Chris Dillow's Blog, page 195

Doubts about wage-led growth

Today's GDP figures suggest that even one of the left's better economic ideas might not be effective.
I'm referring to wage-led growth - the idea that a shift from profits to wages will raise aggregate demand.
This would be true if the marginal propensity to spend out of £1 of wages is higher than the marginal propensity to spend out of profits.
For most of the 00s, this was in fact the case. Between 2005 and 2010, non-financial firms' capital spending fell even though retained profits grew by 21.7% - implying a slightly negative marginal propensity to spend. However, during this time consumer spending rose 19.9% as disposable income grew 19.1% - an MPC of over unity*.
These numbers suggest a shift from profits to wages would raise aggregate demand.
But today's news suggests the numbers are changing. They show that in Q2 nominal consumer spending rose only 0.1%; it fell 0.8% in real terms. But wage incomes actually rose, by 0.4% nominal. This suggests the marginal propensity to consume out of wage income is low now.
If this is the case - and the usual caveats apply to one quarter's numbers - then policies aimed at boosting wages might not increase aggregate demand by much. This could be because people would use wage rises to repay debt.
By contrast, business investment rose 8% in Q2 despite a fall in profits. This would be vindication of wage-led growth, if investment rose because capitalists anticipated that higher wages would raise aggregate demand. But I don't think this is the case. Instead, it could be that firms are finally starting to spend the cash they built up during the 00s.
It might be, then, that shifting incomes from profits to wages now would actually depress aggregate demand. Workers would use pay rises to repay debt, whilst capitalists might regard falling profits as a reason to hang onto their cash.
You might wonder how this story fits in with my long-held view that there's a dearth of investment opportunities.
One possibility is that the dearth is diminishing. Another  is that overconfident bosses are spending their cash piles on projects that might not turn out to be as profitable as hoped.
Whatever. My point is that wage-led growth could be an idea whose time has passed. Even if there were policies that would raise the wage share - which is not clear - doing so mightn't raise aggregate demand. As I've said, it's harder for governments to  raise economic growth than generally supposed.
 * Tables A22 and A40 of this pdf.

Unemployment, scarring & well-being

Morrissey was right. When he sang "I was looking for a job and then I found a job and heaven knows I'm miserable now", he was getting at an important point.
In a new paper, Wolfgang Maennig and Markus Wilhelm show that the link between unemployment and well-being is asymmetric. Although people who lose their jobs tend to become much less happy, the unemployed who find work see a much smaller rise in happiness. Depending on controls, losing your job has an impact upon happiness that five-to-ten times greater than the impact of finding a job.
This suggests that unemployment might have a long-term scarring effect upon well-being. Getting a job does not return one's well-being to its pre-unemployed state.
This is not because the new job often pays less well than the old one, as people lose job-specific human capital; the findings control for changes in income.
 Nor is it because people get used to unemployment and so learn to appreciate the leisure which they lose on finding a job. This research shows that people who stay unemployed actually become unhappier, corroborating other research showing that people don't adapt to being jobless.
Now, this research is not the final word. Taken on its own, it implies that someone who suffers several periods of job loss and job finding would eventually see their wellbeing fall to zero, which doesn't happen. So something else is going on.
I suspect this something is that becoming unemployed damages our self-image. It tells us that we are not in control of our own destiny, and some people - enough to affect average happiness - take this badly. This shock is not full reversed by getting a new job. If I'm right, we wouldn't expect repeated cycles of job loss and job finding to continually grind unemployment down, as it's the first spell of joblessness that does most damage.
Whatever. This hints at an important point. There's a trade-off between a flexible labour market, in which there are high rates of job loss and creation, and personal well-being. You can't have both.
This is a big problem, because economic growth probably requires (pdf) significant rates of job turnover.

The NMW: a menace to youth?

Tim thinks that the Low Pay Commission is coming round to his way of thinking. He notes a report in Telegraph and says:

We said that if you bring a min wage, one which continually rises above general wage inflation, then you will get to a point where it does severely crimp employment prospects. And it will be first evident among the young, untrained and untried.

Now, let's leave aside the fact that the Commission has not done anything as vulgar as actually present new facts here; a chat to a Torygraph reporter does not count as evidence. And let's also leave aside the fact that others have found the link between the NMW and youth unemployment to be surprisingly elusive.
Let's instead do some simple maths. There are 4.06 million 18-24 year-olds not in full-time education. 2.77 million of these are in work, and 1.29m - 31.8% - are unemployed or inactive. This means that to get the employment rate up to 80% for this group would require an increase in employment of 17.3%.
How could such a rise be achieved by abolishing the NMW? There are only two possibilities: either the abolition allows wages to fall a very long way; or the price elasticity of demand for young workers is very high.
The former seems unlikely. I suspect that even if people did turn up to work for derisory pay, the effort they put in would be minimal. Remember, it's not just laws that set the minimum wage - social norms do too. And it's possible that these put a floor under wages that isn't far below the legal one.
The latter is also doubtful. High elasticities usually exist only where there are close substitutes. Yes, it's likely that an average 20 year-old is a close substitute for an average 21-year-old, and this will generate a high price-elasticity of demand for 20-year-olds. To this extent, abolishing the youth NMW might expand youth employment a lot.
But the corollary of this is that the youth NMW is currently having the opposite effect - of supporting demand for 21-year-olds.
What's more, this is only true for averages, and we're not dealing with averages here. As Tim says, the youth NMW bears heaviest upon the least skilled, the "untrained and untried." But these, by definition, have fewer close substitutes and so the price elasticity of demand for them is likely to be low.
These thoughts lead us to the conclusion - that even if we do live in the Econ 101 world in which lower prices of youth workers raise demand, it is improbable that abolishing the NMW alone would create anything close to full employment among the young.
There are many other things wrong with the youth labour market: lack of demand, lack of skills, poor matching between skills and vacancies, whatever.  The NMW is a lesser problem. Blaming it for youth unemployment is an example of what I've called the "small truth, big error" rhetorical trick. 
The notion that scrapping minimum wages is sufficient for full employment of young people is fancifully utopian.

The growth raindance

Andrew Tyrie wants George Osborne to do a raindance:

Mr Tyrie called for the tax system to be simplified and business taxation to be reduced, and said he wanted to see fewer regulations and changes to labour laws…
"A much more coherent and credible plan for supply-side reform to improve the long-term economic growth rate of the UK economy is now needed."

This runs into an embarrassing fact - that history shows that Tory "supply side reform" has not raised growth. In the 23 years since Nigella's dad cut the top rate of income tax to 40%, GDP growth has averaged 1.92% a year. In the previous 23, it averaged 2.47% a year. Even if we ignore the recent recession (and there's no reason we should) growth in the 20 years after Lawson's Budget averaged 2.4% a year - less than in the 1965-88 period. 
This matters. Since the 80s, Tory supply-siders have had pretty much the policies they hoped for - deregulation, lower corporate taxes, lower top taxes, privatization and much weaker trades unions. And yet growth during this period has been no higher than it was when, according to legend,  Red Robbo and Paddy Fleming were shouting "everybody out" every day.
This is not necessarily proof that "supply side" policies alone fail. It could be that no government policies can reliably raise long-term growth, because this is determined by factors which governments cannot control, such as entrepreneurial spirit or the rate of monetizable innovation.
This is why I say Tyrie wants the Tories to do a raindance. He wants them to give the impression of doing something, so that they can claim credit if growth picks up later. This is policy-making not as rational, empirically-guided activity, but as ritual.

"Values" and the crisis of social democracy

Phillip Collins in the Times (£) reminds me why I'm a Marxist rather than a social democrat. He mocks Ed Miliband's claim that Britain has been run by people with the "wrong values" as being "the dying breath of vintage social democracy."
What Philip doesn't do, though, is show why Miliband is so wrong.
To do this, let's concede his factual premise - that bosses have had the "wrong values". How can this be so?
Miliband seems to suggest that it might be just bad luck.
Nonsense.
What he misses is that selection effects and incentives serve to generate the "wrong values" at the top. I mean this in four ways:
1. It tends to be the ambitious and charming to rise to the top, but these are disproportionately psychopaths.
2. Bosses and politicians are selected for their irrational overconfidence. This means that, when they get power, they are likely to over-rate their own ability and so undertake dangerous policies such as takeovers.
3. "Yes men" tend to get promoted more than nay-sayers and "trouble-makers". This can contribute to groupthink in boardrooms in which bad decisions are not sufficiently scrutinized.
4. Even if these selection effects were not to work, and bosses had "good values", competitive pressures would compel them to act badly. As Marx wrote:

Capital is reckless of the health or length of life of the labourer…But looking at things as a whole, all this does not, indeed, depend on the good or ill will of the individual capitalist. Free competition brings out the inherent laws of capitalist production, in the shape of external coercive laws having power over every individual capitalist.

Granted, Marx slightly overstated the case: it can sometimes be rational for bosses to offer good pay and conditions. But the general point holds (sometimes). The bank boss who didn't hold dodgy mortgage securities or sell payment protection insurance policies would have seen his bank's share price fall and been under threat of losing his job.
The problem, then, is not one of values but of mechanisms. Capitalism contains mechanisms which tend to produce the "wrong values". The challenge for social democrats is: can you provide alternative mechanisms that constrain this tendency?
Years ago, the answer was: yes, sort of. Strong trades unions acted as a countervailing power - for example by reining in bosses' "greed."
But in a world of weak unions, what have social democrats got? Nothing, I fear, but windy moralizing.
Another thing: It's quite possible that politicians, quangocrats and top civil servants are also selected for overconfidence and "yes-men" characteristics. If so, this just deepens the mess that statist social democracy is in.

Libertarians in the ghetto

This post by Tom Papworth depresses me. He cites Robert Nozick's famous Wilt Chamberlain parable to show that:

Egalitarianism is completely incompatible with freedom. The guardian of distributional justice must constantly intervene to thwart free exchange among individuals.

This is daft. Wilt Chamberlain was in fact taxed very heavily - top tax rates in the 60s were over 70% - and yet he continued playing. His fans weren't "thwarted" from seeing him play at all. Tom's claim that high taxes undermine incentives is, in this case, plain wrong.
Yes, Chamberlain's fans would have been thwarted, had their desire been to see him make even more millions than he did. But it's not obvious they did want this.
Tom is wrong in another sense. He says that egalitarians are mistakenly "fixated on money":

What matters in society is one's ability to satisfy one's ends, not the amount of cash one has under the mattress. Therefore an equal society is surely one where everybody's ends are equally satisfied. If Wilt and his fans are equally happy, society is equal even as Wilt amasses his millions. If Wilt and his fans are compelled to have the same amount of money, and as a result Wilt's fans feel deprived of good basketball while Wilt gets to accompany the President to an important funeral, society is unequal even if Wilt and his fans have a similar bank balance.

This is wrong, and not just because progressive taxes did not deprive Wilt's fans of good basketball. It's also wrong because the monetary inequality that arises from such voluntary transactions can cause other ends to become unsatisfied.
For example, the rich might use their wealth to fund political causes, thus generating inequality of political power. Or they might misinterpret their good luck as some reward for their own virtue and so develop an excessive arrogance or sense of entitlement, thus threatening social cohesion. Or they might just spend their money on inherently scarce positional goods, which third parties - who otherwise have no view on Wilt Chamberlain - cannot then afford.
All of this, though, is a secondary issue. Egalitarians' objection to inequality is not, principally, that it rewards the likes of Wilt Chamberlain or even Carlos Tevez. It's that, instead, a lot of inequality arises from non-voluntary mechanisms such as exploitation or primitive accumulation (which is still going on today). Nozick himself saw this. He wrote:

One cannot [his emphasis] use the analysis and theory presented here to condemn any particular scheme of transfer payments, unless it is clear that no considerations of rectification of injustice could apply to justify it (Anarchy, State and Utopia p 231)

All of this brings me to my main gripe. If Tom had spoken to any egalitarian, or read Jerry Cohen, he would be aware of the sort of points I've made and would have tackled them. But he shows no sign of having done so. He's just constructed some straw man ("the egalitarian") and knocked him down with a 40-year-old story that actual, real egalitarians have long since answered (whether well or badly is another matter).
He is, then, just stuck in some intellectual ghetto talking to fellow believers.
But of course, it would be absurd to think that only "libertarians" are guilty of this. Lefties do it too; I don't have to name names, do I?
And this is why I say I'm depressed. What we're left with is not a political discussion at all, but rather two mutually ignorant circle jerks. 

In defence of short-termism

Yesterday, Ed Miliband attacked "short-termist culture" and people who chase a fast buck. This is a mistake. There's much to be said for short-termism.
The evidence that investment is being held back by short-termism comes from a recent paper (pdf) by Andrew Haldane and Richard Davies. They say:

Cash-flows 5 years ahead are discounted at rates more appropriate 8 or more years hence; 10 year ahead cash-flows are valued as if 16 or more years ahead; and cash-flows more than 30 years ahead are scarcely valued at all.

But I'm not sure this is irrational or even wrong. This is because Knightian uncertainty increases very sharply as we look further ahead.
Put yourself in the shoes of a CEO looking one or two years ahead. He's got a fair idea of how Porter's five forces (or another other framework for analyzing business prospects) will look. New products or powerful new rivals don't usually emerge that quickly.
But if he looks 10-20 years ahead, he'll not have a clue. We can't predict how technology and market power will shift over such horizons.
This means that whilst we might have some idea about investment paybacks over one or two years, we can't have such firm ideas over 10-20 years. In this context, short-termism is reasonable.
If we'd had long-term investment in manufacturing in the 80s, we'd have built lots of factories making fax machines and instant cameras.
And in the early 70s, British Rail's long-term thinking caused it to patent a space ship. Its customers would probably have preferred a little more short-term investment in the 7.52 from Orpington.
I suspect that a lot of what looks like long-term investment is in fact short-termism that got lucky. When Bill Gates started Microsoft in the early 80s, it wasn't because he was preparing for a boom in computer demand 15 years hence. It's because he saw a little niche and lucked out as the niche grew.
What's more, short-termism can protect us from two cognitive biases.
One is overconfidence. Given that the long-term future is unknowable, investment in long-term projects is often founded upon overconfidence about one's predictions; this might be true for high speed rail. Short-termism offsets this.
The other bias is the planning fallacy. Complex projects take longer and cost more than expected. Had we had a little more short-termism, we'd not have wasted hundreds of millions on rejigging NHS IT systems or on building a tram system in Edinburgh.
The record, then, surely shows that governments shouldn't encourage long-termism. Its own long-termism is bad enough.
This is all the more true if we ask: what can governments do to ensure that companies can earn long-term returns? The most effective thing they can do is to reduce the uncertainty firms face about future competitive threats. But this requires the government to protect vested interests - which is exactly what Mr Miliband pledged not to do. 

Jockeys, whips & market failure

The British Horseracing Authority has announced tougher new rules on jockeys' use of the whip. This draws attention to an insufficiently appreciated failing of free markets.
What I mean is that using the whip is an example of an arms race. In the absence of rules against whipping, each jockey would whip his horse to go faster. The upshot would be no advantage to individual jockeys - only one of whom could win the race - but lots of discomfort to the gee-gees.  In other words, the rational pursuit of individual self-interest leads to an outcome that is, in aggregate, worse for everyone* - "smart for one, dumb for all", as Robert H. Frank has said.
What's more, this problem cannot be solved reliably merely by voluntary contracts. Jockeys cannot agree among themselves not to use the whip, simply because any individual jockey would have an incentive to defect and use the whip to increase his chances.
The only solution, then, is to have rules imposed from outside, as the BHA is doing.
But here's the thing. There are, perhaps, lots of examples in economic behaviour of arms races.
1. In a workplace each individual has an incentive to work longer hours to win promotion. But if everyone does so, individuals' chances of promotion don't change. All that happens is that people work longer (pdf) than they'd like.
2. One objection to  Catherine Hakim's advice that women should make more of their erotic capital is that, if all women do this they will over-invest in surgery, clothes and cosmetics without improving their earnings. Men will benefit from there being fewer munters, but women will lose.
3. Education, arguably, has become an arms race. If loads of people have degrees, others need one merely to avoid the negative signal sent by not having one. And yet others will get a postgraduate degree to signal their superiority over first degree-holders. The upshot is over-spending on education and over-qualified workers.
4. Robert H. Frank has argued (pdf) that Americans' over-indebtedness in the 00s arose from a kind of arms race. As people saw friends and neighbours spending more, they too spent more in order to keep up with the Jones'. The result was high debt and anxiety arising from a fear of "falling behind."
In all these cases, rational self-interest can lead to a decline in aggregate well-being. Adam Smith's invisible hand, then,  fails more often than is generally realized. In this sense, the BHA has reminded us of the limits of "neoliberalism"
* I'm ignoring here the possibility that race-goers gain utility from the increased speed of all horses.

Social democracy in hard times

I know a party conference isn't the place for clear thinking about fundamental issues. But even so, Ed Balls' speech contrives to miss the basic challenge facing policy-makers.
His five point "plan for growth" consists mainly of temporary tax breaks and the pulling forward of public investment. This would be OK(ish) if our problem were merely a cyclical one of temporarily weak demand.
But it is not. We also face the problem that a combination of slower productivity growth and the investment dearth mean that might well face years of sluggish growth - and the "tough fiscal rules" Balls advocates would merely exacerbate this.
Balls, though, gives little hint of being aware of this. He seems to be in a pre-crisis mindset which imagines that economic growth can be achieved if only policy-makers do the right thing. But what if it can't? What does a leftist economic policy then look like. As Hopi asked:

What is a progressive social democratic party actually for, if it is not able to spend more money than in the past?

I'd suggest four possibilities:
1. Given that investment opportunities are scarce, we must make the most of the few we have. This means investment mustn't be held back by red tape or by a lack of finance; Adam Posen's call (pdf) for a state bank is thus worth considering. But we shouldn't be too optimistic about what these can achieve.
2. There's a case for limiting top pay. The point here is not merely about fairness. One lesson of the collapse of the banks is that high pay doesn't work. It doesn't call forth "talent", but rather destructive rent-seeking and risk-taking.
3. There's also a case for more redistribution to the lower-paid and unemployed. It looks as if the main problem for coming years will be a lack of demand for labour more than a lack of supply. Worrying about blunting work incentives in this context is silly.
4. Workplace democracy. Again, another lesson of the banking crisis is that top-down organizations can fail badly; naturally, given his Brownian managerialism, Balls cannot see this. Managers should be seen not as superheroes capable of transforming organizations but rather as custodians and administrators, and be selected and paid accordingly. Note that I regard worker democracy as a means of increasing equality in part by curbing top pay.
What's more, with public spending likely to be squeezed, it is vital that we make the most of every pound that's spent. This requires that public sector workers have more control, as it is they more than managers pursuing vainglorious strategies who know the detailed nitty gritty of how cash is wasted.
Now, you might object here that I'm seeing my favourite hobby-horses here. Maybe. Please suggest alternatives. The key point, though, is that Labour must ask what social democracy looks like in hard times.
Not only did Balls not answer this question, he didn't even ask it.

"Losing the economic argument"

Douglas Alexander says that Labour has been losing the economic argument. And the opinion polls (pdf), as described by Martin Kettle, bear him out. This is puzzling in two senses.
First, although Labour has (so far) lost the argument in terms of public opinion, it has not lost the argument intellectually. There was a powerful case for it to run deficits even in the mid-00s, and there is, of course, a strong argument against fiscal austerity now.
Secondly, support for austerity is not obviously founded in self-interest. The same polls that show support for the Tory position also show that  71% of voters worry that they will suffer directly from the cuts. And public service users aren't the only losers. Savers are also losing; the counterpart of tight fiscal policy is a prolonged loose monetary policy which is keeping interest rates negative in real terms. When Danny Alexander boasts that the coalition has kept interest rates low, he is confessing to imposing losses upon  millions of older, wealthier voters.
So, why isn't Labour doing better on this issue? I suspect there are five reasons.
1. Labour hasn't tried very hard to defend its case - partly because it doesn't know how to position itself with regard to its time in office.
2. The Coalition has a vivid metaphor  - that we have "maxed out our credit card." Although this is economically illiterate, it is a clearer, simpler message than the alternative.
3. The Coalition has been able to exploit the illusion of "necessity". They've succeeded in presenting cuts as inevitable.
4. Bayesian conservatism. Very many losers from tight fiscal policy - the older, richer people who'd see their interest income rise if fiscal policy were looser and monetary policy tighter - are disposed to support the Tories anyway. (They re not alone in supporting policies against their self-interest; Hampstead lefties who favour higher taxes on the rich do the same.)
5. The guilt-by-association fallacy.  Labour's economic case suffers from negative halo effects. It is closely associated with Gordon Brown, who is a deeply unpopular figure. And it is associated with wasteful public spending.  These negative associations detract support from what is a respectable intellectual case.
Whatever the cause, there's a message here. It's the same message we get from two apparently very different subjects - the inefficiency of tax systems and popular opposition to fixes for the euro area's debt problem. What we see in all cases is that, in politics, rational self-interest does not always win.