Archive for the ‘Inequality’ Category
As I illustrated in a previous post, “a significant proportion of the balance sheet of wealthy Americans is made up of real assets – real estate, stock and business holdings”. Therefore “what wealthy Americans, businesses and banks share is a common interest in supporting asset prices (real and nominal), a lack of interest in seeking full employment unless it is a prerequisite for supporting asset prices, and an aversion to any policies that can trigger wage inflation”. The fact that our dominant macroeconomic policy doctrine depends upon the ‘wealth effect’ simply reflects the fact that our economy is driven by wealthy special interests.
The real question again is why there isn’t more mass opposition to such a blatantly regressive policy regime. In previous posts(1, 2), I have argued that crony capitalism achieves broad-based support by piggybacking upon broad-based programs aimed at the middle class. But they also achieve this support due to the absence of a safety net that breeds middle-class insecurity. This carrot-and-stick approach ensures middle-class support for the same stabilising policies that transfer wealth to the one percent. As the table below (taken from Edward Wolff’s paper) shows, the most significant asset holding of the middle class in the United States is their principal residence. The data is no different in the United Kingdom (table below from the ONS). Supporting house prices therefore is the sop that special interests need to provide to the middle class in order to ensure their support for the ‘wealth effect’-driven economy.
Although there are many instances of direct subsidies to middle-class households via cheaper mortgages (George Osborne’s latest policy being yet another example), these are dwarfed by the impact of the primary guiding principle of macroeconomic policy throughout the neo-liberal era – house prices must keep going up. Rising house prices don’t just act as a carrot to the home-owning middle classes. The fear of being left behind and being out priced by a rising market also acts as a stick to those who don’t own homes. Again, middle-class support for the crony capitalist plutocracy is driven by the stick as much as it is by the carrot. Those who “fear” that the latest housing scheme “risks driving up prices” should realise that the increase in house prices is not an unintended consequence but the primary aim of our crony capitalist policy regime.
In a perceptive post, Reihan Salam makes the point that private equity firms are simply an industrialised version of corporate America’s efficiency-seeking impulse. I’ve made a similar point in a previous post that the the excesses of private equity mirror the excesses of the economy during the neoliberal era. To right-wing commentators, neoliberalism signifies a much-needed transition towards a free-market economy. Left-wing commentators on the other hand lament the resultant supremacy of capital over labour and rising inequality. But as I have argued several times, the reality of the neoliberal transition is one where a combination of protected asset markets via the Greenspan Put, an ever-growing ‘License Raj’, regulations that exist primarily to protect incumbent corporates and persistent bailouts of banks and large corporates have given us a system best described as “stability for the classes and instability for the masses”.
The solution preferred by the left is to somehow recreate the golden age of the 50s and the 60s i.e. stability for all. Although this would be an environment of permanent innovative stagnation bereft of Schumpeterian creative destruction, you could argue that restoring social justice, reducing inequality and shoring up the bargaining position of the working class is more important than technological progress. In this post I will argue that this stability-seeking impetus is counterproductive and futile. A stable system where labour and capital are both protected from the dangers of failure inevitably breeds a fragile and disadvantaged working class.
The technology industry provides a great example of how disruptive competitive dynamics can give workers a relatively strong bargaining position. As Reihan notes, the workers fired by Steve Jobs in 1997 probably found employment elsewhere without much difficulty. Some of them probably started their own technology ventures. The relative bargaining power of the technology worker is boosted not just by the presence of a large number of new firms looking to hire but also by the option to simply start their own small venture instead of being employed. This vibrant ecosystem of competing opportunities and alternatives is a direct consequence of the disruptive churn that has characterised the sector over the last few decades. This “disorder” means that most individual firms and jobs are vulnerable at all times to elimination. Yet jobseekers as a whole are in a relatively strong position. Micro-fragility leads to macro-resilience.
In many sectors, there are legitimate economies of scale that prevent laid-off workers from self-organising into smaller firms. But in much of the economy, the digital and the physical, these economies of scale are rapidly diminishing. Yet these options are denied to large sections of the economy due to entry barriers from licensing requirements and regulatory hurdles that systematically disadvantage small, new firms. In some states, it is easier to form a technology start-up than it is to start a hair-braiding business. In fact, the increasingly stifling patent regime is driving Silicon Valley down the same dysfunctional path that the rest of the economy is on.
The idea that we can protect incumbent firms such as banks from failure and still preserve a vibrant environment for new entrants and competitors is folly. Just like a fire that burns down tall trees provides the opportunity for smaller trees to capture precious sunlight and thrive, new firms expand by taking advantage of the failure of large incumbents. But when the incumbent fails, there must be a sufficient diversity of small and new entrants who are in a position to take advantage. A long period of stabilisation does its greatest damage by stamping out this diversity and breeding a micro-stable, macro-fragile environment. Just as in ecosystems, “minor species provide a ‘‘reservoir of resilience’’ through their functional similarity to dominant species and their ability to increase in abundance and thus maintain function under ecosystem perturbation or stress”. This deterioration is not evident during the good times when the dominant species, however homogeneous, appear to be performing well. Stabilisation is therefore an almost irreversible path – once the system is sufficiently homogenous, avoiding systemic collapse requires us to put the incumbent fragile players on permanent life support.
As even Marxists such as David Harvey admit, Olsonian special-interest dynamics subvert and work against the interests of the class struggle:
the social forces engaged in shaping how the state–finance nexus works…differ somewhat from the class struggle between capital and labour typically privileged in Marxian theory….there are many issues, varying from tax, tariff, subsidy and both internal and external regulatory policies, where industrial capital and organised labour in specific geographical settings will be in alliance rather than opposition. This happened with the request for a bail-out for the US auto industry in 2008–9. Auto companies and unions sat side by side in the attempt to preserve jobs and save the companies from bankruptcy.
This fleeting and illusory stability that benefits the short-term interests of the currently employed workers in a firm leads to the ultimate loss of bargaining-power and reduced real wage growth in the long run for workers as a class. In the pursuit of stability, the labour class supports those very policies that are most harmful to it in the long run. A regime of Smithian efficiency-seeking i.e. the invisible hand, without Schumpeterian disruption i.e. the invisible foot inevitably leads to a system where capital dominates labour. Employed workers may achieve temporary stability via special-interest politics but the labour class as a whole will not. Creative destruction prevents the long-term buildup of capital interests by presenting a constant threat to the survival of the incumbent rent-earner. In the instability of the individual worker (driven by the instability of their firm’s prospects) lies the resilience of the worker class. Micro-fragility is the key to macro-resilience but this fragility must be felt by all economic agents, labour and capital alike.
Many economists and commentators blame the Federal Reserve for the increasingly tepid economic recovery in the United States. For example, Ryan Avent calls the Fed’s unwillingness to further ease monetary policy a “dereliction of duty” and Felix Salmon claims that “we have low bond yields because the Fed has failed to do its job”. Most people assume that the adoption of a higher inflation target (or an NGDP target) and conventional quantitative easing (QE) via government bond purchases will suffice. Milton Friedman, for example, had argued that government bond purchases with “high-powered money” would have dragged Japan out of its recession. But how exactly is more QE supposed to work in an environment when treasury bonds are trading at all-time low yields and banks are awash in excess reserves?
If we analyse monetary policy as a threat strategy, then how do we make sure that the threat is credible? According to Nick Rowe, “The Fed needs to communicate its target clearly. And it needs to threaten to do unlimited amounts of QE for an unlimited amount of time until its target is hit. If that threat is communicated clearly, and believed, the actual amount of QE needed will be negative.” In essence, this is a view that market expectations are sufficient to do the job.
Expectations are a large component of how monetary policy works but expectations only work when there is a clear and credible set of actions that serve as the bazooka(s) to enforce these expectations. In other words, what is it exactly that the central bank threatens to do if the market refuses to react sufficiently to its changed targets? It is easy to identify the nature of the threat when the target variable is simply a market price, e.g. an exchange rate vs another currency (such as the SNB’s enforcement of a minimum EURCHF exchange rate) or an exchange rate vs a commodity (such as the abandoning of the gold standard). But when the target variable is not a market price, the transmission mechanism is nowhere near as simple.
Scott Sumner would implement an NGDP targeting regime in the following manner:
First create an explicit NGDP target. Use level targeting, which means you promise to make up for under- or overshooting. If excess reserves are a problem, get rid of most of them with a penalty rate. Commit to doing QE until various asset prices show (in the view of Fed officials) that NGDP is expected to hit the announced target one or two years out. If necessary buy up all of Planet Earth.
Interest on Reserves
Small negative rates on reserves or deposits held at the central bank are not unusual. But banks can and will pass on this cost to their deposit-holders in the form of negative deposit rates and given the absence of any better liquid and nominally safe investment options, most bank customers will pay this safety premium. For example, when the SNB charged negative rates on offshore deposits denominated in Swiss Franc in the mid-1970s, the move did very little to stem the inflow into the currency.
Significant negative rates are easily evaded as people possess the option to hold cash in the form of bank notes. As SNB Vice-Chairman Jean-Pierre Danthine notes:
With strongly negative interest rates, theory joins practice and seems to lead to a policy of holding onto bank notes (cash) rather than accounts, which destabilises the system.
Quantitative Easing: Government Bonds
Conventional QE can be deconstructed into two components: an exchange of money for treasury-bills and an exchange of treasury-bills for treasury-bonds. The first component has no impact on the market risk position of the T-bill holder for whom deposits and T-bills are synonymous in a zero-rates environment. But it is also irrelevant from the perspective of the banking system unless the rate paid on reserves is significantly negative (which can be evaded by holding bank notes as discussed above).
The second component obviously impacts the market risk position of the economy as a whole. It is widely assumed that by purchasing government bonds, the central bank reduces the duration risk exposure of the market as a whole thus freeing up risk capacity. But for most holders of government bonds (especially pension funds and insurers), duration is not a risk but a hedge. A nominal dollar receivable in 20 years is not always riskier than a nominal dollar receivable today – for those who hold the bond as a hedge for a liability of a nominal dollar payable in 20 years, the dollar receivable today is in fact the riskier holding. More generally the negative beta nature of government bonds means that the central bank increases the risk exposure of the economy when it buys them.
Apart from the market risk impact of QE, we need to examine whether it has any impact on the liquidity position of the private economy. In this respect, neither the first or the second step has any impact for a simple reason – the assets being bought i.e. govt bonds are already safe collateral both in the shadow banking system as well as with the central bank itself. Therefore, any owner of government bonds can freely borrow cash against it. The liquidity preference argument is redundant in differentiating between deposits and an asset that qualifies as safe collateral. Broad money supply is therefore unaffected when such an asset is purchased.
If conventional QE were the only tool in the arsenal, announcing higher targets or NGDP targets achieves very little. The Bank of England and the Federal Reserve could buy up the entire outstanding stock of govt bonds and the impact on inflation or economic growth would be negligible in the current environment.
Credit Easing and More: Private Sector Assets
Many proponents of NGDP targeting would assert that limiting the arsenal of the central bank to simply treasury bonds is inappropriate and that the central bank must be able to purchase private sector assets (bonds, equities) or as Scott Sumner exhorts above “If necessary buy up all of Planet Earth”. There is no denying the fact that by buying up all of Planet Earth, any central bank can create inflation. But when the assets bought are already liquid and market conditions are not distressed, buying of private assets creates inflation only by increasing the price and reducing the yield of those assets i.e. a wealth transfer from the central bank to the chosen asset-holders. As with quantitative easing through government bond purchases, the inability to enforce adequate penalties on reserves nullifies any potential “hot potato” effect.
Bernanke himself has noted that the liquidity facility interventions during the 2008-2009 crisis and QE1 were focused on reducing private market credit spreads and improving the functioning of private credit markets at a time when the market for many private sector assets was under significant stress and liquidity premiums were high. The current situation is not even remotely comparable – yields on private credit instruments are at relatively elevated levels compared to historical median spreads but the difference in absolute terms is only about 50 bps on investment-grade credit (see table below) as compared to much higher levels (at least 300-40 bps on investment grade) during the 2008-2009 crisis.
A quantitative easing program focused on purchasing private sector assets is essentially a fiscal program in monetary disguise and is not even remotely neutral in its impact on income distribution and economic activity. Even if the central bank buys a broad index of bonds or equities, such a program is by definition a transfer of wealth towards asset-holders and regressive in nature (financial assets are largely held by the rich). The very act of making private sector assets “safe” is a transfer of wealth from the taxpayer to some of the richest people in our society. The explicit nature of the central banks’ stabilisation commitment means that the rent extracted from the commitment increases over time as more and more economic actors align their portfolios to hold the stabilised and protected assets.
Such a program is also biased towards incumbent firms and against new firms. The assumption that an increase in the price of incumbent firms’ stock/bond price will flow through to lending and investment in new businesses is unjustified due to the significantly more uncertain nature of new business lending/investment. This trend has been exacerbated since the crisis and the bond market is increasingly biased towards the largest, most liquid issuers. Even more damaging, any long-term macroeconomic stabilisation program that commits to purchasing and supporting macro-risky assets will incentivise economic actors to take on macro risk and shed idiosyncratic risk. Idiosyncratic risk-taking is the lifeblood of innovation in any economy.
In other words, QE is not sufficient to hit any desired inflation/NGDP target unless it is expanded to include private sector assets. If it is expanded to include private sector assets, it will exacerbate the descent into an unequal, crony capitalist, financialised and innovatively stagnant economy that started during the Greenspan/Bernanke put era.
Removing the zero-bound
One way of getting around the zero-bound on interest rates is to simply abolish or tax bank note holdings as Willem Buiter has recommended many times:
The existence of bank notes or currency, which is an irredeemable ‘liability’ of the central bank – bearer bonds with a zero nominal interest rate – sets a lower bound (probably at something just below 0%) on central banks’ official policy rates.
The obvious solutions are: (1) abolishing currency completely and moving to E-money on which negative interest rates can be paid as easily as zero or positive rates; (2) taxing holdings of bank notes (a solution first proposed by Gesell (1916) and also advocated by Irving Fisher (1933)) or (3) ending the fixed exchange rate between currency and central bank reserves (which, like all deposits, can carry negative nominal interest rates as easily as positive nominal interest rates, a solution due to Eisler (1932)).
I’ve advocated many times on this blog that monetary-fiscal hybrid policies such as money-financed helicopter drops to individuals should be established as the primary tool of macroeconomic stabilisation. In this manner, inflation/NGDP targets can be achieved in a close-to-neutral manner that minimises rent extraction. My preference for fiscal-monetary helicopter drops over negative interest-rates is primarily driven by financial stability considerations. There is ample evidence that even low interest rates contribute to financial instability.
There’s a deep hypocrisy at the heart of the macro-stabilised era. Every policy of stabilisation is implemented in a manner that only a select few (typically corporate entities) can access with an implicit assumption that the impact will trickle-down to the rest of the economy. Central-banking since the Great Moderation has suffered from an unwarranted focus on asset prices driven by an implicit assumption that changes in asset prices are the best way to influence the macroeconomy. Instead doctrines such as the Greenspan Put have exacerbated inequality and cronyism and promoted asset price inflation over wage inflation. The single biggest misconception about the macro policy debate is the notion that monetary policy is neutral or more consistent with a free market and fiscal policy is somehow socialist and interventionist. A program of simple fiscal transfers to individuals can be more neutral than any monetary policy instrument and realigns macroeconomic stabilisation away from the classes and towards the masses.
There are many similarities between a resilience approach to macroeconomics and the Minsky/Bagehot approach – the most significant being a common focus on macroeconomies as systems in permanent disequilibrium. Although both approaches largely agree on the descriptive characteristics of macroeconomic systems, there are some significant differences when it comes to the preferred policy prescriptions. In a nutshell, the difference boils down to the question of when and where to intervene.
A resilience approach focuses its interventions on severe disturbances, whilst allowing small and moderate disturbances to play themselves out. Even when the disturbance is severe, a resilience approach avoids stamping out the disturbance at source and focuses its efforts on mitigating the wider impact of the disturbance on the macroeconomy. The primary aim is the minimisation of the long-run fragilising consequences of the intervention which I have explored in detail in many previous posts(1, 2, 3). Just as small fires and floods are integral to ecological resilience, small disturbances are integral to macroeconomic resilience. Although it is difficult to identify ex-ante whether disturbances are moderate or not, the Greenspan-Bernanke era nevertheless contains some excellent examples of when not to intervene. The most obvious amongst all the follies of Greenspan-era monetary policy were the rate cuts during the LTCM collapse which were implemented with the sole purpose of “saving” financial markets at a time when the real economy showed no signs of stress1.
The Minsky/Bagehot approach focuses on tackling all disturbances with debt-deflationary consequences at their source. Bagehot asserted in ‘Lombard Street’ that “in wild periods of alarm, one failure makes many, and the best way to prevent the derivative failures is to arrest the primary failure which causes them”. Minsky emphasised the role of both the lender-of-last-resort (LOLR) mechanism as well as fiscal stabilisers in tackling such “failures”. However Minsky was not ignorant of the long-term damage inflicted by a regime where all disturbances were snuffed out at source – the build-up of financial “innovation” designed to take advantage of this implicit protection, the descent into crony capitalism and the growing fragility of a private-investment driven economy2, an understanding that was also reflected in his fundamental reform proposals3. Minsky also appreciated that the short-run cycle from hedge finance to Ponzi finance does not repeat itself in the same manner. The long-arc of stabilised cycles is itself a disequilibrium process (a sort of disequilibrium super-cycle) where performance in each cycle deteriorates compared to the last one – an increasing amount of stabilisation needs to be applied in each short-run cycle to achieve poorer results compared to the previous cycle.
Resilience Approach: Policy Implications
As I have outlined in an earlier post, an approach that focuses on minimising the adaptive consequences of macroeconomic interventions implies that macroeconomic policy must allow the “river” of the macroeconomy to flow in a natural manner and restrict its interventions to insuring individual economic agents rather than corporate entities against the occasional severe flood. In practise, this involves:
- De-emphasising the role of conventional and unconventional monetary policy (interest-rate cuts, LOLR, quantitative easing, LTRO) in tackling debt-deflationary disturbances.
- De-emphasising the role of industrial policy and explicit bailouts of banks and other firms4.
- Establishing neutral monetary-fiscal hybrid policies such as money-financed helicopter drops as the primary tool of macroeconomic stabilisation. Minsky’s insistence on the importance of LOLR operations was partly driven by his concerns that alternative policy options could not be implemented quickly enough5. This concern is less relevant with regards to helicopter drops in today’s environment where they can be implemented almost instantaneously6.
Needless to say, the policies we have followed throughout the ‘Great Moderation’ and continue to follow are anything but resilient. Nowhere is the farce of orthodox policy more apparent than in Europe where countries such as Spain are compelled to enforce austerity on the masses whilst at the same time being forced to spend tens of billions of dollars in bailing out incumbent banks. Even within the structurally flawed construct of the Eurozone, a resilient strategy would take exactly the opposite approach which will not only drag us out of the ‘Great Stagnation’ but it will do so in a manner that delivers social justice and reduced inequality.
- Of course this “success” also put Greenspan, Rubin and Summers onto the cover of TIME magazine, which goes to show just how biased political incentives are in favour of stabilisation and against resilience. ↩
- From pages 163-165 of Minsky’s book ‘John Maynard Keynes’:
“The success of a high-private-investment strategy depends upon the continued growth of relative needs to validate private investment. It also requires that policy be directed to maintain and increase the quasi-rents earned by capital – i.e.,rentier and entrepreneurial income. But such high and increasing quasi-rents are particularly conducive to speculation, especially as these profits are presumably guaranteed by policy. The result is experimentation with liability structures that not only hypothecate increasing proportions of cash receipts but that also depend upon continuous refinancing of asset positions. A high-investment, high-profit strategy for full employment – even with the underpinning of an active fiscal policy and an aware Federal Reserve system – leads to an increasingly unstable financial system, and an increasingly unstable economic performance. Within a short span of time, the policy problem cycles among preventing a deep depression, getting a stagnant economy moving again, reining in an inflation, and offsetting a credit squeeze or crunch…….
In a sense, the measures undertaken to prevent unemployment and sustain output “fix” the game that is economic life; if such a system is to survive, there must be a consensus that the game has not been unfairly fixed…….
As high investment and high profits depend upon and induce speculation with respect to liability structures, the expansions become increasingly difficult to control; the choice seems to become whether to accomodate to an increasing inflation or to induce a debt-deflation process that can lead to a serious depression……
The high-investment, high-profits policy synthesis is associated with giant firms and giant financial institutions, for such an organization of finance and industry seemingly makes large-scale external finance easier to achieve. However, enterprises on the scale of the American giant firms tend to become stagnant and inefficient. A policy strategy that emphasizes high consumption, constraints upon income inequality, and limitations upon permissible liability structures, if wedded to an industrial-organization strategy that limits the power of institutionalized giant firms, should be more conducive to individual initiative and individual enterprise than is the current synthesis.
As it is now, without controls on how investment is to be financed and without a high-consumption, low private-investment strategy, sustained full employment apparently leads to treadmill affluence, accelerating inflation, and recurring threats of financial crisis.” ↩
- Just like Keynes, Minsky understood completely the dynamic of stabilisation and its long-term strategic implications. Given the malformation of private investment by the interventions needed to preserve the financial system, Keynes preferred the socialisation of investment and Minsky a shift to a high-consumption, low-investment system. But the conventional wisdom, which takes Minsky’s tactical advice on stabilisation and ignores his strategic advice on the need to abandon the private-investment led model of growth, is incoherent. ↩
- In his final work ‘Power and Prosperity’, Mancur Olson expressed a similar sentiment: “subsidizing industries, firms and localities that lose money…at the expense of those that make money…is typically disastrous for the efficiency and dynamism of the economy, in a way that transfers unnecessarily to poor individuals…A society that does not shift resources from the losing activities to those that generate a social surplus is irrational, since it is throwing away useful resources in a way that ruins economic performance without the least assurance that it is helping individuals with low incomes. A rational and humane society, then, will confine its distributional transfers to poor and unfortunate individuals.” ↩
- From pg 44 of ‘Stabilising an Unstable Economy’: “The need for lender-of-Iast-resort operations will often occur before income falls steeply and before the well nigh automatic income and financial stabilizing effects of Big Government come into play. If the institutions responsible for the lender-of-Iast-resort function stand aside and allow market forces to operate, then the decline in asset values relative to current output prices will be larger than with intervention; investment and debt- financed consumption will fall by larger amounts; and the decline in income, employment, and profits will be greater. If allowed to gain momentum, the financial crisis and the subsequent debt deflation may, for a time, overwhelm the income and financial stabilizing capacity of Big Government. Even in the absence of effective lender-of-Iast-resort action, Big Government will eventually produce a recovery, but, in the interval, a high price will be paid in the form of lost income and collapsing asset values.” ↩
- As Charlie Bean of the BoE suggests, helicopter drops could be implemented in the UK via the PAYE system. ↩
Mitt Romney’s campaign for the Republican nomination for the US Presidential election has triggered a debate as to the role of private equity (PE) in the economy. The critical of the private equity industry tend to focus on their perceived tendency to layoff employees and increase leverage. Regarding layoffs, there is very little evidence that PE firms are worse than the rest of the corporate sector. However, this does not imply that their role is entirely positive. But it does imply that the excesses of PE mirror the excesses of the larger economy during the neoliberal era. This is obvious when the role of leverage is examined. As Mike Konczal notes, “something did change during the 1980s, and LBO was part of this overall shift.” The road that started with LBOs in the 1980s ended with the rash of dividend recapitalisations between 2003–2007, a phenomenon that has even resurfaced post the crisis.
It is easy to find proximate causes for this dynamic and commentators on both sides of the political spectrum attribute much of the above to the neo-liberal revolution – the doctrine of shareholder value maximisation, high-powered managerial incentives, a drive towards increased efficiency etc. The acceleration of this process in the last decade usually gets explained away as the inevitable consequence of a financial bubble with irrationally exuberant banks making unwise loans to fuel the leverage binge. But these narratives miss the obvious elephant in the room – the role of monetary policy and in particular the dominant monetary policy doctrine underpinning the ‘Great Moderation’ which focused on shoring up financial asset prices as the primary channel of monetary stimulus, otherwise known as the ‘Greenspan Put’. All the above proximate causes were the direct and inevitable result of economic actors seeking to align themselves to the central banks’ focus on asset price stabilisation.
As I elaborated upon in an earlier post:
creating any source of stability in a capitalist economy incentivises economic agents to realign themselves to exploit that source of security and thereby reduce risk. Similar to how banks’ adaptation to the intervention strategies preferred by central banks by taking on more “macro” risks, macro-stabilisation incentivises real economy firms to shed idiosyncratic micro-risks and take on financial risks instead. Suppressing nominal volatility encourages economic agents to shed real risks and take on nominal risks. In the presence of the Greenspan/Bernanke put, a strategy focused on “macro” asset price risks and leverage outcompetes strategies focused on “risky” innovation. Just as banks that exploit the guarantees offered by central banks outcompete those that don’t, real economy firms that realign themselves to become more bank-like outcompete those that choose not to…….When central bankers are focused on preventing significant pullbacks in equity prices (the Greenspan/Bernanke put), then real-economy firms are incentivised to take on more systematic risk and reduce their idiosyncratic risk exposure.
The focus on cost reduction and layoffs is also a result of this increased market-sensitivity combined with the macro-stabilisation commitment encourages low-risk process innovation and discourages uncertain and exploratory product innovation. The excesses of some forms of private equity are often instances in which they apply the maximum possible leverage to extract the rents available via the Greenspan Put. Dividend recaps are one such instance.
James Kwak summarises the case of Simmons Bedding Company:
In 2003, for example, THL bought Simmons (the mattress company) for $327 million in cash and $745 million in debt. In 2004, Simmons (now run by THL) issued more debt and paid a $137 million dividend to THL; in 2007, it issued yet more debt and paid a $238 million dividend to THL. Simmons filed for bankruptcy in 2009.
The obvious question here is why banks and financial institutions would lend so much money and allow firms to lever up so dramatically. Kwak lays the blame on the financial bubble, principal-agent problems, bankers bonus structures etc. TED counters that lenders do in fact typically make informed decisions and also correctly points out that the rest of corporate America is not immune to such leveraged mishaps either. Both explanations ignore the fact that this sort of severely tail-risk heavy loan is exactly the payoff which maximises the banks‘ and their employees’ own moral hazard rent extraction. In an earlier post, I identified that many hedge fund strategies are an indirect beneficiary of moral hazard rents – the same argument also applies to some private equity strategies.
But as I have noted on many occasions, the moral hazard problem from tail-risk hungry TBTF financial institutions is simply the tip of the iceberg. It was not only the banks with access to cheap leverage that were heavily invested in “safe” assets, but also asset managers, money market mutual funds and even ordinary investors. The Greenspan/Bernanke Put incentivises a large proportion of real and financial actors in the economy into taking on more and more tail risk with the expectation that the Fed will avoid any outcomes where these risks will be realised.
Too many commentators fail to recognise that so much of what has made the neo-liberal era a thinly disguised corporate welfare state can be traced to the impact of a supposedly “neutral” macroeconomic policy instrument that in reality has grossly regressive consequences. To expect corporate America to not take advantage of the free lunch offered to it by the Fed is akin to dangling a piece of meat in front of a tiger and expecting it not to bite your hand off.
In my posts on the subject of cronyism and rent-seeking, I have drawn heavily on the work of Mancur Olson. My views are also influenced by my experiences of cronyism in India and comparing it to the Olsonian competitive sclerosis that afflicts most developed economies today. Although there are significant differences between cronyism in the developing and developed world, there is also a very significant common ground. In some respects, the rent-extraction apparatus in the developed world is just a more sophisticated version of the open corruption and looting that is common in many developing economies. This post explores some of this common ground.
Mancur Olson predicted the inexorable rise of rent seeking in a stable economy. But he also thought that once rent-seeking activities extracted too high a proportion of a nation’s GDP, the normal course of democracy and public anger may rein them in. Small rent seekers can fly under the radar but big rent-seekers are ultimately cut back to size. But is this necessarily true? Although there is some truth to this assertion, Olson was likely too optimistic about the existence of such limits. This post tries to provide an argument as to why this is not necessarily the case. After all, it can easily be argued that rents extracted by banks already swallow up a significant proportion of GDP. And there is no shortage of corrupt public programs that swallow up significant proportions of the public budget in the developing world. In a nutshell, my argument is that rent-extraction can avoid these limits by aligning itself to the progressive agenda – the very programs that purport to help the masses become the source of rents for the classes.
A transparent example of this phenomenon is the experience of the Mahatma Gandhi National Rural Employment Guarantee – a public program that guarantees 100 days of work for unskilled rural labourers in India. In a little more than half a decade since inception, it accounts for 3% of public spending and economists estimate that anywhere from a quarter to two-thirds of the expenditure does not reach those whom it is intended to help. So how does a program such as this not only survive but thrive? The answer is simple – despite the corruption, the scheme does disburse significant benefits to a large rural electorate. When faced with the choice of either tolerating a corrupt program or cancelling the program, the rural poor clearly prefer the status quo.
A rather more sophisticated example of this phenomenon is the endless black hole of losses that are Freddie Mac and Fannie Mae – $175 billion and counting. The press focuses on the comparatively small bonus payments to Freddie and Fannie executives but ignores their much larger role in the back door bailout of the banking sector. Again the reason why this goes relatively uncriticised is simple – despite the significant contribution made by Fannie and Freddie to the rents extracted by the “1%”, their operations also put money into the pockets of a vast cross-section of homeowners. Simply shutting them down would almost certainly constitute an act of political suicide.
The masses become the shield for the very programs that enable a select few to extract significant rents out of the system. The same programs that are supposed to be part of the liberal social agenda like Fannie/Freddie become the weapons through which the cronyist corporate structure perpetuates itself, while the broad-based support for these programs makes them incredibly resilient and hard to reform once they have taken root.
Those who cherish the progressive agenda tend to argue that better implementation and regulation can solve the problem of rent extraction. But there is another option – complex programs with egalitarian aims should be replaced with direct cash transfers wherever feasible. This case has been argued persuasively in a recent book as an effective way to help the poor in developing countries and is already being implemented in India. There is no reason why the same approach cannot be implemented in the developed world either.
All economists assert that wants are unlimited. From this follows the view that technological unemployment is impossible in the long run. Yet there are a growing number of commentators (such as Brian Arthur) who insist that increased productivity from automation and improvements in artificial intelligence has a part to play in the current unemployment crisis. At the same time, a growing chorus laments the absence of innovation – Tyler Cowen’s thesis that the recent past has been a ‘Great Stagnation’ is compelling.
But don’t the two assertions contradict each other? Can we have an increase in technological unemployment as well as an innovation deficit? Is the concept of technological unemployment itself valid? Is there anything about the current phase of labour-displacing technological innovation that is different from the past 150 years? To answer these questions, we need a deeper understanding of the dynamics of innovation in a capitalist economy i.e. how exactly has innovation and productivity growth proceeded in a manner consistent with full employment in the past? In the process, I also hope to connect the long-run structural dynamic with the Minskyian business cycle dynamic. It is common to view the structural dynamic of technological change as a sort of ‘deus ex machine’ – if not independent, certainly as a phenomenon that is unconnected with the business cycle. I hope to convince some of you that our choices regarding business cycle stabilisation have a direct bearing on the structural dynamic of innovation. I have touched upon many of these topics in a scattered fashion in previous posts but this post is an attempt to present many of these thoughts in a coherent fashion with all my assumptions explicitly laid out in relation to established macroeconomic theory.
Imperfectly competitive markets are the norm in most modern economies. In instances where economies of scale or network effects dominate, a market may even be oligopolistic or monopolistic (e.g. Google, Microsoft) This assumption is of course nothing new to conventional macroeconomic theory. Where my analysis differs is in viewing the imperfectly competitive process as one that is permanently in disequilibrium. Rents or “abnormal” profits are a persistent feature of the economy at the level of the firm and are not competed away even in the long run. The primary objective of incumbent rent-earners is to build a moat around their existing rents whereas the primary objective of competition from new entrants is not to drive rents down to zero, but to displace the incumbent rent-earner. It is not the absence of rents but the continuous threat to the survival of the incumbent rent-earner that defines a truly vibrant capitalist economy i.e. each niche must be continually contested by new entrants. This does not imply, even if the market for labour is perfectly competitive, that an abnormal share of GDP goes to “capital”. Most new entrants fail and suffer economic losses in their bid to capture economic rents and even a dominant incumbent may lose a significant proportion of past earned rents in futile attempts to defend its competitive position before its eventual demise.
This emphasis on disequilibrium points to the fact that the “optimum” state for a dynamically competitive capitalist economy is one of constant competitive discomfort and disorder. This perspective leads to a dramatically different policy emphasis from conventional theory which universally focuses on increasing positive incentives to economic players and relying on the invisible hand to guide the economy to a better equilibrium. Both Schumpeter and Marx understood the importance of this competitive discomfort for the constant innovative dynamism of a capitalist economy – my point is simply that a universal discomfort of capital is also important to maintain the distributive justice in a capitalist economy. in fact it is the only way to do so without sacrificing the innovative dynamism of the economy.
Competition in monopolistically competitive markets manifests itself through two distinct forms of innovation: exploitation and exploration. Exploitation usually takes the form of what James Utterback identified as process innovation with an emphasis on “real or potential cost reduction, improved product quality, and wider availability, and movement towards more highly integrated and continuous production processes.” As Utterback noted, such innovation is almost always driven by the incumbent firms. Exploitation is an act of optimisation under a known distribution i.e. it falls under the domain of homo economicus. In the language of fitness landscapes, exploitative process innovation is best viewed as competition around a local peak. On the other hand, exploratory product innovation (analogous to what Utterback identified as product innovation) occurs under conditions of significant irreducible uncertainty. Exploration is aimed at finding a significantly higher peak on the fitness landscape and as Utterback noted, is almost always driven by new entrants (For a more detailed explanation of incumbent preference for exploitation and organisational rigidity, see my earlier post).
An Investment Theory of the Business Cycle
Soon after publishing the ‘General Theory’, Keynes summarised his thesis as follows: “given the psychology of the public, the level of output and employment as a whole depends on the amount of investment. I put it in this way, not because this is the only factor on which aggregate output depends, but because it is usual in a complex system to regard as the causa causans that factor which is most prone to sudden and wide fluctuation.” In Keynes‘ view, the investment decision was undertaken in a condition of irreducible uncertainty, “influenced by our views of the future about which we know so little”. Just how critical the level of investment is in maintaining full employment is highlighted by GLS Shackle in his interpretation of Keynes’ theory: “In a money-using society which wishes to save some of the income it receives in payment for its productive efforts, it is not possible for the whole (daily or annual) product to be sold unless some of it is sold to investors and not to consumers. Investors are people who put their money on time-to-come. But they do not have to be investors. They can instead be liquidity-preferrers; they can sweep up their chips from the table and withdraw. If they do, they will give no employment to those who (in face of society’s propensity to save) can only be employed in making investment goods, things whose stream of usefulness will only come out over the years to come.”
If we accept this thesis, then it is no surprise that the post–2008 recovery has been quite so anaemic. Investment spending has remained low throughout the developed world, nowhere more so than in the United Kingdom. What makes this low level of investment even more surprising is the strength of the rebound in corporate profits and balance sheets – corporate leverage in the United States is as low as it has been for two decades and the proportion of cash in total assets as high as it has been for almost half a century. Specifically, the United States has also experienced an unusual increase in labour productivity during the recession which has exacerbated the disconnect between the recovery in GDP and employment. Some of these unusual patterns have been with us for a much longer time than the 2008 financial crisis. For example, the disconnect between GDP and employment in the United States has been obvious since atleast 1990, and the 2003 recession too saw an unusual rise in labour productivity. The labour market has been slack for at least a decade. It is hard to differ from Paul Krugman’s intuition that the character of post–1980 business cycles has changed. Europe and Japan are not immune from these “structural” patterns either – the ‘corporate savings glut’ has been a problem in the United Kingdom since atleast 2002, and Post-Keynesian economists have been pointing out the relationship between ‘capital accumulation’ and unemployment for a while, even attributing the persistently high unemployment in Europe to a lack of investment. Japan’s condition for the last decade is better described as a ‘corporate savings trap’ rather than a ‘liquidity trap’. Even in Greece, that poster child for fiscal profligacy, the recession is accompanied by a collapse in private sector investment.
A Theory of Business Investment
Business investments can typically either operate upon the scale of operations (e.g. capacity,product mix) or they can change the fundamental character of operations (e.g. changes in process, product). The degree of irreducible uncertainty in capacity and product mix decisions has reduced dramatically in the last half-century. The ability of firms to react quickly and effectively to changes in market conditions has improved dramatically with improvements in production processes and information technology – Zara being a well-researched example. Investments that change the very nature of business operations are what we typically identify as innovations. However, not all innovation decisions are subject to irreducible uncertainty either. In a seminal article, James March distinguished between “the exploration of new possibilities and the exploitation of old certainties. Exploration includes things captured by terms such as search, variation, risk taking, experimentation, play, flexibility, discovery, innovation. Exploitation includes such things as refinement, choice, production, efficiency, selection, implementation, execution.” Exploratory innovation operates under conditions of irreducible uncertainty whereas exploitation is an act of optimisation under a known distribution.
Investments in scaling up operations are most easily influenced by monetary policy initiatives which reduce interest rates and raise asset prices or direct fiscal policy initiatives which operate via the multiplier effect. In recent times, especially in the United States and United Kingdom, the reduction in rates has also directly facilitated the levering up of the consumer balance sheet and a reduction in the interest servicing burden of past consumer debt taken on. The resulting boost to consumer spending and demand also stimulates businesses to invest in expanding capacity. Exploitative innovation requires the presence of price competition within the industry i.e. monopolies or oligopolies have little incentive to make their operations more efficient beyond the price point where demand for their product is essentially inelastic. This sounds like an exceptional case but is in fact very common in critical industries such as finance and healthcare. Exploratory innovation requires not only competition amongst incumbent firms but competition from a constant and robust stream of new entrants into the industry. I outlined the rationale for this in a previous post:
Let us assume a scenario where the entry of new firms has slowed to a trickle, the sector is dominated by a few dominant incumbents and the S-curve of growth is about to enter its maturity/decline phase. To trigger off a new S-curve of growth, the incumbents need to explore. However, almost by definition, the odds that any given act of exploration will be successful is small. Moreover, the positive payoff from any exploratory search almost certainly lies far in the future. For an improbable shot at moving from a position of comfort to one of dominance in the distant future, an incumbent firm needs to divert resources from optimising and efficiency-increasing initiatives that will deliver predictable profits in the near future. Of course if a significant proportion of its competitors adopt an exploratory strategy, even an incumbent firm will be forced to follow suit for fear of loss of market share. But this critical mass of exploratory incumbents never comes about. In essence, the state where almost all incumbents are content to focus their energies on exploitation is a Nash equilibrium.
On the other hand, the incentives of any new entrant are almost entirely skewed in favour of exploratory strategies. Even an improbable shot at glory is enough to outweigh the minor consequences of failure. It cannot be emphasised enough that this argument does not depend upon the irrationality of the entrant. The same incremental payoff that represents a minor improvement for the incumbent is a life-changing event for the entrepreneur. When there exists a critical mass of exploratory new entrants, the dominant incumbents are compelled to follow suit and the Nash equilibrium of the industry shifts towards the appropriate mix of exploitation and exploration.
A Theory of Employment
My fundamental assertion is that a constant and high level of uncertain, exploratory investment is required to maintain a sustainable and resilient state of full employment. And as I mentioned earlier, exploratory investment driven by product innovation requires a constant threat from new entrants.
Long-run increases in aggregate demand require product innovation. As Rick Szostak notes:
While in the short run government spending and investment have a role to play, in the long run it is per capita consumption that must rise in order for increases in per capita output to be sustained…..the reason that we consume many times more than our great-grandparents is not to be found for the most part in our consumption of greater quantities of the same items which they purchased…The bulk of the increase in consumption expenditures, however, has gone towards goods and services those not-too-distant forebears had never heard of, or could not dream of affording….Would we as a society of consumers/workers have striven as hard to achieve our present incomes if our consumption bundle had only deepened rather than widened? Hardly. It should be clear to all that the tremendous increase in per capita consumption in the past century would not have been possible if not for the introduction of a wide range of different products. Consumers do not consume a composite good X. Rather, they consume a variety of goods, and at some point run into a steeply declining marginal utility from each. As writers as diverse as Galbraith and Marshall have noted, if declining marginal utility exists with respect to each good it holds over the whole basket of goods as well…..The simple fact is that, in the absence of the creation of new goods, aggregate demand can be highly inelastic, and thus falling prices will have little effect on output.
Therefore, when cost-cutting and process optimisation in an industry enables a product to be sold at a lower cost, the economy may not be able to reorganise back to full employment with simply an increased demand for that particular product. In the early stages of a product when demand is sufficiently elastic, process innovation can increase employment. But as the product ages, process improvements have a steadily negative effect on employment.
Eventually, a successful reorganisation back to full employment entails creating demand for new products. If such new products were simply an addition to the set of products that we consumed, disruption would be minimal. But almost any significant new product that arises from exploratory investment also destroys an old product. The tablet cannibalises the netbook, the smartphone cannibalises the camera etc. This of course is the destruction in Schumpeter’s creative destruction. It is precisely because of this cannibalistic nature of exploratory innovation that established incumbents rarely engage in it, unless compelled to do so by the force of new entrants. Burton Klein put it well: “ firms involved in such competition must compare two risks: the risk of being unsuccessful when promoting a discovery or bringing about an innovation versus the risk of having a market stolen away by a competitor: the greater the risk that a firm’s rivals take, the greater must be the risks to which must subject itself for its own survival.” Even when new firms enter a market at a healthy pace, it is rare that incumbent firms are successful at bringing about disruptive exploratory changes. When the pace of dynamic competition is slow, incumbents can choose to simply maintain slack and wait for any promising new technology to emerge which it can buy up rather than risking investment in some uncertain new technology.
We need exploratory investment because this expansion of the economy into its ‘adjacent possible’ does not derive its thrust from the consumer but from the entrepreneur. In other words, new wants are not demanded by the consumers but are instead created by entrepreneurs such as Steve Jobs. In the absence of dynamic competition from new entrants, wants remain limited.
In essence, this framework incorporates technological innovation into a distinctly “Chapter 12” Keynesian view of the business cycle. Although my views are far removed from macroeconomic orthodoxy, they are not quite so radical that they have no precedents whatsoever. My views can be seen as a simple extension of Burton Klein’s seminal work outlined in his books ‘Dynamic Economics’ and ‘Prices, wages, and business cycles: a dynamic theory’. But the closest parallels to this explanation can be found in Rick Szostak’s book ‘Technological innovation and the Great Depression’. Szostak uses an almost identical rationale to explain unemployment during the Great Depression, “how an abundance of labor-saving production technology coupled with a virtual absence of new product innovation could affect consumption, investment and the functioning of the labor market in such a way that a large and sustained contraction in employment would result.”
As I have hinted at in a previous post, this is not a conventional “structural” explanation of unemployment. Szostak explains the difference: “An alternative technological argument would be that the skills required of the workforce changed more rapidly in the interwar period than did the skills possessed by the workforce. Thus, there were enough jobs to go around; workers simply were not suited to them, and a painful decade of adjustment was required…I argue that in fact there simply were not enough jobs of any kind available.” In other words, this is a partly technological explanation for the shortfall in aggregate demand.
The Invisible Foot and New Firm Entry
The concept of the “Invisible Foot” was introduced by Joseph Berliner as a counterpoint to Adam Smith’s “Invisible Hand” to explain why innovation was so hard in the centrally planned Soviet economy:
Adam Smith taught us to think of competition as an “invisible hand” that guides production into the socially desirable channels….But if Adam Smith had taken as his point of departure not the coordinating mechanism but the innovation mechanism of capitalism, he may well have designated competition not as an invisible hand but as an invisible foot. For the effect of competition is not only to motivate profit-seeking entrepreneurs to seek yet more profit but to jolt conservative enterprises into the adoption of new technology and the search for improved processes and products. From the point of view of the static efficiency of resource allocation, the evil of monopoly is that it prevents resources from flowing into those lines of production in which their social value would be greatest. But from the point of view of innovation, the evil of monopoly is that it enables producers to enjoy high rates of profit without having to undertake the exacting and risky activities associated with technological change. A world of monopolies, socialist or capitalist, would be a world with very little technological change.”
For disruptive innovation to persist, the invisible foot needs to be “applied vigorously to the backsides of enterprises that would otherwise have been quite content to go on producing the same products in the same ways, and at a reasonable profit, if they could only be protected from the intrusion of competition”. Burton Klein’s great contribution along with Gunnar Eliasson was to highlight the critical importance of entry of new firms in maintaining the efficacy of the invisible foot. Klein believed that
the degree of risk taking is determined by the robustness of dynamic competition, which mainly depends on the rate of entry of new firms. If entry into an industry is fairly steady, the game is likely to have the flavour of a highly competitive sport. When some firms in an industry concentrate on making significant advances that will bear fruit within several years, others must be concerned with making their long-run profits as large as possible, if they hope to survive. But after entry has been closed for a number of years, a tightly organised oligopoly will probably emerge in which firms will endeavour to make their environments highly predictable in order to make their environments highly predictable in order to make their short-run profits as large as possible….Because of new entries, a relatively concentrated industry can remain highly dynamic. But, when entry is absent for some years, and expectations are premised on the future absence of entry, a relatively concentrated industry is likely to evolve into a tight oligopoly. In particular, when entry is long absent, managers are likely to be more and more narrowly selected; and they will probably engage in such parallel behaviour with respect to products and prices that it might seem that the entire industry is commanded by a single general!
This argument does not depend on incumbent firms leaving money on the table – on the contrary, they may redouble their attempts at cost reduction via process innovation in times of deficient demand. Rick Szostak documents how “despite the availability of a massive amount of inexpensive labour, process innovation would continue in the 1930s. Output per man-hour in manufacturing rose by 25% in the 1930s…..national output was higher in 1939 than in 1929, while employment was over two million less.”
Macroeconomic Policy and Exploratory Product Innovation
Monetary policy has been the preferred cure for insufficient aggregate demand throughout and since the Great Moderation. The argument goes that lower real rates, inflation and higher asset prices will increase investment via Tobin’s Q and increase consumption via the wealth effect and reduction in rewards to savings, all bound together in the virtuous cycle of the multiplier. If monetary policy is insufficient, fiscal policy may be deployed with a focus on either directly increasing aggregate demand or providing businesses with supply-side incentives such as tax cuts.
There is a common underlying theme to all of the above policy options – they focus on the question “how do we make businesses want to invest?” i.e. on positively incentivising incumbent business and startups and trusting that the invisible hand will do the rest. In the context of exploratory investments, the appropriate question is instead “how do we make businesses have to invest?” i.e. on compelling incumbent firms to invest in speculative projects in order to defend their rents or lose out to new entrants if they fail to do so. But the problem isn’t just that these policies are ineffectual. Many of the policies that focus on positive incentives weaken the competitive discomfort from the invisible foot by helping to entrench the competitive position of incumbent corporates and reducing their incentive to engage in exploratory investment. It is in this context that interventions such as central bank purchase of assets and fiscal stimulus measures that dole out contracts to the favoured do permanent harm to the economy.
The division that matters from the perspective of maintaining the appropriate level of exploratory investment and product innovation is not monetary vs fiscal but the division between existing assets and economic interests and new firms/entrepreneurs. Almost all monetary policy initiatives focus on purchasing existing assets from incumbent firms or reducing real rates for incumbent banks and their clients. A significant proportion of fiscal policy does the same. The implicit assumption is, as Nick Rowe notes, that there is “high substitutability between old and new investment projects, so the previous owners of the old investment projects will go looking for new ones with their new cash”. This assumption does not hold in the case of exploratory investments – asset-holders will likely chase after a replacement asset but this asset will likely be an existing investment project, not a new one. The result of the intervention will be an increase in prices of such assets but it will not feed into any “real” new investment activity. In other words, the Tobin’s q effect is negligible for exploratory investments in the short run and in fact negative in the long run as the accumulated effect of rents derived from monetary and fiscal intervention reduces the need for incumbent firms to engage in such speculative investment.
A Brief History of the Post-WW2 United States Macroeconomy
In this section, I’m going to use the above framework to make sense of the evolution of the macroeconomy in the United States after WW2. The framework is relevant for post–70s Europe and Japan as well which is why the ‘investment deficit problem’ afflicts almost the entire developed world today. But the details differ quite significantly especially with regards to the distributional choices made in different countries.
The Golden Age
The 50s and the 60s are best characterised as a period of “order for all” characterised by as Bill Lazonick put it, “oligopolistic competition, career employment with one company, and regulated ﬁnancial markets”. The ‘Golden Age’ delivered prosperity for a few reasons:
- As Minsky noted, the financial sector had only just begun the process of adapting to and circumventing regulations designed to constrain and control it. As a result, the Fed had as much control over credit creation and bank policies as it would ever have.
- The pace of both product and process innovation had slowed down significantly in the real economy, especially in manufacturing. Much of the productivity growth came from product innovations that had already been made prior to WW2. As Alexander Field explains (on the slowdown in manufacturing TFP): “Through marketing and planned obsolescence, the disruptive force of technological change – what Joseph Schumpeter called creative destruction – had largely been domesticated, at least for a time. Whereas large corporations had funded research leading to a large number of important innovations during the 1930s, many critics now argued that these behemoths had become obstacles to transformative innovation, too concerned about the prospect of devaluing rent-yielding income streams from existing technologies. Disruptions to the rank order of the largest U.S. industrial corporations during this quarter century were remarkably few. And the overall rate of TFP growth within manufacturing fell by more than a percentage point compared with the 1930s and more than 3.5 percentage points compared with the 1920s.”
- Apart from the fact that the economy had to catch up to earlier product innovation, the dominant position of the US in the global economy post WW2 limited the impact from foreign competition.
It was this peculiar confluence of factors that enabled a system of “order and stability for all” without triggering a complete collapse in productivity or financial instability – a system where both labour and capital were equally strong and protected and shared in the rents available to all.
The 70s are best described as the time when this ordered, stabilised system could not be sustained any longer.
- By the late 60s, the financial sector had adapted to the regulatory environment. Innovations such as Fed Funds market and the Eurodollar market gradually came into being such that by the late 60s, credit creation and bank lending were increasingly difficult for the Fed to control. Reserves were no longer a binding constraint on bank operations.
- The absence of real competition either on the basis of price or from new entrants meant that both process and product innovation were low just like during the Golden Age but the difference was that there were no more low-hanging fruit to pick from past product innovations. Therefore, a secular slowdown in productivity took hold.
- The rest of world had caught up and foreign competition began to intensify.
As Burton Klein noted, “competition provides a deterrent to wage and price increases because firms that allow wages to increase more rapidly than productivity face penalties in the form of reduced profits and reduced employment”. In the absence of adequate competition, demand is inelastic and there is little pressure to reduce costs. As the level of price/cost competition reduces, more and more unemployment is required to keep inflation under control. Even worse, as Klein noted, it only takes the absence of competition in a few key sectors for the disease to afflict the entire economy. Controlling overall inflation in the macroeconomy when a few key sectors are sheltered from competitive discomfort requires monetary action that will extract a disproportionate amount of pain from the remainder of the economy. Stagflation is the inevitable consequence in a stabilised economy suffering from progressive competitive sclerosis.
By the late 70s, the pressures and conflicts of the system of “order for all” meant that change was inevitable. The result was what is commonly known as the neoliberal revolution. There are many different interpretations of this transition. To right-wing commentators, neoliberalism signified a much-needed transition towards a free-market economy. Most left-wing commentators lament the resultant supremacy of capital over labour and rising inequality. For some, the neoliberal era started with Paul Volcker having the courage to inflict the required pain to break the back of inflationary forces and continued with central banks learning the lessons of the past which gave us the Great Moderation.
All these explanations are relevant but in my opinion, they are simply a subset of a larger and simpler explanation. The prior economic regime was a system where both the invisible hand and the invisible foot were shackled – firms were protected but their profit motive was also shackled by the protection provided to labour. The neoliberal transition unshackled the invisible hand (the carrot of the profit motive) without ensuring that all key sectors of the economy were equally subject to the invisible foot (the stick of failure and losses and new firm entry). Instead of tackling the root problem of progressive competitive and democratic sclerosis and cronyism, the neoliberal era provided a stop-gap solution. “Order for all” became “order for the classes and disorder for the masses”. As many commentators have noted, the reality of neoliberalism is not consistent with the theory of classical liberalism. Minsky captured the hypocrisy well: “Conservatives call for the freeing of markets even as their corporate clients lobby for legislation that would institutionalize and legitimize their market power; businessmen and bankers recoil in horror at the prospect of easing entry into their various domains even as technological changes and institutional evolution make the traditional demarcations of types of business obsolete. In truth, corporate America pays lip service to free enterprise and extols the tenets of Adam Smith, while striving to sustain and legitimize the very thing that Smith abhorred – state-mandated market power.”
The critical component of this doctrine is the emphasis on macroeconomic and financial sector stabilisation implemented primarily through monetary policy focused on the banking and asset price channels of policy transmission:
Any significant fall in asset prices (especially equity prices) has been met with a strong stimulus from the Fed i.e. the ‘Greenspan Put’. In his plea for increased quantitative easing via purchase of agency MBS, Joe Gagnon captured the logic of this policy: ““This avalanche of money would surely push up stock prices, push down bond yields, support real estate prices, and push up the value of foreign currencies. All of these financial developments would stimulate US economic activity.” In other words, prop up asset prices and the real economy will mend itself.
Similarly, Fed and Treasury policy has ensured that none of the large banks can fail. In particular, bank creditors have been shielded from any losses. The argument is that allowing banks to fail will cripple the flow of credit to the real economy and result in a deflationary collapse that cannot be offset by conventional monetary policy alone. This is the logic for why banks were allowed access to a panoply of Federal Reserve liquidity facilities at the height of the crisis. In other words, prop up the banks and the real economy will mend itself.
In this increasingly financialised economy, “the increased market-sensitivity combined with the macro-stabilisation commitment encourages low-risk process innovation and discourages uncertain and exploratory product innovation.” This tilt towards exploitation/cost-reduction without exploration kept inflation in check but it also implied a prolonged period of sub-par wage growth and a constant inability to maintain full employment unless the consumer or the government levered up. For the neo-liberal revolution to sustain a ‘corporate welfare state’ in a democratic system, the absence of wage growth necessitated an increase in household leverage for consumption growth to be maintained. The monetary policy doctrine of the Great Moderation exacerbated the problem of competitive sclerosis and the investment deficit but it also provided the palliative medicine that postponed the day of reckoning. The unshackling of the financial sector was a necessary condition for this cure to work its way through the economy for as long as it did.
It is this focus on the carrot of higher profits that also triggered the widespread adoption of high-powered incentives such as stock options and bonuses to align manager and stockholder incentives. When the risk of being displaced by innovative new entrants is low, high-powered managerial incentives help to tilt the focus of the firm towards a focus on process innovation and cost reduction, optimisation of leverage etc. From the stockholders and the managers’ perspective, the focus on short-term profits is a feature, not a bug.
So long as unemployment and consumption could be propped up by increasing leverage from the consumer and/or the state, the long-run shortage in exploratory product innovation and the stagnation in wages could be swept under the rug and economic growth could be maintained. But there is every sign that the household sector has reached a state of peak debt and the financial system has reached its point of peak elasticity. The policy that worked so well during the Great Moderation is now simply focused on preventing the collapse of the cronyist and financialised economy. The system has become so fragile that Minsky’s vision is more correct than ever – an economy at full employment will yo-yo uncontrollably between a state of debt-deflation and high,variable inflation. Instead the goal of full employment seems to have been abandoned in order to postpone the inevitable collapse. This only substitutes an economic fragility with a deeper social fragility.
The aim of full employment is made even harder with the acceleration of process innovation due to advances in artificial intelligence and computerisation. Process innovation gives us technological unemployment while at the same time the absence of exploratory product innovation leaves us stuck in the Great Stagnation.
The solution preferred by the left is to somehow recreate the golden age of the 50s and the 60s i.e. order for all. Apart from the impossibility of retrieving the docile financial system of that age (which Minsky understood), the solution of micro-stability for all is an environment of permanent innovative stagnation. The Schumpeterian solution is to transform the system into one of disorder for all, masses and classes alike. Micro-fragility is the key to macro-resilience but this fragility must be felt by all economic agents, labour and capital alike. In order to end the stagnation and achieve sustainable full employment, we need to allow incumbent banks and financialised corporations to collapse and dismantle the barriers to entry of new firms that pervade the economy (e.g. occupational licensing, the patent system). But this does not imply that the macroeconomy should suffer from a deflationary contraction. Deflation can be prevented in a simple and effective manner with a system of direct transfers to individuals as Steve Waldman has outlined. This solution reverses the flow of rents that have exacerbated inequality over the past few decades, as well as tackling the cronyism and demosclerosis that is crippling innovation and preventing full employment.
It is widely accepted that in times of financial crisis, central banks should follow Bagehot’s rule which can be summarised as: “Lend without limit, to solvent firms, against good collateral, at ‘high rates’.” However, as I noted a few months ago, the Fed and the ECB seem to be following quite a different rule which is best summarised as: “Lend freely even on junk collateral at ‘low rates’.”
The Fed’s response to allegations that they went beyond their mandate for liquidity provision is instructive. In the Fed’s eyes, the absence of credit losses signifies that the collateral was sound and the fact that nearly all the programs have now closed illustrates that the rate charged was clearly at a premium to ‘normal rates’. This argument gives the Fed a significant amount of flexibility as a rate that is at a premium to ‘normal rates’ can still quite easily be a bargain when offered in times of crisis. Nevertheless, the Fed can point to the absence of losses and claim that it only provided liquidity support. The absence of losses is also used to refute the claim that these programs create moral hazard. However, both these arguments ignore the fact that the creditworthiness of assets and the solvency of the banking system cannot be separated from the central banks’ actions during a crisis. As the Fed’s Brian Madigan notes: “In a crisis, the solvency of firms may be uncertain and even dependent on central bank actions.”
However, the Fed’s response does highlight just how important it is to any central bank that it avoid losses on its liquidity programs – not so much to avoid moral hazard but out of simple self-interest. If a central bank exposes itself to significant losses, it runs a significant reputational and political risk. Given the criticism that central banks receive even for programs which do not lose any money, it is quite conceivable that significant losses may even lead to a reduction in their independent powers. Whether or not these losses have any ‘real’ relevance in a fiat-currency economic system, they are undoubtedly relevant in a political context. The interaction of the central bank’s desire to avoid losses and its ability to influence asset prices and bank solvency has some important implications for its liquidity policy choices – In a nutshell, the central bank strongly prefers to backstop assets whose valuation is largely dependent on “macro” systemic risks. Also, when it embarks upon a program of liquidity provision it will either limit itself to extremely high-quality assets or it will backstop the entire spectrum of risky assets from high-grade to junk. It will not choose an intermediate threshold for its intervention.
The first point is easily explained – by choosing to backstop ‘macro’ assets whose prices and performance are strongly reflexive with respect to credit availability, the program minimises the probability of loss. For example, a decision to backstop housing loans has a significant impact on loan-flow and the ‘real’ housing market. A decision to backstop small-business loans on the other hand can only have a limited impact on the realised business outcomes experienced by small businesses given the idiosyncratic risk inherent in them. The negatively skewed payoff profile of such loans combined with their largely ‘macro’ risk profile makes them the ideal candidates for such programs – such assets are exposed to a tail risk of significant losses in the event of macroeconomic distress, which is the exact scenario that central banks are mandated to mitigate against. The coincidence of such distress with deflationary forces enables central banks to eliminate losses on these assets without risking any overshooting of its inflation mandate. This also explains why central banks are reluctant to explicitly backstop equities even at the index level – the less skewed risk profile of equities means that the risk of losses is impossible to reduce to an acceptable level.
The second point is less obvious – If the central bank can restrict itself to backstopping just extremely low-risk bonds and loans, it will do so. But in most crises, this is rarely enough. At the very least, the central bank is required to backstop average-quality assets which is where the impact of uncertainty is greatest and the line between solvency and liquidity risk is blurriest. But this is not the strategy that minimises the risk of losses to the central bank. The impact on the system from the contagious ripple effects of the losses incurred on the junk assets can cause moderate losses on higher-quality assets. This incentivises the Fed to go far beyond the level of commitment that may be optimal for the economy and backstop almost the entire sphere of “macro” assets even if many of them are junk. In other words, it is precisely the desire of the Fed to avoid any losses that incentivised it to expand the scope of its liquidity programs to as large a scale and scope as it did during the crisis.
These preferences of the central bank have implications for the portfolios that banks will choose to hold – banks will prefer ‘macro’ assets without excessive micro risk as these assets are more likely to be backstopped by the central bank during the crisis. This biases bank portfolios and lending towards large corporations, housing etc. and against small business loans and other idiosyncratic risks. The system also becomes less diverse and more highly correlated. The problem of homogeneity and inordinately high correlation is baked into the structural logic of a stabilised financial system. Such a system also carries a higher risk of asset price bubbles – it may be more ‘rational’ for a bank to hold an overpriced ‘macro’ asset and follow the herd than to invest in an underpriced ‘micro’ asset. Douglas Diamond and Raghuram Rajan identified the damaging effects of the implicit commitment by central banks to reduce rates when liquidity is at a premium: “If the authorities are expected to reduce interest rates when liquidity is at a premium, borrowers will take on more short-term leverage or invest in more illiquid projects, thus bringing about the very states where intervention is needed, even if they would not do so in the absence of intervention.” Similarly, the incentives of the central bank to avoid losses at all costs perversely end up making the financial system less diverse and fragile.
When viewed under this logic, the ECB’s actions also start to make sense and criticisms of its lack of courage seem misguided. In terms of liquidity support extended, the ECB has been at least as aggressive as the Fed. in fact, in terms of the risk of losses that it has chosen to bear, the ECB has been far more aggressive. Despite the losses it faces on its Greek debt holdings,it has nearly doubled its peripheral government bond holdings in recent times. This is despite the fact that the ECB runs a significant risk of losses on its government bond holdings in the absence of massive fiscal transfers from the core to the periphery, a policy for which there is little public or political appetite.
The ECB’s desire for the EFSF to take over the task of backstopping the periphery simply highlights the reality that the task is more fiscal than monetary in nature. Relying on the ECB to pick up the slack rather than constructing the fiscal solution also exacerbates the democratic deficit that is crippling the Eurozone. The ECB is not the first central bank that has pleaded to be relieved of duties that belong to the fiscal domain. Various Fed officials have made the same point regarding the Fed’s credit policies – drawing on Marvin Goodfriend’s research, Charles Plosser summarises this view as follows: “the Fed and the Treasury should agree that the Treasury will take the non-Treasury assets and non-discount window loans from the Fed’s balance sheet in exchange for Treasury securities. Such a new ”accord“ would transfer funding for these special credit programs to the Treasury — which would issue Treasury securities to fund the transfer — thus ensuring that these extraordinary credit policies are under the oversight of the fiscal authority, where such policies rightfully belong.” Of course, the incentives of the government are to preserve the status quo – what better than to let the central bank do the dirty work as well as reserving the right to criticise it for doing so!
This highlights a point that often gets lost in the monetary vs fiscal policy debate. Much of what has been implemented as monetary policy in recent times is not only not ‘neutral’ but is regressive in its distributional effects. In the current paradigm of central bank policy during crises, systemic fragility and inequality is an inescapable structural problem. On the other hand, it is perfectly possible to construct a fiscal policy that is close to neutral e.g. Steve Waldman’s excellent idea of simple direct transfers to individuals.
Regardless of if and when Greece defaults, it is now clear that the Eurozone faces an existential crisis. The contradictions in the Euro are a symptom of a much deeper malaise and the inherent fragility of the European political project. As Martin Kettle points out, lifelong Europhiles now openly question whether the European Union itself is on its last legs.
At the heart of the European Union’s problems lies a structural ‘democratic deficit’. David Marquand gets to the heart of the matter in his excellent new book on Europe – at its core, Europe was always a technocratic undertaking aimed at transcending the “clamorous irrationality of political life”, in need of popular support but “wary of popular engagement”. This technocratic focus was not a bug but a feature, a natural byproduct of the emphasis on the “low politics” of agriculture, free trade, regulatory harmonisation etc. that is so amenable to technocratic decision-making. Underlying this approach was a “theory that integration would spread ineluctably, like an inkblot, from one policy domain to another…..The end was political, but the means were economic; and the means gradually eclipsed the end. Integration was supposed to spread, irresistibly and irrevocably, from one economic field to another; there would be no breaks in the process, when popular consent would have to be mobilized. Economic success, facts on the ground—market freedom, economies of scale, rapid growth, rising living standards—would be enough to embed the project in the public culture. There was no need to buttress legitimacy of the fact with the legitimacy of shared purposes. That would take care of itself.”
But as Marquand notes, this economistic and technocratic view is not rooted in the effective democratic consent of the citizens of Europe. In Marquand’s words:
You can’t hold institutions you don’t understand to account; and it is hard to see how they can represent you. And no one outside a tiny group of Euro-actors and Euro-academics understands how the European Union works. National politics often baffle ordinary citizens, not least because national governments are entangled in increasingly complex webs of European and global interdependence. But the citizens of the Union’s member states mostly have at least a vague notion of what national political parties stand for, and who national leaders and would-be leaders are. In the time-honored phrase, they can, if they wish, “throw the rascals out.” And there is, at least, a tenuous connection between their votes and the policies their governments pursue, None of this is true of Union politics. Voters in European elections can’t throw the rascals out. The connection between their votes and Union policies is not just tenuous but invisible. There is no shortage of rascals, but the most egregious of them belong to national governments and administrations, not to European institutions of any kind. Even the ones that do belong to European bodies—notably, Commission and Council permanent officials—are mostly out of reach of European voters and their representatives in the European Parliament. Worse still, there are no Europe-wide political parties to focus debate and offer choices to a European electorate. European citizens vote in European elections when they do (and, as earlier chapters have shown, increasing numbers don’t) to punish or reward national political parties, fighting on essentially national platforms. And though the European Parliament’s role in the Union’s legislative process has grown immeasurably in recent years, the process itself is both labyrinthine and impenetrable by outsiders….the EU has no buck—or, at least, no buck that stops. There is only an endless maze of indeterminacy.
Apart from a growing apathy (as signalled by the low and falling turnout in European Parliament elections), a perceived inability to influence political outcomes through the democratic process opens the door for the electorate to pursue more radical options. It is not a coincidence that so many of the protests and movements across Europe in Greece, Spain, Ireland and France have focused on the common theme of demanding more direct and local democracy. Although most of these protests have been allied with a distinctly left-wing political stance, they share the emphasis on more direct democracy with many right-wing Euroskeptics. This radicalisation in response to a perceived loss of democratic voice is easily understood when viewed in the context of the history of democratic rights and universal suffrage. As Albert Hirschman has pointed out in his book ‘Shifting Involvements: Private Interest and Public Action’, the introduction of universal suffrage effectively delegitimised more direct revolutionary political action. In his words:
when the vote was granted to the people of France, and in particular to that obstreperous, unruly, and impulsive people of Paris which had just made the third revolution in two generations, it became enthroned in effect as the only legitimate form of expressing political opinions. In other words, the vote represented a new right of the people, but it also restricted its participation in politics to this particular and comparatively harmless form. It was similarly a means of offsetting the perpetual Parisian avant-garde and direct-action leanings by the much more traditional and law-abiding mood of the provinces. This interpretation of the universal vote decision as restraining and conservative in fact though not, of course, in intent is suggested by the conservative outcome of the April 1848 elections to the Constituent National Assembly-and, more important, by the moral force and claim to legitimacy which this freshly elected body was able to throw against the insurgents of June 1848. If insurrection is justified in the absence of free and general elections, as republican opinion maintained at the time, then, in counterpart, the implantation of universal suffrage could be held to be an antidote to revolutionary change. This was indeed the way the more conservative republicans saw it soon after the February Revolution, and the idea is well expressed in the contemporary slogan, “the universal suffrage closes the era of revolutions.”
Hirschman quotes Gambetta’s imploring speech to his fellow conservatives in defence of universal suffrage which captures this logic perfectly:
I speak to those among the conservatives who have some concern for stability, some concern for legality, some concern for moderation … in public life. To them I say: How could you not see that with universal suffrage, provided you let it function freely and respect, once it has spoken, its independence and the authority of its decisions-how could you fail to see, so I ask, that you have here a means of ending all conflicts peacefully, and of solving all crises? How could you fail to understand that, if the universal suffrage functions in the fullness of its sovereignty, revolution is no longer possible because revolution can no longer be attempted and that a coup d’Etat need no longer be feared when France has spoken?
It is in the troubled periphery of the Eurozone that this structural deficiency has reached a boiling point with the situation being made worse by the participation of the even less democratically accountable IMF. As the Guardian notes: “Eurozone policymakers too often treat democratic accountability as a luxury rather than a necessity, as shall be made amply clear this week when Brussels will force the Athens parliament to pass a raft of sharp spending cuts, tax hikes and privatisations – despite the hostility of Greek voters.” For much of the middle class in Greece, exit via emigration is a costly option given that they do not possess significant financial assets that can be easily transferred out of the country. As Hirschman would have predicted, absence of a viable exit option combined with the neutering of the democratic voice makes direct, even revolutionary action the only feasible option for many such Greek citizens.
The Greek middle class also feels squeezed due to what they perceive as the unfair burden of taxation foisted upon them relative to businessmen or the self-employed. Although it is entirely possible that this is simply a function of cronyism and corruption, taxing those who are least able to exit without incurring significant pain is the easy way out even in the absence of cronyism. In a globalised economy with free movement of capital, peripheral economies are unable to tax those sections of the populace who possess a credible threat of exit. The focus of increased taxes on those least able to exit, even if the policy is regressive, is therefore logical.
In a world where capital flight is an option for a select elite, social inequality instead of being alleviated by government policy is almost always exacerbated by it. Even the most progressive taxation and policy regime in theory translates into a regressive regime in practise. As Hirschman notes (emphasis mine):
There are numerous varieties of such mobility: transnational corporations can move subsidiaries from one country, considered unsafe, to another; more threateningly, mobility can take the form of international banks refusing to “roll over” their loans to a country that is considered to be “out of line.” Still, the principal weapon is wielded by the country’s own citizens – particularly of course by the more opulent ones among them – as they engage in capital flight on a massive scale whenever they feel threatened by domestic developments.
Occasionally these various exits do occur, according to the 18th-century script, in response to the arbitrary and capricious actions of the sovereign. But a much less favorable interpretation may be in order: exit of capital often takes place in countries intending to introduce some taxation that would curb excessive privileges of the rich or some social reforms designed to distribute the fruits of economic growth more equitably. Under these conditions, capital flight and its threat are meant to parry, fight off, and perhaps veto such reforms; whatever the outcome, they are sure to make reform more costly and difficult. It looks, therefore, as though the availability of the kind of exit that was hailed by Montesquieu and Adam Smith were today a serious menace: it damages the capability of capitalism to reform itself.
Hirschman also identified that the problem afflicts countries at the periphery of the global economy to a much larger extent than it does those at the core:
Capital flight is obviously much less of a weapon in the largest and most powerful countries where the owners of capital feel that there is no place else to go. Here it can be expected that voice will be activated by the impossibility of exit. Capitalists will make elaborate attempts to influence public opinion and public policy. An ideology in defense of capitalism will arise. At the same time, concessions are likely to be forthcoming where reforms of the system are obviously needed and are essential to the demonstration that the capitalist system can itself evolve and ameliorate the problems it creates. Purely on the basis of the differential availability of exit for capital and capitalists, one might therefore expect that the largest and most central countries of the capitalist system would be, at one and the same time, the ideological bulwarks of the system and its most active problem-solvers; the more peripheral states, on the other hand, might be in the grip of an anticapitalist ideology, and would at the same time exhibit unconscionable extremes of wealth and poverty……Here is perhaps a key to the old puzzle why anticapitalist revolutions have consistently broken out at the periphery rather than at the center of the capitalist system.
The simplistic viewpoint that democratic liberal Europe is immune to the kind of revolutionary uprisings we have seen in the Arab countries this spring is wrong – it is not just dictatorships that are prone to violent expressions of popular anger. The electorate needs to believe that their vote counts and that decisions impacting their lives are taken by a government that is accountable to them. Clearly this is no longer the case in many parts of the EU. And this disenchantment with vote as the mechanism of voice means that the people of Europe may choose much more radical means of voicing their frustration.
Triggered by Robert Kuttner’s column in the American Prospect, the explanation du jour of our current economic malaise blames the ‘rentier class’ i.e. owners of financial assets – the thesis being that wealthy Americans do not want any more inflationary policies to be enacted and may even prefer deflation instead. Paul Krugman argues that wealthy Americans do not want inflation because financial securities are overwhelmingly held by the richest 10% of the population. But what matters for the incentives of rich households is what proportion of their balance sheet is made up of nominal financial securities. And Edward Wolff’s paper shows us that a significant proportion of the balance sheet of wealthy Americans is made up of real assets – real estate, stock and business holdings.
Similarly, a return to deflation will result in a fall in demand for products and services sold by businesses and a deterioration in bank balance sheets with increased and disruptive bankruptcies. As Brad DeLong noted, no one benefits from a deflationary collapse in the economy. A much better explanation is offered by Matthew Yglesias when he observes that “the Fed has hardly been indifferent to the potential for monetary expansion. It’s just that the goal of monetary expansion has been to do just enough to stabilize financial asset prices without going far enough to produce catch-up growth in the labor market.” What wealthy Americans, businesses and banks share is a common interest in supporting asset prices (real and nominal), a lack of interest in seeking full employment unless it is a prerequisite for supporting asset prices, and an aversion to any policies that can trigger wage inflation.
This bias towards asset price inflation doesn’t just impact the amount of stimulus. It has an influence on the type of stimulus that is preferred in this class conflict. The goal of asset price inflation without wage inflation is best achieved by an exclusive reliance on monetary policy – as I discussed in a previous post, a combination of “liquidity” facilities to prevent a collapse in shadow money supply and open market operations/QE to reduce real rates across the risk-free curve. Given the anaemic state of household balance sheets and insensitivity of corporate investment to interest rates due to a cronyist corporate sector, lower rates will not trigger sufficient real economic activity to trigger wage inflation but they will support real asset prices. Even within the ambit of fiscal policy, supply-side incentives for businesses are preferred. Given a less than competitive corporate sector, these will feed through to business profits more than they will feed through to wage inflation and employment.
Some of you may have noticed the distinctly Marxist tone of this debate – an emphasis on class conflict that rarely permeates economic discussion in mainstream circles. This is not a coincidence – as I observed in an earlier post, the dynamics of a crony capitalist economy resemble a zero-sum Marxian class struggle. Rather than expanding the size of the economic pie, economic agents focus their energies on trying to capture a larger slice of a static, stagnant output.