Austerity Politics: Materialism vs. Ideationalism in the Eurozone

In a series of videos, Mark Blyth discusses the intellectual history of austerity -- the basis for his forthcoming Oxford UP book. Annoyingly, the video is organized as a playlist, so the video switches every ten minutes or so rather than playing through. The talk is well worth an hour's watching nevertheless, and I look forward to reading the book when it comes out in April.

I don't want to take too much away from him, but I have a few problems with in Blyth's analysis of current events. When he talks about the eurozone crisis he diagnosis it correctly: in a currency union, if everyone devalues internally then recession will continue; in a currency union, devaluation externally is impossible; the only other option is default. Where Blyth goes wrong is when he says that austerity is a choice, even under these conditions. Here I disagree for reasons I outlined in a previous post (see also the follow-up: "There Will Be Austerity"). Any of default, internal devaluation, and external devaluation is a form of austerity. What form is chosen is a political question. Each of these imposes costs on a different groups of people, so the political battle is of a distributional nature. Blyth insists (sometimes) that this is not the case, that austerity is the result of a cognitive or ideological blunder, and expresses a preference for a policy which is not politically feasible, nor normatively desirable (at least for much of the eurozone): turn the ECB into a "bad bank", and load it up with all of the underperforming assets being carried by eurozone banks.* While this would be great for some eurozone countries, it would be horrible for others. Which is why I think this political question is ultimately of a distributional, rather than ideational, nature.

In a another, somewhat similar way I think Blyth contradicts himself about the causes of the eurozone mess. On the one hand, he maintains that the root cause is profligacy on the part of the eurozone banks: they loaded up on too much sovereign debt from the europeriphery, as evidenced by declining interest rate spreads among the eurozone members. On the other hand, Blyth argues that the sovereigns themselves were not profligate; with the exception of Greece, they were all fiscally sound before the crisis and bailouts. But both cannot be true. If the euro sovereigns did not issue massive quantities of bonds, then there would not be massive quantities of sovereign bonds for banks to buy, in which case the banks would not be in any trouble at all.

This is an important point for him, because he claims that the eurozone crisis (and the US crisis) is the "greatest bait-and-switch in human history". Specifically, he claims that private obligations -- incurred by banks -- became public obligations -- via bailouts -- and now governments are the ones being chastised for fiscal profligacy and the public is having to pay through austerity policies. While not entirely false, this account needs more than he gives it. The story he's telling goes like this: Sovereign debt becomes bank assets, which then become sovereign liabilities again once the sovereigns begin to have trouble servicing they debt, which pushes the banks into insolvency, thus necessitating a bail out. But if this is not the fault of sovereigns then there must be a missing step somewhere. Otherwise I'm not sure where the "bait-and-switch" comes in. I think he can fairly easily square this circle by reference to capital inflows from the eurocore to the europeriphery which fed real estate booms, as well as European appetite for U.S. asset-backed securities. But then he can't explain the convergence in European sovereign borrowing costs so simply.

In the Q&A someone asks Blyth how he defines "austerity". I perked up at this point, because I've written about the slipperiness of definitions of austerity before. His answer, I think, leaves something to be desired. Blyth answers that to him "austerity" is not a combination of any particular policies, but rather a belief in the supposed expansionary properties of fiscal consolidation. Krugman also talks about the problems with "expansionary austerity" a lot, but it seems to me that this contradicts Blyth's own narrative about the ideological history of austerity. As Blyth tells it, austerity has traditionally been viewed (by Schumpeter and others) as the "purge" which must follow the "binge". It is the necessary hangover after the party. Well, such analogies provide no indication that austerity will be expansionary; quite the opposite. It is called "austerity" after all, not "luxury".

At times, Blyth conflates the "expansionary austerity" argument with the "Treasury View" (and earlier versions such as Ricardian equivalence). This is incorrect. The Treasury View -- which largely prompted Keynes' General Theory, as a retort -- is that government spending would "crowd out" spending in the private sector, so the effect of public spending would be neutral (or negligible), not expansionary.

Later, Blyth tries to make the case that shift from Schumpeterian "hangover" austerity to "expansionary" austerity occurred in the Bocconi school of economics in Milan, and was given full voice by Alberto Alesina.** So far as I can tell, this entire school of thought consists of a mere handful of academic papers authored by an even smaller number of economists (see lit review in this paper), the most significant of which (Alesina's) was published in 2010, well after austerity politics had begun in Europe and the U.S. Does Blyth seriously think that the German Finance Ministry, or U.S. Federal Reserve Board of Governors, are primarily influenced by these somewhat-marginal Italian economists rather than more traditional, distributional, political economy concerns? If so, he needs to do more to make case. Perhaps it's in the book, but as I've written before claims of expansionary austerity are mostly attacking a straw man.

These qualms aside, as intellectual history Blyth's talk is excellent and I expect his book will be outstanding as well. I've been waiting for it for what seems like years now, and I'll be happy to get my hands on a copy.

*Note that I think this is possible, and perhaps normatively desirable, but only if the legal standing and conceptual nature of the ECB changes in fundamental ways. As many have noted, this would transform the ECB into a quasi-dictatorial body with nearly no democratic oversight. Perhaps this is itself desirable to some, but there are major downsides to such a policy choice even assuming that the ECB chooses to behave as Blyth seems to think it will. As such, I see no clear sign that it will happen the way Blyth wants it to happen in the near term. Also note that Blyth says that the U.S.'s TARP was an analogous policy. It wasn't. TARP was administered by the Treasury, not the central bank, and was therefore the sort of private-obligation-into-public-obligation program that Blyth decries as a "bait and switch". The TALF program, which was administered by the Fed, supported new issuance of asset-backed securities (with the securities as collateral) as a means of unfreezing credit markets during the winter of 2008-9. The Fed bought some "toxic assets" as part of PPIP, but these later turned into billions in profit. The Fed is not now, nor has it ever been, a "bad bank".

**Alesina did do his undergraduate degree in economics at Bocconi, but he did his PhD at Harvard and has been on Harvard's faculty for almost his entire career. At one point he was the department chair. I.e., Alesina's saltwater credentials are intact. For the record, here are Alesina's current views on the effects of austerity on growth. The short answer? It depends. The longer answer? Austerity via tax increases harms economic growth, while austerity via spending cuts has a neutral effect. Nowhere does he say that austerity of any sort will be expansionary. So it is probably better to put Alesina in the "Treasury View" camp, at least as it relates to spending cuts, rather than the "expansionary austerity" camp. In which case, Blyth may need a better definition.

On Keynes, Marx, Krugman, Cowen, and the Possibility of Utopia Via Inequality

At the end of a good post on the shift of income shares earned by capital (more) and labor (less) in the US over the past few decades, Krugman writes:

I think we’d better start paying attention to those implications.

What implications?

[I]t makes nonsense of just about all the conventional wisdom on reducing inequality. Better education won’t do much to reduce inequality if the big rewards simply go to those with the most assets. Creating an “opportunity society”, or whatever it is the likes of Paul Ryan etc. are selling this week, won’t do much if the most important asset you can have in life is, well, lots of assets inherited from your parents. And so on.  

I think our eyes have been averted from the capital/labor dimension of inequality, for several reasons. It didn’t seem crucial back in the 1990s, and not enough people (me included!) have looked up to notice that things have changed. It has echoes of old-fashioned Marxism — which shouldn’t be a reason to ignore facts, but too often is. And it has really uncomfortable implications.

As it happens, I've been writing about this for quite some time. It was the focal point of my criticism of Tyler Cowen's "Great Stagnation" hypothesis (e.g. 1, 2, 3, and others), which I said was a "Great Redistribution". Basically the question I'd like to answer is why mean and median incomes have diverged, as pictured in the graph above. A "Great Stagnation" hypothesis seeks only to explain the flattening of median income growth. But we haven't had a Great Stagnation, since mean income growth has continued, at least until the Great Recession.

A Great Redistribution view, on the other hand, says that the structure of the global economy has changed over the past 40 years in ways that benefit (US) capital and hurt most of (US) labor. Specifically, the rise of a low-skill labor force in the former global South has competed away wage gains from low-skill American workers, while the rise of a medium-skill industrialized labor force in places like the NICs has competed away wage gains from medium-skill American workers. Additionally, the rise of mechanized labor (via robotics, which prompted Krugman's post) shifts income from labor to capital. Take a look at this chart:

Wages are converging globally, and since the US had disproportionately high wages this is hurting American labor in relative terms. At the same time, the global market has expanded dramatically. This increases the return to high-skill American labor as well as the owners of capital, who can now sell their production to much larger markets. This is particularly the case for goods and services which are reproducible at essentially zero marginal cost: think intellectual property and entertainment. Since the "high skill labor" and "owners of capital" groups are not mutually exclusive, this shows up in the data as both a) increasing wage inequality, and b) increasing returns to capital.

This is the simplest story in the world... basically just stating comparative advantage, at a mix of sectoral and factoral levels. The fact that it's so novel -- even to someone with a Nobel Prize in international macroeconomics! -- is a point of evidence that our intellectual class is way too focused on explaining everything locally. The Great Redistribution view has plenty of implications for political economy at global and local levels, but it is essentially a rejection of many public choice arguments, which tend to emphasize capture of political institutions by bankers or other oligarchs as the fundamental driving force in recent trends in the American economy.

I'm not sure what Krugman means by "uncomfortable implications". It could mean that the fact that the economy is working the way the way it's supposed to is an inconvenient truth for those who think that our political economy is being wrecked by those who prefer public choice explanations. But I doubt Krugman means that. It could mean that the "Golden Age" of American labor that Krugman loves so much -- the 1950s-1960s -- was a historical anomaly, the result of specific contingent circumstances that are not likely to be replicated ever again (and would be tragic if they were, given that that arose because of two devastating world wars and a Great Depression). But I doubt Krugman means that either. It could mean that the technocratic neoliberal vision is a fraud, and that the politics of distribution is likely to dominate capitalist political economies for the foreseeable future.

In any case, as an example of this Krugman talks about "re-shoring", the process of bringing manufacturing production back to the United States. Krugman suggests that this will have no major effect on employment or the income accruing to labor, because much of this production is done using robots. I think he's right that the direct effects on labor and wages will not be much. The indirect effect could be much higher, however. Why? Because in order to have robots build things, you first have to have factories. Humans have to build those. And you have to have roads to transport the goods. Humans have to build those too. And you have to have shops where the goods can be sold. Humans have to work in those shops. The desire for human labor that is complementary to robot labor can support wage gains for the median worker. That may not be enough to overwhelm the relative redistribution from the median worker to the top 10%, but it can help the absolute numbers.

American labor can benefit in another way: by receiving more non-cash compensation. The trend in the US is to provide more years of subsidized non-work at the beginning and end of life -- longer periods of education, longer retirements as lifespans increase -- and more non-cash benefits -- subsidized health care and education -- in a somewhat egalitarian way. These programs are overwhelmingly funded by the top 10% of wage earners, who are the high-skilled workers and the owners of capital*. To the extent that goods are increasingly created by non-human labor they free up people to do other things, some of which will not be market work. We'll call that "unemployment" or "underemployment" but if we generate sufficient national income to guarantee minimum standards of living at a level that ensures human dignity it will function as quasi-early retirement.

At the same time, quality of life continues to increase rapidly as the marginal cost of entertainment, education, and other goods approaches zero as a result of advances in information technology. This gain is felt by the median member of society as much as the richest person in society, and is more valuable for those with more available time. In terms of maximizing valuable leisure and minimizing alienating labor the typical citizen might be doing better, maybe even much better, than she otherwise would even while the data continue to show that she is doing much worse.

If this is an equilibrium it will have some negative consequences, for sure. Among them will be a reduction in social mobility and an increasingly bitter political economy. But Keynes dreamed of a world in which the gains from capitalism were distributed in a way that allowed people to work less, and some people are still dreaming of it. Marx too: his criticism of capitalism was not just that it generated inequality, but that it created alienation as labor became routinized. Marx didn't care about social mobility... he cared about human dignity. So maybe the left should welcome our new robot overlords (and their capitalist owners) for bringing the vision of Keynes and Marx closer to reality. Instead of slaving away in factories we can all post kittens to Tumblr and write stimulating blog posts. Yeah, maybe it looks like inequality, but it could end up being Utopia.

*The US tax code is already pretty progressive, and is likely to get much more progressive over the coming years, beginning with whatever deal comes out of the fiscal cliff negotiations. At the same time, the US benefit system is one of the least progressive, but I expect this to change over the coming decades for political economy reasons. Ultimately it will be up to the democratic system to manage these structural shifts.

Is Job Creation Really Impossible?

This is a strong conclusion to a good post from Krugman:

My point, then, is that this claim — and the lionization of high earners as people who make a vast contribution to society [via job creation] — is not, in fact, something that comes out of the free-market economic principles these people claim to believe in. Even if you believe that the top 1% or better yet the top 0.1% are actually earning the money they make, what they contribute is what they get, and they deserve no special solicitude.

Here are his assumptions earlier in the post: "Yet textbook economics says that in a competitive economy, the contribution any individual (or for that matter any factor of production) makes to the economy at the margin is what that individual earns — period." The upshot being that the entire idea of a "job creator" is misguided. All of the value that factors of production add to the economy is recouped by those factors of production, and none "trickles down" to anyone else.

Correct me if I'm wrong, but doesn't the relevant "textbook economics" assume not only a competitive market but also constant returns to scale and no spillover effects? How often do we think all three of these things hold? Doesn't a Keynesian view of the world explicitly claim that in a depression there are often scale returns to be captured, as well as positive spillover effects from investment? How else could the Obama administration (like all administrations) claim that it has "saved or created" so many thousands of jobs via fiscal policy?

New Research

On the Network Topology of Variance Decompositions: Measuring the Connectedness of Financial Firms Francis X. Diebold, Kamil Yilmaz
NBER Working Paper No. 17490
We propose several connectedness measures built from pieces of variance decompositions, and we argue that they provide natural and insightful measures of connectedness among financial asset returns and volatilities. We also show that variance decompositions define weighted, directed networks, so that our connectedness measures are intimately-related to key measures of connectedness used in the network literature. Building on these insights, we track both average and daily time-varying connectedness of major U.S. financial institutions' stock return volatilities in recent years, including during the financial crisis of 2007-2008.

This is important work, and I know that several regulators and central banks (including the Bank of England) are starting to take this sort of modeling -- weighted, directed networks -- very seriously. When you're trying to track sources of systemic weakness you really need to know what the system looks like. The problem isn't just "too big too fail", it's also about which firms are tightly connected to many other firms. These two will often correlate, but not always and not perfectly, so knowing the difference is important.

The Stock Market Crash of 2008 Caused the Great Recession: Theory and Evidence Roger Farmer
NBER Working Paper No. 17479
This paper argues that the stock market crash of 2008, triggered by a collapse in house prices, caused the Great Recession. The paper has three parts. First, it provides evidence of a high correlation between the value of the stock market and the unemployment rate in U.S. data since 1929. Second, it compares a new model of the economy developed in recent papers and books by Farmer, with a classical model and with a textbook Keynesian approach. Third, it provides evidence that fiscal stimulus will not permanently restore full employment. In Farmer's model, as in the Keynesian model, employment is demand determined. But aggregate demand depends on wealth, not on income.

I think some of this gets to my confusion about Keynesianism from a few days back. I think the last sentence particularly drives at what I was saying before: if the monetary multiplier is low because of expectations, then how can the fiscal multiplier be high under the same set of expectations? It makes more sense (to me) for behavior to be conditioned by wealth more than income, particularly if the income is temporary. I clearly need to become more familiar with Farmer's work.

And here's a near-complete preprint of Herb Gintis' most recent book, The Bounds of Reason: Game Theory and the Unification of the Behavioral Sciences. Via one of Phil Arena's commenters.