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Noahpinion: What Causes Recessions? Debt Runups or Wealth Declines?

June 7th, 2016 No comments

Noah Smith asks what seems to be an interesting question in a recent post: “what leads to big recessions: wealth or debt”?

But I’d like to suggest that it’s actually a confused question. Like: is it the heat or the (relative) humidity that makes you feel so hot? Is it the voltage or the amperage that gives you a shock, or drives an electric motor? The answer in all these cases is obviously “Yes. Both.”

The question’s confused because wealth and debt are inextricably intertwined. “Wealth” is household net worth — household assets (including the market value of all firms’ equity shares) minus household sector debt. Debt is part (the negative part) of wealth.

Still, it’s interesting to look at time series for household-sector assets, debt, and net worth, and see how they behave in the lead-ins to recessions.

I’ve pointed out repeatedly that year-over-year declines in real (inflation-adjusted) household net worth are great predictors of recessions. Over the last 65 years, (almost) every time real household net worth declined, we were just into or about to be into a recession (click for interactive version):

Update 6/8: This was mistakenly showing the assets version (see next image); it’s now correctly showing the net worth version.

This measure is eight-for-seven in predicting recessions since the late sixties. (The exception is Q4 2011 — false positive.) It makes sense: when households have less money, they spend less, and recession ensues.

But now here’s what interesting: YOY change in real household assets is an equally good predictor:

Adding the liability side of the household-sector balance sheet (by using net worth instead of assets) doesn’t seem to improve this predictor one bit. This perhaps shouldn’t be surprising. Household-sector liabilities, at about $14 trillion, are pretty small relative to assets ($101 trillion). Even if levels of household debt make big percentage moves (see the next graph), the actual dollar volume of change isn’t all that great compared to asset-market price runups and drawdowns. Asset levels make much bigger moves than debt levels.

It’s also interesting to look at changes in real household-sector assets (or net worth) compared to changes in real household-sector liabilities:

As we get closer to recessions, the household sector takes on debt progressively more slowly, with that shift happening over multiple years. (2000 is the exception here.) That speaks to a very different dynamic than the sudden plunges in real assets and net worth at the beginning of the last seven recessions. Perhaps: household’s portfolios are growing in these halcyon days between recessions, so they have steadily less need to borrow. And as those days continue, they start to sniff the next recession coming, so they slow down their borrowing.

My impressionistic take, unsupported by the data shown here: Higher levels of debt increase the odds that market drawdowns will go south of the border, driving the economy into recession. And they increase the likely depth of the drawdown, as lots of players (households and others) frantically need to shrink and deleverage their balance sheets, driving a downward spiral.

If the humidity’s high, and it gets hotter, you’re really gonna notice the change.

My obstreperous, categorical take, cadging from the past master of same:

Recession is always and everywhere a financial phenomenon.

Cross-posted at Angry Bear.

How Perfect Markets Concentrate Wealth and Strangle Growth and Prosperity

June 5th, 2016 5 comments

Capitalism concentrates wealth. Ridicule Marx and his latter-day disciples all you like (I’ll help); he definitely got that right.

But capitalism is a big word with lots of meanings, and enough ideological baggage to fill a Lear Jet. Let’s talk about something more precise: perfect markets, with ownership, in which individuals compete with others to produce stuff, and store up savings. You can see this kind of perfect world in agent-based simulations like Sugarscape. Start with a bunch of sugar farmers trying to accumulate sugar in an artificial world, hit Go, and watch what happens.

Here’s what happens to wealth concentration (number of poorer farmers on the left, richer on the right):

Screen Shot 2016-06-04 at 8.14.52 PM

Wealth is pretty evenly distributed at the beginning (top). That doesn’t last long. You can see the same effect in another Sugarscape run, here compared to real-world wealth distributions:

Screen Shot 2016-06-04 at 7.28.09 AM

That’s the Gini coefficient for wealth. Zero equals perfect equality; everyone has equal wealth. 1.0 equals perfect inequality; one person has all the wealth.

Perfect markets concentrate wealth. It’s their nature. But at some point, market-generated wealth concentration strangles those very markets (compared to markets with broader distributions of wealth). If a handful of people have all the wealth, how many iPhones will Apple sell? If only a few have the wealth to buy cars, automakers will produce a handful of million-dollar Bugattis, instead of forty handfuls of $25,000 Toyotas. Sounding familiar?

But wealth concentration doesn’t just strangle the flows of spending, production, and income. It throttles the accumulation of wealth itself. Another simple simulation of an expanding economy (details here) explains this:

Screen Shot 2016-06-04 at 10.49.29 AM

The dynamics are straightforward here: poorer people spend a larger percentage of their income than richer people. So if less money is transferred to richer people (or more to poorer people), there’s more spending — so producers produce more (incentives matter), there’s more surplus from production, more income, more wealth…rinse and repeat.

This picture says nothing about how the wealth transfers happen (favored tax rates on ownership income, transfers to poorer and older folks, free public schools, Wall Street predation, the list is endless). It just shows the results: As wealth is transferred up to the rich, on the left, and wealth concentration increases, our total wealth increases more slowly. When that transfer is extreme, even in this growing economy the poorer people end up with less wealth. (Note how the curves get steeper on the left.) As wealth concentration declines on the right, our total wealth increases faster, and poorer people’s wealth increases much faster. Note that richer people still get richer in most scenarios — it’s a growing economy, always delivering a surplus from production, and increasing wealth — just more slowly.

And that’s just talking dollars. If we start thinking about our collective “utility,” or well-being — the total of everybody’s well-being, all summed up — the effects of wealth concentration are even more profound. Because poorer people getting more does a lot more for their well-being than richer people getting more. (Likewise, even if the richer people actually lose some of their wealth, they’re not losing as much utility.)

Because: Declining marginal utility of wealth (or consumption, or whatever). This is one of those Econ 101 psychological truisms that seems to actually be true. The fourth ice-cream cone (or Bugatti, or iPhone) just doesn’t deliver as much utility as the first one. Plus, a Bugatti in one person’s hands doesn’t deliver as much utility as forty Toyotas in forty people’s hands. (Prattle on all you want about relative and revealed preferences; you won’t alter this reality.)

So if we were to re-work the chart above showing utility instead of dollars, you’d see far greater increases in utility on the right side, especially for poorer people. Widespread prosperity both causes and is greater prosperity.

Why, then, aren’t we spending our lives on the right side of this chart? It’s a total win-win, right? The answer is not far to find. Nassim Taleb shows with some impressive math (PDF) what’s also easy to see with some arithmetic on the back of an envelope: if a few richer people (who dominate our government, financial system, and economy) have the choice between making our collective pie bigger or just grabbing a bigger slice, grabbing the bigger slice is the hands-down winner.

That’s why decades of Innovative Financial Engineering has served, mostly, not to efficiently allocate resources to efficient producers, improve productivity, or increase production. Rather, these fiendishly clever entrepreneurial inventions control who gets the income from production. You can guess who wins that game. Top wealth-holders would be nuts to play it any other way (if you go with economists’ definition of rationality…).

But for the rest of us, it’s a loser’s game — at least compared to the world we could be living in. If household incomes had increased along with GDP, productivity, and other economic-growth measures for the last two or four decades, a typical household would have tens of thousands of dollars more to spend each year — and much bigger stores of wealth to draw on. If you think that sounds like a thriving, prosperous society…you’re right.

To summarize: perfect markets, left to their own devices, concentrate wealth. Concentrated wealth results in less wealth, and far less collective well-being. (You’ll notice that I haven’t even mentioned fairness. It matters. But I’ll leave that to my gentle readers.)

This all leads one to wonder: how could we move ourselves into that happy world of rapidly increasing wealth and well-being on the right side of the graph? Hmmmm….

Cross-posted at Evonomics.

You Don’t Own That! The Evolution of Property

April 24th, 2016 4 comments

Get off my lawn.

In a recent post on the “evolution of money,” which concentrated heavily on the idea of (balance-sheet) assets, I promised to come back to the fundamental idea behind “assets”: ownership. Herewith, fulfilling that promise.

There are a large handful of things that make humans uniquely different from animals. In many other areas — language, abstract reasoning, music-making, conceptions of self and fairness, large-scale cooperation, etc. — humans and animals vary (hugely) in degree and kind. But they still share those phenotypic behavioral traits.

I’d like to explore one of those unique differences: ownership of property. Animals don’t own property. Ever. They can and do possess and control goods and territories (possession and control are importantly distinct), but they never “own” things. Ownership is a uniquely human construct.

To understand this, imagine a group of tribes living around a common water source. A spring, say. There’s ample water for all the tribes, and all draw from it freely. Nobody “owns” it. Then one day a tribe decides to take possession of the spring, take control of it. They set up camp surrounding it, and prevent other tribes from accessing it. They force the other tribes to give them goods, labor, or other concessions in return for access to water.

The other tribes might object, but if the controlling tribe can enforce their claim, there’s not much the other tribes can do about it. And after some time, maybe some generations, the other tribes may come to accept that status quo as the natural order of things. By eventual consensus (however vexed), that one tribe “owns” the spring. Other tribes even come to honor and respect that ownership, and those who claim and enforce it.

That consensus and agreement is what makes ownership ownership. Absent that, it’s just possession and control.

It’s not hard to see the crucial fact in this little fable: property rights are ultimately based, purely, on coercion and violence. If the controlling tribe can’t enforce its claim through violence, their “ownership” is meaningless. And those claimed rights are not just inclusionary (the one tribe can use the water). Property rights are primarily or even purely exclusionary. Owners can prevent others from doing anything with the owners’ property. Get off my lawn!

When push comes to shove (literally), when brass tacks meet the rubber on the road (sorry, couldn’t resist), ownership and property rights are based purely on violence and the threat of violence. Full stop, drop the mic.

In the modern world we’ve largely outsourced the execution of that violence, the monopoly on violence, to government. If a family sets up a picnic on “your” lawn, you can call the police and they’ll remove that family — by force if necessary. And we’ve multiplied the institutional and legal mechanics and machinery of ownership a zillionfold. The whole world’s financial machinery — the immensely complex web of claims, claims on claims, and claims on claims on claims, endlessly and densely iterated and interwoven — all comes down to (the threat of) physical force.

There are obviously many understandings and implications to this reality (e.g. Where did your ownership claim originate? Who got excluded, originally?), which I’ll leave to my gentle readers. But I’d like to close the loop on the the comparatively rather desiccated ideas of balance-sheet assets, and money, explored in my previous post.

When the one tribe takes control of the spring, they add that spring as an asset on lefthand side of their (implicit) balance sheet. Voila, they’ve got net worth on the righthand side! In standard modern terminology, the spring is a “real” asset — a direct claim on a real good, as opposed to a financial asset, which (by definition) has an offsetting liability on some other balance sheet — is a claim on that other balance sheet’s assets, is a “claim on claims.” The tribe’s asset — its claim to the spring and the output from the spring (capitalized using some arbitrary discount rate) — has no offsetting liability on other balance sheets. It’s a purely inclusionary claim. Right?

Wrong. It’s an exclusionary claim. Which means there is a liability, or negative net worth, on others’ balance sheet(s) — at least compared to a counterfactual fable in which all the tribes have free access to the spring. “Real” assets — balance-sheet entries representing direct claims on real goods (even your claim to the apple sitting on your kitchen counter) — have offsetting entries on the righthand side of the “everyone else” or “world” balance sheet. A truly comprehensive and coherent accounting would require first assembling such a pre-human or pan-human world balance sheet. Practically, that’s utterly quixotic. Conceptually, it’s utterly essential.

So while the distinction between real and financial assets can have conceptual and analytic value, it’s important to realize that the claims behind real and financial assets are far more similar than they are different. A deed to land — the legal instrument encoding an exclusionary claim — is quite reasonably viewed as a financial asset. There is an offsetting balance-sheet entry elsewhere, if only implicit. Donald Trump certainly views the deeds he “owns” as financial instruments, fundamentally similar to his stocks and bonds. Just: the legal terms of those financial instruments — the inclusionary and exclusionary rights they impart — vary in myriad ways. (Aside: economists really need a biology-like taxonomy of financial instruments, categorized across multiple dimensions. Where’s our Linnaeus?)

Balance sheets, accounting, and their associated concepts (assets, liabilities, net worth, equity and equity shares) are the technology humans have developed to manage, control, and allocate our (violence-enforced) ownership claims, a crucial portion of our social relationships. At first the balance sheets were only implicit — when the tribe first laid claim to the spring. But humans started writing them down and formalizing them, tallying those ownership and obligation relationships, thousands or tens of thousands of years ago. (Coins weren’t invented till about 800 BC.)

When some clever talliers started using arbitrary units of account to tally the value of diverse “assets,” and those units were adopted by consensus, we got another invention: the thing we call money. Like ownership rights, the unit of account’s value is maintained by consensus and common usage among owners and owers. But like ownership, its value is ultimately enforced by…force.

Balance sheets. All is balance sheets…

</DryAndDweebyAccountingSpeak>

I find it distressing that this kind of deep and fundamentally necessary thinking about ownership and property rights is absent from introductory (and ensuing) economics courses — both textbooks and coursework. Likewise concepts like value, utility (carefully interrogated), and yes: money (ditto). I don’t think you can think coherently about economics if you haven’t carefully considered these issues and ideas. It’s that kind of deep and broad, ultimately philosophical, thinking, in the context of a broadly-based liberal-arts education, that makes American universities — somewhat surprisingly to me — the envy of the world.

Before leaving, I have to give full props here to Matt Bruenig, who delivered this clear and coherent Aha! understanding of ownership for me after I’d struggled with it for decades. It seems so simple and obvious now; others have certainly explained it before. I feel like a dullard for taking so long.

Cross-posted at Evonomics.

Note To Economists: Saving Doesn’t Create Savings

March 31st, 2016 10 comments

Is Saving a Sin?

If you save more, if everybody collectively saves more, there are more savings, right? There’s more money that firms can borrow and invest to make us all more prosperous. Household saving “funds” business investment, so if we all save more, the world will be more productive and prosperous. You hear this all the time. And it makes sense, right?

Wrong. It’s hogwash. Incoherent codswollop. Gobbledegook faux-accounting-think. Bunkum. Think: fallacy of composition — believing something is true of the whole because it is true of the parts.

You may know the much-discussed paradox of thrift: If everybody saves more, there’s less spending, so less income, less aggregate demand. On the surface, at least, that seems rather straightforward. But the real paradox here lies in the plural: the stock of monetary “savings” that lurks, implicit, at the core of the paradox. If we save more, are there more savings?

Start by knowing this: “Savings” (the plural) is not a measure in the national accounts, even though economists and commentators use the word ubiquitously. (Think: Bernanke’s “global savings glut.”) Search the Fed’s quarterly Z.1 report, the Financial Accounts of the United States. You’ll see. There are various measures of “saving,” with various accounting definitions — “flow” measures — but there’s no named measure of our collective stock of savings. (This makes some “stock-flow consistent” models somewhat…problematic.)

Then ask yourself:

When you spend money — transferring it to someone else in return for newly-produced goods and services — does it affect our collective monetary savings? In strict accounting terms, obviously not. Your money just moves from your account to someone else’s account; it doesn’t disappear. Your bank has less deposits; the recipient’s bank has more deposits. Aggregate monetary savings is unchanged by that accounting event. (The economic effects of that transaction — what behaviors it triggers — are another matter entirely.) One person’s spending is another person’s income. And vice versa.

But what if you don’t spend? You “save” instead, leaving the money sitting untouched in your account instead of transferring it to somebody else’s account. Does that increase aggregate monetary savings? Even more obviously not. That “act” of saving (not-spending) is quite literally a non-event.

In the simplest accounting terms, household monetary saving is just a residual measure of two flows — income minus expenditures. It’s perfectly understandable on that individual, micro level of a household. Less so in the aggregate. Because in aggregate, income = expenditures. And since saving = income – expenditures, saving must equal zero. What’s with that? (Note that in the stylized world of the National Income and Product Accounts, households only consume; they don’t invest. All household spending is consumption spending. Only firms invest, and all their spending is investment spending.)

So how does saving actually work? What does it mean to “save” — as an individual or a household, as a country, or as a world? Start with individuals, and the vernacular understanding of “household saving.”

You work your whole life, spending somewhat less than you earn (“saving”), leaving the residual sitting in your checking account. Maybe you swap some of that checking-account money with others in exchange for a deed to a house, or a portfolio of stocks and bonds, which go up in value over the years. Eventually you retire and live off that stock of “savings” (plus ongoing returns from those savings). In that everyday, individual context, savings (the stock) means “net worth” — your balance sheet assets minus your balance sheet liabilities. When you hit retirement, net worth — your savings — is the financial indicator that really matters. Bottom line: “How much money do you have?”

But what about our collective monetary savings — the stock measure that’s missing from the national accounts? That’s also best represented by aggregate household assets, or net worth. (For a sector with no externally-held assets or liabilities, assets and net worth are the same. For the world, assets equals net worth. We don’t owe anything to the Martians. The righthand side of the world balance sheet is all net worth.) For reference, U.S. household assets are about $101 trillion. Net worth is about $87 trillion. The household sector owes about $14 trillion to other sectors. (Here.)

It’s important to remember: households own all firms, at zero or more removes. A company can be owned by a company, which can be owned by a company, but households are the ultimate owners. (Firms’ liabilities are netted out of their net worth, by definition.) This because: Households don’t issue equity shares — their liability-side balancing item is net worth, not shareholder equity. Firms don’t own households. (Yet.) Companies’ net worth is telescoped onto the lefthand, asset side of household balance sheets. So household net worth = private-sector net worth. When it comes to tallying up private asset ownership — claims on existing goods and future production — the accounting buck stops at households.

The monetary measure “household net worth” is national accountants’ best effort at tallying up the markets’ best estimate of what all our real stuff is worth, in dollars. (More precisely, what all the claims on those goods are worth.) It’s far from a perfect measure; its relationship to government net worth, for instance (if that’s even meaningfully measurable), is decidedly iffy. See in particular J. W. Mason’s article on Germany’s uncanilly low household net worth. But it’s pretty much the best, maybe the only, measure we have.

So if monetary saving doesn’t increase the stock of monetary savings, how do we “save,” collectively? By producing long-lived goods — goods that we don’t consume within the accounting period. Machinists create drill presses, carpenters create houses, inventors create inventions, businesspeople create companies, economists create textbooks (yeah, I know…), teachers and their students create knowledge, skills, and abilities. All that tangible and intangible stuff that we can use and consume in the future constitutes our collective “real” wealth.

The financial system creates claims on all that stuff (and on future production), in the form of financial instruments — from dollar bills to checking-account balances to deeds on houses to collateralized debt obligations. The markets assign and adjust dollar values for those claims. When you hold those instruments, you’re holding a promise that you can purchase and consume real goods in the future. They’re claims (again at zero or more removes) on existing goods and future production. The markets constantly adjust those instruments’ prices/values based on our collective expectations of future production — our optimism/pessimism, or “animal spirits.”

With that as background, here’s the crux of the “saving” problem: Economists confuse saving money with saving corn. They conflate stocks of money (claims on stuff) with stocks of stuff. Think: “financial capital.” It’s an oxymoron. Capital is real stuff — despite Piketty and others’ inconsistent and self-contradictory use of wealth and capital as synonyms. See for instance, “capital is imported (net) to fund the trade deficit,” here. (And again, see J.W. Mason on this conundrum.)

This confution of monetary and real saving — financial instruments versus real capital — is a problem because money/financial instruments are nothing like real goods. These promises, or claims, are created with zero resource inputs to production. (Promises are cheap — actually, free.) And they are not ever, cannot be, consumed or used as actual inputs to production. (You can’t eat promises, or feed them into an assembly line.) That stock of dollar-designated claims, monetary wealth, is simply created and destroyed — expanded and contracted — by the creation/destruction of financial instruments, and their repricing in the markets.

Consumption reduces our stock of stuff. If we eat less corn, we have a larger stock of corn remaining. Consumption spending doesn’t reduce the stock of anything. If we spend less money, we still have the same stock of money.

Corn is produced and consumed. Financial/monetary wealth — the netted-out, dollar-denominated value of our web of promises and claims — simply appears and vanishes. That’s the magic of this social-accounting construct we call money.

A semi-aside on the accumulation of real, long-lived goods, real wealth: There’s another widespread though often-implicit logical accounting error that merits enthusiastic eradication. Starting with accounting definitions: (C)onsumption spending is paying people to produce goods that will be consumed within the accounting period. (I)nvestment spending is paying people to produce goods which will exist beyond the accounting period. C + I = Y (GDP, or total spending).

The error: More consumption spending means less investment spending — less accumulation of real goods, real wealth. Right? Wrong. That thinking assumes Y is fixed, which is only a given in accounting retrospect. If we spend less on consumption goods, we might just spend less, total — less Y, with no effect on investment spending. Obvious behavioral/incentive thinking actually suggests even worse: if consumers spend less, firms will do less investment spending. Both categories of spending, and total Y, will be lower (relative to a counterfactual of more consumption spending).

So what are the modern mechanisms of this relationship, between monetary savings and real goods? How do we collectively “monetize” our ever-increasing stock of real goods, our “real” savings, to create monetary savings? Three ways (none of which is “personal saving”):

1. Government deficit-spends money into existence. Treasury simply deposits dollars, created out of thin air, into private-sector checking accounts, either as transfers or in return for goods and services. This increases both private-sector balance-sheet assets, and private sector net worth — because no private-sector liabilities are created in the process. (Treasury then selling bonds, and the Fed buying them back, doesn’t directly affect private-sector assets or net worth. It simply swaps asset for asset, and alters the private sector’s portfolio mix, bonds versus checking-account deposits — though again with potential carry-on economic effects.)

2. Banks issue new loans, dollars that are also created ab nihilo. This loan issuance increases private-sector assets, but the act of lending/borrowing itself does not increase net worth, because borrowers simultaneously takes on liabilities equal to the new assets. New loans from banks only increase net worth if the leveraging later pays off (an economic effect), via mechanism #3.

3. As we create more stuff and decide that existing stuff is worth more, the financial system creates new financial instruments, and the existing-asset markets bid up prices of existing instruments (stock shares, deeds, etc.) — expanding the stock of claims to approximate the expanded stock of stuff. Market runups increase household balance-sheet assets, with no increase in household liabilities. So like government deficit spending but unlike bank lending, market runups increase household net worth. Voila, households have more money. This is arguably the dominant financial mechanism for “money printing.” (This reality highlights the pervasive “conservation of money” fallacy that still plagues even much “stock-flow consistent” thinking, a fallacy that’s beautifully explicated in this paper by Charlotte Bruun and Carsten Heyn-Johnsen. It also points out the deep conceptual problems of “income” measures that don’t include capital gains income — where “saving” doesn’t equal change in net worth.)

That Econ 101 circular-flow diagram might need some rethinking.

Over the long run, our stock of real goods and our stock of dollar-valued claims on those goods (tallied as balance-sheet assets or net worth) go up roughly together. But it’s a very long-run thing, subject to variations spanning decades, even centuries, and contingent on shifts in societal attitudes, cultural norms, institutional structures, political power, monetary policy regimes, beliefs, geopolitical forces, environmental exigencies, and technological disruptions, among other things. If Piketty’s Capital depicts nothing else, it depicts that reality.

Many things affect our collective saving and savings, real and monetary. But one thing is sure: the non-act of personal monetary saving does not increase our collective monetary savings. Personal saving does not create funds (much less “loanable funds”). That notion is incoherent, in simple, straightforward accounting terms.

Rather, the economic effects work like this: more spending causes more production (incentives matter, right?), which creates more surplus and stuff — both long-lived and short-lived — more value. The value of the long-lived stuff is then monetized by the government/financial system through the creation of new dollar-denominated financial instruments/legal claims, and price runups on existing instruments/claims.

In three simple words: spending causes saving. Real, collective accumulation of real, long-lived stuff. Monetary saving — not-spending part of your income this year — doesn’t, collectively, create either real or monetary savings.

Maybe the Demon Debt is not the Great Evil after all. Maybe Selfish Saving — hoarding of claims against others — is actually the greater economic sin.

Cross-posted at Evonomics.

 

Why Economists Ignore So Much of Rich People’s Income

January 25th, 2016 Comments off

Yes: Concentrated Wealth and Inequality Crushes Economic Growth

December 15th, 2015 2 comments

Like it or not, if countries want to join the “rich country-club,” they need to redistribute wealth. What has not been studied much — at least partially because the data is hard to come by — is the distribution of wealth within countries, and how that relates to economic growth.

My devoted readers will undoubtedly remember my 2008 research into rich countries’ wealth inequality and economic growth. (In case you haven’t heard, wealth inequality utterly dwarfs income inequality.) Here’s the bottom line:

Correlations Between Rich Countries’ Wealth Concentration/Inequality and:

GDP per capita growth from 1970 to 2005 (35 years) -.67
…from 1975 (30 years) -.58
…from 1980 (25) .11
…from 1985 (20) .22
…from 1990 (15) .68
…from 1995 (10) .38
…from 2000 (5) .44

This analysis suggests that in rich countries, greater wealth inequality/concentration goes with faster economic growth over the shorter term, but over the long term it’s associated with much weaker growth. In the long run, trickle-down fails badly. (Viz, the increasing wealth concentration and moribund growth in the U.S. post-Reagan.)

There are numerous problems with this analysis, discussed in that previous post. Not much data was available back then, and the statistical correlation analysis is decidedly sophomoric.

But now we (finally!) have some more sophisticated work on this correlation from professional economists Sutirtha Bagchia and Jan Svejnar: “Does wealth inequality matter for growth? The effect of billionaire wealth, income distribution, and poverty.” (Gated; a much earlier and different ungated 2013 version is here. A two-page descriptive policy research brief published by the right/libertarian Cato Institute is here.)

Bagchia and  Svejnar’s (robust) top-line conclusion:

wealth inequality has a negative relationship with economic growth

(So much for “incentives.”) B&S attempt to distinguish between “politically connected” and unconnected (market-driven) wealth inequality, and conclude that only politically connected wealth inequality — “cronyism” — has a negative association with growth.

I don’t have access to the latest gated paper, but @NinjaEconomics has posted the key table (click for larger):

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Key points:

• B&S are looking at growth rates over ensuing five years (average annual change in GDP/capita). Interestingly, their negative correlations for this short lag period contradict mine for rich countries, which only showed negative correlation over decades. (It infuriates me, by the way, that every growth-correlation study doesn’t look at multiple time lags, where possible. They should all look like this.)

• Their sample set is a complete grab-bag of countries* — from tiny to large, developed, less-developed, emerging, etc. This gives higher N so greater statistical significance, but makes the true significance of the findings…questionable. We’ve known for decades that predictors and causes of growth are very different in developed and less-developed countries. I’d personally love to see their results for prosperous countries only.

• Such an analysis of similar, prosperous countries would allow them to use the narrower but more reputable Luxembourg Wealth Study data, rather than the data set they constructed based on spottier and far less rigorous Forbes 400 billionaire lists. (Their data and analysis files have not been made available for public vetting.)

• The rather tortuously constructed classification of “politically connected” versus market-driven wealth is, in their own words, “somewhat subjective.” It could not really be otherwise — wildly so, in fact. That they are “fully up-front about how we carry out the classification” does not obviate that reality.

• As Brad DeLong has pointed out, even with that subjectively constructed data set, B&S:

failed to find a statistically significant difference between the effect on growth of politically-connected wealth inequality and the effect on growth of politically-unconnected wealth inequality. That would be a more accurate description of what the data say.

They trumpet their non-statistically significant finding, in what surely looks like an attempt to downplay their significant main finding.

But perhaps to their chagrin, their main finding holds: wealth concentration, inequality, kills economic growth.

* From the 2013 paper: Australia, Bangladesh, Belgium, Brazil, Bulgaria, Canada, Chile, China, Colombia, Costa Rica, Denmark, Dominican Republic, Finland, France, Germany, Greece, Hong Kong, Hungary, India, Indonesia, Ireland, Italy, Japan, Malaysia, Mexico, Netherlands, New Zealand, Norway, Pakistan, Peru, Philippines, Poland, Portugal, Republic of Korea, Singapore, Spain, Sri Lanka, Sweden, Thailand, Trinidad and Tobago, Tunisia, Turkey, United Kingdom, United States, and Venezuela.

Cross-posted at Evonomics.

Did Money Evolve? You Might (Not) Be Surprised

November 25th, 2015 Comments off

You probably won’t be surprised to know that exchange, trade, reciprocity, tit for tat, and associated notions of “fairness” and “just deserts” have deep roots in humans’ evolutionary origins. We see expressions of these traits in capuchin monkeys and chimps (researchers created a “cash economy” where chimps were trained to exchange inedible tokens for food, then their trading behaviors were studied), in human children as young as two, in domestic dogs, and even in corvids — ravens and crows.

But humans are unique in this as in many other things. We use a socially-constructed mechanism to effect and mediate that trade — a thing we call “money.” What is this thing? What does it mean to say that it’s “socially constructed”? What are the specifics of that social construct? How does it work?

Money has lots of different meanings when you hear it in the vernacular. A physical one- or five-dollar bill is “money,” for instance (“Hands up and gimme all your money!”). But so is a person’s net worth, or wealth (“How much money do you have?”), even though dead presidents on paper or even checking-account balances are often insignificant or ignored in tallies of net worth (think: stocks, bonds, real estate, etc.).

You might think you could turn to economists for an understanding of the term. Not so. They don’t have an agreed-upon definition of “money.” The closest they come is a tripartite “it’s used as” description that completely begs the question of what money is: It’s used as a medium of account, as a medium of exchange, and as a medium of storage. I and many others have pointed out the myriad problems with this tripartite non-definition. Start by asking yourself: what in the heck do they mean by “medium” in each of those three? You’ll often hear economists speak of (undefined) “monetary assets,” “monetary commodities,” and similar, attempting to communicate in absence of a definition.

When economists speak of the “money supply” (a stock measure, not a flow measure as suggested by “supply”), they are gesturing toward a body of financial securities that are somewhat currency-like. Primarily: they’re used in exchanges for real-world goods and services, and have fixed values relative to the unit of account — e.g. “the dollar” (think: “the inch”). They assemble various “monetary aggregates” of these currency-like things — MB (the “monetary base”), M0, M1, M2, M3, and MZM (“money of zero maturity”). Here’s a handy chart on Wikipedia.

This conflation of “money” with currency-like financial securities reveals a basic misunderstanding of money that pervades the economics profession. That misunderstanding is based on a fairly tale.

In the golden days of yore, it is told, all exchange was barter. Think: Adam Smith’s imagined bucolic butcher and baker village. This worked fine, except that your milk wasn’t necessarily ready and to hand when my corn came ripe. And moving all those physical commodities around was arduous. This inserted large quantities of sand and mud into the gears and wheels of trade.

But then some innovator came up with a great invention — physical currency! Coins. “Money.” This invention launched humanity forward into its manifest destiny of friction-free exchange and the glories of market capitalism.

Except, that’s not how it happened. No known economy was ever based on barter. And coins were a very late arrival.

The best efforts at understanding the nature and origins of money have come from anthropologists, archaeologists, and historians who actually study early human commerce and trade, and from various associated (“heterodox”) fringes of economic thinking. David Graeber recounts much of this history (though unevenly) in Debt: The First 5,000 Years. Randall Wray, a leading proponent of the insurgent and increasingly influential Modern Monetary Theory (MMT) school of economics, has offered up some great explications. (Though even he is reduced, at times, to talking about “money things.”) If you’re after a gentle introduction, Planet Money has a great segment on money’s rather vexed history and odder incarnations.

The main finding from all this: the earliest uses of money in recorded civilization were not coins, or anything like them. They were tallies of credits and debits (gives and takes), assets and liabilities (rights and responsibilities, ownership and obligations), quantified in numbers. Accounting. (In technical terms: sign-value notation.) Tally sticks go back twenty-five or thirty thousand years. More sophisticated systems emerged six to seven thousand years ago (Sumerian clay tablets and their strings-of-beads predecessors). The first coins weren’t minted until circa 700 BCE — thousands or tens of thousands of years after the invention of “money.”

These tally systems give us our first clue to the nature of this elusive “social construct” called money: it’s an accounting construct. The earliest human recording systems we know of — proto-writing — were all used for accounting.* So the need for social accounting may even explain the invention of writing.

This “accounting” invention is a human manifestation of, and mechanism for, reciprocity instincts whose origins long predate humanity. It’s an invented technique to do the counting that is at least somewhat, at least implicitly, necessary to reciprocal, tit-for-tat social relationships. It’s even been suggested that the arduous work of social accounting — keeping track of all those social relationships with all those people — may have been the primary impetus for the rapid evolutionary expansion of the human brain. “Money” allowed humans to outsource some of that arduous mental recording onto tally sheets.

None of this is to suggest that explicit accounting is necessary for social relationships. That would be silly. Small tribal cultures are mostly dominated by “gift economies” based on unquantified exchanges. And even in modern societies, much or most of the “value” we exchange — among family, friends, and even business associates — is not accounted for explicitly or numerically. But money, by any useful definition, is so accounted for. Money simply doesn’t exist without accounting.

Coins and other pieces of physical currency are, in an important sense, an extra step removed from money itself. They’re conveniently exchangeable physical tokens of accounting relationships, allowing people to shift the tallies of rights and responsibilities without editing tally sheets. But the tally sheets, even if they are only implicit, are where the money resides.

This is of course contrary to everyday usage. A dollar bill is “money,” right? But that is often true of technical terms of art. This confusion of physical tokens and other currency-like things (viz, economists’ monetary aggregates, and Wray’s “money things”) with money itself make it difficult or impossible to discuss money coherently.

What may surprise you: all of this historical and anthropological information and understanding is esoteric, rare knowledge among economists. It’s pretty much absent from Econ 101 teaching, and beyond. Economists’ discomfort with the discipline’s status as a true “social science,” employing the methodologies and epistemological constructs of social science — their “physics envy” — ironically leaves them bereft of a definition for what is arguably the most fundamental construct in their discipline. Likewise for other crucial and constantly-employed economic terms: assets, capital, savings, wealth, and others.

Now to be fair: a definition of money will never be simple and straightforward. Physicists’ definition of “energy” certainly isn’t. But physicists don’t completely talk past each other when they use the word and its associated concepts. Economists do when they talk about money. Constantly.

Physicists’ definition of energy is useful because it’s part of a mutually coherent complex of other carefully defined terms and understandings — things like “work,” “force,” “inertia,” and “momentum.” Money, as a (necessarily “social”) accounting construct, requires a similar complex of carefully defined, associated accounting terms — all of which themselves are about social-accounting relationships.

At this point you’re probably drumming your fingers impatiently: “So give: what is money?” Here, a bloodless and technical term-of-art definition:

The value of assets, as designated in a unit of account.

Which raises the obvious questions: What do you mean by “assets” and “unit of account”? Those are the kind of associated definitions that are necessary to any useful definition of money. Hint: assets are pure accounting, balance-sheet entities, numeric representations of the value of goods (or of claims on goods, or claims on claims on…). That’s where I’ll go in my next post.

Sneak preview: we’ll start by thinking carefully about another (evolved?) human social construct without which assets don’t, can’t, exist — ownership.

* Some scholars believe repeated symbolic patterns going back much further, in cave paintings for instance, embodied early “writing,” but that is widely contested, and nobody knows what the symbols — if they are symbols — represented.

Cross-posted at Evonomics.

Why Tyler Cowen Doesn’t Understand the Economy: It’s the Debt, Stupid

November 16th, 2015 Comments off

In a recent post Tyler Cowen makes an admirable effort to lay out his overarching approach to thinking about macroeconomics, revealing the assumptions underlying his understanding of how economies work. (Even more salutary, this has prompted others to do likewise: Nick Rowe, Ryan Avent.)

Cowen’s first assertion:

In world history, 99% of all business cycles are real business cycles.

This may be true, but it is almost certainly immaterial to the operations of modern, financialized monetary economies. He acknowledges as much in his second assertion:

In the more recent segment of world history, a lot of cycles have been caused by negative nominal shocks. I consider the Christina and David Romer “shock identification” paper (pdf, and note the name order) to be one of the very best pieces of research in all of macroeconomics.

That paper, which revisits and revises Friedman and Schwartz’s Monetary History, is clearly foundational to Cowen’s understanding of how economies work, so it bears examination — in particular, its foundational assumptions. The Romers state one of those assumptions explicitly on page 134 (emphasis mine):

…an assumption that trend inflation by itself does not affect the dynamics of real output. We find this assumption reasonable: there appears to be no plausible channel other than policy through which trend inflation could cause large short-run output swings.

This will (or should) raise many eyebrows; it certainly did mine. Because: it completely ignores the effects of inflation on debt relationships.

It’s as if Irving Fisher and Hyman Minsky had never written.

Assuming “inflation” means roughly equivalent wage and price increases, at least over the medium/long term (yes, an iffy assumption given recent decades, but…), inflation increases nominal incomes without increasing nominal expenditures for existing debt service. (Yes, with some exceptions for inflation-indexed debt contracts.) Deflation, the reverse. Nominal debt-service expenditures are (very) sticky. Or described differently: inflation constitutes a massive ongoing transfer of real buying power from creditors to debtors — and again, deflation the reverse.

“No plausible channel”?

Excepting one passing and immaterial mention of government debt, the the words “debt” and “liability” do not appear in the Romer and Romer paper, and it has only two passing mentions of “assets.” It’s as if balance sheets did not exist — which in fact they do not in the national accounting constructs then existing, that the Romers, Friedman, Schwartz, and presumably Cowen today are using in their mental economic models and in the “narrative” approach to explaining economies that Friedman, Schwartz, and the Romers explicitly champion.

If you go further and allow that wages and prices can inflate at different rates (which you must, given recent decades), you have extremely large and changing differentials between price inflation, wage inflation, and (especially) asset-price inflation.

All of these inflation dynamics are assumed away, made invisible and immaterial, in Romer and Romer — hence largely, at least presumably so, in Cowen’s understanding of economies. It is explicitly assumed (hence concluded) that those dynamics have no “real” effect. As in Romer and Romer, the words “debt,” “liability,” and “asset” are absent from Cowen’s “macroeconomic framework.” (Though he does give a polite if content-free nod to Minsky in his ninth statement.)

This explains much, in my opinion, about Cowen’s — and many other mainstream economists’ — flawed understanding of how economies work.

Cross-posted at Angry Bear.

Wait: Maybe Europeans are as Rich as Americans

November 6th, 2015 6 comments

I’ve pointed out multiple times that despite Europe’s big, supposedly growth-strangling governments, Europe and the U.S. have grown at the same rate over the last 45 years. Here’s the latest data from the OECD, through 2014 (click for larger):

Screen shot 2015-11-06 at 5.19.42 PM

And here’s the spreadsheet. Have your way with it. More discussion and explanation in a previous post.

You can cherry-pick brief periods along the bottom diagonal to support any argument you like. But between 1970 and 2014, U.S. real GDP per capita grew 117%. The EU15 grew 115%. (Rounding explains the 1% difference shown above.) Statistically, we call that “the same.”

Which brought me back to a question that’s been nagging me for years: why hasn’t Europe caught up? Basic growth theory tells us it should (convergence, Solow, all that). And it did, very impressively, in the thirty years after World War II (interestingly, this during a period when the world lay in tatters, and the U.S. utterly dominated global manufacturing, trade, and commerce).

But then in the mid 70s Europe stopped catching up. U.S. GDP per capita today (2014) is $50,620. For Europe it’s $38,870 — only 77% of the U.S. figure, roughly what it’s been since the 70s. What’s with that?

Small-government advocates will suggest that the big European governments built after World War II are the culprit; they finally started to bite in the 70s. But then, again: why has Europe grown just as fast as the U.S. since the 70s? It’s a conundrum.

I’m thinking the small-government types might be right: it’s about government. But they’ve got the wrong explanation.

Think about how GDP is measured. Private-sector output is estimated by spending on final goods and services in the market. But that doesn’t work for government goods, because they aren’t sold in the market. So they’re estimated based on the cost of producing and delivering them.

Small-government advocates frequently make this point about the measurement of government production. But they then jump immediately to a foregone conclusion: that the value of government goods are services are being overestimated by this method. (You can see Tyler Cowen doing it here.)

That makes no sense to me. What would private output look like if it was measured at the cost of production? Way lower. Is government really so inefficient that its production costs are higher than its output? It’s hard to say, but that seems wildly improbable, strikes me as a pure leap of faith, completely contrary to reasonable Bayesian priors about input versus output in production.

Imagine, rather, that the cost-of-production estimation method is underestimating the value of government goods — just as it would (wildly) underestimate private goods if they were measured that way. Now do the math: EU built out governments encompassing about 40% of GDP. The U.S. is about 25%. Think: America’s insanely expensive health care and higher education, much or most of it measured at market prices for GDP purposes, not cost of production as in Europe. Add in our extraordinary spending on financial services — spending which is far lower in Europe, with its more-comprehensive government pension and retirement programs. Feel free to add to the list.

All those European government services are measured at cost of production, while equivalent U.S. services are measured at (much higher) market cost. Is it any wonder that U.S. GDP looks higher?

I’d be delighted to hear from readers about any measures or studies that have managed to quantify this difficult conundrum. What’s the value or “utility” of government services, designated in dollars (or whatever)?

Update: I can’t believe I failed to mention what’s probably the primary cause of the US/EU differential: Europeans work less. A lot less. Like four or six weeks a year less. They’ve chosen free time with their families, time to do things they love with people they love, over square footage and cubic inches.

Got family values?

I can’t believe I forgot to mention it, because I’ve written about it at least half a dozen times.

If Europeans worked as many hours as Americans, their GDP figures would still be roughly 14% below the U.S. But mis-measurement of government output, plus several other GDP-measurement discrepancies across countries, could easily explain that.

Cross-posted at Angry Bear.

 

Why Prosperity Requires a Welfare State

November 5th, 2015 Comments off

I’ve got a new post up at a new site, Evonomics Magazine (“The next evolution of economics”). It’s an impressive offshoot with some great articles, assembled by folks involved with The Evolution Institute, which I’m a big booster for.

Screen shot 2015-11-05 at 11.17.04 AM

My readers here will find much familiar in the post, but I’m happy with how it pulls various threads together. I’ll be following comments over there, so have your way with it.

Cross-posted at Angry Bear.