Keynesianism: death premature?

John Maynard Keynes helped revolutionize macroeconomics with his seminal General Theory, supplemented by John Hicks. Since its publications most countries in the western world had adopted his theories, the European social democrats more so than others.

One of the principal hypotheses in that book was that during pronounced recessionary periods uncertainty rules. Investors and firms are loath to put their money into increasing capacity because of depressed aggregate demand, occasioned by high levels of unemployment and declining wages. Against the classical economists, Keynes reckoned that the economy could reach an equilibrium with these negative features. Recovery required government intervention in two forms: monetary expansion and fiscal stimulus.

Those who followed Keynes after the war sought to tame what appeared to be naturally occurring business cycles. When times are good, raise taxes and curtail federal spending. During austere periods, the opposite should hold.

Then along came William Phillips, a New Zealand economist. He observed an historical relationship between inflation and unemployment rates. This observation came to be known as the Phillips Curve: the lower the unemployment rate the higher the inflation level.

However, both Keynes and Phillips were upended by events in the 70s and 80s. There was the 1973 oil crisis, which led to soaring petroleum prices. Since much of the industrial economy depended on oil, GDP fell. At the same time things got more expensive—inflation rose. Diminished production led to higher unemployment. Both the high unemployment and high inflation undermined the Phillips Curve.

Prosecuting the Vietnam War also drove up prices. When Richard Nixon assumed office, he subsequently imposed wage and price controls then unilaterally prohibited the direct conversion of dollars to gold, a key feature of the Bretton-Woods Agreement, which had governed international monetary systems and currencies. Wikipedia:

By the early 1970s, as the Vietnam War accelerated inflation, the United States as a whole began running a trade deficit. The crucial turning point was 1970, which saw U.S. gold coverage deteriorate from 55% to 22%. This, in the view of neoclassical economists, represented the point where holders of the dollar had lost faith in the ability of the U.S. to cut budget and trade deficits.

In 1971 more and more dollars were being printed in Washington, then being pumped overseas, to pay for government expenditure on the military and social programs. In the first six months of 1971, assets for $22 billion fled the U.S. In response, on August 15, 1971, Nixon unilaterally imposed 90-day wage and price controls, a 10% import surcharge, and most importantly “closed the gold window”, making the dollar inconvertible to gold directly, except on the open market. Unusually, this decision was made without consulting members of the international monetary system or even his own State Department, and was soon dubbed the Nixon Shock.

Those studying economics during this volatile period began to question the wisdom of Keynes. In particular, the University of Chicago economics department, led by Milton Friedman, started developing their own macroeconomic theories, including an emphasis on monetary policies and “rational expectations.” Eventually one Chicago economist, Robert Lucas, pronounced Keynesian economics dead, or words to that effect.

It may be helpful to view a chart I prepared of this interval.

We see that oil prices rose sharply in 1973 and continued through 1975, before stabilizing, yet only to resume their upward trajectory in 1978, peaking in 1980. GDP, after rising steadily from 1970 to 1973, fell into negative territory between 74 and 75. The money supply (M1) also fell during that recession, which likely exacerbated the economic contraction. Inflation also soared during this period, coinciding with the 73 oil crisis. The 70s and 80s, we see, were rather unstable. Lots of peaks and valleys occurring frequently.

I’ve set off the years of Paul Volcker’s chairing the Federal Reserve. Just before he left, he reduced the money supply. It dropped even more dramatically in the two years after his departure, during George H.W. Bush’s presidency. Then from 80 to 92, the last year I’ve reflected in the chart, money supply soared along with an uptick in inflation. But by now oil prices had subsided, although GDP tapered off slightly in 1991.

All in all a crazy period, much different from the relative calm of the 50s and Clinton’s second term, which I did not show above. Indeed, and as I’ve mentioned before, Nixon’s assumption of office ushered in the Great Divergence, beginning a long, and as yet unceasing, process of greater wealth disparity, declining marginal tax rates, increasing federal debt, and the growth of the financial sector.

But I would suggest that it’s premature to bury Keynes. His theories applied especially to recessionary conditions, in particular those marked by depressed aggregate demand,  a zero interest rate on US Treasuries, and low inflation, if not deflation. Some, including Ben Bernanke and Paul Krugman refer to these special conditions as a liquidity trap. (They were describing Japan at the time, but for Krugman at least the U.S. is in one now.)

I would suggest further that the anti-Keynesians had reached their conclusions in reaction to special conditions, namely that period we call “stagflation”—the combination of economic stagnation (reduced GDP) and higher inflation. This period, it seems, was caused by exogenous events (oil crisis, escalating war costs, and the Nixon Shock).

Today’s crisis has endogenous factors, namely the collapse of the housing bubble and major financial institutions (e.g., Lehman Brothers). What created the bubble can by explained as a prolonged Minsky moment. Animal spirits got carried away in herd-like fashion.

Now the world seems to be on a financial precipice, with another recession more likely, both here and in Europe. Unemployment rates remain stubbornly high. People aren’t buying things. And despite record low mortgage rates, home sales continue to decline along with housing prices.

What to do?

Republicans argue that taxes should be lowered further still, even in the face of rising deficits and reduced industrial capacity. Meanwhile, corporations are hoarding rather than investing cash. With lower taxes, they’d hoard even more.

The newly energized Keynesians, however, desperately urge governments to spend a lot more money to put people to work. I mean a lot more. Unless the economy starts growing robustly, too few jobs will be created. And it doesn’t look as if the private sector is the answer. In this situation, only the government can help—or so argued Keynes.

Alas, and assuming Keynes is correct in both his diagnosis and prescription, there’s little, if any, political will to fix the problem. We’re stuck, it seems, in yet another lost decade—if not longer.

Higher wages and higher employment

This seems counterintuitive: raising wages yields higher output. Intuition suggests that by lowering wages, all other things being equal, more people would be working, since employers prefer low unit labor costs. And with more people working at lower wages, firms would produce more output, thereby increasing GDP. However, this situation does not obtain under certain conditions. What are those conditions? Zero interest rates and either deflation or very low inflation, both operative in the current economy.

I argued previously that higher wages were necessary to spur recovery. That’s because we’re suffering from insufficient aggregate demand. In other words, we don’t have enough money to buy goods and services, which means that companies will produce less, if at all. Declining production leads to layoffs and reduced aggregate demand—and so on. Indeed, the latest report on wages shows that we’re making less money and therefore buying fewer products and services.

Increased productivity can, and I think should, lead to increased wages. But compensation hasn’t kept pace with productivity. Somebody has benefited from the higher output per worker. Here’s a hint: it’s not the worker.

There’s an interesting paper linked by the Bureau of Labor Statistics: “The compensation-productivity gap: a visual essay.” As the title suggests, there are lots of graphs and charts. Here’s one:

Since the end of WWII, we have been working more efficiently, increasing output with fewer labor-hours. But beginning in the early 70s employers, rather than workers, pocketed the difference. (By the way, this growing gap fits in nicely with my Great Divergence observation. America, in very many significant respects, began to look and feel different after Nixon assumed office.)

We hear a lot these days about “inflexible” wages. Those who use such terms believe that workers make too much. That if wages fell, employment would rise. Krugman and others disagree. Here’s Krugman:

Under depression-type conditions, with short-term interest rates near zero, there’s no reason to think that lower wages for all workers — as opposed to lower wages for a particular group of workers — would lead to higher employment.

Krugman refers to a paper by Gauti Eggertsson of the New York Federal Reserve. It’s worth quoting from the abstract:

Can government policies that increase the monopoly power of firms and the militancy of unions increase output? This paper studies this question in a dynamic general equilibrium model with nominal frictions and shows that these policies are expansionary when certain “emergency” conditions apply. These emergency conditions–zero interest rates and deflation–were satisfied during the Great Depression in the United States. Therefore, the New Deal, which facilitated monopolies and union militancy, was expansionary, according to the model.

The Great Divergence coincided with a decline in union participating rates and a sharp fall in the marginal income tax rate. That’s also when the really, really rich began extracting huge—and I mean huge—dollars from the economy, at the expense of the Rest of Us.

By the way, the vertical axis represents annual income.

Union workers began disappearing during the late 50s (source). How low will the red line go?

FDR evidently encouraged union militancy or, at least, looked the other way. But irascible Labor, demanding more money and better working conditions, helped pull the nation out of the Depression.

No such parallels today, however. With union participation rates falling and falling, Labor has but a small voice to push back against the rising power of Capital.

As I’ve suggested elsewhere, this lopsided arrangement bodes ill for the Rest of Us, but also for Capital itself. We ain’t got no money to buy Capital’s products.

Tacoma teachers

The teachers fought back, and they won. They refused to accept the demands of management for lower salaries, bigger class sizes, and reduced emphasis on seniority.

For a detailed report of who was involved and what was at stake, read this. You’ll notice several irritants: the Gates Foundation, Teach for America, and Strategies 360.

Strategies 360 was founded by Ron Dotzauer, the husband of a former PUD commissioner. He and his firm have been involved in a number of different issues, from land use matters to political campaigns to lobbying.

It’s added another bullet to its resume: busting unions. From the article:

Strategies 360 is a marketing firm used last year in Seattle by another Gates-funded group, the Alliance for Education, to conduct a push-poll advocating performance-based pay for teachers, the anti-union Teach for America program and an end to seniority protections for teachers. The firm then used the push poll to set up an Astroturf group in Seattle, called the Our Schools Coalition, to push corporate school reform.



The New York Times has a nice piece on Ichiro. His streak of 200-hit seasons has ended, unless he can somehow manage to get 16 hits in tonight’s last game.

It doesn’t seem that long ago that he joined the Mariners for their one miracle year, in which they tied the record for most wins in a season—116. Ichiro batted .350, racking up 242 hits, mostly singles—stats that earned both the Rookie of the Year and MVP awards.  This year, his eleventh, finds his average down to .272, the first time he’s hit below .300.

Ichiro will be 38 next year, yet he’s stolen 40 bases. He keeps himself fit, and he still has remarkable flexibility and durability. Could he turn things around next year? Probably.

But one thing is certain. I seriously doubt that Ichiro will become any team’s batting coach. His approach at the plate defies baseball wisdom, from Ted Williams to Charlie Lau. No young player should or would try to copy Ichiro’s swing. It’s better suited for cricket than baseball.


This should scare you

Health insurance premiums are soaring. If you’re lucky enough to have a job and your employer provides medical insurance, his or her annual cost has doubled in the last 10 years, from around $7,000 per annum to roughly $15,000 today. But hold on. That annual premium is expected to double again by the end of the next decade.

These frightening stats come by way of the Kaiser Family Foundation’s annual survey. (You can download the full report here.) The survey also found that employees are having to foot more of the bill. Couple that inconvenience with stagnant or falling wages, and we can appreciate that a worker’s take-home pay has declined, which also means that the worker is spending less on other things, which helps explain why the economy continues to sputter.

What I’ve never understood is why the business community and far too many of us oppose universal health care systems. They really do save money. And they relieve businesses of the complex and dreary task of managing employees’ insurance. For that matter, purveyors of medical care should also welcome universal health care; they wouldn’t have to fill out those endless forms for an unwieldy array of different insurers.

So, if a universal health care system is better than our private, market-based system, why don’t we have one? Simple. It’s called bribery, and it’s legal.

The job of members of Congress is to stay in office. To do so, they must raise and spend a boatload of dollars each election cycle. Who’s got the money? Corporations and rich individuals, many of whom are in the health insurance and delivery businesses. They buy Congress.

And they also fund huge propaganda campaigns to convince us that we have the best health care system in the world; anything else is just “socialism.” We believe this crap, which is why we re-elect Senator X.

We know how

Thus sayeth Messrs. Krugman and Baker. Here’s Baker in a recent blog:

We know how to get out of this mess, we have known how for 70 years. We just need the government to generate demand. That means spending money. Ideally it would spend money on useful things like education, health care, and infrastructure, but even if it spent money in wasteful ways it would still create jobs and put people to work.


…We just need to spend money. That applies to both the United States and the euro zone countries. The problem is that we have more people in political leadership positions who want to be morality cops and lecture about balancing budgets rather than focus on policies that will restore economic growth. This includes the top officials at the European Central Bank, many of the voting members of the Federal Reserve Board’s Open Market Committee and much of the political leadership in the euro zone countries, the United Kingdom and of course here.

So, there.

Whither the left—or just more withering?

The tragedy of the liberal class and the institutions it controls is that it succumbed to opportunism and finally to fear. It abrogated its moral role. It did not defy corporate abuse when it had the chance. It exiled those within its ranks who did. And the defanging of the liberal class not only removed all barriers to neofeudalism and corporate abuse but also ensured that the liberal class will, in its turn, be swept aside.

— Chris Hedges, Death of the Liberal Class

We certainly have the Right, in all its bile and vitriol. It has succeeded far beyond what many had imagined, figuring prominently in the wholesale “shellacking” of 2010. Yes, it has always been there, lurking in the darker recesses of the social fabric. Now it has become mainstream.

As historian Michael Kazin writes in the New York Times:

…the Tea Party rebellion — led by veteran conservative activists and bankrolled by billionaires — has compelled politicians from both parties to slash federal spending and defeat proposals to tax the rich and hold financiers accountable for their misdeeds. Partly as a consequence, Barack Obama’s tenure is starting to look less like the second coming of F.D.R. and more like a re-run of Jimmy Carter — although last week the president did sound a bit Rooseveltian when he proposed that millionaires should “pay their fair share in taxes, or we’re going to have to ask seniors to pay more for Medicare.”

Both Hedges and Kazin write of the co-option of the liberal class, which had been dedicated to the betterment of humankind. The New Left, arising in the 60s, jettisoned the tenets of and enthusiasm for working men and women. Kazin writes:

Liberal universities, Web sites and non-governmental organizations cater mostly to a professional middle class and are more skillful at promoting social causes like legalizing same-sex marriage and protecting the environment than demanding millions of new jobs that pay a living wage.

What to do? Kazin’s prescription:

A reconnection with ordinary Americans is vital not just to defeating conservatives in 2012 and in elections to come. Without it, the left will remain unable to state clearly and passionately what a better country would look like and what it will take to get there.

Years ago, while I was pursuing “social justice” causes, my apparent fellow travelers were devoting their energy and resources to mostly land use issues under the rubric of environmentalism. Worthy pursuits, for sure. But they often wound up in a contest between “jobs” and “sustainability.”

For a brief moment there was a push to unite the various emphases. We established a group with the rather long-winded title of “Second District Alliance for Peace, Jobs, and Justice.” Its few members hailed from Snohomish, Whatcom, and Skagit counties. Meetings were held in LaConner, above a now-defunct book store, or at the Swinomish Reservation across the river. The group was defined by what it opposed more than for its vision. We were against the Everett homeport, nuclear power, US involvement in Latin America, and anything said or supported by Ronald Reagan.

But despite including “jobs” in the title, our outreach to unions was thin at best. By the 80s, certainly, unions wanted no part of the Left and viewed environmentalists as threats to their own jobs. Remember the spotted owl?

As I said, there was a brief moment. For whatever reasons, the group dissipated. We lost the homeport battle, such as it was. The killings continued in El Salvador. Reagan was re-elected by a landslide. Meanwhile, the union participation rate fell further.

After these events, I took to writing, as much for therapeutic purposes as for any hope of actually changing things. It had occurred to me back then that the problem with “the Left” was that it had become splintered—as it neglected Labor. Instead of recognizing that the underlying causes of one problem, say unbridled sprawl, were really the same for a wide array of problems—from environmental destruction and war to growing inequality and increased corporatization—the Left broke off into small subgroups, each focused on just one issue or topic. There were no thoughts of “solidarity.”  I began writing about the “stiletto” approach to different but ultimately related matters. In so doing, we—always the presumptuous ‘we’—had permitted ourselves to be divided and therefore conquered. Yep, the collapse of the Left was largely self-inflicted.

I thought then, as I still do, that we are in this endless struggle between Labor and Capital. The failure to appreciate this dialectic facilitates Capital’s hegemony. Lest you doubt this description, look at what’s happening around the globe right now: a sense of dread over the economic system itself, which seems on the verge of collapse, according to some observers. Capital has simply been too successful for its, and our, own good.

Unfortunately, the apologists for Capital live and operate within both political parties. (That Barack Obama would appear in Seattle for a few hours yesterday to solicit private donations for his re-election fund in two events closed off to the public surely underscores this phenomenon.) Unlike our counterparts in other democracies, we lack an official party of Labor. We have “Democrats,” who are more likely to align their interests with Wall Street than union halls.

Kazin invites us to “paraphrase” Joe Hill. “…the left should stop mourning its recent past and start organizing to change the future.”

Forgive my cynicism, but I can’t even find “the left.” Does a glance in the mirror count?