The Terrifying Truth About Economics

This post, and a follow-up post, are about the extremely dangerous economic and political predicament of the United States in 2016. With regard to our economic situation, the danger of another crash, and a complete collapse into another Great Depression within a very few years, is much more serious than nearly everyone imagines. The “truth about economics” is that inequality of income and wealth itself has enormously debilitating effects that academic economics does not comprehend, because the study of income and wealth distribution has been suppressed for over a century. A thorough study of inequality’s causes and effects leads to conclusions that are very frightening.

In her acceptance speech at the Democratic convention (7/28/16), Hillary Clinton offered an opinion that has been pretty much overlooked by the media: “I believe that our economy isn’t working the way it should because our democracy isn’t working the way it should.” This little-noticed point is certainly true in its most obvious sense: Dysfunctional democracy leads to economic failure. Unless the institutions needed for a stable economy are created and preserved, through democratic government, the economic power inherent in the possession of wealth will prevail over the interests of the many. But the opposite frame of this causal relationship is perhaps even more significantly true: “Our democracy isn’t working the way it should because our economy isn’t working the way it should.”

Economic failure seriously affects democracy as well, and this reverse focus allows us to perceive the great power of economic systems, and to understand their social consequences. This year’s presidential race is all about economics, yet economic reality has receded into the background of the media tempest. A pervasive reason for this is the massive confusion in the media and in academia attending the causes of our persistent decline, which everyone can clearly feel, but no one successfully explains.

The Problem of Simplistic Thinking

Consider the illuminating observations about cause and effect by Berkeley professor of linguistics and cognitive science George Lakoff (“Understanding Trump,” The Blog, The Huffington Post, here), on the topic of “Direct vs. Systemic Causation”:

Direct causation is dealing with a problem via direct action. Systemic causation recognizes that many problems arise from the system they are in and must be dealt with via systemic causation. Systemic causation has four versions: A chain of direct causes. Interacting direct causes (or chains of direct causes). Feedback loops. And probabilistic causes. Systemic causation in global warming explains why global warming over the Pacific can produce huge snowstorms in Washington, D.C.: masses of highly energized water molecules evaporate over the Pacific, blow to the Northeast and over the North Pole and come down in winter over the East coast and parts of the Midwest as masses of snow. Systemic causation has chains of direct causes, interacting causes, feedback loops, and probabilistic causes — often combined.

Direct causation is easy to understand, and appears to be represented in the grammars of all languages around the world. Systemic causation is more complex and is not represented in the grammar of any language. It just has to be learned.

Empirical research has shown that conservatives tend to reason with direct causation and that progressives have a much easier time reasoning with systemic causation. The reason is thought to be that, in the strict father model, the father expects the child or spouse to respond directly to an order and that refusal should be punished as swiftly and directly as possible.

The most simplistic of economic ideologies involve ideas invoking perceptions of direct causes and effects, or a chain of direct causes. But we need to recognize that systemic causation exists and is enormously significant. For example, the conservative argument against raising the minimum wage is that doing so will discourage investment and employment, shrinking the economy. But this perspective is the opposite of the truth, as “feedback loops” are involved here. If every employer is paying a minimum wage, no disadvantage from doing so is experienced by any employer. And with all the additional demand flowing from the higher wages, sales improve across the board. Thus, the net effect of increasing the minimum wage is to stimulate, not depress, economic growth. (With an increase in the minimum wage, only those employers who have gained an unfair advantage by paying to little will suffer, and they will suffer only the loss of that unfair advantage.)

The Problem of Denialism

Other major problems contribute greatly to our inability to understand the powerful harm caused by inequality. One is the psychological tendency to deny unpleasant facts. Throughout history, myths and fantasies of all sorts, most of them driven by fear, have gained control of human minds. Climate denialism is driven by the powerful desire of wealthy interests to avoid change, and depletion of their wealth. By 2016, it had become abundantly clear that producers of fossil fuels had been denying the evidence of manmade global warming for decades. I’ll mention just one authoritative report that “Exxon has done a masterful job of hedging its bets, both by omission and commission omitting (from its SEC 10-K reports) for many years, and then grossly understating, the vast array of direct and indirect risks it faces as a result of climate change.” (Climate Science & Policy Watch, “Exxon Mobil and Climate Change: A Story of Denial, Delay, and Delusion, Told in Forms 10-K (1993-2000),” March 8, 2016, here.)

Hillary Clinton addressed climate change as well in her acceptance speech, stating: “I believe in science. I believe that climate change is real and that we can save our planet while creating millions of good-paying clean energy jobs.” In stressing that fighting climate change offers broad economic benefits as well as the benefit of preserving our social and environmental world, she echoed President Obama’s forceful presentation of the previous evening. This should not be the slightest bit controversial: It seems surreal that a major candidate for the presidency should have to argue on behalf of saving the planet. However, even after all that has been learned over the last decade, despite all of the predictions of melting ice, rising sea levels, receding shorelines, and species extinctions established by science, the forces of capitalism are still strongly resisting the call to save our world.

This denialism is clearly motivated by the powerful interests of those with the economic power to do so to continue taking massive profits from the world’s most profitable corporate income source – fossil fuels. The wealthiest among us who are capable of doing so avoid acting to deal with the inevitable catastrophic effects of global warming. It matters not whether they are unconcerned about the fate of the planet, or blinded by a misguided faith that the huge costs of dealing with these effects, and even the effects themselves, will not significantly affect them. It should be regarded as insane, frankly, to deny the proven requirements of our survival: We are forced to conclude, therefore, that the interest of wealth preservation holds an insanely powerful grip on wealthy denialists.

It should not be surprising to learn, then, that since the earliest days of the Industrial Revolution more than 150 years ago an equally pernicious denialism has exercised great control over the development of mainstream economic thinking. The “neoclassical” economic ideology that promotes the virtue of profits, and champions capitalism over all other forms of socioeconomic organization, completely dominates mainstream academia today. Classical economics, as discussed below, began with intense concern about poverty and inequality in the 16th through 18th Centuries, but with the advent of “capitalism” and the Industrial Revolution, the classical philosophy atrophied, and by the Great Depression of the 1930s it was all but dead — and with the demise of classicism came the death of “scientific” economics.

The Limited Growth and Cloistering of Factual Knowledge  

The human mind, with its penchant for mythology and religious ideology, readily accepts comforting ideas that seem plausible on their face, but cannot survive factual or even, in many cases, logical scrutiny. Neoclassicism relies on a host of such fanciful, imaginary ideas: Over its first few centuries, economic ideology developed mainly through philosophical thought, without the benefit of much useful data. Thus, imagination has pretty much ruled the development of ideology from the beginning. Verifiable, fact-based knowledge could not evolve properly, because the study of poverty and the distribution of income and wealth are especially data-intensive subjects. The necessary data, and the powerful computer technology needed to process and test it properly, until quite recently did not exist.

The ideas that evolved were stored away, mainly, in libraries and the files of academic institutions, cloistered and far less accessible than today. It has only been since development of the internet “cloud,” with its vast reservoir of information, that anyone outside of ivied halls of academia who wanted to invest the enormous time and effort needed to figure out “the economics of inequality,” and try to advance the economics discipline scientifically, could attempt to do so. Unfortunately, by the time that became feasible to do (well into the 21st Century), neoclassical thinking had ossified and formed a protective layer of institutional support that is all but impervious to challenge. Moreover, it appears, there are not many professional fact-finders like myself, whose careers were outside of the controlled environments of academia but nonetheless depended on objective, open-minded evaluations of economic issues, and who are old enough and sufficiently experienced in relevant areas of inquiry to advance the discipline and to thoroughly review the history of U.S. inequality unfettered by the biases of neoclassical thinking.

Stunningly, I appear to be the only person to do so thus far. Because I firmly believe that the survival of our democracy and our economy will require a much broader understanding of the extensive perils attending extreme inequality, I felt compelled to write a book and try to overcome the many obstacles it faces. Especially at this time, when the Democratic Party needs to spread feelings of optimism and hope, and remains itself substantially in the dark about the broader truths of dynamic income and wealth distribution, I remain quite frankly terrified about our future. For now, I feel virtually alone, like a modern-day Chicken Little, appearing to make a preposterous “the-sky-is-falling” claim. This election year, however, many untutored people are seeing firsthand what mainstream economics denies, just as “ordinary” people did during the Great Depression, when John Maynard Keynes first leveled his academic sights on neoclassicism.

I’ll return below to a discussion of how (and why) neoclassicism has drastically misled us, but first, I’ll identify what I feel are the main truths neoclassical ideology has been denying.

How Our Economy Really Works

            The following is a summary of my major ­conclusions about how market economies work, and in particular about the history of the United States experience with inequality and its effects, set forth in my e-book “Reinventing Economics: The Failure of Capitalism and the Economics of Inequality” ($9.99 at Amazon Kindle). This was a serious, scientific effort of several years, and the results, as I have said, are alarming. Here are the basic facts:

  • The most important factor determining decline or growth, depression or prosperity, is the degree of income and wealth inequality in the system;
  • At high levels of income and wealth concentration, such as exist today, GDP (income) growth is markedly slowed. The ultimate, inexorable result is depression, and it is government’s main job, therefore, to prevent the rise of excessive economic inequality;
  • Because it takes money to make money, and financial wealth compounds, once the conditions for inequality growth are established it continues steadily and exponentially;
  • American inequality began to grow with the Reagan Administration, and was intensified over subsequent GOP administrations, as taxes on corporate earnings and top incomes were drastically reduced;
  • Those tax cuts have been financed by growing national debt and shrinking government services (austerity). The national debt now (as of July 2016) totals over $19.4 trillion (“Federal Debt Clock,” here);
  • This amounts to a per capita national debt of $59,646 (as of 8/1/2016);
  • Top 1% financial wealth, including estimates of money removed to “off-shore” accounts to avoid taxation,  has risen even more,  by an estimated $23-25 trillion or more (between 1980 and 2014);
  • Bottom 90% incomes are stagnant, as almost all income growth is now going high in the top 1% and the top 0.1% of reported incomes; Incomes in the bottom 80% are declining, and wealth inequality is even higher and growing faster. The bottom 60% of American have zero wealth (net worth);
  • As net worth declines beneath the top 1%, debt increases, and debt bubbles are rapidly growing in student debt, automobile debt, credit card balances, and once again in mortgage debt. With low and gradually declining levels of consumer demand, investment in manufacturing and retail sectors is growing more stagnant;
  • Decline in the private sectors of the economy has meant declining tax revenues at all levels of government. The federal government has cut back on spending, but the GOP-controlled Congress has minimized the potential stimulation of “fiscal” policy by seeking to greatly reduce programs in which spending would aid lower-income people.

We’re in a Gradually Deepening Depression.

As data on inequality published by the Congressional Budget Office (CBO) reveals, the consequent “hollowing out” of the middle class, which has gained much attention this year, is due not as much to the repression of wages and incomes – which has been substantial – but to the even larger concentration of small business income at the top. Much of that is a consequence of the merger boom, in which large corporations have swallowed up smaller ones, and much of it relates to the ability of giant retailers like Wal-Mart to drive smaller competitors out of business.

For a number of years the Fed has hoped for enough growth to increase the basic “federal funds” rate, regaining monetary flexibility, and in December of 2015 a modest increase was hopefully implemented, for the first time since 2006 (See, e.g., Vox Explainers, Timothy B. Lee, ed., 12/16/15,  here), but prospects have since dwindled. This is a clear indication of stagnation. As Bill Bonner sums it up (Bonner & Partners, “Why Yellen Can Never Normalize Interest Rates,” Bonner & Partners, 4/6/2016, here ):

For the last eight years, the Fed has tried to stimulate the economy with ultra-low interest rates. Business, consumers, and government now almost all depend on credit… and most need ultra-low rates to make ends meet.

In his New York Times Op-ed, Paul Krugman occasionally observes that real interest rates in the United States, that is adjusted for inflation, are negative. This is a problem in Europe as well, as recently German investors were reportedly willing to purchase debt securities at nominally negative rates. Paying banks to hold your money signifies significant stagnation. The exception to Bonner’s statement, therefore, is the case of big businesses that do not, on average, need even lower ultra-low rates to prompt them to borrow, but instead have already amassed hundreds of billions of dollars of profit that idly await the expectation of profitable investment opportunities.

U.S. stock market indices have all the while boasted all-time record highs. To the average American, this means that our economy is doing well. However, it is a sign of the excessive cash balances held by the large banks and corporations. Large corporations that provide goods and services for public consumption, on balance, are not doing so well. Even the ultimate consumer retailer, Wal-Mart, which managed to become transform vertical and horizontal monopolistic market power into perhaps the largest retail giant in history, is now contracting, announcing in January 2016 the closing of 154 stores in the United States and 269 worldwide. (USA Today, 1/16/16, here). Faced with stagnant or declining demand, monopoly and oligopoly firms cut back operations to try to maintain optimal profits.

Thus the high level of stock market success reflects growing inequality, not real economic growth. In all likelihood, there are only a few more years before the next stock market crash, as one or more debt bubbles burst or the dollar collapses because the federal debt can no longer be serviced by raising still more debt.

Meanwhile, a U.S. federal debt crisis looms. Budget deficits have been continuous for decades, interrupted only by a brief period of surpluses during the Clinton Administration, made possible by the dot.com revolution and the investment of billions in a nationwide fiber optic network. Even then, income inequality increased sharply and top 1% income percentage grew rapidly. Throughout the 21st Century, federal debt has skyrocketed. This situation amounts to what the great French classical economist Jean-Baptist Say (1767-1832) referred to as a “perpetual annuity:” Principle is never repaid, and continues to earn interest perpetually. Worse, as the amount of outstanding debt continues to grow, the interest obligations continue to grow, exponentially.

Today, interest on the debt exceeds all discretionary government spending categories except for defense, and as I document in my book, the CBO in 2014 projected that net interest on the federal debt will exceed the entire defense budget by 2021. CBO also showed in 2014 that while the Obama Administration has succeeded in reducing deficits to nearly 2% of GDP by 2016, deficits will grow again, under a continuation of current policies, to over 4% of GDP by 2021, and 5% of GDP by 2025. But these are optimistic estimates, because CBO does not account for the dynamic effects of growing inequality.

This is all a direct consequence of growing inequality. In effect, too much money has concentrated at the top, and the federal government’s ability to stimulate the economy has been effectively stymied by regressive income and wealth taxation. As explained in my book, “the Quantity Theory of Money,” a tautology worked out in the 19th Century by the American economist Irving Fisher (1867-1947), among others, established that economic activity is constrained by the amount and velocity of money. My book explains how the QTM, expanded to account for income and wealth distribution, reveals the declining velocity of money attending growing inequality. This is a significant addition to economic theory, and it conclusively disproves some time-honored neoclassical myths, especially the “trickle-down” myth that the wealthiest among us can get richer without depriving others of real wealth.

Why “Neoclassical” Economics Misses All of This

            The mainstream story we get in the media is well off the mark. We are told that the economy is rebounding from the Great Recession, and that the economic future looks promising, but we are being thoroughly misled. Politics, as explored more thoroughly in the next post, provides part of the explanation for this: Even though President Obama and his policies are not responsible for our worsening situation, and in fact have restrained our growing depression, voters with no understanding of economics tend to  blame sitting presidents for the state of the economy. In an election year, the party in the White House is always anxious to nullify that impression. This year is only slightly unusual in that regard.

There are deep-seated academic reasons, however, for our misperceptions about how the economy works. The first seven chapters of my book contains a detailed history of the development of economic ideology, and this article will provide a brief summary of my findings:

Distribution, Until Quite Recently, Has Long Been Neglected

Although a preoccupation of the “classical” economists, the subjects of poverty and income and wealth distribution have been long neglected, and are relatively new to modern economics:

  • “Classical” economics began to develop in Europe during the Enlightenment, in the 17th Century (U.S. history.org, here). Ideas about trade, commerce, and production were explored by mainly British philosophers, notably from John Locke (1632-1704) to John Stuart Mill (1806-1873). These two are famous for their “liberal” views and support of personal freedoms. The first comprehensive text on classical ideas was Wealth of Nations, published in 1776 by Adam Smith (1713-1790). According to Smith, the “science” of political economy “proposes two distinct objects: first, to provide a plentiful revenue or subsistence for the people, or more properly to enable them to provide such a revenue or subsistence for themselves; and secondly, to provide the state or commonwealth with a revenue sufficient for the public services. It proposes to enrich both the people and the sovereign.” Smith and Mill were especially outspoken about the evils of poverty, idle wealth, and inequality;
  • All of the classical economists through Mill were “socialist” idealists, and Mill brought the classical school to near its zenith, just as the Industrial Revolution was beginning. In the late 19th Century, a new school — which has evolved into the modern “neoclassical” school — began to form around the idea that economics is about how to optimize personal profit and wealth. That school, for over 150 years, has ignored and suppressed the study and understanding of inequality, its mechanisms and its implications;
  • The early classical thinkers, notably Smith, T.R. Malthus (1766-1834) and David Ricardo (1772-1823), lived in a society experiencing severe epidemics and widespread poverty. They were greatly concerned with the topic of “economic rent,” and both Malthus and Ricardo opened their “Principles” books with that topic. Economic rent is compensation provided to individuals not contributing directly to production. In their day, these were the wealthy owners of agricultural land, a group especially despised by Smith for their perceived greed. Agriculture was labor intensive at that time, and “capital,” which consisted mainly of primitive plowing and harvesting equipment, was a relatively minor component of production. Thus, taxation aside, the amassing of great wealth by landowners was the major source of economic disparities;
  • The German Karl Marx (1818-1883) along with Friedrich Engels (1820-1895) expanded the idea of “economic rent” to include all profit, which by definition consists of compensation in excess of direct costs of production. Marx predicted that unconstrained capitalism would ultimately destroy itself, leading to depression, unless it evolved into a more socially sustainable system;
  • In the classical tradition, an American contemporary Henry George (1839-1897), author of Progress and Poverty (1879), saw the accumulation of land rents as the underlying cause of poverty and depression. Thus, he joined Marx in describing a basic mechanism for the growth of inequality. George’s fame and influence during his lifetime was enormous, but his legacy has since been mostly denigrated and forgotten;
  • During the Great Depression, the British economist John Maynard Keynes (1883-1946) published his General Theory of Employment, Interest and Money (1936). Keynes created an intellectual sensation by explaining how consumption, saving and investment change over time. Keynes was sharply critical of the growing neoclassical ideology for painting a static, overly optimistic picture of an economy, incapable of explaining or anticipating growth or decline — presenting, in his view, a snapshot of an economy at full employment. In this regard, he was critical of the fundamental supply and demand based ideology of Alfred Marshall (1842-1924) and Arthur Cecil Pigou (1877-1979), among others;
  • Keynes was arguably the last thinker in the traditional classical line. He wanted to explain aggregate change over time, something neoclassicism could not do. Marshall, for example, simply extended the concept of supply and demand “equilibrium” to an entire economy, pointedly presuming that economies will find optimal growth automatically. Keynes himself did not escape this paradigm entirely, however: His full employment model was based on the idea that economies are optimal at full employment, and he argued that government action would be needed to ensure full employment. Nonetheless he continued to talk in terms of “equilibrium” (using the term nearly 90 times in his book) despite the fact that his own general theory implied that no force existed that would automatically correct economic downturn, and stressed the importance of “effective demand” to stimulate investment;
  • Keynes opened his final chapter, in which he developed the policy implications he believed his full employment model presented, with this:  “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.” While inequality was on clearly on his mind, he nonetheless considered distribution to be arbitrary (and presumably without significant effect). That was fundamental error. The Austrian school, mainly Friedrich Hayek (1899-1992) attacked his idea that government “fiscal policy” (deficit spending) could stimulate investment and growth on the ground that inflation was a more likely consequence than growth. The Austrians had a point, but the debate has remained inconclusive, even as Keynes’s influence has drastically declined;
  • The dynamics of distribution will ultimately explain the outcome of that debate, for stimulation and growth ultimately depend upon the way the proceeds of government borrowing are distributed throughout the economy, and upon the dynamic effects of Keynes’s “principle of effective demand,” which was perhaps the salient feature of his general theory;
  • Distributional ideas could not be expected to develop in the absence of comprehensive data on the distribution of income and wealth. Two decades later, in 1955, the American economist Simon Kuznets (1981-1985) asserted that an understanding of how economies grow and change would require understanding the mechanics of income distribution and inequality. At that time he complained of a serious paucity of data;
  • Kuznets’s warning went unheeded in the second half of the 20th Century, when income inequality stopped declining in America and began it marked rise, until the French economists Thomas Piketty (Paris School of Economics) and Emanuel Saez (Berkeley) compiled a comprehensive database of U.S. income from income tax records for the entire period (about a century) of U.S. federal income taxation. Their database, which has enabled refined research, has been available only for a little over a decade.

The Neoclassical Stranglehold

No sense of how wealth and income distribution affect economic health and well-being has yet to gain a foothold in mainstream economics, and the very idea that inequality has dynamic effects still seems alien to even supposedly objective observers of the economic record. Indeed, I had to develop the basics of distributional macroeconomics on my own. (See Chapters 8-10 of my book).

The truth once uncovered is not hard to understand, and the American electorate increasingly gets it, at least as a visceral reaction to their own economic experiences. But only a  small minority of economic professionals – a short list that includes Robert Reich, Joseph Stiglitz, and Senator Bernie Sanders’s economic advisers – appear to understand the essential features of inequality dynamics. Mason Gaffney, the eminent Georgist economist and author of “The Corruption of Economics,” has long argued that the American neoclassical establishment corrupted economics in marginalizing Henry George and removing his popular ideas from academic orthodoxy. Here is an excerpt from Gaffney’s assessment of the consequences:

It took a generation, but by 1930 [the neoclassical school] had succeeded in reducing [Henry George] in the public mind. In the process of succeeding, however, they emasculated the discipline, impoverished economic thought, muddled the minds of countless students, rationalized free-riding by landowners, took dignity from labor, rationalized chronic unemployment, hobbled us with today’s counterproductive tax tangle, marginalized the obvious alternative system of public finance, shattered our sense of community, subverted a rising economic democracy for the benefit of rent-takers, and led us into becoming an increasingly nasty and dangerously divided plutocracy.

In the context recent economic developments, that summary seems less hyperbolic than it might have only a few years ago: The term “plutocracy” is commonly used these days to describe our society, increasingly by the renegade voters of both political parties who feel the system is “rigged” against them. Money buys pro-wealth law, trumping democracy, and it has bought favorable economics, too. Indeed, money underlies all power and social developments, one transaction after another, and it is delusional to imagine otherwise.

Although Gaffney speaks in conspiratorial terms, it is enough to know that neoclassicism favors the interests of wealth: Hence, the elitist academic and media institutions have always favored its development. I prefer to think of false ideologies as byproducts not of conspiracy, but of denialism, i.e., the rejection of objective science. We can think simply of the power of money driving objective science into a deep ideological black hole. From whatever perspective we choose to view them, there have been numerous conscious efforts to thwart ideas that diminish capitalism, or that are critical of the accumulation of great wealth or of extreme income inequality. These efforts should be of great concern to anyone who still believes economic ideology is the product of objective, scientific investigation.

Neoclassicism has assigned to “microeconomic” ideas the task of explaining aggregate growth, and developed the elaborate system of “supply side” thinking that provides the framework for mainstream economics. The supply-side approach is the ultimate embodiment of anti-Keynesian thinking: It obliterates consideration of effective demand from the causes and effects associated with aggregate activity, rendering impossible any realistic explanation of growth or decline (as Keynes dramatically explained), and negating any realistic evaluation of taxation or tax progressivity. As has become crucially important today, it removes from consideration all aspects of the macroeconomic significance of income and wealth distribution. The significance of inequality was routinely obscured, for this reason, even well before Kuznets warned the economics profession of its ultimate significance.

Right-wing ideologues have retrenched, and deflected, behind the interests of wealth in reducing government and avoiding tax increases on corporations and top incomes. Alarmingly, these agendas are reaching peak dominance today, even after 35 years of rising inequality. The responsibility for this lies with the neoclassical bias dominating the economics profession.

America’s dean of neoclassicism is Paul Samuelson, the first recipient of the Nobel Prize in economics. Over more than fifty years, he published 18 editions of his textbook Economics. Samuelson set himself up as the spokesperson and ultimate arbiter for the economics profession, inventing a “neoclassical synthesis” which purported to incorporate the best and most advanced ideas in economics. In reality, it emphasized the pro-capitalist themes of neoclassicism, at the expense of all competing points of view. Here are some of Samuelson’s major transgressions:

  • The contributions of John Maynard Keynes were severely marginalized. Credit for “business cycle” theory is given to other economists, ignoring the role of and explanation for the rise and fall of investment and demand inherent in Keynes’s revolutionary “general theory.” Implying (without discussion) that Keynesian theory had lost its vitality as a result of later developments in the field, this approach locked into place supply side ideology, and eviscerated (again without discussion) Keynes’s “principle of effective demand”;
  • This also protected from challenge the neoclassical myth that continuous growth and prosperity are inevitable, a myth he religiously promoted. Eventual recovery from recessions was presumed to be inevitable, and depressions were characterized as nothing more than severe recessions. Samuelson went to great lengths to assert the ultimate resiliency of capitalist markets. Characterizing Karl Marx’s theory of capitalist decline as the proposition that inequality would tend to grow over time, Samuelson in 1963 claimed that Marx’s theory had been “disproved” by the declining income inequality experienced in America after WW II;
  • After inequality had risen steadily for more than twenty years, however, in 2004 (along with William Nordhaus) Samuelson redoubled his efforts to marginalize Marx as an economic thinker, characterizing him as a disgruntled and unpopular socialist, and further emphasizing Arthur Okun’s popular thesis in Equality and Efficiency (1978) that reducing inequality would counter-productively reduce “efficiency.” He even re-wrote Adam Smith’s reference to the quasi-religious metaphor “the invisible hand” in The Wealth of Nations (1776), completely changing Smith’s meaning and making it appear that Smith supported the neoclassical myth of perfect efficiency, which he manifestly never did. Okun, it turns out, had no support for his nonsensical theory other than a citation to Smith’s invisible hand metaphor! His line of reasoning, incredibly, leaves the impression that inequality is a necessary component of prosperity and growth;
  • Approvingly following the lead of John Bates Clark (1847-1938) — a founder of American neoclassicism after whom an annual award to the most promising young American economist has been named — Samuelson drastically changed the concept of “economic rent” that had been so crucial to early classical economists, from money collected with no contribution of real value, to representing a higher price for a fixed quantity of output. This perverted view obscures the rent component of income, rendering income size irrelevant, and making insensible the idea that wealthy people could possibly make too much money.

Neoclassical, supply side ideology has so “emasculated the discipline,” as Gaffney put it, that debates about government policy, and indeed the role of government itself, are entirely dysfunctional and ineffectual. The ultimate objective of trivializing income and wealth inequality is, quite apparently, to avoid the taxation of top incomes and wealth. To this end, neoclassicism enables the obfuscation we have seen on tax policy, and on the need for progressive taxation, creating a fertile ground for the libertarian ideologues who now control the national government.

The Case for More Government

Here is a case study of neoclassicism’s deep corruption of our collective mentality on the role of government. Just two days ago, The New York Times (8/3/16, here) published an article by its experienced and influential economics reporter, Eduardo Porter, entitled “The Case For More Government, Not Less.” The opening paragraphs focused on what the American people already believe, minimizing the provision of new information to anyone not reading the entire article:

It may be hard to remember, but Americans once appreciated the government that serves them. That’s long gone.

Over the last six years, according to the Pew Research Center, four out of every five — or more — have said the government makes them feel either angry or frustrated. Last March, the ranks of the incensed included 78 percent of Bernie Sanders’s supporters and a whopping 98 percent of those backing Donald J. Trump.

More than half of voters — including 61 percent of Mr. Trump’s supporters — feel they are not keeping up with the rising cost of living. Three-quarters of Mr. Trump’s supporters feel that life for people like them is worse than it was 50 years ago.

This kind of reporting sets up a causal “feedback loop,” per George Lakoff: Over time, public perceptions and beliefs become self-reinforcing, resistant to change. Which helps explain why Porter continued with this:

These frustrated Americans may not fully realize it, under the influence of decades worth of sermons about government’s ultimate incompetence and venality. But there’s a strong case for more government — not less — as the most promising way to improve the nation’s standard of living.

Last month, four academics — Jeff Madrick from the Century Foundation, Jon Bakija of Williams College, Lane Kenworthy of the University of California, San Diego, and Peter Lindert of the University of California, Davis — published a manual of sorts. It is titled “How Big Should Our Government Be?” (University of California Press).

“A national instinct that small government is always better than large government is grounded not in facts but rather in ideology and politics,” they write. The evidence throughout the history of modern capitalism “shows that more government can lead to greater security, enhanced opportunity and a fairer sharing of national wealth.”

It is indeed a compelling case, unassailable to anyone familiar with Keynes’s long-ignored principle of effective demand, and this quotation from the article is spot on. The article laid out the authors’ recommendations for government strategy, which include redistributive policies like expanding unemployment and health insurance, paid sick leave, wage insurance, and “more resources for poor families with children and for universal early childhood education.” Americans are only beginning to understand a point Porter does not make, namely, that this stimulates economic activity because it circulates money mostly hoarded in the coffers of wealthy people and their corporations to people who are guaranteed to spend most or all of it. So the program’s cost remains in the forefront of the reader’s mind as the discussion continues:

This agenda won’t come cheap. They propose raising government spending by 10 percentage points of the nation’s gross domestic product ($1.8 trillion in today’s dollars), to bring it to some 48 percent of G.D.P. by 2065.

That might sound like a lot of money. But it is roughly where Germany, Norway and Britain are today. And it is well below government spending in countries like France, Sweden and Denmark.

This agenda, of course, is more popular among liberals than conservatives. Economists on the right insist that higher taxes and bigger governments reduce incentives to work and invest, harming economic growth. In one study, the Nobel laureate Edward Prescott argued that the higher taxes needed to fund a bigger government discouraged Europeans from working.

Porter notes that the conservative argument is “hardly watertight,” but in truth it actually leaks like a sieve, and Porter presents the arguments of “economists on the right” in a way that affords them far too much credibility: The idea that higher income taxation discourages work and investment is a false “trickle-down” myth that has been thoroughly disproved by a century’s worth of evidence, as I explain in my book. Porter is content to mention alternative factors contributing to fewer working hours in Europe, including “tight labor market regulations,” high value spent on free time. But, consistent with conservative economic thinking, Porter’s analysis derails on the subject of taxation:

Europe’s reliance on consumption taxes — which are easier to collect and have fewer negative incentives on work — allowed them to collect more money without generating the kind of economic drag of the United States’ tax structure, which relies more on income taxes.

Here Porter explicitly accepts the conservative “trickle-down” taxation dogma — and of course consumption taxes are extremely regressive, as they hit low-income and wealthy people equally, but are a much higher percentage of low incomes. The suggestion that European stimulus results from lower reliance on income taxation (if true) than on far more regressive consumption taxation is inherently anti-Keynesian, and it is wrong.

The link in this quotation is to a much earlier Porter article (“Combating Inequality May Require Broader Tax,” 11/27/12, here), in which he acknowledged that “raising more money from the wealthy might go a long way toward righting our lopsided economy,” and “may help us dig out of our immediate fiscal hole,” he nonetheless opined:

[I]t is unlikely to be enough to address our long-term needs. The experience of many other developed countries suggests that paying for a government that could help the poor and the middle class cope in our brave new globalized world will require more money from the middle class itself.

Many Americans may find this hard to believe, but the United States already has one of the most progressive tax systems in the developed world, according to several studies, raising proportionately more revenue from the wealthy than other advanced countries do. Taxes on American households do more to redistribute resources and reduce inequality than the tax codes of most other rich nations.

But taxation provides only half the picture of public finance. Despite the progressivity of our taxes, according to a study of public finances across the industrial countries in the Organization for Economic Cooperation and Development, we also have one of the least effective governments at combating income inequality. There is one main reason: our tax code does not raise enough money.

This paradox underscores two crucial lessons we could learn from the experience of our peers around the globe. The first is that the government’s success at combating income inequality is determined less by the progressiveness of either the tax code or the benefits than by the amount of tax revenue that the government can spend on programs that benefit the middle class and the poor.

A bit more reflection reveals that the whole analysis is misguided on the issue of progressiveness, with disastrous results:

  • One of the studies cited by Porter in this earlier article (“Income Inequality and Growth: The Role of Taxes and Transfers,” OECD, Economic Department Policy Notes No. 9, January 2012, here), correctly observed that: “The personal income tax tends to be progressive, while consumption taxes and real estate taxes often absorb a larger share of the current income of the less well-off”;
  • Porter’s views have not changed in nearly three years, for he still believes that Europe’s consumption taxation is more progressive;
  • The OECD study concluded that “tax and transfer systems reduce overall income inequality in all countries,” but this can be true only in countries where income inequality is actually declining. Porter acknowledged rising U.S. inequality in this earlier article: Since the recession of 2008, “93 percent of our income growthin the first two years of the economic recovery to the richest 1 percent of families, and only 7 percent to the rest of us;”
  • There are degrees of progressiveness, and income taxation within the top 1% is regressive. We could (and should) define the progressiveness of the entire tax system in terms of whether or not inequality is increasing. It is simply not true that “the United States already has one of the most progressive tax systems in the developed world”;
  • Porter adds that “Progressive taxes make it hard to raise money because they distort people’s behavior. They encourage taxpayers to reduce their tax liability rather than to increase their pretax income,” “high corporate taxes encourage companies to avoid them,” and “high taxes on capital income also encourage avoidance and capital flight.” This is the laundry list of conservative arguments against taxing the wealthy and their giant corporations, and it is completely bogus.

It is becoming increasing obvious that the conservative line is a bunch of malarkey: Corporations have extremely low, inequality producing taxation of capital income, as Piketty and Saez have conclusively demonstrated. Hundreds of billions of dollars of profits flow into their coffers annually. Yet, for them, tax avoidance is already a well-established way of life. Ignoring distribution has made it possible for them to conflate the effects of lowering taxes at the top with the opposite effects of lowering taxes farther down the income ladder. Lowering their taxes even further would merely add to the severe damage discussed above that the American economy and lower-income classes are already suffering.

Now we know what Eduardo Porter, and presumably the billionaire owners (Mexican billionaire Carlos Slim owned the largest share as of January, 2015, here) and the editorial board of The New York Times actually believe (or at least what they want us to believe) about inequality and tax economics. We must remember that it is thoroughly anti-Keynesian, and that Paul Krugman’s “neo-Keynesian” analyses are presumably similarly constrained: Krugman has consistently described inequality as merely a “political” problem, not an economic one. The next post, “The Terrifying Truth About Politics,” will discuss how, in this plutocratic environment, our headlong plunge toward disaster is likely to play out in American politics.

JMH – 8/5/2016

This entry was posted in - FEATURED POSTS -, - MOST RECENT POSTS -, Ecology, Economics, Federal Budget and Spending, Federal Debt, Freedom and Democracy, Government in Society, Wealth and Income Inequality. Bookmark the permalink.

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