Joseph Stiglitz – thinking liberal

Are politicians as stupid as Joe Stiglitz says?

Our politicians are being stupid. Thus says the eminent US economist Joseph Stiglitz in a recent article The Politics of Economic Stupidity. In spite of its title, however, the article spends most it words explaining the economics, and actually says very little about the politics, beyond saying it is stupid in pretty much all of the developed world. He is venturing similar views to fellow US academic and Nobel Laureate Paul Krugman (who is even more vocal about stupidity) and the FT’s Martin Wolf (whose comments are more closely argued and less polemical). All three are formidable intellects. Why are they saying this? And why are their views having such little impact on those responsible for economic policy?

The starting off point is the meagre rate of economic growth enjoyed by developed economies (mainly the USA, Japan, the Euro area and the UK) since the economic crash of 2007/08. The politicians cheer from the rooftops if growth occasionally reaches the rate of 3% per annum. But all economies are well below where they expected to be at this point by forecasters in 2007. Growth is meagre and living standards for the median citizen are hardly advancing at all. After a recession you should expect a rapid bounce-back, and then a resumption of steady growth of 2-3%, referred to as the “trend” rate, observed since the 1950s.

The proximate cause of this slow growth is, as these economists have it, a lack of demand. In other words our economies are producing enough goods and services, but not enough people are buying them. This shouldn’t happen. Economics is a circle: what we pay people to produce things is spent by them, creating demand. Demand and supply should balance out. But this can go wrong. If people save too much, and this isn’t balanced by investment, then there can be a downward spiral, in a process brought to popular consciousness by the economist Maynard Keynes in the 1930s. This is what seems to be happening across the various world economies now.

The traditional answer to this problem is for governments to stoke up demand artificially and thus stabilise things. In recent decades the consensus was that he best way of doing this is through monetary policy, usually low interest rates. This encourages people and businesses to spend more; once they spend more the system stops leaking, growth picks up and things settle back to a nice even flow. This should all be a nice self-adjusting process which does not lead to worse problems down the track. But, as Mr Stiglitz points out, this process does not seem to be working. I think he is right here, as I have blogged before, although most economists are in various states of denial about this state of affairs – so central has a particular idea of money and monetary policy become in conventional economics.

That leaves a second weapon in the conventional toolkit: fiscal policy. This means that the governments deliberately spend more than they raise through taxes, creating extra demand that then plugs the gap. This has been the incessant cry of “Keynesians” ever since 2008. But this isn’t as simple as it looks. It is not self-adjusting the way that monetary policy is supposed to be. The risk is that you build a pile of government debt that cannot be repaid, causing another economic disruption down the track that undoes all your good work. Or to put it another way, it often means prolonging unproductive and unsustainable activities that will drag the economy down in due course. It is meant to be a temporary corrective, not a long-term solution.

But, Mr Stiglitz and Mr Wolf say (I’m not so sure about Mr Krugman – he has become so polemical that I’ve stopped reading him), there is a way to square the circle. There is a magic bullet (they don’t actually say that). Public investment. If fiscal policy can be directed towards investment projects it will be sustainable. These projects will generate a return from which government debt can be repaid, either through direct revenues, or through higher taxes. And when government borrowing rates are as low they currently are, it doesn’t take much of a return to achieve this. And yet the developed world governments are reluctant to do this. This is what Mr Stiglitz is calling economic stupidity.

But alas life is not so easy. Public sector investment is an elephant trap. Investment projects that generate their own revenues and collateral don’t need the public sector to run them. Indeed it is almost always better to let them run in the private sector, where management and accountability is sharper. And by and large all the easy ones are being done already. It leaves some big projects that turn out to be very risky – like, for example, Britain’s HS2 fast railway. And because they are risky they are slow to get up and running, and not much use as tool for temporary fiscal policy.

But there is another set projects where the returns are indirect – they come from taxes in various guises. These include things like roads and bridges (given the difficulty of charging economic tolls), schools and hospitals, under Britain’s NHS. But the returns are difficult to judge and projects are selected not through a process of objective rating of financial return, but through political arm-twisting in a bid for short-term prestige. And the more urgent the need to create economic demand, the worse in quality these decisions are.

Examples about. After 2008 China embarked on a massive and urgent infrastructure programme. But although the country remains underdeveloped, much of this money was wasted; whole cities have been built and lie empty. The Chinese government is now grappling with a rising tide of bad debts from the state banks that backed these projects. Japan in the 1990s invested massively in infrastructure projects; the country is littered with “bridges to nowhere” and its economic problems are as intractable as ever. In Britain in the early 2000s the country invested in a whole host of Public Private Partnerships. Many of these are turning sour because it turns out the facilities (notably in the NHS) were not actually needed. Though the political opprobrium surrounds the PPP structure, and the way that there was no real risk sharing with the private sector, we mustn’t forget the problem at the heart of it all – public sector organisations are very bad at choosing investment projects. (Actually private sector organisations aren’t any better if the accountability is weak – but that’s another story). I could go on with other examples of government expenditure that were sensible in principle but badly designed in practice (Labour’s Building Schools for the Future, for example).

The upshot is that public investment is no magic bullet. It’s a good idea, and we should do more of it – but a top down blitz directed by the need to rebalance the economy in the short term is asking for trouble. Each project needs to be properly thought through and well managed. That means you can’t get them going in a hurry.

So what to do? I think we need to be more realistic about the direction our economy is going. Things are changing. The demographics are adverse. The excessive wealth of an elite is economically inefficient. Modern businesses require less physical investment. Technological innovation is more about improving the quality of life than ramping up consumption. Economist such as Mr Stiglitz and Mr Wolf are well aware of these pressures. I think their time would be better spent helping us to craft long term solutions rather than ranting on about “stupidity” that turns out to be not so stupid after all.

Inequality should be at the heart of the economic debate

Today the eminent US economist Larry Summers writes in the FT. His subject is the US economy, but the problem he addresses affects most developed economies in some shape or form, and the British economy quite closely. Unfortunately, so many economists of his generation, an obsession with short-term macroeconomic theory means that he doesn’t seem to get the big picture. Inequality lies at the heart of our economic malaise.

This debate is being conducted by academic economists in their own language, but it matters to all of us. I will summarise. Mr Summers’s starting proposition is that the US economy is suffering from “secular stagnation”. What this means is that the economy is stuck in a pattern of slow growth that does not fulfil the potential that population growth and advances in productivity should give it. This certainly seems to be true, though I think that the ability of developed economies to grow consistently at 2% per annum, the “trend rate”, must be subjected to critical analysis, rather than simply assuming it can be continued indefinitely because it has been achieved in the second half of the 2oth Century.

Mr Summers then says that there are three basic ways of trying to tackle this. First is “supply side” reforms; this means trying to fix fundamental bottlenecks in the economy, such as education. Worthy though he says these ideas are, the problem with this is that it does not fix a lack of demand in the economy; there is no point in producing more if nobody buys. This line of reasoning is very much behind the Keynesian critique of austerity economics. While there is a certain logic to it, it sounds too much like saying these problems are too much effort to fix, so let’s try something else – which is a road to nowhere. It used to be that economists blamed politicians for being too short-termist; now it is the other way around.

The second strategy is to loosen monetary policy. The problem is that monetary policy in the US (and the UK) is technically very loose as it is. I say technically, because in some respects monetary policy is quite tight in fact (because banks are reducing their balance sheets) – though there is little the authorities can do about it. Further loosening of policy (as advocated by the likes of Paul Krugman, for example) will simply inflate bubbles and get us back to the fix we found ourselves in 2007. He is surely right here – though I would add that I think that monetary policy is massively over-rated as a policy instrument by conventional economists anyway.

The third strategy is to use government spending to keep up demand, preferably by spending on infrastructure, that will be of long term benefit to the economy. He also says that governments should try to persuade the private sector to spend more, by which he mainly seems to mean the corporate sector to invest more.

The problem I have with this is its superficiality. The “secular stagnation” problem Mr Summers describes is a serious malfunction of the economic machine. This can be seen most clearly if you follow Mr Krugman’s logic. He says that the way out is to reduce interest rates to the point at which investment gets stimulated. And since interest rates are currently low, that means that we should have an effectively negative rate by stoking up inflation a bit. In other words, he is saying that the problem is that profitable investment is impossible, so we need to encourage investment that is marginally unprofitable. How on earth can an economy grow on that formula?

Surely we need to spend a bit more time getting to the bottom of exactly why are in this fix, and then trying to direct public policy to fixing it. Here I follow another prominent US economist: Joseph Stiglitz (or I think I do). The culprit for lack of demand in the economy is quite clear: it is lack of investment, especially from the private sector. You can make up for this shortage of investment by running government deficits, but you are in trouble if this is more than a temporary measure. The problem is that there is systemic reason for the shortage of private sector investment, which running government deficits does nothing to fix. It is rising inequality. Big surpluses are accumulating in some parts of the economy: in the personal wealth of the very rich, and on company balance sheets. This is not being spent on investment, but being held in cash to spend later, or chasing a merry go round of assets, real estate and shares, whose overall quantity is not expanding.

There are two problems here: inequality and the fact that savings are not translated into proper investments. The first of theses is the more fundamental. The Economist published an interesting article on the subject, reviewing the work of a French economist, Thomas Piketty. They point out that the inequality problem has been with us before: in the period up to 1914, giving rise to the critique of Karl Marx, amongst others. Mr Piketty thinks that developed economies are reverting to the 19th century type. The problem is slowing population growth, combined with technology that makes it easy to substitute people with machines. If he is right, the problem is not about to go away. It is the central political question of our time.

So what are the answers? First of all we need to tax the rich harder. Given that so much wealth ends up in slippery multinational networks, this means international cooperation. It also means rebalancing industry and jobs so that we are less over-supplied with unskilled workers. The pressure on the finance industry, especially investment banking, needs to be maintained. All this means reversing the conventional wisdom of the Ronald Reagan and Margaret Thatcher years – but not a recreation of the failed policies that preceded them.

This is an agenda of the left. It will be vigorously opposed by the right. Perhaps at long last the consensus that has ruled developed world politics will break up. But economists like Mr Summers do us no favours by concentrating on palliatives rather than solutions.

Capitalism in crisis. A smaller state and lower taxes will make things worse, not better.

The advanced capitalist economies are in trouble. Economic growth is anaemic or negative; government debt mounting; banking systems are on life support. There are big differences between the individual economies, but some combination of these three, or at least two of them, afflicts more or less all major economies – Australia and some Scandinavian economies excepted perhaps. The crisis may not be as severe as the one in the 1970s (it is if you measure GDP statistics but not by any other measure), but there is a pervasive sense of hopelessness. Nobody seems to have a convincing solution.

Broadly two narratives are offered. On the left the crisis is attributed to greedy bankers and corporate bad behaviour – and the answer is to ratchet up state spending to provide a Keynesian stimulus together with some very vague ideas on improving regulation of big business. On the right the crisis is attributed to an excessive state, and the answer is to roll it back to get out of the way of free enterprise. Neither is very convincing. For a much more convincing narrative, go to the eminent American economist and Nobel Laureate Joseph Stiglitz. He recently published a book on the topic: The Price of Inequality: How Today’s Divided Society Endangers our Future. I haven’t read it, alas, but it is reviewed by the Economist here, and Professor Stiglitz wrote an article for the FT here. A weakness is that his comments are focused especially on the US – but they have a global resonance.

This crisis has been evolving since the 1980s, while two important trends have been evident: the advance of technology and globalisation. These have rendered much of the earlier economic infrastructure obsolete and forced a major restructuring of the world economy, with big impacts in both the developed and devoping worlds – many of them very positive. Running alongside this has been a major shift in the balance of economic power from labour to capital. This is evidenced by a declining proportion of GDP attributed to wages and salaries and an increasing proportion to business profits. This in turn has led, especially in the US, to a dramatic rise in the inequality of wealth and income distribution. I have not been able to lay my hands on a clear set of statistics to demonstrate this – and not being a student any more I do not have access to the OECD or other statistical databanks – or not in a form I can work with. But this is widely attested to. Incidentally income inequality is not the only aspect of this problem, the amassing of corporate power that we can see in Japan and Germany, for example, is another dimension of the same problem.

This is where it gets interesting. One of the characteristics of the very wealthy (including big corporations) is that they do not spend as much of their income as poorer folk. They like to amass wealth, to exercise power, to pass on to later generations, or simply because they are too busy creating it to spend it. This creates a problem made famous by Maynard Keynes, and explored by all Economics undergraduates: if there is a surplus of saving over investment opportunities then the economy as a whole starts to shrink: people are producing more than is being consumed. That, in essence is what the crisis is about. Changes to the world economy have skewed the distribution of income in such a way that it is slowly suffocating the economy as a whole. This is not unprecedented: something like this happened in the early days of capitalism in the mid 19th century, but was resolved when the balance of power shifted back to labour. I have read a claim that there was a similar crisis in the 1920s and 1930s – but I am less convinced that skewed income played such an important role in then.

Now there are broadly four ways that sinking domestic demand from excess savings can be countered. First, an economy can run an export surplus which transfers the excess supply to other economies; this might be called the German solution. Second investment levels can be stoked up to absorb the surplus savings: this is roughly what happened in America in the 1990s with madness of the high-tech boom. Third consumption can be ramped up amongst the less well off by encouraging private debt, usually aided and abetted by a property bubble – the US and UK economies did in the 2000s. Finally government spending can take up the slack, either financed by taxes or, more usually, by borrowing.

Each of these four solutions has been tried by the major world economies, and all have given rise to problems. Export surpluses simply transfer the problem elsewhere – and are only globally sustainable where the counterpart deficits are being used to finance worthwhile investment. But the developing world, where most such investment is taking place, has often been running trade surpluses. Otherwise surpluses build up into assets that have to be unwound painfully. Investment looks like a good idea, but to work these investments have to pay back, otherwise you simply postpone trouble. This has proved much more challenging than many have allowed – I did not use the word “madness” in connection with the high tech boom of the 1990s for nothing. Private debt amongst the less well off might work if their incomes are rising – but the problem arises because they are not. And finally excess state funding carries its own problems. It is economically inefficient, and, financed by debt it simply builds a future financial crisis.

So what to do? It is worth noting that the left’s narrative on the crisis is closer to mark than the right’s. Cutting taxes and the power of the state will not unleash a flood of new investment, as the right claims – it will make matters worse by choking demand further. The left is right (as it were) to see that a large state is part of the solution, rather than the problem. Where they are wrong is to think that a bit of fiscal stimulus will restore the economy back to health – because it fails to deal with the root causes of the problem. Taxes have to rise, and especially on capital and the rich. And there is rather a tough consequence. This may help break the cycle of the rich not spending enough – but at a cost to the overall efficiency of the economy. We have to lower our expectations of what an economy can deliver.

And what of the megatrends that caused the problem in the first place? As I have argued on this blog before, I think globalisation is running its course and will not be the force it once was. There will be less pressure on developed societies from developing world competition. As for technology, let us hope that it starts to fulfil its promise of empowering the individual. Only this will ultimately restore the balance of power between businesses and their employees in a way that does not suffocate enterprise.

Is the US economy heading for a fall?

Most of the worry about the world economy is being directed towards Europe, and the Eurozone in particular. I am amongst a very small group of optimists on that front – but it is easy to see why people are worried. In fact it is only through a prolonged period of crisis that Europe will find an enduring solution. But meanwhile, should we be worried about the US too?

What prompted this thought was this article in Vanity Fair by the eminent economist Joseph Stiglitz (thanks to Marisha Ray for drawing my attention to this on Facebook). It’s subject is inequality, and why it is corroding the US economy, and why the elite (the top 1%) should worry. Judging by the FB comments, some readers saw this critique as applying to government thinking right across western world – the view that austerity economics is driven by an idealogical view of the role of government. But I took it as a very specific critique to the US.

Professor Stiglitz does not spend much time justifying the statement that inequality in the US is high and increasing. The problem is that almost all the benefits of growth are accruing to the top 1% of the population – and bypassing those on middle incomes. In other words the problem is not an underclass that is disappearing from sight – but a substantial majority of the population being left behind, with the creation of a fabulously rich elite. There are many ways of looking at the statistics on this, but for me one of the most important is the historically high level in national income that is taken up by business profits – the benefit of which goes overwhelmingly to the elite. This may or may not be outrageous in its own right, but Professor Stiglitz points out a number of practical problems that arise from this:

The very rich spend less of their income on consumption and save the rest. The more wealth that concentrates in their hands, the more consumption overall will fall as a proportion of the economy. Unless there are enough constructive channels for their savings then unemployment will result – unless alternative demand comes from somewhere. That alternative might be an investment boom (as with high tech in the late 1990s) or with big government deficits, propping up the economy now.
The rich elite use their power to protect vested interests and direct their energies to what economists call “rent-seeking”: activities that enrich the individuals themselves but not the economy as a whole. Under his analysis the finance industry is largely based on rent-seeking. As energies are diverted from genuine economic growth, the economy overall weakens. What is good for the profits of existing businesses is often not good for the whole economy – which needs new businesses to come forward.
The majority who are seeing their incomes stagnate, and find it more and more difficult to join the elite, get resentful, breaking down the trust that underlies all successful economies.

But there is a political puzzle at the centre of this. Why is the Republican Party both veering to the right and retaining substantial popularity? Surely the welling up of resentment against the elite should translate into overwhelming political pressure for a more egalitarian system? I think the American suspicion of government is to blame. I don’t think that the majority of American people are particularly happy with the way their living standards are being held back. But, incredible as it may sound to European ears, many of them think it is “socialist” government policies that are to blame. Shrink the government, cut taxes and the 99% will start to catch up with the 1%. Of course, huge funds from the elite are available to support this view in the media – through political campaigning and biased news coverage, such as Fox News. It hardly helps that a lot Americans seem to think they can have their cake and eat it: huge expenditure on entitlement programmes (especially Medicare) without the need for increased taxes.

If Professor Stiglitz is right then the US would be suffering from long term low economic growth, as the various toxic effects of its skewed income and wealth distribution gradually overwhelm the highly dynamic core economy. And indeed, measured per capita (i.e. taking into account population growth), the U.S managed annual growth of only about 1.4% in the first decade of this century (compared to the UK 1.7%, or Germany (1.9%) – though France only managed under 1% – figures from Wikipedia).

Still lacklustre growth won’t cause a crash. Italy has made an art of surviving such a challenge. But the proximate cause of a crisis is clear enough – the government’s budget deficit of 7.6%, and the lack of any political consensus in how to handle it. There are three ways in which this could cause a problem. The first is if the US government should hit the Spanish problem of being unable to borrow because of a loss of market confidence. This looks implausible. Investors have too few choices where to put their surplus funds. The second is expenditure cuts sucking demand out of the US economy, causing a prolonged recession. This could happen if the Republicans take control in this year’s elections. The third is political gridlock causing government funding to seize up, and causing technical default. This looks all too possible if the Republicans control either or both houses of Congress, as looks probable. Even if Mitt Romney should gain control of the presidency (and he’s doing well on fundraising), he may well run into trouble with Congress as he desperately tries to find practical answers to the deficit problem.

And what if the US survives the budget crunch in 2013? If growth continues to be lacklustre, and the top 1% continue to hog the benefits, surely US public anger will turn on the elite, as it did briefly in the last days of President Bush? I share the European view that a smaller government, reduced regulation and lower taxes will make the problem worse, not better. That will be a sight to watch from a safe distance.

Time to wake up to the de-industrialisation of advanced economies

Trying to understand the global economic crisis? This article from Joe Stiglitz is required reading.

I have flagged it already on Facebook and Twitter, but without much in the way of reflection. In fact it has produced an epiphany moment for me. I have maligned Professor Stiglitz in a past blog as producing only superficial commentary on the crisis, alongside his fellow Nobel laureate Paul Krugman. This was based on one or two shorter articles in the FT and some snatches on the radio; I wasn’t reading or listening carefully enough. Professor Stiglitz is one of the foremost economists on the current scene. He used to be part of the Clinton administration, and worked at the World Bank in the 1990s, but his views proved politically unacceptable. He also wrote the standard text book on public economics, which I used in my not so recent degree course.

The article is wonderful on many levels, but the epiphany moment for me came with his observation that, underlying the current crisis, is a long-term decline of manufacturing employment in the US, and by implication, other advanced economies too. He draws an interesting parallel with the Great Depression, which was caused, he claims, by a comparable shift from agricultural employment – again in the US; I think that such a shift was less marked in Britain, but the depression was also less severe. This decline in employment brought about a doom-loop of declining demand across the economy as a whole – which was only reversed by World War 2. The war effort caused a boom in manufacturing industry which was readily redeployed into the postwar economy. This view of the Great Depression rises above the fierce controversies over fiscal and monetary policy, and places them in a proper context.

We have been witnessing the decline in manufacturing employment for some years, and grappling with its social consequences. The important point is that it is mainly irreversible. It has been brought about by technological change, which has improved productivity. There is a limit to the number of manufacturing products that we can consume – just as there is a limit to the food we can consume, and we are at that limit. So the number of jobs declines.

Of course the picture is complicated by the rise of manufacturing in the developing world, and especially China, and their exports to the developed world. In the US I am sure, and certainly in the UK, more manufacturing output is now imported than exported, causing a further loss of jobs. This is reversible, though, and in due course will reverse, as the developing world advances and loses its temporary competitive edge. But this won’t be enough to reverse the overall trend of rising productivity.

But advancing productivity should be good news in the long run. It releases the workforce to do other things, or, if people prefer, to increase leisure time. So what replaces the manufacturing jobs, in the way that manufacturing took over from agriculture? Services, of course. What is, or should be, the product of these services? Improved wellbeing.

Services have rather a poor reputation in our society. Traditionalists see them as ephemeral, compared to the real business of making things – a bit like Soviet planners were obsessed with producing steel rather than consumer goods. More thoughtful people associate them with poor quality jobs in fast food restaurants or call centres. But it doesn’t have to be this way.

We need to develop clearer ideas of what tomorrow’s service-based economy will look like. That’s important because the way out of the current crisis is through investments that will take us closer to this goal, just as war led to investment in manufacturing in the 1940s (and earlier in Europe).

And the key to this is thinking about wellbeing. This is important because one of the answers could be an increase in leisure, hobbies and voluntary activities – which is not normally regarded as economic activity at all. Reflecting on this, I think are two areas whose significance will grow and where investment should be made, both of which raise awkward political problems – health and housing.

It is easy to understand that health and social care will take up a higher proportion of a future economy than they do now, and not just because of demographic changes. These services are vital to wellbeing. But we are repeatedly told that we can’t afford to expand them. And that is because we are reaching the limits of what state-supplied, taxpayer funded services can deliver in the UK. (In the US it’s another story for another day). The health economy of tomorrow will have a larger private sector component, whether integrated with the NHS or parallel to it. But what should our priorities now be, while this private sector is on the back foot? It seems sensible to make the NHS more efficient and effective, but foolish to cut jobs. We should be building the skill base alongside the reform programme. The chief critics of the government’s NHS plans (including the Labour front bench) are that NHS reforms should be stopped so that they can focus on the critical business of raising efficiency. But maybe it should be the other way round – we should be pushing ahead with reform, but relaxing the efficiency targets and letting the costs rise a bit until the economy starts showing greater signs of life. then, as any cuts are made the private health sector can take up the slack.

Perhaps housing is pushing at the boundaries of what “services” are. We traditionally view this as a capital investment. But what I mean is providing more and better places for people to live in, whether they own them or not. Most of the country is quite well off here, but poor housing is probably what divides rich from poor more than anything else – and more investment in the right places (decently sized social housing) could rebalance things nicely and dramatically improve wellbeing.

But beyond this we badly need to get out of a manufacturing mindset, both in the private and public sectors. We should not view division of labour and specialisation as the ideal form of organisation (massive call centres, and so on), and we should value listening skills much more – I nearly wrote “communication skills” but most people understand this about getting over what you want to say, not understanding what your customer or service user actually needs. This is happening only very slowly.

So I would add a third priority: education. We need to greatly expand the teaching of life skills at school and elsewhere. This would not only help build the skills that tomorrow’s economy needs. It would help people make better choices in a changing world.