Because I will be leaving town for five days tomorrow, I must preview my next post in my “Finding a New Macro economics” series (with the promise to finish it next Thursday and Friday, providing a fuller discussion and appropriate citations). I cannot let this moment pass, however, without driving this stake in the ground.

I have just posted the second of two articles comprehensively, and I hope readably, demonstrating how far from reality modern economics has strayed. I showed that the fictions-masquerading-as-economics called “trickle down” and “austerity” are illogical and unable to pass basic data runs. Still, they are promoted by the leading economists at Harvard even when their studies, after their errors are corrected, verify reality and not their fantasy economics.

The next step for me after that is to begin demonstrating how awful economic reality has actually become, and in the process identifying more precisely why.  It was in that regard that Paul Krugman’s Oped in this morning’s New York Times stopped me in my tracks, and I rushed to the computer.  If you haven’t already done so, please read “Sympathy for the Luddites” (here), and for the superstitious among you, yes, today is Friday the 13th.

This is the closest Paul Krugman has come to a modern theory of inequality, but locked in his neoclassical prison, he falls just short, just as Keynes did eighty years ago.  This article shows exactly where the neoclassical paradigm fails and where that failure leaves us.

The topic is declining labor productivity, labor’s declining share, and education, a perfect topic for this discussion, and one I have already mentioned in this series of posts and was soon to return to.

There will be no more citations or quotations in this preview, and there is too little time this morning for me to dig out quotations, so nearly all of this is extemporaneous. The only place I am going beyond my own immediate thoughts is back to Krugman’s article to make sure I haven’t distorted his message in the relating of it.

The Education Problem

With all that we’ve seen, the trillions of dollars of wealth transfers and idle wealth at the top, we can now see how tragically ludicrous the official explanation of inequality from the political right truly is. Right up into 2012 the Cato Institute, for example, insisted there is no inequality problem. Faced with undeniable evidence of the rising 1% income share, though, they had to say something, so this is what they said: Inequality is the problem of uneducated people not making as much as educated people. The solution? Get an education.

Unfortunately, even as they were advancing that argument the median income was sinking, and many highly educated people, those who had not become unemployed, were struggling to stay out of poverty. I know several young educated adults who consider themselves lucky right now to have more than one job, with that objective in mind, and I’ll bet you do too.

Alas, this became the official inequality position of Ben Bernanke and others high in government. As I’ve pointed out before, this was the only substantive explanation for rising income inequality offered in the 2012 Economic Report of the President.

As I write this, however, even getting a higher education is becoming far too prohibitive. There is a student loan bubble that grew to over $1 trillion by November of last year. Many thousands of young Americans, despite doing their best to enter the labor market competitively, are saddled with tens of thousands of dollars of education debt many will be paying off for many years, perhaps their entire careers.  Now Congress is considering whether to allow the interest rate on government loans for education to double from 3+% to 6+%.  That will put higher education out of reach for thousands more of the intelligent, hopeful young Americans who have been hoping, not necessarily for the good life, but for some sort of real life and productive career. It goes without saying that the institutions that would be providing such education are contracting, and weakening their offerings.  Some will no doubt fail and close down.

Paul Krugman’s article quite properly points to the other side of the coin. Increasing productivity of capital through advanced automation and technology has eliminated here in the U.S. a great many jobs that people used to get paid to do. And people could acquire expensive sophisticated training for one set of skills only to see the demand for those skills vanish, and find themselves needing to acquire more expensive education; to do it all over again. The value of education has never been in such serious trouble in the modern age.

Yes, this is “structural unemployment,” and it’s a huge problem, as I’ve discussed, that America will have to solve if it wants to survive. And, as Krugman suggests, it is a world-wide problem.

The Neoclassical Trap

But, Krugman argues, these are new problems that have only been with us since about 2000. That, however, is incorrect: Income inequality, which has always been an incipient problem for market economies, was greatly aggravated by the Reagan Revolution, and had already become a major problem in the U.S. by 2000, obscured from view only by the Clinton administration’s good fortune with the dot.com boom and by the neoclassical packaging of economic information and ideas.  (During the Clinton years, rising executive pay in response to major wealth transfers from increased corporate profitability actually accelerated.)  Check the top 1% share data, which shows that inequality had greatly increased in the 20 years before 2000.  So it’s wrong to hang the inequality problem entirely on the messiness of the marketplace; capitalism itself, by its very nature, causes inequality.

Still, he tells us, this is nothing but structural unemployment. Once we get everyone retrained and employed, all will be well.  Does he really believe that? Paul Krugman has at last, however, reached the end of his neoclassical rope.  Things have gotten so bad, he suggests, that there is nothing else we can do but socialism (oops! I misspoke!); there is nothing else we can do but improve the social safety net.  

Then, essentially, he begs for mercy:

I can already hear conservatives shouting about the evils of ‘redistribution.’ But what, exactly, would they propose instead?

Krugman knows very well what they propose: “Break away from your lazy welfare dependency,” “get a job,” ”get an education,” “repeal Obamacare,” etc. The 1% has been able to maintain an ostensible jagged piece of high moral ground because of the Neoclassical hole mainstream economists have put themselves in; and they are destroying America with it.

Is Paul Krugman fearful of the “redistribution” argument? He should be, until is it properly answered. I remember President Obama quickly denying, under sharp, almost disrespectful  questioning by Bill O’Reilly, that he is trying to redistribute income. The truth is, however, that we are in a depression because of massive redistribution to the top, and the destruction since Reagan of the traditional means of limiting such inequality growth — progressive taxation.

Paul Krugman doesn’t have this perspective yet, so all he can do is ask for mercy. Not once in this morning’s Oped does he mention higher taxes on corporations and top incomes! Not once!

They Are Not Stupid

And so he leads with his chin as he enters an intellectual debate with the intellectually bankrupt Carmen Reinhart and Kenneth Rogoff. They are not stupid, and I have to believe they know exactly what they are doing as they bring Paul Krugman to his knees.

Carmen Reinhart is anything but stupid. In her letter to Paul Krugman she taunts him for citing John Maynard Keynes. “We’ve read Keynes too,” she replies, knowing that she has just gone over the heads of 99.9% of her readers.  She’ll leave it to Krugman to explain why Keynes shows her perspective is baseless, because she knows he won’t. He had his chance in 2012, in End This Depresssion Now!, and he did not hurt them there. In this way, with no effort at all, she cloaks her manifestly uneconomic trickle-down and austerian views with an aura of legitimacy.  Your move, Paul Krugman.

And Kenneth Rogoff is anything but stupid. At the age of 14, he became the NY state chess champion and attained the master rank.  When he was 21 or 22, he came to Albany and played a simultaneous match against about 60 opponents at an area mall.  I was one of his opponents, and have always been quite proud to say that I was one of the few he did not beat.  Only slightly above average as a competitive chess player, I had no chance at all against a player of his caliber. I lucked out, though, when he blundered on my board in the early middle game, losing a rook for a pawn. He spotted his error seconds later, as he was rushing on to the next board; he turned back for a quick glance and shook his head, then moved on. About five hours into the game, to his surprise, I offered him a draw, and he took it.  He lost only one game on that day.

I was always more of an economics prodigy. I wrote a paper for a labor law seminar on the incompatibility of full employment and price stability that earned an “A” from guest reviewer Gardner Ackley, the former Chairman of the Council of Economic Advisers, who had just returned to Ann Arbor from his stint as Ambassador to Italy. So I know too much to be easily persuaded that Reinhart and Rogoff do not know exactly what they are doing, although that is the argument politely made by their opponents. It is possible that the intellectual minefield that is professional economics is so convoluted as to bring down even the best and the brightest, once they stumble into it.  I will never know.

The Truth Is Mostly Common Sense

Fortunately you don’t have to be as smart as Kenneth Rogoff to understand economic truth, you just have to avoid being duped by spurious arguments and, quite possibly, being persuaded to become a professional economist yourself.  Keynes took us most of the way, but he stopped just short at a critical point; and if he were around today, he might say: “My bad.” At least I would hope so. But he’s gone, so those of us with more than a passing interest in survival must step up to the plate. It’s not that easy, to be sure, when you have to start over, in effect, and weed out all of the bad ideas and the obfuscation. But we will find the answers, and once we have them, we will see that they can be understood by any intelligent person.

I’ll re-post much of this in my “Finding a New Macroeconomics” series.  Meanwhile, have a good week, and keep your thinking caps on!

JMH – 6/13/2013

“The backlash from hell” – Bass Resources (here)

The discovery of an error in an influential research paper by Harvard University economists Carmen Reinhart and Kenneth Rogoff has sparked an academic firestorm. It’s time to sort through the wreckage. – Betsey Stevenson and Justin Wolfers [1]

In the last post in this series, we took a hard first look at the Reinhart/Rogoff thesis, originally floated in early 2010, that public debt/GDP ratios over 90% cause growth to decline.  This was an influential idea that quickly gained control of the political agenda around the world, becoming the alleged rationale for “austerity” in government, and the sole economic rationale for the Republican Party’s austerity-driven federal budget proposals in the United States. In my review of the authors’ own initial presentations, however, I did not find a reasoned basis for this unusual idea. Relying entirely on the alleged virtue of a “decidedly empirical” approach, they left important questions unanswered. I was forced to wonder if they felt their rationale was already so well-known within the profession that it didn’t need to be publicly articulated. 

Despite their lack of theoretical support, and a reasoned critique [2] posted by the Economic Policy Institute (EPI), this popular theory apparently attracted little academic attention at the time. Two years later, however, with the unexpected allegation from a U. Mass. graduate student and his faculty advisors that factual errors in their study actually nullified their statistical findings, both academia and the media suddenly became intensely interested.

After the initial frenzy of coverage, this second round of controversy is subsiding now somewhat, as Reinhart and Rogoff have backed away from their over-ambitious support of the “90% tipping point” thesis. But that is only the first step: The newly-awakened interest has provoked an abundance of competing opinions and allegations which might lead to a more thorough review of the empirical and theoretical aspects of debt and growth. As Dean Baker recently remarked: “The silly spreadsheet error was important in the debt debate controversy because it allowed for a real debate.” [3]

The time has come, as Stevenson and Wolfort put it, to “sort through the wreckage.” That’s going to be a big job, however, more extensive than the task described by Stevenson and Wolfert themselves, for the wreckage includes more than just a damaged interpretation of statistical results. It extends deeply into the “science” of economics itself. Our objective is a reasoned appreciation of the relationship between debt and growth, and its status in macroeconomic theory. The task reminds me of my numerous experiences with untangling backlash on a fishing reel; it’s a step-by-step process, and concentration and patience are required. We need to understand what makes sense. This post offers a new framework for that understanding.

The Reinhart/Rogoff Perspective

Initially, it seemed as if Reinhart and Rogoff, as economic historians, were “fishing” as well, casting back over centuries of data to see what they might discover about how financial crises affect growth.  In their August 11, 2010 article, published shortly after EPI released its critique of their study, they made it clear that their interest went well beyond mere curiosity, for they had explored “the contemporaneous link between debt, growth, and inflation at a time in which the world['s] wealthiest economies are confronting a peacetime surge in public debt not seen since the Great Depression of the 1930s and indeed virtually never in peacetime.” [4] And, they continued:

One need look no further than the stubbornly high unemployment rates in the U.S. and other advanced economies to be convinced how important it is to develop a better understanding of the growth prospects for the decade ahead.

In other words, from the perspective of economic history as the history of financial crises, they argue that high levels of public debt (public debt/GDP ratios) could be a determinative factor, if not the determinative factor, controlling growth and prosperity. They imply, moreover, that their study will help us understand U.S. growth prospects in the coming decade. This seemed to be their response to Irons and Bivens’s conclusion, in their EPI paper, that “the GITD ’90% threshold’ for gross government debt should not be used as a guide for U.S. fiscal policy, as both the theory and the data in the paper rest on exceptionally shaky foundations.”

They also discussed the corollary question of causality between high public debt and low growth, which they did not test empirically:

We examine average and median growth and inflation rates contemporaneously with debt. Temporal causality tests are not part of the analysis. The application of many of the standard methods for establishing temporal precedence is complicated by the nonlinear relationship between growth and debt (more of this to follow) that we have alluded to.  But where do we place the evidence on causality? For low-to-moderate levels of debt there may or may not be one; the issue is an empirical one, which merits study.  For high levels of debt the evidence points to bi-directional causality.

As the recent controversy retreats from public view there appears to be universal or near-universal agreement that low levels of public debt and growth are not problematically related; but at high levels of public debt, there remains this nagging question of causality. Most economists, I assume, have no difficulty with the idea that at high levels of public debt, further decline of private sector growth creates the need, all else equal, for additional federal borrowing.  But the existence of a bi-directional causality is not obvious.  

Here is where the issue gets really interesting; in their introduction, Irons and Bivens listed this as their first major finding:

The GITD report examines yearly growth and debt levels, with no allowance for an impact over time, or a more complicated dynamic relation between growth and debt. There is no compelling theoretical reason why the stock of debt at a given point in time should harm contemporaneous economic growth. (Emphasis added.)

The regression of contemporaneous data over two hundred years may well present a substantive problem for Reinhart and Rogoff, for without time series analysis of the data, causation is not directly implicated. However, it seems possible that elements of causation may be preserved even in a regression of contemporaneous data. I would want to submit that question to a top-notch statistician; if that is true, it would seem especially significant that Reinhart and Rogoff found no material correlation below the alleged 90% “tipping point.” But the question remains: What dynamic factors might cause declining growth at extremely high levels of public debt? Neither Reinhart and Rogoff, nor Irons and Bivens, reached that underlying question in their presentations. But that is the fundamental theoretical question, and we must reach it now.

Growth, “Trickle-down,” and “Austerity”

John Maynard Keynes established, beyond any credible doubt, that the level of economic activity (and growth) depends on the level of effective demand. His reasoning was set forth in the third chapter of The General Theory of Employment, Interest, and Money; because of their length, I’ve posted the most important paragraphs from Chapter 3 separately and linked them (here).  

Because of it’s infallibility, I’ll call Keynes’s rationale “The Law of Effective Demand.” It’s as irrefutable as “Say’s Law,” but explains so much more. In its most irreducible form, Say’s Law says: “Every sale is a purchase.” Reduced to its essence, The Law of Effective Demand says: “You can’t buy anything if you don’t have any money.” No, I’m not being facetious. Here’s the bottom line: If you want more growth, you need to create more demand and more employment. 

In the linked passages from his third chapter, Keynes also demonstrated a complete grasp of the mechanism for inequality growth. He appeared to appreciate the drag that growing income and wealth concentration has on growth and he was only one lap around the track, I suspect, from finding a way to incorporate income distribution into his “full employment” model. He didn’t get there, however, so “mainstream” economics regressed back into a neoclassical synthesis. Because the Law of Effective Demand is tautological, its influence has dominated every piece of macroeconomic data ever generated. Still, because he claimed to have solved the poverty problem, at their expense, the wealthy elite have disliked Keynes from the beginning and created ideas designed to undermine his General Theory; and at one level — the neoclassical level — the General Theory was vulnerable to such attacks. We face the two most influential of those ideas here:

“Trickle-down”

Also known as “supply-side” economics, this is the idea that the less corporate earnings and top incomes are taxed, the more the economy will grow. Conversely, it holds that higher taxes at the top will discourage investment and employment. This is a flat-out rejection of Keynes’s General Theory, which reasons that there will be no current investment in the means of producing goods and services that are not expected to sell; investments require the expectation of future profitability, and expectations of future growth are constrained by experience, which is constrained by the Law of Aggregate Demand. The current situation is a good example: Four years since the Crash of 2008, interest rates remain extremely low in an effort to encourage investment, but as nearly everyone from Ben Bernanke to Reinhart and Rogoff understands, the U.S. economy on its current course is many neoclassical years [5] away from full employment.  

Trickle-down is not only based on faulty psychology, it is physically impossible: money is created and destroyed in specific ways. Trickle-down imagines that when the existing money supply is being used for contraction (i.e., redistributed into wealth and income at the top), the people below the top who are losing their share of the money supply will somehow magically increase their consumption, as if they still had that money, and the economy will somehow magically grow. [6] This “pixie dust” idea flatly violates The Law of Effective Demand.    

Recent experience has provided ample and dramatic proof of that, as I pointed out in a recent blog post (here): 

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. [7]

Back in the 1960s, trickle-down mythology was generally understood to be insensible; but one-half century later, just as we are learning how deadly it really is, it has triumphed politically. Grover Norquist has famously obtained pledges from the vast majority of Republicans in Congress never to increase taxes (here); and Chris Mooney cites Mitch McConnell as endorsing trickle-down as the official economics of the Republican Party. As Mooney observes, trickle-down claims have moved well beyond the basic argument, that cutting taxes at the top will encourage investment and growth, all the way to the preposterous claim that a tax cut will actually more than “pay for itself” through growth and increased government revenues.  Mooney concludes: 

It isn’t just misinformation about taxes, deficits, and how our economy came to ail so badly – though there’s plenty of that.  But we’re also talking about putting the entire U.S. economy and way of life in jeopardy on the basis of questionable economics. . . [8]

Although budget deficits and the national debt can be reduced either by cutting government spending or by raising taxes, it is noteworthy that neither side in the Reinhart/Rogoff debate discusses taxation; the only reference to taxation I can recall seeing is the temporary Reinholt and Rogoff reference to Robert Barro’s study on optimizing the choice between taxation and public borrowing. This debate has been almost entirely focused on the option of reducing debt by cutting government spending.

“Austerity”

Austerity is the idea that cutting government spending can actually stimulate economic growth. Like trickle-down, this theory must contend with The Law of Aggregate Demand, and even more directly so. Each spending reduction is itself a constrictive reduction in demand; so how might austerity stimulate growth, that is, “pay for itself”? Wikipedia (a recent addition, last modified on June 1, 2013) provides a reasonably objective description of the austerity idea [9], which can be summarized as follows: 

1. High debt-to-GDP ratios can signify inadequate government “liquidity” to creditors;

2. In adverse conditions, governments can demonstrate liquidity by spending less and increasing tax revenues;

3. The macroeconomic effect of reducing government spending is to reduce growth and GDP, hence reducing the debt-to-GDP ratio;

4. Thus, austerity does not improve growth, unless growth improves pursuant to a controversial theory called “expansionary fiscal contraction”: 

In macroeconomics, reducing government spending generally increases unemployment. * * * Under the controversial theory of expansionary fiscal contraction (EFC), a major reduction in government spending can change future expectations about taxes and government spending, encouraging private consumption and resulting in overall economic expansion.

The EFC theory, attributed to Francesco Giavazzi and Marco Pagano (1990), holds that in some circumstances “a major reduction in government spending that changes future expectations about taxes and government spending will expand private consumption, resulting in overall economic expansion.” [10] The abstract of the Giavassi/Pagano paper [11] elaborates:

According to conventional wisdom, a fiscal consolidation is likely to contract real aggregate demand. It has often been argued, however, that this conclusion is misleading as it neglects the role of expectations of future policy; if the fiscal consolidation is read by the private sector as a signal that the share of government spending in GDP is being permanently reduced, households will revise upward the estimate of their permanent income, and will raise current and planned consumption. 

I doubt this theory has “often” been argued, because like trickle-down, it is extremely anti-Keynesian — it violates The Law of Effective Demand.  A permanent reduction in government spending means less economic activity and declining growth, so a perception of declining government spending would likely cause households (especially those dependent on small business income) to revise their expectations of future income downward.    Moreover, while growth expectations determine current and planned investment, current consumption is constrained by current income, especially for low- and middle-income households who have precious little ability in a depression to raise current and planned consumption in response to anything.  

In a recent Oped Paul Krugman, America’s most vocal anti-austerian, condemned a more recent (2009) Alesina/Ardagna version of expansionary fiscal contraction, “Large Changes in Fiscal Policy: Taxes Versus Spending” (2009) [12], along with the Reinhart/Rogoff study,  for lacking a real-world factual foundation:  

The dominance of austerians in influential circles should disturb anyone who likes to believe that policy is based on, or even strongly influenced by, actual evidence. After all, the two main studies providing the alleged intellectual justification for austerity — Alberto Alesina and Silvia Ardagna on “expansionary austerity” and Carmen Reinhart and Kenneth Rogoff on the dangerous debt “threshold” at 90 percent of G.D.P. — faced withering criticism almost as soon as they came out. And the studies did not hold up under scrutiny. By late 2010, the International Monetary Fund had reworked Alesina-Ardagna with better data and reversed their findings. [13]

The Institute for America’s Future, a progressive think tank, has released an anti-austerity statement signed by over 460 American economists, arguing:

There is no theory of economics that explains how we can deflate our way to recovery. Businesses are not basing investment decisions on how much Congress cuts the debt in 2023. As Great Britain, Ireland, Spain and Greece have shown, inflicting austerity on a weak economy leads to deeper recession, rising unemployment and increasing misery.

In a deep recession, deficit reduction is a moving target. If you cut spending and consumer purchasing power in an already depressed economy, unemployment rises and revenues fall — and the goal of a smaller deficit keeps receding like a mirage in a desert. When private purchasing power is depressed by the aftermath of a financial collapse, only public investment can make up the gap.

The budget hawks have the sequence backwards. Public outlay for jobs and recovery come first, growth is restored, and revenues follow. Budget cuts in a deep slump lead only to a deeper slump. [14]

This is pure Keynesian short-run logic, proven out time and again. And so the debate continues, with the austerian case against taxing the rich resting on a slender reed, supposrted only by erroneous data as the corrected data continue to verify reality. It is important, as Krugman notes, that Reinhart/Rogoff’s theory is an austerity theory: The notion that at high debt/GDP ratios growth is curtailed is just the flip side of the austerity doctrine’s assertion that growth can be stimulated by reducing high public debt/GDP ratios.

The Reckless Republican Plan 

Here is the familiar chart from Paul Ryan’s 2012 House budget proposal: 

The first premise of this chart, represented by the down-sloping green line, is that austerity is the path to prosperity. The claim, released on the same day (March 20, 2012) by both Paul Ryan in the House Budget Committee’s Fiscal Year 2012 Budget Resolution (here) and James Pethokoukis of the American Enterprise Institute (here), is that that the budget plan will eliminate the national debt by 2050. This is an audacious replay of the Heritage Foundation’s predictions for the effect of the Bush tax cuts, and it suffers from exactly the same denial of economic reality.    

Beyond the false claim that austerity will increase growth, the trickle-down ideology also maintains that not doing austerity reduces growth, and this is where Reinhart/Rogoff and the other austerians come in.  The big red triangle and the upward-sweeping projection called “current path” represents that “debt as a share of the economy” will rise exponentially if the austerity path is not followed. By 2050, the assertion is, public debt will rise to 350% of GDP.

Importantly, as shown in post #8 in this series (here), Irons and Bevins (EPI) prepared a chart of all of the Reinhart/Rogoff observations of the U.S. public debt/GDP ratio plotted against contemporaneous growth.  That chart shows that since 1800 the public debt/GDP ratio has rarely exceeded 80%, and never exceeded 130%, the point it approached in 1946 immediately following WW II. After the record decline in 1946, the U.S. economy began to grow as the U.S. government pursued an expansionist policy with a top marginal income tax rate around 90% and heavy investment in a middle class economy; and the national debt as a percent of GDP rapidly declined thereafter. Thus, the high debt did not cause declining growth; progressive taxation permitted improved growth and declining debt in following years.

It’s entirely unlikely that any government could reach the point of holding debt at 350% (never mind 800% as projected by Ryan for 2080) of GDP, for the U.S. over $50 trillion (based on the current level of GDP), without an extremely regressive tax system; nor would it last very long if it did, as real growth would be greatly inhibited by the extremely high cost of servicing that much debt. Certainly, to avoid default, very highly progressive taxation would be required, if there were any rich people in the economy left to tax. But how could the U.S. have borrowed $50 trillion in the first place? And where, is it imagined, has the $50 trillion of borrowed money gone in this scenario?    

This Republican plan even ignores the austerians’ own caveat that austerity could only work if spending cuts are accompanied by tax increases to help reduce the debt/GDP ratio; instead, the Ryan budget  proposes huge tax cuts at the top. A double whammy of failed austerity and failed trickle-down, both guaranteed by The Law of Effective Demand, would virtually guarantee the demise of the already depressed U.S. economy, in fairly short order.     

This isn’t just non-economics, it’s very sloppy non-economics. Because the austerity and trickle-down ideologies are false, it is not surprising that the quirky statistical anomaly presented by Reinhart and Rogoff is the only study cited by Paul Ryan in support of the his budget proposal. Why is this important? As Chris Mooney reminds us, this is about “putting the entire U.S. economy and way of life in jeopardy.”

Ask yourself this question: If the trickle-down and austerity doctrines are so unsound, why do they still dominate public debate and control policy?        

Reinhart, Rogoff, and Inequality

To the bannermen of the top 0.1% who argue the supremacy of “stylized facts,” ideology trumps unpopular facts every time, and they can make it stick because they own major universities like Harvard, and most of the media, and inundate with a continuous stream of working papers and journal articles. On these points, Krugman asserted himself as forcefully as he could in “The 1 Persent Solution”:

You can’t understand the influence of austerity doctrine without talking about class and inequality. * * * [T]he wealthy, by a large majority, regard deficits as the most important problem we face. * * * The wealthy favor cutting federal spending on health care and Social Security — that is, “entitlements” — while the public at large actually wants to see spending on those programs rise. You get the idea: The austerity agenda looks a lot like a simple expression of upper-class preferences, wrapped in a facade of academic rigor. What the top 1 percent wants becomes what economic science says we must do. * * * The 1 percent may not actually want a weak economy, but they’re doing well enough to indulge their prejudices.

And this makes one wonder how much difference the intellectual collapse of the austerian position will actually make. To the extent that we have policy of the 1 percent, by the 1 percent, for the 1 percent, won’t we just see new justifications for the same old policies? I hope not; I’d like to believe that ideas and evidence matter, at least a bit. Otherwise, what am I doing with my life? But I guess we’ll see just how much cynicism is justified. [14]     

At least a bit? Why such timid understatement? Verifiable ideas and evidence are all that really matters. The “intellectual collapse of the austerian position” must not be allowed to obscure the overwhelming victory of the Reinhart/Rogoff side in this debate: Remember, the purpose of trickle-down and austerity ideology is and always has been to protect the wealthy from taxation, and this entire Reinhart/Rogoff debate so far as I can determine, has taken place with no mention of taxation. Mainstream economics still ignores income and wealth distribution; and Paul Krugman limits himself to noting that this debate is on the front lines of class warfare.  

Here is my assessment of how the Reinhart/Rogoff debate might be resolved if income and wealth redistribution were taken into account:

1. Those who argue that growth declines somewhat through the Reinhart/Rogoff categories as the debt/GDP ratio gradually increase (including Reinhart/Rogoff themselves) are apparently correct. This has been shown to be not about financial crises, however, but it likely accurately reflects the inexorable growth of debt interest as the public debt rises, and the growth of inequality as the wealthy increasingly “earn” this debt interest from the not-so-wealthy;

2. For the last 30 years or so, as income inequality has sharply risen, the federal government has borrowed the money to pay the interest, which now totals over $220 billion annually. [15] This is not about crowding out other possible private sector uses of debt for economic expansion, not with about $2 trillion or so sitting idle in investment accounts. It’s about crowding out public sector uses of funds for economic expansion, operating functionally as automatic “austerity” machine;

3. The cost of interest on the debt, however, is minor relative to the size of the debt itself. Rising income inequality both reduces growth and, in today’s circumstances, directly increases the level of debt.  So, yes, higher debt/GDP ratios are closely related to lower growth;  

4. All of the outstanding $16.7 trillion of U.S. debt has effectively financed wealth transfers to the top 1%, through avoided taxation of top 1% income, which makes the inequality problem today far worse than I had previously dared to imagine. This consistently reduces GDP and raises the level debt, so that the debt/GDP ratio will continue to rise. The implications:

a. The idea that austerity might help at all, never more than a dream and a prayer, is beyond all reason;

b. More federal borrowing will aggravate the rise of the debt/GDP ratio and contribute directly to further decline in growth and increase in inequality;

c. In the interest of debt management, fiscal responsibility, and economic growth, it is essential to immediately institute a sufficiently progressive program of federal taxation.

In other words, the one thing essential to the survival of our capitalist market economy, adequately progressive taxation, is something that no one in the Reinhart/Rogoff debate even mentioned.                          

The Neoclassical Prison

Imprisoned by their own neoclassical thinking, mainstream economists today have been playing the 1%’s game, in the 1%’s ballpark. Thus, while Krugman celebrates the ”intellectual collapse of the austerian position” he attributes the lack of an outright Keynesian victory in the policy war to the notion that “ideas and evidence” must not matter any more.

I single out Krugman, of course, because he is our Keynesian leader.  But the problem is not Krugman’s alone: The real problem is that the Neoclassical synthesis, the attempted merger of incompatible “macroeconomic” and “microeconomic” systems, long ago nullified Keynes’s core wisdom (here). Only a year ago Krugman, in End This Depression Now!, made this pronouncement:

My guess — and it can’t be more than that, given how little we understand some of these channels of influence — is that the biggest contribution of rising inequality to the depression we’re in was and is political. [17]

That’s the wrong guess, and this issue is too important for mere guesswork. For the last few years the rumblings from mainstream economists have been mostly the sounds of distant thunder, and here’s why:

1. Keynes made it clear that market economies are unstable, but he was unable to break away from his own bad habits of thought. He used the word “equilibrium” 85 times in The General Theory. “Equilibrium” is a “microeconomics” concept, requiring the ceteris paribus (all else equal) assumption, and only a small handful of established economists, such as James Galbraith, have emphasized that there is no reason to assume that economy-wide decline can turn around on its own;

2.  Most mainstream economists today appear to believe, however, that an economy will eventually correct itself. This, however, is the “famous optimism” of classical economics that Keynes rejected, and adhering to that belief is a rejection of Keynesian economics;

3. The ultimate proof awaited the collection of adequate income distribution data, as Simon Kuznets warned back in the 1950s.  And that proof, now in hand, demonstrates that a modern capitalist economy can be far more unstable than Keynes, or Hayek for that matter, in all likelihood ever imagined it could be.

Adhering to the notion of eventual, automatic recovery to full employment, then, is a full-bore retreat into the classical world, the world occupied by Paul Ryan and the Harvard economists who preach the supremacy of “stylized facts.” And they are happy to play in that world — it may not be a game they can win, but it’s one they cannot lose.      

The Legacy of Reinhart/Rogoff 

Because of the confused state of economic “science,” the wreckage of this debate is a confused tangle of reactions and ideas. Most of the media reports dealt solely with the statistical issues. An early post by Ann Landrey, and the later Stevenson/Wolfers article, argued that the computer glitch had not damaged the Reinhart/Rogoff thesis. [18] These were followed by a flurry of articles by more progressive reporters announcing that a computer glitch had brought on the demise of the austerity doctrine. [19] Veteran Washington Post correspondent Robert J. Samuelson walked us through the statistical issues and concluded: “What’s sobering about this brawl is that it settles nothing.” [20] 

Dean Baker at CEPR threw up his hands and declared: “As a general rule economists are not very good at economics”: 

The debt-to-GDP ratio can be thought of as something like the color of a house. Suppose Reinhart and Rogoff told us that people who lived in blue houses had 40 percent less income than people who lived in houses painted other colors. Presumably people would be skeptical of the results, but if their finding was really true, then we would probably want to encourage people in blue colored houses to paint them a different color. [21]

Krugman’s Discomfort 

There is almost nothing in these articles to alert readers to possible questions about the soundness of the classical economics that gave birth to the austerity doctrine, or the neoclassical fusion called “mainstream economics” that sometimes challenges it. For his part, Paul Krugman weighed in not by attacking the Reinhart/Rogoff results, which he said he “never believed,” but by criticizing them for “evading the critique.” [22] Krugman, however, hadn’t objected to their results when he cited them a year ago in his book, and indeed he appeared to have endorsed their “financial crisis” theory of high public debt and and its association with high unemployment. [23] Hence, his recent reaction only led to a celebrity-feud between Krugman and Reinhart/Rogoff, which the press is loving. [24] Both sides have played their hands and neither side wants to risk looking even worse. That’s a stalemate; which as chess Grandmaster Kenneth Rogoff would be pleased to explain, is a draw.

Meanwhile, Paul Krugman continues to demonstrate that he accords no macroeconomic significance to income and wealth redistribution. [25] And as deficit problems mount, he continues to shrug off continuing very large deficits as a minor problem, insubstantial because, although very large, the deficit is not expected to increase as a percentage of GDP. [26] But the bottom 99%’s share of GDP has been declining since the Crash of 2008 and the start of this depression. Just a few days ago, [27] Krugman once again expressed his long-time conviction that “if Washington would reverse its destructive budget cuts, if the Fed would show the ‘Rooseveltian resolve’ that Ben Bernanke demanded of Japanese officials back when he was an independent economist, we would quickly discover that there’s nothing normal or necessary about mass long-term unemployment.” 

But he should have been warning us that we’ll never return to the growth and prosperity we once had until we reduce the concentration of wealth and income at the top, which has grown far too great to allow the United States economy to ever return to the levels of employment and prosperity we once knew.  As 460 economists have argued, we cannot “deflate our way to recovery” and, I submit, we cannot borrow our way to recovery either.

Mainstream Keynesians are skating on very thin ice. Let me put it this way: Unless the neoclassical position is correct that income and wealth redistribution has no material macroeconomic significance, Paul Krugman’s debt and deficit arguments will prove to be as wrong as the CBO deficit projections upon which they are based, and as Ryan, Reinhart and Rogoff are about the efficacy of austerity. We’ll know for sure in less than two years. Meanwhile, time is running out on the quest for a new macroeconomics.   

I’ll return in the next post to developing a fuller understanding of some important aspects of wealth transfers, and a better understanding of how much damage has already been done.

JMH – 6/12/2013 (ed. 6/13/2013)

_____

[1] “Refereeing Reinhart-Rogoff Debate,” by Betsey Stevenson and Justin Wolfers, Bloomberg, April 28, 2013 (here).

[2] ”Government Debt and Economic Growth: Overreaching Claims of Debt ‘Threshold’ Suffer from Theoretical and Empirical Flaws,” by John Irons and Josh Bivens, Economic Policy Institute, Briefing Paper #271, July 26, 2010, pp. 1-2 (here).

[3] “Excel Spreadsheet Error, Ha Ha! Lessons From the Reinhart-Rogoff Controversy,” by Dean Baker, The Blog, Huffington Post, May 27, 2013 (here).

[4] “Debt and Growth Revisited,” by Carmen M. Reinhart and Kenneth Rogoff, VOX,August 11, 2010 (here).

[5] I.e., assuming there is no more inequality growth.

[6] No, increasing household debt is not magic, but it just makes matters worse.

[7] “Amygdalas Economicus: Perspectives on Taxation,” by J. M. Harrison, January 24, 2013 (here).

[8] Chris Mooney, The Republican Brain: The Science of Why They Deny Science – and Reality, John Wiley & Sons, NY, 2012, Ch. 10, “The Republican War on Economics,” p. 190.

[9] “Austerity,” Wikipedia, last modified June 1, 2013 (here).

[10] “Expansionary Fiscal Contraction,” Wikipedia, last modified March 13, 2013 (here). (The quoted language is from the Wiki-summary, not the authors.)

[11] “Can Severe Fiscal Contractions be Expansionary? Tales of Two Small European Countries,” by Francesco Giavazzi and Marco Pagano, NBER Macroeconomics Annual, Vol. 5, 1990, JSTOR, Chicago Journals, Abstract (here); For Giavazzi’s broader discussion of public debt issues, see also, “Fiscal Policy after the Financial Crisis,” Introduction by Alberto Alesina and Francesco Giavazzi, NBER conference held December 12-13, 2011 (here).

[12]  ”Large Changes in Fiscal Policy: Taxes Versus Spending,” by Alberto F. Alesina and Silvia Ardagna, NBER, Working Paper 15438, October 2009 (here).

[13] ”The 1 Percent’s Solution,” by Paul Krugman, The New York Times, April 25, 2013 (here).

[14] “Jobs and Growth: Not Austerity,” Institute for America’s Future (here), February 1, 2013 (here).

[15] ”The 1 Percent’s Solution,” supra. 

[16] See, e.g., “National Debt Interest Payments Dwarf Other Government Spending [CHART]” by  Danielle Kurtzleben, U.S. News, November 19, 2012 (here).

[17] Paul Krugman, End This Depression Now!, W.W. Norton & Company, NY (2012), pp. 84-85. My review of his Chapter 5 suggests that the section “Inequality and Crises” (pp. 88-82) best reveals how his logic falters on inequality.

[18] “A Study That Set the Tone for Austerity Is Challenged,” by Ann Lowry, The New York Times, April 16 (here); ”Refereeing Reinhart-Rogoff Debate,” by Betsey Stevenson and Justin Wolfers, Bloomberg, April 28, 2013 (here).

[19] “Austerity Fanatics Refuse To Admit They’ve Just Been Completely Discredited,” by Mark Gongloff, The Huffington Post, April 22, 2013 (here); “Reinhart And Rogoff Make More Mistakes While Admitting To Research Flaws, by Mark Gongloff (report), The Huffington Post, April 22, 2013 (here); ”Who Is Defending Austerity Now? The Excel error heard ’round the world has deficit-cutters backpedaling,” by Matthew O’Brien, The Atlantic, April 22, 2013 (here); ”Austerity doctrine is exposed as flimflam,” by Katrina vanden Heuvel, The Washington Post, April 23, 2011 (here).

[20] “The Reinhart/Rogoff brawl,” by Robert J. Samuelson, The Washington Post, April 24, 2001 (here).

[21] “Reinhart-Rogoff One More Time: Why the 90 Percent Never Should Have Been Taken Seriously,” by Dean Baker, Center for Economic and Policy Research (CEPR), May 11, 2013 (here).

[22] “Reinhart-Rogoff, Continued,” by Paul Krugman, The New York Times, April 16, 2013 (here).

[23]  Paul Krugman, End This Depression Now!, W.W. Norton & Company, NY (2012), pp. 128-128.

[24] Coverage abounds: See the Reinhart letter to Krugman (5/25/2013, here), Krugman’s follow-up Oped (5/26/2013, here), and Fareed Zakaria’s “today is my lucky day” interview (6/1/2013, here).

[25] E.g., (a) “The Twinkie Manifesto” (11/18/2012, here) where he stated that that a high top income tax rate is “not incompatible” with growth, when he could and should have argued that progressive taxation is essential to growth; (b) more recently in “From the Mouths of Babes” (5/30/2013, here), where claimed, while defending food relief to the unemployed on both moral grounds and because it stimulates the economy, that the economy is depressed because “many players in the economy slashed spending at the same time, while relatively few players were willing to spend more,” when he could and should have said that we’re in a depression because so much income and wealth has concentrated at the top that many players who would not otherwise be destitute are now involuntarily in need of help buying food.

[26] “Dwindling Deficit Disorder,” by Paul Krugman, The New York Times, March 10, 2013 (here).

[27] “The Big Shrug,” by Paul Krugman, The New York Times, June 9, 2013 (here). 

Economics has been under fire since the recent crisis for enshrining abstract models that offer little connection to the real world. In “Growth in a Time of Debt,” our data-intensive approach aims at providing stylised facts, well beyond selective anecdotal evidence, on the contemporaneous link between debt, growth, and inflation at a time in which the world['s] wealthiest economies are confronting a peacetime surge in public debt not seen since the Great Depression of 1930s and indeed virtually never in peacetime. As Paul Krugman (2009) observed, “they’ll (the economists) have to do their best to incorporate the realities of finance into macroeconomics.” One might add as a corollary, however, that such discipline is especially needed when those realities are inconvenient to strongly held opinions. – Carmen M. Reinhart and Kenneth Rogoff [1]

This lead-in quotation is from August of 2010, eight months after the authors released their study “Growth in a Time of Debt,” which by then had faced considerable scrutiny and criticism. With a touch of the customary defensiveness of academicians, it is an almost defiant promotion of statistical analysis. In the space of single paragraph, “stylized facts” are elevated to the status of “realities.”  Wikipedia defines a “stylized fact” as follows:

In social sciences, especially economics, a “stylized fact” is a simplified presentation of an empirical finding. A stylized fact is often a broad generalization that summarizes some complicated statistical calculations, which although essentially true may have inaccuracies in the detail. [2]

“Inaccuracies in the detail” can become a significant concern, which is exactly what happened recently (in April of 2013) when a graduate student and his faculty advisers published findings of statistical errors in this study, reinvigorating the controversy that had nearly faded away over the last two years.  But a stylized “fact” may suffer from more than just errors of detail: It may also also be so poorly constructed, oversimplified, or based on such a weak logical foundation, that it really is not essentially true. 

When the recent round of controversy surfaced last month, I knew it would be important to study the issues associated with “Growth in a Time of Debt,” especially since both growth and debt are centrally involved in the economics of inequality we’ve been discussing.  How a topic like this is vetted, both professionally and to the public, can tell us much about the enormous variety of ideas brought to bear in such controversies, and help illuminate the connection between “the real world” and “abstract models.” 

Reinhart/Rogoff  (2008-2009)

I began examining the more recent work of Reinhart and Rogoff looking for something called “Reinhart Rogoff 2008″ and although I have not pinned that reference down specifically, I did locate their 2009 book, This Time Is Different, and their March 2008 working paper entitled “This Time Is Different: A Panoramic View of Eight Centuries of Financial Crises.” [3]  At that point, Reinhart and Rogoff were working as economic historians, painstakingly gathering data and conducting detailed studies of the history of financial crises. Here is their description of the nature of this work and their conclusions:

This paper offers a detailed quantitative overview of the history of financial crises dating from the mid-fourteenth century default of Edward III of England to the present subprime crisis in the United States. Our study is based on a comprehensive new statistical dataset compiled by the authors that covers every region of the world and spans several centuries. Inevitably, a database of this scale and scope, involving so many primary and secondary historical sources (that do not always agree), will contain some errors and omissions, despite our best efforts* * *

Our principle aim here has been to illustrate some core features of this sweeping database, trying to bring out a few fundamental regularities. We are fully aware that, in such a broad synthesis, we are inevitably obscuring important nuances surrounding historically diverse episodes. With these caveats in mind, this “panoramic” quantitative overview has revealed a number of important facts. First and foremost, we illustrate the near universality of episodes of serial default and high inflation in emerging markets, extending to Asia, Africa, and until not so long ago, Europe. We show that global debt crises have often radiated from the center through commodity prices, capital flows, interest rates, and shocks to investor confidence. We also show that the popular notion that today’s emerging markets are breaking new ground in their extensive reliance on domestic debt markets, is hardly new.

This brings us to our central theme—the “this time is different syndrome.” There is a view today that both countries and creditors have learned from their mistakes. Thanks to better-informed macroeconomic policies and more discriminating lending practices, it is argued, the world is not likely to again see a major wave of defaults. Indeed, an often-cited reason these days why “this time it’s different” for the emerging markets is that governments there are relying more on domestic debt financing. Such celebration may be premature. Capital flow/default cycles have been around since at least 1800 — if not before. Technology has changed, the height of humans has changed, and fashions have changed. Yet the ability of governments and investors to delude themselves, giving rise to periodic bouts of euphoria that usually end in tears, seems to have remained a constant.  [4]

In effect, they argued, their study shows that economic history has consistently repeated itself, and that human behavior has not changed enough even in these modern times to produce a different result. Such findings are credible, certainly, and in the broader context of human history unsurprising.

“Growth in a Time of Debt” (2010-2011)

Importantly, with “Growth in a Time of Debt” (GITD) Reinhart and Rogoff veered away from economic history into an important area of theoretical macroeconomics. The “concluding remarks” in their report offers these as their principal findings:

Our main finding is that across both advanced countries and emerging markets, high debt/GDP levels (90 percent and above) are associated with notably lower growth outcomes. In addition, for emerging markets, there appears to be a more stringent threshold for total external debt/GDP (60 percent), that is also associated with adverse outcomes for growth. [5]

The main feature of GITD is its correlation of data over many years among groups of countries. It was the study of the United States, however, that attracted the most attention and generated the most controversy.  This  graph [6] shows their specific results for the United States:

For the United States, public debt/GDP ratios are not shown to vary significantly with inflation or the rate of growth except when they exceeded 90%. However, the debt/GDP ratios were very high (above 90%) during a period when GDP was declining, which also happened to be a period of high inflation.  In their August 11, 2010 report they emphasized, with reference to the entire reported group of advanced countries:

[I]t is evident that there is no obvious link between debt and growth until public debt exceeds the 90% threshold. (Original emphasis.) [7]

They clarified that for emerging markets, they found that “annual growth declines by about two percent” when gross external debt (public and private) reaches 60% of GDP, and that “for levels of external debt in excess of 90 percent of GDP, growth rates are roughly cut in half.” [8] However, they said that because of data limitations: “We are not in a position to calculate separate total external debt thresholds (as opposed to public debt thresholds) for advanced countries.”  And they added:

For the five countries with systemic financial crises (Iceland, Ireland, Spain, the United
Kingdom, and the United States), average debt levels are up by about 75 percent, well on track to reach or surpass the three year 86 percent benchmark that Reinhart and Rogoff (2009a,b) find for earlier deep post-war financial crises. [9]

“Surprisingly,” they reported, “the relationship between public debt and growth is remarkably similar across emerging markets and advanced economies.” Further, ”Our main result is that whereas the link between growth and debt seems relatively weak at ‘normal’ debt levels, median growth rates for countries with public debt over 90 percent of GDP are roughly one percent lower than otherwise; average (mean) growth rates are several percent lower.”  

Thus, with respect to public debt, for all studied countries they found no strong link between public debt and growth below the 90 percent debt/GDP ratio, and:

We find no systematic relationship between high debt levels and inflation for advanced economies as a group (albeit with individual country exceptions including the United States).  By contrast, inflation rates are markedly higher in emerging market countries with higher public debt levels. [10] 

My Review

WP15639

This report raised some of the major concerns that I occasionally encountered, during my career, in evaluating policy recommendations based on statistical analyses. The way Reinhard and Rogoff presented their case raised an initial red flag. They chose to emphasize up front that their approach is “decidedly empirical,” using “a broad new historical data set on public debt (in particular, central government debt)” to incorporate “data on forty-four countries spanning about two hundred years.” 

This emphasis on the empirical nature of their study and their use of “stylized facts” seemed to anticipate the kind of criticism their report would eventually receive. Anticipating criticism is important, but although the authors opened with a generalized promotion of empirical research, they did not follow that up with a rigorous, organized explanation of their results or theoretical justification for their conclusions.  

Most of the major issues in macroeconomics involve the determinants of growth, and there are many factors influencing growth, so for a high ratio of public debt to GDP to be the overriding factor in any set of circumstances, much less consistently so, is an unusual and seemingly far-fetched proposition.  Nonetheless, the authors provided only a couple of scattered references to possible explanations for a negative influence on growth of high levels of public debt; and there was no mention of potential offsetting positive influences of public debt on growth, such as government spending.  

Nor did the authors suggest how the use of centuries of historical data might help explain what is happening today. It seemed to me that, especially spanning all of these countries over all of these years and in all sorts of circumstances, some factor that made public debt the consistent enemy of growth would have to be identified before it could reasonably be hypothesized that the 90% debt/GDP ratio was a tipping point at which significantly lower growth consistently kicks in. With none identified, it was not surprising that the empirical analysis failed to detect the existence of any such factor at any debt/GDP ratios below 90%.  

It was surprising, therefore, to see these economists imply that such a factor exists without careful explanation. I looked for such an explanation in the section “Debt, Growth, and Inflation” [11] but found only an off-hand reference to a 1979 paper. The “simplest” connection between public debt and growth, they suggested, is found in “Robert Barro (1979)”:

Assuming taxes ultimately need to be raised to achieve debt sustainability, the distor- tionary impact . . . is likely to lower potential output. Of course, governments can also tighten by reducing spending, which can also be contractionary. [12]

This brief description of Barro’s thesis, if that’s what it is, is hazy at best: What, exactly do they mean by the terms “debt sustainability” and “distortionary impact”? The cited Barro study presents a complicated theory about choice between taxation and public borrowing that, I suggest, mere mortals should not be asked to try to wade through. [13] When articles like that are cited, even to other economists, plain-English explanations of any credible arguments are mandatory.

The authors did not begin discussing such core questions until they got to their “concluding remarks,” and the discussion there was less than reassuring:

Why are there thresholds in debt, and why 90 percent? This is an important question that merits further research, but we would speculate that the phenomenon is closely linked to logic underlying our earlier analysis of “debt intolerance” in Reinhart, Rogoff, and Savastano (2003). As we argued in that paper, debt thresholds are importantly country-specific and as such the four broad debt groupings presented here merit further sensitivity analysis. A general result of our “debt intolerance” analysis, however, highlights that as debt levels rise towards historical limits, risk premia begin to rise sharply, facing highly indebted governments with difficult tradeoffs. [14]

Thus, they said, they could not yet definitively answer such basic questions, but this brief discussion raised others: What might we learn from a further “sensitivity analysis” of their own self-generated “four broad debt groupings”? If debt thresholds are “importantly country-specific,” why did they base conclusions on a statistical analysis correlating data from 44 countries over two centuries?

More red flags popped up when I saw that the authors soon began to speculate publicly about the policy implications for the U.S. of findings that their study had failed to make:   

One need look no further than the stubbornly high unemployment rates in the US and other advanced economies to be convinced how important it is to develop a better understanding of the growth prospects for the decade ahead. We have presented evidence – in a multi-country sample spanning about two centuries – suggesting that high levels of debt dampen growth. One can argue that the U.S. can tolerate higher levels of debt than other countries without having its solvency called into question. That is probably so.  [15]

Thus, having raised in WP15639 (and elsewhere) the specter of rising “debt intolerance,” they then suggested here that the U.S. can probably tolerate higher levels of debt than other countries, but not without concern for the specter of “having its solvency called into question.” 

Frankly, I found the Reinhart/Rogoff presentation in WP15639, even when it does not digress into obscurantism or innuendo, too casual and rambling. My first impression was that the authors either believe the underlying economic explanations for their conclusions are so “obvious” or non-controversial as not to warrant elucidation, or they want to avoid discussing them. On further reflection, though, I found myself wondering why the authors considered a study this inconclusive to be worthy of publication.  

The AER Article    

Four months after WP15639 was published in January of 2010, Reinhart and Rogoff’s very similar article was published in the May issue of the American Economic Review. [16] Much of the language was identical, but the shift had focused: The graph and associated discussion of the isolated U.S. data, which was soon to be the subject of the EPI’s briefing paper (discussed next), was gone, and the paper now focused solely on the multi-country regression results.  The reference to “Robert Barro (1979)” was missing as well, and the uncertainty expressed in their first concluding remarks was removed.

The AER article detracted from their arguments about the United States, and failed to enhance their overall case about the relationship between public debt and growth. The explanation from WP15639 was repeated that they “will not attempt to determine the genesis of debt buildups but instead simply look at their connection to average and median growth and inflation outcomes.” [17]  They continued to concede that the genesis of buildups could be important:

In principle, the manner in which debt builds up can be important. For example, war debts are arguably less problematic for future growth and inflation than large debts that are accumulated in peacetime. Postwar growth tends to be high as wartime allocation of manpower and resources funnels to the civilian economy. Moreover, high wartime government spending, typically the cause of the debt buildup, comes to a natural close as peace returns. In contrast, a peacetime debt explosion often reflects unstable political economy dynamics that can persist for very long periods. [18]

Here, the authors simply gloss over the example of the United States, where the post-WW II debt was reduced and nearly eliminated over the period 1946-1980, when America’s “peacetime debt explosion” began. Nowhere have they offered any suggestion of what “unstable political economy dynamics” might have caused the run-up of $16 trillion of public debt in the U.S. over the past three decades.  Instead of coming to grips with that issue, they retreated into generalities, and elected to argue dubious claims about the correlation between annual public debt/GDP ratios and contemporaneous GDP over 200 years.  This posture, frankly, casts doubt on their objectivity.    

Summary

I’ll be polite: The Reinhart/Rogoff thesis concerning a causal relationship between public debt and growth is weakly supported, both factually and theoretically. They have awarded supreme value to econometric results and declined to try to account for factors they concede are important, such as the genesis of debt. That is not to say that extremely high levels of public or total debt do not present problems. However, in asserting that the 90% public debt/GDP ratio is a tipping point for declining growth, across emerging and advanced nations alike, these researchers invited criticism on several levels. 

The EPI Response 

The Reinhart/Rogoff August 11, 2010 paper “Debt and growth revisited” was posted two weeks after the Economics Policy Institute (EPI) published a briefing paper on GITD by John Irons and Josh Bivens, who noted that many had come to advocate deep cuts in federal spending to keep the debt-to-GDP ratio from reaching the alleged 90% threshold. Irons and Bivens maintained, however, that the GITD approach and findings contained “several theoretical and empirical flaws. . . , especially as they relate to the U.S. economy,” and they concluded that “the GITD ’90% threshold’ for gross government debt should not be used as a guide for U.S. fiscal policy, as both the theory and the data in the paper rest on exceptionally shaky foundations.” [19] These were their main concerns: 

1. GITD makes no allowance for a more complicated dynamic relation between growth and debt, and there “is no compelling theoretical reason why the stock of debt at a given point in time should harm contemporaneous economic growth”;

2. The empirical findings are not likely to be relevant to today’s U.S. economy. “In particular, the United States economy has only exceeded the 90% threshold in six of the 218 years examined in the GITD paper, and these six years are constituted by a single consecutive time-span in the 1940s dominated by the defense buildup and subsequent demobilization around World War II”;

3. No evidence on causality is given, and “contemporaneous causality is more likely to run in the opposite direction, that is, “from slow growth to high debt levels”;

4. The GITD paper “is only able to base its conclusion on an analysis of gross debt rather than the more appropriate measure, public debt. The debt that is economically relevant is the debt held by public [i.e., excluding "intra-governmental holdings"].

The authors presented the following diagram plotting U.S. growth and debt levels taken from the GITD database to illustrate the second point.  They argue that the incidences of decline occurred in the 1945-1947 period, when there was an “historically unprecedented withdrawal of government spending.”  [20]

At about this time, Howard Baker of the Center for Economic and Policy Research (CEPR) presented a different argument relating to the “more complicated dynamic relation between growth and debt”: 

In many of the cases, such as Japan and Italy in recent years, the high debt countries are also countries with little or no population growth. This means that we would expect a slower rate of GDP growth, other things equal. While there is undoubtedly some endogeneity to population growth (e.g. higher GDP growth leads to more immigration), we should still expect the benefits of growth to show up in higher per capita income.  [21]

Because the GITD study involved contemporaneous observations of public debt/GDP ratios and growth rates, going back 200 years, this point related mainly to Irons and Bivens’s first concern; we are reminded of the limitations of static “stylized facts.”    

The Conservative Reaction 

As we noted, conservatives have seized on GITD as support for reducing budget deficits and cutting government spending. U.S. Representative Paul Ryan, for example, advanced this argument in both the FY 2012 and FY 2013 House Budget Resolutions: 

The economic effects of a debt crisis on the United States would be far worse than what the nation experienced during the financial crisis of 2008. * * * Absent a  bailout, the only solutions to a debt crisis would be truly painful: massive tax increases, sudden and disruptive cuts to vital programs, runaway inflation, or all three. * * * Even if high debt did not cause a crisis, the nation would be in for a long and grinding period of economic decline. A well known study completed by economists Ken Rogoff and Carmen Reinhart confirms this common sense conclusion.

The study found conclusive empirical evidence that gross debt (meaning all debt that a government owes, including Debt held in government trust funds) exceeding 90 percent of the economy has a significant negative effect on economic growth. This is bad news for the United States, where gross debt exceeded 100 percent of GDP last year. The study looked specifically at the United States, focusing on growth and inflation relative to past periods when this Nation has experienced high debt levels. Not only is average economic growth dramatically lower when gross U.S. debt  exceeds 90 percent of the economy, but also inflation becomes a problem.

Essentially, the study confirmed that massive debts of the kind the nation is on track to accumulate are associated with “stagflation” (– a toxic mix of economic stagnation and rising inflation.) [22] 

This argument has considerable superficial appeal, but it has two big problems:

1. Ryan has exaggerated the import of the Reinhart/Rogoff findings, as discussed. Again, the two researchers themselves could not claim to have found “conclusive” evidence linking public debt to growth, because they could only “speculate” as to the explanation for their empirical results;

2. Ryan himself has proposed a controversial “austerity” budget which, because  ”trickle-down economics” is nonsense, would far more severely restrict growth, rendering this debate about public debt levels moot.

I will return to the disproof of the trickle-down fantasy in the next post, where I will recap  the thorough explanation included in my recent post “Amygdalas Economicus: Perspectives on Taxation” (here). The point here is that the damage to growth of severe “austerity” cuts in government programs ensures even less government revenue in the future, actually increasing the debt-to-GDP ratio (both by reducing GDP and by increasing debt).  

Importantly, the Ryan argument that growth is reduced if the budget is not slashed is circular, because GITD relied mainly (as expressed in the oblique reference to “Barro (1979)”) on the prospect of just such austerity budgeting as its argument that higher debt/GDP ratios reduce growth. [23] We are treated here to “economics” chasing its own tail — but that’s the only recourse when your own underlying theory of economics is illogical and false.

The argument in the House Budget Resolution is, moreover, disingenuous on its face: Massive spending cuts and massive tax increases, along with the prospect of “runaway inflation” are Paul Ryan’s complete list of the tragic consequences of a “debt crisis.” But his budget proposals already include massive spending cuts, along with additional tax reductions for corporations and the wealthy (a top rate of 25% instead of the current 40%), making any “debt crisis” a crisis for the bottom 99%. Paul Ryan’s reference to GITD is merely a scapegoat for austerity. The ”Blueprint for American Renewal” is an illusion, and even Paul Ryan can see that he isn’t offering the bottom 99% a “path to prosperity.”     

“Growth in a Time of Debt” (2013)

Into this world of massive befuddlement, along came Herndon, Ash and Pollin two months ago to inform us that Reinhart and Rogoff had made mistakes that led to the incorrect econometric conclusions; their own data do not even suggest a material decline in growth at high levels of public debt. [24] Citing instances of its impact, including on the House Budget Committee arguments just discussed, these authors noted the enormous influence that GITD has had on public policy in the U.S. and around the world:

RR have clearly exerted a major influence in recent years on public policy debates over
the management of government debt and social policy more broadly. Their findings have provided significant support for the austerity agenda that has been ascendant in Europe and the United States since 2010. [25]

For the sake of argument, they accepted the premise that causation runs from the level of public debt to growth, not the other way around.  However, they maintained:

A necessary condition for a stylized fact is accuracy. We replicate RR and find that coding errors, selective exclusion of available data, and unconventional weighting of summary statistics lead to serious errors that inaccurately represent the relationship between public debt and growth among these 20 advanced economies in the post-war period. Our most basic finding is that when properly calculated, the average real GDP growth rate for countries carrying a public debt-to-GDP ratio of over 90 percent is actually 2.2 percent, not 0.1 percent as RR claims. That is, contrary to RR, average GDP growth at public debt/GDP ratios over 90 percent is not dramatically different than when public debt/GDP ratios are lower. 

We additionally refute the RR evidence for an “historical boundary” around public debt/GDP of 90 percent, above which growth is substantively and non-linearly reduced. In fact, there is a major non-linearity in the relationship between public debt and GDP growth, but that non-linearity is between the lowest two public debt/GDP categories, 0-30 percent and 30-60 percent, a range that is not relevant to current policy debate. [26]

Obviously, this was a major development.  On April 16, 2013, Reinhart and Rogoff responded in the Wall Street Journal:

We literally just received this draft comment, and will review it in due course. On a cursory look, it seems that Herndon Ash and Pollen also find lower growth when debt is over 90% (they find 0-30 debt/GDP, 4.2% growth; 30-60, 3.1 %; 60-90, 3.2%; 90-120, 2.4%; and over 120, 1.6%). These results are, in fact, of a similar order of magnitude to the detailed country by country results we present in table 1 of the AER paper, and to the median results in Figure 2. And they are similar to estimates in much of the large and growing literature, including our own attached August 2012 Journal of Economic Perspectives paper (joint with Vincent Reinhart). However, these strong similarities are not what these authors choose to emphasize. * * *

The 2012 JEP paper largely anticipates and addresses any concerns about aggregation (the main bone of contention here), The JEP paper not only provides individual country averages (as we already featured in Table 1 of the 2010 AER paper) but it goes further and provide episode by episode averages. Not surprisingly, the results are broadly similar to our original 2010 AER table 1 averages and to the median results that also figure prominently. It is hard to see how one can interpret these tables and individual country results as showing that public debt overhang over 90% is clearly benign. [27]

On April 29, Ash and Pollin in a New York Times Oped, discussed their report (co-written with graduate student Thomas Herndon) and the Reinhart/Rogoff response to it:    

We identified a spreadsheet coding error — which Ms. Reinhart and Mr. Rogoff promptly acknowledged — that affected their calculations of growth rates for big economies since World War II. We also asserted that the two of them erred by omitting some data and improperly weighting other statistics. In an Op-Ed essay and appendix last week, Ms. Reinhart and Mr. Rogoff denied those accusations.

They referred to this debate as an “academic kerfuffle,” but we believe the debate has been constructive, because it has brought greater clarity over the ideas shaping austerity policies in both the United States and Europe.

The most important insight for anyone following this debate, and one that Ms. Reinhart and Mr. Rogoff acknowledge, is that there is no evidence supporting the claim that countries will consistently experience a sharp decline in economic growth once public debt levels exceed 90 percent of G.D.P. Although the two of them partly backed away from that claim in a 2012 paper in The Journal of Economic Perspectives, they have now done so more definitively, saying the 90 percent figure is not “a magic threshold that transforms outcomes, as conservative politicians have suggested.”

However, Ms. Reinhart and Mr. Rogoff stubbornly maintain that “growth is about 1 percentage point lower when debt is 90 percent or more of gross domestic product,” a core finding of their 2010 paper.

There are serious problems with this claim. The most obvious is that the median growth figures they reported in the 2010 paper are distorted by the same coding error and partial exclusion of data from Australia, Canada and New Zealand that tainted their average growth figures. When we corrected for these errors, the difference in median economic growth rates was only 0.4 percentage points between countries whose public-debt-to-G.D.P. ratio was between 60 percent and 90 percent, and those where the ratio was over 90 percent (2.9 percent median growth, versus 2.5 percent). The difference between 0.4 percent and 1 percent is quite substantial when we’re talking about national economic growth. [28]

 What All This Means

This post has reviewed the theoretical and factual inadequacies of Reinhart and Rogoff’s original 2010 presentation, first from the standpoint of my findings about their own failure to make a case for or develop a compelling framework for their thesis, and second from the standpoint of specific additional and overlapping criticisms raised by Irons and Bivens of EPI. Following that, we reviewed the separate, independent claim by Herndon, Ash and Pollin that statistical and factual errors called into serious question the numerical bases for their conclusions.  

We should be prepared for this debate to continue for some time. I submit that this “kerfuffle” cannot be resolved within the economic framework specified for the debate. One thing you will notice is that the entire debate, just as did the entire entire Keynes-Hayek debate 80 years ago, takes place in the arena of the “neoclassical paradigm” described by Polly Cleveland, as discussed in the previous post. Once we begin to appreciate the macroeconomic significance of income and wealth redistribution, however, everything changes, including the nature of this debate.  

In the “neoclassical arena” the only reference to income and wealth distribution we have seen in this debate has been the qualitative observation that “austerity” helps the rich get richer; but that figures into the debate mostly as a coincidence — “by the way, when we do austerity budgeting, the rich get richer” — and only occasionally as the motive for promoting the trickle-down ideology as legitimate economic theory, for obvious political reasons. This steers the debate in the wrong direction: Unfortunately, ignoring the consequences of redistribution — as all these economists on both sides of the Reinhart/Rogoff debate do — makes economic theory ineffectual in resolving major questions like the impact of public debt on growth.

There is nothing wrong with the neoclassical case against trickle-down, as far as it goes, but it does not go far enough.  We can’t deal with the effect of public debt on growth until we properly understand how it affects growth: Notwithstanding the concerns of Reinhart, Rogoff and others about how large amounts of public debt might impact financial markets in extremis, we will get nowhere until we understand that: (1) increasing inequality curtails economic growth; (2) inequality growth is controlled by progressive taxation; and (3) America’s public debt has been raised to finance lower taxation of top incomes and, accordingly, resulted in greater inequality.  Thus, high levels of public debt in America (and presumably elsewhere) do indeed reduce growth.

What this means, however, is exactly the opposite of what Paul Ryan says it means. Paul Ryan is offering America a “double whammy” — reduced growth through increasingly regressive federal taxation, and reduced growth through further reductions in government spending.  Insufficiently progressive taxation has already reduced growth substantially and led the United States into a depression.  Thus, the Ryan plan is literally a death sentence for the American economy.  To appreciate this, however, we must stop debating in the neoclassical arena.  Even if we could do it, the answer is not to borrow more money.  There is only one correct answer, and that is more progressive taxation.  We have to tax the rich.

The Reinhart/Rogoff kerfuffle is such an effective device for demonstrating these points that I will devote another post to it before turning to further refinement of the basic concepts established in posts 1-7 of this series. 

JMH – 6/5/2013 (edited 6/6/2013)

[1] “Debt and Growth Revisited,” by Carmen M. Reinhart and Kenneth Rogoff, VOX, August 11, 2010 (here).

[2] “Stylized fact,” Wikipedia (here).

[3] Karmen M. Reinhart and Kenneth S. Rogoff, This Time Is Different: Eight Centuries of Financial Folly, Princeton University Press, 2009 (here), a book translated into 20 languages; “This Time Is Different: A Panoramic View of Eight Centuries of Financial Crises,” by Reinhart and Rogoff, National Bureau of Economic Research, NBER WP13882, March 2008 (here).

[4] WP13882, pp. 51-53.

[5] “Growth in a Time of Debt,” by Carmen M. Reinhart and Kenneth Rogoff, National Bureau of Economic Research (NBER), WP15639, January 2010 (here), pp. 22-23.

[6] Id. at 10.

[7] “Debt and Growth Revisited,” supra.

[8] WP15639, p. 3.

[9] Id. at 4.

[10] Id. at 2-3. 

[11] Id. at 6.

[12] The reference appears to be to “On the Determination of the Public Debt,” by Robert J. Barro, Journal of Political Economy, University of Chicago Press, 1979 (here), Harvard DASH download (here).

[13] Here’s the basic description by Barro of his work: “This paper develops a simple theory of ‘optimal’ public finance that identifies some factors that would influence the choice between taxes and debt issue. The model accepts the Ricardian invariance theorem as a valid first-order proposition but introduces some second-order considerations involving the “excess burden” of taxation to obtain a determinate (optimal) amount of debt creation. It should be stressed that some typical features of public debt analysis, such as shifting of the tax burden to future generations, crowding out of private investment, etc., are excluded by the assumption that the Ricardian proposition is valid on the first order” (p. 941).

[14] WP15639, supra, p. 23.

[15] “Debt and Growth Revisited,” supra.

[16] “Growth in a Time of Debt,” by Carmen M. Reinhart and Kenneth S. Rogoff, American Economic Review, Papers & Proceedings (100), May 2010, pp. 573-578.  

[17] Id. at 574.

[18] Ibid.

[19] “Government Debt and Economic Growth: Overreaching Claims of Debt ‘Threshold’ Suffer from Theoretical and Empirical Flaws,” by John Irons and Josh Bivens, Economic Policy Institute, Briefing Paper #271, July 26, 2010, pp. 1-2 (here).

[20] Id. at 1-2, 4-5, 7.

[21] “Debt and GDP Growth: Reinhart and Rogoff, One More Time,” by Dean Baker, Center for Economic and Policy Research (CEPR), July 30, 2010 (here).

[22] “The Path to Prosperity: A Blueprint for American Renewal,” by Paul Ryan, FY 2013 House Budget Resolution, p. 80 (here) (Emphasis added); ”The path to Prosperity: Restoring America’s Promise,” by Paul Ryan, FY 2012 House Budget Resolution, p. 21 (here).

[23] WP15639, supra, p. 6.

[24] “Does High Public Debt Consistently Stifle Economic Growth? A Critique of Reinhart and Rogoff,” by Thomas Herndon, Michael Ash, and Robert Pollin, Political Economy Research Institute (PERI), U. Mass. Amherst, April 2013 (here).

[25] Id. at p. 4.

[26] Id. at pp. 2-3.

[27] “Reinhart-Rogoff Response to Critique,” Real Time Economics, The Wall Street Journal, April 16, 2013 (here).

[28] “Debt and Growth: A Response to Reinhart and Rogoff,” by Robert Pollin and Michael Ash, The New York Times, April 29, 2013 (here).

During the Great Depression, to his credit, Keynes bucked his colleagues by claiming that government spending could revive a depressed economy. But, caught in the neoclassical paradigm, he got the mechanism wrong. Keynes argued, as does Krugman today, that the problem is a lack of consumer demand. Consumers want to save instead of spend. Lacking demand, businesses won’t invest. So there’s a “savings glut” or “liquidity trap” — billions in cash sloshing around seeking in vain for investment opportunities. The solution: government should borrow some of that loose cash and spend it, no matter on what: war, high-speed rail, fixing potholes, or education. Deficits be damned.

In my view, we don’t have a “liquidity trap”; we have an “inequality trap.” What’s that? An “inequality trap” happens in a downturn, when the One Percent, big corporations and banks hoard cash, starving small businesses for capital. The greater the inequality and deeper the downturn, the tighter the trap. [1] – Mary (Polly) Cleveland

Robert Reich’s book “Aftershock” reminded me that a market economy is a machine, and that the discipline of “economics” is supposed to explain how the machine works. When the operation of the machine is poorly understood, or completely misunderstood, the translation of economics into coherent government policy becomes confusing and convoluted.

Reich related the story of how Marriner Eccles, a wealthy industrialist and banker, had become Roosevelt’s Secretary of the Treasury and helped to guide the U.S. economy out of the Great Depression. [2] From his career and from the Great Depression, Eccles had gained some valuable insights:

When Eccles’s anxious bank depositors began demanding their money, he called in loans and reduced credit in order to shore up the banks’ reserves. But the reduced lending caused further economic harm. Small businesses couldn’t get the loans they needed to stay alive. In spite of his actions, Eccles had nagging concerns that by tightening credit instead of easing it, he and other bankers were saving their banks at the expense of the community — in “seeking individual salvation we were contributing to collective ruin.”

Economists and the leaders of business and Wall Street — including financier Bernard Baruch; W.W. Atterbury, president of the Pennsylvania Railroad; and Myron Taylor, Chairman of the United States Steel Corporation — sought to reassure the country that the economy would correct itself automatically, and that the government’s only responsibility was to balance the federal budget. Lower prices and interest rates, they said, would inevitably “lure ‘natural new investments’ by men who still had money and credit and whose revived activity would produce an upswing in the economy.” Entrepreneurs would put their money into new technologies that would lead the way to prosperity. But Eccles wondered why anyone would invest when the economy was so severely disabled. Such investments, he reasoned, “take place in a climate of high prosperity, when the purchasing power of the masses increases their demands for a higher standard of living and enables them to purchase more than their bare wants. . .”

In questioning the standard arguments of the “free market” crowd, which remain the same today despite a different environment for innovation and change, Eccles had anticipated the basis of Keynesian economics.  The truth was, and still is, that government action is needed to lift an economy out of a depression.

The Keynesian Playbook

Keynes’s ideas for how to revive a recessed or depressed economy are pretty straight-forward. Any student emerging from a college course in introductory economics or macroeconomics should have something like this summary of the Keynesian playbook in mind:

1. Monetary policy: Through various measures to control the money supply and the interest charged to private banks, the (private) Federal Reserve System can influence the interest rates charged the public on loans for investment or consumption. High interest rates discourage borrowing and growth, and low interest rates encourage borrowing and growth;

2. Fiscal policy: When monetary policy is insufficient to maintain full employment, the central government can borrow money and inject it directly into the economy through government spending. Such “deficit spending,” called “stimulus,” is a conscious effort by government to increase economic activity and incomes.  ”[E]ven if you don’t believe that stimulus is forever,” Paul Krugman recently reminded us, “Keynesian economics says not just that you should run deficits in bad times, but that you should pay down debt in good times.” [3]

The Keynesian playbook envisions a roughly balanced federal budget over time; borrow when you must, and pay it back when you can.  The first thing I noticed when I started earnestly studying the inequality problem, however, was that over nearly the entire period of inequality growth since 1980 our federal government has borrowed tons of money (the national debt now totals nearly $16.8 trillion) without paying it back. [4] That’s nearly one year’s GDP. [5] Shouldn’t that have been considerably more than enough to stimulate the economy back to full employment? In fact, shouldn’t such a huge expansion of the money supply have resulted in a devastating inflationary spiral? Why, instead, has there been no inflationary spiral, and why are we in a depression? When these questions hit home, I set out to answer them: The explanation, logic insisted, had to be related to inequality growth.

The Keynesian Mistake 

With apologies for the redundancy we would not need in a single text, let’s review some key points established in prior posts in this series: Keynes’s General Theory is a “full-employment” model, built around investment and consumption, that failed to take into account the distribution of wealth and incomes. Keynes correctly understood that market economies are inherently unstable, and are not self-correcting, and he established that stimulating demand will counter unemployment, improving income and growth.

He ignored, however, potential changes in income and wealth distribution, and a major factor about which Henry George, during the previous depression, had given a great deal of thought: economic rent. Keynes expressly assumed that income at full employment implied full production, i.e., optimal resource utilization, because he believed that “the volume of employment” and “the quantity of effort currently devoted to production” are “almost the same thing” (post 1, note 6). However, some incomes can increase dramatically with little or no change in production — just ask a successful hedge fund manager — and when they do, income is automatically redistributed up, and inequality grows. 

All such “unearned income” is misleadingly reported as “GDP,” so aggregate GDP, the measure of reported income, is not equivalent to aggregate production as Keynes had assumed.  Apparent income growth does not equal real income growth. Rather:

Real income  =  Apparent income  -  Redistributed rent

∆ Real income  =  ∆ Apparent income  -  ∆ Redistributed rent

This difference between apparent and real income represents the difference between prosperity and poverty, as Henry George first perceived 135 years ago.

Joseph Stiglitz now argues that such excess earnings pervade the economy, and Mason Gaffney’s core thesis is that “the structural flaw in capitalism is our tolerance of unearned income and wealth” (post 4). Even Keynes himself intuitively endorsed that understanding when he said of the “inequitable” distribution of his day: “Much lower stakes will serve the purpose equally well, as soon as the players are used to them” (post 4, note 7). In other words, economies can function optimally without nearly as much inequality. Missing from that thought, however, is that optimizing growth and prosperity — indeed economic survival — requires much less inequality.

A Two-Economy Perspective

A “two-economy” perspective is needed to grasp this important fact. Again, that growing income inequality causes reduced growth and economic stagnation is something that could not have been understood, and with a few exceptions including Simon Kuznets in the 1950s had not even been suspected, until reliable long-range distributed income data became available. Two separate segments of the economy must be conceptualized along inequality lines, and I have been referring to these two segments as “the top 1%’s economy” and “the bottom 99%’s economy.” An even better conceptual dividing line today appears to be between the “top 0.1%’s economy” and the “bottom 99.9%’s economy.” Either will suffice for conceptual purposes.    

Conceptually, the two segments function differently.  Returns on investments, and profits (economic rents), are in the top portion, and the bottom portion consists of labor incomes and consumption. [6] Of course, in any economy everyone participates in consumption and many individuals receive more than one type of income. The important distinction between the two segments is that individuals near the bottom of the income ladder receive almost entirely labor income, and consume all or nearly all of it, often accumulating debt and establishing negative net worth.

Looking at the economy in this segmented fashion allows an immediate appreciation of the main macroeconomic mechanism of inequality growth.  Keynes’s model led us astray because aggregate consumption is not independent of income distribution: As income concentrates more and more in the top 1%’s economy aggregate consumption, and consequently aggregate income growth, declines sharply. I have found only a handful of studies of the propensity to consume out of very high incomes, and more such study is needed.  At the bottom end of the spectrum, roughly the bottom 90% of income earners on average spend all of their incomes, and then some. The important point is that the aggregate ”marginal propensity to consume” is useless, for it masks the decline in aggregate income growth caused by growing income inequality; it hides income redistribution.  

Here again is the table of Census Bureau data from our discussion of the impact of growing income inequality on overall GDP growth in the third post in this series (here):

U.S. average annual real income growth

                                        1947 to 1979                1979 to 2010

Lowest fifth                     2.5%                                -0.4%

2nd fifth                           2.2%                                  0.1%

Mid fifth                           2.4%                                  0.3%

4th fifth                             2.4%                                  0.6%

Top 5th                             2.2%                                   1.2%

The table shows that the income inequality growth that began during the Reagan administration resulted not only in an unequal distribution of income growth, but also in considerably less total growth for everyone.  There is exponentially more growth, moving up through the top quintile, and as discussed above, much of the growth high in the top fifth was not even real growth, but “profit” (economic rent) instead. The latest data from Piketty and Saez show that no growth has taken place since 2008 below the top 1%, which implies that this trend is not only continuing but accelerating.

One point is now crystal clear: The “supply-side” a.k.a. “trickle-down” notion that making the rich richer boosts the economy is not even close to the truth. The truth, instead, is diametrically the opposite, that as the very rich get richer everybody else (not just the poor) get poorer. The effect of the very rich getting increasingly richer is what we should expect, when we think it through: The active money supply and the bottom 99%’s real economy are increasingly constricted.

Two related points are equally important: Keynes had accurately perceived that any decline in consumption will have a stagnating effect. But, unlike a drop in the propensity to consume out of current income, which was the focus of his General Theory, income redistribution involves longer-term, real structural changes in an economy — jobs, businesses, wage and salary levels, etc., are changed: (1) As these changes get built into the structure of the economy, they become harder to reverse; it’s a far more serious problem than just affecting consumer and investor “confidence;” (2) Unlike the propensity to consume, income inequality is not bounded by the current level of aggregate income; lower consumption out of a given aggregate income results, in the first instance, in increased saving, but income inequality can keep growing and reducing aggregate income indefinitely, until nearly everyone is broke.  (The economy collapses completely, of course, as the Gini coefficient [7] approaches 1.)

Thus, a trend of growing income inequality reduces growth far more substantially than would any change in the propensity to consume, making market economies vastly more unstable than Keynes had thought or than he reflected in his model. Paul Krugman correctly reports: “The disastrous turn toward austerity has destroyed millions of jobs and ruined many lives.” [8] He has yet to account, however, for the underlying reason austerity is so destructive today.

This gets us back to Polly Cleveland’s observation from the opening quotation: “Keynes argued, as does Krugman today, that the problem is a lack of consumer demand. Consumers want to save instead of spend.” But inequality growth requires reduced consumption even when consumers do not want to reduce spending. This is where the “two economy” perspective is needed: Consumers in the top 1% economy want to save most of their rapidly increasing incomes because they neither need nor want to spend very much of it. Correspondingly, the fact that people in the bottom 99%’s economy are losing their jobs and incomes is not because they have collectively decided to spend less, but because they have less money to spend (and are compensating by running up household debt). So demand has fallen and saving has gone up, but not because anyone has made a conscious decision to reduce spending and consumption.  The answer therefore is not to try to stimulate consumption and investment; the answer is to reverse inequality growth. 

Conflation

Inflation is an increase in prices for goods and services and a decline in the value of money. Arguments about the causes and effects of inflation have dominated economic debates since Keynes started thinking in macroeconomic terms. One thing is certain: higher prices (all else equal) requires an increase in the money supply.  Keynesian monetary and fiscal policies both involve expanding the money supply, and injecting more money into circulation.  The ultimate question is how much of this stimulation an economy can absorb before real growth lags behind increases in the money supply, and prices start rising.

That issue suffused the famous debate between Keynes and the Austrian economist Friedrich Hayek, back in the 1930s.  Nicholas Wapshott’s 2012 book Keynes Hayek: The Clash That Defined Modern Economics [9] is a fascinating account of the “Great Debate” which, in its early years, was highly contentious as each professed the deep failings of their adversary’s communication and comprehension skills (among other things). Similar exchanges between Hayek and Keynes’s bannerman, the Italian economist Piero Sraffa, even seemed incomprehensible to many of their contemporary economists. [10] When the dust had settled, it appeared the Great Debate was over two ultimately very different approaches to developing economic theories:

Hayek was convinced that the economy as a whole was an elusive subject that could only be understood, and even then only partially, by considering the interaction of individuals in the marketplace. Keynes, however, was in the process of making a breakthrough in thinking that would emerge only on publication of The General Theory. He believed an economy could best be understood by grasping the big picture, looking from the top down at aggregates of such elements of the economy as supply, demand, and interest rates. Hayek was stuck in what came to be known as “microeconomic” thinking, looking at the different elements such as costs and value that made up an economy, while Keynes was making the leap to a new way of considering the working of the economy: macroeconomics, which appraised the economy as a whole. It is little wonder that the arguments between Keynes and Hayek before The General Theory was published settled so little. . . [11]

Some remnants of static microeconomic thinking, such as “equilibrium” concepts and the false idea that economies are self-correcting, survive today in macroeconomics. The question of the inflationary impacts of monetary expansion is relatively easier to resolve. Following in Hayek’s footsteps, Milton Friedman put it this way:

Just as an excessive increase in the quantity of money is the one and only important cause of inflation, so a reduction of the rate of monetary growth is the one and only cure for inflation.  The problem is not one of knowing what to do.  That is easy enough. Government must increase the quantity of money less rapidly. [12]

That seems unexceptionable; but less rapidly than what? Modern Keynesians, like James Tobin, appear to have been more certain of the need for government intervention to counter natural decline than conservative economists like Friedman, whose bias against government participation in the economy led him to oppose fiscal policy altogether, and to insist that economies are self-correcting.  

But here’s the rub:  The debate between the Chicago School and Keynesians today, as was the Great Debate between Keynes and Hayek in the 1930s, is “caught in the Neoclassical paradigm,” as Polly Cleveland puts it.  The entire debate is beside the point, because it overlooks the redistribution of wealth and incomes. Assuming a constant, unchanging distribution of wealth and incomes, both sides assume that a steady, base-level demand will already be in place to naturally support price increases when fiscal or monetary policy expand the money supply. But with growing inequality, the air has already leaked out of that balloon, and any stimulus from deficit spending can, at best, only slightly temper the growing decline.  There is no prospect of inflation.

So the problem is not inflation — it’s conflation:  That is a term that came to me as I was thinking about the intersection of the contraction of the active bottom 99% economy caused by growing income inequality with the inflation created by expansion of the money supply through fiscal or monetary policies.  Here’s my definition:

“Conflation” n. - A circumstance in which monetary inflation caused by an expansion of the money supply is offset by a constriction of the active economy through massive income and wealth redistribution.

Coincidentally, “conflation” is already a word, with meanings that are not inapt here: According to on-line Merriam-Webster, it refers to a “bringing together” or “melding,” a “fusion,” or “amalgamation;” and yes, “confusion.” 

Let’s take a for instance. Paul Krugman recently wrote:

Ever since the financial crisis struck, and the Federal Reserve began “printing money” in an attempt to contain the damage, there have been dire warnings about inflation — and not just from the Ron Paul/Glenn Beck types.  Thus, in 2009, the influential conservative monetary economist Allan Meltzer warned that we would soon become “inflation nation.” * * * And now, sure enough, the Fed really is worried about inflation.

You see, it’s getting too low. * * *

It’s not hard to see where inflation fears were coming from. In its efforts to prop up the economy, the Fed has bought more than $2 trillion of stuff — private debts, housing agency debts, government bonds. It has paid for these purchases by crediting funds to the reserves of private banks, which isn’t exactly printing money, but is close enough for government work. Here comes hyperinflation!

Or, actually, not. From the beginning, it was or at least should have been obvious that the financial crisis had plunged us into a “liquidity trap,” a situation in which many people figure that they might just as well sit on cash. America spent most of the 1930s in a liquidity trap; Japan has been in one since the mid-1990s. And we’re in one now.

Economists who had studied such traps — a group that included Ben Bernanke and, well, me — knew that some of the usual rules of economics are in abeyance as long as the trap lasts. Budget deficits, for example, don’t drive up interest rates; printing money isn’t inflationary; slashing government spending has really destructive effects on incomes and employment. [13]

But we have to ask: How could inflation be getting too low while the Fed and Ben Bernanke are, well, spending like a fleet of drunken sailors? Are “the usual rules of economics” suddenly in abeyance, or have they been trumped by the impact of redistribution?  Isn’t all that money, somehow, getting hung up in the top 1%’s economy, not finding its way into active circulation?  And these questions as well: Doesn’t the data really mean that conflation is shrinking the active money supply faster than actions by the Fed can grow it? Isn’t Paul Krugman’s “liquidity trap” really an “inequality trap”?

The Inequality Trap

It’s no surprise that monetary policy won’t work in these circumstances. Polly Cleveland has it right: There just is not enough prospective return for corporations to invest in more production, or for banks to lend money for such investments — so they hoard cash, just as Eccles said the banks did during the Great Depression:

The multinationals are indeed awash in cash. In an article appropriately titled, “Dead Money,” The Economist reports how major corporations trim real investment — such as new technology — while piling up cash. For example, firms in the S&P 500 held about $900 billion in cash at the end of June, up 40 percent from 2008. The Economist dismisses the conservative claim that “meddlesome federal regulations and America’s high corporate-tax rate is locking up cash and depressing investment.” Why? All big multinational firms have been hoarding cash, not just U.S. – based ones; it’s been a growing trend since the 1970s.

The big banks are also awash in cash. For example, JP Morgan’s September 2012 balance sheet shows that out of $2,321 billion in assets, JP Morgan holds $887 billion in “Cash and Short-Term Investments” — over a third! [14]

Cleveland posits that Keynes got the mechanism wrong: “Keynes argued, as does Krugman today, that the problem is a lack of consumer demand. Consumers want to save instead of spend.” I have no wish to quibble over semantics, but Keynes was correct that reduced “demand” causes the problem of decay and instability; we might even say that declining consumption is the instability problem; being in a depression means that most people just don’t have enough money any more. But Cleveland is absolutely correct that the mechanism for recovery from an inequality trap is not to try to stimulate more demand; the real “demand” never left the bottom 99%’s economy, only the money did. Hence the cure requires reducing inequality itself: That is the point Keynes overlooked, and Krugman has yet to recognize; and that is the salient point here.  

After all, what Cleveland has described is exactly the description of a liquidity trap; but it’s a question of degree. Think of the “inequality trap” as a monster liquidity trap: When the bottom 99%’s economy is rapidly shrinking from inequality growth, there is far less reason for capitalists to invest in producing things for consumers to buy — they’ve already taken too much money, and what they’ve left behind for the bottom 99% to function with can’t even support the current prices. Conflation is deflationary, but instead of prices falling, inequality grows.

Put most simply and directly, the top 0.1% is systematically removing the money supply from the bottom 99.9%’s economy, and the result is hundreds of billions of excess dollars “sloshing around” at the top with no apparent place to go.  

I’m running out of polite ways to say this: Growing inequality depresses growth. Because, as Krugman does point out, liquidity traps only occur in a depression, and because depressions are the natural result of the concentration of income and wealth at the top, any liquidity trap is an inequality trap.  So I’d like to stop mincing words from here on out: Cleveland’s term “inequality trap” is such an exquisitely accurate term for what is really going on, I suggest we use it, and drop the term “liquidity trap” entirely.

Cleveland has reached the same major conclusions I have reached, among them: “An ‘inequality trap’ requires different measures from a ‘liquidity trap.’ It requires raising taxes on the One Percent and the big corporations — instead of borrowing from them and running up the deficit.” And, moreover: “Today’s depression is a small business depression.” In a more recent post, she emphasizes that inequality growth is responsible for the decline of middle class investment:

Joseph Stiglitz says that “Inequality is Holding Back the Recovery“. He’s right, but he gives the wrong reason, that “our middle class is too weak to support the consumer spending that has historically driven our economic growth.” * * * The real reason inequality stalls the economy is that natural resources and capital are monopolized at the top, kept away from the middle class that could invest them far more productively. * * * In my view, it is not the loss of middle class spending that holds back the economy; it is the loss of middle class investment. [15]

The CBO income inequality analysis confirms that small businesses are being absorbed by the top 1% at an alarming rate.  I would not put it the way Cleveland has, however: The loss of middle class spending does hold back the economy; declining consumption is the engine underlying the spiral of declining income and growing inequality. The argument we must press with mainstream Keynesians is that the middle class has not decided to spend less, it has simply been left with less money to spend — and less money to invest as well. I believe that is essentially what Joseph Stiglitz is saying, and what separates his perspective from Paul Krugman’s.

Conflation and the National Debt

What I have been arguing for some time is that income and wealth distribution is the most important factor determining growth and prosperity. The instability created by income redistribution is far more substantial than that caused by mere shifts in demand. We can see that in the history of the last thirty years.

As we noted at the top, the National debt now totals nearly $16.8 trillion. Paul Krugman discusses demand stimulation as if it’s just a question of more federal borrowing, as if there is a separate category of debt the proceeds from which can be used make the economy grow, instead of continuing to decline.  [16]  But there is only one kind of debt, and despite borrowing more than $16 trillion over the last three decades, the U.S. economy is gradually sinking into Great Depression II.

It’s important to remember that the interest burden on the national debt is rapidly growing. In November of 2012, the Congressional Budget Office (CBO) reported that taxpayers currently spend $220 billion per year for interest on the debt, and that amount is expected to rise to over $1 trillion a year by 2020. [17] Servicing the debt in these circumstances is such a significant problem that before long, with the continuing decline in its tax base, the federal government will be able to afford to pay for little else.  As we’ve discussed, cutting back government spending on other things in a manic push for “austerity” is such a suicidal idea that there is no workable alternative to substantially increasing tax progressiveness and significantly increasing taxes on top incomes.   

It’s also important to remember that to the extent the debt is owned by wealthy Americans and their corporations, the national debt effectively functions as an inequality machine.  It used to be said that the national debt is “money we owe ourselves.”  However, the top 1% of U.S. income earners hold about 70% of the financial wealth, so the lion’s share of national debt interest paid to Americans goes to the top 1%.  Much of the increasing interest obligation also, problematically, accrues to overseas investors and foreign governments.  Thus, even if more deficit spending could be added to try to stimulate jobs and growth, these problems would be exacerbated.  

As we have been discussing, wealth transfers to the top 1%’s economy constitute  economic rent, in the form of “unearned income”; that is, money collected via monopolistic market power in excess of the expenses and capital costs necessary to produce the required return on the capital investment.  By definition, the money required to pay these costs has already been spent out of gross receipts, so all that is left is economic rent.  Future posts in this series will refine the concept of economic rent.

For now, recall that taxation at the top controls the amount of economic rent that is retained in the top 1% and effectively removed from the bottom 99%’s economy, retired from active circulation. After thirty years of accumulation, this idle wealth  measures in the trillions. And it’s much more than financial wealth looking for investment opportunities. Much of it has been converted into idle forms of net worth, such as real estate, yachts, collections of fine art, or extra mansions.  The portion that is retained as financial wealth constitutes, essentially, the “billions in cash sloshing around and looking for investment opportunities” that Polly Cleveland referred to above. We can be reasonably certain that very little of this financial wealth is actively looking for investment opportunities; it’s locked in the inequality trap.  

Importantly, as Piketty and Saez and others have established, the top 1% greatly increased its income over the past thirty years by reducing their own federal tax obligations.  How much they saved cannot be directly computed, because the tax reductions changed income. As related in post #4, my own conservative estimate of the amount of increased wealth accumulated between 1982 and 2010 by the top 1% (using reported net worth data in 2010 dollars), was $11.8 trillion, which amounts to over $38,000 per capita for the 2010 U.S. population.  

Future posts will discuss evidence that the amount of wealth hoarded at the top has been highly underestimated.  The important points here are that wealth transfers to the top have been greatly increased via tax reductions, and that those tax reductions were offset by deficit spending.  In effect, the increased federal debt financed wealth transfers to the top — a huge increment of growing inequality.  

Using the $11.8 trillion figure as a conservative proxy for the amount of such wealth transfers, on average about $420 billion of wealth has transferred up annually.  It has not been a linear progression, however: the top tax rate has been near its lowest level for years, only recently increasing from 35% to nearly 40%, well below the 70% rate in effect when there was relatively constant income inequality in the 1970s (and capital gains have been taxed pretty much at the level of ordinary income taxes on poverty-level incomes); and the top 1%’s economy has been growing, both in number of households and income per household. So, for now, it’s not unreasonable to assume that annual wealth transfers to the top are, conservatively, at least in the $600-700 billion range. 

The point is, our conflation estimates must recognize that a continuing reduction of the bottom 99%’s economy on this order of magnitude will have to be stopped to stop inequality growth. Government cannot possibly borrow that kind of additional money, given the currently excessive level of national debt and the urgent need to start reducing it [18], but it is equally important that, given the ineffectiveness of the last four years of record “stimulus” from deficit spending, there is no basis for imagining that more of the same would help at all; and what’s worse, it would do nothing to stop, or even slow, the rate of inequality growth.           

The magnitude of the income and wealth redistribution problem is virtually unimaginable, and future posts will discuss indications that the inequality data we have been using greatly understate the severity of the problem. Hopefully this post gives some indication of how dangerous inequality growth really is for the U.S. economy. If we cannot escape from the “neoclassical paradigm,” however, the extreme danger will remain hidden — until it’s too late. 

JMH – 5/27/2013 (ed. 5/28/2013) 

________

[1] “Is Paul Krugman’s Liquidity Trap Really an Inequality Trap?” by Mary Manning (Polly) Cleveland, The Blog, Huff Post Business, January 13, 2013 (here) . Polly Cleveland is an active member of the Association for Georgist Studies (here).   

[2] Robert B. Reich, Aftershock: The Next Economy and America’s Future, New York, Alfred A. Knopf (2010), “Eccles’s Insight,” pp. 11-18, quoted at 12-13.

[3] “The Chutzpah Caucus,” by Paul Krugman, The New York Times, May 5, 2013 (here).

[4] “The Debt to the Penny, and Who Holds It,” Treasury Direct, May 23, 2013 (here).

[5] The debt is not a serious problem, Krugman argues: “the ratio of debt to G.D.P. . . measures the government’s fiscal position better than a simple dollar number,” and except for the two George Bushes, in every president since WW II left office with a lower “debt ratio” than when they came in: “So debt increases that didn’t arise either from war or from extraordinary financial crisis are entirely associated with hard-line conservative governments.” Ibid.  I’m still worried: We’ll take a close look at the “debt ratio” concept in the next post, when we discuss the the Reinhart/Rogoff debacle.

[6] Henry George identified a third factor of production, and used a traditional, less expansive definition of economic rent in his analysis: “Land, labor, and capital are the factors of production. * * * In returns to these three factors is the whole produce distributed. That part which goes to land owners as payment for the use of natural opportunities is called rent.” Progress and Poverty, Evergreen Books. Kindle Edition, July 29, 2011, p. 131.

[7] “Gini coefficient,” Wikipedia (here).

[8] ”The Chutzpah Caucus,”supra (here).

[9] Nicholas Wapshott, Keynes Hayek: The Clash That Defined Modern Economics, W.W. Norton & Company, NY and London, Kindle Edition (2012).

[10] Id. at Chs. 6-8, pp. 81-122.

[11] Id. at 120-121.

[12] Milton & Rose Friedman, Free to Choose, Harcourt Brace Jovanovich, NY, 1980, p. 270.

[13] “Not Enough Inflation,” by Paul Krugman, The New York Times, May 2, 2013 (here).

[14] ”Is Paul Krugman’s Liquidity Trap Really an Inequality Trap?”, supra (here).

[15] “Joseph Stiglitz Is Right About Inequality, but for the Wrong Reason,” by Mary Manning (Polly) Cleveland, The Blog, Huff Post Business, March 4, 2013 (here).

[16] Paul Krugman, End This Depression Now!,  W.W. Norton & Company, NY (2012), pp. 208-230.

[17] “National Debt Interest Payments Dwarf Other Government Spending,” by Danielle Kurtzleben, U.S. News, November 19, 2012 (here).

[18] Here is a decent federal spending pie chart for FY 2011, showing total spending of $3.64 trillion, debt interest of $247 billion and a military/defense budget of $728 billion (here). As shown on white house historical budget records (Table 1.1, here), deficits have mushroomed to historical levels already, exceeding $1 trillion all four years since the Crash and the start of the depression (2009-2012). This record-breaking fiscal “stimulus” hasn’t improved the bottom 99%’s economy, and as we have seen, the top 1%’s economy has grabbed 121% of all income growth over this period. We’ll look at these facts again at the beginning of the next post. 

The academic economics profession ought to have been most intimately involved in analyzing and debating a broken capitalist system whose deep crisis had confounded all its confident expectations. It has done nothing of the sort. Instead it proceeds as if — and indeed mostly still insists that nothing has happened to disturb its fifty-year celebration of capitalism’s efficiency and growth. A few professors of economics (e.g., Paul Krugman) and business (e.g., Nouriel Roubini) have commented on the absurdity of that insistence. But most of them could get no further than to recycle Keynes’ 1930s critiques of a depressed capitalism and his recommendations for deficit spending and monetary stimuli by government.  And, of course, the few right-wing economists who have taken the crisis seriously, utilized it to push yet again for less government economic intervention.  –  Richard Wolff [1] 

There is much truth in Wolff’s assessment of America’s celebratory attitude toward capitalism, especially within the academic community, and he properly links that attitude to our current predicament.  The idea that market economies are wonderful and efficient has been deeply ingrained in our thinking, so much so that efforts to understand why we are back in a depression, even for liberal economists who care deeply about the growth of inequality, have proceeded with a “business as usual” approach to economic analyses, even as we become aware of the urgent need for a fundamental rethinking of “business as usual” macroeconomics.

New generations of economists grow out of a culture in which there is much inertia on economic thinking.  The daily news reports on the latest stock market information are almost entirely useless; and the radio and TV discussions of economic and financial issues that flood the airwaves are at best superficial and confusing, and at worst wrong. There is a big advantage for people like me who learned economics in the early 1960s, for we are in a position to understand what has happened over the last fifty years; and those of us who have not been within the academic community can take a hard, objective look from the outside at everything that is going on. I have been conducting such an investigation of inequality growth over the last two and one-half years, and I have reached some startling conclusions.

“Economics” today evokes for me the image of a huge, disabled tanker drifting toward a major catastrophe. My tiny tugboat is unable to affect its course; and there are thousands of tugboats in the water, all pushing and pulling in different directions.

An Immature Science

Economics, as a social science, never matured enough to be helpful in countering serious decline and depression. It never got a complete handle on how market economies really work. John Maynard Keynes took the best shot at figuring it out, but in explaining why unfettered capitalist economies are unstable, he failed to account for the most influential factor, the distribution of wealth and incomes. [2]

He thought he had isolated three independent variables that together explain aggregate income and employment — the interest rate, the marginal efficiency of capital, and propensity to consume — and he even accounted for the dynamic “multiplier” effect of rising or falling demand, as changes in aggregate consumption change aggregate income. His General Theory, however, failed to account for the huge effect on demand of income redistribution. The “propensity to consume” and the “consumption function” are not independent of income distribution. As income concentrates more and more at the top of the income ladder, aggregate consumption declines sharply, creating a vicious cycle of contraction as increasing inequality causes further declines in consumption, production, and income (GDP) growth.

Thus, market economies are vastly more unstable than Keynes perceived them to be; concentration of income and wealth at the top causes income growth to decline more rapidly, with more chilling effects on employment and investment than those caused by the garden variety shifts in aggregate demand economists are used to contemplating. As Simon Kuznets warned in 1955, we could not become aware of the magnitude of such effects until the distributional data became available. We are now learning, unfortunately, that these effects are far greater than most of us could have imagined.

The last post in this series established that the progressiveness of taxation is directly, mathematically related to the degree of inequality in the distribution of wealth and incomes.  Just as a faucet controls the amount of water moving through a pipe, the progressiveness of taxation controls the amount of income and wealth concentrating at the top.

This previously well-understood fact has been all but forgotten today. No well-known economist (to my knowledge) has publicly joined in my argument that, after 30 years of growing inequality, closing the taxation faucet to curtail the flow of incomes and wealth to the top has become essential to recovery, and ultimately to the survival of our economy.

The Krugman Conundrum

Paul Krugman, America’s most influential Keynesian, has a tugboat of his own, much bigger than mine — but unfortunately it is not entirely pointed in the right direction.  His tugboat is preoccupied with battling an entire fleet of pirate ships that have seized and disabled the tanker, and he could use some help.  But while his colleagues have resorted to championing more progressive taxation on fairness grounds, Krugman himself has not even expressly acknowledged the relevance of progressive taxation to growth and recovery.  Here is a recent comment on tax progressiveness from his New York Times column:

Consider the question of tax rates on the wealthy. The modern American right, and much of the alleged center, is obsessed with the notion that low tax rates at the top are essential to growth. Remember that Erskine Bowles and Alan Simpson, charged with producing a plan to curb deficits, nonetheless somehow ended up listing “lower tax rates” as a “guiding principle.”

Yet in the 1950s incomes in the top bracket faced a marginal tax rate of 91, that’s right, 91 percent, while taxes on corporate profits were twice as large, relative to national income, as in recent years. The best estimates suggest that circa 1960 the top 0.01 percent of Americans paid an effective federal tax rate of more than 70 percent, twice what they pay today. [3]

This is a good comment as far as it goes, but it does not expressly connect the progressiveness of taxation to income growth; it merely rejects the false idea that lower taxes at the top will increase growth. Nor does it mention the casual conflation of taxation of top incomes with taxation of bottom incomes embedded in the “guiding principle” of lower tax rates, a gimmick used successfully to leverage the false promise of “trickle-down” into real economic analysis.

We owe Paul Krugman much gratitude, and a great deal of credit, for his own obsession with “austerity” and “trickle-down,” two insanely magical ideologies that have dragged economics back into the dark ages of the 17th Century, well before philosophers like Adam Smith and John Baptiste Say began to work some basic tautologies into coherent economic theories. [4]  As I said, he’s not getting enough help from other economists in those efforts. But perhaps especially for that reason, as America’s premiere warrior against economic insanity, Krugman has a responsibility to clarify the implications of progressive taxation.

Krugman is among those actively recycling the traditional Keynesian playbook, arguing that fiscal and monetary policy alone can accomplish recovery, and rather easily. [5] The next post will show that the Keynesian playbook cannot work today, because it does nothing to stem the transfer of wealth to the top in the normal course of the economy’s operation, and that “taxing the rich” is essential to escaping from our very serious inequality cycle.  Yes, I am saying that Paul Krugman is wrong on that score.  

Of course, he is right that the “austerity” hysteria must be subdued. But Krugman also argues:

The chances of a real turn in policy, away from the austerity mania of the last few years and toward a renewed focus on job creation, are much better than conventional wisdom would have you believe. And recent experience also teaches us a crucial political lesson. It’s much better to stand up for what you believe, to make the case for what really should be done, than to try to seem moderate and reasonable by accepting your opponents’s arguments. Compromize, if you must, on the policy — but never on the truth. [6]

So, I am encouraged to say, here is the uncompromising truth: The only time cutting government participation in the economy would make any sense would be when the economy is overheated, and it is a terrible idea to do it in a recession. Krugman, Reich, and the other opponents of “austerity” policy are absolutely right about that. But, as explained in the next post, we’re not in a situation where merely increasing government participation might thaw out the stalled economy sufficiently for a recovery.  We’re in an inequality-generated depression, which is sucking the life out of the economy faster than it could possibly be resuscitated by more government borrowing and spending. We need much more progressive taxation; it’s time to tax the rich.

Krugman’s Perspectives Revisited

Paul Krugman’s public influence on economic issues today is unmatched.  He is the premiere voice of American mainstream Keynesianism, providing his views to millions of readers every Monday and Friday in the New York Times, and he is the most followed and talked about economist in America. So understanding his views on inequality, and its causes and cures, is extremely important. When he became the lead New York Times correspondent in economics in 2007, he attributed the decline of inequality after WW II (the “Great Compression”) to Roosevelt’s New Deal policies, and he said this:

Because of “movement conservative” political dominance, taxes on the rich have fallen, and the holes in the safety net have gotten bigger, even as inequality has soared. And the rise of movement conservatism is also at the heart of the bitter partisanship that characterizes politics today. Why did this happen? Well, that’s a long story. . . . For now, though, the important thing is to realize that the story of modern America is, in large part, the story of the fall and rise of inequality. [7]

It appeared that inequality would be a major focus of his blog, and that he would become a major authority on the topic.  But as Timothy Noah reported [8] in 2012: 

In his 2007 book The Conscience of a Liberal, Paul Krugman concluded that there is “a strong circumstantial case for believing that institutions and norms. . . are the big source of rising inequality in the United States.” Krugman elaborated in his New York Times blog:

The great reduction in inequality that created middle-class America between 1935 and 1945 was driven by political change: I believe that politics has also played an important role in rising inequality since the 1970s.  It’s important to know that no other advanced economy has seen a comparable surge in inequality. [9]

The problem with this emphasis on an “institutions and norms” explanation for rising inequality is that it takes us “out of the game,” leaving us out of touch with real economic, distributional explanations.  When we focus on politics as an exclusive explanation for rising income inequality, we ignore important economic phenomena.  Just observing, as Krugman did, that the United States had the biggest advance in income inequality doesn’t tell us much; it is more important to know that no other advanced economy has seen a comparable decline in the taxation of top incomes: The Piketty and Saez data, as shown in the fourth post of this series, show that the United States economy has both the highest level of inequality and the lowest marginal income tax rates among all advanced economies.

Krugman already had this bias toward “institutions and norms” explanations back in 2007, and he never lost it. In 2012, he concluded that inequality is a “political” problem. [10] This implies a belief that income and wealth distribution do not have macroeconomic implications, a belief intimately connected with another perspective that also obscures the foundation for a better understanding of the economics of inequality — the “normality” presumption that economies are self-correcting, as described by James Galbraith in an earlier post in this series:

The deepest belief of the modern economist is that the economy is a self-stabilizing system. This means that, even if nothing is done, normal rates of employment and production will someday return. Practically all modern economists believe this, often without thinking much about it. [11]

That assumption clearly masks the macroeconomic damage done by the concentration of income and wealth at the top.

The Rise of “Behavioral Economics”

Around the turn of the 21st Century, with inequality already a very serious problem and America about eight years from crashing into its next depression, the new field of “behavioral economics” was gaining traction in academic circles.  Camerer and Loewenstein explain the theory behind behavioral economics:

Behavioral economics increases the explanatory power of economics by providing it with more realistic psychological foundations. * * *  At the core of behavioral economics is the conviction that increasing the realism of the psychological underpinnings of economic analysis will improve economics on its own terms – generating theoretical insights, making better predictions of field phenomena, and suggesting better policy. This conviction does not imply a wholesale rejection of the neoclassical approach to economics.  [12]

It is a creditable idea, certainly, to use other social sciences to refine economic analysis “on its own terms,” but behavioral economics must be limited to that objective. It should only be used to enhance economic analyses, not to justify ignoring core economic concepts and relationships.

Consequently, the intersection of behavioral economics with the economics of inequality has had disastrous consequences. When economists should have been concentrating on the macroeconomic implications of the Piketty and Saez data series, many were focusing on social and political explanations for the growth income inequality. This trend overpowered consideration of fundamental macroeconomic explanations, and in some cases led to a “wholesale rejection” of economic analysis.

In Krugman’s case, turning to behavioral economics may have been related to his contemporary view, expressed in a June 10, 2009 lecture, that most macroeconomics of the past 30 years has been “spectacularly useless at best, and positively harmful at worst.” [13] Thus, even unprovoked by some breakthrough in behavioral economics, there already had been something of a wholesale rejection of traditional macroeconomics. As The Economist smugly put it:

These internal critics argue that economists missed the origins of the crisis; failed to appreciate its worst symptoms; and cannot now agree about the cure. In other words, economists misread the economy on the way up, misread it on the way down and now mistake the right way out. [14]

The Economist didn’t provide any answers either. But while the confused economics profession was waiting for the emergence of a more complete macroeconomics, the answer was not to seek behavioral and psychological explanations for why incomes and wealth are concentrating high within the top 1% while most incomes are declining, poverty is rising, and the middle class is evaporating.  But that is essentially what has happened.

Political decisions and social considerations lie behind all of economics. But “behavioral economics” is only intended to enhance our understanding of economic theories and phenomena, not to replace them.  Unfortunately, as the field of economics has been near-fatally wounded by supply-side, pixie-dust fantasies, other social sciences have moved in to replace economics altogether in the inequality debate.  But in the process of taking over the inequality debate, such models have corrupted the basic premises of behavioral economics itself.

Joseph Stiglitz focuses more directly on the underlying economic aspects of the problem of inequality growth.  With respect to institutional, political and social causes and even some of the more directly economic causes like globalization and technological change, Stiglitz politely argues:

[T]here is a growing consensus among economists that it is hard to parse out cleanly and precisely the roles of different forces. * * * To me, much of this debate is beside the point. The point is that inequality in America (and some other countries around the world) has grown to where it can no longer be ignored. [15]

We cannot ignore the basic features of the inequality engine if we hope to fix it.

JMH – 4/20/2013

_________

[1] Richard Wolff, Occupy the Economy: Challenging Capitalism, City Lights Books, SF (2012), Introduction, pp. 9-10.

[2] Wall Street is the source of our biggest problem, as “Occupy Wall Street” properly understood. But from a purely economic standpoint, the private banking system is just represents a collection of private business practices that, far more than most, enables the extraction of pure economic rent from the bottom 99%’s economy.

[3] ”The Twinkie Manifesto,” by Paul Krugman, The New York Times, Op-ed, November 19, 2012 (here).

[4] The final post in this series will show how terribly, harmfully wrong “trickle-down” really is.

[5] Paul Krugman, End This Depression Now!,  W.W. Norton & Company, NY (2012) pp. 208-230.

[6] Id. at 224. 

[7] ”Introducing This Blog,” by Paul Krugman, The Conscience of a Liberal, The New York Times, September 18, 2007 (here).

[8] Timothy Noah, The Great Divergence, Bloomsbury Press , N.Y. (2012), pp. 113-114.

[9] “Introducing This Blog,” supra.

[10] Paul Krugman, End This Depression Now!,  W.W. Norton & Company, NY (2012), Ch. 5, “The Second Gilded Age,” pp, 71-90.

[11] James Galbraith, Presidential Address, Association for Evolutionary Economics (January 5, 2013).

[12] “Behavioral Economics, Past Present and Future,” by Colin F. Camerer and George Loewenstein, CalTech and Carnegie-Mellon University, 2002 (here).

[13] “What Went Wrong With Economics,” The Economist, July 16, 2009 (here).

[14] “The other-worldy philosophers,” The Economist, July 16, 2009 (here).

[15] Joseph E. Stiglitz, The Price of Inequality: How Today’s Divided Society Endangers Our Future, New York and London, W. W. Norton & Company, 2012, pp. 79-80.

Fairness requires that people who make more money pay a higher portion of their incomes in taxes than people with less money. That’s called a progressive tax system, and it’s been a foundation stone of America’s tax code. [1] – Robert Reich 

Each of the seven reforms that we have described yield a double dividend: enhanced economic efficiency and increased equality. But even after we do that, large inequalities will remain, and to provide revenues for public investment and other public needs, to help the poor and the middle class, to ensure the existence of opportunity for all segments of the population, we’ll have to impose progressive taxes and, most importantly, do a better job in closing loopholes. As we’ve seen, in recent decades, we’ve been creating a less progressive tax system. [2] – Joseph Stiglitz 

In Chapter 7, we saw that tax cuts didn’t create the Great Divergence, because changes in the distribution of pretax income were much larger than changes in the distribution of posttax income. Nonetheless, the federal tax system’s ability to mitigate income inequality has diminished. * * * A more progressive tax system would increase the government’s impact on income distribution, which was (and remains) substantial. [3] – Timothy Noah  

These statements are from the latest books, all published in 2012, of three of the leading participants in the effort to save our economy from the strangulation of growing inequality. These are the most influential books on inequality coming out in 2012, but unfortunately they have left us hanging on the question of taxation.  

This is not a small matter: All three support higher taxation at the top of the income ladder, but none of them acknowledge that tax progressiveness is fundamental to controlling income and wealth distribution. The inequality cycle that has landed America in another depression began in 1980, with the expansion in the Reagan administration of the profitability of corporations. The huge reduction in taxation of the corporations and people who have received these excess profits has allowed them to keep and hoard huge chunks of the money supply, forcing the bottom 99%’s economy into an ever-worsening depression.  

What I have been saying for the better part of the past two years, but have not seen anyone else argue, is that because inequality is an ongoing process with hundreds of billions of dollars of wealth transferring to the top every year, the survival of the U.S. economy depends upon increasing taxes at the top to their former degree of progressiveness.  Vastly more taxation is needed to counter the continuous redistribution of income and wealth to the top through excess profits and other forms of economic rent. 

To attribute the need for higher taxes on top incomes only to “fairness” as Robert Reich does, and President Obama has been doing, overlooks this macroeconomic need for higher taxation at the top. Yes, tax progressiveness is a foundation stone of America’s tax system, but Reich has not yet (so far as I am aware) argued that the degree of tax progressiveness controls the degree of inequality growth, and that a certain degree of progressiveness is essential to economic survival.  To implicitly concede that tax increases at the top are not essential to growth and recovery is to implicitly grant supply-side advocates like Grover Norquist and Paul Ryan their argument that further tax reductions will not harm the economy — and their corollary argument that taxes at the top must not be increased.       

Joseph Stiglitz has presented the best analysis of income inequality to date, and he has recommended seven reforms to increase efficiency and reduce the ability of corporations and their owners to collect economic rent, all excellent suggestions.  He acknowledges that his proposals will take time to become effective, and that they will not be sufficient.   That’s important, because as the facts and analysis in the last two posts in this series suggest, the holes through which excess profits and other economic rents are siphoned to the top can only be partially plugged.

“After we do that,” Stiglitz states, “we’ll have to impose progressive taxes and, most importantly, do a better job in closing loopholes.” Although Stiglitz may not be suggesting that we actually wait until his other proposed reforms are in place before implementing tax reforms, still this hardly seems like a ringing endorsement of progressive taxation. If Stiglitz agreed with me that more progressive taxation is essential to recovery and growth, why would he argue that closing loopholes is more important than raising tax rates?  

A Paul Krugman protégé, Timothy Noah puts tax reform at the front of his list, even though Paul Krugman himself does not even mention increased taxation in his latest book as a potential factor in economic recovery and growth. [4] Noah actually does emphasize the redistribution function of income taxation:

“The income tax is . . . directly redistributive.  The government takes money from one group of people (through taxes) and then hands it over to another group (through government benefits and appropriations).” [5]

His train quickly derails, however, with his conclusion that “tax cuts didn’t create the Great Divergence, because changes in the distribution of pretax income were much larger than changes in the distribution of posttax income.”  This conclusion is both incorrect and confusing: If a more progressive tax system “would increase the government’s [substantial] impact on income distribution,” how could a less progressive tax system (reducing the top income tax rate) fail to increase income inequality? We’ll review Noah’s reasoning after we review the relationship between taxation and income inequality.

Progressive Taxation and Inequality

Once the distributional effects of taxation are recognized, the causal relationship between taxation and inequality is apparent.  Concentrating income and wealth at the top, we noted earlier, restricts consumption and demand, constricting the 99%’s economy.  That’s why we’re in a depression.  The obverse proposition is also true: Reducing the concentration of income and wealth at the top expands the 99%’s economy.  

It is worth noting that this was obvious to Keynes and others of his day.  Immediately after he started his last chapter by identifying “the failure to provide for full employment” and the “arbitrary and inequitable distribution of wealth and incomes” as the two outstanding faults of the modern market economy, Keynes remarked:     

Since the end of the nineteenth century significant progress towards the removal of very great disparities of wealth and income has been achieved through the instrument of direct taxation — income tax and surtax and death duties — especially in Great Britain. [6]

In their 2007 study, Thomas Piketty and Emmanuel Saez provided this definition of “progressive” taxation:

[A] tax system can be defined as progressive if after-tax income is more equally distributed than before-tax income, and regressive if after-tax income is less equally distributed than before-tax income. [7]  

This is an excellent definition of tax progressiveness, because it depends on more than just tax rates: Increasing tax rates at the top and/or decreasing tax rates at the bottom will tend to make taxation more progressive, but given that today all income growth is going high within to the top 1% (121% to the top 1% in 2009-2011), much depends on how government spends incremental tax revenue so as to redistribute income back down. The distribution of after-tax income would not become substantially more equal if people were effectively required to spend their money at “the company store;” for example, if a huge increase in unemployment insurance payments all had to be spent at Walmart. 

In addition to higher taxation and government spending, dynamic changes in the economy are required, including improved employment, median incomes, and small business earnings, for the economy to work its way back to a healthy income distribution.  But no amount of stimulation will work, as I will show in this blog series, without sufficiently progressive taxation to stop the bleeding.  Recovery will be much more difficult than it was for reduced tax rates at the top to aggravate inequality and cause income decline over the last 30 years, as detailed in the last two posts in this series, while both insufficiently “progressive” taxes (as defined by Piketty and Saez) and a Walmart-style excess profit machine have been at work in the economy.  Why? Because regardless whether inequality is increasing or decreasing, an unfettered capitalist economy is constantly creating more excess profits and inequality. That’s what it does; it’s the ultimate objective of every for-profit enterprise:

This graph, which I have discussed extensively in other posts, including most recently “Amygdalas Economica: Perspectives on Taxation” (here), pretty much says it all. The authors explain their conclusions regarding the information presented on the graph:

Two important lessons emerge from this panel. Considering first the top income share excluding realized capital gains which corresponds roughly to income taxed according to the regular progressive schedule, there is a clear negative overall correlation between the top 1% income share and the top marginal tax rate: (a) the top 1% income share was high before the Great Depression when top tax rates were low (except for a short period from 1917 to 1922), (b) the top 1% income share was consistently low between 1932 to 1980 when the top tax rate was uniformly high, (c) the top 1% income share has increased significantly since 1980 after the top tax rate has been greatly lowered. * * *

Second, the correlation between the top shares and the top tax rate also holds for the series including capital gains.  Realized capital gains have been traditionally tax favored (as illustrated by the gap between the top tax rate and the tax rate on realized capital gains in the figure) and have constituted the main channel for tax avoidance of upper incomes. [8]

The authors did not present regression results to show the high inverse correlations between the top tax rate and capital gains tax rate and income inequality; the close correlations are apparent on close visual inspection.  

Their explanation of inequality growth has evolved considerably since their first paper in 2001, in which they suggested: (1) that “the ‘technical change’ view of inequality dynamics [suggested by Kuznets in 1955] cannot fully account for” the U-shaped pattern of income inequality change over the century; (2) that ”the large shocks that capital owners experienced during the Great Depression and World War II seem to have had a permanent effect;” (3) that ”a plausible explanation is that steep progressive taxation, by reducing drastically the rate of wealth accumulation at the top of the distribution, has prevented large fortunes to recover fully yet from these shocks”; and (4) as for the recovery of top wage shares since they “dropped precipitously” during WW II, “we emphasize the role of social norms as a potential explanation for the pattern of wage shares.” [9]

As an initial cut at explaining the strange new income distribution patterns they had discovered, this was a creative effort.  At least they acknowledged then that progressive taxation reduces the rate of wealth accumulation — although they only focused on how “steep”  progressiveness had “drastically” reduced wealth accumulation after WW II, when the middle class was growing and American prosperity was rising. Ten years later, they no longer suggest this favoritism toward wealth accumulation, so far as I am aware, but their “social norms” explanation was still being promoted in 2012 by Paul Krugman [10] as the best explanation for income inequality growth, while he ignored the macroeconomic effects of taxation they now emphasize.    

The Piketty and Saez data show that top income shares respond immediately to reductions in the effective taxation of top incomes. The reason for this seems straightforward: reducing taxation of top incomes immediately increases the conversion of economic rent into idle wealth, depressing the active economy. The after-tax incomes of the very wealthy are immediately increased by hundreds of billions of dollars, while the bottom 99% money supply is correspondingly shrunk, as a large portion of those billions are retired from active circulation.   

In November of 2012, the Congressional Research Service (CRS) published a regression study by Thomas L. Hungerford confirming the Piketty and Saez 2011 results.  His study shows a high correlation between the top 0.1% of incomes and the top tax rates, from 1945-2010: Although the import of these results is clear, Hungerford only cautiously reported them: “The top tax rate reductions appear to be associated with the increasing concentration of income at the top of the income distribution. * * * Tax policy could have a relation to how the economic pie is sliced — lower top tax rates may be associated with greater income disparities.” [11]  Maybe. 

It is startling to see this point hedged, since everyone from Keynes to Piketty and Saez have virtually taken it for granted that taxation redistributes income. Nonetheless, the CRS withdrew this report “against the advice of the agency’s economic team leadership,” after Senate Republicans “raised concerns about this paper’s findings and wording.” [12]

Hungerford’s study also confirmed that since 1945, and especially since 1980, the average effective tax rates for the highest-income taxpayers have declined significantly: [13]

Timothy Noah’s Mistake

Timothy Noah concluded, we pointed out at the top, that  ”tax cuts didn’t create the Great Divergence (the growing income inequality over the last 30 years), because changes in the distribution of pretax income were much larger than changes in the distribution of posttax income.”  The logic chain that leads to this confusion begins this way:

[T]ax brackets, including the top one, tell you only the marginal tax rate, that is, the rate on that portion of earnings exceeding a given threshold.  The percentage of total income that you actually pay in taxes is known as the effective tax rate.  And the effective income-tax rate on top incomes, you might be surprised to learn, didn’t change all that much. [14]

Noah is correct that what matters is the effective tax rate on top incomes, because it reflects the actual impact of taxation. However, his conclusion that the effective rate on top incomes has not declined much is wrong: As shown in the previous graph from the Hungerford study, the effective tax rates of both the top 0.1% and the top 0.01% have fallen dramatically since 1980.  The Hungerford study suggests that the U.S. needs effective tax rates in the 40-45% range from its top earners (along with a restoration of former corporate earnings tax levels) to counter inequality growth. 

For the effective tax rate not to decline when the marginal top rate was being slashed would have been nearly impossible; there would have to have been a major, continuous offsetting increase in tax loopholes, over the thirty years, as the top rate declined. 

Noah got off track during his review of the study of the progressiveness of the entire federal tax system Piketty and Saez published in 2007. [15] Whether federal taxes are high enough to be sufficiently progressive to retard inequality growth is an important question, but that’s a different question than whether effective income tax rates declined when the marginal rates did.

Noah’s erroneous conclusion that effective taxes on top incomes have not declined over the past thirty years appears to stem from a source of confusion in the Piketty and Saez 2007 study.  That was a study of all income-related taxation and, as they explained, the category “corporate tax” allocates among income classes corporate retained earnings using capital gains (computed from income tax returns in their data base) as a proxy. Capital gains were therefore excluded from the computation of “individual tax” amounts to avoid a double-count. 

This graph displays for both 1960 and 2004 the cumulative effective tax rate of each of the four federal taxes included in the study, over the entire range of income classifications:

“Capital gains” are shown here as “corporate tax,” so the graph shows the effective income tax rate on top incomes, including capital gains, declining from about 50% in 1960 to about 30% in 2004.  This history is entirely consistent with both the correlation between the top marginal rates and the top 1% share Piketty and Saez identified in their 2011 study, as well as the correlation between the top effective rates and the top 0.1% and 0.01% income inequality  shown by Hungerford.

Optimal Taxation of Top Incomes

The data from the studies reported in this post indicate that it is only when the top marginal income tax rate is at or above 70% and the effective tax rates on top 0.1% and 0.01% incomes are in the 40-45% range that we have not seen rapidly rising income inequality.  A capital gains rate of at least 35% seems essential. Of course, all taxation has income and wealth redistribution effects, and it would be an oversimplification to argue that income and capital gains taxes are the entire issue. However, those are the taxes that are applied to the money that the wealthiest among us take as excess profits and other forms of economic rent, so it should not be surprising to find that the progressiveness of top income taxation is so highly, and inversely, correlated to the growth of inequality and the decline of the economy.

Inequality is about the accumulation of wealth at the top when that wealth is not taxed back down. There is a continuous accumulation of transferred wealth to the top, perpetual income inequality growth, and a continuous decline for the bottom 99% whenever taxation of top incomes and wealth is inadequate to keep this process in check.

I find these conclusions inescapable: (1) The top economic responsibility of government is to regulate income and wealth distribution, and; (2) Maintaining a sufficiently progressive tax system is its primary tool in doing so. The high correlation Piketty, Saez and Stantcheva have shown among wealthy countries between their top tax rates and their top 1% income shares confirms that this is the reality we face.

Conclusion

So far, these conclusions are not materially shared within the economic community.  Stiglitz and Reich have come closest to this position.  However, Paul Krugman, America’s most influential Keynesian, continues to ignore the macroeconomic role of taxation.  The next post will address this lingering marginalization of distribution issues and explain how it is creating confusion and muddling the debate over appropriate policy, enhancing the effectiveness of the efforts by the “trickle-down” forces to prevent the policies needed for recovery and economic health.         

JMH – 5/15/2013

______

[1] Robert B. Reich, Beyond Outrage: What has gone wrong with our economy and our democracy, and how to fix them, Random House, Inc., NY, Kindle Edition, 2012, KL1151.

[2] Joseph E. Stiglitz, The Price of Inequality: How Today’s Divided Society Endangers Our Future, Norton, NY, Kindle Edition, 2012, p. 273.

[3] Timothy Noah, The Great Divergence: American’s Growing Inequality Crisis and What We Can Do about It,  Bloomsbury Press, NY, 2012, pp. 179-180.

[4] Paul Krugman, End This Depression Now!,  W.W. Norton & Company, NY (2012), Ch. 12, “What It Will Take,” pp. 208-223.

[5] The Great Divergence, supra, p. 110.

[6] John Maynard Keynes, The General Theory of Employment, Interest and Money, Signalman Publishing, Kindle Edition, 2010, p. 251.

[7] “How Progressive is the U.S. Federal Tax System? A Historical and International Perspective,” by Thomas Piketty and Emmanuel Saez, Journal of Economic Perspectives, Volume 21, Number 1, Winter 2007,  p. 4 (here).

[8] “Optimal Taxation of Top Labor Incomes: A Tale of Three Elasticities,” by Thomas Piketty,  Emmanuel Saez, and Stefanie Stantcheva, Centre for Economic Policy Research (CEPR), DP No. 8675, November, 2011, pp. 24-25 (here).

[9] “Income Inequality In the United States, 1913-1998,” by Thomas Picketty and Emmanual Saez,  National Bureau of Economic Research (NBER), Working Paper 8467, September, 2001, p. 1 (here).

[10] Paul Krugman, End This Depression Now!,  W.W. Norton & Company, NY (2012) p. 81.

[11] “Taxes and the Economy: An Economic Analysis of the Top Tax Rates Since 1945” by Thomas L. Hungerford, Congressional Research Service (CRS), September 14, 2012  (here).

[12] “Nonpartisan Tax Report Withdrawn after G.O.P. Protest,” by Jonathan Weisman, The New York Times, November 1, 2012, here.  The report was subsequently updated on December 12, 2012 (here).

[13] Id.

[14] The Great Divergence, supra, p. 111.

[15] “How Progressive is the U.S. Federal Tax System? A Historical and International Perspective,” supra.

We scarcely have time to congratulate ourselves on [the victory of market economics over socialism] before confronting failures like the growing concentration of economic power, growing inequality of income and especially wealth, stagnant or falling real wage rates, homelessness and beggary, chronic unemployment, growing crime rates and personal insecurity, low domestic capital formation, obsolescence in the face of rising foreign competition, dangerous dependence on foreign oil, growing recourse to the underground economy, falling literacy and educational attainments, anomie and substance addiction, rampant self-seeking and predation, falling affordability of housing, and rising social divisions leading toward class warfare.

The thesis here is that the structural flaw in capitalism is our tolerance of unearned income and wealth. The idea of free markets is that income should go to incite and reward productive activity; wealth should incite and reward saving and capital formation. Unearned income and wealth do neither. Unearned wealth today (like slave-owning in the past) actually deters saving by the fairly obvious route of satisfying the owners’ need for the security of wealth, without their actually creating any capital. – Mason Gaffney [1] 

The above recitation of capitalist “failures” by the renowned Georgist economist Mason Gaffney emphasizes the interconnection between the “growing inequality of income and especially wealth” in America and its worsening depression-like economic woes. The last post showed that over the last thirty years U.S. income has become increasingly concentrated high in the top 1%, and that the growth of income inequality has been continuous and accelerating.  It has been a broad-based trend, with income concentration growing in all sectors of the economy, especially the business and corporate sectors. Although this trend encompasses both labor and capital income, the highest concentration growth has been in capital and business income. This indicates a broad-based transfer of income and wealth to the top 1% in the normal operation of the economy, a redistribution coming mainly from an increase in corporate profits; and the data show that, although both factors are at work, the higher profits and consequent inequality are generated more by the exercise of market power to generate “unearned income and wealth” than from direct suppression of labor’s share.

The core “Keynesian” factor in the mechanism of this inequality growth identified earlier is what we used to call, back in the 1960s, the “consumption function;” this is the expression of one of Keynes’s three independent variables, the propensity to consume. However, it is not the aggregate consumption function — that is, the overall economy-wide propensity to consume — with which we are concerned: When income and wealth are redistributed to the top, as discussed in the last post, it is the materially lower marginal propensity to consume from very large incomes that drives depressed growth and contraction, and that is the major source of instability and contraction in market economies. With the new distributed income data, economists can now develop distributed propensity to consume data and distributed consumption functions, although so far as I am aware none have yet done so.  

The other core aspect of inequality growth is the removal of this redistributed income from the active economy, to be salted away as idle savings without adding to the level of production. This is where the second part of the Gaffney quotation gets to the heart of the matter: What Gaffney calls “unearned income and wealth” — i.e., money acquired beyond the amount actually needed for the provision of productive activity and capital formation — provides a near-perfect explanation of the mechanism of growing inequality.  Put another way, it is money redistributed to the top in excess of the incremental production of real value. In fact, I will venture to argue that the accumulation of “unearned income and wealth” is the inequality problem; buyers are continuously receiving insufficient real value in exchange for their money, and losing ground relative to sellers; the result is a combination of reduced  production of real value and contraction of the active money supply.  

“Political and Social” Explanations

The public and professional discussion so far about the causes of inequality  has focused mostly on “the declining labor share,” including, “changes in technology, increasing globalization, changes in market structure, and the declining negotiating power of labor.” [2] These are all aspects of the decline but, as Stiglitz puts it, the identification of such proximate causes is mostly “beside the point.” [3] Focusing on such social and structural problems is not inappropriate, but that focus distracts from an understanding of the underlying mechanism of inequality growth, which is independent of its manifestations.  

Similarly beside the point is the argument that the sudden explosion of CEO pay relative to the incomes of typical employees relates to political and social acceptability of raising executive compensation.  Paul Krugman, as noted earlier, has argued that the growth of inequality should be thought of as mainly a “political” phenomenon:

Thomas Piketty and Emmanuel Saez, whose work I’ve already mentioned, have argued that top incomes are strongly affected by social norms.  * * * [That argument suggests] that changes in the political climate after 1980 may have cleared the way for the raw exercise of power to claim high incomes, in a way that wasn’t considered doable earlier. It’s surely relevant here to note the sharp decline in unionization during the 1980s, which removed one player that might have protested huge paychecks for executives. [4]     

With all due respect to these major players in the economic debates, this logic seems unrealistic: How often have American CEOs whose corporations are greatly increasing their profits actually not considered it “doable” to give themselves substantial raises?  And how often do they decline to give themselves raises even when company earnings are declining?  More importantly, it invites inattention to (or even dismissal of) the underlying question of how changing income distribution affects aggregate income growth; the perspective nicely mirrors the characterization Keynes made of the distribution of wealth and incomes as “arbitrary” when he created a full employment model without accounting for redistribution.  

We should be looking for such social and political explanations for the skyrocketing levels of CEO compensation only if changing levels of executives’ compensation do not affect the amount they spend and save, and the amount left over for everyone else to spend and save; that is, only if income and wealth distribution lack macroeconomic significance. But that is not the case. Recall what Keynes said about the difficulty of shedding the old ideas of classical economics that he challenged: “The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds.” [5] Today, many mainstream Keynesian economists appear to be facing this same difficulty in dislodging the presumption built into Keynes’s General Theory that wealth and income distribution, somehow, lack economic significance. 

Such “social and political” arguments also ignore the extreme and so far successful opposition of the very wealthy in the United States to paying higher taxes on whatever they do decide to pay themselves. The better argument seems to be that their corporations are making too much money and that these top executives are, as best they can (with perhaps a few exceptions), keeping as much of these excess earnings as possible. The following chart of major countries, plotting their top 1% income share against their top marginal tax rate in 2004-2008, was published by Piketty and Saez themselves: [6]   

Compared with top executives in other countries, this chart shows that in the years leading up to the Crash of 2008, the wealthy elite in the United States better overcame whatever reservations they might have had about increasing their incomes, and they succeeded more than the wealthy in those other countries in minimizing their marginal income tax rate (and hence their effective tax obligations).

The Reagan Revolution

The political and social factors affecting executive compensation and the institutional factors affecting labor’s share are certainly real, but I suggest we think of them as “secondary causes” — i.e., factors that come into play only as a consequence of, or independent of, these “primary causes” of increasing inequality and declining growth and prosperity. The 30-year decline in growth and prosperity was the direct result of two broad policy initiatives initiated during the Reagan Administration:

(1) Deregulation of business and finance, which allowed corporations to increase their profits and the wealthiest Americans to increase their incomes; and

(2) Reduced taxes on top household incomes and corporate earnings, which allowed the wealthiest Americans to keep a greater share of their higher incomes and accumulate greater wealth.

Certainly no set of policies could have been better designed to maximize inequality growth and minimize overall income (GDP) growth.  The next post will focus on taxation, and the balance of this post will focus on the elusive concept of “excess profit” or excess return to capital, a.k.a. “unearned income.”

“Unearned” Income and Wealth

How do we know when the wealthiest people are making and keeping too much money? When the time came to discuss that issue, Keynes offered only this:

For my own part, I believe that there is social and psychological justification for significant inequalities of incomes and wealth, but not for such large disparities as exist today. There are valuable human activities which require the motive of money-making and the environment of private wealth-ownership for their full fruition. * * * It is better that a man should tyrannize over his bank balance than over his fellow-citizens; and whilst the former is sometimes denounced as being but a means to the latter, sometimes at least it is an alternative. But it is not necessary for the stimulation of these activities and the satisfaction of these proclivities that the game should be played for such high stakes as at present. Much lower stakes will serve the purpose equally well, as soon as the players are accustomed to them. [7]

Beyond rejecting Marxist socialism, Keynes found no way to identify what might be insufficient inequality to motivate innovation and growth, and what would be too much inequality. His statement is reminiscent of the famous comment by Justice Potter Stewart in a concurring opinion in a 1964 obscenity case: “I know it when I see it.” [8]    

Today, with the income distribution of a century available, we can now do better than that. We have already seen that when inequality becomes too great, the economy is driven into a depression and everyone, except for the hyper-rich, are doing worse.  Disparities as great as that are clearly unacceptable.  A more precise standard lies in the concept of “economic rent,” which consists of payments for which no new value is created, including all unearned income and excess profits.  Stiglitz identifies the connection between economic rent and inequality:

[M]uch of the inequality in our economy was the result of rent seeking. In their simplest form, rents are just redistributions from the rest of us to the rent seekers.* * What is striking is the prevalence of limited competition and rent seeking in so many key sectors of the economy. [9]

Stiglitz’s new book is the first to broadly associate inequality growth with economic rent since the American economist Henry George published Progress and Poverty in 1879, two depressions and 133 years earlier.  George observed that “current political economy cannot explain why poverty persists in the midst of increasing wealth,” [10] George’s perceptive insight that the collection of “unearned” returns creates inequality provides a crucial factor still missing from mainstream theory:  Transfers of economic rent to the top converts money that could otherwise be used for productive activity into idle wealth.  When money (e.g., the unearned income of hedge fund managers) is redistributed upward without producing new value, resources are idled and growth is retarded.  Stiglitz elaborates:

To put it baldly, there are two ways to become wealthy: to create wealth or to take wealth away from others. The former adds to society. The latter typically subtracts from it, for in the process of taking it away, wealth gets destroyed. A monopolist who overcharges for his product takes money from those whom he is overcharging and at the same time destroys value. To get his monopoly price, he has to restrict production. * * * Today, over a century after the railroad barons dominated the economy, much of the wealth at the top in the United States – and some of the suffering at the bottom – stems from wealth transfers instead of wealth creation. [11]

If we define “excess earnings” as “profit” — i.e, all payments for goods and services in excess of their cost — then all excess earnings are economic rent.  Given that the primary objective of most corporations in a capitalist, market-based economy is to maximize profit, the objective of capitalism in effect is to maximize economic rent.  Thus, it is the profit motive that makes instability and decline basic features, as we have been discussing, built into the capitalist market system.  

Expanding Market Power

Since 1980, excess earnings have been enabled and expanded throughout the economy by lax anti-trust law enforcement, relaxed essential industry and financial transaction regulation, control of government contracting, and a new corporate culture that values financial gain over productivity and employment. These developments are well documented. [12] Barry Lynn gives a typical example of one of the most important trends, the concentration of market power in mega-corporations like Exxon Mobil, General Electric, Monsanto or Walmart:

Until we elected Ronald Reagan president, both Democrats and Republicans made sure that no chain store ever came to dominate more than a small fraction of sales in the United States as a whole, or even in any one region of the country.  Between 1917 and 1979, for instance, administrations from both parties repeatedly charged the Great Atlantic and Pacific Tea Company, the chain store behemoth of the mid-twentieth century that is better known as A&P, with violations of antitrust law, even threatening to break the firm into pieces.  Then in 1981 we stopped enforcing that law.  Thus, today Wal-Mart is at least five times bigger, relative to the overall size of the U.S. economy, than A&P was at the very height of its power (citation). Indeed, Wal-Mart exercises a de facto monopoly in many smaller cities, and it sells as much as half of all the groceries in many big metropolitan markets. [13]

The assumptions of classical economics that ensure a supply price for any product or service equal to its cost (i.e., there is no profit) are perfect competition and perfect knowledge.  These are the conditions necessary for absolutely efficient markets.  Of course, these conditions have never been met in the real world, and there are many things capitalist firms can do to thwart market efficiencies, enabling them to charge above-cost prices.    

One important point of intersection of Georgist and Keynesian theory lies with the “cost of capital,” a concept that has for decades been implicit in my profession, utility rate regulation.  Rate regulation is intended to provide a substitute for competition in the case of providers of essential services like telephone, natural gas, electric or water services. These are industries where monopolistic market power could easily produce excess earnings, if the firms are allowed to charge whatever they wish for the essential services they provide. Rates are set to include all of a company’s reasonable costs, including their costs of capital.  

Any excess of earnings above a regulated firm’s cost of capital would be “excess profit,” i.e., economic rent, and for decades in the U.S., monopoly providers of regulated services have been allowed to charge rates that would allow no more than a reasonable opportunity to achieve earnings sufficient to attract equity capital in the financial markets – i.e., to earn their “cost of capital,” or the “fair rate of return” — while providing high quality service. This cost of capital is equivalent to one of the three independent variables in Keynes’s model — the “marginal efficiency of capital.” It is, in theory, the present value of all expected future returns on the common stock of regulated firms, and it is the cost of capital Keynes identified, across an entire economy, for full employment and growth.  

In a “rate case” the monopoly provider of regulated service justifies all of its costs, including labor and management compensation. Federal and state commissions charged with rate regulation have designed rates to allow for reasonable levels of executive and management compensation as part of the cost of providing good service.  Firms charging regulated rates can contribute to income inequality in their actual operation, however, by increasing executive compensation while cutting back on other operating costs.  It appears that the effectiveness of rate regulation has declined in recent years in this respect; for example, in the case of electric service:

Over a decade of deregulation, the frequency and duration of outages has crept up, maintenance of aging infrastructure has been deferred, line workers have been laid off — and CEOs’ salaries have risen an average of 150 percent nationwide, a Hearst Newspapers investigation has found. [14]

However ineffective the laws designed to promote competition and the minimization of monopolistic market power (anti-trust laws), or reasonable prices for service provided by natural monopolies (rate regulation) may have recently become, they do at least provide theoretical benchmarks for avoiding the severe growth of inequality witnessed in the United States over the last three decades.

Wealth Transfers

It is difficult to estimate the amount of wealth that has transferred to the top over the last 30 years.  The data provided by Edward N. Wolff, a leading authority on U.S. wealth distribution, [15] shows not only that wealth inequality was considerably higher than income inequality in 2007, but that the concentration of wealth at the top has not changed much over the last 30 years:

Top 1% Share

                    Year                                             Income             Net Worth     Non-Home Wealth                                        

                1983 (1982 for income)              12.8%                   33.8%                   42.9%

                2007 (2006 for income)            21.3%                   34.6%                   42.7%          

                2010                                                                            35.5%                   42.1%  

At the beginning of the Reagan Administration, significant income and wealth concentration already existed in the United States, and the top 1% owned about 43% of financial (non-home) wealth.  The concentration of reported wealth did not change much thereafter, despite a near doubling of the top 1% share of income.  The question arises, with the top 1% income concentration nearly doubling, why hasn’t wealth concentration increased noticeably?  

One part of the answer may be that because net worth is much greater than GDP (nearly four times larger in 2010), its rate of change in response to income inequality should be much lower; note, however, that since the Crash of 2008 U.S. wealth inequality data has begun to show some material growth. Another part of the answer appears to be that much of U.S. top 1% wealth in recent years is not reflected in these data because it is held in “offshore” accounts, a matter that in 2012 began to attract a great deal of new attention. [16] Thomas Piketty has observed: 

So far, we have not taken this (offshore money) into account in the World Top Incomes database.  We tried always to be very clear that [our results are] certainly a lower bound, not only for the level of inequality, but probably for the trend as well. [17]

This important topic needs more attention.

Conservatively assuming that the top 1% share of net worth has been a constant 34% (although according to the Wolff data it rose to 37-38% from the mid-1980s to the late 1990s), using Census Bureau net worth data and the GDP deflator provided by St. Louis Fed. Research, I have computed that the top 1% share of net worth, in 2010 dollars, grew about $11.8 trillion from 1982 to 2010.  According to census data, there were about 306 million people in 2010 in the bottom 99% of the U.S. population.  In 2010 dollars, this works out to a transfer from the bottom 99% to the top 1% of about $38,560 per capita. That’s nearly $1,400 annually of per capita economic rent, or “excess earnings,” going to the top 1%.

Conclusion

Governments in the U.S. cannot regulate the rates of all monopolies or near-monopolies, and it is impossible to prevent the taking of “excess earnings.”  The amount of reported wealth transfers to the top 1% since 1980 is startling and, quite frankly, sobering. This enormous redistribution of wealth from the bottom 99% has already caused substantial damage, and the process continues. The ultimate and crucial question is this: What are the basic income and wealth distribution requirements for U. S. survival? Fortunately, a market-based society can regulate the amount of excess earnings it allows the wealthy to keep: It can tax them back down.  But it must have the intelligence, and the will, to do so.

______

[1] “’Capital’ Gains and the Future of Free Enterprise,” by Mason Gaffney, Workpapers, rev. December, 1991 (here).

[2] The 2013 Economic Report of the President, p. 60 (here).

[3] Joseph E. Stiglitz, The Price of Inequality: How Today’s Divided Society Endangers Our Future, New York and London, W. W. Norton & Company, 2012, pp. 79-80.

[4] Paul Krugman, End This Depression Now!,  W.W. Norton & Company, NY (2012) pp. 81-82.

[5] John Maynard Keynes, The General Theory of Employment, Interest, and Money, 1935, New York and London, Harvest/Harcourt, Inc., 1953, 1964 ed., 1991 printing, Preface, p. viii.

[6] “Optimal Taxation of Top Labor Incomes: A Tale of Three Elasticities,” by Thomas Piketty,  Emmanuel Saez, and Stefanie Stantcheva, , DP No. 8675  (CEPR, November, 2011) (here), p. 50.

[7] The General Theory, supra, p. 374.

[8] Concurring Opinion in Jocobellis v. Ohio, 378 U.S. 184 (1964).

[9] The Price of Inequality, supra, pp.96-97.

[10] Henry George, Progress and Poverty, San Francisco 1879, Bob Drake, editor,  the Robert Schalkenbach Foundation, Fourth Edition, New York 2006, p. 28.

[11] The Price of Inequality, supra, p 32.

[12] See, e.g., Nomi Prins, It Takes a Pillage, John Wiley & Sons, NJ (2009); Jacob S. Hacker and Paul Pierson, Winner-Take-All Politics, Simon & Schuster, NY (2010); Barry C. Lynn, Cornered: The New Monopoly Capitalism and the Economics of Destruction, Wiley & Sons, NJ (2010); see also David Cay Johnston, The Fine Print, Penguin Group, NY (2012), and Free Lunch, Penguin Group, NY (2007).

[13] Cornered, supra, p. 6.

[14] “An industry in disconnect,” by Eric Nalder , Albany Times Union, January 13, 2012 (here).

[15] “Recent Trends in Household Wealth in the United States: Rising Debt and the Middle-Class Squeeze – an Update to 2007,” by Edward N. Wolff, Working Paper No. 589, Levy Economics Institute of Bard College, March 2010, p. 3 (here); 2010 data reported in “Wealth, Income and Power,” by G. William Dumhoff (here).

[16] See, e.g., ”The Price of Offshore Revisited: New Estimates for Missing Global Private Wealth, Income, Inequality, and lost taxes,”  by James S. Henry, the Tax Justice Network, 2012 (here) and “Wealth doesn’t trickle down  - it just floods offshore, research reveals,” by Heather Stewart, The Observer, July 21, 2012 (here); Paul Buchheit argues from the TJN study that an estimated $8-12 trillion of U.S. money could be “stashed in far-off hiding places” — “Ten Numbers the Rich Would Like Fudged,” by Paul Buchheit, Common Dreams, November 19, 2012 (here).

[17] “Inequality: You Don’t Know the Half of It,” by Nicholas Shaxson, John Christensen and Nick Mathiason, The Tax Justce Network, July 22, 2012, pp. 10-11 (here).

The Growth of U.S. Income Inequality

The United States has the highest level of income inequality among wealthy nations, and the highest level of correlated health and social problems, both by wide margins. [1]

This status was achieved by the United States over three decades during which the bottom 99% lost one-fifth of its share of total income (GDP).  As shown on the graph of the Piketty/Saez data shown in the previous post, the percentage of total GDP taken by the top 1% of income earners increased from 8.9% to 23.5% between 1976 and 2007, for a 14.6% reduction in the bottom 99%’s  share of total income. [2]  Total GDP in 2007 was $13.8 trillion, so the bottom 99% was getting $2.0 trillion less that year than if income were distributed as it had been in 1976.  That lost income averages, among the 111 million estimated 2007 U.S. households, $18,300 per bottom 99% household. And this considerable loss of the buying power of most Americans took place before the 2008 crash.

Over these three decades, income inequality has skyrocketed.  Some examples: from 1979 to 2007, total top 1% real household pre-tax income grew by 224%, and top 0.1% real household pre-tax income grew by 390%, while the entire bottom 90%’s real income grew by only 5%; [3] the multiple by which average corporate CEO pay exceeds a typical worker’s income rose from 42 times in 1980 to 343 times in 2010; [4] and in 2006 a group of 25 hedge fund managers “made three times as much money as [all of] the eighty thousand New York City schoolteachers.” [5]

Near the bottom, the 2009 median real incomes of Americans with high school diplomas ($32,900 for men and $25,000 for women in 2009) were below the poverty threshold for a household of eight ($35,300), while the median real incomes of college graduates ($51,000 for men and $40,000 for women in 2009) were only marginally above that poverty threshold; [6] when median incomes of college graduates are adjusted to net out the average cost of a college education, the 2009 median income for a female college graduate (about $35,000) was also below the $35,300 poverty threshold for a household of eight. [7] 

These remarkable statistics on increasing income inequality only begin to convey the true enormity of the distribution problem.

Inequality and Growth

As Kuznets anticipated, this significant contraction of the bottom 99% economy necessarily entails an extreme reduction of overall growth. Total per capita income grew 90% over the first of two comparable 30-year periods (1946-1976), but only 64% over the following 30 years (1976-2006). [8] Here is the distribution of average annual real income growth published by both the Economic Policy Institute and the President’s Council of Economics Chairman Alan Krueger: [9]

                              1947 to 1979                1979 to 2010

Lowest fifth                     2.5%                                -0.4%

2^nd fifth                            2.2%                                  0.1%

Mid fifth                           2.4%                                  0.3%

4^th fifth                             2.4%                                  0.6%

Top 5^th                              2.2%                                  1.2%

Why would rising income inequality cause overall income growth to decline?  The salient observation was made by Joseph Stiglitz, as quoted in the last post: “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.” Accordingly, as income becomes more concentrated at the top, aggregate consumption and income growth necessarily decline.

Because income inequality growth is a systemic problem, it has no natural tendency to correct itself or stabilize.  Indeed, the U.S. income contraction is now accelerating. All growth has ceased except within the top 1%. Saez reports [10] the following figures for the allocation of income growth between the top 1% and the bottom 99%:

Period                                        Top 1%                 Bottom 99%

1923-1929                                 70%                                     30%

1960-1969                                   11%                                   89%

1992-2000                                  43%                                   57%

2002-2007                                  65%                                   35%

2010                                               93%                                     7%

2009-2011                                  121%                                  -21%

The 65% top 1% share of income growth from 2002-2007 (before the Crash of 2008) is comparable to the 70% of growth that went to the top 1% in 1923-1929 before the Great Depression.  The 121% top 1% growth in 2009-2011 means that the only growth now taking place is high within in the top 1%.  This is reflected in the near-exponential inequality growth within the top 1%: [11] 

       Group           2010 share     2010 ave. income     2010 over 1980

Top 1%              19.8%                  $1,019,098               2.36x

Top 0.1%            9.52%               $4,906,513                3.34x

Top 0.01%         4.63%             $23,846,950                4.32x

Income concentration in the top 0.01% is now accelerating, and virtually the entire rest of the economy is losing ground.

Small Business Income 

Most of the discussion about inequality so far has focused on the reasons for labor’s declining share. The 2013 Economic Report of the President, for example, reports: “Proposed explanations for the declining labor share in the United States and abroad include changes in technology, increasing globalization, changes in market structure, and the declining negotiating power of labor.” [12] 

Direct labor share suppression is important, but except for the lowest quintile, it is a relatively minor part of the problem.  Lower 99% capital suppression — the suppression of small businesses within the middle class — is a bigger factor.  The bottom 99% has unavoidably experienced a severe decline in capital income as well as labor income.   

A 2011 Congressional Budget Office study of the major income sources [13] shows corporate and small business income concentrating faster than labor income from 1979-2007. “Corporate” income refers to the gains from distributed earnings of large corporations.  “Business” income refers to the earnings of small businesses —  partnerships and smaller,  apparently mostly privately held, corporations.  

The increase in the top 1% share of corporate income is not surprising, since the top 1% share of total income has been at or below 24% while the top 1% has held 42% or more of financial wealth over these three decades. But the concentration of small business income, which was also more highly concentrated in 1979,  also grew far more than the inequality of labor income: The top 1% share of small business income grew from less than 20% to more than 45% over these years.  

This shifting of small business income to the top 1% reflects the decline of local small businesses and of the middle class in general, as large corporations like Walmart have acquired their retail market shares.  Mega-corporations like Walmart and Home Depot have consolidated their market power in producer, wholesale and and retail markets as they grew through mergers and acquisitions, after the demise of anti-monopoly law enforcement that began in earnest in 1980. [14]  

The most highly concentrated income source is capital gains, of which 75% were going to the top 1% by 2007.  Thus, while the bottom 99% income share plunges in 2013, many corporations have reported all-time record profits, and the stock market has posted all-time highs.  

Stagnation

In 2009, Paul Krugman wrote: “Over the past year, by a number of measures, the world has experienced a slump every bit as severe as the first year of the Great Depression.” [15]  A “depression” is an abnormally severe downturn lasting more than a few months, and the so-called U.S. “Great Recession” is now more than four years old.

With the steady contraction of the bottom 99% economy since the 1970s, not surprisingly, recessions have progressively become deeper and longer-lasting.  Using its Payroll Employment Index (PEI), the Bureau of Labor Statistics has charted the length and severity of the last six recessions: [16] 

By that measure, the latest downturn, which began in September 2008, is by far the worst since WW II. [17] Employment bottomed out in January 2008, two years into the “Great Recession,” with a -6.4 “percent job loss from peak,” and it has gradually improved since. But the economy must add 200,000 new jobs per month for employment to return to the pre-recession peak, not counting the additional new jobs needed for normal growth, [18] by February 2016, 6.5 years after the “Great Recession” began.

Although 181,000 jobs were added in January 2013, and over 200,000 in February, only 88,000 jobs were added in March.  The media focus has been on whether the contraction resulting from the $85 billion federal spending cuts mandated by the March 2013 “sequestration” has begun to kick in.  Regardless, severe sequestration impacts are expected, ranging from the CBO forecast of a 750,000 job reduction in 2013 [19]  to an Aerospace Industries Association (AIA) projection of 2.14 million job losses in FY 2012 and 2013, nearly half of which “would come from small businesses.” [20]  According to the AIA study, “the unemployment rate will climb above 9 percent . . . reducing the projected growth in 2013 by two-thirds.”

Many economists focus on the gradual decline of the unemployment rate (7.6% in March 2013) as a sign of gradual recovery to “normal,” but even mainstream media has reported that the “participation rate” – the percent of non-working people actively looking for work – has fallen to the lowest level since 1979.  It has become impossible to predict when, if ever, 2007 job levels will be restored.  

(May 3 update: I’ve added following graph to clarify this point:

The New York Times on Friday, May 3, reported that the unemployment rate had fallen to 7.5% in March. [21] But in a companion article, “Keeping Up, Not Getting Ahead,” the point illustrated by this graph of BLS data was made: “The American economy continues to add jobs in proportion to population growth. Nothing less, nothing more.” [22] In terms of the share of adults with jobs, there has been no improvement in three years and there is no apparent prospect in this trend of returning to the pre-depression level of the share of adults with jobs by February, 2016.)  

Perpetually high unemployment, however, is only part of the stagnation problem: As unemployment rose sharply in 2010 from about 5% to 10%, the median income fell by 10% during 2010 and 2011. [23] Reduced pay rates and hours worked translate into reduced income and growth, and less job creation. Other signs of growing depression since 2010 — reports of which are becoming increasingly common as 2013 unfolds — include growing poverty, an increasing foreclosure rate, declining construction and infrastructure, reduced educational opportunity and mobility, downsizing and closure of schools and essential government services, and the decline and bankruptcy of cities, towns and small businesses. 

Conclusions 

This review of the last thirty years of growing income inequality in the United States makes several things abundantly clear:

(1) Income distribution has enormous economic significance.  By 2007, the declining income share of the bottom 99% had reduced its purchasing power by $2 trillion per year, more than $18,000 per lower 99% household.  After the Crash of 2008, median income tumbled another 10% while unemployment jumped to 10%.  (I have mentioned without documenting other important indicia of depression, because we are all becoming increasingly aware of them, and a detailed review is beyond the scope of this post.) Declining purchasing power means lower consumption, and the lesson of Keynesian macroeconomics is that means lower investment and economic contraction;

(2) This is a destabilizing contraction: The faith of economists discussed in the previous post that a market economy will eventually return to full employment on its own is baseless.  The ever-widening income gap, and an accelerating growth of inequality, confirm that whatever stabilizing forces are imagined to exist, or that might exist if the problem was simply temporary swings in the “propensity to consume” out of a stable level of income, truly do not.  Recessions have become progressively worse since 1980, and we’re now in a depression with no end in sight;

(3) The increase in income inequality is directly linked to a severe decline in income growth which, as discussed in more detail in the next post, can only be explained by the removal of vast sums of money from the active economy of the bottom 99% and sequestered (as inactive wealth) within the top 1%. Moreover, over time the destination of the wealth transferred up from below has narrowed to individuals very high up within the top 1%, possibly mostly within the top 0.1%-0.01%.

The contraction of demand and income growth inherent in growing income inequality make it clear that the appearance of another depression has been no coincidence.  There are effectively two economies now, a “providing” economy and a “taking” economy, and the reports of aggregate income and other aggregate data, as Simon Kuznets warned back in 1955 (and as Joseph Stiglitz warns today), have become all but useless.  

The next post takes a closer look at theoretical aspects and policy ramifications of the inequality problem: Since vast quantities of money are now being siphoned up from the bottom 99% and a portion of the lower end of the top 1%, the proper response is not to stimulate demand through expansionary fiscal policy. When inequality is rapidly growing, that hasn’t worked.  People whose income share is declining have insufficient demand because of their inadequate and declining purchasing power; therefore, increasing government spending without correcting the causes of inequality growth can’t reverse the decline and stimulate growth.           

JMH – 4/29/2013; updated 5/3/2013; conclusion clarified 5/4/2013

______

[1] Richard Wilkinson and Kate Pickett, The Spirit Level, New York, Bloomsbury Press (2010).  The indexed health and social factors include life expectancy, math and literacy, infant mortality, homicides, imprisonment, teenage births, trust, obesity, mental illness (including addiction) and social mobility.  Wilkinson and Pickett also studied the individual relationship of the various factors to income inequality.  The measure of income inequality was the ratio of top and bottom 20% (quintile) average incomes, which shows a much less pronounced inequality level than the 1%/99% ratio.  These results have not been widely criticized, but not successfully challenged.

[2] See, e.g., “Income Inequality In the United States, 1913-1998,” by Thomas Picketty and Emmanual Saez, Working Paper 8467 (National Bureau of Economic Research, September 2001) (here);   “How Progressive is the U.S. Federal Tax System? A Historical and International Perspective,” by Thomas Piketty and Emmanuel Saez, Journal of Economic Perspectives, Volume 21, Number 1, Winter 2007,  pp. 3–24 (here);  and “Optimal Taxation of Top Labor Incomes: A Tale of Three Elasticities,” by Thomas Piketty,  Emmanuel Saez, and Stefanie Stantcheva, , DP No. 8675  (CEPR, November, 2011) (here).

[3] Economic Policy Institute (EPI) analysis of Piketty/Saez data (2008); “Snapshot: Incomes rising factest at the top,” by Arin Karimian, The EPI blog (October 20, 2011) (here).

[4] AFL-CIO study, reported at “CEOs earn 343 times more than typical workers,” by Jennifer Liberto, CNN Money (April 20, 2011) (here).

[5] Paul Krugman, End This Depression Now!, New York & London, W.W. Norton & Co. (2012), p. 82.

[6] These conclusions are based on a study I conducted in 2012 of trends in income levels for men and women with and without college and advanced levels of education.   Income data are from from Fast Facts, Institute of Education Sciences (IES), National Center for Education Statistics (here);  Poverty threshold data (updated for inflation) are from the U.S. Dept. of Commerce, Bureau of the Census (here).

[7] I used present value computations from a study by Skidmore economist Sandy Baum, U.S. News and World Report, October 30, 2008 (here).

[8] “Average Income in 2006 up $60,000 for Top 1 Percent of Households, just $430 for bottom 90 Percent: Income Concentration at Highest Level Since 1928, New Analysis Shows,” by Chye-Ching Huang and Chad Stone, Center on Budget and Policy Priorities (CBPP), rev. October 22, 2008 (here); “A guide to Statistics on Historical Trends in Income Inequality,” by Chad Stone, Danilo Trisi and Arloc Sherman, CBPP (rev. October 23, 2012) (here).

[9] EPI (updated, October 5, 2012); “Family Income Growth in Two Eras,” by Alan Krueger, Reuters, January 13, 2012 (here).

[10] “Striking it Richer: The Evolution of top incomes in the United States”, by Emmanuel Saez, March 2, 2012 (here); updated with 2011 estimates , January 23, 2012 (here).

The outstanding faults of the economic society in which we live are its failure to provide for full employment and its arbitrary and inequitable distribution of wealth and incomes. – John Maynard Keynes [1]   

It was late in 2010 when I first saw a version of this graph showing changes in the share of total U.S. pre-tax income for the top 1% of incomes from 1913-2007. [2] It shows the top 1% share peaking in 1928 at 23.9%, one year before the stock market crash of October 29, 1929 ushered in the Great Depression.  Following WW II, that share gradually declined for three decades as prosperity grew, from 12% in 1946 to a low of 8.9% in 1976.  Then in 1980 the trend abruptly reversed and the top 1% share grew over the next three decades to 23.5% in 2007, one year before America’s worst-ever stock market crash on September 20, 2008 ushered in the “Great Recession.”

This kind of graph, and this kind of data, are new to economists, most of whom had not previously paid any attention to income distribution.  There has been a delayed response to the emergence of this data: It was not until 2012 that some of the most prominent U.S. economists even began to weigh in publicly on whether this correspondence between high income inequality and stagnation is more than just coincidental:  Nobel Laureate Paul Krugman, who did not address income inequality in his previous book on depression-era economics, [3] said this in his latest book, published in May of 2012: “The fact that a return to pre-Depression levels of inequality was followed by a return to depression economics could be just a coincidence.” [4] In his view, “rapidly rising incomes at the top” reflect “the same social and political factors that promoted lax financial regulation.” [5] Two months later, in his new book on inequality, fellow Nobel Prize winner Joseph Stiglitz remarked:  “It is perhaps no accident that this crisis, like the Great Depression, was preceded by large increases in inequality.” [6] Unlike Krugman, Stiglitz links inequality growth to aggregate demand and to overall income growth. 

The underlying question is whether the distribution of money within populations has macroeconomic significance, and the abundance of caution shown by economists in addressing that question shows how profoundly the emergence of detailed income distribution data has changed their world.  Phrasing these questions conversely may make them easier to answer: How could the amount of money most people possess lack macroeconomic significance? If income and wealth distribution does have material economic significance, how could the association of high inequality with depression be a coincidence?  

This graph reveals a close correspondence between growing income inequality and stagnation that was previously invisible: the growth of inequality was overlooked for years, because aggregate income (GDP) data hide income redistribution between the top 1% and the bottom 99%.  The income share data reveal a steady contraction of the bottom 99%’s share of the economy since 1980, suggesting that the increased concentration of income and wealth within the top 1% is related to the market crash in 2008 and the even worse decline that followed.  It further suggests that, unless the causes of this continuing inequality growth are reversed, the U.S. economy is headed inevitably for Great Depression II.  Hence, there is an urgent need to understand how inequality affects growth and prosperity.

As a career practitioner of regulatory economics, required by law to limit utility earnings to “reasonable returns” on investment, my initial impression was that excessive corporate profits have resulted in greater allocations of income and wealth to the top 1%, leaving too little money for everyone else.  Although that explanation is essentially correct, it has not been obvious to most economists.  

Those of us learning economics in the early 1960s were taught that Keynes had solved the depression problem, but as discussed in the previous post, Keynes’s General Theory took no account at all of wealth and income distribution, which he described in the above quotation  as “arbitrary.” Keynes’s “General Theory of Employment” included only determinants of demand and investment: (1) the interest rate; (2) the economy-wide “propensity to consume”; and (3) the “marginal efficiency of capital” (which is equivalent, over an entire economy, to the “cost of capital” used to set rates on regulated services).  

As noted in the previous post, Keynes expressly assumed that optimal demand would produce full employment, and that maintaining full employment would solve the “poverty” problem. But importantly, in Keynes’s model the levels of demand, employment, and investment do not depend in any way on the distribution of income and wealth; aggregate income (GDP) does not change with growing inequality. Accordingly, virtually all Keynesians have since ignored distribution presuming, as the Keynesian model effectively requires them to do, that growing inequality lacks macroeconomic significance.

One distinguished economist, however, believed otherwise.  When income inequality was falling in the 1950s, Nobel laureate Simon Kuznets, though hampered by an “extreme scarcity of relevant data,” argued insightfully that income distribution is a key determinant of growth:

Without  better knowledge of the trends in secular income structure  and of the factors that determine them, our understanding of the whole process of economic growth is limited; and any insight we may derive from observing changes in countrywide aggregates over time will be defective if these changes are not translated into movements of shares of the various income groups. [7] 

The data Kuznets (and Keynes) lacked is available today, however, and it offers a more complete understanding of how market economies work.

Instability and Growth

Keynes understood market economies to be inherently unstable, always tending toward decline and unemployment, and his explanation for this tendency revolutionized economics:  classical theory assumed that following a downturn an economy would always return to full employment “equilibrium” as savings and investment equilibrate; however, in a dynamic economy capital investment and job creation depend on expectations of future demand, and expected future returns on investment, which typically decline with falling consumption; thus, a decline in consumption leads to less, not more, investment and employment:

A decreased readiness to spend will be looked on in quite a different light if, instead of being regarded as a factor which will [all else equal] increase investment, it is seen as a factor which will [all else equal] diminish employment. [8] 

The central government could counter such slumps, Keynes argued, by stimulating demand and growth with monetary policy (lowering interest rates) or fiscal policy (deficit spending).

This “demand-side” explanation of how markets work, as the distinguished macroeconomist and Nobel Laureate James Tobin put it in 1997,  implies that “our market capitalist economy, left to itself, without government intervention,” does not “systematically return, reasonably swiftly, to a full employment state whenever displaced from it.” [9] Since the 1970s, however, mainstream economics has retreated back into the classical model, rejecting that conclusion:  “Most economists believe that a market economy is a self-correcting system,” Clifford W. Cobb wrote in 2009, [10] and James Galbraith recently concurred:

The deepest belief of the modern economist is that the economy is a self-stabilizing system. This means that, even if nothing is done, normal rates of employment and production will someday return. Practically all modern economists believe this, often without thinking much about it. [11]

This dubious faith in an automatic return to full employment after a typical fluctuation in spending on consumption or investment, such as a mild recession, denies that the instability of growth Keynes identified as resulting from such fluctuations in demand will be anything but temporary.  As such, this view, especially when motivated by a desire to minimize central government action through fiscal or monetary policy, retreats to the classical theory’s assumption of automatic adjustment to full employment equilibrium.  

According to Tobin, whether modern capitalist economies, left on their own without government supervision, “systematically return, reasonably swiftly, to a full employment state whenever displaced from it,” is one of “the central questions before economists of our generation.”  [12]  As Cobb and Galbraith suggest, Keynes’s negative answer to that question has apparently been rejected by most economists.

Introducing the Inequality Factor   

That is unfortunate, for the instability created by normal fluctuations in demand and investment, self-correcting or not, is only a minor aspect of the instability problem.  The entire debate over The General Theory ignores the far more substantial effects of growing inequality. Inequality results from structural changes in an economy — such as the development of monopolistic market power, the decline of trade unionism, or the effects of technological change — that affect income levels and wealth accumulation.  Unlike aggregate demand, these factors do not appear to have arguable cyclical or ebb-and-flow tendencies; the consistently unfailing purpose of capitalism is to maximize profits.  

Growing income inequality also causes aggregate demand to decline. As Joseph Stiglitz explained:

[W]hen money is concentrated at the top of society, the average American’s spending is limited. * * * 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. [12]

Thus, when money transfers to people in the top 1% who have the lowest propensity to consume, the growing concentration of income itself reduces consumption and growth. People in the bottom 99% end up spending less not because they decide to spend less, but because they have less money to spend.  A depression, with its massive unemployment, poverty, and starvation, cannot be explained as an aggregate decision by the vast majority of households to reduce their consumption.  And because the distributional instability problem is declining income, not declining demand, its solution will be found not in Keynesian policies designed to stimulate demand and investment, but in measures that will reverse the growth of inequality.  

Keynes’s General Theory and demand-side model did provide part of the explanation for instability and stagnation, and that was an important first step.  But the second step — recognition of the inherent tendency of unfettered capitalism toward an unstable distribution of wealth and incomes — is far more important. Paul Krugman’s characterization of distribution issues as “social and political” is more semantic than real — all economic questions are fundamentally social and political in nature. But to dismiss distribution issues this way begs the questions posed by growing inequality: What happens when more and more of an economy’s money — its income and wealth — is transferred into the hands of a progressively smaller group of people? Why has so much money been transferring up over the last three decades? What are the transfer mechanisms, how are they created, and how can they be controlled?   

The answers to these questions reveal a major, and stunning, flaw in Keynes’s model. Recall this premise to Keynes’s model, cited in the previous post:

[T]he national income depends on the volume of employment, i.e. on the quantity of effort currently devoted to production. . . [T]here is a unique correlation between the two.  [14]

As discussed, Keynes intended to specify in his model the most important determinants of aggregate income, and his system of recommendations for government action is based upon using his model’s three determinants to maximize income (GDP).  As this quotation reveals, his approach depends on the assumption that “the national income” represents “the quantity of effort currently devoted to production.”  In other words, his model assumes that all income is compensation for actual production, for the creation of real value. This amounts to the assumption that there is no collection of excessive income or accumulation of extraordinary wealth by people at the top for which no real value has been created — i.e.,  that there is no collection of “economic rent.”  As discussed in a later post in this series, the collection of massive quantities of economic rent lies behind the inequality crisis.  This is the primary engine driving inequality growth and stagnation, and it explains why the Keynesian model fails to work.     

Not surprisingly, the newly available income share data reveal that traditional Keynesian demand stimulation offers both an inadequate level of response and the wrong kind of response to rising income inequality.  As income growth concentrates more and more at the top, even carefully targeted deficit spending may do little to counter the upward redistribution of wealth, and it will likely have minimal effect on the continuous and accelerating concentration of U.S. income.  

To determine the best policies for the United States today, it is necessary first to review the scope and nature of American inequality growth over the past thirty years.  The next post in this series provides such a review.

JMH – 4/27/2013

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[1] John Maynard Keynes, The General Theory of Employment, Interest, and Money, 1935, New York and London, Harvest/Harcourt, Inc., 1953, 1964 ed., 1991 printing, p. 372. (For a fuller  understanding of Keynes’s General Theory  and his full employment model, see especially: pp. 30-32; Book 3, “The Propensity to Consume”; Book 4, “The Inducement to Invest,” esp. Chs. 11-14, and 18, “The General Theory of Employment Restated”; and Ch. 24.)

[2] Robert B. Reich, Aftershock: The Next Economy and America’s Future , NY, Alfred A. Knopf (2010), p. 21.  The graph is constructed from the database of Thomas Piketty and Emmanuel Saez: See, e.g., Journal of Economic Perspectives, Vol. 21, No. 1, Winter 2007, pp.3-24; and with Stephanie Stantcheva, DP No. 8675 (CEPR, November, 2011).

[3] Paul Krugman, The Return of Depression Economics and the Crisis of 2008, W.W. Norton & Company, NY (1999, 2009).

[4] Paul Krugman, End This Depression Now!,  W.W. Norton & Company, NY (2012) p. 82.

[5] Ibid.

[6] Joseph E. Stiglitz, The Price of Inequality: How Today’s Divided Society Endangers Our Future, New York and London, W. W. Norton & Company, 2012, pp. 84-85.

[7] “Economic Growth and Income Inequality,” by Simon Kuznets, The American Economic Review, Vol. 45, No. 1, (March, 1955), p. 27.

[8] The General Theory, supra, pp. 184-185.

[9] “An Overview of the General Theory,” by James Tobin, Cowles Foundation Paper (here),  947 (1997) (here), p. 4.

[10] Clifford W. Cobb, Introduction, After the Crash: Designing a Depression-Free Economy - Selected Works of Mason Gaffney,  MA, Wiley-Blackwell (2009), p. 3.

[11] James Galbraith, Presidential Address, Association for Evolutionary Economics (January 5, 2013).

[12] James Tobin, op. cit.

[13] Joseph E. Stiglitz, The Price of Inequality: How Today’s Divided Society Endangers Our Future, supra at 84-84.

[14] The General Theory, supra, p. 246.