Friday, October 31, 2014

Government and the Fallacy of Composition




A successful society perpetuates itself.  It first of all must balance its internal functions. Since a society is made up of people, this means it must balance the interests of its members. Second it must be able to unify and make coherent its collective action.  It must act effectively in its environment, both to secure resources for itself, and to act against threats to itself. 

Every successful society has a government.  This implies that governments are necessary for successful societies.  What functions do governments fulfill, and which are necessary? The Constitution of the United States, the founding document of its government, lists several functions in its preamble:” …to form a more prefect union, establish justice, insure domestic tranquility, provide for the common defense, promote the general welfare, and secure the blessings of liberty to ourselves and our posterity.”  (And we already come up against a defect in the Constitution in the preamble: the only coherent purpose it authorizes for society in its environment is for the common defense. There is no explicit purpose expressed for taking coherent action to secure resources, or assure an economic future, although this might be inferred from ‘promote the general welfare.’)

As may be, for a society to perpetuate itself, its government must act against the forces, both internal and external to that society, which will debilitate and cripple that society. 

One of the most important sources of internal socially disruptive forces is a result of the fallacy of composition:  When one person may do a thing it may be good for himself, but when many, or all, do it, the result is bad for society, that is, bad for all individuals.  Therefore one of the most important functions of government is the prevention, or if prevention is impossible, the countering, of situations where the failure of composition pertains. 

These are many.  And of these many fall under the general category of externalization of costs.  Pollution, for instance, is externalizing the cost of producing a good or service.  Costs are also externalized when a company pays less than subsistence, forcing its employees to go elsewhere, often to charity of governmental assistance, to supplement their earnings.  These can be phrased in terms of a tragedy of a commons:  Pollution consuming the commons of the air we breath and the water we drink.  Low pay to workers is abusing the market.  Clearly, each company can make more profit by paying its workers less.  But if all companies pay their workers less, all companies will make less money,   Just as clearly, if all companies pay their workers more, the workers will have more to spend, and all companies will make more money. 

Another is the ‘Paradox of Thrift,’ brought to the attention of economists by John Maynard Keynes.  If one person saves, he may be better off, but if all people save, there is a shortage of spending, the economy contracts, people become unemployed, and in general, everyone is worse off.   The government can counteract this by lowering interest rates, increasing inflation, or increasing its own spending, either by deficit spending or increasing tax and spend. 

Consider the fact that Americans work harder than people in any other developed country, yet our society is the most unequal among them.  Cynics have the people believing that by working harder, they can each of them get ahead.  But it is like a race:  Even if everybody runs faster, still only a few will get the prizes.  Even if everybody works harder, still only a few will advance.  The efforts of workers are increasingly devalued.  This is becoming increasingly obvious as growth stagnates, and increases in income and wealth are becoming more and more concentrated among the few percentages at the top.  See my last post. But the top percentages promote this myth, because all the benefits of all that harder work, all that greater productivity, by the workers, accrue to the wealthy.

So this is a failure of government. The government is already failing in its purpose to promote the general welfare, promoting instead the welfare of a few at the expense of the many, and by allowing increasing segments of population to become indentured by debt to a few, failing to secure the blessings of liberty for them.  Indeed, as the government increasingly becomes a creature of the wealthy, its failures may be expected to increase, as it becomes less and less capable of defending against fallacies of composition.  Already economic crimes among the wealthy, taking from society, from the commonwealth, without return, go unpunished. As regulations are weakened, as more and more costs or production are externalized, as the unfettered free market succumbs to the tragedy of the commons, not just the worker, but the wealthy, will be the poorer. 

The commonwealth is also the wealth of the wealthy.  They already control it, but in the obsession of each to ‘own’ an ever greater share of  it, they will destroy the world, and the wealth of us all.

Friday, September 26, 2014

Income Growth During the Latest Expansion



Check this out:



The article is titled “This Really Depressing Graph about the Economy is Turning Heads.”  Which it should.  I share it here with you.  The source is Pavlina Tcherneva, who is an economist at Bard College, in Annandale-on-Hudson, New York, and the Levy Economics Institute, a think tank associated with the college, using data from Piketty and Saez.  Basically it shows the wealthy’s control of the economy increasing until now the growth of their wealth and income is obtained by plundering the rest of the economy, which is to say us, the rest of the people.  The graph charts increase in income, but you better believe the rich are getting richer, at our expense, we are getting poorer.  Not much of a recovery, this latest, when it is gotten for a few by preying on the many.

Thanks, Yahoo, for the pointer, on Sept. 25, 2014. 

Sunday, August 31, 2014

Something from Adam Smith


Having wiled away the month, and having come up with nothing of my own, I present this little gem from Adam Smith, from his CONCLUSION to CHAPTER XI, OF THE RENT OF LAND, the concluding chapter of BOOK I of his AN INQUIRY INTO THE NATURE AND CAUSES OF THE WEALTH OF NATIONS.

...

The whole annual produce of the land and labour of every country, or, what comes to the same thing, the whole price of that annual produce, naturally divides itself, it has already been observed, into three parts; the rent of land, the wages of labour, and the profits of stock; and constitutes a revenue to three different orders of people; to those who live by rent, to those who live by wages, and to those who live by profit. These are the three great, original, and constituent, orders of every civilized society, from whose revenue that of every other order is ultimately derived.

The interest of the first of those three great orders, it appears from what has been just now said, is strictly and inseparably connected with the general interest of the society. Whatever either promotes or obstructs the one, necessarily promotes or obstructs the other. When the public deliberates concerning any regulation of commerce or police, the proprietors of land never can mislead it, with a view to promote the interest of their own particular order; at least, if they have any tolerable knowledge of that interest. They are, indeed, too often defective in this tolerable knowledge. They are the only one of the three orders whose revenue costs them neither labour nor care, but comes to them, as it were, of its own accord, and independent of any plan or project of their own. That indolence which is the natural effect of the ease and security of their situation, renders them too often, not only ignorant, but incapable of that application of mind, which is necessary in order to foresee and understand the consequence of any public regulation.

The interest of the second order, that of those who live by wages, is as strictly connected with the interest of the society as that of the first. The wages of the labourer, it has already been shewn, are never so high as when the demand for labour is continually rising, or when the quantity employed is every year increasing considerably. When this real wealth of the society becomes stationary, his wages are soon reduced to what is barely enough to enable him to bring up a family, or to continue the race of labourers. When the society declines, they fall even below this. The order of proprietors may perhaps gain more by the prosperity of the society than that of labourers; but there is no order that suffers so cruelly from its decline. But though the interest of the labourer is strictly connected with that of the society, he is incapable either of comprehending that interest, or of understanding its connexion with his own. His condition leaves him no time to receive the necessary information, and his education and habits are commonly such as to render him unfit to judge, even though he was fully informed. In the public deliberations, therefore, his voice is little heard, and less regarded; except upon particular occasions, when his clamour is animated, set on, and supported by his employers, not for his, but their own particular purposes.  

His employers constitute the third order, that of those who live by profit. It is the stock that is employed for the sake of profit, which puts into motion the greater part of the useful labour of every society. The plans and projects of the employers of stock regulate and direct all the most important operation of labour, and profit is the end proposed by all those plans and projects. But the rate of profit does not, like rent and wages, rise with the prosperity, and fall with the declension of the society. On the contrary, it is naturally low in rich, and high in poor countries, and it is always highest in the countries which are going fastest to ruin. The interest of this third order, therefore, has not the same connexion with the general interest of the society, as that of the other two. Merchants and master manufacturers are, in this order, the two classes of people who commonly employ the largest capitals, and who by their wealth draw to themselves the greatest share of the public consideration. As during their whole lives they are engaged in plans and projects, they have frequently more acuteness of understanding than the greater part of country gentlemen. As their thoughts, however, are commonly exercised rather about the interest of their own particular branch of business. than about that of the society, their judgment, even when given with the greatest candour (which it has not been upon every occasion), is much more to be depended upon with regard to the former of those two objects, than with regard to the latter. Their superiority over the country gentleman is, not so much in their knowledge of the public interest, as in their having a better knowledge of their own interest than he has of his. It is by this superior knowledge of their own interest that they have frequently imposed upon his generosity, and persuaded him to give up both his own interest and that of the public, from a very simple but honest conviction, that their interest, and not his, was the interest of the public. The interest of the dealers, however, in any particular branch of trade or manufactures, is always in some respects different from, and even opposite to, that of the public. To widen the market, and to narrow the competition, is always the interest of the dealers. To widen the market may frequently be agreeable enough to the interest of the public; but to narrow the competition must always be against it, and can only serve to enable the dealers, by raising their profits above what they naturally would be, to levy, for their own benefit, an absurd tax upon the rest of their fellow-citizens. The proposal of any new law or regulation of commerce which comes from this order, ought always to be listened to with great precaution, and ought never to be adopted till after having been long and carefully examined, not only with the most scrupulous, but with the most suspicious attention. It comes from an order of men, whose interest is never exactly the same with that of the public, who have generally an interest to deceive and even to oppress the public, and who accordingly have, upon many occasions, both deceived and oppressed it. 
________________
Smith, Adam (2011-01-12). AN INQUIRY INTO THE NATURE AND CAUSES OF THE WEALTH OF NATIONS (non illustrated) (Kindle Locations 4147-4191).  . Kindle Edition.

Thursday, July 31, 2014

A Problem with Capitalism



Capitalism, as a system, is inherently unstable.

Consider a closed economy.  By closed we mean no money, and no resources, flow in or out of it.    This is more general  than it seems, since we are really talking net flow:  We are thus talking about any economy where the flow of money in and the flow of money out are equal in magnitude. And any economy where the flow of resources in and the flow of resources out are equal in magnitude.
   
The economy consists of capital and labor. Profit is required by capital, in order to invest in greater production, that is, more capital.  Thus capital must exploit labor.  But, since the economy is closed,  labor is capital's only market, except for itself.  (Capital does not give its money, its demand, away to third parties.) But, capital cannot take a profit from itself. (Well, it can. But this is called taking a loss, when the expense borne by capital is greater than the return.)  Indeed, capital  cannot even break even, selling to itself, because of the  costs of business, and  because of the depreciation of capital. 
Thus, capital must get in return more than it produces. (This is on two levels, real and financial.) So it takes a profit from labor.  But what does this mean?    The capitalist exploits labor twice.  First, less is paid for labor than that labor produces. This produces a surplus of goods. This surplus is the profit of the capitalist.  Some of this surplus is retained by the capitalist. Yachts, for instance.  But yachts are an expense to the capitalist.  And not all of this surplus can be retained. If it is, that is the break even point  for the capitalist. 

So the surplus must be sold, and it can only be sold to labor.  This requires that the capitalist takes less from labor than it gives labor. But second, the capitalist takes more from labor than it gives labor in the first place as wages.  But this results in an ever diminishing market, whereas the capitalist requires an ever expanding market. 

Capital, in maximizing its profits, minimizes the return labor gets, even to the point where labor's return is negative.  That is, each year labor is paid less, in real terms, than the year before.   But this collapses the market for capital.  This is the problem.  

Indeed, for its market to grow, the capitalist must give labor (or some third party) some of the surplus of production.  That is, capital must share its profits with labor.  That is, labor must receive more than its costs.  This will result in an expanding market, which is required for capital to grow.  
Now with a closed real economy, the money supply can be changed. Thus an economy can be closed in real terms, (this is called Autarky,) yet 'open' in terms of money supply.   That is, the money supply can be adjusted to favor either the financial or the real sector of the economy. 
 
Keeping a fixed money supply is good for finance, but death to producers of real goods and services.  Finance takes money out of the real economy.  This is finance's cost, to the real economy, of doing business.  This is its profit, as it redistributes demand in the real economy.   Thus the money supply in the real economy decreases, and the real economy experiences deflation.   But this means that, on average, the producers of real goods experience negative profit.  Roughly, this means that, each year, over half of all non-financial businesses suffer losses.  

Loaning money to the real economy does not reduce this over time, but rather increases it, because of the interest.  Thus a period of deflation may be compensated for by finance loaning sufficient money to the real economy.  However, it will subsequently be followed be an even greater period of deflation, as the loans come due.  But this is superposed on the decline in production brought about by non-financial companies making negative profits. They will make money, and perhaps grow, while the money is being lent, but their markets will subsequently suffer an even greater contraction when loans come due, and can no longer be rolled over.  Thus while there are fewer dollars, they are also pursuing fewer goods, which may even be inflationary, if production declines at a rate greater than the money supply in the real economy. Meanwhile, the supply of money in the financial sector increases, but has no outlet, except in bidding up asset prices. Of course, real assets, that is the producers of real goods, are increasingly overvalued, as their markets are increasingly undermined. Depending on the degree of indebtedness, the transition is more or less dramatic.  

Therefore, the money supply must expand so that this profit, the money finance takes out, is zero.  This requires that the money supply be expanded in the real economy, and not in the financial economy, which will merely aggravate the situation. Effectively, this means it must be done fiscally, and not monetarily.   Finance must be taxed, and the money spent in the real economy.    

Monday, June 30, 2014

Underemployment



Why are there so many underemployed college graduates in the US? 

"About 48 percent of employed U.S. college graduates are in jobs that the Bureau of Labor Statistics (BLS) suggests requires less than a four-year college education. Eleven percent of employed college graduates are in occupations requiring more than a high-school diploma but less than a bachelor’s, and 37 percent are in occupations requiring no more than a high-school diploma;" http://centerforcollegeaffordability.org/research/studies/underemployment-of-college-graduates

The surplus of college graduates  is not because labor is overcapitalized.  College graduates require more capital to justify their employment, (as college graduates, vs.  eg. as hamburger helpers.) It is because capital, that is, the economy, is undercapitalized. 

Of course, this is actually a relative thing. If the increase in human capital was greater than the increase in physical capital, then there would be a surplus of college graduates.  If the increase in physical capital was greater than the increase in human capital, there would be a shortage.  And in some fields, noticeably medicine, there are. In medicine, demand has increased due to the affordable care act, while the supply of doctors has been restricted by the AMA. The result is that doctors, at least in some specialties, command very high fees.  In some of the sciences, on the other hand, where the economy has been losing capital, that is, contracting rather than growing, labor is relatively overcapitalized.  The supply of scientists  has outpaced the demand, as the government and industry have cut back on research.  This has led to an increase in credentialism, that is, an increase in the requirements to obtain a position, and a pool of underpaid research assistants with increasingly bleak prospects.  

There are, however,  some general causes for the undercapitalization of the economy.

One is unequal trade. A country which runs a trade deficit has an increase in the consumer surplus, since things are cheaper, but a decrease in the producer surplus, since domestic companies are unable to make as much profit.  But investment in capital comes out of the producer surplus, and since that is less, capital investment is less.  The (real) economy grows slower.

 Undercapitalized infrastructure is a second. Inadequate infrastructure increases costs, reducing producer surplus and making industry less productive.  In fact, a reduction in the capitalization of infrastructure is to be expected in a mature economy under siege, since  all capitalization is out of the producer surplus. This is also a vicious cycle:  Decaying infrastructure reducing producer surplus reducing ability to maintain infrastructure, etc.

A third cause of the undercapitalization of the economy is the burden of health care.  With the costs of health care approaching 17% of the economy, fewer resources are left for the rest of the economy.  Of course, capitalization of the health care sector increases employment opportunities there, as we mentioned above.

And excessively large and costly financial sector is a fourth:  The financial sector is overhead on a nation's industry.  It does not in itself produce.  Its burden, the resources it consumes,  is proportionate to its size, and subtracts from t he resources available to the real economy.  It is also relatively immune to foreign competition, with results similar to healthcare.

A fifth cause is the inefficient use of what capital already exists:  Consider energy.  Underpriced  energy makes labor relatively overpriced, reducing its use. This increases the ratio of capital to labor in dependent industries.  Both capital and labor are thus used inefficiently. A greater burden is placed on a smaller portion, but a larger portion is left idle, of both capital and labor.  It also reduces capitalization of the infrastructure required for extracting and delivering energy, and thus harms basic industry.   Meanwhile, the labor burden is concentrated on fewer workers, often past the point of diminishing returns. (That labor expelled from production is forced into the inferior market, ie underemployed.) Producers that are less efficient energy users are excluded at the margins, even though they may have used labor more efficiently. They must compete against the(subsidized) more efficient energy users.  While at the same time underpriced energy is put to inefficient uses.  

A sixth and perhaps most important cause of an undercapitalized economy is government. On the one hand, it is overhead.  On the other, in the modern economy its policies help determine the direction of societal growth, and thus those sectors where the economy is invested in and capitalized.  For instance, by overcapitalizing the military and the security state, it detracts from the investment in basic industry required for real growth.  Government has also pursued policies that favored the growth of oligopoly and oligopsony.   Oligopoly, while it increases the producer surplus, reduces the market and thus the need to invest in productive capital.  A consequence is money hoards in the hands of a few, while the rest of the economy is starved.    Oligopsony in labor markets will result in depressed wages in needed sectors, thus shortages in those sectors while at the same time discouraging entry.  Graduates look for work elsewhere in the economy, where growth is depressed.

Seventh, increasing complexity means an increase in structural unemployment, as there will be greater mismatch of training to skills needed by the economy.  

Finally, as we have detailed previously here at http://anamecon.blogspot.com/2011/09/unemployment-average-wage-and.html the the rich pay themselves too well. If the mean wage was lower, more people would be able to be employed, although whether they would have jobs appropriate to their skills is another matter.

Saturday, May 31, 2014

A Keynesian Look at the Great Recession



               Recently there has been a prolonged period of productivity increase without a corresponding increase in labor income.   The result is that the supply of goods and services throughout the economy has increased, while the purchasing power of labor has not. We analyze  the consequences of this from a Keynesian point of view.

In Diagram  0 we show the classical Aggregate Supply curve AS. It is just a vertical line at the size of the economy, the size of the Gross National Product of the economy.  The thinking behind the classical AS curve is that production is independent of price level.  If money is added to the economy, or the velocity of money increases, prices merely rise, or inflate, but production does not increase.  Similarly, if money leaves the economy, or the velocity of money decreases, prices merely decrease, or deflate.  Production does not decrease.  The actual price level at e is set by the intersection with the Aggregate Demand Curve AD, which is the relationship between the total demand for goods and services and the price level.  If the price level goes up, things are more expensive, and people can buy, or choose to buy,  a smaller quantity of goods.  If the price level goes down, things are cheaper, and people can buy, or choose to buy, a larger quantity of goods.  So for a given quantity and velocity of money, at a given supply of goods and services, there is feedback: An increase in quantity demanded, above Q drives the price level back up toward e, and a decrease in quantity demanded  below Q drives the price level back down toward e.  



This is the same sort of feedback that sets the equilibrium for the intersection of ordinary supply and demand curves:  If the price of a good goes up, manufacturers want to make more, but people want less of it.  If the price goes down, manufacturers want to make less, but people want to buy more.  These two tendencies settle where the supply and demand curves intersect.

Diagram  1  shows the Keynesian Aggregate Supply   AS curve, as opposed to the classical Aggregate Supply curve.  The rationale for the Keynesian AS curve bending  back is the idea that, if the price level goes below this level, production decreases dramatically because wages (and actually some other prices, too, under oligopoly,) do not decrease rapidly.  They are considered 'sticky,' for various reasons, and so instead of wages going down, employment decreases.  That is unemployment increases. Fewer workers implies, in the short run, production of goods and services decreases.  That is, Aggregate Supply decreases.  Meanwhile, the Aggregate Demand curve shifts to the left, because fewer workers have  money to purchase things. This is the situation during a depression or recession.   (Shown in red. The AD curve is about in the position it was during the Great Depression, when first demand, and then production, decreased by about a third.)  The capacity to produce is still there.  It is still at Q, but it isn't being utilized. Actual production is reduced to Q'.  The GNP is smaller than it could, and should be.







The curved region of the AS curve represents the idea that, as the economy approaches full capacity, resource bottlenecks appear, as some sectors reach full capacity before others, driving up the price level. The closer to full capacity, the greater the number of bottlenecks, and the more the price is driven up.  We show the equilibrium point, where the economy is actually performing, part way up the curve, at less than full employment, and at less than full utilization of capital and resources. We would expect this situation in a growing economy. An economy only rarely operates at 'full' capacity.

In Diagram 2 we see what happens when wages increase along with labor productivity.  More is being produced, so the AS curves shifts to the right, and more is being demanded, since wages have also increased.  Both curves shift a comparable amount , so employment remains  high, as does the utilization of capital.  Other things being equal, the price level stays the same, while the economy, the GDP, grows from Q to Q'.  (We are implicitly adjusting for any inflation.)  
   


 Next, in Diagram 3,   we consider when wages do not increase at a rate equal to the increase in labor productivity,  Since productivity increases, more is being produced, so the AS curve shifts to the right.     The Aggregate Demand curve also shifts to the right, but not as much.  This is because income which would have gone  to labor instead goes to the owners of capital, who save a greater proportion of their income.  Saving more, they spend proportionately less.




  Since it moves less, it is now further back along the backward bend of the Aggregate Supply curve, into the recession region.  Because labor borrows, in order to maintain its living standards, this does not happen gradually.  This borrowing temporarily shifts the AD curve along with the AS curve, as in Diagram  2.  But this can only be temporary, because eventually labor's credit runs out, and this happens suddenly.  When it happens, the AD curve shifts back to the left (the red AD" curve), and we have a recession. (Diagram  4.) 

       
            Here the economy produces at quantity Q", less than the potential Q', which the real economy has grown capable of producing.   With labor productivity increased, but demand down, the economy becomes locked into a high unemployment mode, with reduced demand.  It also becomes locked into a mode of low capacity utilization of capital and resources.  This discourages investment.  

            There still remain questions. One is why haven't prices declined significantly?  Well, one of the things that has been happening is that the economy has been running a trade deficit for a number of years.  So for a long time now, many sectors have already been running at below capacity.

           Another, more ominous possibility is that the consequences of Quantitative Easing are slowly being felt in the real economy.  People have wondered why, with an apparent increase in the money supply, there hasn't been inflation.  But if the money is trapped outside of the real economy,  then the quantity (M x V) hasn't changed much.  This is  because although M has increased, V, in reality, counting all the QE money outside of the real economy which has zero velocity, has become very low, and is only slowly increasing as more money slowly enters the real economy.  One of the reasons this money is slow to enter the real economy is the dearth of investment opportunities, a consequence of the fact that, although nominally the economy is growing, from the point of view of employment, and labor income, and thus consumer demand, it is still in recession.