Asymptosis

This graph speaks volumes:

Profits as a Percent of GDP: Financial Corporations vs. Nonfinancial Corporations

We saw a big decline in real businesses’ profit share in the 40s, then a slower semi-steady decline through the 70s, as wages constituted a larger share of GDP. Financial corps doubled, expanding and increasing profits, but they remained small in the big picture.

Then post-80, we saw two big moves: a dive in real business profit share below any historical norm, and the beginning of the long secular rise in financial corp profits share (quadrupling between 1980 and 2010).

How did financial corps achieve this? Simple: they’re licensed to print money, and they devoted that money to paying off the managers of real businesses to hand over those businesses’ profits. The C suite of America’s corporations went from being managers of real businesses creating real value, to being financial prestidigitators. And those individuals were handsomely rewarded for their obeisance to the financial corps.

The people who work for those real companies, of course — the vast pyramid of sub-C-suite toilers who don’t get a share of the kickbacks…haven’t gotten a share of the kickbacks.

Compensation of Employees/GDP

That 4% or 5% of GDP income flow — remember, that’s every year – was transferred from households to financial corporations, courtesy of bought-and-paid-for real-corp CEOs.

Got incentives?

Cross-posted at Angry Bear.

The OECD has finally updated their national account data with 2011 info for most countries, so I thought I’d update this post from a couple of years ago.

If you’re thinking that the current (overblown) hoo-ra-ra about U.S. government deficits is a result of too much spending, or that U.S. taxes are insanely high and always going up, you might want to think again (click for larger):

While the U.S. number is up from its low or 24.1% in 2009, it’s still hovering at the bottom of the OECD league table.

Got tipping points?

Cross-posted at Angry Bear.

I’ve ground the axe quite a bit over the years for the argument that Kevin Drum makes — and dismisses — here.

In brief: poorer people spend a larger share of their income/wealth than richer people. So if poorer people have more income/wealth — if the distribution is more equal — there will be higher money velocity/more spending/more production/higher GDP.

(Search for “marginal propensity” and follow Related Links to see my stabs at this.)

But Kevin — who certainly has the political inclination to make this argument — says:

This sounds pretty plausible, doesn’t it? Higher inequality should generate less consumption, which in turn produces a weaker economy. Unfortunately, the data says something else. “I wish I could sign on to this thesis,” says Paul Krugman, “and I’d be politically very comfortable if I could. But I can’t see how this works.”

Me neither. I spent a couple of months trying to write a magazine piece based on this thesis, and I finally gave up. By the time I was done, I just didn’t believe it. So I gave up and spiked the idea.

I’ve tweeted him and posted a comment, but haven’t heard: what made him give up on this? What convinced him otherwise?

And in response to a recent post where I ground this axe, Scott Sumner responded:

But you really need to give up on that MPC stuff, it was discredited decades ago. Monetary offset rulz.

This in keeping with his seeming assertion that nothing matters except monetary policy, because monetary policy will (or at least should) always offset it.

But still: Sumner, Drum, and Krugman all seem to think that the distribution/MPC/velocity argument has no legs. They’re quite categorical about this.

SRW took a stab at the subject recently, telling a story that I find quite convincing. But didn’t really explain to me why so many feel so certain that it’s not true.

Can folks (especially those who don’t believe this argument) point me to what might be considered definitive takedowns? I have notions about what they might say, but want to see the best argument(s) out there.

These takedowns should, just for instance, convincingly debunk this paper (sorry, gated), which suggests that rising income inequality ’67-’86 resulted in 12% lower consumption spending in ’86 than would have occurred if inequality had remained the same.

Cross-posted at Angry Bear.

I’m joking of course. He’s still grinding the supply-side axe (though judiciously here, IMO). But you gotta admire a fellow when he follows the logic of the data where his own logic requires him to go. He’s just done three posts about Germany’s growth and unemployment rates through the great recession:

Annualized change, Q1 2006 – Q4 2012:

RGDP: 1.3%
NGDP: 2.4%

But the unemployment rate fell from about 12% to 5.4%.

Lackluster GDP growth coupled with a damned impressive drop in unemployment. How do you account for that in Scott’s long-argued model, where NGDP growth drives employment growth?

As he says, he buries the lede in his first post. Here it is, from the end of the post (I’m reversing these two paras to make it flow even better; emphasis mine, correction his):

Recessions are not caused by less spending; they are caused by less income going to workers.  Usually the two go hand-in-hand, but the German miracle tells us that when they diverge, it is employer employee income that matters most.

When I started blogging I assumed wage targeting would be politically impossible, and knew that NGDP targeting was already a well-regarded concept.  So I latched on to NGDP targeting.  But in retrospect I wish I’d latched on to aggregate employee income.  Call it “income targeting.”

Did I mention admirable? Speaking of the very argument he’s been making doggedly and insistently for years, he says:

I took some shortcuts, instead of staying true to the “musical chairs model.”  In the past I’ve often argued that a fall in NGDP causes unemployment because there is less income to pay workers, and yet hourly wages are sticky.  Some workers end up sitting on the floor.  The logic of that model suggests that the real problem is not unstable NGDP, but rather instability in a component of NGDP, namely total wages and salaries.

And speaking of the school of economics based on that thinking, a school that he’s been primarily responsible for creating and popularizing, he says:

Now that market monetarism riding high, I figured it was time for a vicious internecine struggle for the soul of market monetarism.  Consider this the first shot. 

The fruit doesn’t fall far from the tree, of course; in his second post he attributes the “miracle” largely to “structural”/supply-side factors:

Germany did lots of labor market reforms, which I’ve discussed in previous posts, and this opened up lots of low wage jobs.

The basic idea: the Hartz reforms beginning in 2003 resulted in more jobs, though often with shorter hours and/or lower wages, all netting out to a larger share of GDP going to employee compensation.

This is not crazy. But it’s incomplete. And he even acknowledges that in a nod to his commenters:

Many commenters pointed to various job sharing programs, or subsidies to keep workers employed during the recession. Libetaer used the metaphor of putting 2 workers in one chair.  The one chair reflects relatively meager growth in NGDP, and the two workers represent job sharing.

The key problem I find in his thinking is his glossing over a key word in the preceding: subsidies. He only discusses job sharing, which fits neatly in his musical-chairs analogy. (How about musical benches instead? When the music “stops” — national income is weak — workers squeeze in more tightly.)

But the Hartz reforms did more than make it easier for firms to hire cheap (create more chairs/bench space); they increased subsidies for low-wage and part-time jobs. This 1) makes it easier for employers to hire lower-productivity workers for low wages, 2) gives those lower-productivity workers sufficient incentive to take those jobs, and 3) increases the share of national income going to lower-income workers.

And since those workers have a high propensity to spend their income, all things being equal that distributional shift should mean there’s a higher average velocity of money, aggregate demand, NGDP, etc., all in a virtuous cycle. (See JW Mason here and me here.)

Scott says much the same thing from a different direction:

The welfare loss to a society from a 5% RGDP shock is much greater if 5% of workers lose their jobs, as compared to all workers staying employed, but working 5% less hard.

This is a statement about absolute utility, but (hence, because spending is driven by the desire for utility) it’s also a statement about different policies’ distributional effects on spending and aggregate demand. Because subsistence has (very!) high utility, cutting some subsistence incomes (which would surely be re-spent) results in a bigger hit to aggregate demand than cutting many marginal incomes (which are less likely to get re-spent). It’s straightforward Marginal Propensity to Spend out of income thinking.

I’m here to suggest that the same logic, rather inevitably, applies to subsidies for low-wage jobs (paid for by better-off taxpayers). We redirect disposable income at the margin from higher-income folks, and flow it into the hands of lower-income folks who will spend it on. Got velocity?

Which brings me back to the axe that I’m forever grinding: the best and most feasible structural labor-policy change we could make in the U.S. to improve long-term macroeconomic performance would be to greatly expand the Earned Income Tax Credit (while streamlining its tortured administration and — to increase its “salience” — delivering the credit on weekly paychecks as we do with payroll tax deductions).

If these subsidies were sufficient to make low-wage work/workers attractive for both employers and workers (and perhaps if they subsidized hourly compensation rather than annual family income), we might even be able to do what the Germans, with their generous low-wage subsidies, have been able to do: do without minimum-wage laws.

I bet Scott would like that.

And we still haven’t talked about national compensation/income targeting by the Fed, which promises to be a very lively discussion indeed. (I can just see Ben Bernanke slapping his forehead and looking heavenward.)

Cross-posted at Angry Bear.

An old friend dropped by recently and we had a few beers on the back deck. He runs his family’s commercial real-estate business; they own and operate half a dozen or so pretty large properties (and just bought another) — a mall, office buildings, mixed use.

I was really curious to talk to him about why commercial property owners don’t invest more in energy efficiency. By all accounts there’s great ROI in doing so — serious low-hanging fruit.

Why do commercial property owners leave five-dollar bills lying on the sidewalk?*

At least, it sure looks like there are five-dollar bills lying around. Here from a McKinsey report (PDF; see page 15) showing how much it costs to save (not buy/pay for) a million BTUs of energy, by instead investing in energy efficiency:

Sorry, it’s hard to see without going to the PDF. But short story: there are quadrillions of BTUs in efficiency savings available for less than $2 per million BTUs.

Now look at the cost of buying a million BTUs instead, to heat your building or power your plant (2011 figures, Energy Information Administration):

Coal: $2.39/MMBTU
Petroleum: $12.48
Natural Gas: $4.72

This is the cost to a utility company buying these fuels. The meter cost of the electricity produced (after line losses, administration, profits, etc.) — the cost for building owners — will of course be somewhat higher.

So it sure seems like there’s money to be picked up. Why don’t building owners do it? The short answer my friend and I came to? Triple-net leases — the ubiquitous standard in the commercial real-estate industry.

In these leases tenants pay per-square-foot rent, plus their pro-rata share (by square feet) of the building’s 1) taxes, 2) insurance, and 3) repairs, maintenance, and energy expenses. (Many NNN leases don’t include pro-rata energy costs, but tenants are separately metered and either pay directly or through the landlord. There are lots of variations, but landlords rarely pay all energy costs.)

Notice what is not included: the cost of improvements — for instance improvements to increase energy efficiency. So the owner gets all the costs, right up front. And the benefits go mostly or completely to the tenants, in the form of lower energy bills.

“But hey,” I asked my friend, “don’t lower energy costs for tenants mean you can charge more rent? Doesn’t it all come out in the wash?”

“Welllllhh,” he said… Most tenants are on long leases. “We just signed a ten-year lease with the anchor tenant for our mall.” My friend won’t see any dollar benefit from those energy savings for a long time, as leases turn over and are renegotiated. And it’s not at all clear how much benefit he’ll get, because tenants tend to fixate on the square-footage rental rate, which would go up. 

Imagine you’re a leasing agent for the building, trying to rent some space. You’re competing with other buildings that haven’t done the energy upgrade, so their rent/square foot is lower. You’re stuck saying “yeah yeah yeah yeah but you’ll spend less on energy!” This, if you even get the chance: Prospective tentants scanning the listings might never even call you because your rent is so high.

A building owner considering a big spend for energy efficiency really has to think thrice: would I rather have a million dollars, cash in hand, or the likely but uncertain prospect of higher profits somewhere (perhaps way) down the road? It’s easy to understand why they make the choices they do.

And all of this is true even though there’s money lying on the ground waiting to be picked up.

It’s a classic coordination problem — people acting in their own best-guess best interests, with ridiculously inefficient results — that is caused or at least greatly exacerbated by the institutional convention of triple-net leases. (The reasons the convention arose are yet another subject, about passing off risk and retaining returns.)

Obviously triple-net is not the sole villain in this very big picture. From the McKinsey report:

Got central planning?

* For those who don’t know the old joke: Two economists walking along, they see a five-dollar bill lying on the sidewalk. One of them gestures for the other to pick it up. “I’m not picking that up,” says the other. “If it were there somebody would have picked it up already!”

Cross-posted at Angry Bear.

Fiscal austerity–or deficit cutting–is the subject of much current debate. As Europe proves, severe austerity can slow growth or lead to recession.

Despite periodic slowdowns, the US economy is on a sustainable fiscal path. The deficit is projected to drop below 2.5 percent of GDP by 2017, below its 30-year average, helped partially by the sequestration budget cuts.

Instead of pursuing short-term fiscal reform, as suggested in the president’s recently released budget, Congress should focus on working toward long-term tax and entitlement reform.

via Austerity undone – Economics – AEI.

Cross-posted at Asymptosis.

I finally figured out a simple way to explain my confusion (and that of many others, including many economists) with the whole Saving issue. I may also have figured out a useful solution to that confusion, which I present at the bottom here for my gentle readers’ delectation and denunciation.

Econ profs: I’m really curious. Do you think this post would help your intro students understand this stuff?

First: The accounting’s fine. Of course. But for some not-crazy reasons, the definition of “Saving” changes in the course of the accounting.

Thinking of the “real” sector for the moment, for simplicity and clarity. For each of the economic units at the bottom level of that sector (households and nonfinancial businesses), Saving means money saving:

(1) Saving = Income – Expenditure

But at the top, the level of “sectoral” saving, Saving means saving of real goods:

(2) Saving = Income - Consumption Expenditures

Or in words that more aptly describe what’s being depicted:

(3) Saving = Production – Consumption

(Reminder: Consumption Spending + Investment Spending = Expenditures = Income = Production)

Explanatory aside: There’s Gross or Net Saving, depending on whether Consumption just includes Consumption Spending (on goods that are bought and consumed within the period), or also includes Consumption of Fixed Assets — the very real “depreciation” of those assets. Gross is long-lived goods produced; Net is long-lived goods added, above and beyond what’s “consumed.”

Back to identities: Unlike every other measure in the national accounts, if you sum up the money Saving of all the bottom-level units, it doesn’t equal Saving for the sector. Rather:

(4) Sectoral Saving = Units’ Combined Money Saving + Investment Spending*

Investment spending, of course, causes the creation of real, long-lived goods. But this is the thing that has confused me from the get-go: Saving is (savings are) some combination of money and real goods? Aren’t financial assets supposed to be representative of, proxies for, the real assets? (Equally confusing: economists’ insistence on talking about “capital” as if it were some undifferentiated, homogeneous or vaguely contiguous lump of real and financial capital.)

Here’s what you need to know to sort that out: You know that money saving? It’s zero.

Read more…

I’m just sayin’. (Emphasis mine, words Solow’s):

[Bernanke's] preferred answer is better and more system-oriented regulation. One has to ask then why regulation failed to see the crisis of 2007–2008 coming and take action to head it off. Bernanke suggests that regulators were lulled into inattention by the so-called Great Moderation. Our masters are all too eager to take the Panglossian view that a system of “free markets,” including financial markets, is self-regulating and self-stabilizing. Bernanke is surely right about this. The scholar of the 1930s has to be aware that there was similar talk about the New Era in the years before 1929. Dr. Pangloss has lots of helpers among the sharpshooters who profit most from the absence of effective oversight, and among simpleminded ideologues. They are still with us.

Cross-posted at Angry Bear.

Erica Payne sent out a request for writeups from Patriotic Millionaires members, and I provided this. I hate not to re-use perfectly good copy…

I live (quite well) off financial investments — no need to work any more — and my taxes every year are ridiculously, embarrassingly low. Meanwhile tens, hundreds of millions of hard workers who spend all their money — enriching entrepreneurs like me, and spurring economic growth — are throttled by tax bites that far exceed mine.

This tax structure and its terrible incentives are destroying, for my children and grandchildren, the opportunities for personal fulfillment and enrichment that America provided me. I wholeheartedly support the specific initiatives of Patriotic Millionaires, but I think far more is needed to create a national tax structure that actually is progressive above $60 or $80K a year in income. Us rich folks aren’t paying nearly our share of the bill — paying for what we receive — or re-investing in the country that gave us such remarkable opportunities. Don’t we care about our kids?

Americans have told us what they want — rich and poor, tea partiers and raging liberals (the polls aren’t hard to read) — and we need to pay for it.

True conservatives pay their bills.

Cross-posted at Angry Bear.

Many economists — mostly the freshwater/neoclassical/supply-side/conservative types, but also many on the left — hold in their heads a very peculiar model of how economies work. It’s a model of a barter/real-goods economy in which money only plays the role of convenience.

In this model, if you don’t eat some portion of the corn you grew this year, you’ve “saved.” You can eat it next year. Makes perfect sense.

You can see this thinking played out in Scott Sumner’s justification for consumption taxes:

I’d tax people on the basis of how many resources they consume, or take out of society, not what they produce.

He describes the opposite approach — taxing returns on financial investments or “savings” — as “morally grotesque.”

Now let’s think about this, and think about how these economists think about this. They’re assuming that if you “save” (a.k.a. don’t spend), you don’t “consume resources.” You “save” them, and don’t “take them out of society.”

This makes absolutely no sense. If you forego a massage this week, or wait a few years to get your house painted, is the labor for that massage or paint job “saved”? How about this year’s sunlight — the ultimate source of that labor power? Can you use it next week, or next year? Understand: services comprise 80% of U.S. GDP. And that’s before you even think about Apple and similar, with their just-in-time, on-demand supply chains — when you buy it, and only when you buy it, they produce it.

If you don’t buy it, it doesn’t get produced.

And if you don’t buy it, and they don’t expect you to buy it soon, they don’t invest to build the capacity needed to produce more in the future. (That investment and real-capacity building is true “national saving.” S really is I.)

That mental model, which is so widely prevalent, is a fundamental error of composition: confusing the individual with the aggregate. (And a confution of money-saving and real saving.) Sure, you’ve saved money for your (or your great-grandchildren’s) future. And when you don’t get a massage, others can sign up for that time slot, or buy a massage for a lower price. This is about competition among individuals, not how many resources we as a society produce and consume. If we all consume less, as a society we produce (and “save”) less — both for current consumption and for future production.

So in a very real (dynamic) sense, it’s the savers who are “taking resources out of society.” (And in a somewhat abstract sense, you can imagine those foregone resources being stored, hoarded, and  rendered impotent in ever-growing and largely inert Cayman-island bank accounts.)

This is not really revelatory; I know these economists understand the paradox of thrift. But they ignore and eschew it in their real-good, barter-based mental economic models. I would suggest that the explanation for this error of composition is revealed by Scott’s words: “morally grotesque.” Moralistic beliefs about how individual humans should behave make it impossible for many economists to embrace an aggregate economic reality of which they are fully cognizant.

* Yes: non-renewable natural resources are consumed when people produce, buy, and consume stuff (both goods and services). But 1. Compared to human effort, those resources constitute a small part of the inputs to GDP, and 2. this is not what economists who are subject to this thinking are talking about. All those in-ground resources are not counted as existing “capital” in the national accounts, for instance — so they can’t be depleted from those accounts — and the accounted “cost” of those resources consists almost entirely of the cost of digging them up. This is the subject for another post.

Cross-posted at Angry Bear.