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):

Capture

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.

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Something for everyone to hate

So I’ve finally got around to the post I promised would be my “next post” three posts ago, back in December! If I were Queen Penelope, what taxes would you be in for, and what could you expect in return?

There’s a mixture of left and right-wing ideas here, hence the title of the post. But here goes, in point form, and without any detailed description:

Taxes:

  • V.A.T. of at least 20%, on all goods and services with no exceptions.
  • Personal tax brackets from 20% to 50%, rising incrementally.
  • Tax credits available as a fixed amount, higher for married people with children under 18, or single parents with children.
  • Payroll taxes levied at the same rates for all, no exceptions.
  • Low corporation tax rate of 15%.
  • Tax on the disposal of financial assets (this one will get a post all of its own and this time I do promise it won’t take four months).
  • Carbon taxes and “sin taxes” maintained at fairly high levels.
  • No capital gains tax.
  • No tax on interest income from investments.

Spending:

  • free education all the way to third level (first degree) studies. Tuition only but with means-tested assistance available for other expenses, with STEM fields receiving higher priority. A form of national service (two to three years, depending on the level of assistance) mandatory after graduating, serving in the field of study. This will be paid, but not at market rates. Some of this may take place in the private sector, with the government paying a portion of the wage.
  • free health care (means tested).
  • income supplement to low income workers with families.
  • unemployment benefit, on the condition that people make themselves available for work in a government program, such as the national service program described above.
  • disability benefit, upon regular assessment by the person’s own doctor, and a state doctor.

So there you have it – the complaints department is located below, in the comments section.

And in other news…..the IMF also discovers we need air to breathe

Earlier this week Ashoka Mody, one of the original troika representatives when they took hold of the Irish economy last year, has admitted that austerity alone was a mistake.

Then the Taoiseach comes up with “well, hindsight is a wonderful thing.”. Yes, Enda, it is, but there was no need for hindsight when many economists, including Nobel prize winner Paul Krugman, economics popularist David McWilliams and your’s truly told you so back then. It’s information that can be found in standard textbooks for third-level economics studies.

But I suppose you need to be a VSP (Very Serious Person) to be taken seriously.

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.

On taxes and government spending

Economics is intertwined with politics, indeed in Adam Smith’s time no distinction was made between the two disciplines. One of the great questions right at the heart of this intersection-from-hell is that of how involved the government should be with regard to the economy. Everybody has an opinion, ranging from the extreme left’s Soviet-style planned economies to the extreme right’s libertarianism and laissez-faire approach. Neither approach can be shown to be empirically unworkable, yet planned economies were tried, and failed, and a completely “free market” is an elusive fantasy – fairytale economics.

So it would seem that the sensible approach would be a mixture of the two, but how to mix them is crucial, and economic success doesn’t always mean political success, especially in the short term. That is because you humans are very short-sighted when it comes to your comforts. Most of you would choose a lifetime of poverty if it meant you could be rich for just one day, as long as that day is today. But I digress….

Taxes – Spending = Surplus (or Deficit). Even politicians can understand the mathematics of this (you’d think). Raise taxes or cut spending (or do both), you get a surplus. Lower taxes or increased spending puts you in deficit. Countries are not corporations; a budget deficit is not necessarily a bad thing and, as David McWilliams points out in this piece: if everyone and everything is balancing their budget at the same time, that’s a recipe for disaster. Because my spending is your income, and vice versa. A targeted mix of policies is necessary to balance a myriad of potentially conflicting forces.

In general, I like taxes. But taxation is a powerful tool and should be used responsibly. It’s a bit like chemotherapy, it might kill the cancer but could also kill the patient. Tax policy needs to be simple. The simpler the tax, the harder it is to avoid. I love VAT, I could wax lyrical about VAT for hours (don’t worry, I won’t). VAT is a beautiful tax because it’s simple, impossible to avoid, and all the work in its collection is borne by VAT vendors, not the government. It’s also about the most fair tax you could imagine; because it’s a tax on consumption, everybody pays, and what’s more everybody pays the same percentage. Whoever invented VAT should be knighted and sainted.

I cannot understand how, in general, the same people who favour cutting taxes also want spending cuts. Lower taxes and increased spending are two sides of the same coin, they bring you to the same point, and can even complement each other. Of course you can’t always substitute one for the other; roads won’t be built and maintained if we cut taxes. And governments can be wasteful spenders. A low corporation tax, as we have in Ireland, is another way for the government to invest money (that would otherwise be raised by a higher tax) in job creation. This is an example of a sensible, targeted policy. It involves one tax type, and achieves a very specific outcome. Now think of the govt spending equivalent: Family Income Supplement (FIS). This is a social welfare payment made to working people  with families, to supplement their income (the clue is sort-of in the name). This effectively allows employers to get away with paying lower wages; it’s not only the employee who is being subsidised here. Now why would you be in favour of a low corporation tax, but averse to a government income subsidy? The answer is that some humans hold economic ideas the same way they do religious ones, and they don’t think about the implications of those ideas; this applies to left and right equally.

Which brings me to a final musing; there’s a growing fascination in right-wing economics with an unsubstantiated fantasy called “Supply-side theory”. One of the central dogmas of this religion is that lowering taxes leads to increased government revenues. Even if the Laffer Curve was an actual curve, and not just a series of disjointed dots (with very different results for different countries) which is what the actual data gives us, it’s still the Laffer Curve not the Laffer Vertical Line and you might just still be on the left hand side of it. It’s amusing that this is presented as a serious economic study……….sure, and Alice in Wonderland is a great work of non-fiction. To be fair to supply-siders, other economic factors, especially shifts in demand, are always getting in the way of them ever proving their theory. Which kinda just goes to show that those factors are much more important.

Why the Treaty is bad for Ireland right now

I mentioned in my previous post that I’m not sure if the referendum at the end of this month is really going to matter in the end. But I feel compelled to lay out the economic reasons why this treaty will not work. It has a fatal flaw which will lead to the break-up of the Eurozone anyway. Humans, this is not heterodoxy that I’m about to preach to you; you will find this in any university Economics textbook.

First, let’s revisit the Treaty (summarised):

The budgetary position of each government must be balanced or in surplus. Budgetary discipline requires an annual government deficit of no more than 3% of GDP, together with a debt-to-GDP ratio of 60%. The annual deficit target implies a ‘structural deficit’ which should not exceed 0.5% of GDP annually, unless it has a debt-to-GDP ratio “significantly below” 60% and the long-term sustainability risks to the public finances are low.

Ok, what is a structural deficit?:

A structural deficit seeks to measure the underlying state of the public finances, independent of the ups and downs of the business cycle. Such a deficit results from a fundamental imbalance in government receipts and expenditures, in other words when the fiscal regime in a country persistently yields revenue below expenditure.

On the face of it, this is quite good. Let me explain: An actual budget position is not necessarily a good indication of fiscal policy. For this reason economists distinguish between a “full-employment budget” – what we would be spending and taking in with taxes if the economy was at full employment, and the “actual budget” – the real position at any given time with respect to tax revenues vs expenditure. If the economy goes into recession, we expect tax revenues to fall and the deficit to grow. To try to balance the actual budget under these conditions would be suicidal; indeed this is a “policy trap” that the US government fell into in the early 1930s that plunged them into the deepest part of the Great Depression. An actual budget deficit is not in itself an indication that there is a problem with your economic fundamentals. Yet the temptation is there to misdiagnose the problem, ignore external factors and conclude that the government must be spending too much. It’s like if your child does badly in a school test; is your first conclusion that the child is lazy and didn’t study hard enough, or do you also look at how the teacher is presenting the material? I think that would depend a lot on the child’s record in this regard, and that’s really what the above italicised paragraph is saying.

So the Treaty is not saying we should balance our actual budget every year, which would be calamitous. Europe wants us to balance our full-employment budget (this is what is meant by reducing the “structural deficit”). Since this budget doesn’t automatically swing into deficit during recessions, it does not give a false signal that a tax increase or spending cut is needed.

What then, is the problem?

It’s the Recession, baby. This one in particular, which is why it has a capital “R”. In a severe recession, balancing the full employment budget is inadequate. All it does is to allow the automatic stabilisers (economic features that mitigate recessions without changes in policy, such as the existing tax regime) to combat the recession. It does not allow the government to go one step further and actively fight the recession by introducing fiscal stimulus. Such stimulus, for example, a cut in the tax rate, would violate the rule, since it would pull us into structural deficit. So this rule is an unambitious strategy that aims to avoid destabilising actions, not to actively stabilise the economy. It reminds me of the doctor’s motto: Primo non nocere, (First, do no harm).

There are two other ways to ensure a measure of government restraint while allowing the government to take initiative in managing the economy. You could aim to balance your full-employment budget only during times of full employment, allowing a deficit in times of recession, but returning to balance when full employment is achieved. Or you could aim to balance the actual budget over the business cycle (instead of every year), using surpluses in good times to cover deficits during recessions. But neither of these approaches is allowed by the Treaty. Also, remember that we have been asked to write this balanced budget rule into our Constitution (hence the referendum). This effectively removes the power of our government to deal with unforeseen emergencies in the future. It also raises some technical complications. How exactly is the budget to be defined? And who, if not us, is going to interpret what “the underlying state of the public finances” really is?

Let’s look at a real world implication of what I’ve been talking about. Ireland has a very low corporation tax rate, something I agree with in principle. But let’s say the government wants to attract business to a specific part of the country. They would need to introduce a specific policy for that region, perhaps to exempt corporations from local taxes for a period of time, or perhaps payroll taxes. This is a change in policy, which, if it moves us into structural deficit, would not be allowed. Europe already doesn’t like our low corp tax, I can foresee a very close scrutiny of such measures not passing muster in Brussels. I can also see our government (this is Ireland, remember, the land of the “little lie”) being tempted to change accounting methods to remove such deficit items from the structural budget. Europe won’t be fooled. Also, although we’ve been assured that our corp tax rate won’t be changed, what if Europe decides tomorrow that our low corp tax is a fundamental policy error that is causing us to remain in deficit too long? They couldn’t directly force us to raise the tax rate, but they could penalise us in so many other ways that could outweigh the benefits of having it.

I was going to talk about the Euro as well, but this post is too long already. I’m off to tell the human that I’m hungry – maybe he’ll do a special trip to the shops for me. If not, I’ll ignore him for the rest of the day.