Category Archives: Uncategorized

Why NAIRU is “zOMG HYPERINFLATION”

Does employment and inflation have a relationship? Yes of course. Can a wage-price spiral happen? Yes it can. A lot of economists exploit this possibility to incorrectly argue for NAIRU.

This post is a continuation of a recent post Simon Wren-Lewis, NAIRU And TINA in which I argued that NAIRU is not a useful concept and is counterproductive.

That wage-price spirals can happen isn’t a proof for NAIRU itself. NAIRU is defined as the unemployment rate Ubelow which prices start accelerating (or inflation starts to rise indefinitely). But the NAIRU hypothesis is a hypothesis of certainty. Economies are complex dynamical systems and just because wage-price spirals may have happened in the past doesn’t imply that it will always happen.

In the last mentioned how stock-flow consistent models, full employment can be achieved with no rising inflation, just higher inflation when parameters about wage-bargaining aren’t changing or if intervals between settlements shorten.

As I said in my previous post, NAIRU advocates think that a fraction of the workforce should be kept unemployed to keep inflation under control. By claiming that there exists a NAIRU or an unemployment rate below which prices necessarily start accelerating, they do a huge disservice to not just Economics but also to the welfare state. Any politician reading about NAIRU is likely to take away the incorrect notion that if unemployment is pushed too low, hyperinflation can happen. Hence the politician responsible for taking decisions is likely to postpone or abandon the pursuit for full employment.

So one can cogently believe all three of the following:

  • there is a relationship between employment and inflation
  • wage-price spiral can occur
  • NAIRU is wrong.

In other words, NAIRU proponents exploit the possibility to claiming a certainty. Wage-price spirals happened in the 70s and Joan Robinson even saw it coming. But wage-spiral is not NAIRU. Conflating the two is vile.

What are the solutions if a wage-price happens? There is a lot of literature for an “incomes policy” from economists such as Nicholas Kaldor. For the purposes of this post, it’s not necessary to go in that direction as it’s not needed in current times at least in the advanced economies.

The All American iPhone: Bad, Or Good?

The new American President Donald J. Trump is pushing for bringing back jobs to the U.S. as everyone knows. In his inauguration speech he said:

 We must protect our borders from the ravages of other countries making our products, stealing our companies, and destroying our jobs. Protection will lead to great prosperity and strength.

I will fight for you with every breath in my body – and I will never, ever let you down.

America will start winning again, winning like never before.

We will bring back our jobs. We will bring back our borders. We will bring back our wealth. And we will bring back our dreams.

We will build new roads, and highways, and bridges, and airports, and tunnels, and railways all across our wonderful nation.

We will get our people off of welfare and back to work – rebuilding our country with American hands and American labor.

We will follow two simple rules: buy American and hire American.

Now this has led to the repetition of the story that offshoring jobs is beneficial to the U.S. The Apple iPhone is used frequently to tell the story. According to this story, as argued by many such as the MIT Technology Review, the all-American iPhone will be pricier and hence bad for the U.S. One of the arguments is that the iPhone is so complicated that it’s even impossible to make everything in the U.S! While that is certainly true, it doesn’t mean that remaking the iPhone in America, i.e., most of it is not possible or bad.

In fact such denialism has quite contributed to the rise of Trump. People interested in politics and to the left of Trump on the economic left in the “political compass” should have a look into such things.

Let’s say that Apple manufactures most parts of iPhones in the U.S. Since its costs will rise, as it has to pay more labour for example, it will be priced higher if Apple wants to keep the same margin. Now since wages are a source of domestic demand for the U.S. economy, this will lead to higher output and income for U.S. economic units. It will also lead to an improvement in the U.S. balance of payments and international investment position as the U.S. is paying foreigners lesser in the new supply chain than is the case now. Higher U.S. employment would also mean higher wage-bargaining and higher wages. Higher prices won’t hurt iPhone buyers since real incomes would rise.

Needless to say, there’s also an international aspect. That iPhones will be more expensive might mean lower volume of iPhone exports. But price is not the only thing consumers look at. So the fall in exports won’t hurt if that’s the case. Moreover, a rise in U.S. output would be beneficial to the world and iPhone exports needn’t fall. Something has to fall you’ll say. Yes, Apple’s market share will fall, although not the absolute value of its profits.

Donald Trump has to be resisted for his authoritarianism and xenophobic policies. But economic myth-making is not the right way.

Simon Wren-Lewis, NAIRU And TINA

Last month, Matthew C Klein wrote an article for Financial Times’ blog Alphaville arguing against the concept of NAIRU. Today, Simon Wren-Lewis published a reply to Klein on his blog defending NAIRU. SWL’s argument is essentially that there is no alternative (TINA):

… But here is the rub. If we really think there is no relationship between unemployment and inflation, why on earth are we not trying to get unemployment below 4%? We know that the government could, by spending more, raise demand and reduce unemployment. And why would we ever raise interest rates above their lower bound?

… There is a relationship between inflation and unemployment, but it is just very difficult to pin down. For most macroeconomists, the concept of the NAIRU really just stands for that basic macroeconomic truth.

The sad part of this argument is that NAIRU isn’t the only answer to the relationship between (un)employment and inflation. Both of the following can be true:

  • There is a relationship between employment and inflation.
  • The concept of NAIRU is false.

What is NAIRU (non-accelerating inflation rate of unemployment)? According to the originators of this incorrect idea, it is the rate of unemployment U* below which inflation starts rising indefinitely. It’s a bit of a misnomer as it’s prices which is accelerating, not inflation. Nonetheless, the extreme nature of this should be clearly stated: NAIRU advocates think that a fraction of the workforce should be kept unemployed to keep inflation under control. 

Post-Keynesians have rejected these arguments since the beginning. In their book Monetary Economics, Wynne Godley and Marc Lavoie show that in their model full employment can be achieved without a runaway inflation.

This is not the first time SWL has defended orthodoxy. A few years ago, he called rational expectations “one of economics’ major achievements” and also that:

It is not a debate about rational expectations in the abstract, but about a choice between different ways of modelling expectations, none of which will be ideal. This choice has to involve feasible alternatives, by which I mean theories of expectations that can be practically implemented in usable macroeconomic models.

However for the foreseeable future, rational expectations will remain the starting point for macro analysis, because it is better than the only practical alternative.

Link

Dean Baker — The Trouble With International Trade: People Understand It

Dean Baker:

[these days,] major news outlets have been filled with misleading and dishonest stories claiming that the real cause of manufacturing job loss has been automation and that people are stupid to worry about trade.

From December of 1970 to December of 2000 we lost 130,000 manufacturing jobs, less than one percent of the total. There was plenty of productivity growth in manufacturing over these three decades. While manufacturing employment did fall as a share of total employment, there was little change in the absolute number of manufacturing jobs over this long period.

By contrast, manufacturing employment dropped by more than 3.4 million, or more than 20 percent, in the seven years from 2000 to 2007. This was trade. The trade deficit exploded over this period to almost 6 percent of GDP, which would be more than $1.1 trillion in today’s economy.

[the title is the link]

Dean Baker On Automation

In his farewell address, Barack Obama toed the New Consensus’ line (around 12:50 in the video in the link):

… But, for all the real progress that we’ve made, we know it’s not enough. Our economy doesn’t work as well or grow as fast when a few prosper at the expense of a growing middle class, and ladders for folks who want to get into the middle class.

That’s the economic argument. But stark inequality is also corrosive to our democratic idea. While the top 1 percent has amassed a bigger share of wealth and income, too many of our families in inner cities and in rural counties have been left behind.

The laid off factory worker, the waitress or health care worker who’s just barely getting by and struggling to pay the bills. Convinced that the game is fixed against them. That their government only serves the interest of the powerful. That’s a recipe for more cynicism and polarization in our politics.

Now there’re no quick fixes to this long-term trend. I agree, our trade should be fair and not just free. But the next wave of economic dislocations won’t come from overseas. It will come from the relentless pace of automation that makes a lot of good middle class jobs obsolete.

In other words, Obama says that international trade and globalizing production aren’t responsible for weak employment and labour markets, but it’s automation.

Dean Baker has been writing a series of good articles puncturing these arguments. In his latest, titled Badly Confused Economics: The Debate on Automation, he writes that productivity hasn’t been rising much and that if tightness of the labour market is cited as one of the reasons for hikes in interest rates by the Federal Reserve, that’s contradictory. Baker says:

… The other reason why the concern over automation seems misplaced is that it is directly at odds with how we talk about other areas of economy policy. To take an example that has recently been in the news, the Federal Reserve Board raised interest rates in the United States last month. It is widely expected to raise interest rates several more times in 2017.

The reason for raising interest rates is that the Fed is concerned that the economy is creating too many jobs. This will increase workers’ bargaining power, putting upward pressure on wages. A more rapid rate of wage increases will lead to more rapid inflation. To prevent this outcome, the Fed wants the economy to have fewer jobs.

But how can it make sense that, at a time when we are worried that automation is destroying a massive number of jobs, we also need the Federal Reserve Board to add to the job destruction by raising interest rates? If automation is leading to mass job destruction the Fed should not have to be worried about overly tight labor markets.

Dean Baker On US Manufacturing And International Trade

The U.S. manufacturing deficit was $831 billion in 2015. The 2016 number might be out in a few days. Dean Baker has an excellent articlePainful Nonsense on Trade on his blog in which he debunks the claims of most economists that the US trade imbalance didn’t lead to job losses. He says:

… Note that the level of manufacturing employment, while it has cyclical ups and downs, is nearly constant from 1970 to 2000 at around 17 million. It plunged in the early years of the last decade as the trade deficit exploded. Most of the fall in employment was before the collapse of the housing bubble in 2008. This is what happens when a trade deficit increases from around 1.5 percent of GDP, the mid-1990s level, to almost 6.0 percent of GDP at its peak in 2005–2006 (over $1.1 trillion in today’s economy).

and also that the comparison to Germany is misleading:

DeLong also does a bit of sleight of hand in telling us that the loss of manufacturing employment is the same everywhere, pointing out that even Germany, the big success story, saw employment in manufacturing fall from about 40 percent of the labor force in 1971 to 20 percent at present. This is true, and if the United States had the same share of its workforce employed in manufacturing as Germany, we would have another 15 million manufacturing jobs.

A similar point was made by Wynne Godley in 1995! In A Critical Imbalance In U.S. Trade, The U.S. Balance Of Payments, International Indebtedness, And Economic Policy he said:

It is sometimes said that manufacturing has lost its importance and that countries in balance of payments difficulties should look to trade in services to put things right. However, while it is still true that manufacturing output has declined substantially as a share of GDP, the figures quoted above show that the share of manufacturing imports has risen substantially. The importance of manufacturing does not reside in the quantity of domestic output and employment it generates, still less in any intrinsic superiority that production of goods has over provision of services; it resides, rather, in the potential that manufactures have for expansion in international trade.

Dani Rodrik On Free Trade

In a recent article for Foreign Policy, Dani Rodrik makes this claim:

Meanwhile, economists rightly point out that trade is only weakly implicated in the major economic problems of the day — deindustrialization and income inequality. They are correct that the distributional consequences of trade are better addressed with safety net programs and nontrade remedies. But they have systematically downplayed these consequences — especially when the requisite compensatory programs have remained on paper. And they seem unable to grasp the valid core of the public’s concern about social dumping.

It’s a bit disappointing that Dani Rodrik who presents himself as a dissenter is towing the line of the New Consensus. The new trade theory, which is a part of the new consensus says that free trade is fine as long as losers are compensated. In this article Rodrik states the same but just takes issue on the latter part, i.e., compensation.

This line of argument is deeply flawed. An individual country’s growth has a deflationary bias because free trade puts a rein on fiscal policy to achieve full employment. So who is there to compensate? Moreover, it’s not comparative advantage which governs economic dynamics but absolute advantage via Gunnar Myrdal’s principle of circular and cumulative advantage . As Nicholas Kaldor says, “success breeds further success and failure begets more failure.”

Moreover it’s the the whole world economy which has a deflationary bias because of free trade as pointed out by Nicholas Kaldor in his 1980 article Foundations And Implications Of Free Trade Theory

In a recent article on the ‘Causes of Growth and Recession in World Trade’,1 T. F. Cripps has demonstrated that a country is not ‘balance of payments constrained’ if its full employment imports, M*, are less that its import capacity M̅ (as determined by its earning from exports). Such a country is free to choose the level of domestic demand which it considers optimal for its own circumstances,2 whereas the other countries from whom M* > M̅, must, under conditions of free trade, reduce their output and employment below the full employment level, and import only what they can afford to finance. He then shows that the sum of imports of the ‘unconstrained’ countries determine the attainable level of production and employment of the ‘constrained’ countries, and the remedy for this situation requires measures that increase the level of ‘full-employment’ imports or else reduce the export share of the ‘unconstrained countries’. The ‘rules of the game’ which would be capable of securing growth and stability in international trade, and of restoring the production of the ‘constrained’ countries to full employment levels, may require discriminatory measure of import control, of the type envisaged in the famous ‘scarce currency clause’ of the Bretton Woods agreement.

In the absence of such measures all countries may suffer a slower rate of growth and a lower level of output and employment, and not only the group of countries whose economic activity is ‘balance-of-payments constrained’. This is because the ‘surplus’ countries’ own exports will be lower with the shrinkage of world trade, and they may not offset this (or not adequately) by domestic reflationary measures so that their imports will also be lower. Provided that the import regulations introduced relate to import propensities (i.e. to the relation of imports to domestic output) and not to the absolute level of imports as such, the very fact that such measures will raise the trade, production and employment of the ‘constrained’ countries will mean that the volume of exports and domestic income of the ‘unconstrained’ countries will also be greater, despite the downward change in their share of world exports.3

Footnotes:

1Cambridge Economic Policy Review (March 1978), pp, 37-43.

2Owing to the widespread view according to which a given increase in effective demand is more ‘inflationary’ in its consequences if brought about by budgetary measure than if it is the result of additional investment or exports (irrespective of any limitations of import capacity) the inequality or potential inequality in its payments balance may cause a surplus country to regard a lower level of domestic demand as ‘optimal’ in the first case than in the second case.

3In other words, if countries whose ‘full employment’ balance of payments shows a surplus because M* < α W (where M* is the level of full employment imports, α is the share of a particular country’s exports of in world trade W) after a reduction of α to α̂ (α̂ < α) through the imposition of discriminatory measures, the country will still be better off if α̂ W* > α W where W* is the volume of world trade generated under full employment conditions.

Of course, the solution is hard and in my opinion, international agreements to reach balanced trade is the correct way. Free trade is the most sacred tenet in all of macroeconomics and it’s not going to be easy to get rid of it.

Mario Draghi On Settlement Of Intra-Eurosystem Claims

Recently, Mario Draghi—in a letter responsing to questions about TARGET2 imbalances to two members of the European Parliament—says the following:

If a country were to leave the Eurosystem, its national central bank’s claims on or liabilities to the ECB would need to be settled in full.

Since many years many economists, led by Karl Whelan have refused to accept this. There has been a denial via various arguments. The main argument of this camp has been that TARGET2 assets of the ECB doesn’t really matter, presumably because central banks create money and can be capitalized using a bookkeeper’s pen. That is a strange argument because if a country were to leave the Eurosystem and cannot settle its claims to the ECB, the ECB will take a loss. It has less interest earning asset than otherwise and since the ECB’s profits ultimately get distributed to national treasuries, treasuries’ income doesn’t matter according to this argument.

Another way to see this argument is wrong is to think of the international investment position of the remaining region if a country leaves. It’s net international investment position falls. Does international investment position not matter?

Yet another argument. Suppose the day before a country leaves the Euro Area and the Eurosystem, the ECB were to buy that country’s government bonds. The leaving country’s NCBs’ liabilities to the rest of the Eurosystem will fall and its government’s liability will rise. This transaction is a purely financial account transaction in international accounts. How it is that one is debt and the other not debt? Those who claim that the intra-Eurosystem debts do not matter seem to believe that it’s not debt.

Of course, Mario Draghi’s position can be legally challenged. There’s hardly any mention in the legal documents of the Euro Area explicitly stating what happens. But since intra-Eurosystem claims (i.e., NCB TARGET2 balances) earn or pay interest, this makes the case for the settlement of the claims. In law, the reasons why they were created are sometimes used if something is not explicitly stated.

Ha-Joon Chang’s Kicking Away The Ladder Theory

With recent political changes such as Brexit and Trump, economists have been struggling to understand what’s going on. While there’s some concession with phrases such as “inclusive globalization” (which doesn’t mean much in practice), the global elite is upping its call for free trade.

I’d argue that it’s the macroeconomics of international trade which makes Post-Keynesian economics different from the orthodox. In recent times, economists have conceded a lot about the macroeconomics of fiscal policy and money, they have become more confident about their orthodoxies on international trade. Even with the former they are returning to their orthodox opinions with the argument that heterodox ideas make sense only if the zero lower bound (ZLB) is reached. But “free trade” is the holy cow which will be difficult for orthodoxy to ever abandon.

Ha-Joon Chang is a great writer and communicator on economics. In his 2002 book Kicking Away The Ladder: Development Strategy in Historical Perspective, he argues for a fresh look at how nations developed and how they used a mix of free trade and protectionism whenever it suited them more. Once they became advanced, they want to prevent others from adopting their strategy – they are kicking away the ladder they used to climb to top.

In a shorter article Ha-Joon Chang explains:

Central to the neoliberal discourse on globalization is the conviction that free trade, more than free movements of capital or labor, is the key to global prosperity. Even many of those who are not enthusiastic about all aspects of globalization–ranging from the free-trade economist, Jagdish Bhagwati, advocating capital control to some non-governmental organizations (NGOs) accusing the developed countries for not opening up their agricultural markets–seem to agree that free trade is the most benign, or at least a less problematic, element in the progress of globalization.

Part of the conviction in free trade that the proponents of globalization possess comes from the belief that economic theory has irrefutably established the superiority of free trade, even though there are some formal models which show free trade may not be the best. However, even the builders of those models, such as Paul Krugman, argue that free trade is still the best policy because interventionist trade policies are almost certain to be politically abused. Even more powerful for the proponents of free trade, is their belief that history is on their side. After all, the defenders of free trade ask, isn’t free trade how all the world’s developed countries have become rich? What are some developing countries thinking, they wonder, when they refuse to adopt such a tried and tested recipe for economic development?

A closer look at the history of capitalism, however, reveals a very different story (Chang, 2002). As we shall establish in some detail in this paper, when they were developing countries themselves, virtually all of today’s developed countries did not practice free trade (and laissez-faire industrial policy as its domestic counterpart). Rather, they promoted their national industries through tariffs, subsidies, and other measures.

and introduces the phrase “kicking away the ladder”:

Thus seen, contrary to the popular belief, Britain ‘s technological lead that enabled this shift to a free trade regime had been achieved “behind high and long-lasting tariff barriers” (Bairoch, 1993, p. 46). And it is for this reason that Friedrich List, the nineteenth-century German economist who is mistakenly (see section 3.2 below) known as the father of modern “infant industry” theory, wrote the following passages.

It is a very common clever device that when anyone has attained the summit of greatness, he kicks away the ladder by which he has climbed up, in order to deprive others of the means of climbing up after him. In this lies the secret of the cosmopolitical doctrine of Adam Smith, and of the cosmopolitical tendencies of his great contemporary William Pitt, and of all his successors in the British Government administrations.

Any nation which by means of protective duties and restrictions on navigation has raised her manufacturing power and her navigation to such a degree of development that no other nation can sustain free competition with her, can do nothing wiser than to throw away these ladders of her greatness, to preach to other nations the benefits of free trade, and to declare in penitent tones that she has hitherto wandered in the paths of error, and has now for the first time succeeded in discovering the truth [italics added] (List, 1885, pp. 295–6).