I’m off on holiday on Wednesday, returning mid next week.
So, while I’m in one of my favourite places – I thought I’d share with you all (that haven’t seen it) one of my favourite things.
(And maybe if that’s enough – go read/watch the lectures from Skidelsky on Keynes and Caldwell on Hayek available here).
I’m getting quite interested in an issue and was wondering if any readers could suggest any books, articles (I have access to several academic databases) or online stuff that might be useful?
What I want is something on the macroeconomics of transnational firms – the kind of mesoeconomic stuff that Stuart Holland was writing about in the 1980s.
The issue that is bothering me is that most macroeconomics assumes that there is a “corporate sector” or “firms”, but tends to think of them (as convenient short hand) as being entirely domestic.
Or if they are asking that question – it is usually outside of the standard macroeconomic model
As an example – macroeconomists have various competing ideas about what makes firms choose to invest (expectations, cost of capital, interest rates, credit availability, demand, etc), but rarely ask the question – what makes them invest in this country?
So, we might have a firm that has good expectations for profits in country A, easily available finance, etc, etc and it might decide to build a new factory in country B. A standard one country macroeconomic model risks missing this. Equally, conditions in country B might be awful with depressed demand and high interest rates… but there might be circumstances when investment was still high as firms located production there in order to meet demand in country A.
This strikes me as problematic. Especially as transnational firms take on an ever increasing role in the economy.
The outlook for the US economy is deeply troubling. Amid a well publicised slowdown in the rate of recovery from a recession that was deeper than originally thought, a dual crisis is underway – one of jobs and one of investment. With political paralysis looming, no easy resolution is in sight.
This matters to people in the UK for two reasons – first, the US is still the major driver of the world economy and second the twin crisis of jobs and investment faced by the US may be a sign of things to come on this side of the pond.
The jobs crisis is the most immediate problem facing the country. As Robert Reich has noted, the economy is not generating enough jobs to keep up with population growth – let alone make inroads into reducing the pool of 15 million Americans out of work.
12,000 new jobs in July — when 125,000 are needed monthly just to keep up with population growth, when more than 15 million Americans are out of work, and when more than a half million more state and local jobs are on the chopping block.
As Brad DeLong has shown, this is increasingly looking like a jobless recovery.
(Note in particular the brief bounce in employment – and try not to get carried away with the similar bounce the UK has experienced)
44.9% of the unemployed have now been out of work for over 6 months, up from 34.2% one year ago.
The bigger long term issue though is the fall in US investment. As John Ross has convincingly argued:
The driving force of the depth of the US recession is also clear. It was due to the decline in US fixed investment. As shown in Figure 2, measured in constant 2005 prices, US GDP in the 2nd quarter of 2010 was $147 billion below its 4th quarter 2007 level. However several components of US GDP are already above their 4th quarter 2007 levels – inventories are up $63 billion, government consumption up $112 billion, and net trade up $135 billion. Consumer expenditure was below its 4th quarter 2007 level but only by $80 billion. But US private fixed investment was down $412 billion – dwarfing all other contributions to the recession.
This fall in investment is not only the driver of the current recession; it is also likely to affect the long run potential of the US economy to grow.
As John has pointed out previously the US has lost its position as the world’s largest supplier of capital.
Michael Pettis has argued that the US risks being flooded with excess capital from abroad (particularly China):
It [the USA] is far more likely to be swamped by a tsunami of foreign capital. This tsunami will bring with it a corresponding surge in the US trade deficit and, with it, a rise in US unemployment. It will also force the US Treasury to increase the fiscal deficit as more of the jobs created by its spending leak abroad.
Therein lies the problem. A reduction in net foreign capital inflows means a welcome decline in the US trade deficit, but the US is likely to see just the opposite. Foreign capital will push desperately into US markets and as an automatic consequence the US trade deficit will surge. So the problem isn’t too little capital inflow or a sudden boycott of USG bonds. On the contrary, the US will see too much capital inflow.
The US (like the UK) already had a low level of investment as a proportion of GDP before the financial crisis. The chart below shows fixed investment as a percentage of GDP for the G7 countries since 1980. Investment is much higher in emerging economies.
Notice how the US and UK are the laggards.
How then does one square the idea of a rapidly growing, dynamic US economy with the notion of an economy that is plagued by serial underinvestment?
There is no doubt that US GDP growth compares very favourably to that of, say, Europe. However when one stops looking at headline numbers and starts to examine per capita data, a different picture emerges.
According to the US Bureau of Labor Statistics (page 14 of this pdf) US GDP per capita grew by 1.2% annually between 2000 and 2008 -the same rate as Germany and Japan and lower than much of Europe, let alone Asia. Growth in US GDP per hour worked (page 17) in the period 1979 to 2008 was lower than that of France, Germany, Spain and the UK.
The headline growth of the US may look strong – but much of this is the product of a growing labour force, working longer hours for lower real wages.
The consequences of all of this have been spelt out by Ed Luce in the FT.
The slow economic strangulation of the Freemans and millions of other middle-class Americans started long before the Great Recession, which merely exacerbated the “personal recession” that ordinary Americans had been suffering for years. Dubbed “median wage stagnation” by economists, the annual incomes of the bottom 90 per cent of US families have been essentially flat since 1973 – having risen by only 10 per cent in real terms over the past 37 years. That means most Americans have been treading water for more than a generation. Over the same period the incomes of the top 1 per cent have tripled. In 1973, chief executives were on average paid 26 times the median income. Now the multiple is above 300.
The trend has only been getting stronger. Most economists see the Great Stagnation as a structural problem – meaning it is immune to the business cycle. In the last expansion, which started in January 2002 and ended in December 2007, the median US household income dropped by $2,000 – the first ever instance where most Americans were worse off at the end of a cycle than at the start. Worse is that the long era of stagnating incomes has been accompanied by something profoundly un-American: declining income mobility.
I’m hardly a revolutionary socialist (I spent most of the last 6 years working in finance for start) but when the world’s major capitalist economy is facing near double-digit unemployment, much of it long term, when median incomes are stagnating, when investment has fallen off a cliff and when government appears powerless to stop this – shouldn’t we call it a crisis of capitalism?
In the meantime, I’ve been meaning to plug the Institute for New Economic Thinking for a while. Anyone interested in economics or economic policy would be well advised to have a good look at their website – which is crammed with video interviews, lectures, debate and links.
Pretty much their entire inaugural conference is now available (videos of lectures, presentations and pdfs of speeches). Lots of this is worth watching/reading – topics covered include the depression, the economic changes over the last 30 years, inequality, financial sector reform, political economy and policy.
The new section of their website – “The Deficit Debate” – is the place to go for anyone interested in stepping above party political point scoring.
George Osborne tells us he wants a “new economic model” based on “long term saving and investment.”.
The OBR has reassured him he’ll get it – with an investment boom due to arrive over the next five years. I’m more sceptical.
In the Budget, the OBR was explicit about why it is forecasting this boom (my emphasis):
“C.24 Business investment is forecast to pick up during 2010, though in the year as a whole it rises by only 1½ per cent. The recovery is maintained in 2011, although it takes until 2013 before investment returns to its prerecession peak. From 2011 onwards business investment rises at rates between 8 and 11 per cent.
C.25 The measures to reform corporation tax, which are estimated to reduce the cost of capital faced by firms by about 3 per cent, should have a positive effect on investment. The introduction of the bank levy may partially offset the fall in the cost of capital should banks pass on some or all of the levy in the form of a higher cost of corporate finance. Even this partial offset is likely to be moderated to the extent that the levy is reflected in lower bank profits and remuneration.
C.26 Business investment growth is higher than in the pre-Budget forecast as the boost from the lower cost of capital feeds through. Business investment also strengthens as resources released from the government sector flow into the private sector. The level of business investment is around 1 per cent higher in 2014 than in the pre-Budget forecast.”
The Government then (both the Chancellor and his OBR) appear to believe that reducing the cost of capital will lead to higher investment, which is a statement straight out of neo-classical macroeconomics.
In reality of course, the cost of capital is one factor amongst many that business people must weigh up when deciding whether or not to invest. And the cost of capital also depends upon the rate at which one borrows, rather than simply the level of tax levied on future profits, let alone considerations of pesky things like capital allowances (which they have cut).
The Chart below compares business investment to Corporation tax from 1980 to 2009 – which the OBR seems to think is the decisive factor.
I’m far from convinced that we’re about to experience an investment boom…
Richard Toye’s article on Labour and Rearmament in the 1930s is well worth a read. (whole text available here). (And whilst I’m on recommendations, his book on the broader theme of Labour and Planning, 1931-1951 is superb).
Leaving aside the question of rearmament, one notion that really comes across is the tendency of the Party in the 1931-1935 period to attack the government for not balancing the budget. This was driven by multiple factors – the desire to lay to rest the ghosts of 1929-1931, to rebuild a sense that Labour could be trusted with the public finances and to undermine the legitimacy of the National Government, which after all had been brought into being on the notion that it would tackle the deficit.
The Party’s Finance and Trade Policy sub-committee, under Dalton, stated in 1935:
In 1931 we were attacked because we could not balance the budget by taxation. We should reverse that and turn it against the Government. Whatever is required should be met by the taxation of those able to pay … We stand for an honestly balanced budget.
(I’ve been promising Paul some thoughts on Modern Monetary Theory ( MMT) for about a week now, I started writing it up this weekend and realised I was actually writing about two different things – MMT and fiscal policy, so I’ve split the post into two – this is on fiscal policy and more specifically on MMT will follow).
In a comment over at Don Paskini’s last week, Paul wrote that we should focus on “enlightened fiscal policy (post-Keynesian) and leave monetary policy as the sideshow that it is”.
That kind of comment makes me a little uneasy, because as much as I think cutting the deficit now will be unproductive and dangerous – I don’t have that much faith in fiscal policy as a tool alone.
What really worries me about MMT is comments such as this from Warren Mosler, a doyen of MMT, (emphasis all mine):
UK News – GDP Stronger than Expected
As expected, boom time for now as the massive deficit spending raised savings and incomes, recharging consumer batteries, and supply the financial equity to fuel the subsequent expansion.
Look for rate hikes to add gasoline to the fire as well.
The risk of slowing from fiscal tightening is way down the road.
In fact, it’s usually the automatic stabilizers that tighten things sufficiently to throw the economy into reverse.
Again, years down the road.
I’d bet all the money in my wallet (a grand total of £13.45p it seems), that now is not “boom time” for the UK economy. Leaving aside that most of the “massive deficit spending” was actually a fall in tax revenues (much of it related to property and finance) rather than a stimulus as such and leave aside that Osborne is planning to try and close this deficit anyway – on what level does this analysis actually work?
Is any deficit large enough likely to bring about “boom time”?
I think at this point we need start considering multipliers and the power of fiscal policy.
Simply put the fiscal multiplier is the relationship between changes in government spending and taxes and changes in economic output.
This long-ish post from Chris Giles over at the FT, runs through the issues in a good amount of detail.
If the multiplier was zero then changes in taxes and spending would have no effect on the economy, if the multiplier was negative then less government spending will lead to faster growth.
The FT summarised the different possible assumptions as follows (my emphasis):
Zero: This is the cop out assumption that fiscal policy has no effect on the economy. It means the growth forecast will be unaltered whatever you do to taxation and public spending. It is not necessarily wrong, as is evident in this rather nice and simple academic paper on the VoxEU.org website. But to say the multiplier is zero at a time of significant impairment of monetary policy and weakness in Britain’s main export market is a strong assumption.
Negative: This is the assumption that sorting out Britain’s fiscal mess will so improve confidence in the economy that growth will be faster than previously thought and borrowing even lower as a result. If the OBR choose a negative multiplier, the Office will give George Osborne the perfect honeymoon gift. In a rather cynical Britain, the OBR would need some quite powerful evidence if it were to go down this route, as it would smack of the OBR having been captured by its political master in its first outing.
Between zero and one: Here we are in “crowding out” territory. Fiscal tightening does impede growth, but cutting £1 of spending reduces gross domestic product by less than £1. This zone would be viewed as a pretty normal assumption for Britain, an open economy with a flexible exchange rate. It is where many economists would implicitly put themselves because they are very prone to talk about the fiscal headwinds to growth.
One: Assuming a multiple of one suggests that taking £1 of public spending out of the economy reduces GDP also by £1. Such fiscal tightening would have quite a marked effect on growth and significant second round effects, implying more spending cuts and tax increases.
Greater than one: If we are in this zone, cutting the deficit is amplified into lower output and at some point a high multiplier implies that deficit reduction so damages growth as to worsen the budget deficit. This was Labour’s argument in the general election that did not convince the public. It was based on the assumption that the economy was too fragile now to take deficit reduction, not that the multiplier is always greater than one. Were Sir Alan Budd’s new OBR to take this assumption, it would represent a declaration of war on the Treasury and the new government. I think we can rule it out, but given that makes the OBR’s decision highly political.
The OBR in the budget set out the multipliers as follows:
Table C8: Estimates of fiscal multipliers
Change in VAT rate 0.35
Changes in the personal tax allowance and National Insurance Contributions (NICs) 0.3
AME welfare measures 0.6
Implied Resource Departmental Expenditure Limits (RDEL) 0.6
Implied Capital Departmental Expenditure Limits (CDEL) 1.0
To give this context the IMF (page 35 of this) in March 2009 gave its multiplier assumptions as:
The range of growth estimates reflects different assumptions on fiscal multipliers. The low set of multipliers included a multiplier of 0.3 on revenue, 0.5 on capital spending and 0.3 on other spending.
The high set of multipliers included a multiplier of 0.6 on revenue, 1.8 on capital spending and 1 for other spending.
In the US Moodys estimated (page 3 of this) multipliers as follows:
Nonrefundable Lump-Sum Tax Rebate 1.02
Refundable Lump-Sum Tax Rebate 1.26
Temporary Tax Cuts
Payroll Tax Holiday 1.29
Across the Board Tax Cut 1.03
Accelerated Depreciation 0.27
Permanent Tax Cuts
Extend Alternative Minimum Tax Patch 0.48
Make Bush Income Tax Cuts Permanent 0.29
Make Dividend and Capital Gains Tax Cuts Permanent 0.37
Cut Corporate Tax Rate 0.30
Extend Unemployment Insurance Benefits 1.64
Temporarily Increase Food Stamps 1.73
Issue General Aid to State Governments 1.36
Increase Infrastructure Spending 1.59
As can been seen, above there are a range of estimates of different multipliers, to take two examples:
Capital spending: The OBR estimated the UK capital spending multiplier at 1.0. But in the US Moody’s estimated it as 1.59. The IMF suggests a range running from 0.5 to 1.8.
Welfare spending: The OBR estimates this multiplier 0.6. In the US estimates of similar measures were 1.64 and 1.73. The IMF suggests 0.3 to 1.0.
One thing leaps out – no matter which set of numbers one uses (IMF, OBR, Moodys) capital spending and transfers to those most in need (AME Welfare in the UK, food stamps, unemployment insurance, etc in the States) – have the highest multipliers.
Now, for what it’s worth I think the OBR multiplier numbers all look a little on the low side but I don’t think they are massively off. UK fiscal policy multipliers are lower than US numbers as we are a more open economy. Put more money in people’s hands (either through a tax cut or a benefit increase) and they’ll spend more of it on imports (which subtract from growth).
The overall lesson of this is – fiscal policy is not a panacea that can fix the economy. Cutting spending now will lead to lower growth and increase the risk of a double dip but this doesn’t mean fiscal policy can solve all of our problems, in the long run – especially in an open economy like the UK, monetary policy is far more important. As are other tools – industrial policy, skills policy, regional policy.
So Labour should be setting an economic policy that moves the debate well beyond the size of the deficit.