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):

CWE8LFGU8AEPCAs

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.

Thinking About “Assets” and Ownership

October 20th, 2015 Comments off

My gentle readers will know that I often struggle with economic terminology, both because I find usages are so vague, various, and poorly defined, and because I’m trying to understand fundamental terms’ fundamental meanings. Today I’d like to home in on one of the most fundamental — “assets” — and something even more fundamental that underpins it: “ownership.”

I’ll start with what I think is a usefully precise, technical, term-of-art definition:

Asset. n. A labeled numeric entry on the lefthand side of a balance sheet, designating the value of a claim (necessarily, designated in a unit of account).

This thing called an “asset” only exists, only can exist, on a balance sheet. It’s purely an accounting term, and the entity only exists within an accounting construct. There’s no other meaning for the term. (Making it a usefully precise definition.)

This is contrary to the vernacular, where a house or a drill press is called an asset. (In this technical context these are more usefully called “goods” or “real goods” or “capital goods.”) Because really: how can both a house and the labeled tally of a claim on that house both be called “assets”?

“Financial assets” are distinguished in that they have related, offsetting liabilities on the righthand side of other balance sheets. That’s what defines the term. They’re claims on claims — claims against that other balance sheet’s assets/claims. That’s why there’s a liability entry over there. It’s the right side making a claim against the left side, on behalf of that other balance sheet that holds the asset. As such, financial assets only represent indirect (and variously contingent) claims on real goods, one or more claim-steps removed from claims on the goods themselves.

Purely “real” or nonfinancial assets have no such offsetting claims on other balance sheets. In theory, they represent direct claims on real goods.

That seemingly simple distinction, though, is far from simple when you start exploring it carefully.

To that end, consider the fundamental nature of “claims,” hence the nature and import of “ownership” and “property rights.” Full credit here to Matt Bruenig, who delivered the Aha! understandings for me on these topics — clear and (mutually) coherent definitions and explanations for concepts I’d been worrying at for years.

Mostly simply, ownership is an exclusionary legal claim. Ownership says you may have a picnic on your front lawn — which seems inclusionary, but that’s only meaningful because you may exclude anyone else from doing so. And you may invoke violence (farmed out to the police) to enforce that right of exclusion. As Matt has said so well, a modern ownership claim is best viewed as a violence voucher issued by government.

This imparts a decidedly sinister aspect to the lefthand side of balance sheets — a tally sheet of violence vouchers?

So now to return, with that understanding, to the notion of real vs financial assets. In large, in aggregate, in the big national or global picture, both types of assets ultimately constitute claims on real goods. Someone holding zero real/nonfinancial assets but significant financial assets can make an immediate and successful claim on a new Maserati — a very “real” good. Everyone else is excluded from claiming that Maserati.

If this exclusionary notion is safe, in a very real sense your “real,” “nonfinancial” asset claim is actually offset by a liability — on the (EverybodyElseIn)TheWorld balance sheet. Call the entry “Stuff that we’re excluded from touching.” If all those exclusionary claims wall off AllTheGoodStuff with violence, we’re talking a very real liability indeed — even though this imaginary World Balance Sheet doesn’t, and practically probably can’t, exist.

This notional balance sheet may seem crazy and outlandish to us. But our ownership, property-rights, and “asset” structures do and have seemed equally outlandish to other cultures:

…fee-simple ownership is not the only basis for ownership and possession of land. Many eastern cultures and tribal cultures throughout the world follow the “communal property system” in which ownership of land belongs to the entire social/political unit, like the tribe, families, bands, and nations.

From the inside, ideologies always look like common sense.

 

Thinking about Value, and the National Accounts

October 18th, 2015 6 comments

The remarkable discussion on “national wealth” and the national accounts that is running over at Interfluidity (373 comments and counting…) in response to my last post prompts me to recount an anecdote that I think is germane.

I took exactly one accounting class in my life, at the NYU MBA school — essentially Accounting for Non-Accountants, teaching us to deconstruct corporate statements into cash flow.

There were two profs. (I don’t remember their names.) The lead was an old hand, a long-time member of the Financial Accounting Standards Board (FASB), and a real comedian. The young guy was the straight man and enforcer — assignments, testing, and nuts-and-bolts lectures.

The beginning of the very first lecture, given by the old guy, has stuck with me ever since. He started with an anecdote. (Here recounted from distant memory.)

When I was an undergrad (he said), I hung out with these economics types. I was thinking of buying a new car. They told me, “don’t do that! As soon as you drive it off the lot it’ll lose a third of its value!”

But anyway, I went ahead and did it. I went through all the paperwork with the salesman, signed on the dotted line, and he handed me the keys. “Here you go,” he said. “Drive it away.”

I looked at him like he was crazy. “I’m not gonna drive it away,” I said. “It’ll lose a third of its value!”

Ba dum ba.

Then he explained why he used that anecdote right up front, framing the whole (rather grueling) semester-long exercise to come: Accounting, he said, is an exercise in assigning value to things that are often (mostly?) deucedly difficult to e-value-ate. Whether it’s the value of that car (before and after it leaves the lot), or the “wealth of nations,” accounting is inherently a problematic exercise in estimation. We just do the best we can.

Based on a decade or so of wrestling with the national accounts, I’d extend that thinking further. Sure, estimating value can be very iffy, but that estimation is also, always, a function of the accounting constructs and architecture used to do that estimation. Simply put, the national accounts are an economic model of the national economy. The map is not the territory. The presentation is inevitably stylized, like a Mercatus or Peters projection — and the choice of presentation has similarly important rhetorical and political implications.

The implication: as with any economic model, to understand what you’re seeing, you need to look not only at the results presented within the model, but at the model itself. You need to (at least) consider not just potential errors within a model, but model error itself. To get very philosophical: National account structures are, ultimately, epistemological structures — systems for trying to “know” things.

The national accounts, by their very status and position, discourage examination of their model. The notion that they’re “just accounting,” adding and subtracting straightforward measures, reifies them, and the model they present. The assumptions underlying that model are rendered invisible, apotheosized as god-given truths.

National-accounting sages are very much aware of this reality. Check out Jorgenson, Hulten, Hall, etc. on the “zero-rent” economic model that lies (hidden) at the core of the national accounts as constructed. (They mostly argue: appropriately so.) Or spend some time in that Interfluidity comments thread. If you haven’t thought critically and carefully about the national accounts’ economic model, you don’t understand the national accounts. (I’m not, by the way, claiming that I do. Despite lengthy exertions. Necessary versus sufficient and all that.)

That old-hand FASBer imparted, I think, a profoundly important truth. I’ve been struggling with its implications ever since.

To put across exactly how important and profound that truth is, I’ll end by passing the baton to John Maynard Keynes in his essay on “National Self-Sufficiency”:

Once we allow ourselves to be disobedient to the test of an accountant’s profit, we have begun to change our civilization.

I only got a B+ in the course, by the way.

 

Where MMT Gets Its Accounting Wrong — And Right

October 2nd, 2015 78 comments

Modern Monetary Theory has been revolutionary in economics, and its influence is — beneficially — ever-more pervasive. It has opened the eyes of a generation to a clear-eyed, accounting-based methodology that trumps dimensionless theory, and has brought a deep, nuts-and-bolts understanding of money, debt, and financial institutions to a discipline where that understanding has been inexcusably absent. Witness: a whole raft of papers from central-bank economists worldwide embracing MMT principles (though often not MMT by name), and eviscerating decades or centuries of facile and false explanations of monetary mechanisms.

But MMT’s terminology and associated accounting constructs remain problematic and contentious, even among some MMT supporters like the splinter group, the Modern Monetary Realists. Some of this contention results from the usual resistance to new ideas and ways of thinking. But some arises, in my opinion, because MMT terms and accounting constructs are indeed problematic. (The terminological confusion even causes some to object correctly, but for the wrong reasons — and vice versa!)

These difficulties are apparent when you consider one of MMT’s central and oft-repeated mantras and accounting identities, here in its simplified form for a closed economy ignoring Rest of World, courtesy of the redoubtable Stephanie Kelton:

Domestic Private Surplus = Government Deficit

This suggests an important truth, as far as it goes: public (monetarily sovereign federal government) deficit spending creates private assets out of thin air. The government spends new money, created ab nihilo, into private accounts. +Private Assets. No change to private liabilities. So: +Private Sector Net Worth.

But it doesn’t actually go very far. That “private surplus” (a term that is absent from the national accounts, and from MMT’s ur-text, Monetary Economics by Godley and Lavoie) is not defined in accounting terms, except circularly and tautologically: it’s the amount that private assets increase as a result of government deficit spending. That makes the identity true by definitional tautology.

But contrary to what’s at least implied by the equal sign, deficit spending is not the only way that private assets increase, or even the primary way. It’s not the only source of private-sector “surplus” or “saving,” as is often suggested in MMT discourse. Not even close.

Start by thinking in terms of Household Net Worth. This measure has the virtue of encapsulating and telescoping all private-sector net worth, because households ultimately own firms, at zero or more removes, but firms don’t own households (yet…). Citibank may own some GE shares, but Citibank is ultimately owned by households. Because: firms issue equity shares; households don’t. It’s an asymmetric, one-way ownership relationship.

Then take a look at this paragraph from MMTers extraordinaire Eric Tymoigne and Randall Wray:

MMT does differentiate between saving (in the flow of funds it is the change in net worth: ΔNW) and net saving (saving less investment). Net saving shows how the accumulation of net worth occurs beyond the accumulation of real assets. For the domestic private sector, this comes from a net accumulation of financial claims against the government and foreign sectors.

Some of the problems with this paragraph:

• Pace T&W, there is no “saving” measure in the Fed’s flow of funds accounts (FOFAs) that equals ΔNW — whether you’re talking net or gross saving (with or without consumption of fixed capital), including or excluding capital transfers.

• The “net saving (saving less investment)” bruited in that paragraph is confusingly at odds with the existing definition of the term as used in the national accounts — gross saving minus consumption of fixed capital.

• “Net accumulation of financial claims” does not appear anywhere in the national accounts, and has an uncertain relationship with a measure that the FOFAs do provide: “Net acquisition of financial assets.” Are these the same measures? If not, what is their accounting relationship?

I find here a set of terms that I’m unable to resolve into a coherent set of accounting statements — despite years of diligent and highly motivated efforts to do so. (I’m an ardent MMT supporter; I wouldn’t be thinking these thoughts if it weren’t for the MMT cabal.)

The core problem is these measures’ opaque relationship to net worth, and change in net worth. The problem exists because they don’t incorporate the primary way that net worth (wealth) is accrued: market revaluation of existing assets, a.k.a. capital gains. Market runups increase private-sector assets, without increasing liabilities. Voila: higher private-sector net worth. “Money” created, ab nihilo.

MMTers seem to have these conceptual, terminological problems for the same reason as more traditional economists (and due to MMTer’s efforts at speaking in those economists’ language): they’re still “thinking inside the NIPAs” — despite MMTers well-founded devotion to the FOFAs.

The BEA’s National Income and Product Accounts, pioneered by Simon Kuznets in the 1930s, are essentially income statements. They are one of the primary data sources for the FOFAs. But the NIPAs have a key failing: they don’t include balance sheets (the essential second component of a coherent accounting, which the FOFAs add). And the NIPAs completely ignore (with good reason) existing-asset exchanges and revaluations.

Absent balance sheets, and accounting for existing-asset revaluation, it’s impossible for balance sheets — and net worth, period to period — to…balance. Economists who don’t deeply understand that — and I will assert that few economists do, because they’re conceptually trapped inside the NIPA’s balance-sheet-free definitions of income and saving — cannot form a coherent understanding of an economy’s workings.

In Monetary Economics, Godley and Lavoie (G&L) do show a deep understanding of revaluation’s importance — they give extensive coverage to the Haig-Simons accrual-based mark-to-market accounting approach that I also favor. But you’ll be hard-pressed to search Google for top MMT names (Wray, Tymoigne, Kelton, Fullwiler) and find asset revaluation, capital gains, or Haig-Simons accounting incorporated into their discussions of income or saving.

This even though the FOFAs (presented in the Fed’s Z.1 reports) provide exactly that: balance sheets and income statements based on Haig-Simons  accounting — using accrual-based, marked-to-market revaluation of existing assets — wherein the sum of accounted flows totals to balance sheets’ period-to-period net worth changes. See for instance the Household tables B.101 (bottom line: net worth) and R.101 (top line: change in net worth).

Those FOFA tables are the source of the Integrated Macroeconomic Accounts for the United States (IMAs), which unlike the NIPAs, conform (mostly) to the international System of National Accounts (SNAs). See for instance Household table S.3.a, which includes the income statement and balance sheet on a single page (bottom line: net worth).

You will find a similar Haig-Simons approach in Armour, Burkhauser, and Larrimore 2013, an analysis that merits significantly more attention, and replication. (The authors, inexcusably, have not made their data set available.) The FOFAs and IMAs provide the necessary revaluation estimates for such a replication, estimates which Armour et. al. achieve by their own methods (somewhat different from the Fed’s, but using similar indices).

This is all important because the widespread MMT statement (at least implied, and frequently explicit) — that government deficits are the source of private saving (or “surplus”) — is at least a poor explanation of economic workings, and at worst just wrong. Government deficits are a source of private saving.

The two primary sources of private assets (hence saving) are:

  1. Surplus from production (how “surplus” is commonly used in the national accounts), monetized by the markets for newly produced goods and services.
  2. Revaluation of existing assets — assets produced in previous periods — realized in the existing-asset markets.

I would even go so far as to say that these are the primary mechanisms whereby “money” is created. Deficit spending is small beer compared to cap gains. Asset markets go up, and there’s more money. This eschews the widespread confution of money with “currency-like things,” suggesting rather that all assets — which since they exist on balance sheets are necessarily designated in a unit of account — embody “money.”

As an aid to untangling the confusion that I still find inherent in MMT discourse, I offer up the following taxonomy of sources for household income. It’s explained in detail here.

Household Income Sources
Comprehensive Income (gross contributions to net worth, before netting out expenditures) Non-Property Income (compensation for labor) Other Labor Income Social benefits and other transfers received (including employers’ social contributions)
Primary Income Primary Labor Income: Wages and salaries
Comprehensive Property Income (compensation for ownership) Primary Property Income: Dividends, interest, proprietors’ income, rental income, and operating surplus
Other Property Income Market asset revaluation (capital gains)
Other changes in asset volume

Here’s what that looks like in an accounting statement, here using IMA data:

Screen shot 2015-10-02 at 9.01.27 AM

Before you raise objections, I point you again to further explanation of this construct, here.

Like Armour et. al., I use a measure labeled “Comprehensive Income” that includes accrued, marked-to-market capital gains. I go a step further, however, and propose another measure based on that, a residual of sources and uses: “Comprehensive Saving.” That measure has a singular virtue: it equals change in net worth.

“Primary income” — the vestige of the NIPA’s “income” measure that is carried over into the FOFAs and IMAs (but properly labeled as “Balance of primary incomes”) — is given as an addendum measure. The measure here varies from the FOFAs/IMAs only in that interest paid is not deducted from income; it’s tallied under Uses.

Comprehensive Saving does not, of course, equal government deficit spending. (Nor does Primary Saving.) Such spending contributes to private-sector saving, but it’s not even vaguely identical.

Before concluding, I’d like to touch on private-sector bank lending. (Modern Monetary Realists, are you listening?) Its direct effect on net worth is zero. It creates new assets — bank deposits. But unlike government deficit spending, it also creates equal and opposite offsetting liabilities on both the borrower’s and the bank’s balance sheets. Both balance sheets expand, equally on the left and right sides.

Borrower: +Assets (new bank account deposits)  +Liabilities (new loan payable)

Bank: +Assets (loan receivable)  +Liabilities (customer deposits withdrawable)

So the act of private lending itself creates new assets, but it doesn’t directly, in accounting terms, increase private-sector net worth.

But: borrowers use many of those loans to create real assets — goods, capital — that are then sold at a higher value (or marked to market at a higher value). That markup increases private sector net worth, and private lending is a huge catalyst for that process. But that is an economic effect, not an accounting identity.

So yes: private bank loans create new private-sector assets, and they have the indirect economic effect of increasing net worth, but they don’t, directly and in and of themselves, increase private-sector net worth. Government deficit spending does. MMTers are right that it’s special in that way.

What they’ve missed — or caused many of their followers to miss — is that it’s not the only thing that’s special in that way.

Really, it’s not even close:

Screen shot 2015-10-02 at 10.21.20 AM

Runups in stock and real-estate markets create new wealth, net worth, “savings,” money, out of thin air — just like deficit spending, but by a different mechanism.

The markets create money too.

Cross-posted at Angry Bear.