Is employment still a useful economic indicator?

I feel a little silly just typing that. I know what some of you are thinking – this cat is about to ignore around half of the macroeconomic theory built up over the last 80 years. Well I’m just getting started, so bear with me a while.

Firstly, this (click to enlarge):


If you ever wanted just one visual that encapsulates the inherent contradiction in post 1970’s capitalism, this is it. But what happened in the early 70’s to cause this disconnection? There are few theories and everyone favours their pet one, but I think it’s a mix of them all – the end of the Bretton Woods system of fixed exchange rates, the start of globalisation, oil price shocks, the beginning of the financialisation of the world economy and huge improvements in technology.

Now let’s look at the bigger picture of employment vs GDP per capita (for the US, data taken from the IMF’s World Economic Outlook database, using 1980 as the base year):

Capture econocat

Note that the point of this is to show the separation, not what is happening at the margins, which still clearly indicates that a change in GDP correlates with a change in employment. Bar some recessionary blips, the trajectory of economic output has been far steeper than that of employment, which leads me to conclude that a significant feature of today’s economy is that employment no longer matters. And if employment no longer matters, then we can dispense with much of macroeconomic theory. If the long-run Phillips curve is indeed vertical (meaning that beyond a certain point, additional fiscal and monetary stimulus only leads to rising prices), then it is perhaps no surprise that, as I noted in this post, neither the Keynesian nor the monetarist approach is working to restore the economy to full employment. Further, what does “full-employment output” even look like now? There’s no longer any such thing. The old rulebook should be thrown away; it’s time to move away from old style left vs right economics, and find out what works today.

(I’ve updated the post to include this, from the same data set mentioned above; GDP per person employed. If employment mattered, ie if we expect to see a relationship between employment and output, this would be a much flatter line):

Capture 2

It’s my prediction that what will eventually replace neoliberal capitalism is a two-tier economy. We should stop giving our money to the financial sector, shop local, use public transport, cycle, recycle and use green energy wherever possible. With so many of us having less and less share of the economy, we need to make our share count. If employment no longer matters, let’s get to where our money doesn’t either. Let’s watch the mainstream economy collapse under the weight of its own contradiction – the idea that their income is somehow unrelated to our wages.


Is the Economic Rulebook failing us?

One of the questions I’ve always wanted to try to find an answer to is: Is there a level of economic growth at which our happiness (as in a general state of wellbeing) will start to decline?

That this is going to very difficult has never put me off; I believe it can be done, I just don’t know how yet, mainly because it’s going to take time to come up with reliable definitions that we can then attempt to measure. The subjective nature of happiness is only the start of the difficulties.

What has spurred my return to this question is the contrasting approaches to the latest global recession, and how none of them seem to be working. The spending approach of the US seems to be working marginally better than the austerity of Europe, but I fear the associated cost of this, huge deficits and unheard of levels of govt debt, compounded by monetary policy gone mad, are pushing the world economy toward a point of no return. By this I don’t mean apocalypse, just a painful re-set that in retrospect might not be such a bad thing. Things will not, and cannot, continue as they are.

Painting the picture with a very broad brush, this is what we have: unprecedented levels of economic activity, with most of the influence centred in the financial, not the productive, sector of the economy. Technological gains that have pushed output up, but with employment lagging behind, this coupled with downward pressure on wages since the 1980s has created a huge gap between what the economy is capable of producing (and is being pressured to produce by an out of control financial sector) and what people are capable of consuming. This results in consumption pressure, from direct means such as promoting easy credit and media-led lifestyle choices, to indirect ones such as built in redundancies and unnecessary packaging. This creates the credit bubbles that, when they burst, result in recessions. We then get slapped on the wrist for our poor choices, but are still encouraged to pay our debts and somehow find the money to keep the whole show on the road, while those who put the air in the bubble not only start again, but have the audacity to grade us on how we dance to their tune (the ratings agencies, fow whom I have a question: Once you’ve downgraded every country in the world, what then?).

I want to have a quick look at the US Federal Reserve, because the state of their finances is perhaps the best indicator of how things have changed in the last 30 years. In 1985 the balance sheet of the US Fed was just over 200 billion dollars. Holdings of US govt bonds accounted for about 80% of the assets, with notes in circulation making up abount 80% of the liabilities. In 2012, the balance sheet is over 2 trillion dollars, up tenfold since the 80s. This in itself is not the worry – you would expect your money supply to grow as your population does, and as the economy grows. But let’s look at the components: on the asset side, govt bonds are now about a third, with mortgage backed securities (including the crap that kick-started the economic collapse of 2008) another third. On the liabilities side, notes in circulation is down to about half, with the other half being the deposits held by commercial banks.

So what does this mean? Well the US Fed is buying up all the bad debt from banks, and also about 75% of the govt bonds being issued. They don’t exchange actual money for this, they increase the reserve deposit amount for that particular bank (whether it be a commercial bank or the US Treasury). It’s just an accounting entry. That bank can then proceed to lend out a multiple of it’s reserve deposit, the mechanism I described in this post. The purchase of govt bonds basically sets the interest rate; inflating the demand for the securities (by buying them up) increases the price, decreasing the yield, which is effectively the interest rate.

So currently we see interest rates near zero – this has always been the monetarist approach to stimulating an economy. But it’s not working. The US economy is recovering, but very sluggishly; and this with goverment spending at unprecedented levels (what’s it now – 16 trillion in debt?) and monetary policy reduced to buying your own products to make the demand seem high. This suggests to me that this time it might have gone too far. I mean it’s ok to buy up all the rubbish that’s already exploded in our faces once, and even to buy up your own securities and have a government in huge debt, as long as the rest of the world maintains its confidence in you. But you can’t keep it up forever, and when this one blows, that will be it.

Perhaps it’s about time we stopped using the word “recession” and started to recognise that unemployment is no longer a result of bad macroeconomic policies foisted upon us by our ideological rivals (as neither ideological approach is working). Instead, we need to see it as a sign that the economic system as a whole has let us down, that consumers just can’t keep pace with the level of output, and no amount of easy credit is going to make a bad situation look different – we’re starting to see it for what it is. Unemployment should be our signal that bigger is not better any more.

When I said before that we’re all responsible for Neoliberalism, I meant it. There’s no global conspiracy foisting this upon us, although there are players who benefit, and they are certainly not complaining. But we’ve all bought into this philosophy that we must achieve economic growth at all costs; the management of every corporation in the world is under pressure to deliver better results than the previous year, every year. But by cutting labour costs they are ultimately cutting off the branch they are sitting on – each one just thinks it won’t happen to them.

Can we find a way of using technology to actually make our lives easier, instead of just producing more? Couldn’t we use the enormous technological gains we have made to benefit more people – imagine an approach that values employing more people each to do less work, keeping production levels constant. And making benefits for unemployed people a mainstay of any civilised economy. This can be done in such a way that incentives to work and make profits are not removed, but this approach will result in a more even distribution of the fruits of the economy’s labour – not as an end to itself, but with the ultimate goal of ensuring a market place where everything that is produced can be sold without the need to go into debt.

In my next post I’ll be looking at my proposed tax and spending regime that will be designed to encourage the type of economic responses that I believe can save capitalism from itself.

Our banking system is broken

Conventional banking plays a vital role in any economy. In a strictly technical sense, banks do create money. Here’s how it works: Banks are required by law to hold a certain percentage of their liabilities (deposits made by you and me) as actual cash reserves. This is so that we can draw  cash at the ATM when we need to, or move our money to another bank if we so choose. We’ll assume a nice tidy figure of 10 percent (the actual requirement is usually lower). Now let’s say you come into some money; maybe through a relative’s will, or whatever; a sum of €100000.00. In a state of bliss you deposit the money at your local branch. Does it all just sit there, waiting for you to draw it out again? Nuh uh. The bank only has to hold onto €10000.00, they can lend the rest to somebody else. So €90000.00 goes to the local shoe store as a loan to buy stock. As soon as they pay for the stock, another bank somewhere else has an additional €90000.00 in deposits, they keep €9000.00 and loan out the other €81000.00. And so it goes on; taken to it’s limit with an infinite number of rounds, we can calculate that the deposit multiplier is equal to the reciprocal of the required reserve ratio. In this case:

M = 1/10% = 10.

Your initial deposit of €100000.00 has enabled lending of €1 million. Congratulations.

But you might also notice that the system only works if banks are actually lending. What is happening at present in Ireland is that banks are not lending. In the first place, people are reluctant to deposit money with Irish banks, and money that is there is not being circulated, which is how a normal economy functions.

How do we remedy this?

  • just like in any other market (this being the market for credit), deal with the demand issues. The government is addressing this in their Action Pan for Jobs 2012. Supply always follows demand.
  • Simplify the business of banking. It’s too complex, to the point that we still don’t even know how deeply in the dwang we are with Anglo Irish Bank, more liabilities keep popping out of the woodwork. This is a direct consequence of the neoliberal emphasis on transaction for transaction’s sake. Banks must shed peripheral “business” (which is no more or less than financial alchemy) and do the only thing they do well – take deposits and make (sensible) loans. The personal relationships between bank managers and their customers must be re-instituted as a matter of urgency.
  • Allow the failed banks to fail so that they stop bleeding us dry. Sounds simple enough (you’d think). Allow other players to enter the market, you know, banks that actually want to conduct the business of banking here.
  • Large-scale debt forgiveness / reductions for those in negative equity or labouring under heavy business debts as a result of the recession. Stop throwing around stupid phrases like “moral hazard”. There’s nothing immoral about having bought a house that’s now valued at a fraction of what the mortgage is.

I have more to add on morality and economics in general, but that will be for my next post.

Noam Chomsky on the financialisation of the US economy

See “Jobs aren’t coming back”. Noam Chomsky has written a piece on what he calls the de-industrialisation of the US economy since the 1970s, essentially outlining the neoliberal paradox that I wrote about before.

I don’t agree with everything he says; for example I think the Occupy movement was, unfortunately, a waste of time. A movement with with no concise message is never going to get anywhere. If there is to be salvation from neoliberalism, it’s not going to come by breaking down capitalism. It’s more likely to be effected by a change in mindset (and for this reason Occupy is not totally irrelevant) leading to changes in the way we measure things. This must involve everything from statistics to accounting standards and it will be a huge undertaking.

Chomsky’s article is, however, a nice summary of some of the themes I’ve been introducing.