time a prominent conservative has said something along these lines. Ever since a financial crisis plunged us into recession it has been a nonstop refrain on the right that the unemployed aren’t trying hard enough, that they are taking it easy thanks to generous unemployment benefits, which are constantly characterized as “paying people not to work.” And the urge to blame the victims of a depressed economy has proved impervious to logic and evidence.

This argument, Krugman continues, overlooks that: “Benefits, especially for the long-term unemployed, have been slashed or eliminated.” While “there are still almost three million Americans who have been out of work for more than six months, the usual maximum duration of unemployment insurance,” and “extended benefits for the long-term unemployed have been eliminated — and in some states the duration of benefits has been slashed even further”: 

Only 26 percent of jobless Americans are receiving any kind of unemployment benefit, the lowest level in many decades. The total value of unemployment benefits is less than 0.25 percent of G.D.P., half what it was in 2003, when the unemployment rate was roughly the same as it is now. It’s not hyperbole to say that America has abandoned its out-of-work citizens.

And that’s just what I found skimming today’s news!  

Conclusion

Denial of climate science has prevented appropriate action to counter impending global climate disaster. But as we fight to preserve a future for humanity on this planet, we should consider that unfettered capitalism, and the unrestrained pursuit of profits, routinely interferes with that future, and is destroying any prospects for it.

All of us, moreover, have been in denial about the true nature of market economies, and misled about how they work, grow and decline, for far too long. Now we need to learn, and remember as well, that market economies are unstable, and that unfettered capitalism contains the seeds of its own destruction and is slowly failing.

Although there will, in all likelihood, still be human life on this planet in 2100, continuing to survive along with a severely reduced number of other animal and plant species, sufficient economic prosperity and the social determination needed to conduct the required battle against climate change may well not make it through another decade. In that eventuality, the world one hundred years from now will be far less hospitable than otherwise.

The appearance of Naomi Klein’s book at this time is important. Whatever else she is right or wrong about, she is correct that climate change raises the stakes, drastically and forever. Our struggle with and within ourselves is much deeper and more critical than we have yet dared to imagine.

JMH – 9/22/2014 (ed. 9/23/2014)

 

   

 

 

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Labor Day Blues – Mourning the Death of Economics

I had other plans for this morning, but today’s newspapers had stories that hit me hard. I have known I needed to improve upon my own recent efforts to clarify the true nature of our economic situation, and to provide a view of the basics from 5,000 feet. Three articles launched my determination to write about it this morning: 

Labor Suppression

The first was a front page article in the New York Times, by Steven Greenhouse, “More workers are claiming wage theft” (here) . Greenhouse reported on a growing number of lawsuits claiming violations of minimum wage and overtime pay laws, including a major suit brought against a west coast trucking company. My initial reaction: This is not news. Who among us old folks has not, at some point or another, been cheated out of wages or commissions by an unscrupulous employer? On the larger scale of things, we recall John Steinbeck’s The Grapes of Wrath, and Upton Sinclair’s The Jungle, and we know about a broad history of repression of labor.

Wage theft is nothing new, and it goes back no doubt for millennia. For as long as it has existed, I am certain, money has been stolen. But each generation must learn history’s lessons all over again. Today’s darling author is Ayn Rand, whose book Atlas Shrugged preached the glories of unfettered capitalism. It is easy for today’s quasi-prosperous youth to ignore the dark side of human nature, just as today’s economists by and large ignore the dark side of capitalism. But with every month that passes, the dark side is becoming harder to ignore.       

Trickle-down Thinking

The second was a syndicated Op-ed by Charles Krauthammer, appearing in my home-town Albany Times Union, entitled “Lower Corporate Tax Rates Now” (here). Krauthammer argues that minimizing corporate taxation is not unpatriotic, because corporations have an “indisputable fiduciary responsibility” to protect shareholder interests. The appeal to liberals, he says, is economic fairness, so why not eliminate loopholes for a “level playing field”? In his view, the amount of tax revenues doesn’t matter, because “lowering rates stimulates the economy,” and if we had an aggressive president, he’d “address corporate tax reform with a serious revenue-neutral proposal to Congress:”

We might end up with something like the historic bipartisan tax reform of 1986 that helped launch two decades of nearly uninterrupted economic growth.

All over America today, and around the world, people are reading Krauthammer’s words and thinking he’s knowledgeable and authoritative. Actually, his proposal is the worst thing we could do: Lowering rates at the top (corporate profits and top incomes) reduces the progressiveness of taxation and depresses the economy. As I have detailed in recent posts, the “historic bipartisan tax reform of 1986″ launched nearly three decades of steadily declining economic growth, coupled with rapidly rising income and wealth inequality. The facts are fully detailed in my recent post “Inequality Suppresses Growth: A Serious Problem?” (here). 

As a visual reminder, here is the Piketty/Saez graph of distributed (1%/99%) income over the last century, together with the top income tax rate:

DP8675b

On this Labor Day, I wonder: how many people have actually seen this graph, and has Krauthammer seen it? Sadly, These realities are not presented in the mainstream newspapers I follow: We only get to read Krauthammer’s trickle-down misconceptions. When the trickle-down anesthesia wears off, the deep pain will not have been cured — it will be worse. Today’s liberals have indeed been thinking mostly in terms of “fairness,” but they should be thinking about the threat to our survival.

The Federal Debt

The third piece that set me to this task was Paul Krugman’s Op-ed “The Medicare Miracle” in The New York Times (here).  Here’s his intro:

The story so far: We’ve all seen projections of giant federal deficits over the next few decades, and there’s a whole industry devoted to issuing dire warnings about the budget and demanding cuts in Socialsecuritymedicareandmedicaid. Policy wonks have long known, however, that there’s no such program, and that health care, rather than retirement, was driving those scary projections.  

Once again, there is no mention of taxation, and there never has been with Krugman, even if we go all the way back to his policy recommendations in his 2012 book End This Depression Now!  In fact, though he frequently maintains there is no evidence that reducing taxation of the wealthy and corporations will increase growth, the Krauthammer version of trickle-down ideology, he inexplicably endorses the claim that increasing their taxes can (and has) reduced growth.

This is untenable: Trickle-down in any formulation is nothing but pure fantasy. The debt itself, along with lower growth and higher inequality, was the direct consequence of the tax reductions shown in the graph, and our greatest growth took place during decades of highly progressive taxation. I do not know how to deal with this huge blind spot in Krugman’s thinking. I do know, however, that his reputation as a leading populist allows the Krauthammers of the world to surf in his wake, posing as equally “liberal” while asking the bottom 99% to hand over to the top 1% the keys to the treasury.   

The View from 5,000 Feet

Here’s an overview of the major relevant points, the factual proof of which can be found on this blog. The first is really a “philosophical” point.

Liberal v. Conservative

Political ideas, I believe, have colored our perceptions of the real world. For example, when I was young, maintaining a balanced budget, living within your means, and paying your debts, was generally considered a “conservative” attitude. In politics, however, conservative has come to mean what is good for wealth. Hence the economics of conservatives consists of the ideologies that argue what is good for wealth is good for everyone. And the traditional “conservative” idea that governments should balance their budgets is downplayed in favor of ever-expanding government debt. The same is true of “left” vs. “right.” These designations are tendentious and meaningless. If there is a useful, scientific dichotomy, it is “wrong” vs. “right.”

The Failure of “Economics”

Economics as a “science” got derailed with the development of market capitalism over 150 years ago. In the late 19th Century, theorists like A. Marshall, A. C. Pigou, V. Pareto, and L. Walras in Europe, and in the United States J.B. Clark and P. Samuelson, gradually generalized theories of individual or firm behavior into explanations of aggregate economic outcomes. This trend involved what logicians call the “fallacy of composition.” Per Wikipedia:

The fallacy of composition arises when one implies that something is true of the whole from the fact that it is true of some part of the whole.

The “trickle-down” myth is an excellent example: Although a successful industry or firm will grow or flourish with more money at its disposal, it is untrue that an entire economy will flourish when more money is put to the disposal of specific firms or industries.

There is a finite money supply — not fixed, but finite. Everything depends on the availability of money. Keynes realized that within the constraints of a given supply of money, allocating relatively more of it to saving and investment meant reducing the amount used for current consumption, and vice-versa. New money is created, here in the U.S., when banks extend credit. If I buy a house, the money loaned to me is new money, and it begins to circulate as soon as I spend it. Economy-wide, this is the process of income growth, and it takes place reflecting a growth in the population.

Keynes argued that there could be too little consumption at times, and that this would effectively reduce future investment and production. As I pointed out, it was a “dynamic” perspective that he traced all the way back to T.R. Malthus. This introduces an element of instability, and central government plays a central role in controlling the business cycle by borrowing for stimulation (fiscal policy) and making credit for expansion easier by controlling the prime interest rate (monetary policy).

Responsibilities to shareholders, as Krauthammer has pointed out, require minimizing corporate tax responsibility.  Business interests, perhaps realizing that government debts would have to be repaid and that tax increases would eventually be required if tax rates were not already high enough to generate government surpluses, floated the fallacious idea that an economy can grow just as fast, perhaps faster, if the wealthy business segment reduced its contribution to society’s common costs. Today, it is this false “trickle-down” perspective that dominates economic thinking.

 Income and Wealth Distribution

We are beginning to understand, but only in recent years, that there is a tight, causal relationship between effective demand (consumption from income), taxation, and income and wealth distribution. Thus, when  taxes were greatly reduced on corporations and the wealthiest households in the 1980s, a cycle of income and wealth inequality began. Government replaced revenues lost because of these tax reductions by borrowing money.

So, while as illustrated in this second Piketty/Saez graph, the lower taxes continued to drive up the top 1% share of income, the federal debt grew to its current level of about $17.6 trillion:

DP8675aGovernment borrowing had increased the money supply, but as we have seen, over the past 30-40 years an ever-increasing proportion of this new money ended up in the top 1% as incomes concentrated at the top. 

The market competition assumed in the neoclassical model to provide an “efficient” allocation of resources has all but disappeared in our modern economy of huge nationwide and international corporations. Thus, the ability of these top corporations to make excess profits has increased enormously. By my estimates, the top 1% has increased its net worth (both reported in U.S. accounts and estimated in off-shore accounts) by $22-25 trillion since 1980, and the wealth transfers and sequestration of this money necessarily both absorbed the expansion from federal borrowing and reduced the savings of the middle and lower classes.    

The Federal Debt Crisis

There apparently was never any expectation or impetus to pay back the federal debt — which has financed so very much increased wealth at the top — at least among those continuously benefiting from this continuing process of wealth concentration. The Crash of 2008 raised the stakes considerably, markedly reducing overall income growth and increasing unemployment. The effect on government financing has become increasingly catastrophic.

The “conservative” position, promoted by the Congressional Budget Office (CBO) and Paul Krugman, is that we’re doing fine: there will be growth in the future, enough to reduce the budget deficits for at least a few years, before they start climbing again. From this morning’s Op-ed, here’s Krugman’s position in a nutshell:

First, our supposed fiscal crisis has been postponed, perhaps indefinitely. The federal government is still running deficits, but they’re way down. True, the red ink is still likely to swell again in a few years, if only because more baby boomers will retire and start collecting benefits; but, these days, projections of federal debt as a percentage of G.D.P. show it creeping up rather than soaring. We’ll probably have to raise more revenue eventually, but the long-term fiscal gap now looks much more manageable than the deficit scolds would have you believe.

What??  Federal deficits are not way down, as shown in this graph from the Wall Street Journal I recently posted. They only slightly decline before rising again significantly to $1 trillion per year, and from now on they will be consistently worse than any year before Crash of 2008: 

federal deficit projections 8-27-14 wsj- cbo

Worse, CBO has projected that interest on the debt will increase, between now and 2024, at about 17 times the rate of all discretionary government expenditures, and nearly 4 times the rate of the mandatory programs Krugman discusses today. As I emphasized, by 2021 the interest on the debt will exceed the entire defense budget! Clearly, government operations are severely limited by this rapidly developing crisis.

Worse still, this “forecast” is considerably over-optimistic, by an uncertain amount: CBO projected GDP (income) to grow at 2.1% annually, even though it has grown only 1.4% annually over the last decade, according to Standard & Poor’s. This lower growth reflects the past effects of growing inequality and wealth concentration, the future growth of which, according to data from Piketty/Saez, is not only continuing but accelerating.

There is no basis in these facts for finding that the fiscal crisis has been stalled “perhaps indefinitely,” or even at all. And Krugman’s hopeful expectation that this exponentially increasing debt is only creeping up relative to GDP requires a liberal application of the trickle-down assumption that growth in income and consumption can take place without the distribution of more money throughout the system.    

Remember, inequality reduces income growth, and interest on the debt is paid to wealthy people, so growing interest automatically concentrates income and wealth, reducing aggregate growth still further. This is a “mini” vicious cycle, operating within the broader inequality-driven cycle of decay.

Paul Krugman ignores these Keynesian dynamics and related implications of inequality growth: It does not seem unlikely that another bubble will burst (the student debt bubble?) before 2020; and there is no apparent  basis for Krugman’s apparent perception that that we can coast beyond 2020 without a significant increase in tax revenues from top incomes and corporations.    

As I argued in my last post, Republican strategies in this election year rely on keeping people convinced of the validity of trickle-down “economics.” It is not really surprising, then, to see the New York Times on Labor Day doubling down on this strategy in its major economics column. So, yes, count me as a “deficit scold.” But I am one of those on the “Left” who want to reduce inequality and increase growth and prosperity, not one of those on the “Right” who want to reduce government.

JMH – 9/1/2014 (ed. 9/2/2014)

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False Forecasts and Dangerous Delusions

The celebrated optimism of traditional economic theory, which has led to economists being looked upon as Candides, who, having left this world for the cultivation of their gardens, teach that all is for the best in the best of all possible worlds provided we will let well alone, is also to be traced, I think, to their having neglected to take account of the drag on prosperity which can be exercised by an insufficiency of effective demand. For there would obviously be a natural tendency towards the optimum employment of resources in a Society which was functioning after the manner of the classical postulates. It may well be that the classical theory represents the way in which we should like our Economy to behave. But to assume that it actually does so is to assume our difficulties away.

— John Maynard Keynes, The General Theory of Employment, Interest and Money (1935), Signalman Publishing. Kindle Edition, 2010, p. 23.

These are the concluding remarks from Keynes’s seminal Book I, Chapter 3, “The Principle of Effective Demand.” The crucial fact he noted is “the drag on prosperity which can be exercised by an insufficiency of effective demand.” Importantly, this was not his own original idea. He found the essence of it in his considerable review of the history of political economy. It was through T.R. Malthus, in his early 18th Century debate with David Ricardo, that: “the notion of the insufficiency of effective demand takes a definite place as a scientific explanation of unemployment.” (The General Theory,  p. 240):

I distinctly maintain that an attempt to accumulate very rapidly, which necessarily implies a considerable diminution of unproductive consumption, by greatly impairing the usual motives to production must prematurely check the progress of wealth.

By wealth, as the term was used in classical economics by Smith, Ricardo and Mill, Malthus meant tangible output. Keynes quickly turned to the 1889 text by J.A. Hobson and A. F. Mummery, The Physiology of Industry, which Keynes hailed as a reawakening of “theories of under-consumption” (Id.)

Though it is so completely forgotten to-day, the publication of this book marks, in a sense, an epoch in economic thought. (p. 241)

They attacked the premise in the theory of Smith and Ricardo that:

Saving enriches and spending impoverishes the community along with the individual, and it may be generally defined as an assertion that the effective love of money is the root of all economic good. Not merely does it enrich the thrifty individual himself, but it raises wages, gives work to the unemployed, and scatters blessings on every side (pp. 241-242).

This, you may recognize, is the familiar “trickle-down” theory. Hobson and Mummery rejected that idea, arguing instead:

Our purpose is to show that these conclusions are not tenable, that an undue exercise of the habit of saving is possible, and that such undue exercise impoverishes the Community, throws laborers out of work, drives down wages, and spreads that gloom and prostration through the commercial world which is known as Depression in Trade.

In other words — and this was the main point of Keynes’s General Theory — depression is the proximate result of declining effective demand. But Keynes’s correct view did not survive the 1960s and 1970s. I say this to anyone uncertain about the invalidity of the classical and neoclassical rejection of the principle of effective demand: I can find no valid evidence — any evidence at all in modern economic history — supporting either Say’s Law (“supply creates its own demand”) or the trickle-down theory (accurately re-framed thus: “more wealth at the top automatically increases supply, which then creates its own demand”).

CBO Adopts “Trickle-Down” Ideology 

Re-posted here is the discussion of CBO forecasting from my last post. Before getting to that, I want to remind the reader that CBO in its July 2014 Outlook (Ch. 6, p. 70) formally adopted the trickle-down and austerity doctrines as articles of faith (For a fuller discussion, see my recent post “Breaking News: CBO Infected with Trickle-Down Disease”):

  • “Higher debt crowds out investment in capital goods and thereby reduces output relative to what would otherwise occur”;

This is the now discredited Reinhart/Rogoff theory supporting the “austerity doctrine,” a trickle-down variation asserting that reduced national government spending (effective demand) promotes growth (i.e., “creates its own demand.”) 

  • “Higher marginal tax rates discourage working and saving, which reduces output.”

This is the “Laffer Curve” argument, the converse of the trickle-down myth (i.e., because more wealth at the top from reduced taxation automatically increases supply, which then increases demand, it follows that less wealth at the top caused by higher taxation, reduces growth.)

Let’s be clear about this: The agency charged with providing objective advice to the U.S. Congress about future income growth expectations has formally concluded that demand has no effect on growth, and adopted the even more fanciful myth that growing demand is created by the mere existence of supply.

We must remember how dramatically the trickle-down fantasy has been disproved. This is from my post “Amygdalas Economicus: Perspectives on Taxation,” January 24, 2013:

In their April 27, 2001 report “The Economic Impact of President Bush’s Tax Relief Plan” (The Heritage Foundation, Center for Data Analysis Report #0101, April 27, 2001, here), D. Mark Wilson and William Beach predicted that the Bush plan would significantly increase economic growth and family income while “substantially reducing federal debt.” In fact, they predicted, the Bush plan would greatly increase government revenue, so much so that “the national debt would effectively be paid off by FY 2010.” In other words, they argued that the Bush tax cuts would more than pay for themselves, by an incredible amount.

What actually happened, however, is that the federal debt, which was at about $6 trillion in 2001, increased to about $13.6 trillion by the end of 2010 (Treasury Direct, here).  The Heritage Foundation’s estimate of supply-side “stimulation” was off by almost $14 trillion, nearly one year’s GDP.

To make that forecast a reality, the deficit would have to have been converted into a surplus, which meant that by a wide margin the tax cut would have to have paid for itself. Not only that, but the surplus would have to have been sufficient to retire over $6 trillion of debt in 8 years. It is difficult to accept that anyone could be stupid enough to believe that propaganda, so we can only assume its conjurers simply hoped to fog it by an ignorant, inattentive public.

But the propaganda continued when Paul Ryan issued the House Budget Committee’s Fiscal Year 2012 Budget Resolution on March 20, 2012, entitled “The Path to Prosperity: A Blueprint for American Renewal” (here), and an endorsement of the plan was released on the same day by James Pethokoukis of the American Enterprise Institute (here). As I discussed:

The proposal was to keep the Bush tax cuts, and reduce taxes on top incomes even more (there would be only two tax brackets, 10% and 25%) and reduce the corporate rate from 35% to 25%, while funding these cuts by slashing federal programs.  There was no explanation of how, exactly, this austerity program would stimulate growth, but the prediction was graphically displayed that, without these tax cuts, debt would rise to 300% of GDP by 2050, yet with them the entire federal debt, which was then over $16 trillion, would be paid off by 2050:

Pages from pathtoprosperity2013bThis time, the degree to which the proposed tax cuts would allegedly more than pay for themselves became astronomical:  Without those cuts, the graph predicts, the debt would rise to about 300% of GDP by 2050. So these tax cuts would produce additional government revenues on the order of $45-50 trillion!  

 CBO’s False Forecasting

With this background in mind, let’s review the discussion of CBO forecasting from my last post:

Of course, no one has a crystal ball, and CBO in its “Budget and Economic Outlooks” suggests that we not regard its “projections” as forecasts. But we do, because we think they are capable of making at least short-run forecasts. Paul Krugman confirms that expectation when he says (in “The Fiscal Fizzle”) things like this:

The budget office predicts that this year’s federal deficit will be just 2.8 percent of G.D.P., down from 9.8 percent in 2009. It’s true that the fact that we’re still running a deficit means federal debt in dollar terms continues to grow — but the economy is growing too, so the budget office expects the crucial ratio of debt to G.D.P. to remain more or less flat for the next decade.

And he relies entirely on the CBO to claim this:

I’m not sure whether most readers realize just how thoroughly the great fiscal panic has fizzled — and the deficit scolds are, of course, still scolding. They’re even trying to spin the latest long-term projections from the Congressional Budget Office — which are distinctly non-alarming — as somehow a confirmation of their earlier scare tactics.    

All that supply-side “forecasting” can hope to accomplish, however, is guess the degree to which future growth will track the economy’s “productive potential,” which no macroeconomic forecaster actually has any way of identifying. We saw that in spades in our review of Thomas Piketty’s book “Capital in the Twentieth Century,” which attempted to resurrect an antique, controversial production-function model as the “Second Fundamental Law of Capitalism.” (See my post series “Picking Piketty Apart,” including “His Contribution,” 6/14/2014, “His ‘Laws of Capitalism’,” 6/21/2014, and “Time’s Running Out,” 6/23/2014). He candidly conceded that the model could not be used for forecasting, and explained it was only “valid” in the long run, which left me and others at a loss to explain why he decided to write a book about it.

What’s more, income (GDP) data contain a great deal of economic rent, which has zero tangible value. The point is, the only hope for making any predictions for the future is to follow trends in aggregate demand, and supply-side forecasters do not do that. Thus, the entire neoclassical paradigm unravels as we drift deeper and deeper into recession and depression.

What CBO does, it turns out, is first decide how much optimism it can sell, then unveil numbers for a basic ten-year forecast reflecting that degree of optimism. In its February, 2014 “Outlook”, for example, it projected a rapid return to an indefinite continuation of 2.1% annual growth, even though (by S&P’s calculation) growth has averaged only 1.4% over the last decade. Then it generated numbers for the intervening years and presented them as if they were the product of some sort of prognostication.  In other words, CBO is actually backcasting, not forecasting!

Here’s the proof: From its “Budget and Economic Outlook, 2014-2024″ (here), pdf (here) we can extract the following data (in $billions) :

Baseline Outlook

Item                                                          2013      . . . .        2017    . . . .      2022

1. Y-E debt, as a % of GDP [1]          72.1                        72.3                     76.8

2. Publicly held debt  [2]                 11,982                    14,507                 19,001

3. GDP   [2]                                             16,627                   20,054                 24,746

4. Computed GDP (l 2/l 1)               16,619                   20,065                 24,740    

[1]  Table 1-1, p. 9            

[2]  Table 1-2, p. 12

The numbers check. There is no reason to suspect, reading these numbers, that CBO isn’t using algorithms that project either publicly held debt or GDP as dependent variables. However, when we go back two years and look at data from “The Budget and Economic Outlook: 2012-2022″ (here) pdf (here), we see that it does no such thing:

Baseline Outlook

Item                                                          2013      . . . .        2017    . . . .      2022

1. Y-E debt, as a % of GDP [1]          75.1                         68.5                    62.0

2. Publicly held debt  [1]                 11,945                    13,509                15,291

3. GDP   [2]                                            15,914                    19,708                24,665 

4. Computed GDP (l 2/l 1)              15,905                    19,721                 24,663  

Alternative Fiscal Scenario 

Item                                                          2013      . . . .        2017    . . . .      2022

1. Y-E debt, as a % of GDP [1]          77.8                        84.0                     94.2

2. Publicly held debt  [1]                 12,374                    16,560                23,232

3. GDP   [2]                                            15,914                    19,708                 24,665 

4. Computed GDP (l 2/l 1)              15,905                    19,714                 24,662

[1] Table 1.7, p. 22

[2] Table 1.3, p. 10. Note: No separate GDP was provided for the A.F.S.

.   .   .   .   .   .   .  .

The entire outlook revolves around a judgmentally presumed amount of growth that will take place over the next ten years  no matter what else happens. In its February 2014 report, CBO presumed a GDP of $24.7 trillion  in 2022. This is up slightly, but still rounding to $24.7 trillion it used in its January 2012 outlook two years earlier.

Incredibly, this GDP number was not allowed to change, whether the debt was seen as rising to $15.3 trillion or to $23.2 trillion! This preposterous approach renders the entire “outlook” meaningless and nonsensical. The amount of debt is integrally related to GDP — at a very minimum, income tax revenues vary with GDP, so an additional $8 trillion of debt needed in the A.F.S. automatically implies a gigantic decline in GDP, and the associated need for more borrowing. 

This approach is fatally pernicious: For any given higher A.F.S. level of “projected” debt, GDP is necessarily lower than presented in the report. 

There is no indication that CBO believes debt might go up because the federal government will grow substantially, or that if it did there would be no stimulus, and the constant presumption of GDP growth invalidates the figures for debt as a percent of GDP. But Because CBO is backcasting from a presumed GDP ten years down the road, its numbers simply bear no relation to what may happen in the next few years, and will obscure the likelihood of impending crisis.  

CBO has conceded it made as optimistic an assumption for growth as it could for the next ten years.  But it’s only playing “pin the tail on the donkey,” then waiting around to see what actually happens. In the meantime, from the perspective of its economic “outlook,” no actual changes in the rate of growth, no amount of decline in  income or consumer and investment demand, are allowed to modify the ultimate expectation of growth built into the GDP presumed for the end of a decade. [Note #1 – omitted here]

CBO might protest that it is constantly revising it projections to reflect real changes in economic conditions. It appears not, but if so, that is all it is doing. It should stop pretending to see ten years into the future, certainly not 35 years into the future, and then disclaiming its work as non-forecasting.

Some immediate points:

It’s unclear why the amount of public debt, which now officially exceeds $17 trillion, is reported at much lower levels by CBO. Perhaps the $17 trillion number includes some debt not held by the public? This needs clarification. [Note #2 – omitted here];

CBO’s long-range “Outlook” in July of 2014 said debt would reach 100% of GDP finally in 2039. In 2012, Reinhart and Rogoff reported it was almost already there;

Regardless, CBO has no handle on the growth rate of debt because it does not account for changes in spending and demand, only potential production;

Its assumption of 2.1% annual growth instead of 1.4% or less is unfounded, admittedly optimistic, and dangerously over-optimistic because we’re in an unacknowledged depression.

Although we do not need to worry about the national debt itself causing decline,  we now know that the inequality caused by the high level of debt does, and the escalating inequality spiral will continue to depress growth even more rapidly than would the operation of Keynesian dynamics alone.

The one factor that any forecaster should be most certain of, at least in the short run, is the amount of debt and debt interest. As my letter to the Times Union reported, even under its optimistic scenario for GDP growth, CBO had debt interest exceeding the entire defense budget by 2021. It further covered up its expected growth of debt interest in the July report. There has to be some reason or reasons why CBO is unwilling to frankly discuss the debt problem any more. Could that reason possibly relate to the reason(s) that S&P suddenly surfaced a week or so later with the warning that inequality depresses growth? 

_______

The Perverse Bias in CBO’s Approach

I noted late yesterday (10:30 p.m. on 8/27) that CBO had just released “An Update to the Budget and Economic Outlook: 2014-2024″ (August 2014, here), which I have yet to thoroughly review. I did make a couple of initial observations:

  • CBO said it has reduced its estimate of the 2014 budget deficit. But on p. 6 it also stated: “The agency has significantly lowered its projection of growth in real GDP for 2014, reflecting surprising economic weakness in the first half of the year. However, the level of real GDP over most of the coming decade is projected to be only modestly lower than estimated in February.” This sentence, I noted, re-enforces the false impression CBO gives of actually projecting GDP over ten years (or more) as a dependent variable, and obscures its actual method of forecasting.
  • I noted that this latest report has 2022 GDP at $24,565 billion, just $181 billion lower than its February 2014 projection of $24,746 billion, cited above. So even though CBO has “significantly lowered its projection of growth in Real GDP for 2014″, it has not allowed any modification of the presumed level of ten-year growth.

We need to be clear about the implications of CBO’s approach. Like its Alternative Fiscal Scenario in 2012, this change in growth expectation does not impact the final expected GDP at the end of ten years. That is because this ending level of GDP was never forecast, it was presumed:

  • Perversely, no reductions in growth expectations are allowed to alter this final expectation. Because lower growth entails lower government revenues, a revised baseline would show higher deficits, debt and debt interest throughout the decade. Instead, CBO somehow arranges for additional growth later in the decade so that the amount of GDP at the end does not change.
  • Misrepresenting the state of the economy and the budget this way is certainly irresponsible. It would seem to meet the political requirements of a Republican Congress that is concerned in this election year about pressure for more progressive taxation. After the election, if the Republicans take over both the House and the Senate, they can proceed unmolested with bills to reduce taxes, and continue to attack President Obama’s vetoes with charges that he is interfering with the “path to prosperity.”
  • The approach requires the continuing acceptance of trickle-down ideology by an uninformed and unwary public.  

Worse, using this trickle-down approach prevents CBO from making anywhere near accurate baseline projections in the first instance, thus further covering up the pace at which grave danger may be approaching:

  • While it is busy obscuring the effects of any budget changes on growth, and vice-versa, CBO neglects to inform either its baseline or alternative scenarios with the impacts of changing levels of consumer or investor demand. Unless Keynesian insights are restored, the next great depression will blow in as unanticipated as the last one.
  • Already, CBO has ignored the fact that for the last ten years average growth has been 1.4%, simply desiring to be as optimistic as they think possible; the world is led to believe CBO has some legitimate reason to believe that growth will improve, but that belief is founded on nothing more than neoclassical ideology.
  • The most severe demand-side cause of decline is growing income and wealth inequality, because the effect of hundreds of billions of dollars of wealth transfers annually to the top is to impoverish the active economy, to a degree vastly exceeding the effect of business cycle swings in savings and investment. Neoclassical supply-side forecasting is blind to these developments.
  • CBO has now been alerted by S&P of something we already knew — that inequality suppresses growth. If CBO does not respond soon by renouncing its adoption of trickle-down economics, we can only assume that its bias and deception are intentional and will continue.   

So far as I am aware, CBO has made no serious effort to counter the public perception that it is actually forecasting future growth:

  • Paul Krugman, as noted above, actually has the impression that CBO has a factual basis for projecting “the crucial ratio of debt to G.D.P. to remain more or less flat for the next decade.” CBO has made no such finding. It has simply decreed that it will;
  • The political Right has wasted no time reaffirming that perception. The Wall Street Journal, on the same day the report was released (“Deficit Forecast Trimmed as Rates Stay Low,”  by Damian Paletta, WSJ, August 27, 2014, here), highlighted the updates along with this graph showing the deficits “projected” out through 2024:

federal deficit projections 8-27-14 wsj- cbo

The WSJ presents these projections as if they were the product of actual forecasts, not numbers derived from a presumed level of growth. Paletta presented a middling assessment similar to Krugman’s, opening with “The agency now expects growth of 1.5% [in 2014] reflecting ‘the surprising weakness in the first half of the year’.” CBO is said to have  “an upbeat view on economic growth in the next few years,” and: “The darkest clouds . . . for the next decade came in its warning about the continued growth of the federal debt.”

There is no sense of alarm in this report, even though CBO does not foresee any year for the rest of the decade when the deficit will be outside of the $500-$1,000 billion range. CBO has said this is a trend that cannot be “indefinitely” sustained, which is obvious, but it it has expressed no concern about the prospects of the trend being sustained through 2024, and in the July report it even pretended to believe the trend could be sustained to 2039. But how could that be even remotely possible? How long might we expect this trend to last, and why? In its July report, CBO clearly covered up the implications of its February “forecast,” as discussed in my letter to the Albany Times Union, and that is not a good sign. 

Given what we now know about CBO’s false “forecasting,” we should have no confidence any more in any of its pronouncements. Even its rosiest, handpicked scenario for the next decade looks bleak. Paul Ryan and CBO should be called out now on their trickle-down games — before the election. 

JMH – 8/28/2014

 

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Inequality and Debt, Dysfunctional Forecasting, and the Discomfort Zone to the Left.

For much of the past five years readers of the political and economic news were left in little doubt that budget deficits and rising debt were the most important issue facing America. Serious people constantly issued dire warnings that the United States risked turning into another Greece any day now. President Obama appointed a special, bipartisan commission to propose solutions to the alleged fiscal crisis, and spent much of his first term trying to negotiate a Grand Bargain on the budget with Republicans. That bargain never happened, because Republicans refused to consider any deal that raised taxes. Nonetheless, debt and deficits have faded from the news. And there’s a good reason for that disappearing act: The whole thing turns out to have been a false alarm. — Paul Krugman, “The Fiscal Fizzle: An Imaginary Budget and Debt Crisis,” The New York Times, July 20, 2014, here.

[W]hen economic myths persist, the explanation usually lies in politics — and, in particular, in class interests. There is not a shred of evidence that cutting tax rates on the wealthy boosts the economy, but there’s no mystery about why leading Republicans like Representative Paul Ryan keep claiming that lower taxes on the rich are the secret to growth. Claims that we face an imminent fiscal crisis, that America will turn into Greece any day now, similarly serve a useful purpose for those seeking to dismantle social programs. — Paul Krugman, “Hawks Crying Wolf,” The New York Times, August 22, 2014, here.

As often happens, on a day I sit down to write a post, Paul Krugman publishes an Op-ed that helps me focus. Let’s get Krugman’s points from July 20 and today (August 22) freshly in mind: In today’s Op-ed, on the topic of monetary policy, Krugman opened by pointing out that the political right bases its case for lower taxes on top incomes and corporations on Paul Ryan’s false “trickle-down” argument while arguing that, because we face a fiscal crisis, we must “dismantle social programs.” A month ago, Krugman challenged the warnings from the right that there is a fiscal crisis, citing the “distinctly non-alarming” July 2014 report from the Congressional Budget Office (CBO). I.e. — there is no fiscal crisis, hence no need to dismantle social programs.

Krugman is correct about the Republican Party in Congress consistently seeking budget cuts and also seeking to cut top tax rates and taxes on giant corporations. The problem is, there actually is a demonstrable fiscal crisis, one that CBO inexplicably saw fit to cover up in its July Report. (See my post “Breaking News: CBO Infected With Trickle-Down Disease,” July 27, here.)

A brief summary of the data revealing this cover-up was included in a letter to the editor of the Albany Times Union, here. In that letter, with no reference to any implications or motivations (letters to the editor have to be short), I merely observed that CBO’s published baseline ten-year “outlook” (a projection that assumes current “laws” remain unchanged) had debt interest increasing 278% by 2024, while discretionary spending would go up by only 16%, the defense portion of that by 19%, and non-discretionary spending by 77%. By 2021, the cost of the debt would exceed the entire defense budget.

In its July “Outlook,” however, CBO presented  graphs (no data) representing that debt interest will remain well below, and grow roughly parallel to, major medical programs and Social Security, not only out to 2024, but for another 25 years as well. This directly contradicted it February projections, which CBO said it was re-endorsing. My only inference from these facts, apart from CBO’s gross misrepresentation, was this: “Obviously, mushrooming debt and interest are squeezing out financing for government programs.” The cited facts, well vetted by the TU, stand in direct contradiction to Paul Krugman’s assertion in July, based on CBO’s July report, that the “alleged fiscal crisis … turns out to have been a false alarm.”

The Discomfort Zone on the Left

Although such a letter to the editor would get support from the “Left” if, for example, it was accompanied by a request for higher taxes on the wealthy and corporations, merely asserting there is a fiscal crisis makes it look like I am siding with the “Right.” That is because Paul Krugman, instead of arguing that higher taxes on the rich are required, has opted instead to contend that there really is no looming fiscal crisis and because, since Krugman’s views dominate progressive thinking, people tend to believe him. 

Thus, my letter was not welcomed by the Left. One former colleague in mediation services, who never fails to provide supportive reactions, sent an e-mail saying: “It’s a dense subject that, I have to admit, I have not fully appreciated.” He suggested I should have emphasized up front that government programs are being squeezed out. 

Another former colleague sent me this e-mail message: 

Michael, I am stunned. You are a traitor to the left. Haven’t you been reading Paul Krugman, telling us how the deficit hawks are nuts, it’s not a problem? 

There it was: the argument that, given Krugman’s proclamation that there is no fiscal crisis, I must be aiding and abetting the Right. Many progressives who read my article may have had that reaction. When I explained that I thought Krugman was wrong about that, he responded:

Oh. Sorry, I guess I didn’t get that Krugman is just not left enough for you!! 

This former colleague, by the way, is a “conservative” who said he agrees with my assessment of the budget problem. Hence, he was merely chiding me for taking issue with Krugman. He happens to agree with Krugman’s perspective that inequality is merely a non-economic, political issue: Indeed, it is this perspective, attractive to the Right, that has taken Krugman out of the game. Without appreciating how inequality affects growth and decline, neither Paul Krugman nor my “conservative” friend can get beyond moral considerations pertaining either to inequality or to taxation. If inequality is presumed to have no economic consequences, the debate is an inconclusive one over moral and philosophical issues, and this is emotional turf on which the Right has held its own.  

This leaves my perspective — that inequality is a dangerous economic condition — in a no-man’s land I’ll call: “The Discomfort Zone to the Left.” By that, I mean, to the “left” (for those inclined to see economics in terms of a left/right continuum) of Paul Krugman, and of the neoclassical economists whose world-views still have not allowed them to understand the mechanics of growth and decline. So far, it’s been fairly lonely in the Discomfort Zone. Robert Reich and Joseph Stiglitz are here, along with a handful of heterodox economists. If Paul Krugman would expand his perceptions, he could narrow the Discomfort Zone, but so far he has pointedly rejected Stiglitz’s analysis.  

Unfortunately, in conceding the economics of inequality to the “Right,” Krugman has given up an enormous amount of territory, indeed most of it. As I have increasingly emphasized over the past three years, because his views are taken as gospel by most of the “Left,” he endangers us all. So I’ll review my perspectives on growth and inequality again, with emphasis on political considerations, to explain the grave danger Krugman’s perspectives have put us in.

The Inequality Problem 

As shown in my last post (“Inequality Suppresses Growth: A Serious Problem?”, here), income inequality began to grow quickly in the U.S. during the Reagan presidency, when deregulation and lax enforcement of anti-monopoly laws allowed corporations to consolidate and greatly increase their profits, and the wealthiest Americans correspondingly to greatly increase their incomes. Simultaneously, a trend of reduced taxation of their income and wealth enabled them to keep increasingly more of these profits, and wealth concentration grew commensurately.

Here in the Discomfort Zone, I have found no one other than myself willing press this point strongly, although as the decline continues economists like Reich and Stiglitz appear to be increasing the call for progressive taxation. I can only assume that others demure for political or professional reasons. But these tax reductions lie at the heart of the inequality problem: The redistribution of wealth and income to the top has greatly reduced productivity and income growth, to the point of depression. The financing of a stunningly substantial portion of the increased wealth at the top with government credit has greatly amplified the inequality problem, and it has created what has become an intractable budget crisis.

Simply put, here is what has happened: Our government, and the entire bottom 99% of income earners, have been pressed to the task of further enriching the top 1% with money borrowed by the federal government, implicitly agreeing to eventually pay for that enrichment. Wealth of such a magnitude could not have come directly from existing bottom 99% income and wealth, but the bottom 99% has effectively been given an open-ended deferred payment plan: We have been allowed to pay off later our “debt” to those few high within the top 1% whom we  have made inconceivably wealthy.

To be sure, the top 1% does contribute some tax revenues, but they are increasingly depositing vast sums (conservatively estimated at about $8 trillion) off-shore, out of reach of U.S. taxation; and their corporations, which are now operating with an ever-growing array of First Amendment rights, are optimizing the social and political power of their money here while they are “legally” declared to be “citizens” of some other country that will not require as much taxation on the earnings they collect here. They do not pay enough taxes here to prevent the interest on the government’s debt from growing exponentially, and that interest has for decades provided a perpetual annuity for the holders of government bonds.

These powerful few are poised for a potentially complete takeover of the U.S. government. Among the thugs in their employ are those who would “shrink” the U.S. government until it is small enough to “drown in the bathtub” (Grover Norquist). However else we may choose to describe this obscene program, it is a prescription for the increasingly less gradual decline, and the ultimate destruction, of the United States and its economy. Let me put it somewhat more mildly:

From the standpoint of maximizing tangible productivity and optimizing social welfare, a more mismanaged economy can scarcely be imagined.

The perception of this reality exists mostly to the Left of Krugman’s perspectives, for he has not recognized any such economic implications of income inequality, which, in his 2012 book End This Depression NOW!, Ch. 5, he wrote off as a “political” problem with no macroeconomic consequences. The Discomfort Zone to the Left of Paul Krugman is, indeed, a vast territory.

The Reign of Ideology

This blog is replete with the details of the critique of neoclassicism and its fanciful ideological offshoots, so I’ll just summarize them here. The core tenet of neoclassical faith is that market economies will always, following a downturn or crisis, return fairly rapidly to a state of full employment “equilibrium.” This belief grew out of the static classical image of an economy in full employment, with current income either spent on current consumption or invested in “capital stock” for additional production. Because economic outcomes are said to be governed by “laws,” moreover, they are presumed to be fair and equitable. There is no such thing as unreasonable inequality.

This ideology, although growing out of the static classical model, conflicted directly with the ideas of classical economists who maintained that wealth distribution was not a result of natural law, but of Society’s choices (e.g., John Stuart Mill) and who observed that much of income and wealth was “economic rent” — payments to landowners whose mere ownership of land contributed nothing to the production of tangible wealth (e.g., Adam Smith, T.R. Malthus, Henry George). With the development of capitalism in the mid-19th Century, corporations began to take over most or all of the means of production, and “rent” increasingly became an element of “profits” which, like land rents, necessarily declined over time (Karl Marx). The only way to keep profit levels up, over time, was to distribute less value down.

New arguments emerged to respond to these well-established contradictions to the perfect efficiency presumed in the neoclassical system. For example: (a) Preserving economic “freedom” will protect incentives for investment and growth, while effective market competition will continuously provide optimal efficiency (e.g., Milton Friedman); (b) Attempts to reduce inequality by redistributing income and wealth back into the active economy would entail a “trade-off” with the optimal efficiency and growth provided by the “invisible hand” of Adam Smith  (e.g., Arthur Okun); and (c) Inequality is only the addition of growth at the top with no diminution of the income or wealth of anyone else (e.g., Martin Feldstein’s “magic bird” argument).

Friedman, Okun, and Feldstein were active in the 1960s and 1970s, and influential in the movement to marginalize Keynesian economics. An outgrowth of Okun’s trade-off and Feldstein’s magic bird arguments was the “trickle-down” myth that dominates political discourse today: Simply put, it is the idea that income and wealth transfers to the top create growth, as the “job creators” automatically expand their investments. A related idea, the “austerity doctrine,” is that if central government, to balance its budget, refrains from taxing the rich, but instead cuts back its spending, the economy will grow. These perverse ideologies simply deny both Keynes’s “principle of effective demand,” the truth of which has been repeatedly verified ever since the Great Depression and  WW II, and the fundamental logic of the risk/reward assessments underlying investment decisions.

Krugman has repeatedly denounced the trickle-down myth, as in the second quotation above, but has treated it as a plausible factual proposition lacking real-world verification, not as a logically unsound idea. And he has not yet clearly rejected the corollary proposition that higher taxation at top incomes diminishes growth, by reducing investment incentives. This reverse trickle-down myth fails for the same reasons. 

Inequality and Growth

In my last post, I discussed Standard & Poor’s recent conclusion that income inequality reduces growth (“How Increasing Income Inequality Is Dampening U.S. Economic Growth, And Possible Ways To Change The Tide,” August 5, 2014, here). I provided evidence of the validity of this conclusion. It’s enormous significance lies in establishing that the distribution of wealth and income is the basic determinant of prosperity and decline, and that falling growth is a huge problem that cannot be countered by merely stimulating demand and employment.   

Those of us in the Discomfort Zone, including Reich and Stiglitz,  have explained for several years, in terms of Keynes’s “marginal propensity to consume,” that aggregate consumption declines when income concentrates because wealthier people spend a lower percentage of their income on consumption than do middle class and poor people.  This wisdom has been lost on neoclassical economics, which has discarded Keynes’s principle of effective demand and rejected Keynesian “demand-side” economics in favor of full reliance on “supply-side” ideas.

In the context of America’s extreme inequality, this Keynesian reality should now be intuitively obvious: How in the world could the U.S. maintain the same level of consumption, and therefore production and income, after the income share of a mere 1% of the population increased from 9% (1979) to almost 25% of the income (2007)? The income share of the other 99% is correspondingly reduced, and aggregate consumption and growth necessarily declines substantially, as shown in my previous post. Martin Feldstein’s opposing “magic bird” hypothesis would require that, somehow, higher inequality itself magically expands the money supply. Regardless, the ultimate proof lies in the facts of experience:

US GDP 10-year moving average

This graph shows the decline since 1968 of the U.S. GDP ten-year rolling average growth rate. The curious factor here is the long period (about 1975-2005) of roughly 3% annual growth. The decline to about 1.5% average growth after the Crash of 2008 is substantial, and it has stumped mainstream economists, who have termed the trend “secular stagnation,” or “the new normal.” The most likely explanation for the Crash itself seems to be the collapse of effective demand driven by the steadily increasing income inequality, and perhaps by some degree of exhaustion of the support to the active money supply given by the creation of federal debt. This entire topic is rife with important research topics. 

Even small swings in the GDP growth rate, which varies within a narrow range, can be quite significant. During the period after WW II when prosperity was rising and income inequality declining, GDP growth averaged over 4%.  By the mid-1970s, the average growth rate had declined to about 3%, where it remained until the Crash. The U.S. population is now growing only about 0.7% annually, close to the slow population growth in the depression years, and down from 1.2% growth rate of the 1990s, “a decade of economic expansion” (The Guardian, December 31, 2013, here). But the 1990s was also a decade of rapid income inequality growth as well, with real median income growth well below the 3.0% average GDP growth.  The average of 1.4% aggregate growth since the Crash, as computed by Standard and Poor’s, likely represents declining per capita income for most of the bottom 99%: Yet another area brimming with research topics for Raj Chetty’s legions of “scientific” economists for whom, he says, the mysteries of growth “remain elusive.”

As a rough rule of thumb, we can probably think of aggregate GDP growth rates of 4.0% and higher as representing prosperity, 2.0% and below as reflecting depression, and 2-4% as representing average prosperity. The Crash of 2008 marked the end of period of steady average prosperity (rapidly increasing inequality supported by government debt) and the beginning of a gradually deepening depression. The new depression era has been a bizarre period with high inflation for top 1% luxury items — yachts, penthouses, antiques, fine art, etc. — generated by surplus financial wealth (see “Welcome to the Everything Boom, or Maybe the Everything Bubble,” by Neil Irwin, New York Times, July 7, 2014, here) and the more modest inflation below the top 1% for everyday consumer products, generated not by excessive consumer demand but by monopolistic market power, through excess profits.      

Growing inequality must be understood as separating the aggregate economy into two ever-increasingly independent economies, and failure to see the aggregate economy in such distributional terms leads to political error. For example, an editorial from The Orange County Register, “Student loans only inflate the U.S. debt,” was recently reprinted in The Albany Times Union (August 23, 2014, here), and it began:

Perhaps we should not be surprised that the Obama administration’s solution to a problem of high debts is to incur even more debt. This was the thinking with the economy as a whole, which has languished for more than five years since the official end of the 2007-09 recession, and now the administration is doubling down on this strategy to address student loan debt.

The editorial correctly notes that the more than $1.1 trillion of student loan debt is “the worst credit risk of any major debt category.” The author could only think of the cost to taxpayers, however, blaming the Obama administration for extravagant spending, with no awareness of the relevance of income and wealth inequality to the issue.

Here is the neoclassical mistake: The taxpayers who should be footing the education bill are those who have been enriching themselves at everyone else’s expense for three decades, depleting student resources and thereby directly causing the enormous student debt. Nor was there any appreciation that the enormous “bubble” may soon pop, creating still more inequality and reduced growth, if this debt is not properly managed by the government. Declining education, like declining health care, decaying infrastructure, failing municipal governments, and environmental decline, and so forth, is a direct consequence of the impoverishment of America caused by rising inequality.    

As explained above, the controlling factor is Keynes’s groundbreaking “principle of effective demand.” Keynes excluded income and wealth distribution from his full employment model in 1935, and the data needed for a distributional application of Keynesian macroeconomics has only recently become available: It’s worth reading a key passage from Keynes’s crucial Chapter 3, “The Principle of Effective Demand,” (Sec. II), updated to include [in brackets] references to inequality:

This analysis provides us with an explanation of the paradox of poverty in the midst of plenty. For the mere existence of an insufficiency of effective demand may, and often will, bring the increase of employment to a standstill before a level of full employment has been reached. The insufficiency of effective demand will inhibit the process of production in spite of the fact that the marginal product of labour still exceeds in value the marginal disutility of employment.

Moreover the richer [more unequal] the community, the wider will tend to be the gap between its actual and its potential production; and therefore the more obvious and outrageous the defects of the economic system. For a poor [highly unequal] community will be prone to consume by far the greater part of its output, so that a very modest measure of investment will be sufficient to provide full employment; whereas a wealthy [the wealthy segment of a highly unequal ] community will have to discover much ampler opportunities for investment if the saving propensities of its wealthier members are to be compatible with the employment of its poorer members. If in a potentially wealthy community the inducement to invest is weak, then, in spite of its potential wealth, the working of the principle of effective demand will compel it to reduce its actual output, until . . . its surplus over its consumption is sufficiently diminished to correspond to the weakness of the inducement to invest.

But worse still. Not only is the marginal propensity to consume weaker in a wealthy [more highly unequal] community, but, owing to its accumulation of capital being already larger, the opportunities for further investment are less attractive unless the rate of interest falls at a sufficiently rapid rate.

This should resonate with anyone familiar with what has been happening in the U.S. since 1980. Notice that Keynes appeared to assume that full employment would be a sufficient response to the “paradox of poverty in the midst of plenty.” Extreme inequality, however, introduces the circumstance where money diverted from commerce to idleness and hoarding at the top vastly exceeds the shifts in the propensity to consume associated with the business cycle.

Notice, too, that the last two sentences of this quotation actually describe the anatomy of a depression. It describes what Paul Krugman calls a “liquidity trap,” but as Polly Cleveland has deftly noted, the liquidity trap may more accurately be described as an “inequality trap.” Above all else, it describes an economy shrinking deeper into depression. Keynes failed to note only that an inequality cycle will continuously worsen if the circumstances giving rise to it are not corrected.

Inequality and Debt

The federal debt now exceeds $17 trillion, and following graph, which I constructed more than a year ago, shows that the national debt has been rising faster than GDP since 1980:

chartgoHere, GDP (income), top 1% net worth (wealth) and the national debt are shown from 1982 through 2010, and GDP and the debt out to 2012. The national debt has grown steadily, exponentially over the last 20 years,  until 2010 when it was poised to reach the level of real GDP.  (NOTE: I have no definitive explanation of how CBO has computed the debt at only 73.6% of GDP in 2014 and 79.2% in 2024, but see the discussion of forecasting issues, below.)

Because the national debt is the major source of the rising concentration of wealth, and because income is concentrating high within the top 1%, top 1% wealth is also necessarily growing faster than GDP. Before the Crash of 2008, top 1% net worth reported to the Census Bureau (i.e., excluding unreported off-shore wealth) had grown by about $19 trillion. Remember, this stunning development is almost entirely due to the tax reductions on top incomes.

Politically, the effort by Republicans to regain control of the Senate in 2014 and to regain the presidency after 2016 entails the time-honored strategy of blaming the president for current economic woes.  That strategy is likely to work, even though the national debt was over $10 trillion when Obama took office (Treasury Direct, here), and interest has been compounding in perpetual annuity during the “Great Recession,” drastically reducing bottom 99% incomes and exacerbating the deficits ever since. Here’s a chart of the growth of the debt (as a percent of GDP) by administration (Wikipedia, here):

US_Federal_Debt_as_Percent_of_GDP_by_President_(1940_to_2012)


Debt grows exponentially, all else equal. So this chart shows the Reagan/GHW Bush years to be the worst from the standpoint of federal borrowing in excess of GDP growth. During the Clinton Administration the “dot.com” boom enhanced GDP growth and government revenues, and taxes on top incomes were increased, so debt as a percent of GDP declined. The GW Bush years were marked by extensive spending on the Middle East wars, collapse of the dot.com boom, and massive tax cuts for the rich, so debt as a percent of GDP again rose.

The Obama years have seen the sharpest increase in the debt/GDP ratio since the early years of the Roosevelt presidency. A different circumstance back then was that heavy borrowing was needed to finance America’s entry into WW II whereas, as noted, the current steep increase results from society’s decision to finance the exponentially increasing income inequality, and the unimaginable, depression-level income and wealth wealth concentrations at the top; after WW II the debt/GDP ratio fell with the redirection of war-time spending toward domestic recovery and infrastructure rebuilding, and the maintenance of very high marginal income tax rates. Over the last 35 years, however, the tax structure that is driving wealth to the top has not been corrected; the Republican Party will not allow reestablishment of the necessary level of taxation.

None of this is expressly recognized by neoclassical economists, however, whose deficient understanding of how the economy works permits them to ignore these tragic developments. It’s an incredibly huge gap between an appropriate distributional economics and this bankrupt neoclassical view — it’s the broad wasteland of the Discomfort Zone.

Reinhart, Rogoff, and Ryan

Consider the case of the study by Carmen Reinhart and Kenneth Rogoff “Growth in a Time of Debt” (GITD) a study seemingly transported to the Discomfort Zone from the Twilight Zone! The authors had run regression analyses of many decades of national income against national government (public) debt for several countries, and regarding the United States they reached the conclusion that as the PD/GDP ratio approaches 1.0, growth declines. This was music to the ears of Paul Ryan, the 2012 vice-presidential candidate and potential 2016 Republican nominee for the presidency. Ryan is on a quest to cut federal spending without increasing taxation at the top. 

GITD was the sole economic study cited in his 2012 budget proposal, “The Path to Prosperity.” When errors in the Reinhart/Rogoff study forced them to withdraw their hypothesis, that should have been the end of the austerity doctrine — but firmly-held ideological beliefs die hard. Ryan still hopes to ride the twin fantasies of trickle-down economics and the austerity doctrine to his version of “prosperity.”

While reviewing the graphs presented with the Reinhart/Rogoff study, I noticed something that no one else seems to have noticed: If, as the Piketty/Saez data have demonstrated, depressions are stagnation caused by high levels of income inequality, and if as I maintain high levels of income inequality are also the immediate consequence of high levels of public debt, the Reinhart/Rogoff study should reflect that high income inequality is present at high levels of public debt. In fact, I found it to do just that:

Once it is understood that the public debt has essentially financed the enrichment of the wealthiest Americans, it becomes clear that the increase of the PD/GDP ratio to over 90% today is also attributable to that enrichment. That fact is inherently reflected in the Reinhart/Rogoff data. Here again is the chart of the U.S. results for growth provided by Reinhart and Rogoff in their initial workpaper on their “Growth in a Time of Debt” (GITD) study (here). (Chart omitted: Go to “Finding a New Macroeconomics: (10) Reinhart, Rogoff, and Redistribution,” June 30, 2013,  here. )

The Reinhart/Rogoff chart shows that over the 200 or so years covered in their database, growth has been slightly lower on average when the national debt was 30-60% of GDP than when it was below 30%, and lower still when PD/GDP was between 60-90%. It also shows that when the PD/GDP ratios were higher than 30%,  the average (mean) of aggregate income growth was lower than the median aggregate income growth; this confirms that a higher level of income inequality is embedded in the GDP data for these periods of higher PD/GDP ratios. And, of course, the income growth (GDP) data at any point of time would reflect the degree of income inequality present at that time. Notably, these relationships are present in the data for all periods, both when debt was growing and when it was declining, and the Reinhart/Rogoff data cover a 200-year period.

For these reasons, that these factors are reflected so strongly in a regression of contemporaneous observations of PD/GDP and growth, as opposed to a time-series study, is really not surprising, despite the many factors that affect growth. But it is telling: * * * The Reinhart/Rogoff corrected study confirms the relationship between growing income inequality and declining growth.

Here is another fabulous opportunity for scientific research. Indeed, I have suggested running regressions of the PD/GDP ratios against both top 1% income and bottom 99% income.

“Forecasting” in the Blind 

So far this post has clarified that the neoclassical supply-side paradigm has thoroughly covered up the basic nature of how the economy works. Income and wealth distribution data have shown us, beyond doubt, that aggregate growth and prosperity depend upon maintaining adequate demand throughout the economy, and that depends upon optimizing the distribution of income and wealth, and that, in turn, depends upon maintaining a sufficiently progressive level of taxation. Neoclassical economics comprehends none of that. Because we continue to drift down into a deeper depression, unable to recover from the “Great Recession,” mainstream forecasters are befuddled, and I’ve been following that befuddlement closely.

Prompted by Krugman’s report on the “mutilated economy” last November, I reviewed the Fed’s angst about long-term unemployment. (“The Neoclassical Boondoggle and the ‘Mutilated Economy,’ Part 1, 11/15/2013), Part 2, 11/16/2013, and Part 3, 11/19/2013). We have seen as well that IMF economists who pitted the proposition that income inequality depresses growth against Okun’s contradictory theory that there is a “trade-off” between inequality and growth found (apparently to their surprise) that Okun was wrong (“Inequality and Growth – Two Sides of he Same Coin,” 3/28/2014). A year earlier, as just mentioned, we watched the Reinhart/Rogoff claim that their study “Growth in a Time of Debt” (GITD) showed that high levels of public debt depress growth backfire when errors forced them to withdraw their thesis. (There are three posts on this topic in the Finding a New Macroeconomics Series, “Reinhart, Rogoff and Reality,” 5/30/2013, “Reinhart, Rogoff, and Ideology,” 6/6/2013, and “Reinhart, Rogoff, and Redistribution,” June 30, 2013.) 

In July, I responded to Krugman’s Op-ed “The Fiscal Fizzle: An Imaginary Budget and Debt Crisis” (7/20/2014), in which he declared the entire budget scare to be a false alarm, with “The Fiscal Fiasco: A Real Budget and Debt Crisis (7/23/2014) , and “Breaking News: CBO Infected With Trickle-Down Disease” (7/27/2014). Finally, when Standard & Poor’s, a conservative rating agency, felt compelled to announce its awareness of the growing evidence that income inequality depresses growth, I reacted to Krugman’s cautious, somewhat negative response to the S&P announcement with “Inequality Retards Growth: A New View?” (8/9/2014), and my previous post, “Inequality Suppresses Growth: A Serious Problem.”   

CBO’s “Forecasts”

Of course, no one has a crystal ball, and CBO in its “Budget and Economic Outlooks” suggests that we not regard its “projections” as forecasts. But we do, because we think they are capable of making at least short-run forecasts. Paul Krugman confirms that expectation when he says (in “The Fiscal Fizzle”) things like this:

The budget office predicts that this year’s federal deficit will be just 2.8 percent of G.D.P., down from 9.8 percent in 2009. It’s true that the fact that we’re still running a deficit means federal debt in dollar terms continues to grow — but the economy is growing too, so the budget office expects the crucial ratio of debt to G.D.P. to remain more or less flat for the next decade.

And of course, he relies entirely on the CBO to claim this:

I’m not sure whether most readers realize just how thoroughly the great fiscal panic has fizzled — and the deficit scolds are, of course, still scolding. They’re even trying to spin the latest long-term projections from the Congressional Budget Office — which are distinctly non-alarming — as somehow a confirmation of their earlier scare tactics.    

All that supply-side “forecasting” can hope to accomplish, however, is guess the degree to which future growth will track the economy’s “productive potential,” which no macroeconomic forecaster actually has any way of identifying. We saw that in spades in our review of Thomas Piketty’s book “Capital in the Twentieth Century,” which attempted to resurrect an antique, controversial production-function model as the “Second Fundamental Law of Capitalism.” (See my post series “Picking Piketty Apart,” including “His Contribution,” 6/14/2014, “His ‘Laws of Capitalism’,” 6/21/2014, and “Time’s Running Out,” 6/23/2014). He candidly conceded that the model could not be used for forecasting, and explained it was only “valid” in the long run, which left me and others at a loss to explain why he decided to write a book about it.

What’s more, income (GDP) data contain a great deal of economic rent, which has zero tangible value. The point is, the only hope for making any predictions for the future is to follow trends in aggregate demand, and supply-side forecasters do not do that. Thus, the entire neoclassical paradigm unravels as we drift deeper and deeper into recession and depression.

What CBO does, it turns out, is first decide how much optimism it can sell, then unveil numbers for a basic ten-year forecast reflecting that degree of optimism. In Its February, 2014 “Outlook”, for example, it projected a rapid return to an indefinite continuation of 2.1% annual growth, even though (by S&P’s calculation) growth has averaged only 1.4% over the last decade. Then it generated numbers for the intervening years which were then presented as if they were the product of some sort of prognostication.  In other words, CBO is actually backcasting, not forecasting!

Here’s the proof: From its “Budget and Economic Outlook, 2014-2024″ (here), pdf (here) we can extract the following data (in $billions) :

Baseline Outlook

Item                                                          2013      . . . .        2017    . . . .      2022

1. Y-E debt, as a % of GDP [1]          72.1                        72.3                     76.8

2. Publicly held debt  [2]                 11,982                    14,507                 19,001

3. GDP   [2]                                             16,627                   20,054                 24,746

4. Computed GDP (l 2/l 1)               16,619                   20,065                 24,740    

[1]  Table 1-1, p. 9            

[2]  Table 1-2, p. 12

The numbers check. There is no reason to suspect, reading these numbers, that CBO isn’t using algorithms that project either publicly held debt or GDP as dependent variables. However, when we go back two years and look at data from “The Budget and Economic Outlook: 2012-2022″ (here) pdf (here), we see that it does no such thing:

Baseline Outlook

Item                                                          2013      . . . .        2017    . . . .      2022

1. Y-E debt, as a % of GDP [1]          75.1                         68.5                    62.0

2. Publicly held debt  [1]                 11,945                    13,509                15,291

3. GDP   [2]                                            15,914                    19,708                24,665 

4. Computed GDP (l 2/l 1)              15,905                    19,721                 24,663  

Alternative Fiscal Scenario 

Item                                                          2013      . . . .        2017    . . . .      2022

1. Y-E debt, as a % of GDP [1]          77.8                        84.0                     94.2

2. Publicly held debt  [1]                 12,374                    16,560                23,232

3. GDP   [2]                                            15,914                    19,708                 24,665 

4. Computed GDP (l 2/l 1)              15,905                    19,714                 24,662

[1] Table 1.7, p. 22

[2] Table 1.3, p. 10. Note: No separate GDP provided for A.F.S.

.   .   .   .   .   .   .  .

The entire outlook revolves around a judgmentally presumed amount of growth that will take place over the next ten years  no matter what else happens. In its February 2014 report, CBO presumed a GDP of $24.7 trillion  in 2022. This is up slightly, but still rounding to $24.7 trillion it used in its January 2012 outlook two years earlier.

Incredibly, this GDP number was not allowed to change, whether the debt was seen as rising to $15.3 trillion or to $23.2 trillion! This preposterous approach renders the entire “outlook” meaningless and nonsensical. The amount of debt is integrally related to GDP — at a very minimum, income tax revenues vary with GDP, so an additional $8 trillion of debt needed in the A.F.S. automatically implies a gigantic decline in GDP, and the associated need for more borrowing. 

This approach is fatally pernicious: For any given higher A.F.S. level of “projected” debt, GDP is necessarily lower than presented in the report. 

There is no indication that CBO believes debt might go up because the federal government will grow substantially, or that if it did there would be no stimulus, and the constant presumption of GDP growth invalidates the figures for debt as a percent of GDP. But Because CBO is backcasting from a presumed GDP ten years down the road, its numbers simply bear no relation to what may happen in the next few years, and will obscure the likelihood of impending crisis.  

CBO has conceded it made as optimistic an assumption for growth as it could for the next ten years.  But it’s only playing “pin the tail on the donkey,” then waiting around to see what actually happens. In the meantime, from the perspective of its economic “outlook,” no actual changes in the rate of growth, no amount of decline in  income or consumer and investment demand, are allowed to modify the ultimate expectation of growth built into the GDP presumed for the end of a decade. [Note #1]

CBO might protest that it is constantly revising it projections to reflect real changes in economic conditions. It appears not, but if so, that is all it is doing. It should stop pretending to see ten years into the future, certainly not 35 years into the future, and then disclaiming its work as non-forecasting.

Some immediate points:

  • It’s unclear why the amount of public debt, which now officially exceeds $17 trillion, is reported at much lower levels by CBO; This needs clarification. [Note #2]  
  • Regardless, CBO has no handle on the growth rate of debt because it does not account for changes in spending and demand, only potential production;
  • Its assumption of 2.1% annual growth instead of 1.4% or less is unfounded, admittedly optimistic, and dangerously over-optimistic because we’re in an unacknowledged depression;
  • CBO’s long-range “Outlook” in July of 2014 said debt would reach 100% of GDP finally in 2039. In 2012, Reinhart and Rogoff reported it was almost already there;
  • Although we do not need to worry about the debt itself causing decline, we now know that the inequality caused by the high level of debt does, and the escalating inequality spiral will continue to depress growth even more rapidly than would the operation of Keynesian dynamics alone.

The one factor that any forecaster should be most certain of, at least in the short run, is the amount of debt and debt interest. As my letter to the Times Union reported, even under its optimistic scenario for GDP growth, CBO had debt interest exceeding the entire defense budget by 2021. It further covered up its expected growth of debt interest in the July report. There has to be some reason or reasons why CBO is unwilling to frankly discuss the debt problem any more. Could that reason possibly relate to the reason(s) that S&P suddenly surfaced a week or so later with the warning that inequality depresses growth? 

Conclusion

It’s still very lonely here in the “Discomfort Zone to the Left of Paul Krugman.” I know this all seems very complicated to the average untutored mortal, which is why we are susceptible to believing one ideology or another.  And we like to believe that we can trust the “experts,” especially those who can boast a Nobel Prize. We also tend to believe that the more radically extreme an idea seems, the more likely it is to be wrong. The Chicken Little story would have a perverse moral, wouldn’t it, if the sky actually was falling?

Well, my Chicken Little story is based entirely on logical and demonstrable facts, and the deniers are beyond redemption. I don’t get off on negativity and pessimism: I have been trained my entire life and career, however, to look for and accept reality. Those of you who insist on forming your opinions on the basis of “argument by authority,” let me remind you that Joe Stiglitz also has a Nobel Prize. You can check with him, but mainly you should decide for yourself. Read, and think, and pay very close attention to what is happening in your world. The truth really isn’t that difficult to understand. 

I only hope that I’ve disabused you of the notion that I am a “traitor to the Left.” I don’t have a crystal ball, but I do have a gut feeling that we’re just a stone’s throw away from Great Depression #2.

Shall we not go there?

JMH — 8/27/2014

_______

[Note #1, posted 10:30 p.m. on 8/27] CBO has just today released “An Update to the Budget and Economic Outlook: 2014-2024″ (August 2014, here), which I have yet to thoroughly review. CBO says it has reduced its estimate of the 2014 budget deficit. But on p. 6 it also states: “The agency has significantly lowered its projection of growth in real GDP for 2014, reflecting surprising economic weakness in the first half of the year. However, the level of real GDP over most of the coming decade is projected  to be only modestly lower than estimated in February.” That last sentence continues the impression CBO has been giving of actually projecting GDP over ten years (or more) as a dependent variable, obscuring its actual method of forecasting GDP. Note that this report has 2022 GDP at$24,565 billion, just $181 billion lower than its February 2014 projection of $24,746 billion, cited above.

The world (certainly the “conservative” world, here) takes CBO at its word and actually believes (or argues) there is some sophisticated basis for forecasting growth to continue at over 2% for ten years! That, however, is nothing more than neoclassical optimism.

[Note #2, posted 3:00 p.m. on 8/30] Treasury Direct (here) reports “total public debt outstanding” inclusive of “intergovernmental holdings”: E.g., on August 29, the total of total public debt outstanding was $17.7 trillion, and the total of intergovernmental holdings was just over $5 trillion. This explains CBO’s figure of $12.4 trillion for publicly held debt at y.e. 2013. 

The impact of intergovernmental debt is not accounted for at all, however, and that is not just a source of confusion (see Michael D. Tanner’s July 23, 2014 report “D.C. Forgets about the Debt” (here) which focuses on “gross public” debt.) Although CBO is not responsible for any public confusion on this, it is noteworthy that CBO assumes that intergovernmental debt has no material budget implications. In the short run, perhaps not, but CBO purports to make forecasts going out 35 years. Here’s the explanation of debt held by federal accounts from the National Priorities Project (here):

Debt Held by Federal Accounts is money the federal government borrows from itself.  It results from the Treasury using surpluses from some accounts – for instance, Social Security – to buy Treasury bonds, and thus finance current government spending. Borrowed funds ultimately need to be repaid to the original account, with interest.

The process of borrowing, for example, current Social Security payments for current government spending is problematic, because either this interest will ultimately have to be included in the budget (incurring more taxes or borrowing) or if it is not repaid at all the value will have been taken directly from the Social Security fund, a major tax on Social Security and redistribution of wealth, given our current tax structure. CBO’s narrower definition of the budget problem concedes the loss of this value, and imparts an unreasonably more favorable budget outlook.

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Inequality Suppresses Growth: A Serious Problem?

The math is easy: the federal budget over the next decade cannot be made to square without raising a lot more money. The nonpartisan Congressional Budget Office estimates that if we stay on our current path, federal debt held by the public will grow from about two-thirds of gross domestic product today to roughly 100 percent in a decade and twice that much by 2040. It is unlikely that even the most committed Republicans could reverse the trend without higher taxes.

But an equally compelling reason relies on a new understanding of the economics of taxation. For 30 years, any proposal to raise taxes had to overcome an unshakable belief that higher taxes inevitably led to less growth. The belief survived the Clinton administration, when taxes rose and the economy surged. It survived George W. Bush’s administration, when taxes were cut yet growth sagged.

But now, a growing body of research suggests not only that the government could raise much more revenue by sharply raising the top tax rates paid by the richest Americans, but it could do so without slowing economic growth. Top tax rates could go as high as 80 percent or more.

Admittedly, it seems inconceivable that our political system could stomach a tax increase that big. Today, the richest 1 percent of Americans pay a top federal rate of 29 percent, according to Emmanuel Saez, an economist at the University of California, Berkeley. That’s because almost a third of their income derives from capital gains and dividends — which are taxed at a 15 percent rate — while the rest is ordinary income taxed at a top marginal rate of 35 percent.

Nonetheless, the research suggests there is much more money available to close the budget deficit than we previously thought, if only we were willing to raise tax rates to where they were back in the early ’70s, in the administration of Richard M. Nixon.

Taxpayers always want to pay less to the tax man. Still, there’s nothing inevitable about low taxes. In the early 1950s, coming out of World War II, the top federal income tax rate exceeded 90 percent. In 1980, the top marginal rate was 70 percent for families making more than $215,400 — about $587,000 in current dollars. And these families pocketed a much smaller share of the nation’s income than they do now. Today, people earning over $200,000 a year capture more than a third of national income. 

– Eduardo Porter, “The Case for Raising Top Tax Rates,” The New York Times, March 27, 2012 (here), linking “The Budget Message Paul Ryan Really Sent,” by Howard Gleckman, The Tax Policy Center, March 22, 2012 (here). Emphasis added.

This post follows up on my initial discussion of the economics associated with Standard & Poor’s (S&P’s) recent recognition that income inequality reduces income growth, and Paul Krugman’s assertion that this is a “new view” of economics. I will occasionally refer back to points made in that post, but here I set forth evidence demonstrating the correctness of this view of inequality, and showing that inequality poses  a serious, ongoing danger for the United States economy.

To set the stage for that review, let’s connect some important dots: The opening quotation, to which I called immediate attention in this blog nearly two and one-half years ago (here) is presented for its observation that tax increases on top incomes needed to balance the budget have been blocked by the ideological belief that raising taxes on top incomes reduces growth. This is a form of the “trickle-down” argument against taxation, which incorrectly asserts that lowering taxes on top incomes enhances growth. The truth is the opposite: higher taxes at the top serves to redistribute income and wealth to people who spend a greater share of their incomes, thereby increasing investment, jobs, production, and growth.

What may appear to be a different topic — the effect of inequality on growth — really is a the same topic: Inequality is the measure of the concentration of wealth and income, and it occurs naturally in a market economy. The progressiveness of taxation is the measure of the degree to which society allows income and wealth concentration to develop; the immediate effects of reducing the effective taxation of the wealthiest people are to reduce central government’s tax revenues and to increase inequality; and by suppressing income growth, income inequality further suppresses tax revenues. 

That is why saying that increasing growth requires reducing inequality is virtually the same as saying that increasing growth requires higher taxes on top incomes. Likewise, the “trickle-down” myth that progressive taxation has no effect on growth is therefore intrinsically linked to the myth fostered by neoclassical economics, discussed in my last post, that inequality has no macroeconomic consequences. It occurred to me several years ago, as it more recently occurred to the IMF economists whose work is cited by S&P, that inequality and growth are “two sides of the same coin.” It’s a bizarre variation of this metaphor, but given the intrinsic relationship between inequality and tax progressiveness we can say that tax progressiveness, inequality, and growth are “three sides of the same coin.”   

Inequality and Taxation  

To start, let’s pin down the point that reducing taxes on top incomes causes inequality growth. Intuitively, this has to be the case, because doing so instantly increases the incomes of wealthy people relative to the incomes of everyone else. This was obvious to Keynes (see the last chapter to his General Theory), and presumably to all thoughtful people at the turn of the 20th Century when the contrary mythologies were being developed. There is no longer any question, for now there is an ironclad factual record:

DP8675a

This graph was presented by Thomas Piketty, Emmanuel Saez, and Stephanie Stantcheva in their November 2011 CEPR discussion paper “Optimal Taxation of Top Labor Incomes: A Tale of Three Elasticities,” Working Paper 17616 (DP8675, here). It shows that the top 1% share of income and capital gains has varied inversely with the top marginal income tax and capital gains tax throughout the century, ever since income taxation was adopted.

In his book End this Depression NOW! (2012, p. 82) Paul Krugman mentions this evidence, but sees in it no implications for aggregate income:

As Piketty and Saez note, there is a fairly close negative correlation between top tax rates and the top 1 percent’s share of income, both over time and across countries.  

What I take from all of this is that we should probably think of rising incomes at the top as reflecting the same social and political factors that promoted lax financial regulation. 

Well, across countries it is purely a matter of correlation, but for an individual country, over time, its a matter of causation. To be sure, the causal relationship is between income distribution and effective taxation, not marginal income tax rates; but this graph shows that the top marginal rates track inequality closely. The relationship is so tight that, so far as I know, the researchers did not even bother to confirm it with regression analysis.

Recall (from the previous post) that mainstream economists are said to have universally accepted Arthur Okun’s alleged trade-off between inequality and “efficiency” (a basic element of growth), which postulated that efforts to reduce inequality by reducing after-tax income at the top would backfire, reducing growth, even though the only cited support for the proposition was the false mythology developed from Adam Smith’s “invisible hand” metaphor. Mainstream economics is still in the grip of that fantasy: It permeates the S&P report and its call for a cautious approach to curing inequality. It permeates Congressional Budget Office (CBO) forecasts. And this has to be the main reason why the cornucopia of potential research projects available to pin down the real world relationships between effective taxation, inequality and growth were not included by Raj Chetty in his list of ongoing research projects in “scientific” macroeconomics.   

Paul Krugman’s perspectives remain a significant part of our problem: Unfortunately, two and one-half years since the alert sounded by Eduardo Porter, Krugman still fails to sense America’s continuous decline, and continues to express his doubts about the economic implications of inequality, openly rejecting Stiglitz’s perspectives. In his Op-ed in today’s New York Times (“The Forever Slump,” August 15, 2014, here), he opens with this:

It’s hard to believe, but almost six years have passed since the fall of Lehman Brothers ushered in the worst economic crisis since the 1930s. Many people, myself included, would like to move on to other subjects. But we can’t, because the crisis is by no means over. Recovery is far from complete, and the wrong policies could still turn economic weakness into a more or less permanent depression.

Following reiteration of his familiar neoclassical assessment, he then concludes that compared to some other countries “things don’t look that dire in America.” I, too, would like to move on to other subjects: but among “liberal” economists, Paul Krugman holds perhaps the biggest megaphone and bears a heavy responsibility. And he is spreading dangerous misconceptions.   

Mainstream economics has no way to distinguish between a weak recovery from a prolonged cyclical downturn and a steadily worsening depression. Today the situation is being labeled “secular stagnation” and “the new normal.” From a neoclassical perspective, these seem like obvious explanations, but there is a better explanation based on a proper understanding of the effect of inequality on growth, and on the active money supply, as revealed through trends in the national debt (see below). In neoclassical ideology, the storm clouds are always on the horizon, and the horizon keeps receding — until the next big crash. Thus, the responsibility for all this confusion lies with the economics profession.

Inequality and Growth

The Standard & Poor’s report (“How Increasing Income Inequality Is Dampening U.S. Economic Growth, And Possible Ways To Change The Tide,” August 5, 2014, here) is an important summary of the transitional thinking now taking place on the income inequality issue. I feel compelled to vet the entire report. Here’s a summary of its discussion:

*     *     *     *     *

  • (1) S&P concludes that “the current level of income inequality in the U.S. is dampening GDP growth, at a time when the world’s biggest economy is struggling to recover from the Great Recession and the government is in need of funds to support an aging population;”
  • (2) S&P places heavy emphasis on education, arguing:

a. In line with the rate of educational achievement seen from 1960 to 1965, adding another year of education to the American workforce from 2014-2019 would likely increase U.S. potential GDP by $525 billion, 2.4% higher than the baseline forecast; and

b. “If education levels were increasing at the rate they were 15 years ago, the level of potential GDP would be 1%, or $185 billion higher in five years”;

  • (3) U.S. growth has averaged “a mere 1.4% over the last 10 years, through 2013;
  • (4) In recent years, forecasting entities have been reducing their projected growth:

a. S&P has reduced its 10-year U.S. growth forecast to a 2.5% annual rate, down from 2.8% five years ago;

b. S&P has reduced (again) its expectation to 2.0% in 2014; but expects over 3% in 2015;

c. The Fed long-run forecast has drifted down even more, from 2.65% five years ago to 2.2% (mid-point of 2.1-2.3 range);

  • (5) The cited reasons for declining growth rates include:

a. The Fed’s explanations are: (1) the aging population; (2) more modest prospects for productivity growth; and (3) the leveling off of growth in women’s participation in the workforce;

b. S&P now cites extreme inequality as well, which it associates causally with the decline in educational achievement;

  • (6) S&P quotes Robert E. Hall of Stanford: “The years since 2007 have been a macroeconomic disaster for the [U.S.] of an unprecedented magnitude since the Great Depression,” with output in 3013 falling “about 13% below what the previous trend had suggested. Hall does not believe that a sudden surge in output can recover lost ground;
  • (7) S&P notes that income inequality is increasing:

a. Emmanuel Saez reported in 2013 that U.S. income inequality is growing and “has now reached levels not seen since 1928″ in similar circumstances: “a boom in the financial sector [together with] the two worst economic slumps in U.S. history — the Great Depression and the Great Recession;”

b. More recently, the Congressional Budget Office (CBO) reported that in one year, from 2009-2010, after-tax income soared 15.1% for the top 1% but grew less than 1% for the bottom 90%;

c. From the distribution of income among the five quintiles (20 percent groupings) “CBO estimates that the dispersion of market income grew by one-quarter from 1979-2007, but the dispersion of after-tax income grew by one-third”;

d. A Federal Reserve Survey of consumer finances shows that the average household wealth of the top 10% (as shown on Chart #7) grew from about $1.07 million to $1.2 million from 2004 to 2010;

  • (8) S&P notes arguments against concluding that inequality reduces growth:   

a. “To be sure, it seems counter-intuitive that inequality is associated with less sustainable growth, since some inequality by providing incentives to effort and entrepreneurship, may be essential to a functional market economy”;

b. S&P mentions and briefly discusses the related Okun “trade-off” theory;

c. Kristin Forbes (MIT, 2000) argued that “in short and medium terms an increase in inequality has a significant positive effect on expansion — but that was weakened over longer periods of growth;” moreover, a World Bank study found that this positive effect was “almost exclusively reserved for the top end of the income distribution;”

  • (9) S&P reports IMF statistical studies indicating that inequality reduces growth: “Do societies inevitably face a choice between efficient production and the equitable distribution of income? According to IMF economists Andrew Berg, Jonathan Ostry, and Jeromin Zettelmeyer, the answer is no;”
  • (10) S&P argues for restraint and caution in efforts to reduce inequality, in particular by raising taxes at the top and increasing the minimum wage.   

*    *    *    *    *

This presentation constitutes a fairly comprehensive summary of the main arguments concerning inequality issues that have been raised by mainstream, “neo-Keynesian” economists, and it begins to cast doubt on these arguments by observing that growth is being suppressed. I’ve previously discussed the IMF studies on this blog, and review them again below. A discussion about the alleged need for caution in dealing with inequality is called for as well. First, though, let’s fact-check S&P assertion by comparing trends in income inequality with a selection of contemporaneous trends in average GDP growth, over various time periods:   

1. S&P reported average growth of 1.4% from 2003-2013;

2. The Center on Budget and Policy Priorities (CBPP) in 2009 (here) computed cumulative per capita growth over two adjacent 30-year periods, shown on this bar graph, which averaged about 3% annual per capita growth from 1946-1976, and roughly 2.2% per capita growth from 1976-2006:

uneven ditribtion of gains

3. The Pinnacle Digest, in August of 2013 (here) includes a graph of the rolling 10-year average of GDP growth, which provides a different look at changing GDP growth. It shows rolling averages of roughly 4.4% from 1967-1973, 3.3% from 1977-1979, about 3.0% from 1987-1997 and 2002-2005, and about 1.7% from 2009-2012. 

US GDP 10-year moving average4. One final source of data is CBO’s “The Budget and Economic Outlook: 2014 to 2024″ (here), Table 2-2. p.41. CBO reports 4.0% average annual growth for 1950-1973, 3.3% for 1974-1981, 3.2% for 1982-1990 and 1991-2001, and 2.2% for 2002-2013.  

Piketty, Saez, and Stantcheva included, in their in their November 2011 CEPR discussion paper, p. 49 (DP8675, here), the following graph comparing both top 1% and bottom 99% real income shares per adult, from 1913-2008, with the top marginal income tax rate. Each share’s growth rate is indicated by the slope of the trend line. Aggregate income is not shown. For comparison, the trends in aggregate income percentage average annual growth rates listed above are roughly aligned below the graph, by year:

DP8675b

S&P                                                                                                                      |  1.4     |

CBPP                                           |                 3.0               |             2.2                   |      

Pinnacle Digest                                                |4.4|     |3.3|      |  3.0  |  | 3.0 |  | 1.7|

CBO                                                 |           4.0              |  3.3  |          3.3           |  2.2    |

*    *    *    *    *

These numbers are all consistent, except for the CBPP figures, which display per capita growth. (This may be a dubious approach, because growth is a “flow” statistic, and per capita distributions are appropriate for “stock” items. Per capita growth tends to be lower than aggregate growth.) What these numbers show is a steady decline in the income growth rate beginning in the 1970s, remaining steady until the Great Recession when growth was substantially further curtailed. Annual differences are, of course, precisely shown on the Pinnacle Digest graph. Note the consistent correlation since WW II of three causally connected factors – annual income growth, income inequality, and income tax progressiveness.  

It was in this report, incidentally, that Piketty, Saez, and Stantcheva reported their comprehensive study (NBER Working Paper 17626, 2011, here) of the income elasticity of the top income tax rates. That study simply eviscerates the ideologically-conceived “Laffer Curve,” and with it the “trickle-down” myth. Here is their graph:

dp4937

The IMF Study

Earlier in 2011, in “Inequality and Unsustainable Growth: Two Sides of the Same Coin?,” IMF Staff Discussion Note, April 8, 2011 (here), Andrew G. Berg and Jonathan D. Ostry reported their statistical study directly testing the effect on income growth of income inequality. They used multiple regressions of growth against inequality and other factors that might explain growth, and across countries. S&P included this chart of the factors included in the study:

imf study -- factors affecting growth

A follow-up IMF Staff Discussion Note, “Redistribution, Inequality, and Growth,” was reported by Jonathan D. Ostry, Andrew Berg, and Charalambos G. Tsangarides in February 2014 (here).

The authors’ found in the 2011 study that inequality is “one of the most robust and important factors associated with growth duration” (pp. 13-14). Judging from their discussion, this finding had not been expected. They timidly concluded: “The main contribution of this note may be to push slightly the balance of considerations towards the view that attention to inequality may serve both equity and growth at the same time.” (p. 18) Translation: Abject faith in the the Okun “trade-off” theory is probably unjustified.  

The report on the second study acknowledged a significant connection between inequality and growth, and the results were reported a bit less timidly: 

First, inequality continues to be a robust and powerful determinant both of the pace of medium-term growth and of the duration of growth spells, even controlling for the size of redistributive transfers. Thus, the conclusions from Berg and Ostry (2011) would seem to be robust, even strengthened. It would still be a mistake to focus on growth and let inequality take care of itself, not only because inequality may be ethically undesirable but also because the resulting growth may be low and unsustainable.

And second, there is surprisingly little evidence for the growth-destroying effects of fiscal redistribution at a macroeconomic level. (pp. 25-26)

In short, inequality leads to low and likely “unsustainable” growth; and, by the way, there is “surprisingly little evidence” supporting Okun’s theory. The implication is that their mainstream colleagues, including those at S&P, should not be so reluctant to aggressively correct the inequality problem.

A Recap of Inequality Economics

There has always been inequality in market economies and, so long as civilization continues to flourish, there always will be. Wealth naturally concentrates, and concentrated wealth entails income concentration. Given the utter failure of planned “communist” economies, market economies offer a superior system, so long as they can be kept under control. Absolute equality is an impossible and unworthy goal for a modern economy. But central government’s control of income and wealth distribution, by retarding the growth of income and wealth concentration and redistributing money into the active economy, is essential for the optimal functioning of a market economy.

This conclusion requires an understanding of the “principle of effective demand” Keynes introduced in 1935: optimal growth requires consumer spending and, therefore, optimal inequality. Keynes, however, assumed away the inequality problem when he focused on cycles occurring when society collectively increases its saving relative to its spending. Economics ever since Keynes has focused on avoiding the inflation resulting from too much consumer spending when government over-stimulates an economy; but everyone, including Keynes himself, ignored the much greater problem of decline when the active money supply is sequestered from the active economy through income and wealth concentration. We are only now discovering the stunning swiftness with which unfettered capitalism can destroy itself through this mechanism.

Inequality grows through the collection of “economic rent,” i.e., payments made beyond any contribution to the growth of tangible, “real” production of consumer goods and service. Early economists focused on land rents, but corporations have come to control or dominate all of the factors of production (including labor), so “unearned” profits are effectively the main vehicle for increasing inequality while reducing actual production, and real income. This is the mechanism through which inequality reduces growth.

A number of factors determine the ability of corporations to make unearned profits, including monopolistic market power, suppression of wages, and tax avoidance. Beginning with the Reagan administration, efforts to unshackle corporate profiteering through deregulation, already underway, were enhanced. The wealthiest people were making a lot more money, and to keep as much of their gains as possible, they reduced their income tax rates, as shown above.

People still don’t comprehend the enormity of those tax reductions. The enormous national debt, now over $17 trillion, was raised to replace the revenue losses resulting from those tax reductions. That is to say, government debt was used to make the rich richer — to finance income inequality and a vastly higher concentration of wealth.

One reason why the full extent of the damage has been obscured is that analysts continue to evaluate income inequality, as demonstrated by the S&P report, by comparing top 20%, top 10%, or top 5% incomes to those below. To be sure, all of these segments have been growing faster than other incomes below them, but such comparisons drastically understate the true magnitude of transfers of income and wealth to the top. The tipping point is in the top 1%, and wealth and income moves into the top 1%, for example, from the rest of the top 10%: Thus, the transfers to the top 1% are much greater than the net transfers into the entire top 10%. Put another way, top 10% inequality growth is the average of the much lower inequality growth (or even decline) in the second 9% with the extremely high rate of inequality growth in the top 1%.

The stunning fact is that all of that $17 trillion has ended up in the hands of the top 1%, with exponential concentration within the top 0.1% and the top 0.01%. Not finding such an analysis anywhere, I undertook more than a year ago to calculate the growth of top 1% wealth (net worth), using Census Bureau net worth tables and wealth concentration data published by economist Edward Wolff, and others.  These are my results, in constant 2005 dollars:

my graph 1952-1982 c

The volatility of top 1% net worth corresponds to the volatility of top 1% income shown by Piketty and Saez above. Top 1% wealth is growing faster that GDP, at roughly the pace of the national debt. This is what we would expect: as explained, the national debt has effectively financed growing top 1% net worth.

The more or less continuous 3.0% annual growth of GDP from roughly 1985 to 2005, despite declining median income, appears to be accounted for by the increase in the money supply provided by the federal debt; that additional money mainly accounts for this massive wealth concentration. But this is not a full accounting. Left out is American income and wealth at the top that is not reported in the U.S. This is a difficult assessment to make, but European analysts have for some time been estimating the amount of “off-shore” wealth in the world, and the amount attributable to Americans (See “Inequality: You Don’t Know the Half of It,” Tax Justice Network, July 2012, here).

My best estimate is that top 1% net worth has increased by an unimaginable $22-25 trillion between 1980 and 2012. Consequently, as much as $9 trillion, by my rough estimate, has been transferred to the top 1% from the bottom 99% over these years. My sense of it is that the top 1% had already sequestered the new money associated with the national debt by 2008 and, with the Crash the hollowed out middle class had to collapse, with the consequences for growth we have seen. Obviously, this is a crucial topic, sorely in need of further investigation.

Meanwhile, as I explained in my recent posts on the national budget crisis, the woefully underfunded federal government is, more rapidly than the Republican-influenced CBO is willing to allow, approaching the point that the growth of debt and debt interest is ultimately “unsustainable” (February 2014 CBO report, p. 26). But the CBO baseline forecast remains essentially unchanged since March 2012 (here). It now projects about 2.1% growth continuously into the future, out to 2039, shrugging off the fact that growth has only averaged 1.4% for the last decade. It not only expects a magical, automatic return to full employment “equilibrium,” but in conformity with neoclassical dogma, it has never adjusted its forecasts for growth reduction due to inequality, which continues to rise and will have an ever increasing impact on future growth.

CBO seems unlikely to react sensibly to the guarded warning from S&P. It has, as I reported in my earlier posts, projected debt interest to rapidly outgrow other categories of federal spending, surpassing the entire defense budget by 2021. Yet in its July “Long-term Budget Outlook” (here) it failed to reflect that growth on its graphs, and continued to project this “unsustainable” trend out to 2039!

CBO may well take comfort in S&P’s overly cautious analysis. E.g.:

  • “A cautious approach to reducing inequality would benefit the economy, but extreme policy measures could backfire;”
  • “Any clear-headed consideration of these options must recognize that heavy taxation–solely to reduce wage inequality–could do more damage than good. While the IMF studies found that some redistribution appears benign, extreme cases may have a direct negative effect on growth;”
  • “Heavy taxation solely to equalize wages may reduce incentives to work or hire more workers. A number of studies have indicated that losses from redistribution are likely to be minimal when tax rates are low but rise steeply with the tax or subsidy rate.(fn.)”

Again, the second IMF study found no evidence at all supporting the Okun “trade-off” idea, which has basically been refuted anyway by the history of the American economy from WWII until the late 1970s. Only two studies were cited by S&P (Barro R.J., “Government Spending in a Simple Model of Endogeneous Growth,” Journal of Political Economy, 1990 (here); and Jaimovich, N. and S. Rebelo, “Non-Linear Effects of Taxation on Growth,” NBER, 2012 (here), but they do not make even a colorable showing of support for the trade-off argument:

Jaimevich and Rebelo presented a mathematical model, not a study: It makes the theoretical representations behind the Laffer Curve thesis, which have been disproved. [1] The Barro article also presented a model, not a study, but it has no bearing at all on our issue. Even Thomas Piketty — who many of us have argued improperly relates short-term inequality issues to supply-side models of growth in long-term equilibrium — has no use for Barro’s model. [2] Such is the confused state of neoclassicism. 

The bottom line: S&P has come up with no reason to believe that returning to the tax policies in effect when the economy was working well and flourishing, or that aggressively increasing the minimum wage,  would be “extreme policy.”

Conclusion

Inequality issues are nowhere near as difficult to understand as modern neoclassical economics has made them appear.  Once the fundamental importance to stability and survival of the control of income and wealth distribution is understood, the rest should follow in a reasonably straightforward manner. The economics profession, however, long ago abandoned the search for scientific truth in favor of result-oriented mythology. A three-dimensional view of macroeconomics is now available, and economists can for the first time understand how the economy really works, but “scientific” economics still has not recovered from its fantasies.

Our immediate concern has got to be that the continuing concentration of income and wealth within the top 1%  spells imminent trouble for our government and our society. The next crisis will come much sooner than CBO wants to believe. All supply-side growth forecasts, which take no account at all of the gradual but exponentially increasing effect of income inequality on growth, are vastly overoptimistic. Indeed, the problem is worse than that: CBO’s forecasts proceed from a “baseline” forecast of GDP which does not change with alternative scenarios varying factors like government spending and revenues, in which the levels of economic activity and GDP necessarily must change. (More on that later.)

We certainly cannot survive until 2039. The consequences of the next bursting “bubble,” or a default on the national debt, if history is any guide, would likely be a decline to 0.0-0.5% growth, another great depression.

JMH – 8/17/2014 (ed. 8/18/2014)

____

[1] The intent of the model is to reflect that: “Taxes have a small impact on long-run growth when taxes rates and other disincentives to investment are low or moderate. But, as tax rates rise, the marginal effect of taxation also increases.” That’s not illogical: No one would work for nothing, or invest with no prospect of a fair return. But it’s a factual question as to how much opportunity people are willing to give up in exchange for no opportunity at all. That question was answered by the Piketty, Saez, Stantcheva study which showed that the high levels of taxation in effect in the U.S. from WW II until 1980 not only optimized government revenue, but sustained the higher growth rates that the U.S. experienced then. 

[2] “Since the 1970s, analyses of the public debt have suffered from the fact that economists have probably relied too much on the so-called representative agent models, that is models in which each agent is assumed to earn the same income and to be endowed with the same amount of wealth (and thus to own the same quantity of government bonds). * * * In the case of public debt, representative agent models can lead to the conclusion that government debt is completely neutral, in regard not only to the total amount of national capital but also in the distribution of the capital burden. This radical reinterpretation of Ricardian equivalence, which was first proposed by American economist Robert Barro, fails to take account of the fact that the majority of the public debt is in practice owned by a minority of the population.”  – Capital in the 21st Century, p. 135  

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Inequality Retards Growth: A”New View”?

For more than three decades, almost everyone who matters in American politics has agreed that higher taxes on the rich and increased aid to the poor have hurt economic growth.

Liberals have generally viewed this as a trade-off worth making, arguing that it’s worth accepting some price in the form of lower G.D.P. to help fellow citizens in need. Conservatives, on the other hand, have advocated trickle-down economics, insisting that the best policy is to cut taxes on the rich, slash aid to the poor and count on a rising tide to raise all boats.

But there’s now growing evidence for a new view — namely, that the whole premise of this debate is wrong, that there isn’t actually any trade-off between equity and inefficiency. Why? . . . American inequality has become so extreme that it’s inflicting a lot of economic damage. And this, in turn, implies that redistribution — that is, taxing the rich and helping the poor — may well raise, not lower, the economy’s growth rate. 

You might be tempted to dismiss this notion as wishful thinking, a sort of liberal equivalent of the right-wing fantasy that cutting taxes on the rich actually increases revenue. In fact, however, there is solid evidence, coming from places like the International Monetary Fund, that high inequality is a drag on growth, and that redistribution can be good for the economy. 

Earlier this week, the new view about inequality and growth got a boost from Standard & Poor’s, the rating agency, which put out a report supporting the view that high inequality is a drag on growth. The agency was summarizing other people’s work, not doing research of its own, and you don’t need to take its judgment as gospel (remember its ludicrous downgrade of United States debt). What S.& P.’s imprimatur shows, however, is just how mainstream the new view of inequality has become. –– Paul Krugman, “Inequality is a Drag,” The New York Times, August 8, 2014 (here).

These are the first five paragraphs of Krugman’s reaction to the crucial recognition by Standard & Poor’s, a securities rating firm, that rising income inequality reduces income growth. This recognition is crucially important because: (1) S&P has explicitly identified the core connection between growth and income (and wealth) distribution that has eluded mainstream economics for well over a century; (2) This connection directly refutes the neoclassical position that inequality lacks economic significance; and (3) It re-validates John Maynard Keynes’s “demand-side” perspective on how economies work which mainstream “neoclassical” economics has rejected for more than fifty years, instead conceptualizing growth as a “supply-side” phenomenon; and (4) It implicitly comprehends the role that inequality itself plays in stagnation and depression, a role that Keynes himself had not perceived or articulated. 

So this is a big deal. We need to consider why Paul Krugman presents the perception as uncertain, gradually emerging from “growing evidence,” and suggests that the perception might logically be seen as a “liberal equivalent” of the most extreme version of the trickle-down “fantasy.” Given the overriding importance of this matter, and Krugman’s lofty status in the economics community, a careful examination of his presentation is warranted.

This Is Not a “New View”

First, this is not a “new view.” Income inequality has been rising in the United States for 35 years, and although the data has only been available for about a decade, it has been well-established for several years that gradually growing income inequality is associated with gradually falling aggregate income growth. And although the connection between the two is not readily comprehensible to those indoctrinated in the neoclassical, “supply-side” ideology, it is not difficult to understand by anyone, especially among the laity, who can approach the question of growth with an open mind, unencumbered by the supply-side mindset.

The staff at MSNBC, for example, is aware of it: In reporting this S&P study on August 7, 2014 on his MSNBC program, Ed Schultz said, in effect: “Tell us something we don’t already know.” I do not regularly watch TV news programs, but I have seen Rachel Maddow correctly note that income inequality suppresses the growth of even the top income percentiles. 

A few economists whose perspectives are grounded in John Maynard Keynes’s General Theory — such as Krugman’s fellow Nobel Prize winner Joseph Stiglitz and, as cited by S&P, Robert Reich (producer of the movie “Inequality for All”) — have been explaining for several years not only that growing income inequality reduces income growth, but also that it does so by reducing consumer demand and spending and, consequently, investor expectations, per Keynes’s General Theory. See Reich’s clear and informative recounting of the insights of FDR’s Treasury Secretary, Marriner Eccles, regarding the economics of the Great Depression (Aftershock: The Next Economy and America’s Future, 2010, Chs. 1 & 2). Stiglitz, in his 2012 Book The Price of Inequality,  summed it up this way:

[T]his book shows that both the magnitude of America’s inequality today and the way it is generated actually undermine growth and impair efficiency. Part of the reason for this is that much of America’s inequality is the result of market distortions, with incentives directed not at creating new wealth but at taking it from others. (K.Ed., p.6) * * *The simple story of America is this: the rich are getting richer, the richest of the rich are getting still richer, the poor are becoming poorer and more numerous, and the middle class is being hollowed out. (K.Ed. p. 7);

And he explained why growing inequality entails lower growth:

[W]hen money is concentrated at the top of society, the average American’s spending is limited, or at least that would be the case in the absence of some artificial prop, which, in the years before the crisis, came in the form of a housing bubble fueled by Fed policies. (K.Ed., pp. 84-85) * * * Moving money from the bottom to the top lowers consumption because higher-income individuals consume a smaller proportion of their income than do lower-income individuals (K.Ed., p. 85).

The Erroneous Neoclassical Perspective on Growth 

Krugman’s views, however, which I have monitored closely over the past several years, are locked into the neoclassical mindset. As set forth in his most recent book (End This Depression NOW!, 2012, ch 5., pp. 71-90), Krugman believes that income inequality is a political problem, not an economic one.  This has been the mainstream position on inequality for more than  a century.  

He has pointedly disagreed with Stiglitz. (See the BBC interviews of both Krugman and Stiglitz, November 21, 2013, here), and in this Op-ed, after acknowledging S&P’s position that there is “strong evidence” of the relationship between growth and inequality, he reiterates the standard neoclassical explanation of the effects of inequality:

[T]here’s no evidence that making the rich richer enriches the nation as a whole, but there’s strong evidence of benefits from making the poor less poor. But how is that possible? Doesn’t taxing the rich and helping the poor reduce the incentive to make money? Well, yes, but incentives aren’t the only thing that matters for economic growth. Opportunity is also crucial. And extreme inequality deprives many people of the opportunity to fulfill their potential.

Actually, there is strong evidence that high taxes do not, over a broad range of marginal income tax rates that includes the top rates in the United States from the end of WW II until the Reagan presidency, reduce the incentive to make money. The “Laffer curve” has, in my view, been decisively disproved, as I will discuss in my follow-up to this post.

But don’t stop there, Mr. Krugman: Incentives and opportunity are not the only requirements for growth. Both of these factors require the availability of a sufficient money supply, and neoclassical macroeconomics, with its focus on microeconomic (individual firm) theories, has consistently ignored this critical factor for well over a century. Income inequality reflects a shrinking of the active money supply and an associated concentration of wealth at the top. Failing to consider the availability of actively circulating money is a hallmark of the trickle-down myth. Both Krugman and Stiglitz have condemned trickle-down as a clearly false ideology, but look at the divergence between the way they view the relationship of inequality and growth, in comparison to the trickle-down fantasy:

Krugman: You might be tempted to dismiss this notion as wishful thinking, a sort of liberal equivalent of the right-wing fantasy that cutting taxes on the rich actually increases revenue. (Opening quotation)

Stiglitz: What America has been experiencing in recent years is the opposite of trickle-down economics: the riches accruing to the top have come at the expense of those down below. (K. Ed., p. 6)

Who is Krugman writing to here? His audience might be right-wing economists and politicians running our government who, even if they understand the absurdity of the myth that cutting taxes on the richest people’s incomes will help the economy grow, nonetheless also believe that lower taxes at the top and increasing inequality haven’t really hurt the economy either. Stiglitz’s view, however, is that inequality has hurt the economy. I might have thought that Krugman was trying to gently inform these people that the S&P report supports Stiglitz’s perspective — but he disagrees with Stiglitz.

Krugman seems to be backpedaling now, forced to acknowledge that income inequality cannot be merely a political problem. But old ideas die hard, especially when nearly everyone else shares those ideas, so Krugman provides only a limited endorsement of the S&P report: He implies that the relationship between inequality and growth is more controversial and difficult than it actually is, and he endorses S&P’s scaled-back assertion that the infliction of economic damage is limited to only “extreme” inequality. 

He further characterizes “redistribution” as “taxing the rich and helping the poor,” ignoring the competing perception that the persistent growth of income inequality reflects a massive upward redistribution of income and wealth that persistently reduces income growth. His perspective also overlooks the “hollowing out” of the middle class described by Stiglitz; indeed, given that the bottom 60% of income earners collectively have zero net worth, the increasing wealth at the top can only have come from depleting the income and wealth of the declining middle class. (In my follow-up post, I’ll present facts showing that this process has been consistently taking place since 1980, causing considerable economic damage all along.)

Curiously, Krugman also maintains that the S&P report shows “just how mainstream” this “new view” has become. However, it is anything but: The mainstream view continues to be that the economy is growing again, recovering from the Great Recession, and conventional economists continue to ignore redistribution entirely in their analyses of growth. See the CBO’s February 2014 and July 2014 “Budget and Economic Outlooks,” (here) and (here). If, as S&P reports, the facts show that inequality suppresses growth, these forecasts will prove to be overoptimistic out to 2024, and there is no chance that the national debt will fail to reach 100% of GDP before 2039. (See my last two posts.) 

Beyond that, Krugman gratuitously (and inexplicably) criticizes S&P for unrelated reasons, casting doubt on its credibility because its judgment, after all, is anything but “gospel.” I can think of no reasonable explanation for Krugman treating this crucial topic so disingenuously. It is almost as if, as he watches his own firmly held belief system unravel, he is reflexively “killing the messenger.” I am confident, however, that once the full extent of the danger becomes better understood Krugman will be among the first to heartily endorse the “new view.” 

Mainstream Neoclassicism Is Ideology 

Cracks in the neoclassical edifice have over the last few years been cropping up all over, and they have been plastered over by such concepts as “the new normal” and “secular stagnation.” The criticism of mainstream economics has increased so much in the past couple of years that Harvard economist Raj Chetty — the winner of the 2013 John Bates Clark Medal given to the young (under 40) economist making the most significant contribution to the economics discipline — last year rose passionately to the defense of his profession (“Yes, Economics is a Science,” The New York Times, October 20, 2013, here):

I’m troubled by the sense among skeptics that disagreements about the answers to certain questions suggest that economics is a confused discipline, a fake science whose findings cannot be a useful basis for making policy decisions. * * * That view is unfair and uninformed. It makes demands on economics that are not made of other empirical disciplines, like medicine, and it ignores an emerging body of work, building on the scientific approach of last week’s [Nobel Prize] winners, that is transforming economics into a field firmly grounded in fact.

To illustrate his assertion that economic research is unusually difficult to do, he then makes this telling concession:

It is true that the answers to many “big picture” macroeconomic questions — like the causes of recessions or the determinants of growth — remain elusive. But in this respect, the challenges faced by economists are no different from those encountered in medicine and public health. Health researchers have worked for more than a century to understand the “big picture” questions of how diet and lifestyle affect health and aging, yet they still do not have a full scientific understanding of these connections.

And he goes on to assert:

If we could randomize policy decisions and then observe what happens to the economy and people’s lives, we would be able to get a precise understanding of how the economy works.

I have discussed Chetty’s assertions several times, and I continue to find them incredible: The causes of recessions and the determinants of growth are the core questions of macroeconomics, comparable in biology and medicine to questions like how the heart, lungs and central nervous system work. That answers to such fundamental questions should still be “elusive,” i.e. impervious to factual analysis, after more than 250 years of the development of “scientific” economics, is hardly credible; our continuing ignorance of how market economies work must be attributable, instead, to the trumping of scientific inquiry by political influences.

Modern neoclassical macroeconomics is grounded in ideology and philosophy, not in material fact, and despite Keynes’s attempt to alter the history of economic thinking it has remained so for over 150 years. These core questions are the very questions that distinguish macroeconomics from microeconomics, i.e., issues relating to the behavior of individual firms. Modern neoclassical macroeconomics has finessed growth issues, in large measure, by directly applying the microeconomics synthesis developed by Alfred Marshall and Arthur C. Pigou, among others, to aggregate data. 

Notably, Chetty identifies no ongoing research on the effects of income or wealth distribution on growth. It is true that until ten years ago distributional data adequate to understand “how the economy works” was unavailable. But the topic of income inequality, threatening to the interests of the wealthy, was ignored by the “science” of economics from the mid-19th Century until 1955, when Simon Kuznets complained of “the extreme scarcity of relevant data” and warned that “without better knowledge of the trends in secular income structure and the factors that determine them, our understanding of the whole process of economic growth is limited.” (The American Economic Review, Vol. 45, No. 1, March, 1955, p. 27).

Early classical economists like Adam Smith, David Ricardo, and T.R. Malthus, writing around the turn of the 19th Century, placed heavy emphasis in their “Principles of Political Economy” on economic rent, i.e., payments that did not return tangible value to an economy. The creation and redistribution of rent is clearly a matter of extreme importance to any realistic understanding of inequality, growth, idleness, and depression. Indeed, that is the very consideration Stiglitz refers to when he identifies, as the key factor in declining growth and growing inequality, “incentives directed not at creating new wealth but at taking it from others.” Economic rent, however, has been essentially ignored by mainstream economics, in both Europe and the United States, since the mid-19th Century. For an excellent short summary of the attention paid to inequality by philosophers and economists over the centuries, see Polly Cleveland’s article, “Piketty’s Model of Inequality and Growth in Historical Perspective, Part 1,” The Dollars and Sense Blog, July 15, 2014 (here).

Economics and Power

It is understandable that holders of wealth and political power would seek to eradicate factors that might constrain their ability to amass ever more wealth. Other than market regulation, taxation is the primary tool available to governments for controlling the accumulation of rents, so the wealthy and powerful have striven to reduce their taxes. On this matter, Arthur Okun, whose views on efficiency and inequality were alluded to by Krugman above, underscored the obvious forty years ago:

It does not take a research project . . . to identify misplaced — socially unproductive –efforts devoted to tax minimization. High tax rates are followed by attempts of ingenious men to beat them as surely as snow is followed by little boys on sleds. (Equality and Efficiency: The Big Tradeoff, 1975, p. 97) 

Far better, perhaps, to gain sufficient control of government and simply set favorable rates for themselves. Beyond that, control of academia would allow, over time, the eventual perversion of “scientific” economics in order to obscure the truth about growth, and about how the economy really works, behind an ideological smokescreen.

Far-fetched? In 1873, in the Afterward to his Second German Edition of Das Capital, Karl Marx objected that since 1848 in Europe “the bad conscience and the evil intent of apologetic” had replaced “genuine scientific research.” In America, the idea promoted by John Bates Clark that economic outcomes are the inevitable result of rigid, neoclassical “laws” further polluted the atmosphere for scientific research. As Polly Cleveland explains (“Piketty’s Model of Inequality and Growth in Historical Context, Pt 2,” The Dollars and Sense Blog, July 23, 2014, here):

John Bates Clark of Columbia University, for whom is named the prestigious John Bates Clark Medal, transformed economics into an inequality-free abstraction.

Writing in the 1890’s, Clark merged land into physical capital, thus obliterating the classical understanding of land. In the new neoclassical world, capital (including land) originates solely from productive investment. There is no unearned “rent”, only legitimate “profit.” (Ironically, Marx merged rent into profit because he considered both illegitimate.)

Clark reduced economics to only two “factors of production”, capital and labor. In Clark’s model, “supply and demand” in a free market ensure that capital and labor each earns its “marginal product”, that is, the contribution of the final amount supplied. This outcome is supposedly both fair and efficient. 

I could not agree more: Clark, like his European “microeconomic” counterparts,  effectively assumed away the important macroeconomic questions to which, Chetty now tells us, the answers remain elusive. Beyond that, he trivialized the work of the classical economists by burying the one economic consideration most central to income and wealth distribution — economic rent.

My review of Clark’s principal work (The Distribution of Wealth: A Theory of Wages, Interest, and Profits, 1899, 1908, here) revealed a distinctly non-scientific approach to economics. He began his book by proposing to show that “the distribution of the income of society is controlled by a natural law,” which, “if it worked without friction, would give to every agent of production the amount of wealth which that agent creates.” Moreover, “however wages may be adjusted by bargains freely made between individual men, the rates of pay that result from such transactions tend, it is here claimed, to equal that part of the product of industry which is traceable to the labor itself.” This boiled down to the assertion that “so far as it is not obstructed,” a market economy “assigns to everyone what he has specifically produced.” This can only mean one (or both) of two things: (1) As Cleveland put it, all outcomes are presumptively fair and efficient, or (2) Human activities, decisions, and behavior are, somehow, trumped by “natural law.”

Whatever this is, it is not science. 

The Okun “Trade-off”

While we are on the subject of ideology, a brief discussion of Krugman’s beginning oblique reference to Athur Okun’s “trade-off” argument (Equality and Efficiency: The Big Tradeoff, the Brookings Institution, 1975) is in order. I’m sure Krugman has not forgotten his March 9, 2014 New York Times Op-ed, “Liberty, Equality, Efficiency” (here), where he discussed how one source of evidence that income inequality reduces income growth cited by S&P (discussed in my follow-up to this post) has undermined, indeed refuted, Okun’s idea that there is a trade-off between inequality and efficiency. Note that if the “trade-off” theory was correct, at high levels of income inequality, reducing inequality would decrease growth, not increase it. 

Krugman does not condemn Okun’s idea here, although he more tentatively alludes to “growing evidence that the whole premise of the debate is wrong,” and preserves the inference that it seemed reasonable because, allegedly, even most “liberals” believed it. The S&P report also approvingly cites Okun’s book, under the heading “Striking a Palatable Balance”:

In his influential 1975 book “Equality and Efficiency: The Big Tradeoff,” economist Arthur Okun argued that pursuing equality can reduce efficiency. He claimed that not only would more equal income distribution reduce work and investment incentives, but the efforts to redistribute wealth — through, for example, taxes and minimum wages — can themselves be costly.

This would be, of course, in each instance a question of fact. If we are talking, for example, about attempting to reduce inequality by raising the minimum wage or increasing the progressiveness of income taxation, the tradeoff theory in my view boils down to the claim that “trying to increase incomes of working people is likely to reduce total work” (“Inequality and Growth — Two Sides of the Same Coin”, March 28, 2014, here). At best, that is an anti-Keynesian “people are lazy” notion that can make sense only to supply-side ideologues such as those who endorsed the idea in CBO’s July 2014 report on the “Economic and Budget Outlook.”

I have yet to learn of any circumstance in which Okun’s argument actually does make sense. After reading Krugman’s March 9 Op-ed, I quickly ordered a copy of the Okun book, and read it immediately upon arrival. The book is philosophical and ideological in character, and I found that Okun had no factual basis, either general or specific, for the idea that capitalist market economies have any abundance of efficiency to trade off. This he readily conceded: 

The case for the efficiency of capitalism rests on the theory of the “invisible hand,” which Adam Smith first set forth two centuries ago. Through the market, greed is harnessed to  serve  social purposes in an impersonal  and seemingly automatic way. (p. 50)  

Unfortunately, here Okun was merely repeating a myth about Adam Smith developed by the neoclassical school, as I documented in detail in “The Cult of the Invisible Hand,” December 22, 2013 (here). Working on theories in the 1970s, before the internet, Okun and other economists lacked the ability to investigate such ideas that we have today: The truth is that Adam Smith was actually a fairly extreme socialist, with no apparent illusions about market efficiency, who held pre-Keynesian views about how market economies work:

It can never be the interest of the unproductive [landlord] class to oppress the other two classes. It is the surplus produce of the land, or what remains after deducting the maintenance, first, of the cultivators, and afterwards of the proprietors, that maintains and employs the unproductive class. * * * The maintenance of perfect justice, of perfect liberty, and of perfect equality, is the very simple secret which most effectually secures the highest degree of prosperity to all three classes. (Wealth of Nations, 1776, Prometheus Books, Great Minds Series, 1991, p. 454. Emphasis added.)  

The idea of a trade-off between increased inequality and efficiency, such that reducing inequality could hamper growth, never had a basis in fact. In fact, the false notion of perfect efficiency, as we have discussed, owes much to the presumptuous ideology of John Bates Clark. So we should not be at all surprised to learn that growing inequality suppresses growth.

The S&P Report

The Standard and Poor’s report (“How Increasing Income Inequality Is Dampening U.S. Economic Growth, And Possible Ways To Change The Tide,” August 5, 2014, here), takes a different approach to discussing this obviously monumental issue. Its basic take on the inequality problem reflects Keynesian perspectives: “Despite the tendency to speak about this issue in moral terms,” it says, “the central questions are economic ones.” Moreover, it says: “Higher levels of income inequality increase political pressures, discouraging trade, investment, and hiring.” This reasoning is straight from Keynes’s playbook.

Obviously, S&P has much professional skin in this game, but it likely employs mainstream economists who are just as skeptical about how inequality reduces growth as Paul Krugman. Given how controversial this report must have been internally, it seems unlikely that S&P would have released unless it without conviction, and material concerns about the U.S. economy’s declining growth.   

Regardless, this report misrepresents economic history in an apparent attempt to imply that this is a difficult issue which emerges now after centuries of careful scientific focus on inequality. The Report begins: “The topic of income inequality and its effects has been the subject of countless analysis stretching back generations. . .” And: “Given the decades–indeed, centuries–of debate on this subject, it comes as no surprise that the answers are complex.” As discussed above, however, the topic of income inequality has actually been ignored for decades, even suppressed at the hands of ideological influences. 

S&P also maintains:

Keynes first showed that income inequality can lead affluent households (Americans included) to increase savings and decrease consumption, while those with less means increase consumer borrowing to sustain consumption…until those options run out. When these imbalances can no longer be sustained, we see a boom/bust cycle such as the one that culminated in the Great Recession.

Actually, no, he did not. Although S&P’s analysis is theoretically sound, it is important to recognize that it did not come from Keynes. His General Theory (1935) consisted of a three-variable full employment model that took no account whatsoever of income or wealth distribution, which he characterized in his last chapter as “arbitrary.” Keynes discussed the support in his day for the obvious approach of progressive taxation of the highest incomes and wealth, to redistribute the concentrating revenues and wealth back down, but that was virtually the full extent of his discussion of distribution.  

Keynes did identify a “boom/bust cycle” in growth, caused by variations in the aggregate propensity to consume from aggregate income — but his model assumed a given distribution of income and wealth. He believed that fiscal and monetary policy could control market instability, and therefore solve the “poverty” problem.

This is important because Keynes overlooked what recent experience has shown: The impacts on growth of excessive income and wealth concentration dwarf, even over a period as short as 20-30 years, the impacts of narrower decisions about whether to consume or save.

S&P also theorized:  

A degree of inequality is to be expected in any market economy. It can keep the economy functioning effectively, incentivizing investment and expansion — but too much inequality can undermine growth.

As discussed above, the claim that changes in inequality affect people’s incentives to make money is a murky, dubious one. It is also important, moreover, that the operation of redistribution mechanisms can undermine growth at any level of inequality. That is, in fact, what happened after 1980 when income inequality was at its lowest level since WW II.   

Conclusion

S&P’s recent report is correct that excessive income inequality causes declining growth. This fact has been obscured by mainstream economics, which has ignored inequality ever since the middle of the 19th Century, pretty much precisely when capitalist market economies began to develop in both Europe and America.

Today mainstream economists and forecasters, who are becoming increasingly at sea on growth issues, are beginning to discover this relationship. The powerful grip of old ideas — especially those ideas that inherently obscure the truth about growth — can make it impossible to embrace new ideas and perspectives.  It seems to me that the analysts at S&P must have detected reasons for serious concern, or they would not have issued their warning. 

In a follow-up post I will review some of the sources cited by S&P and other information, including the IMF studies in particular, and present factual information from various sources to develop a sense of he severity of the problem and of the implications for the CBO projections of the national debt and debt interest that I discussed in my previous two posts.

JMH – 8/14/2014 (ed. 8/14,16/2014)

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Breaking News: CBO Infected with Trickle-Down Disease

In a recent Op-ed (“The Fiscal Fizzle: An Imaginary Budget and Debt Crisis,” The New York Times, July 20, 2014, here), Paul Krugman argued that the “fiscal panic has fizzled,” citing the most recent Congressional Budget Office “Long-term Budget Outlook,” July, 2014, (here). That report extends through 2039 CBO’s February 2014 presentation of “The Budget and Economic Outlook: 2014 to 2024″ (here). Because only the February report contained the budget details necessary for a sensible review of the budget/debt issue, I limited my analysis in my last post to the February report, deferring to this post a review of the July report.

In my post I explained how the February 2014 report revealed the rapidly increasing danger in the federal budget/debt situation posed by the exponential growth of the interest on the national debt, and by the continuing increase in income and wealth inequality not accounted for by CBO.  In particular, the data showed that debt interest is projected to grow much faster than any other expense category through 2024, as follows:

  • Total mandatory outlays are projected to increase from $2,1 trillion in 2014 to $3.7 trillion in 2024, a 77% increase;
  • Total discretionary outlays are projected to increase from $1.2 trillion in 2014 to $1.4 trillion in 2024, a 16% increase;
  • The defense budget portion of discretionary outlays is projected to increase from $604 billion in 2014 to $719 billion in 2024, a 19% increase;
  • Interest on the national debt is projected to increase from $233 billion in 2014 to $880 billion in 2024, a 278% increase.

[Correction (8/15/2014)  – The interest increase was originally posted as a 378% increase. The percentage increases shown for the other items were computed from the full un-rounded numbers; using the rounded figures shown above produces percentage increases that are slightly different: 76%, 17% and 19% respectively.]

The July report contains no such table, avoids the topic of debt interest, and effectively contradicts these facts in its presentation. Here is a step-by-step review of CBO’s approach and conclusions. 

The Forecast that Isn’t One

CBO begins (opening Notes, p. ii) by contending that the extension of its earlier baseline projections out to 2039 is not a forecast. Indeed, it says, neither the baseline (through 2024) nor the extended baseline through 2039 are meant to be predictions:

CBO’s long-term projections extend beyond the usual 10-year budget window to focus on the 25-year period ending in 2039. They generally reflect current law, following the agency’s April 2014 baseline budget projections through 2024 and then extending the baseline concept into later years; hence, they constitute the agency’s extended baseline. The baseline and the extended baseline are not meant to be predictions of future budgetary outcomes; rather, they represent CBO’s best assessment of how the economy and other factors would affect revenues and spending if current law generally remained unchanged. Thus, they serve as benchmarks for measuring the budgetary effects of proposed changes in law regarding federal revenues or spending. (Emphasis added)

Thus, according to CBO, it is not giving us a forecast, merely “benchmarks” for measuring the effects of proposed changes. However, in its initial Summary (p. 2) it says: 

If current laws remained generally unchanged in the future, federal debt held by the public would decline slightly relative to GDP over the next few years, the Congressional Budget Office (CBO) projects. After that, however, growing budget deficits would push debt back to and above its current high level. Twenty-five years from now, in 2039, federal debt held by the public would exceed 100 percent of GDP, CBO projects. Moreover, debt would be on an upward path relative to the size of the economy, a trend that could not be sustained indefinitely.

In other words, although an increasing debt/GDP ratio is a trend CBO acknowledges cannot be sustained indefinitely, “if current laws remain generally unchanged” CBO is aware of no reason to suspect that the trend in the growth of debt will not be sustained at least until 2039, when according to its algorithm the debt/GDP ratio debt will reach 1.0. That, of course, is a forecast: a particularly useful forecast for anyone not wanting to change current laws, especially laws increasing taxation.

Misrepresenting Debt Interest Growth 

CBO 45471-Long-TermBudgetOutlook - july 2014 - debt as a percent of GDP

This graph is presented on p. 9 of the July 2014 report, where CBO states:

CBO projects that, under current law, debt held by the public will exceed its current percentage of GDP after 2020 and continue rising. By 2039, under the extended baseline, federal debt held by the public would reach 106 percent of GDP —equal to the percentage at the end of 1946 and more than two and a half times the average percentage during the past several decades—and would be on an upward path. That trajectory ultimately would be unsustainable. Moreover, the long-term projections of federal debt presented in this chapter and the next few chapters do not incorporate the negative economic effects of higher debt. Projections that account for those effects show debt reaching 111 percent of GDP in 2039 (see Chapter 6).

I’ll return to the reference to “negative economic effects of higher debt” shortly. For now, we need to consider how CBO projected that federal debt would not exceed its current percentage of GDP until after 2020, and would not continue the rapid rise established after the Crash of 2008. The reduced rate of debt growth shown requires either a slower rate of growth of debt or an increased rate of GDP growth, or both. Here is the first figure, taken from p. 2 of the report:

CBO 45471-Long-TermBudgetOutlook - july 2014 - federal debt spending and revenues

From the bottom up, it shows (a) the undistributed sources of federal revenue, (b) components of total spending, and (c) the national debt (with an overlay trend line of spending and revenues, showing spending gradually rising faster than revenues.

Our immediate concern is with the middle chart, which shows components of federal spending. Net interest on the debt is predicted to rise faster than other categories of spending until 2019, then flatten out thereafter rising at a lower rate until 2039, staying well below and roughly parallel to the other categories — notably “major health care programs” and “social security” — until 2039. This forecast appears inconsistent on its face with CBO’s February 2014 budget analysis which, as reported above, showed total mandatory outlays increasing by 77%, total discretionary outlays increasing by 16%, and debt interest increasing by 278%, through 2024.

In fact, it is greatly divergent from the budget forecast. Here are the relevant data for outlays in 2014, 2019, and 2024 ($billions):                                  

Year    (a) Net Debt Int.    (b) Soc. Sec.          a/b        (c) M’care + M’caid               a/c 

2014                  233                       846               28%                        901                      26%

2019                  569                     1,116               51%                     1,223                      47%

2024                 880                     1,056              83%                     1,661                       53%

________________________________                  

Obviously, debt interest (which compounds) continues to grow faster than other categories of federal spending after 2019, and interest continues to grow faster than do the other categories through 2024. Nonetheless, CBO’s graph shows interest to grow at about the same rate as these other categories after 2019  all the way through 2039.

This is a major misrepresentation of fact, and it seems to explain why CBO neglected to discuss debt interest in the July report, barely mentioning it at all. CBO used to have a reputation for honesty and objectivity, but with this kind of chicanery, which has to be intentional, CBO has lost its credibility.

Why would CBO lie? One likely explanation is that, with the general impression that the national debt will not pose a material problem for another couple of decades, the Republican majority in Congress will have more time to use austerity budgeting to chip away at “entitlement” programs without endangering the public’s acceptance of their trickle-down myth, and without incurring higher taxes. It may face less political risk in 2016 as well if the interest on debt that has built up over 35 years, which cannot properly be blamed on the current administration, can be obscured. If the economy fails much sooner than 2039 — as it simply must, because such an extreme trend of unsupportable national debt is admittedly “unsustainable” — CBO will point to its assertion that its 2014 reports presented merely benchmarks, not forecasts.

Trickle-Down Nonsense

This report has Paul Ryan’s fingerprints all over it. Here is the lead-in graphic to the July report:


CBO 45471-Long-TermBudgetOutlook - july 2014 - debt as percentage of GDPDoes that look familiar? Compare it to the graph that has been emblematic, since 2012, of Paul Ryan’s budget plans. They are virtually identical for the past 15 years or so:

Pages from pathtoprosperity2013b

Although Ryan imagined the national debt rising to almost 300% of GDP by 2039, and even 800% by 2060, neither of which is actually possible, the austerity/trickle-down ideology behind his program is the same as that now propounded by CBO. For a review of Ryan’s mystical argument that cutting federal spending rather than increasing tax progressiveness will lead to “prosperity,” see my recently republished post “Amygdalas Economicus: Perspectives on Taxation,” originally posted January 24, 2013 (here). 

The sole economic support Ryan cited for his ideology, you may recall, was the Reinhart/ Rogoff theory that as the ratio of national debt to GDP approaches unity, growth is depressed. If that were true, the converse of that theory would in such circumstances support the “austerity” doctrine, namely, that cutting government spending will increase income growth. (Note that cutting spending instead of increasing tax progressiveness to reduce the debt is also promoted by the companion trickle-down fantasy that taxing the rich discourages investment and growth.)

Notice the absurd idea glaring up from Paul Ryan’s graphic that cutting spending without increasing taxation of top incomes and corporations will quickly reduce the national debt, eliminating it by 2050 (the green “Path to Prosperity”). CBO could not get away with making such a ludicrous claim, but it can get away with endorsing the trickle-down myth and uses it to inflate its growth projections.   

In a series of posts, I sifted through the complexities of the Reinhart/Rogoff controversy in some detail, concluding that their idea that increased government debt (reflecting greater spending) reduced income growth lacked theoretical support, and was refuted by their own study (GITD) once its statistical errors were corrected. (See “Reinhart, Rogoff, and Reality,” May 30, 2013, here; “Reinhart, Rogoff, and Ideology,” June 6, 2013, here; and “Reinhart, Rogoff, and Redistribution,” June 30, 2013, here.) I also argued, in the last of these posts, that the declining growth at high levels of national debt in the United States is due to growing income and wealth inequality. (Because of the complexity of the competing arguments, I extended my discussion to three posts. My conclusions, although not concisely presented, remain intact.)

CBO’s new ideological/political  bent:

Although Ken Rogoff and Karmen Reinhart withdrew their conclusions, their argument still sways right-wing ideologues. [Note: Stressing the point that the debt interest/GDP ratio is much higher now “than at any time since WWII” sets up the bogus, Ryan-like argument that, pursuant to the Reinhart/Rogoff thesis, the slow pace of growth is the fault of the Obama Administration’s policies.] 

The July CBO report is candid about endorsing, and using for forecasting purposes, Paul Ryan’s supply-side and “trickle-down/austerity” perspectives. In Chapter 6 (p. 70) CBO discusses its perception of “the economic and budgetary effects of various fiscal policies.” According to CBO, these include:

  • Higher debt crowds out investment in capital goods and thereby reduces output relative to what would otherwise occur; [Reinhart/Rogoff and the austerity doctrine]
  • Higher marginal tax rates discourage working and saving, which reduces output. [The “Laffer Curve,” which is the converse of the trickle-down myth.]
  • Larger transfer payments to working-age people discourage working, which reduces output. [People are lazy.] 
  • Increased federal investment in education, infrastructure, and research and development (R&D) helps develop a skilled workforce, encourages innovation, and facilitates commerce, all of which increase output. [Education, research, and infrastructure are important to growth.]

In each of those cases, the opposite change in policy has the opposite effect; for example, lower marginal tax rates increase output relative to what would otherwise occur.

The “trickle-down” component of CBO’s thinking has been repeatedly discredited by the facts, which demonstrate that it is the progressiveness of taxation that determines the amount of effective demand, for the most part, and accordingly output. Piketty/ Saez/Stantcheva published a study in 2011 across a broad database of the income elasticity of the top income tax rate which showed that federal income tax revenues are optimized at a marginal tax rate over 80%. This study fully refuted the Laffer Curve theory that lower tax rates increase investment and output. No rational theory of investment supports that claim; regardless, if you can effectively tax rich people more, it is simply wrong to argue the converse of the Laffer Curve argument — that refraining from such taxation allows income and wealth to “trickle down” from above. In any event, we know that wealth and income has not trickled down as inequality has continued to grow over the last few decades. The result has been lower growth and higher inequality.

The Inequality Factor

As discussed in the previous post, although the conceptual flaws in CBO’s supply-side analysis are hugely consequential, ignoring the major factor determining growth — the distribution of wealth and income — is almost certainly more significant. Not only has CBO corrupted the budget issue by factoring out the growth of debt interest, it has also failed to reflect the continuing absorption of some $500 billion or more annually into top 1% net worth. This factor ensures continuing reductions in government revenues, and the need for even more debt than CBO otherwise computes will be needed.

Looking again at the following portion of Figure 1.1, it does not seem unreasonable to expect a continuing sharp rise in debt in the 2015-2018 period: Growth in the national debt reflects the continuous financing of the regressive tax reductions enjoyed at the top; and each billion dollar increase in the national debt is matched by an off-setting reduction in bottom 99% wealth. 

CBO 45471-Long-TermBudgetOutlook - july 2014 - growth of debt after 2014

The CBO study has materially misrepresented the growth of debt interest, and beyond that it is corrupted by false ideological influences. It is therefore worthless for predicting when the debt will reach the level of GDP. All we can be certain of is that CBO’s assessment is wrong, and far too optimistic. The dynamics of redistribution are brutal, and there is no reason to assume that the debt/GDP ratio cannot reach 1.0 before 2016-2017; it is growing inequality, primarily, that depresses growth, and as the debt raised to finance that inequality rises exponentially, we move closer and closer to a deep depression. And as we have discussed, there is no magic in the 1.0 debt/GDP ratio: If another bubble pops, such as the $1.4 trillion student debt bubble, we can only guess at the severity of the consequences. 

Again, I disagree with Krugman’s strategy, if it is his strategy, to endorse this bogus CBO study and its assertion that everything will be all right for another 25 years “under current laws.” We’re beyond the point where a political gambit like that, with the stakes so high, can make any sense at all. We’re skating on extremely thin ice, and the entire structure could collapse, just as it did in 2008, on very short notice.

JMH — 7/27/2014 (ed. 7/28, 29/2014)

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The Fiscal Fiasco: A Real Budget and Debt Crisis

‘What Good Are Economists Anyway?’ asked Business Week’s cover story for 16 April 2009, noting that though the world is ‘simply too complicated’ for ‘exactitude’ in prediction, it is distressing that ‘seven decades after the Depression, economists still haven’t reached consensus on its lessons’. An even harsher rebuke came from within the profession when Paul Krugman asked, in the pages of the New York Times Magazine, ‘How Did Economists Get It So Wrong?’ (here). Despite his title, Krugman did not have all economists in mind, but only those who followed recent neoclassical fashion (he left undiscussed the reasons why Keynesian theory fell into disrepute in the 1970s). * * * Krugman dismissed the approaches dominating academic economics over the last 30 years as fundamentally misguided and called for a return to Keynesian theory as part of a recognition of the fundamental ‘messiness’ of the economy.

Writing in the Financial Times (August 5, 2009), Robert Skidelsky (best known for his authoritative biography of Keynes) similarly noted that the efficient-market hypothesis’s collision with the iceberg of economic reality had ‘led to the discrediting of mainstream macroeconomics’ and given the lie to economists’ claim to practice a predictive science. Such shock at the predictive failure of economics is surprising, given the dismal record of professional forecasting. — Paul Mattick, Business as Usual: The Economic Crisis and the Failure of Capitalism, Reaktion Books. Kindle Edition, 2011 (pp. 19-20).

In his second-most recent Op-ed (“The Fiscal Fizzle: An Imaginary Budget and Debt Crisis,” The New York Times, July 20, 2014, here), Paul Krugman argued that the “fiscal panic has fizzled,” citing the most recent Congressional Budget Office “Long-term Budget Outlook,” July, 2014, (here):

I’m not sure whether most readers realize just how thoroughly the great fiscal panic has fizzled — and the deficit scolds are, of course, still scolding. They’re even trying to spin the latest long-term projections from the Congressional Budget Office — which are distinctly non-alarming — as somehow a confirmation of their earlier scare tactics. 

The “deficit scolds” Krugman refers to are right-wing economists and politicians who argue that deficit reductions are needed to avoid the serious crisis that will eventually develop with the continuing federal deficits and exponential growth of the national debt. There are two ways to cut the deficit: reducing federal spending or increasing federal revenues. Krugman has been consistently critical of Alan Simpson, Erskin Bowles and the National Commission on Fiscal Responsibility and Reform (here), a conservative group that includes the premier Congressional budget slasher, Congressman Paul Ryan (here). The Republican Party and the economic right generally want lower taxes, and favor the budget slashing approach to reducing the deficit. Indeed, the Washington Post editorial cited by Krugman (here) simply presumes that raising more government revenues by increased taxation of the rich and corporations is out of the question. 

The economic right has little incentive to actually help relieve the Budget and Debt crisis. Ideologically, they express a broad aversion to government, and many powerful “conservatives” today simply want, as Grover Norquist puts, it to “shrink” the federal government “down to the size where we can drown it in the bathtub.” Politically, their agenda is to blame the Obama Administration for our economic woes,  and perfect their control of the national government so they can finish this job. 

Krugman has repeatedly campaigned against “austerity” budgeting, correctly arguing that cutting taxes and government spending has disastrous consequences for recovery and growth, both at home and abroad. In his most recent Op-ed (“Left Coast Rising,” The New York Times,  July 24, 2014, here), Krugman points to the latest confirmations of Keynesian theory from the states of Kansas (whose tax cuts resulted in fiscal crisis and less growth) and California (which has increased taxes without such negative impacts). The lessons are clear: austerity cannot work, and the “trickle-down” fantasy is a hoax. The key to improving the economy, therefore, will be to remove the budget slashers and tax reducers from their positions of control.

To tackle the deficit problem, increasing tax revenues from the wealthy and corporations is a must, but it also appears to be a political impossibility right now. It appears that Krugman, in these circumstances, has opted to argue that there is no need to worry about the deficits right now, in an attempt to disarm the deficit scolds. Although the “fiscal fizzle” argument is a logical  approach to pursuing that political objective, analysis of the CBO forecast shows there actually is a serious budget crisis, and we are running out of time to correct the problem. In my view, facing the truth is preferable to continuing to play a political game. Billionaires like Nick Hanauer (see my last post) deserve to know the urgency of the danger for them in the current situation: We cannot rely on politics, so Hanauer’s initiative remains the best hope for America’s future. So far, however, too few politicians and economists recognize (a) the proven failure of mainstream, neoclassical forecasting, and (b) the brutal consequences of the accelerating inequality of income and wealth.  

The CBO Forecast

Paul Krugman, referring to CBO’s July report, makes this argument:

The budget office predicts that this year’s federal deficit will be just 2.8 percent of G.D.P., down from 9.8 percent in 2009. It’s true that the fact that we’re still running a deficit means federal debt in dollar terms continues to grow — but the economy is growing too, so the budget office expects the crucial ratio of debt to G.D.P. to remain more or less flat for the next decade.

The July report extends through 2039 its presentation in February of 2014 of “The Budget and Economic Outlook: 2014 to 2024″ (here). My analysis here is based entirely on the February report, for two reasons: (1) The February report contained a detailed budget budget forecast but the July report does not, and there is crucial information in the details that are omitted from the July report; (2) I need more time to review the July report for its consistency with the 2024 forecast, and to study the extended projection through 2039.  (I will present a follow-up post as soon as I have completed that review.) 

Here, from the February report (p. 2) is the Summary Table of CBO’s baseline projections, in which both deficit and debt estimates are presented in actual dollars and as a percent of GDP:

CBO budget outlook 45010-Outlook2014_Feb

Note that the real (inflation-adjusted) deficit is projected to grow from -$514 billion in 2014 to -$1,074 billion in 2024.  The national debt is projected to grow from $12.7 trillion in 2014 to $21.3 trillion in 2024. This enormous growth in the debt, however, only results in a projected increase in the debt/GDP ratio from 73.6% to 79.2%. This reflects, of course, a similarly substantial increase in projected GDP.

GDP (income) is projected to grow at a little over 3.1% on average through 2017, and to increase at an average rate of 2.2% in the 2018-2024 period (Summary Table 2, p.6). The data in Table 1 produce rounded GDP figures of $17,278 trillion in 2014 (12,717/.736), and $26,843 trillion in 2024 (21,260/.792). (CBO’s actual estimates are shown on Table 3-1, p. 50, as shown below.) 

Notably, this amounts to a 55% increase in total income through 2024. It is also noteworthy that the U.S. Census Bureau (here) projects the U.S. population to increase at a much slower rate, from 318.9 million in 2014 to 343.9 million in 2024, an increase of 7.9%. The CBO forecast therefore implicitly reflects substantial projected increases in per capita income and in productivity through 2024.

Our first observation must be that the CBO forecast takes no account of future impacts of the ongoing growth of income inequality, and concentration of wealth. CBO acknowledges the substantial decline in GDP (income) growth that has taken place since the late 1970s, reporting (p. 41) the following average annual growth rates: 4.0% (1950-1973); 3.3% (1974-1981) and; 2.2% (2002-2013). The projected average from 2014-2024 is 2.1%. The CBO offers no explanation for this steady decline. As detailed in this blog, that decline in income growth is associated both logically and statistically with increased income inequality. 

Its forecast of growing productivity and per capita income through 2024 simply ignores the 10% decline of median income that has taken place since the Crash of 2008 (while top 1% incomes have grown dramatically); CBO offers a “supply-side” forecast, in fact, that does not account at all for consumer demand. Although the past impacts of inequality growth are reflected in its low income growth expectations, it makes no adjustment for the continuing massive transfers of wealth to the top 1% or the continuing decline in bottom 99% income. I’ll return to this later.

Again, Krugman emphasized this point: “The budget office predicts that this year’s federal deficit will be just 2.8 percent of G.D.P., down from 9.8 percent in 2009.” CBO presented (p. 4) the following graph of revenues and outlays since 1974, as a percentage of GDP: 

CBO 2014_Feb total revenues and outlays

This graph displays the record high (since 1974) ratio of the federal deficit to GDP of 9.8% in 2009, but this huge, unprecedented deficit clearly reflected the Crash of 2008 and the consequent loss of government revenues, as well as the huge outlays expended to bail out investment banks and other financial institutions. That the ratio has fallen again does not indicate that we are out of trouble; indeed, the situation is considerably worse because the debt and interest on the debt is much higher than before the Crash. It is more noteworthy that, while CBO projects rising government revenues, the increase in real outlays projected through 2024 is considerable, and larger. In general terms, the explanation for this rising deficit (p. 74) is clear, as revealed by the following table:  

CBO budget outlook 45010- outlays

  • Total mandatory outlays are projected to increase from $2,1 trillion in 2014 to $3.7 trillion in 2024, a 77% increase;
  • Total discretionary outlays are projected to increase from $1.2 trillion in 2014 to $1.4 trillion in 2024, a 16% increase;
  • The defense budget portion of discretionary outlays is projected to increase from $604 billion in 2014 to $719 billion in 2024, a 19% increase;
  • Interest on the national debt is projected to increase from $233 billion in 2014 to $880 billion in 2024, a 378% increase.

The interest on existing debt is increasing exponentially, because no debt is being retired and all debt holders own a “perpetual annuity” on their bonds. While the interest on existing debt is compounding, moreover, the government is continuing to borrow to cover each year’s new deficit, adding to the balance of debt. Notably, under these projections, sometime in 2020 the interest on the debt surpasses the entire defense budget.

The increase in debt interest is the most certain of these projections, and because as discussed below the forecast is extremely optimistic, this represents a best case scenario for debt interest: These projections do not include any allowance for additional income and wealth concentrations over the next few years: Monopoly-driven excess profits are providing well over $500 billion per year in additional net worth for the wealthiest Americans and their corporations. As mentioned above, the CBO’s projected increase in income obscures the related decline of the median income of the bottom 99%, and fails to recognize that more than 95% of all new income, as reported by Emmanuel Saez, has gone to the top 1% since 2010.

In these circumstances, we are confronted with the very real likelihood that the national debt and the deficits will be be substantially higher in 2024 than projected by CBO, and that the debt interest will surpass the defense budget before 2020.

CBO’s Forecasting Uncertainty

CBO acknowledges the tenuous nature of this situation:

Over the next decade, debt held by the public will be significantly greater relative to GDP than at any time since just after World War II. With debt so large, federal spending on interest payments will increase substantially as interest rates rise to more typical levels (see Chapter 2 for a discussion of the economic outlook). Moreover, because federal borrowing generally reduces national saving, the capital stock and wages will be smaller than if debt was lower. (p. 7) 

Regarding economic growth, its statements maintain guarded optimism. For example: “The CBO projects that … economic activity will expand at a solid pace in 2014 and the next few years,” and that “federal fiscal policy will restrain the growth of the economy by much less than it has recently.” CBO, nevertheless:

. . . estimates that the economy will continue to have considerable unused labor and capital resources— or “slack”— for the next few years. According to the agency’s projections, the unemployment rate will decline gradually but remain above 6.0 percent until late 2016. The labor force participation rate (the percentage of people in the civilian non-institutionalized population age 16 or older who are either working or are available for and actively seeking work), which has been pushed down by an unusually large number of people deciding not to look for work because of a lack of job opportunities, will move only slowly back toward the level it would be without the cyclical weakness in the economy. (p. 27)

CBO’s actual projection, however, reflects the standard neoclassical presumption that an economy will always rebound to full employment “equilibrium,” reflecting the “full potential” of the capital stock:

By the second half of 2017, CBO projects, real GDP will return to its average historical relationship with potential (or maximum sustainable) GDP, which implies that GDP will be slightly below its potential. (p. 27)

The basis of its projection of the rate of income growth through 2024 is said to reflect “long-term trends”:

Over the next decade, potential output is projected to grow by 2.1 percent per year, on average, which is much lower than the average rate since 1950. That difference primarily reflects long-term trends, particularly slower growth of the labor force caused by the aging of the baby-boom generation. (Id.)

This CBO forecast hedges, though, as have all other mainstream forecasts I have reviewed in the last two years: CBO implicitly concedes that it lacks confidence in its projections, reminding us of the element of uncertainty:

The economic recovery has had unusual features that have been hard to predict, and the path of the economy in coming years is also likely to be surprising in various ways. (Id.)

And:

Economic forecasts are always uncertain, but the uncertainty surrounding CBO’s forecast for the next several years is probably greater than it was during the years following previous recessions because the current business cycle has been unusual in a variety of ways. (p. 39)

In these circumstances, CBO simply makes the most optimistic forecast of GDP growth it possibly can (p. 5), given its forecasting techniques:  

CBO budget outlook 45010-Outlook2014 - gdp and potential gdp

CBO assumes the economy rapidly returns to what economists have been calling the “new normal” growth rate, and then continues at that rate, which is termed the “maximum sustainable output of the economy.” This, of course, is pure guesswork.

CBO discusses distribution of income, but only draws inferences from the trend in labor income (wages and salaries), without accounting at all for the concentration of income (p. 43). Thus, CBO produces this graph (p. 43) of “Labor Income”:

CBO budget outlook 45010-Outlook - labor income

The flaw here is that data for”labor income” include the salaries paid to very wealthy people. Thus, CBO ignores other forms of compensation and wealth transfers, ignoring the distribution of income between wealthy and other people, and without considering how growing income inequality affects demand, consumption, and consequently income growth, taxation, and budget deficits.

I’m not picking on CBO in particular here: All of this reflects the bankrupt state of macroeconomic forecasting analysis today. CBO tries to predict the future, but cannot do it any other way than by projecting supply-side “trends” —  i.e., by guesswork. Its projection of household net worth (wealth) highlights the fact that its main problem is reliance on aggregate (as opposed to distributed) data:

CBO budget outlook 45010-Outlook2014 household net worth

This graph has the familiar contours of the top 1% wealth graph, because it fully includes and mainly reflects top 1% wealth. After the Crash of 2008, as is now increasingly common knowledge, wealth lost by the top 1% (mainly stock market values) rebounded, while housing values did not. The bottom 99%, on the other hand, lost a large share of the $3.7 trillion of net worth reduced from the collapse of the housing bubble. 

This forecast, therefore, is basically a projection of the growth of income and wealth of the wealthiest Americans and their corporations. When income and wealth are rapidly redistributing to the top, which has been true for three decades, aggregate net worth data and aggregate “labor income” data are all but useless. Economic science has yet to appreciate that the distribution of income and wealth, in terms of its concentration at the top, is a primary determinant of income growth. Economists have yet to implement distributional forecasting, accounting for the effects on growth of depressed demand.

With that in mind, here’s one more graph from the CBO forecast:

CBO budget outlook 45010-Outlook2014 - federal debt

This is CBO’s first graph (p. 3), and it tracks the national debt as a percentage of GDP. As discussed earlier, CBO identifies that percentage as 73.6% for 2014, and 79.2% for 2024. Notice that from 2007 on out, from the last year or so of the Bush administration, debt has skyrocketed; so has unemployment. After the Crash debt has continued to grow rapidly until the last year or so, when signs of modest growth have appeared that have been eagerly interpreted as “recovery.” (It must be noted, though, there was zero growth in the Q 1 of 2014, speculatively attributed to cold weather.)

It cannot be overemphasized that economists have no good reason to suppose that the national debt will not continue its sharp upward climb after this year. So long as income and wealth continue to concentrate at the top, income will grow ever more slowly, and there is no good reason to imagine that income growth can be sufficient to counter the acknowledged, rapid increase in debt interest. In these circumstances, to mechanically project a near-immediate return to something called “maximum sustainable output” is an exercise in extremely wishful thinking. And remember: even under its own postulated conditions of “maximum sustainable output,” CBO has projected that debt interest will mushroom out of control.

Summary and Overview

Since the early years of the Reagan Administration, income and wealth inequality have grown steadily. Natural inequality growth was heightened by reduced regulation of monopoly profits and increased taking of economic rent at the top, beginning in earnest with the Reagan Administration. Also beginning in earnest with the Reagan Administration was the reduction of federal tax revenues collected from the wealthiest Americans and their corporations. The federal government was not deterred from staying in business, and much of its business turned to the enhancement of wealth. Thus, it incurred massive debt in order to finance these tax reductions.

Today, the interest on that debt is growing exponentially, forcing government to either raise more taxes or cut spending even more drastically than it already has in the last few years. The latter course is actively pursued by the right-wing economists and advocates for the wealthy, who continue to hunger for more wealth with almost no regard for the consequences. They are gradually destroying the U.S. economy and American prosperity, for all but a select few.

Extremists have justified this course of action with a pathological hatred of government, and by the objective, as Grover Norquist puts it, of shrinking the government down to a small enough size to “drown it in the bathtub.” There are less extreme “deficit scolds,” like the Washington Post editors, who expressly only want to socialize banks and too-big-to-fail corporations and financial institutions, making sure that government at least has enough revenue collected from other taxpayers to bail them out again, should there be another crisis like the Crash of 2009.

Paul Krugman has been opposing these hideous, antisocial agendas for some time. In current circumstances, however, in which the full extent of the peril posed by the growing debt interest burden and by the continuing growth of income and wealth concentration are not well understood, he has opted to promote the idea that we have nothing to worry about from the national debt and the growing budget deficits. That strategy, unfortunately, relies on the bankrupt mainstream, neoclassical mindset which has continuously produced unreliable forecasts and which he himself has forcefully challenged.

The CBO forecast reveals the flaws in that mindset, and demonstrates that the danger from our growing debt and budget deficits is real, and growing exponentially. The possibility of not making it to 2024 without a fatal catastrophe is real. In the next post I’ll review a CBO inference which seems absurd on its face: that we might somehow make it to 2039. 

In current circumstances, where threats to the sustainability of our planet’s ecosystem, and the frightfully escalating warfare among nations, can make economic matters seem trivial by comparison, we should ask ourselves how our country, and the rest of the world for that matter, would cope with any of those other problems with a collapse into another great depression. We really need to save the American economy and the federal government.

JMH — 7/25/2014 (ed. 7/26)

Posted in - FEATURED POSTS -, - MOST RECENT POSTS -, Economics, Federal Budget and Spending, Federal Debt, Wealth and Income Inequality | Leave a comment

It’s the Wealth Transfers Stupid

In 1980, the top 1 percent controlled about 8 percent of U.S. national income. The bottom 50 percent shared about 18 percent. Today the top 1 percent share about 20 percent; the bottom 50 percent, just 12 percent.

But the problem isn’t that we have inequality. Some inequality is intrinsic to any high-functioning capitalist economy. The problem is that inequality is at historically high levels and getting worse every day. Our country is rapidly becoming less a capitalist society and more a feudal society. Unless our policies change dramatically, the middle class will disappear, and we will be back to late 18th-century France. Before the revolution.

And so I have a message for my fellow filthy rich, for all of us who live in our gated bubble worlds: Wake up, people. It won’t last.

If we don’t do something to fix the glaring inequities in this economy, the pitchforks are going to come for us. No society can sustain this kind of rising inequality. In fact, there is no example in human history where wealth accumulated like this and the pitchforks didn’t eventually come out. You show me a highly unequal society, and I will show you a police state. Or an uprising. There are no counterexamples. None. It’s not if, it’s when. – Nick Hanauer, “The Pitchforks Are Coming. . . For Us Plutocrats,” Politico Magazine, July/August, 2014 (here)

To begin, a word about my title: It alludes, of course, to James Carville’s famous slogan “It’s the economy stupid,” meant to remind Bill Clinton’s campaign workers that voters’ top concern is always their pocketbooks and the economy.  I’m not fond of that quotation, but I use it because it was recently paraphrased in connection with the principal subject of this post — The Crash of 2008.  The crash and its aftermath were addressed in a recent Op-ed by Paul Krugman entitled “Build We Won’t” (New York Times, July 3, 2014, here). Later, posting that Op-ed in Reader Supported News, editor Marc Ash changed the title to “It Was the Housing Bubble Stupid,” a seemingly innocent endorsement of the argument Krugman made about the Crash of 2008.

When it comes to the economy, I would not call any economist stupid, certainly not a Nobel Prize winner, and especially not Paul Krugman. Every economist has her or his customized framework, or model, of how the economy works, through which facts are filtered and interpreted. There is great variety in these perspectives, and it is not surprising that they have provided a number of  competing explanations for the causes and consequences of the Crash of 2008. It is a complex topic.

The brashness of Ash’s endorsement of Krugman’s Op-ed may have been invited by Krugman’s statement, in his opening paragraph, that:

The basic story of what went wrong is, in fact, almost absurdly simple: We had an immense housing bubble, and, when the bubble burst, it left a huge hole in spending. Everything else is footnotes. 

To accentuate that point, he added in his linked note: “This wasn’t hard or unconventional economics; it was not much beyond Econ 101.”

Ash knows that Krugman must try to explain economics to everyone. But this is not a topic that can properly be reduced to simplistic explanations. The problem is, many of us have never been satisfied with “conventional” explanations of why the bubble existed in the first place, and do not believe that everything else is footnotes. In “The Neoclassical Boondoggle and the ‘Mutilated Economy’,” Part 1 (November 15, 2013, here), Part 2 (November 16, 2013, here), and Part 3 (November 19, 2013here), I provided an in-depth review of Krugman’s conventional analysis of the aftermath of the Crash, which had been set forth, with alarm, in his discussion of the “mutilated economy,” and I find it helpful to review those posts again now. In Part 3, I argued that a far more straightforward explanation of what went wrong was “completely obscured” by “conventional” economics:

It is noteworthy that, nearly six years since the Crash of 2008, mainstream conventional economists meeting at an IMF conference on economic crises agonized over the completely unexpected failure of the U.S. economy to rebound. Even more telling is their growing suspicion that their supply-side perspective is missing an important part of the picture. Most importantly, it does not yet appear to have occurred to them to consider the implications of income and wealth redistribution.

Part 3 discussed Krugman’s analysis, in which he laid out the theory of a “new normal,” a theory which not only presumes the existence of a “normal” state but implies that a huge crisis like the Crash simply ratchets down, permanently, the “old normal.” Krugman pointed out that, up until just now, it has been considered “radical” to believe that the economy does not automatically adjust back to a vigorous full employment, however long it takes:

A number of economists have been flirting with such thoughts (here) for a while. And now they’ve moved into the mainstream. In fact, the case for “secular stagnation” — a persistent state in which a depressed economy is the norm, with episodes of full employment few and far between — was made forcefully recently at the most ultrarespectable of venues, the I.M.F.’s big annual research conference. And the person making that case was none other than Larry Summers (here). Yes, that Larry Summers.

And if Mr. Summers is right, everything respectable people have been saying about economic policy is wrong, and will keep being wrong for a long time. Mr. Summers began with a point that should be obvious but is often missed: The financial crisis that started the Great Recession is now far behind us. Indeed, by most measures it ended more than four years ago. Yet our economy remains depressed.

The elaborate theory of “secular stagnation” does in fact imply, as Krugman now puts it, that “when the bubble burst, it left a huge hole in spending,” and that “everything else is footnotes.” But in that discussion, he did not endorse the simplistic “conventional” theory he presents now; he did not deny that Summers might be right.   

The story of the Crash, however, is not as carved in stone as even Summers makes it seem: My perspective is that the rising concentration of wealth and incomes in the prior 30 years was largely responsible for the huge hole in spending, and that the collapse of housing prices can logically be regarded as a symptom of declining middle class wealth, and thus as a consequence of the ongoing, accelerating decline of bottom 99% wealth and incomes: The problem is inequality, not secular stagnation. 

Hanauer’s Perspective

This apparently has become Hanauer’s perspective too. Our current concern about the future of America’s economy arises after “neoclassical” macroeconomics, for more than a century, has failed accurately to perceive how market economies actually work. Hanauer perceives a clear connection between America’s high level of wealth inequality and its rapidly declining prosperity, and he asserts that we’re all in the same boat, so that he and his fellow “plutocrats,” in their own self-interest, need to stop the inequality growth and reverse the decline that is taking place beneath them.

But, you may ask, isn’t that obvious? Many of us believe that it is, and our numbers are growing. But that has not been obvious to neoclassical economics which has, over the last 150 years or so, treated inequality as irrelevant to growth and prosperity.  The review in my last three posts of Thomas Piketty’s new book “Capital in the Twenty-First Century” explains how the mainstream “supply-side” theories of growth have blunted our recognition of the true nature of market dynamics. Hanauer’s broad perspective is correct, I submit, but it raises questions Hanauer cannot answer: How serious has the inequality problem become in the United States? And how much time does the American economy have left before it succumbs to the collapse he senses is coming?

When I began working on inequality issues over three years ago, I was convinced that if such a pessimistic assessment is truly valid, it would be politically necessary to convince billionaires like Hanauer that their own interests are indelibly linked to those of everyone else beneath them. The publication of Joseph Stiglitz’s book “The Price of Inequality” in 2012, and the release of Robert Reich’s movie “Inequality for All” in early 2014, have helped raise awareness of the contours of the inequality problem, although these two have not been able to answer the second of these two questions. 

That question is not easy to answer, because income and wealth are interconnected in both directions: Wealth produces incomes (returns and profits) and high-end income produces wealth (savings and hoarding). In the first instance, income concentration is determined by institutional factors (market power, taxation, etc.) as well as by the degree of wealth concentration, but as wealth continues to concentrate, the additional returns it produces become a growing contributor to income inequality, accelerating the growth of both income and wealth inequality. 

Robert Reich has, no doubt, influenced many in the top 0.1% with his recent Aspen Lecture (July 3, 201 4, video here). The last question posed to him in the Q&A at the end of that lecture was a big one: What is more important, income or wealth inequality? Reich responded that, despite Piketty’s overall emphasis on wealth inequality, income inequality seems more important in the U.S. today; This is not surprising, for Piketty’s own discussion of the U.S. problem was based on income inequality in the U.S., and his treatment of wealth as “capital” made wealth accumulation in the U.S. seem to be a relatively innocuous long-run problem, as my previous posts explained. Notably, Hanauer stresses wealth inequality as the main concern: Is Reich correct that, for the U.S. economy, income inequality is the primary concern? 

Wealth concentration in the United States, which has gotten far less attention here than income inequality has, I believe, reached dangerously high levels. The concentration of reported net worth has been rising exponentially. That does not diminish the importance of Reich’s emphasis on the debilitating effects of income inequality, which alone is sufficient cause for concern. Reich points out that the (former) middle class has now exhausted the three “coping mechanisms” for dealing with falling median real household income: (1) increased female workforce participation (1980s-1990s); (2) Increased hours worked (1990s); and (3) “Turning our homes into piggy banks,” i.e., borrowing on our home equity. Consumer demand is 70% of the U.S. economy, he says, and that demand continues to decline with declining median incomes. With the coping mechanisms used up, declining demand must accelerate.

Despite the lack of formal economic theoretical support, many wealthy Americans could see what the bursting real estate “bubble” entailed, and began to share Hanauer’s concerns. In 2010, a group calling themselves “The Patriotic Millionaires” (here) began to press for increased taxes on their incomes, stressing the importance to them of a viable economy. Other billionaires, such as Warren Buffett and Bill Gates, spoke out on social and moral concerns and taxation. The majority of the top 0.1% and the top 0.01%, however, apparently remain unconvinced that inequality poses a serious economic problem for them, or a threat to their fortunes. And neoclassical economics continues to be a major impediment to understanding how serious the problem has become or how rapidly it is undermining our society and our democracy.

The Mainstream Perspective

Neoclassical economics, in fact, could not imagine that any collapse will take place, ever, because of its slavish belief in an overall full employment “equilibrium” toward which market economies are always driving. Unfortunately, the equilibrium was never more than a hypothetical state, but as neoclassical theories have been taught over and over again for decades, hypothetical notions have become presumptive. A few contemporary economists, including James Galbraith and Mason Gaffney, have pointed out that most economists simply believe as a matter of faith in an automatic return to full-employment equilibrium. Paul Mattick explains this problem nicely in his 2012 book Business as Usual: The Economic Crisis and the Failure of Capitalism (Reaktion Books, Kindle Edition, pp. 17-18):

In the later nineteenth century the ‘classical’ political economy of Smith, Ricardo, and their followers was replaced by a new ‘neoclassical’ mode of theorizing that was in many ways quite different. It emphasized not, like classical theory, the division of income among social classes, but the decision-making of individuals. Borrowing the concept of ‘equilibrium’ from physics, along with the mathematics of static mechanics, the new economics continued to insist that capitalism by its nature tended to settle in a stable state in which each individual is maximally satisfied, given the constraints set by his or her relations to the rest of the system. (How this idea was to be reconciled with the equally basic dogma that capitalism tends to grow as a wealth-producing system was left for future thinkers to resolve.) From this point of view too, therefore, breakdowns of the market system, as opposed to imbalances in particular markets, are out of the question; what general difficulties do occur must be the effects of some non-economic factor, such as the weather, human psychology or mistaken government policies.

I opined in my last post that macroeconomics was likely led astray from the beginning by the development of theory, over the centuries, from a “supply-side” perspective. Krugman has consistently condemned its extreme formulation, namely, the so-called “trickle-down” fantasy designed to counter proposed taxation of the wealthy and corporations (“Charlatans, Cranks, and Kansas,” The New York Times, June 30, 2014, here). As Krugman’s report on the “mutilated economy” last November shows, moreover, faith in “supply-side” reasoning may now be loosening its grip on fundamental mainstream economics as well. 

And, as Krugman also discussed (with disgust) in this Friday’s Op-ed (“Who Wants a Depression,” The New York Times, July 11, 2014, here) economics is intensely political:

One unhappy lesson we’ve learned in recent years is that economics is a far more political subject than we liked to imagine. Well, duh, you may say. But, before the financial crisis, many economists — even, to some extent, yours truly — believed that there was a fairly broad professional consensus on some important issues.

This was especially true of monetary policy. It’s not that many years since the administration of George W. Bush declared that one lesson from the 2001 recession and the recovery that followed was that “aggressive monetary policy can make a recession shorter and milder.” Surely, then, we’d have a bipartisan consensus in favor of even more aggressive monetary policy to fight the far worse slump of 2007 to 2009. Right?

Well, no. I’ve written a number of times about the phenomenon of “sadomonetarism,” the constant demand that the Federal Reserve and other central banks stop trying to boost employment and raise interest rates instead, regardless of circumstances. I’ve suggested that the persistence of this phenomenon has a lot to do with ideology, which, in turn, has a lot to do with class interests. And I still think that’s true.

He goes on to explain that while lowering interest rates are supposed to spur investment and growth, wealthy people get higher returns when interest rates are high, so their wealth increases faster. The greater the share of top incomes that consists of returns on wealth, the more this factor can potentially influence monetary policy, and accordingly the greater effect monetary policy can have on inequality and depression. 

Market Optimism, and the Bubble Phenomenon

Meanwhile, the growth of income and wealth concentration naturally promotes rosy and impressionistic financial analyses. Take, for example, the most recent Fisher Investments “Stock Market Outlook, 2014: Part 2″ (April, 2014, here). From the report’s Executive Summary:

The bull market turned five during the quarter, prompting many to question how much longer stocks can keep climbing.  (Appendix I) While bull markets can die for many reasons, age, magnitude and gravity aren’t among them. Unless a bull is truncated early by a sweeping, under-appreciated negative force (we can’t identify any such large, stealthy forces on the horizon currently), it will typically run on until sentiment becomes euphoric to the point reality can’t possibly live up to investors’ expectations.

This isn’t the case today. While sentiment has improved somewhat in recent months, a cloud of skepticism remains. Fear of heights, jitters over geopolitical tensions in Eastern Europe and anxiety over future Fed moves have helped keep expectations low. Investors broadly still don’t appreciate how favorable the current landscape is. (Appendix III) Even as final data showed the U.S. economy grew 2.6% in Q4 2013, with corporate profits and business investment hitting new all-time highs, folks fretted growing cash stockpiles and rising stock buybacks as signs businesses aren’t “investing in the future,” robbing the economy of future growth opportunities. (p. 1)

In his e-mail distributing this report, Forbes columnist Ken Fisher asked: “Could this bull market be a bubble in disguise?”, a question the report promised to address. The report progresses thus:

A bull market is like a vector: It will keep running until it loses steam or hits a wall – fundamental negative big enough to put a dent in the global economy that surprises markets. We don’t see any walls within the next 12-18 months. * * * Nor does the bull appear likely to run out of steam in the foreseeable future. Economic and corporate conditions typically exceed  investors’ expectations through most of a bull market — a powerful force pushing stock prices even higher. This bull market has been no exception. It’s no secret US and global economic growth have been lackluster, but even slow growth has exceeded dour “new normal” growth expectations, and fears of global economic doom have proven unfounded. (pp. 6-7). 

The report adds: “Price-to-earnings ratios have been rising, an expected feature of maturing bull markets.” (p. 21) 

In case investors are worried about record stock prices in the face of “lackluster” growth, the report continues:

Lastly, the notion that this bull market is reserved from “reality” is a perception problem. There is no greater reality in equity markets than corporate profitability. As we detailed in Appendix III, profits are high and rising, underpinned by increasing sales. The global economy seems poised to continue growing — an excellent backdrop for continued profit growth ahead. (p. 22)

But might this long bull market just be “a bubble in disguise”?

Bubble fears aren’t likely to exist when a true bubble does — their existence signals still-prevalent skepticism. Bubbles are events of mass psychology: When inflated, few folks fear a bursting bubble. Headlines tend to proclaim the arrival of a virtuous new economy — “it’s different this time” — as they have throughout history. That sentiment seems far removed from today.

Growing wealth inequality reflects the availability of more money to invest, and that bids up equity market prices, but there is necessarily declining wealth below, and a reduction of earnings support for the rising stock prices. Thus, bubbles today are much more than events of mass psychology. They have monetary antecedents and consequences. Similarly, high price-earnings ratios today in U.S. stock markets are much more than just reflections of bull market optimism, and “lackluster” earning and consumption growth in the U.S., together with record corporate profits and corporate earnings, indicates that corporations are collecting substantial amounts of economic rent.

Fisher Investments simply overlooks the growing concentration of wealth and income in America, the factor that ensures the continuing record-setting pace of American securities markets in the face of bottom 99% stagnation. It is irrelevant for America that “fears of global economic doom have proven unfounded”: The U.S. economy has by far the highest inequality among wealthy nations, and whatever happens to the rest of the world, Hanauer’s fears of a collapsing U.S. economy are not unrealistic. 

Importantly, Ken Fisher is one billionaire who seems unlikely to be swayed by Hanauer’s appeal anytime soon.  His firm may be influential enough to influence other plutocrats as well. So we need to keep reminding them, “It’s the wealth transfers stupid.”

Boom or Bubble?

The only sensible answer to Fisher’s question — “boom or bubble?” — seems to be that so long as wealth continues to concentrate at the top, bubbles and crashes are inevitable. Consider the recent view of Neil Irwin (“Welcome to the Everything Boom, or Maybe the Everything Bubble,” Investor Outlook, The Upshot, The New York Times, July 7, 2014, here):

Welcome to the Everything Boom — and, quite possibly, the Everything Bubble. Around the world, nearly every asset class is expensive by historical standards. Stocks and bonds; emerging markets and advanced economies; urban office towers and Iowa farmland; you name it, and it is trading at prices that are high by historical standards relative to fundamentals. The inverse of that is relatively low returns for investors.

The phenomenon is rooted in two interrelated forces. Worldwide, more money is piling into savings than businesses believe they can use to make productive investments. At the same time, the world’s major central banks have been on a six-year campaign of holding down interest rates and creating more money from thin air to try to stimulate stronger growth in the wake of the financial crisis.

This is more ominous than it might at first blush appear. Rising investment prices likely translate, in fairly short order, into rising consumer prices. This is not the classical image of inflation driving up prices because of an excess of consumer demand, which as Reich has observed has been depressed because of rising inequality. Such inequality-driven inflation can only hasten the development of an “everything bubble.”     

About the Crash

Hanauer’s identification of wealth inequality as the incipient cause of decline and potential depression is confirmed by all of this. There is no reasonable basis for expecting a continuing level of “secular stagnation,” for there is no reason to expect no further bubbles and crashes, as wealth continues to concentrate. My computations show an increase in reported top 1% net worth of between 1980 and 2008 of $18 trillion, in 2010  dollars. (See “Inequality and the National Debt,” April 9, 2014, here.) This figure, which does not include estimates of off-shore wealth owned by Americans, amounts to an average top 1% wealth increase of more than $600 billion/year. Since the economy was growing over this period, in the years just before the Crash the amount was greater than this average. Although this much money could not have come directly from bottom 99% wealth, the amounts coming from money created “from thin air” to which Irwin refers impact the bottom 99% through additional inflation, reducing the real value of the bottom 99%’s remaining wealth and incomes. 

Now the significance of the exhaustion of Reich’s three “coping mechanisms” for the bottom 99% looms large. The last of the three, in which houses were converted into “piggy banks” as people borrowed on their equity to obtain needed cash, was in effect a final act of desperation: for the vast majority of wealth holders beneath the top 1%, their primary marketable asset is their homes. Reich has, in fact, accurately described the process through which declining median income facilitates transfers of wealth to the top. The “housing bubble” was a big one:

The U.S. lost $3.4 trillion in real estate wealth from July 2008 to March 2009 according to the Federal Reserve. This is roughly $30,300 per U.S. household (Pew Charitable Trusts, April 28, 2010, here).

Because it does not consider wealth transfers, “conventional” economics misses the essential nature of decline and depression. The conventional view is that the Crash blasted a hole in the economy that merely created a “new normal” of lower growth, and “secular stagnation.” The numbers prove otherwise, however. The Crash of 2008, the subsequent chronic long-term unemployment, the foreclosure epidemic and the sharp decline in median incomes, together with the record gains in stock prices and, indeed, investment prices generally, all tell a different story. It is the story of the enormous power of income and wealth concentration to bring a market economy to its knees.

Two things are occurring now that suggest the U.S. economy is approaching the brink of Great Depression II: (1) The middle and lower classes are running extremely low on collateral to secure the loans they need to meet everyday living expenses; and (2) The federal government has exhausted its ability to finance, with fiscal expansion, the continuing rapacity of profits at the top.

Conclusion

What the supply-side perspective has missed by ignoring inequality altogether is the major role that income and wealth redistribution plays in decline and depression. In fact, inequality growth has proven to be, by far, the most significant determinant of stagnation and declining growth.  So, yes, above all else: “It’s the wealth transfers stupid.” 

JMH – 7/13/2014  

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