Commentary

The economy is not as strong as supporters of Obama would like it to be. Nor is as weak as his Republican opponents describe it as being. Obama is not anti-business. Nor is he particularly pro-worker. His stimulus efforts have been half-hearted and late on the scene. And his opponents have been both vague and deceiving in their alternative policy prescriptions.

In short we are stuck. Rudderless. And having to make do with a year long election evasion of responsibility rather than decisive action.

So last week’s poor employment report comes as no surprise. At 120,000 new jobs it was way short of expectations which all were around 210,000, and it broke a good string of months all topping 200,000+ new jobs. The immediate reaction has been that the odd weather has created a distortion in the seasonal adjustments applied by the government to the raw data. This distortion probably pushed January and February up and March lower than the underlying trend suggests.

It does not, however, alter the broad conclusion: the economy is still falling way short of the level needed to retire full employment within a reasonable time frame. And I take reasonable in this context to be two or less years. No one should take comfort. The economy is making merely patchy progress.

This is entirely unsatisfactory. The tools exist to improve things. Those tools have either been weakly deployed or not deployed at all.

The economics profession has hardly covered itself with glory during the ongoing impasse. We have indulged in a prolonged rehashing of old arguments. We have called each other names. We have thrown intellectual bricks across the divide. And we have failed utterly to cohere around any sort of central policy advice. The enormous divide that freezes our politics into a persistent, testy, and destructive stand-off is mirrored precisely in economics. The subject needs either revamping or abolishing as it now stands. Since neither is likely the public is stuck ill-served and rightly skeptical of anything that emerges from the mouths of economists. Apparently economists do not see themselves as public servants despite the prestige that accrues to those who dispense advice and despite the ease with which economists opine about subjects wear and wide as if they were speaking from a settled base.

One naive acid test for the failure of economics is that after decades of research and the associated torrent of learned papers the discipline is no closer to a coherent understanding of the basics of an actual economy. What we can say with some certainty is that the central tendency within economics is the least useful in that it incorporates an extraordinarily distorted view of human behavior. We thus can conclude that its basic conclusions are wrong, or at least so disconnected with reality as to be useless. As I have tried to explain to you before: economists do not discuss actual economies, they discuss toy, or artificial, ones. They then like to pretend that conclusions drawn from the toy version can provide a basis for prescriptions in the real world. Fortunately for us all the real economy – as opposed to the artificial ones – is sufficiently robust that it can withstand all but the most egregious experimentation inflicted upon it by economists. They can tinker all they like, but things tend to chug along undisturbed.

Except when the experimentation is persistent and entrenched.

When experiments are allowed to run unabated, unchecked, and without balance they cross the line from experiment to performance. They seek to rebuild the real world in the image of the toy. They seek top replicate the naive simplified world of the test tube in the messy and hugely complex actual world.

Thus when economists argue that deregulation is beneficial because it opens up the efficacious effects of the market place they offer no “proof” other than that they have observed such effects in the test tube under massively restricted conditions. They have no idea as to whether that effect is transferable to an actual economy. Nor do they “know” that government intervention in an economy renders it less “efficient”. They assert such things. They have no proof.

What they do, instead, is to advocate deregulation in order to bring the actual economy into closer approximation to their test tube version.

This, you will notice, is the opposite of some other scientific endeavor. Instead of making simple models to test ideas about the world, economists seek to simplify the world to prove the righteousness of their models.

When other disciplines blindly accept the rotten economics that emerges from this perverse approach strange and dangerous things can happen. massively anti-social results can accumulate.

One example of such damage is the entire edifice of modern business theory. Its relentless focus on shareholder value is based upon the notion that “efficient” outcomes can be achieved in the real world. Efficiency, as you all know, is a relative concept. Something is efficient with respect to something else. Orthodox economics pretends that it can produce efficient outcomes. This pretense is dependent upon a highly dubious definition of what efficient is. Business theorists simply accepted that efficiency was possible and then built a set of approaches to accomplish it. They pulled the same trick as economists: by simplifying away all humanity from their models they were able to concoct theories that work in the abstract. They then applied those theories in the real world despite obvious and highly undesirable side effects that arise when humanity is re-introduced. The relentless pursuit of shareholder value – the sine qua non of business strategy – has produced enormous profit for business. It has also produced a string of debilitating side effects for society at large.

It is questionable which is more destructive: modern orthodox economic theory, or the modern business strategies based upon it.

Either way: after all the intellectual effort devoted to both, the results seem to be disappointing. We have a rotten economy. We have huge profits within it. And we have persistent and unacceptably high unemployment.

From my perspective the entire edifice is morally bankrupt.

But what do I now.

This patchwork just won’t do.

Forgive me. My ‘grandmother quotient’ is running at danger levels.

Frequent readers will know the special place my grandmother has in my development. In just a few sharp phrases she influenced me far more than anyone else. One of those phrases grates on me: “Remember, Peter” she said one day “They can always take it away from you.”

Quite why a young boy needed to know this, and who the “they” or the “them” was I never have figured out. But somehow her words resonated and I have been on the side of equal opportunity and other progressive causes ever since. She meant something. She had lived through the fight to level, at least somewhat, the gross inequalities that mar nineteenth century British development, and she emerged a hardened warrior for the underprivileged everywhere. In her own way of course. Always in her own way.

I mention this because I find myself reflecting on her words more frequently nowadays. That’s what I mean by my grandmother quotient. There is a direct relationship between my such reflection and my perception of the state of the economy. I don’t really care how well the economy is doing, so much as I am concerned by how well people are doing.

And therein lies the tale.

Economists are notorious for trying to eliminate people from their theories. That way they can pretend to be scientific in the grand manner of physics and mathematics, rather than in the manner of biology, history, and other subjects rooted firmly in evolution, and, especially, time. Economists use jarring words like ‘agents’ and ‘units’ to strip away humanity and to avoid having to face the consequences of their allocative mechanisms. They make things impersonal so they don’t have to look unemployed people in the eye and explain to them that unemployment is always voluntary – in theory. I imagine they fear they might be punched by the voluntarily unemployed. Sometimes I want to punch them myself. Especially those who are tenured whilst explaining the evils of tampering with free labor markets.

Inequality seems to fall into this same category.

Hey, the economists say, that’s just tough. Stuff happens. But our theories tell us exactly what the right answer is if we all want the most efficient allocation of resources. Right? Those hifalutin equations give us such exact answers. Just look at the decimal points. Such precision is hard won. And worthy of many, many, Nobel prizes. That some folk win, while some folk lose, is just not important. Not at all. What’s important is the efficient of the outcome, and the elegance of the reasoning. Elegance is particularly important in the rarified world of economic theorizing. The fine tuning is nicely balanced. Elegance makes it ever more so.

Perhaps it’s the astonishing capacity of orthodox economists to conduct a conversation with themselves as if they were engaging something else that mystifies me most. They really don’t get out much. Anyone intruding is laughed at as being an amateur. And we all know how simple and naive amateurs can be. After all they never paid their dues to join the club. Within the professional cloisters jargon hangs heavy and the total irrelevance of the conversation to the real economy is itself irrelevant. Economists, as I have shouted out many times, don’t talk about the real economy. They discuss their own imaginary one.

In there, agents patrol endlessly, tirelessly digesting infinite streams of data, calculating at universally unattainable speeds, knowing all, and arriving instantaneously at perfect answers. All in the name of efficiency and allocative maximization. This parallel universe actually parallels nothing. It vectored off a long time ago. There is probably a non-Euclidean geometry to describe the warp into which economics has ventured, but I am unaware of which it is.

Consider this: you are one of those agents.

Think about that. You and your fellow 6.8 billion humans are the stuff of economic theorizing. Or at least the outcomes of what we do every day are. How many economic transactions do we all make a day? Fifty? One hundred? More? Apparently there is a giant hidden hand ensuring that all those transactions – 6.8 billion to the nth power – mesh seamlessly into one gigantic computation that ends up establishing the correct order we know as an equilibrium. Amazing. Death defying. Indifferent to time. Indifferent to uncertainty. Indifferent to any gritty nonsense at all. The miracle of the price mechanism ensures, with unnerving accuracy, that those equations so elegant bring us to the nirvana so longed for by us all. That is the happy place where none of us, not one of those 6.8 billion souls, can change a single thing without setting someone else back.

Wow. That’s quite some trick. I need to meet this price mechanism one day.

Because the one I come across on my daily walks around New York City seems to produce something a little different. Like homelessness. Like inequality. Like a whole lot of things that someone – one of our fellow agents – would like to change, and which probably wouldn’t wreck anything at all for anyone else anywhere.

Meanwhile I have a favor to ask: I am trying to do my best by this rational expectations thing. It’s very difficult. I am worrying endlessly nowadays about the enormous increases in taxes that are inevitable to pay off the needless and thoroughly useless stimulus. Since the stimulus was financed with debt, I am aware of the trajectory of future taxes and need to plan accordingly. I need, in order to maintain my status as a true denizen of orthodox theory’s world, to adjust my current spending. But I have run into some embarrassing issues. Like I have no idea of what those future tax rates might be. And like that fact that my spending bumps along the boundaries of sufficiency, so to reduce it seems likely to inflict quite a bit of near term pain. Then there’s the problem faced by my grandson. He, taking the long view, needs to know crop prices – he lives on a farm – in 2053. After all he is rational. His expectations need to be brought into line. I realize he’s a bit young, but he doesn’t want to tamper with elegance.

Anyway any help you can all provide will be most welcome. We would hate that it were our family to ruin the machinery of equilibrium.

My grandmother would probably look at orthodox economists as being part of the reviled “them”. In their zeal to defend markets from the presumed tampering of the central authorities they managed to provide ideological cover for those who are strong enough to tip the balance in their own favor. Orthodox theory is not neutral. It is biased. Even its axiomatic base is carefully established to ensure the proper outcome. I call it a GIPO system of thought in honor of Milton Friedman who notoriously fended off criticism of orthodoxy’s bizarre assumptions by arguing that those assumptions can be as crazy as all heck as long as the outcome of the theory that rests on them is “correct”. Where correct means that markets are good and governments are bad. Friedman was a libertarian and it was merely coincidence that his scientific enquiries ended up this way. It could have been the other way round. Honestly. By the way: GIPO stands for Garbage In, Perfection Out.

Orthodox economics is GIPO economics.

My grandmother would probably have a few choice words for Thomas Sargent too. He won the Nobel prize recently for his work on rational expectations. Which is why it’s a little odd that he would co-author, with William Silber, an op-ed piece in the Financial Times talking about the problems with the Federal Reserve Board’s attempt to be transparent in its rate setting policies. What’s to discuss? It doesn’t matter what the Fed does. In a rational world we all know, and have taken those policies into account. Indeed we all know exactly what’s going on inside Bernanke’s head. So why discuss? Why comment? Is he disavowing his own Nobel worthy work? Or is he just talking out of both … no surely not.

Oh. Wait. The entire comment was about monetary policy and the evils of quantitative easing, the hyperinflation it will inevitably unleash, and all the other detritus of orthodox theory. It’s that whole “democracy tampers with efficient capitalistic outcomes” thing.

That naughty government. It always manages to muck up sensible, scientific, economies.

I wonder whether my grandmother included the government as part of “them”.

No. Of course not. She quite liked democracy. More than capitalism any day.

The economy has hit one of those dull patches where all we can say is that it appears to be growing, that growth is steady rather than spectacular, and that we all should go about our business and check back later to see if it has been blown off course.

In view of this I think we ought to reflect on some other things.

Like Martin Feldstein’s evident confusion.

He, in true economic guru style, muddles ideology with economic analysis. In today’s Financial Times he sets out to disparage Obama’s impending tax increase. This, it turns out, is the Bush tax increase that has been kicked down the road a couple of years because we all know that such a thing would be hugely counter-productive in the midst of a recession. Only now we are supposed to be recovering so further delay is beginning to look less problematic. Right wingers like Feldstein love to pin the problem on Obama and neatly forget that the issue of whether to implement the planned reversion to Clinton era tax rates was embedded in the 2011 and 2003 tax cuts. Back then the trickery was that in order to avoid the tax cuts looking like they blew up the Federal budget – which they did and were intended to – they had top appear “temporary”. Permanent cuts would have triggered a debate about how to re-balance the budget by slashing spending, and since the Republicans, then in power, wanted to avoid such a conversation, they hid behind the fiction that the cuts were not permanent. The other neat trick was to ensure that any debate took place after George Bush left office. presumably he didn’t want to have to deal with the mess he was making.

So here we are, predictably, with a right winger pinning the blame for an imminent tax increase on Obama, when the entire problem stems from a flawed piece of Republican legislation.

Anyway. According to Feldstein implementing the Bush law would destroy our recovery and thus we ought to avoid, at all costs, re-electing Obama. This is the intent of his article. There is no analysis. There is no justification of keeping taxes at these low levels on the basis of some new economic insight. It is simply Feldstein shilling for Romney. Perhaps he is tired of teaching at Harvard and wants another go at being a policy maker in Washington.

In any case his article is not economics. It is politics.

I find it interesting that the few statistics he gives us in his ideological argument are those of the total revenues of the Federal government. He tells us that, were taxes raise according to the Bush plan, government revenues would rise from 15.8% of GDP all the way to 18.7% in 2013, to 19.8% in 1014, and then stay around 20% for a decade or so. What he avoids telling us that this is comparable to the levels during the Reagan administration when Feldstein was a key policy advisor. Apparently government revenues of around 18% – 19% are deeply threatening to the American way of life in 2013, whereas back in 1987, when they were 18.4% they were no such threat.

Oh. And nor does he mention that revenues hovered at those levels all through the Clinton era – peaking at just over 20% – even while the economy boomed.

Some facts are just too inconvenient to mention.

The problem with an economist being a political shill is that they tend to use facts very selectively and to deploy only those aspects of theory useful to their argument. Other bits, and lost of history, are left out.

Feldsetin is adding nothing to our debate over fiscal policy other than to give color to Republican extremism and its attempt to defund entitlement programs – he comments very briefly that we need a serious debate about how to rein in entitlement spending but glosses over what that might mean. No. His thrust is simply to fire off a salvo about the putative Bush Obama tax increase, and how awful it would be.

If only we were all sensible and elected Republicans, just like Professor Feldstein, academic and impartial as ever, suggests is best given the science of economics upon which he bases his utterly neutral comments.

Sure.

Then there’s the Economist.

I feel sorry for the people there. They want to stay close to economic orthodoxy and preach the gospel of free markets, but every so often it gets in the way of making a sensible comment.

This week they are focused on the returns on equity. In particular they point out the the so-called traditional premium due to equity investment, over safer investments like government bonds, is an illusion. Stocks have underperformed bonds for a decade. This has all sorts of nasty ramifications.

For one ting it helps explain why businesses are slow to invest the mountains of cash they have. The return is there. They’d be giving up on a nice steady income from their investments in bonds. Shareholders who base their long term plans around receiving an equity premium are deluding themselves. This probably is not a great issue to any of us, were it not for the fact that most pension funds base their contributions and pay-outs exactly on earning such a premium. If the equity premium isn’t there, pension funds are left scrambling to earn a return from other sources in order to meet their pension obligations.

So it does matter.

And the Economist chose this week to talk about it.

The real nugget though is hidden from view. What they don’t want to mention too clearly is that this lack of equity premium is a major reason why privatizing Social Security was such a rotten and toxic idea.

Recall that a major plank upon which privatization is based is that the current return on the Social Security fund is tethered to US bonds. It thus doesn’t get that elusive equity premium. So advocates of privatization wave the supposed higher return someone could get from equities and argue that they are forgoing riches untold. Were someone, the story goes, able to untether themselves and play the market, they could dive into that stream that the equity premium provides and retire a whole lot better off than the way the stuffy Social Security system allows. The equity premium is a vein of gold denied to retirees by the government. So: we ought to privatize.

The argument sounds good.

It ignores all the risks associated with equity investment. And it ignores all the fees associated with running a private portfolio. I fact it pretty much ignores all financial theory. But it sounds good.

Until we realize that there is no equity premium. And that we are deluded when we refer to it because it may have been an aberration rather than the norm.

Worse: another thing the Economist touches upon lightly so as not to embarrass the privatization folks is the old supply and emend problem. Were we to privatize and pour more money into the stock market in search of the equity premium chimera, we would assure it’s nonexistence. All that money would drive returns down.

Lastly, we are told that because the premium doesn’t really exist we all should plan to save more in order to beef up our retirement. This would drain spending out of the economy in the short term, drive down returns to business, and make them yearn for the safety of their bond portfolios even more.

And, as Professor Feldstein argues, uncertainty over those returns stops our loyal businesses from investing even though they are flush with cash. So he would probably want a tax cut for business to give them an incentive. But that would imply we need steep cuts in entitlements. Menaing we all would have to save more. Which means that returns would fall more. Which means …

That it must be the government’s fault. Just like erstwhile scientists like Feldstein wanted it to be all along.

Phew.

Ain’t economics grand?