Post-Keynesian Observations

Understanding the Macroeconomy

13. What Must Be Done? Policy Recommendations

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[NOTE: Be sure you have read part 12 before this one! This is part of a series of posts that explain the operation of the macroeconomy and the current crisis and they build on one another.]

As I mentioned in part 10, economics is ultimately about policy. At the end of the day, the reason for all the graphs, equations, charts, data, etc., is to decide how we should organize the economy. In order to make such a determination, we have to know 1) what we think should happen, 2) what is happening, 3) why there is a difference between 1 and 2, and 4) how that can be corrected. With respect to 1, let’s say this boils down to low unemployment and high rates of economic growth. I’d figure acceptable unemployment to be around 4% and a decent rate of GDP growth to be 3% or so.

What do we actually have? As of this writing (February 8, 2009), we have 7.6% unemployment (January 2009) and a rate of real GDP growth of -3.8% (fourth quarter 2008). The former is the worst in sixteen years and the latter is our lowest in over twenty-five years, and forecasts are not optimistic. Those unemployment numbers mean we have 11.6 million people who are looking for jobs–more than the entire population of Cuba, Greece, or Belgium (in fact, more than most countries). Note, too, that the way unemployment statistics work, it’s actually rather easy to count as employed (one hour of paid work in a week means you are employed) and that folks who have given up looking don’t count in the numbers (which will occur as this drags on but probably isn’t a big factor at the moment).

Part 3, has this happened? This was already covered in parts 11 and 12 and can be boiled down to the following:

Systemic Factors (Part 11)
Fall in Investment
Fall in Consumer Durables
Increase in Debt Levels and Consequent Default
Panic and Collapse of Animal Spirits/Spontaneous Optimism

Historical Factors (Part 12)
Financialization
Housing Market Bubble
Income Distribution

These are the reasons why we find ourselves at the opening stages of one of the worst economic downturns since the Great Depression. That just leaves part 4, how to fix it. Following the pattern established above, I want to break the factors into those addressing systemic factors and those fixing the historical factors.

Systemic Factors
DOH! I didn’t realize that I’d already done this in part 10 and consequently spent several hours writing and rewriting section, always with a strange sense of deja vu. Let me salvage from my wasted efforts an overview that I did not include in the previous installment.

At any given moment, there is a finite number of jobs the private sector can profitably support. Critically, there is no guarantee that this number is equal to the number of folks who actually need a job. In fact, as productivity increases and we need fewer people to make the same amount, so it becomes even less likely that the number of potential jobs is equal to the number of people in the workforce. This long-term process is exacerbated when activity in the investment and consumer durable sectors declines at the end of the expansion. It is the great irony of capitalism that at the very moment when we should be enjoying our highest standards of living–when all the factories and restaurants are built and everyone has a new car, new kitchen appliances, additions to their homes, etc.–is when we suffer. Just two years ago, our unemployment was 4.4% and represented only 6.7 million people. Why not now? Because even though we have at least the same productive capacity as then (more, actually), entrepreneurs, quite reasonably, don’t find it profitable to employ people. When you employ someone, they get those little green pieces of paper that entitle you to a share of the stuff we can build and that in turn make it profitable to have made that stuff.

What we therefore need to offset these systemic problems is some source of those little green papers that do not depend on entrepreneurs deciding they can make a profit–the Federal Employment Commission (FEC) mentioned in post 10. The profit motive has done all it can, so the government sponsors employment that can fill the gap in the meantime. When the economy recovers, the government pulls back.

Before I move on to the historical factors, let me quickly mention that the way government spending is structured, we already have some built-in automatic stabilizers. I’d much prefer something along the lines of an FEC, but even now, when the economy goes south, government spending automatically increases (in terms of unemployment insurance, welfare, food stamps, etc.) and the average tax rate and tax revenues fall (since incomes go down). This has definitely had an impact. Before WWII, when the government was tiny and the free market was given greatest freedom, the average recession was around 21 months and the average expansion was roughly 25 months–almost exactly the same. Since, WWII, recessions have lasted 10 months and expansions…wait for it…52-months!!! The latter number is heavily influence by the 120 month expansion in the 1990s, but even dropping that out gives a very respectable 44-month duration for pots-WWII expansions. This is certainly a successful record, but I believe that there must be more careful consideration and monitoring of the programs we undertake so that we can better position ourselves for future challenges. This is particularly so given that the orientation of the private sector has become so short term, a problem created by the historical factors discussed next.

Historical Factors
Of the three items listed here, financialization and the housing market bubble can probably be addressed together. They are a function of the slow but steady shift in our economy from a focus on producing goods and services to managing financial wealth. This is discussed at length in part 12, and we saw the consequences play out over the past year. Increasingly complex and opaque assets were created by people who had no long-term interest in whether or not the assets would be profitable in the long run because they wouldn’t own them any more. The goal was to make a quick buck without really adding anything of value to our pool of goods and services. Furthermore, we are outsourcing low-profit activities in order to raise stock prices. Those activities are typically the ones that employ the most people.

We must reverse the trend of financial market deregulation. The rules limiting the ability of financial institutions to take risks (the costs of which fall upon others) were originally implemented around the Great Depression and because of events very much like those we are witnessing today. Policy makers decided starting in the 1980s that we didn’t need them any more since we hadn’t had any serious issues for many years. That’s a bit like saying that we no longer need seatbelt laws because traffic deaths have declined! They were encouraged by economists who argued that markets were rational and could not consistently make errors.

Finance should be the servant of output and employment and not the other way around. Stock prices and banking news should be a footnote, not the headlines. This is going to be a bitter fight and I am frankly not optimistic because those in the financial sector have a vested interest in keeping things as they are. Let me close this section by quoting from an excellent article in the New Yorker (http://www.newyorker.com/talk/comment/2008/02/04/080204taco_talk_cassidy):

The greatest need is for intellectual reappraisal, and a good place to begin is with a statement from a paper co-authored by Minsky that “apt intervention and institutional structures are necessary for market economies to be successful.” Rather than waging old debates about tax cuts versus spending increases, policymakers ought to be discussing how to reform the financial system so that it serves the rest of the economy, instead of feeding off it and destabilizing it. Among the problems at hand: how to restructure Wall Street remuneration packages that encourage excessive risk-taking; restrict irresponsible lending without shutting out creditworthy borrowers; help victims of predatory practices without bailing out irresponsible lenders; and hold ratings agencies accountable for their assessments. These are complex issues, with few easy solutions, but that’s what makes them interesting. As Minsky believed, “Economies evolve, and so, too, must economic policy.”

Very well said.

As I suggested in part 12, economies with uneven income distributions have weaker economies. There are several reasons for this, but one is the fact that the rich don’t spend much money. The same $10 million dollar salary spread over 100 people generates much more spending that it does if it’s all one person. Income distributions have been deteriorating for the past 40 years and they did the same thing before the Great Depression. Economic growth, when it comes, must be directed toward wage earners and not those scraping the profits off the top. As I mentioned in part 12, this is not a fairness issue, it’s a question of the survival of our system. We can address this through the tax structure, health care reform, and education. If the poor continue to get poorer, the core set of people of create demand for goods and services will be made impotent.

We also have to thing seriously about controlling immigration. With a limited number of employment opportunities, they are not only taking some of those jobs, but they are driving wages down because they are increasing the supply of labor. Mexico certainly has no incentive to help in this process since the status quo provides for them a release valve for their myriad and increasingly serious social, political, and economic problems. Ideally, the best immigration policy would be a strong, healthy Mexico and we cannot forget that. But, that’s not going to happen overnight, and so we need to think seriously about finding some stop gaps while at the same time encouraging long-term reforms that help the poor work their way up (something about which those currently in power don’t care too much about).

That’s it for now. I’m giving exams all week so I may not have another update for a while, but what I want to do next is review the policies currently being discussed and talk about how they fit with what I’ve recommended here.

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Written by rommeldak

February 9, 2009 at 1:14 am

Posted in Uncategorized

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