Wednesday, July 26, 2017

Is Democracy in Chains Good for Buchanan's Legacy?

     My impression of Nancy MacLean's Democracy in Chains is that it is primarily an attack on Charles Koch.   The Koch brothers are hardly an unusual target.   What is special about MacLean's "contribution" is that she uses James M. Buchanan as a club.    Yet another reason for the perfidy of the Koch's is that they are promoting and spreading the ideas of wicked Buchanan.   And what is wicked about Buchanan?   His ideas are at base little more than strategies to fight civil rights and maintain Jim Crow segregation.

      False, but....

      Does this book help or harm Buchanan's legacy?

       For those of us who would like to see Buchanan's body of work become more influential, I think the answer is that it helps.

     There is no such thing as bad publicity.   At least that is what P.T. Barnum said.

      Friedman and Hayek were subject to hatchet jobs.   Buchanan is joining the club of late libertarian Nobel-winning economists.  (Bringing the level of attention Buchanan's ideas receive to that of Friedman and Hayek is a good thing in my opinion.)

   That a left (far left?) historian trashes Buchanan can hardly hurt him on the right.   A leftist tries to paint him as a racist?   That is practically a badge of honor.

    Surely, the field of intellectual battle is on the center left.   And MacLean's careless errors makes her argument against Buchanan very weak.

    Her status as an award winning historian at an elite university is more damaging for the reputation of academic history than to Buchanan.   The more historians and humanities academics defend her--even claiming that making things up is good practice--the more they destroy their credibility.

    I realize that academics seeking Koch money for some kind of university center will see MacLean's book used against them.   Maybe it will be the motivation--filtered through leftist professors--for student protests.   I admit that these are costs.   But let faculty senates discredit themselves.   Let university presidents do their jobs.

    Is Buchanan some shadowy figure with a secret agenda?  Of course not.   His actual views can withstand honest scrutiny.

     Picking apart MacLean's book is necessary.   But don't get mad.   See the opportunity.

Tuesday, July 11, 2017

What James Buchanan Told Me....

Image result for james m. buchanan

... and everyone else in class.

     I took two classes with James M. Buchanan.   The first was in the late seventies at Virginia Tech and the second in the early eighties at George Mason.    He was also a member of my dissertation committee.

     Anyway, in class he explained that when he was in the Navy in WW2, he learned to follow instructions completely.   After the war, when he was at Chicago, he was given a complete bibliography of Public Finance and he took it to be the class reading list, and so he read it all.  (Well, maybe he didn't say he finished it all, but he was working at it when the instructor explained that it wasn't intended to be the reading list for his course.)

     Included on that list was a work by Knut Wicksell.   Wicksell is a quite famous monetary economist, but he also wrote a book on public finance.   Buchanan was especially taken by Wicksell's "A New Theory of Just Taxation."   He told us that his contributions to Public Choice were little more than an elaboration of Wicksell's approach.

      I think he was being more than a bit too modest, but he didn't mention John C. Calhoun or the Southern Agrarians as inspirations.   Looking at his early publications, sure enough, soon after graduate school in the late forties and early fifties  he appeared to be applying the Wicksellian insights.

     The Thomas Jefferson Center for Studies in Political Economy started in 1957.    Here is Buchanan's contemporary description of what it was about.

    Nothing there about protecting states' rights or the desirability of segregation.   I find it hard to see anything "between the lines."   There is just an express support for individual liberty and the free enterprise system.

     Nancy MacLean's Democracy in Chains is not consistent with the James Buchanan I met in the late seventies and I have seen nothing that suggests that the early Buchanan was much different.



NGDP Targeting and a Small Open Economy

IHS and the Mercatus Institute had meeting about monetary policy in San Diego on June 25th.   I was fortunate to attend.

Scott Sumner was interviewed by David Beckworth for Macro Musings.   I suppose we were the live audience.   (As I write, the interview isn't up yet.)

In the question and answer period, Sumner was asked whether it would be possible to test out Nominal GDP targeting in some smaller country--say Kenya--rather than hold out for the Fed or the ECB.  Sumner said that he was not sure that NGDP targeting is appropriate for a small open economy.   The problem is that they may be too specialized in producing a commodity with an unstable world price.

When I spoke to him later, he said that for countries in that situation it is probably better to stabilize nominal labor income.   Of course, Nominal GDP is hardly ideal even for a country like the U.S. either.   Changes in indirect business taxes, for example,  could create problems.   A stable growth path for something like total labor compensation might be better  for the U.S. too.

But I would like to explore the small open economy issue a bit more.   While I can imagine scenarios where shifts in commodity prices might cause problems, I think that the problem isn't really specialization in commodities with unstable world prices.

For example, suppose everyone in a country is a coffee farmer.   The country stabilizes the growth path of nominal GDP, so regardless of world coffee prices or local coffee production, nominal income from coffee sales grows at a stable rate.

How is this possible?   If world coffee prices rise, the value of the currency rises enough so that the domestic price of coffee remains the same.    Nominal incomes remain the same and imported goods become cheaper.

If, on the other hand, coffee prices fall, the value of the currency falls enough so that the domestic price of coffee is unchanged.  Nominal incomes are the same, but imported goods become  more expensive.

Complete specialization in producing a commodity with an unstable price looks like no problem--other than menu cost of all of the shops changing the prices of  imported consumer goods.

Now, lets add a bit more realism.   Who is operating the shops full of imported goods?   What about haircuts?   What about home construction?

If the world price of coffee rises, at first pass, the currency rises in value so that the domestic price of coffee is the same.    Nominal income for the coffee growers and nominal income in the nontraded sector is unchanged.   The imported goods in the shops are cheaper.   If the income and substitution effect for nontraded goods exactly offset, then that is all.   In other words, if the increase in the demand for nontraded goods due to the higher real incomes is equal to the decrease in quantity demanded due to their higher relative price compared to imports, then the distribution of nominal income and the allocation of resources remain unchanged.

However, if the income effect is greater than the substitution effect, the currency must rise more than in proportion to the world price of coffee so that the domestic price of coffee falls, reducing nominal income in the coffee sector.   The profitability of coffee falls a bit, freeing up resources to provide more nontraded goods.   If nothing else, somebody is going to have to handle the increased volume of the imported goods coming in.   Nominal income in the nontraded sector increases.

The less pleasant scenario for this nation of coffee growers is a decrease in the world price of coffee.   The currency falls in value and, at first pass, the domestic price of coffee is the same as is nominal income in the coffee sector.   Imported goods in the shops become more expensive.   If the income and substitution effects exactly offset, nominal incomes in the nontraded sector are unchanged, but real incomes fall just as they do for coffee growers.  There is inflation of consumer goods prices--particularly the imported ones.  If income effect is greater than the substitution effect, the currency will fall enough to raise the domestic price of coffee, making coffee growing more profitable, expanding the demand for labor and other resources no longer needed in the nontraded good sector.

The situation where the substitution effect is greater than the income effect is a bit inconsistent with the conventional terminology of "nontraded goods sector."    The analysis is no different from a situation where there are import competing industries.   If the world price of coffee rises, the currency rises, and the now cheaper imports result in lower demand and lower nominal incomes in the import competing sector.   The currency, therefore, must rise less than in proportion to the world price of coffee, such that domestic coffee prices and nominal incomes in the coffee sector rise an amount that offsets the decline in the prices of import competing goods and the resulting decrease in nominal income in that sector.   Profitability in the coffee sector rises drawing resources from the import competing sector into the production of coffee for export.  Of course, import prices are cheaper, making the effect on real incomes in the import competing sector somewhat ambiguous, but real income rises in aggregate because of the improved terms of trade.

If the world price of coffee falls, the currency decreases in value.   The demand for import competing products rises, resulting in higher prices and higher nominal incomes in that sector.   The decrease in the value of the currency is dampened then, so that there is a decrease in price and nominal income in the coffee sector that offsets the increase in spending and nominal income in the import competing sector.   The increased profitability of the import competing sector creates an incentive to pull resources away from coffee production to the production of goods for domestic consumption.   With the higher prices of imported goods, real incomes in the import competing sector are ambiguous, though aggregate real income falls with the less favorable terms of trade.

It is these considerations that suggest to me that nominal GDP targeting might well be appropriate for a small open economy specializing in the production of a commodity with an unstable world price.   What is Sumner's concern?

Consider a situation where our small open economy has a giant copper mine or maybe a giant diamond mine.    The product makes up approximately all exports and a substantial portion of GDP, but directly generates little employment.

If the world price of copper increases, then the value of the currency increases, the domestic price of copper is unchanged and imported goods are cheaper.    If the income effect is greater than the substitution effect for nontraded goods, then the price of copper rises somewhat less so that the domestic price of copper is less and so nominal income generated by copper falls, making it slightly less profitable to produce so that fewer workers are needed and they can be shifted to the nontraded sector where prices and nominal incomes rise.   Of course, with the assumption that there are very few copper miners anyway, and the other resources useful for copper mining might not be very useful in other endeavors, this adjustment in relative nominal incomes might provide what is superficially the correct signal and incentive to reallocate resources, but there just is not much reallocation possible.  There has just been a pointless inflation in the nontraded goods sector.

If the world price of copper falls, this problem is even more apparent.   The value of the currency decreases.  At first pass, the domestic price of copper is unchanged.   Imported goods are more expensive.   If the income effect is greater than the substitution effect, the value of the currency decreases by less, the domestic price of copper actually rises a bit, nominal income in the copper industry rises, and nominal income in the nontraded sector decreases.   This provides the signal and incentive to shift resources from the nontraded sector to copper production.   But if copper production generates few employment opportunities, the result is that there is really just a pointless deflation of prices and wages in the nontraded sector.   Compounding the pain in the nontraded sector, there is substantial consumer price inflation due to higher import prices.

Inflationary recession in most of the economy, while the copper mine earns more nominal profit.   If the copper mine were privately owned, this would be a political disaster.

If there are import competing industries, these problems are exacerbated.   With an increase in the world price of copper, the value of the currency rises, with nominal income rising in the copper sector while falling in the import competing sector.   While this provides a good signal and incentive to shift more resources to copper production, by assumption that happens to a minor degree.  Again, there is mostly just a pointless deflation of prices and wages in the import competing sector.

If the world price of copper falls, the currency falls in value. Prices and nominal income in the import competing sectors increase, while the domestic price of copper and nominal income in the copper industry decrease an offsetting amount.   While this provides the proper signal and incentive to shift resources from copper production to import competing industries, by assumption, there is little opportunity for such an adjustment.   The result is just an unnecessary inflation in prices and wages in the import competing sector.   Of course, rising import prices imply consumer price inflation anyway.

If there are other export industries along with copper, for example, fruit, an increase in the world price of copper and the resulting increase in the value of the currency will reduce domestic prices and nominal incomes in these other export industries.   While this would provide an appropriate signal and incentive to shift from the production fruit to copper, again, the possibility for such a reallocation of resources is limited by assumption.   With a decrease in the world price of copper, the reduction in the value of the currency will result in higher domestic prices and nominal incomes in other export industries.

Consider a scenario where the copper mine is on a distant offshore island.   The mining is done by a foreign multinational with expatriate workers from other parts of the world.   Leaving aside any income the government collects from this enterprise, does it make any sense to include the nominal output of this operation when determining an appropriate monetary policy for the mainland? It would seem more appropriate for monetary policy to stabilize nominal GDP for the mainland while ignoring what is happening in what is effectively a foreign industry.  

Sumner's suggestion that total labor compensation be stabilized would probably help solve the problem where an export generates a substantial part of GDP and little employment.    But more generally, the problems I see with nominal GDP targeting in this context involves the specificity or substitutability of resources in production of various goods.   My coffee example assumed labor and resources could be shifted between coffee and other products-nontraded, import-competing, or other exports.    My copper example assumed that this was nearly impossible.

I believe this is related to the notion of an optimal currency area.   The example of the copper producing island causing pointless disruption on the mainland makes this plain.  The island and mainland do not make an optimal currency area.   Regardless of its geographical location, however,, the same issues apply.   Regardless of the location of the copper mine, perhaps it is better to stabilize the growth path for nominal production for the rest of the economy (nominal GDP less final copper output.)

But nominal GDP targeting, does not, in general, result in problems when countries are specialized in the production of a commodity with an unstable price.   In the extreme, where all that is produced is such a good, it works quite well.   And it also works even better when resources can be shifted between the export sector, the nontraded sector, the import competing sector, and other export sectors.

Now, it might be that stabilizing the growth path of nominal labor compensation would do ever better.   But nominal GDP targeting would work better than stabilizing the exchange rate or consumer price inflation.

Saturday, July 8, 2017

Employer Power?

    I recently read a claim that employers have unfair bargaining power relative to employees.   The reason is that the employees need money right away while the employers don't need workers right away.   I have certainly heard such a claim before, but it recently struck me that it is silly.

     I certainly agree that many workers need a job right away.   And I also agree that many employers are unlikely to be desperate to fill a vacancy--particularly if an employer has many employees.
      Of course, this is not always true.    Not all workers are so desperate and some employers may be brought to a standstill without a key employee.

      But let us suppose that a currently unemployed worker accepts an unfairly low wage because he needs the money now and cannot hold out for a fair wage.   The employer would be willing to pay more, and if the employee just waited a bit, the employer would offer more.   But the employee cannot. He must eat.

      Now, the unemployed worker is employed.   Earning an unfairly low amount by assumption, but presumably no longer desperate.

      So now the unemployed worker can look for a new job.   He doesn't have to quit, become unemployed, and then look for a new job.   He can seek this new job while continuing to work.

       Now, the claim that the workers have nothing and need money right away no longer applies.   This worker can continue to work at his current pay until a better offer comes along.  

        Is this realistic?   Do firms actually hire the employees of other firms?   Do people accept a new job while they are currently working for an employer?   Or is that sort of thing quite rare, with employers generally hiring those who are unemployed and most employees only obtaining a new job if they have been laid off or fired from their previous job?

        There about 150 million people employed right now in the U.S. and there are about 7 million unemployed people.   Hires are over 5 million per month.   More people are hired in two months than are unemployed today.

       Quits are about 3 million per month.   That is 36 million per year.

       Do all of these people become unemployed?   Of course not.   For the most part, these are people who have been hired while they already have another job which they then quit.

       There are many reasons why someone might quit one job and take another, but a key reason is better pay and benefits.    Of course workers leave one employer and go to another that offers a better deal.   Of course employers will hire currently employed workers.   In fact, there is evidence that they discriminate in favor of the currently employed.

      If the desperation of unemployed workers to take anything was important to employers you would expect that they would be most anxious to hire the unemployed.   But they aren't.   That suggests that employers do not obtain a benefit from this sort of bargaining power.

      Layoffs and other discharges are about 1.6 million per month.   Almost certainly, they add to the pool of unemployed.   (In 2009, layoffs and discharges were almost 2.5 million per month.)   If it weren't for new hires, in 10 years, everyone would be unemployed!    But, more people are hired than lose their jobs.   That is why employment grows.    In the last decade or so, it rises about 200,000 each month because total hires are greater than total separations.

      The point of these figures is to understand that the labor market cannot be identified with people losing their jobs, being desperate to find work, and then employers finally hire the unemployed.   While that is part of the story, workers being hired away from one employer by another is very significant--more significant.

      The pace of new hires is very important.   In 2008 and 2009, new hires dropped significantly.   While there was plenty of hiring--3.5 million a month--that is a lot less than 5 million.     During the year or two when it was worst, something like 70 million people were hired.   But these days more than 100 million people would be hired over a similar period of time.   That makes a big difference.

      As mentioned above, layoffs jumped up too--close to the number of hires.   But the rest of the story is that quits dropped off tremendously, to less than 2 million per month.   Why?   Most likely because firms were hiring less, and that mostly means hiring fewer people away from other employers.  Current employees quit less often since there are fewer new, better job to take.

      When labor demand is strong and growing, wages rise from employees switching employers.   When labor demand is weak and there are few hires, then wages stagnate.

Entrepreneurial Goals

I suppose it is almost the definition of entrepreneurship that profit is sought and loss avoided.   As soon as time is considered, this transforms into maximizing the value of the firm--accepting losses now in exchange for anticipated profits in the future.  But the very logic of value maximization separates the individual entrepreneur from the firm.   Sacrificing profits now for future profits only makes sense if it is possible to sell the firm, or more plausibly, sell an interest in future profits.

However, there is no presumption that a specific individual will save any part, much less all, of his or her income so as to maximize the increase in wealth.   Yet the notion that such a motivation is central to "capitalism" is common.   Weber's Protestant ethic explained economic growth in northern Europe due to the supposed Calvinist view that earning money was a sign of God's favor but spending it on luxuries reflected a sinful worldliness.   This was in contrast to the supposed Catholic view that the whole point of earning money was to use it for something.  (I think this "Catholic" view is more sensible and theologically sound, as well as being more consistent with modern economic reasoning.)  
Even before, Marx more or less treated the income from profit as the same as saving and forecast eventual economic disaster because the growth of wealth will outstrip the investment, really industrialization, entailed by the inevitable development of the material productive forces.   Hegelian hocus pocus really doesn't fit in well with modern economic thought.

Still, it is certainly possible that entrepreneurs would save a substantial portion of their profit.   It seems that many entrepreneurs find their work enjoyable.   They are really too busy to enjoy anything like the consumption they could afford.   To the degree that effort and commitment are more likely to lead to success than a more dilatory approach, many of the most notable entrepreneurs will in fact have that characteristic.    "Why waste my time on lavish consumption activity when I can plow money back into business activity have some real fun!"  Some tycoons, including the President of the United States, have claimed that money is just a way of keeping score.   On this view, the goal is to raise one's standing on the Fortune 500 list--perhaps to reach the top and win the game of life by earning the greatest net worth.

Since earning profit and avoiding loss generates value, value that is typically much greater than what the entrepreneur earns, it would seem that the rest of society is getting something for nothing.   Fundamentally, if someone consumes income then resources must be devoted to produce the goods that are to be consumed.   If the income is never consumed, then the resources can continue to be used for other purposes.

However, this scenario involves the entrepreneur saving all of this additional income, so it isn't available for anyone's consumption in the present.   Presumably, it will be available for someone's consumption when the entrepreneur dies.   So, if an entrepreneur doesn't consume profit but reinvests for fun, and these investments remain profitable, consumption is moved to the future.  Leaving aside inheritance tax, whose future consumption can be increased is determined by the entrepreneur's bequest.

If the relevant comparison is to luxurious consumption by the entrepreneur now, it is difficult to see how this result is any worse.   Of course, some might argue that some of these profits should be taxed and the proceeds transferred so that others might consume more now.

Suppose, however, that that entrepreneur does not use these funds for direct investment, but simply saves them.   There is no longer some story about an entrepreneur using the funds to enjoy business activity, but still, net worth increases as would more passive investment income.    If financial markets function properly, any funds saved result in matching investment by some firm or other.   The greater future output generated by that investment allows for additional consumption for whomever the entrepreneur leaves a bequest.

Unlike the situation where the entrepreneur is directly investing saved profits, these other avenues for saving leave the possibility of some kind of breakdown in financial markets such that saving and investment do not match with full employment of resources.   "The" market interest rate might fail to fall enough to match "the" natural interest rate that coordinates saving and investment.

This sort of problem is always monetary broadly understood.   Saving might occur by accumulating money, and if prices and/or wages are sticky, real output and employment will decline.   In my view, an appropriate monetary regime avoids this perverse result.   And so, the entrepreneur who has no interest in consumption but solely wants to save profit to "win" by accumulating the most wealth only causes problems if there is a less than ideal monetary regime.

That our driven entrepreneur allows for added consumption in the future for whomever he makes his bequest points to an alternative motivation.   The entrepreneur might reduce consumption from what would be possible now with the intention of allowing for added future consumption for his descendants.   But rather than simply allowing his children to consume, I would like to consider another motivation.   The notion that his descendants will permanently earn sufficient capital income to maintain a high level of consumption forever.

While this seems reasonable enough on its face, I think this goal is better motivated by cultural factors that existed prior the modern market system.   As the market order came to dominate, the aristocrats inherited a system that had evolved such that they earned rental income from land.   There was no requirement that aristocrats do much to manage their land, much less become actively involved in business activities.   Aside from living a life of leisure while being doted upon by many personal servants, the only real duty was to participate in what can be broadly understood as governance.   The initial rationale of this system involved military service, and a norm of service as officers in modern armies was really a holdover.

While the time when this income must be rents from land is long past, the notion that one's children and grandchildren and so on can be set up to live in that fashion is a plausible motivation for saving.   So, the entrepreneur earns profits and consumes little immediately, mostly saving.   The point is to leave a sufficient bequest to provide for an adequate (high) income for ones children,   They will then pass on a similar bequest to their children, and so on.

This motivation, however, does not result in capital income being saved in perpetuity.  Once set up properly, the family must avoid dipping into principal (or capital,) but otherwise, the income is spent on consumption that may be lavish by the standards of many people but typical of the upper class.

The entrepreneur consumes less than he otherwise could and saves.   The amount saved is never intended to be consumed, but rather is to form a principal that will generate an income that is intended to be consumed.

This motivation does not require that the entrepreneur enjoy making money or have any particular interest in direct investment.   Still, any notion that this somehow results in too much saving is still less plausible.   The saving is transitional.   Considering the "cultural" factors, the notion that the traditional aristocracy had more income than they could use is pretty implausible.    Quite the contrary.     Even so, if this transitional saving did outstrip investment, any problem with maintaining employment would still be a consequence of an inadequate monetary regime.  

What would be the implication of a negative natural interest rate for entrepreneurs saving their profits?   Assuming that the real market interest rate matches this natural interest rate, then the entrepreneur making money to "keep" score, will provide a bequest to someone that allows for less real consumption than the entrepreneur could have enjoyed.   Of course, if the entrepreneur continues with direct investment, he may well earn more than the natural interest rate.    This is really only relevant with a more passive investment strategy.   If the nominal interest rate is positive, but the real interest rate is negative due to inflation, then I suppose some entrepreneurs would count their nominal gains as making progress in the game.   If the nominal interest rate is negative, however, simply holding onto wealth would be clearly counter-productive.

For the motivation of providing a bequest sufficient for one's descendants to earn a sufficient capital income, it would seem that a permanently negative natural interest rate would make it impossible.   In such a scenario, refraining from consumption now provides no benefit and would earn no reward.  Providing for one's children and more distant descendants would be possible, of course.   But without a positive real interest rate, eventually the wealth will be gone.   However, as is much more likely, the natural interest rate would only be transitionally negative and likely only for the shortest and safest assets.    


Saturday, April 1, 2017

Must Capitalist Economies Grow?

I ran across a claim that a "capitalist" economy must grow.

I believe that one of the key benefits of a market economy is creative destruction.   Entrepreneurship leads to innovation and growth. Profit and loss incentives motivate each firm to introduce new products and methods of production that create a system where larger amounts of better goods and services are produced.  Successful innovation generates greater profit.   Perhaps more important,  innovation by competitors can result in reduced profits and perhaps losses and even bankruptcy.   This creates a powerful incentive to innovate in order to "keep up with the competition."

A somewhat different consequence of profit and loss incentives is to allocate resources to produce whatever goods and services for which people are willing to pay the most.   Competition for resources results in resource prices that communicate opportunity costs--the value of the most important goods and services sacrificed by the use of those resources in production.   If buyers are willing to pay more for products than the opportunity cost of the resources used to produce them, then a firm profits.   If, on the other hand, people are willing to pay less for a product than the opportunity cost, any firm producing that product suffers losses--motivating it to produce less.  Profit and loss creates an incentive to produce more important things and avoid "wasting" resources in producing less important things.

But does any of this mean than capitalist economies must grow?

One "micro" argument would be that larger firms are always more efficient.  This would seem to imply that only one firm can survive competition.   During the competitive process, then, each firm is racing to be the biggest, and so most efficient, which will allow it to increase its lead and eventually "win" the competition by becoming a monopoly.  

I am not sure how seriously to take such an argument.   If a new production technique is introduced that exhibits economies of scale, and there were many firms using some prior approach with fewer such economies of scale, then something like the above process would occur.   Depending on the economies of scale and the demand for the product, it could be that the result is a natural monopoly--a single firm can produce the amount of the product demanded at the lowest cost.   But this is not necessarily true.     It is not always most efficient to produce output in a single giant plant.  It is more common to have many factories or plants even if they are all owned by a single firm.   Having many factories managed by a single firm is not necessarily more efficient than having multiple independent firms in competition.   Organizations have many problems, which generally are described as the cost of bureaucracy.  One key benefit of the market system is that it allows for large scale cooperation without a single massive bureaucracy.   There can instead be many, somewhat smaller, more manageable bureaucracies.

A second argument is "macro."   Here there is a behavioral assumption that is supposed to be a defining characteristic of capitalism.   Firms make profit.   While the owners of the firms consume something, this can be ignored as a practical matter.   The profits are all reinvested making the firm grow.   "Capital," understood as the value of the firm, increases.   "Capitalism" is an economic system that maximizes the growth of capital by maximizing profit.  The greater capital is intended to result in greater profit and so greater increases in capital.   Critics of capitalism claim that this system must eventually collapse.   I read Marx as making an argument along these lines.

I think there are some advocates of the market system who defend it with something like the first part of the argument.   They justify profit based upon how it is used.   Profit is justified because it is reinvested and that creates more growth (and maybe even "more jobs.")    I suppose for a leftist critic of capitalism, reading such claims by their opponents, gives them the impression that everyone agrees that capitalism entails constant growth in capital.   And if these advocates of capitalism focus on the benefits of more capital and justify profit on that ground, then this explains their opposition to policies that reduce profit--such as higher wages.

I think that most economists, including those who are very sympathetic to the market, really don't focus on how profits might be used.   As I mentioned in my first two paragraphs, the profits and losses both motivate innovation and also the allocation of resources to produce what particular goods and services people want to buy the most.   If anything, the assumption is that the entrepreneurs use this source of income to enjoy greater consumption of goods and services.   That is the reward they obtain for their successful innovation or reallocation of resources.    I think allowing entrepreneurs to obtain profit and suffer losses is desirable because the prospect of profit and losses motivates them to do desirable things--innovate and reallocate resources to produce what people want to buy most.

Of course, entrepreneurs may well save part of the income they earn.  Perhaps they will save a substantial portion of it.   Still, any identification of profit with saving and capital accumulation is simply not a key element of modern economics.   Instead, it is common to identify "capitalism" with a "market economy."   My basic framing of the economic problem includes consumption being the purpose of production.   So, as I consider capitalism, I don't start with profit and capital accumulation, must less with a "goal" of maximum aggregate profit and maximum accumulation of capital.  Rather, it is about people achieving their goals, with an emphasis on producing the goods and services they most want to consume.     Perhaps I have some slight idiosyncratic twist to my thinking on this, but I think it is pretty much consistent with mainstream economics.  In my view, this is just a restatement of the centrality of scarcity in economic thinking.

Starting with this notion that the purpose of production is consumption helps make sense of the view that saving is about reducing consumption in the present and increasing it in the future.   For an individual in a market system, to save is to spend less on consumer goods and services now than the income earned now, so that  more can be spent on consumer goods and services later than the income earned later.   Suppose someone works for many years and spends just part of their wage income on consumer goods and services.   The saving each year is income less  consumption.   This person's wealth, or net worth, grows with that saving over the years.   Eventually, this individual retires from work and no longer has any wage income.   However, they continue to purchase consumer goods and services out of their accumulated wealth.   Each year, wealth decreases due to dissaving.   That is, consumption greater than income.

Entrepreneurs earn profit, which is a form of income.   Unless they have some other source of income, they must use some of it to purchase consumer goods and services.  If they earn a very high income, then they can purchase lots of consumer goods and services.   However, like anyone else, they certainly can save.   Still, the basic framing here is that they save by spending less income from profit on consumer goods and services now in order to spend more than their income in the future.

Under most circumstances, both the worker saving for retirement or the entrepreneur saving profit and building a fortune can earn capital income on their wealth.   The worker might put savings in a bank and earn interest.   The entrepreneur might reinvest his saving in his own firm, purchase additional capital equipment, and earn additional profit.   This capital income reduces the amount the worker must save while working to have sufficient consumption when retired.   The already luxurious consumption an entrepreneur could afford now is compounded in the future by the additional income earned on accumulated wealth.

However, this doesn't mean that there is some kind of "system" that has the goal of maximizing aggregate profit with all of it being saved to accumulate as much wealth as possible to increase profit as much as possible.

In my view, the fundamental reason for capital income is productivity.   If fewer resources are used to produce consumer goods and services now, then those current resources can be used in ways that allow for additional production of consumer goods and services in the future that not only replace those sacrificed now, but exceed them.   Generally these techniques involve the use of various sorts of durable tools--machinery, equipment and the like.   More elaborate--more expensive and productive--tools can be used if more resources are available to produce them.

The capital income earned by the worker putting money in a bank for retirement or the entrepreneur reinvesting profit into his or her own enterprise captures part of this additional output as added income.   That it is desirable that people earn capital income is not based on some notion that they will always reinvest such income and accumulate even more wealth which also implies that more valuable and productive capital equipment will be produced and utilized.  Or rather, I don't think of it that way.   It is rather that the prospect of earning such income in the first place motivates people to save more than they otherwise would, resulting in more total output and income than would otherwise exist.

To me, and most all economists, growth is about increases in the production of goods and services.   It isn't about increases in aggregate profit or wealth or the capital stock.   Profit and loss generates powerful incentives for growth, however, nothing in the market system, that is  "capitalism," requires such growth.   If no one was interested in any new good or service or there were no better ways to produce the existing ones, then there would be no more innovation.   One of the key reasons why profit is desirable would no longer exist, though there would still be the second reason--producing the proper mix of existing goods and services in the already discovered most efficient ways.

Most economics is done in the context of a growing population.   This requires some net saving and investment so that a growing work force can utilize the same types and amounts of capital equipment and that there will be more consumer goods and services for the additional people to enjoy.   Such growth could occur with each person and generation enjoying unchanging consumption per capita.   A market system could coordinate that scenario.

If the population were to be constant or even shrink, the market system could coordinate that scenario too.  With a constant population, constant consumption and sufficient capital (tools and the like for each worker) could be maintained with no net saving or investment.   With a shrinking population, the market system could coordinate a shrinking capital stock through negative saving and investment-net dissaving and net disinvestment.   The output of consumer goods and services would shrink over time, reflecting the reality that there would be fewer people to enjoy them.

Or suppose people wanted to enjoy more leisure.  They might prefer shorter workdays, work weeks, longer annual vacations, or perhaps start work later or retire earlier.   If they valued this more than the goods and services that they would not be producing and could no longer afford, then the market system could coordinate that.   Better yet, in the context of creative destruction and growing productivity it is perfectly possible to take the benefits in reduced work time.   Further, a market system could coordinate a mixed result where more consumer goods and services are produced for people to enjoy along with additional leisure time to enjoy them.

If everyone wanted to consume all of their income, so that there was no net saving and no net investment, then wealth would not grow nor would the capital stock.   However, if creative destruction continued, the capital equipment might well improve, and substantially change as old capital goods wear out and are replaced.   Consumption could grow or leisure could expand without any increase in wealth or capital.   (The scenario of no net saving or investment and a growing population is more challenging.)

Nothing in a market system requires constant growth in output.  Nor does capitalism require that profits be saved and used to increase net worth and increase the capital stock.

A separate question is whether a practice of entrepreneurs always saving their profit so that profit always adds to net worth and the capital stock is harmful to the market system.   It is not necessary for capitalism to exist, though it is plainly consistent with capitalism if people behave this way.  What happens?  Does that practice, which some seem to think is an essential defining characteristic of capitalism, have some calamitous consequence?

More later.

Tuesday, March 14, 2017

The Trade Deficit, National Income Accounting and Aggregate Demand

Peter Navarro has been using the national income accounting identity to argue that policies that reduce the trade deficit must increase the production of goods and services in the U.S.   There have been various efforts to dismiss his claim as absurd.   Interestingly, he appears to be following in Keynes' footsteps by being a little confused about the relationship between identities and equilibrium conditions.   But the best way to interpret Navarro's claim is to see it as a very simple Keynesian approach.   On this view, aggregate real output in the U.S. is driven by aggregate demand for goods and services produced in the U.S.

U.S. GDP is a measure of the production of goods and services in the U.S.   The textbook accounting identity is Y = C+I+G+X where Y is GDP, C is consumption, I is investment, G is government spending, and X is net exports.   Net exports are exports minus imports.   If there is a trade deficit, then X is negative, so it subtracts from C+I+G.   The bigger the trade deficit, then, the smaller is GDP.   A smaller trade deficit, or better yet, a larger trade surplus, implies a larger GDP.    Navarro claims that this means that policies that encourage exports or discourage imports will raise GDP.

The argument that this is just an identity points out that the C, I, and G refer to goods and services categorized as consumption, investment, and government in the U.S. regardless of where produced.   Imports are subtracted to get the goods and services produced in the U.S.   Exports are added to account for the goods produced in the U.S. that are not categorized as U.S. consumption, investment, or government because they are accounted for as C, I or G in some other country.

However, I think this is an unfair characterization of Navarro's view.   Navarro's point is that GDP is equal to spending by U.S. residents on domestically produced  U.S. output plus foreign spending on domestically produced output.   The process for calculating GDP is to add up all spending by U.S. residents on different categories of goods and services and then subtracting off spending on foreign produced goods.  This provides spending by U.S. residents on goods and services produced in the U.S. Spending by foreigners on all types of U.S. output is added back.   The result is total spending on U.S. goods and services.   This is nominal aggregate demand.

Navarro's theory is the simple Keynesian one that the various categories of spending are determined, and if it becomes more costly to purchase foreign goods, then spending will be shifted to purchase domestically produced output.   For example, if total spending on consumer goods and services by U.S. residents is $12 trillion, and $2 trillion of that would be spent on foreign consumer goods and services with relatively open markets, a policy of banning all imports would result in U.S. consumers spending $2 trillion more on consumer goods or services produced in the U.S.    The same would be true for investment--purchases of newly-produced capital goods by U.S. firms as well as purchases by various levels of government.   Therefore, a smaller trade deficit (or larger surplus) would be associated with more aggregate demand in the U.S.

Navarro emphasized the possibility of an increase in exports.   Trump's threats to impose higher taxes on imports from Mexico would result in Mexico agreeing to purchase more U.S. products in order to be allowed to continue to export to the U.S...Assuming that spending by U.S. residents on consumer goods, capital goods, and government in aggregate is unchanged, this increase in the demand for U.S. goods by Mexicans increases total spending on domestically produced U.S. goods and services.   Again, the trade deficit is lower and aggregate demand is higher.

In the simplest Keynesian model, output is solely determined by aggregate demand.   If trade policy can expand exports and reduce imports, these "deals" that reduce the trade deficit (or expand a surplus) will increase aggregate demand and so production in the U.S.

This Keynesian model is most plausible when there is unemployment of labor and excess capacity in most sectors of the economy.    The increase in demand both results in more production and more employment.

In a world with near universal price floors, and a quantity of money such that equilibrium prices are below those fixed prices, this Keynesian approach would apply.    If the floors instead apply to wages, the result would be similar.    Of course, rather than hoping for "better" trade deals to raise aggregate demand, it would be possible to repeal the price floors or else increase the quantity of money.

Fortunately, the U.S. does not have anything like universal price floors.   However, in the short run at least, it seems that prices and wages do not immediately adjust so that real aggregate demand equals productive capacity.   In fact, they appear to have some perverse momentum that is only gradually dissipated.   Prices and wages continue to rise even when market conditions suggest they should fall.   Only very gradually does the rate of increase of prices and wages slow.

It is possible then, that during a recession, tough trade negotiations would boost aggregate demand and hasten a recovery.    This is not an argument that reduced imports and expanded exports will permanently increase output and employment.   In other words, Trump's approach might have made sense in 2008 and 2009, but no longer.    The Fed has already started raising interest rates to restrain the growth of spending on U.S. output.   Policy that reduces imports and expands exports would reduce the trade deficit, but it would it would have no impact on aggregate demand or employment.  It would instead just result in higher interest rates.

Even in recession, restrictions on imports can easily backfire.   That is because exports are not fixed.  For a "small" country, this might not be a problem.   But if the U.S. restricts imports, the result could easily be a recession in other countries, which will result in fewer U.S. exports.  The foreigners demand fewer U.S. goods when their economy suffers recession.   This results in reducing income to those producing the exports, which likely would result in reduced demand for both domestically-produced goods and services, and imported goods.    Casual empiricism suggests that triggering a recession in the U.S. is the best way to reduce U.S. imports and so the trade deficit!

For a small country, the amount that it imports from the rest of the word is small, and so reductions have little impact on the world economy.   For such a country, the only problem is "retaliation," where foreign governments restrict imports from the small country and so reduce its exports.  

As a Market Monetarist, I believe that the monetary regime can and should target a stable growth path for nominal GDP--spending on domestically produced output.   What I think is the most reasonable interpretation of Navarro, that trade policy can reduce trade deficits and increase aggregate demand which might hasten the recovery of output and employment in a recession and avoid the need for disinflation, is unnecessary and inappropriate.    Under the current monetary regime, better monetary policy by the Fed would make this unnecessary.

Regardless, thinking of our current situation, and the long run across many business cycles, it is not sensible to have a trade policy that is about expanding aggregate demand to hasten recover from a recession.   The long run analysis must take into account that a trade deficit is matched by a net capital inflow.   The result is a lower natural interest rate and more investment.    That is, the demand for capital goods, including domestically produced capital goods, is higher than it would be if the trade deficit was lower.

If some policy does manage to reduce the trade deficit, the result may well be more domestic production of goods and services that would have been imported and more goods produced for export, but there would be fewer capital goods produced.   The result is a change in the composition of demand and the allocation of resources, but there is no increase in aggregate demand.

Worse, the long run effect of any restriction in the production of capital goods is a lower growth path of productive capacity and so future real GDP will be lower than it otherwise would have been.

And that points to the fundamental determination of trade deficits--the relationship of domestic saving and investment to world saving and investment.   It would be great if foreign governments would reduce barriers to trade and this allowed for increases in U.S. exports.   However, this could easily result in more U.S. imports, leaving the U.S. trade deficit the same.   Americans would earn more from exports and use the extra income to purchase more imported goods.  That is the key reason to export goods and services--getting imports in exchange.    But that also ignores international investment.

If the world interest rate is below the interest rate that would coordinate U.S. national saving with U.S. domestic investment, then foreigners will be motivated to invest in the U.S. to obtain higher returns.   The amount of this net capital inflow must be matched by a trade deficit.  Foreigners will export goods and services to the U.S., not to buy U.S. goods and services and take them home with them, but rather to buy capital goods in the U.S. or else claims to capital goods--like stocks or bonds.

It is important to understand that this is not foreigners buying up a fixed quantity of assets. The U.S. can and does produce additional capital goods to sell to foreigners.   U.S. workers and firms are building a plant for Volvo in the South Carolina lowcountry.   These new capital goods increase future production in the U.S.  A reduction in the trade deficit, then, means that increase in future production does not occur.   That doesn't mean that production doesn't grow over time.   It probably would grow, but its level at any future time would be lower than if there had been a larger trade deficit, net capital inflow, and investment.

The foreign investors expect a return, and the reduction in the growth path of real GDP would not be entirely a decrease in the growth path of real GNP.   Less will be produced in the U.S. in the future than otherwise, but less income will be paid out to foreign investors.   Still, this is unlikely to benefit U.S. workers--even foreign owned capital goods are a complementary factor of production which would tend to raise their incomes.

It is incomes that foreigners earn from U.S. investments that leads some to describe a net capital inflow as an increase in U.S. indebtedness to the rest of the world.   While foreigners could hold deposits in U.S. banks or purchase corporate bonds or U.S. government bonds or even accumulate paper currency, they in fact also purchase equity--stocks--or make direct investments.   If everything goes as planned they can earn income from all of these investments and even repatriate the money they invested at some future time.  But foreign equity investments in the U.S. are not debts of any U.S. resident.

Now, I favor a reduction in the U.S. budget deficit, shifting it to a modest surplus.   This would result in an increase in U.S. national saving.   The result should be a slightly lower trade deficit in the U.S.   Further, I favor social security privatization, shifting from a pay-as-you go system to a fully funded system.   That will increase U.S. private saving.   This also would tend to reduce the trade deficit.    I favor ending excessive regulation of business in the U.S. (A goal I share with Trump.)  This should increase domestic investment in the U.S., which would tend to raise the U.S. trade deficit.

So, I think Navarro isn't just confusing an identity with an equilibrium condition.  He may seem to.   And maybe he is a little confused.   But I think the best way to understand his view is that he is making a simplistic Keynesian argument--acting as if production is always constrained by demand while ignoring key role of productive capacity.   My Economics 201 back in the day emphasized the simple Keynesian Cross.  Advanced Macroeconomics (first year graduate school) was a bit more sophisticated.   Perhaps it was different at Harvard in Navarro's day.  But I suspect he is using a very simplistic approach that most economists understand quite well.

Tuesday, January 31, 2017

Trump's Ban

     When Trump ran for President he proposed a total ban on Muslim's entering the U.S. until our representatives figure out what is happening.   The last part was foolish and the first part was evil.  That he would propose such a thing was something that made him unacceptable.

    Before long, he came up with a different proposal.   This time, it was not Muslims that would be banned but rather people from countries that are sources of terrorism and rather than the ban lasting until we figure out what was going on, people from those countries will be subject to "extreme vetting."   
     Trump's executive order appears more consistent with this second approach, which I think is sensible.   The administrative incompetence was incredible.  There was no need for a rush.   How hard would be to slow down new visas?   How difficult is it to devote more resources to investigation?

     Of course, this would not involve some dramatic "action" by Trump.   It just would have modestly improved security.  

     It is just difficult not to see Trump and his advisors as being both incompetent and cruel.

Saturday, January 21, 2017

Tariffs and Exports

    If the Trump administration imposes a tariff on imports, it will result in a contraction of trade--both imports and exports.   Frequently, it is claimed that this will only occur if foreign governments retaliate to tariffs on their exports to the U.S. with tariffs on U.S. exports to their countries.    However, that is not correct.   There is a market process that brings this about even without "retaliation."

     The most direct process occurs with floating exchange rates, which is at least approximately the U.S. regime.   The tariff reduces the amount of dollars paid for imported goods.   This reduces the supply of dollars on foreign exchange markets and so requires an increase in the value of the dollar for the market to clear.  This partly offsets the tariff by making the dollar prices of imported goods less, but it also makes U.S. exports more expensive for the foreign buyers.   This results in a decrease in exports.

      The U.S. currently has a trade deficit, and the stronger dollar will tend to reduce it.   While an expectation of an increased value of the dollar will encourage foreigners to invest in U.S. financial assets, once the dollar is higher, U.S. real assets will be more expensive for foreigners.   So, the result will tend to be a lower trade deficit as well as reduced exports.

       The U.S. could use monetary policy to prevent the dollar from rising in value.   This is done by increasing the quantity of money.   The equilibrium consequence of this policy is higher inflation in the U.S.  The higher prices in the U.S. will make foreign imports more attractive, partially offsetting the effect of the tariff, but will also make U.S. exports more expensive for foreigners, causing them to purchase less.   Similarly, U.S. assets will be more expensive for foreigners to purchase, so that the trade deficit will be smaller.

       Like most market monetarists, I think that prices are sticky, and that includes wages.   The inflationary process would not be instantaneous or smooth.   The increase in demand though out the economy would likely result in increases in output and employment.   Wages are also very sticky, even in an upwards direction, so real wages would be depressed which should help employment.   That effect would be especially strong in weak areas of the economy--including import competing manufacturing.   Only in "the long run" would higher prices and wages result in a return to equilibrium.

       It would be possible for the central bank to keep keep the dollar from rising while avoiding inflation by sterilization.   The Federal Reserve would need to sell off dollar assets it holds while purchasing foreign exchange--foreign assets.    This can last as long as the Fed has U.S. assets to sell.   The result should be a reduction in imports and a reduced trade deficit.   Unfortunately, the expansion in demand for the products of U.S. import competing industries will be offset by a reduction in the demand for the products of interest-sensitive industries--construction and capital goods.   Once the Fed runs out of U.S. assets, allowing the dollar to rise would result in financial losses to the Fed.   Perhaps this would lock in the inflationary equilibrium.

       It would also be possible to blame the increase in the value of the dollar on currency manipulations by foreigners.   A higher dollar is at the same time a lower pound, euro, yen, and renminbi.   How dare they devalue their currencies to offset the effects of the tariffs?
       Foreign nations could prevent their currencies from losing value by contracting their quantities of money.   In the long run, this would result in them having lower prices and wages, and so U.S. buyers would find their imported goods cheap and they would find U.S. exports expensive.   While that process would likely be long and painful, the effect on U.S. exports would be prompt.   The recession induced by their monetary contraction would result in reduced U.S. sales in their markets.

       Finally, they could keep their currencies from losing value by selling off any U.S. assets they hold and instead accumulating other sorts of foreign exchange or else each their own domestic assets.   This would tend to shrink the U.S. trade deficit by reducing the amount of foreign funding of U.S. investment.   This could last until they run out of U.S. foreign exchange.   Again, any expansion in the demand for import competing industries will be offset by a reduction in demand in interest sensitive industries in the U.S.--construction and capital goods.

      Changes in the composition of the Fed's balance sheet or the balance sheets of foreign central banks could shield U.S. exports from the decrease in imports for a time.   It is only if such adjustments are made that a contraction in U.S. exports would only occur due to retaliation of increased tariffs.

Sunday, January 15, 2017

Border Adjustment Tax

     Congress has proposed several reforms of the corporate income tax.   One reform is a border adjustment tax.   This means that corporate "profit" will be calculated with no deduction for the cost of imported goods and with a deduction of revenues from exports.
      This has been characterized as a tax on imports and a subsidy for exports.   Of course, it isn't actually the payment of a bounty for exported goods, but rather a relief from corporate income tax on profit generated from exports.   Still, the economic impact  should be similar to a more transparent tax and subsidy scheme.
       However, a tariff on all imports and subsidy for all exports has approximately no effect on trade.   A tariff on a single import tends to restrict demand for that imported good, but the resulting appreciation of the dollar expands the demand for other imports while reducing exports.  Trade shrinks.
       A subsidy for a particular export will tend to expand the production of that export, while the appreciation of the dollar will slightly contract other exports and expand imports.   Trade expands.
       But if you tax all imports and subsidize all exports the same, there is no reallocation between various imports or various exports nor is there any expansion or contraction of trade.    The dollar rises, leaving the allocation of resources unchanged.
       The result is not a reduction in the trade deficit or increase in the trade surplus unless the tax impacts saving or investment.   For a trade deficit country, either investment must decrease or saving increase for the trade deficit to decrease.   While possible, this is a second order effect.
        The rationale for the border adjustment tax is to shift from taxing profits from production in the U.S. to instead taxing profits from selling in the U.S.   The result should make the tax system neutral regarding location decisions for firms seeking to sell products in the U.S.
          The tax proposal has other characteristics that also are inconsistent with a tax on profit.   All capital expenditures are to be expensed rather than depreciated.   That means that if a corporation invests its profit in capital equipment, it pays no tax on the profit.  Also, interest expense is not deductible.  That means that corporations will be paying tax on the income they pay out to bondholders, so that all investors, whether stockholders and bondholders will be taxed the same.   This should make the tax neutral regarding the financing of corporations by the issue of stocks or bonds, taking away the existing artificial encouragement of leverage (borrowing.)
         And the corporate tax rate is to be reduced to 20% rather than the unusually high 35% that exists today.
         A true value added tax is a tax on income.   However, the typical value added tax allows expensing of investment, which makes it a tax on consumption.  Border adjustment taxes are typically applied, so that the consumption of imports is taxed just like the consumption of domestically-produced goods.   Exports are exempt, because there is no intention of taxing foreign consumption.
         A national sales tax is more transparent, and would involve the taxation of final sales of consumer goods and services.   (A tax on the sale of all final goods and services would be an income tax.)   Consumption of imported goods would be taxed the same as domestic products, and there would be no taxation of exports.
        The proposed reform of the corporate income tax, then, moves it in the direction of a consumption tax, but the process is not complete because payroll expense will still be deductible.   It would seem, then, that the proposal is a tax on consumption of capital income from sales in the U.S.
         While the tendency for the dollar to rise could occur through a prompt adjustment of the nominal exchange rate with the inflation rate unchanged, this could be prevented by open market purchases of foreign exchange. This resulting money creation would raise the inflation rate.   In the long run, equilibrium would return with prices and wages higher in the U.S.   As U.S. prices rise, imports would expand and exports shrink,  returning imports, exports and the trade deficit to its initial value.
          The use of sterilized foreign exchange transactions would be possible.   Here, the Fed would sell off its holdings of U.S. assets and purchase foreign exchange.   This would tend to reduce the U.S. trade deficit by reducing foreign funding of U.S. investment.   It could last until the Fed runs out of dollar assets.   This policy could be introduced at any time, though it would usually generate a decrease in the U.S. nominal exchange rate.  That would tend to shrink imports and expand exports consistent with the reduction in foreign funded investment in the U.S.   This might be more politically acceptable if it limits and restrains what otherwise would be an increase in the nominal exchange rate.
        Foreign exchange operations are the responsibility of the U.S. Treasury, so I suppose this could be implemented regardless of what the Federal Reserve wants to do.   The Fed could either sterilize to keep to its inflation target or allow inflation to rise until the real exchange rate increases the necessary amount.
        My preference, of course, would be to allow the nominal exchange rate to increase enough.  While I do not favor inflation targeting, nominal GDP targeting would be qualitatively similar in this situation.

Wednesday, January 4, 2017

Deindustrialization and Unionization

      The long run trend for U.S. employment is up.   The unemployment rate fluctuates with the business cycle, but any trend is at best minimal.   Still, there are constant complaints that imported goods are destroying jobs.   Or perhaps it is just the "good jobs."   And what are these good jobs?   They are factory jobs were men of modest education can earn high wages and benefits.   These jobs are supposed to allow those workers to be part of the middle class.
       Surely, this is why the loss of manufacturing employment is counted as a major concern.   These middle-class jobs disappear and some of those losing the jobs, or perhaps just their children and grandchildren, must accept low paying jobs in the service sector.   Of  course, some that are more ambitious may accept more responsibility and risk, or at the very least, seek more formal education, allowing for more skilled work.   Even so, people who are little different in terms of skills and attitudes from those who had "good jobs" in the past  must now take substantially worse jobs.
        A simple model of unionization has the union increasing wages in the union sector.   The quantity of labor demanded by the firms in that sector is lower, reducing employment.   The workers who would have worked in the unionized sector seek employment in the nonunion sector.  The increase in supply in the nonunion sector lowers wages in that sector.   In the simplest model, the workers are identical, so the result is that identical workers earn differential wages depending on their industry.   Wages are above the competitive level in the union sector and below the competitive level in the nonunion sector.
       In the nonunion sector, the labor market clears.   In the union sector, there is a surplus of labor.   Workers from the nonunion sector would prefer "good jobs" in the union sector.    If the union sector is "manufacturing" and the nonunion sector is "services," then this would explain why manufacturing is identified with "good jobs" that are "scarce" and the service sector are "bad jobs."
        Unions took off in the U.S. during the Great Depression.   In my view, this was mostly due to money illusion.   There was massive deflation during the first part of the thirties, and substantial decreases in nominal wages.   While real wages actually increased, workers became very interested in joining unions in order to fight the unfair pay cuts.  Federal government policy changed to strongly support unionization, but the workers supported unionization to fight nominal pay cuts despite growing real wages.
          As time passed, the unionized workforce became less significant, mostly because the growth of unionization failed to keep up with the growth of the labor force.   However, many years ago, someone from "management" once explained that there is little benefit for workers to join a union because employers provide pay and benefits for nonunion jobs that are competitive with union pay and benefits.  There appears to be substantial truth to this notion, most obviously in industries and even firms that have both union and nonunion operations.    Keeping pay and benefits low in the nonunion shop is just asking for an organization drive and the loss of the election.
         This suggests that the proper division in the simple model is not between the union and nonunion sectors, but rather between the "easy to unionize" and "difficult to unionize" sectors.   If manufacturing is on the whole easy to unionize and the service sector is difficult to unionize, then manufacturing will provide "good jobs" that pay more than the competitive amount and the service sector will have poor jobs that pay less than the competitive amount.
         It is certainly plausible that manufacturing is easy to unionize because of economies of scale.  There are also substantial sunk costs, which makes exit difficult, which in turn makes entry risky.  In the rest of this post, I will assume manufacturing is easy to unionize and the result is higher than competitive wages in manufacturing.   The service sector is difficult to unionize and so results in lower wages.  
         This ties to trade because it is a way to bypass the inefficiency created by unionization.   The reduced employment in manufacturing results in too low output and too high prices.   The shift of labor to the nonunion sector results in too high output and too low prices.
          By importing manufactured goods, those in the service sector obtain products at lower prices.   This raises their real income.   The domestic manufacturing industry, which is already too small, reduces output further.   However, the need to meet foreign competition lowers their too high prices.   The reduction in employment in the manufacturing sector increases the supply of labor to the service sector, resulting in lower wages.
          Trade must balance, but it is possible to export services.   Tourism is an obvious example, and there are various sorts of financial services that can be provided to foreigners.   It is also possible that a net capital inflow could fund imports of manufactured goods.   Foreign investment funding an expansion of the service sector would fit in well with this account.  
          Certainly, this story does not account for all of the U.S. experience in the late twentieth century.   The simple model ignores sorting in a labor market where workers are not all the same.   Sectors with excessive wages and and a surplus of labor will tend to hire what they perceive to be higher quality workers.   To some degree, workers left in the low wage sector may be less productive.   Manufacturing output has generally increased in the U.S. and not disappeared.  However, the "problem" of a lack of high paying jobs for workers with little education is not solved by a demand for highly-skilled workers in manufacturing.
          Still, I think it does tell us something about the "problem" of the loss of "good jobs."   That just doesn't make much sense in a competitive labor market.   We can image shifts in the share of income going to labor and capital due to changes in trade or technology.  These changes could tend to depress real wages.  These changes simultaneously expand real output so that the net result is ambiguous.   But these processes do not appear to create the phenomenon of the loss of "good jobs" in import competing industries.  
           If a single industry were unionized or were simply subject to unionization, those working in that sector would almost certainly benefit.   They would receive a larger share of a very slightly smaller pie.   When all manufacturing is unionized or even subject to unionization, the loss in total efficiency is more substantial.   The unionized autoworker pays more for shoes produced by union labor.   The expansion of imports similarly has ambiguous effects.   The union shoe maker can buy a cheaper Korean car, while the union autoworker can buy cheaper Mexican shoes.   Still, the analysis treating "manufacturing" as an aggregate provides some element of truth.   Those keeping the unionized or unionizable jobs get cheaper haircuts and the barber pays more for cars and shoes.   An expansion of imports allows the barber to get cheaper cars and shoes, even if there are more former autoworkers and shoemakers who want to set up barber shops.
           Globally, a pattern of international trade that develops because of unionization is inefficient.   World output and income may be higher than without the trade, but it would be higher still if wages in the unionized and unionizable sector were competitive with wages in the service sector.   That is, if workers in the service sector did not covet "good jobs" in manufacturing, and workers in manufacturing did not see service sector jobs as undesirable.   To the degree this makes the domestic production of manufactured goods more profitable and expands the manufacturing sector at the expense of the service sector, the result would be improved global efficiency.