Keynes

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What The … Where are the Jobs?

Quick question: when does a series of “special circumstances” become the norm?

The reason I ask is that today we heard bad news on the unemployment front. And, frankly, I am tired of being told that the recent string of reversals in the labor market are all just a sequence of disconnected oddities that mean nothing.

Here’s what happened: new claims for unemployment assistance jumped 43,000 to 474,000. That is ridiculous. We are back where we were last summer. All the steady improvement has been surrendered. There is something rotten beneath the surface that needs attention. Now, not sometime soon.

For a few weeks now the claims figures have been backtracking from the improving trend that set in late last year. For a short while, back then, we appeared to be heading in the right direction with claims even falling below the magic 400,000 level many people think represents the line between a bad economy and a decent one. We haven’t regressed back to ‘well and truly rotten’ territory, but we obviously are stuck somewhere in the middle. We are not making progress.

The string of weak reports has engendered something akin to a yawn amongst the high and mighty of the media and policy making. They are all obsessed with the newer and more interesting – in their minds – issues of inflation and debt levels. Jobs are just not high on the agenda at the moment. My guess is that they will be come the next election, when voters will be able to express their dissatisfaction with being left on the outside yet again.

This week’s special excuse is that we just had spring break in New York State where teachers and other state workers all sign on for unemployment for a single week, plus temporary lay-offs in the auto industry. This, they say, explains the latest jump.

Let me see. In February we had eked out sufficient gains to get the weekly claims number down to 375,000. We have given up 100,000 since then. All of it due to quirks? I think not. And why can a spring break figure distort the seasonally adjusted figures? I thought that the entire purpose of making seasonal adjustments was to eliminate the oddities that come along every year. Last I looked we have a spring each year, so why isn’t the spike in New York being smoothed away?

Something seems wrong.

The four week average, which should provide us some immunization against quirky weeks, has now risen by 22,250, back to 431,250, and is the highest since November.

Things are clearly going the wrong way.

Meanwhile, today’s report from ADP, the big payroll processing company, show that the private sector added 179,000 jobs last month. That’s down from March’s 207,000. In rough terms the economy needs to add about 125,000 new jobs each month to keep up with population growth, so April’s figure is very slightly on the good side of that bare minimum. But there is no way to characterize the current labor market as particularly healthy. Far from it.

We will get a better read on things tomorrow when the national employment figures are released, but at this point I doubt we will be very happy with what we hear.

So why is this ongoing malaise not worthy of headlines?

Politics and attention deficit disorder.

Our messed up politics prevents us from keeping our eye squarely on the employment problem. The half-hearted efforts back in 2009 were all we could manage. They cost us dearly, not in dollar terms so much as in emotional terms. The administration believes its own narrative that it fought hard for what it thought it could get. The stimulus we ended up with was insufficient, but just about enough to stop a full blown depression setting in. After that everyone shifted their attention to health care reform and fixing the banks. The energy expended on core economic policy moved from a fiscal approach towards a monetary approach. So all the efforts last year came from the Fed. Its famous QE2 being the centerpiece of stimulus throughout 2010. The public’s disgruntlement then spilled over into an election that pushed a right wing ant-stimulus agenda to the fore. The Republicans successfully used the deficit to frighten voters into viewing austerity as sensible policy. The temporary payroll tax agreement,viewed by supporters of the administration as a victory, is the only stimulative effort in 2011, and as of now there is no credible thinking going on to increase support to the economy. On the contrary, everyone now seems to think we are in strong enough shape that we can apply the brakes to slow down inflation and rein in debt.

I am not one of those people.

The economy is too weak for us to be considering anything other than continued stimulus.

We are not even talking about the most important subjects: jobs and inequality. Instead we are being given silly arguments about how demand is not the problem. We have, we are told, not a magneto problem to use Keynes word, but a structural problem. The magneto is fine. It’s just in the wrong car. What we need to do, apparently, is to get better workers. The ones we have are useless. They don’t match the jobs we have. What we have is a bunch of out-of-date blue collar workers who want good wages. What we need is a bunch of service industry types willing to work for next to nothing.

The long boom in high end incomes during the last thirty years was accompanied by an equally long stagnation for the bottom ninety percent. The bifurcation was remarkable. I happen to think that this separation accounts for much of our trouble. The redistribution of wealth upwards has left the mass of households unable to crank up spending. The traditional policy tools are thus blunted. The marginal kick delivered by stimulative efforts was too low, not just because the total was laughably small with respect to the gap in demand, but was muted additionally by the fact that most households have no second gear to shift into. They are firmly stuck in first gear – survival from pay check to pay check. Adding a few dollars via a tax cut does nothing to make a substantive or meaningful change to that week to week, or month to month, lifestyle. To the extent we have a structural problem in our economy the causation isn’t flowing outwards from a skills mismatch, it is flowing out of our unequal distribution of wealth. Fix that, and the engine starts to run more smoothly and is more responsive to policy.

Besides, if there is a structural skills issue, who is to blame?

Oonce upon a time firms used to spend heavily on training. Those programs fell victim to the national obsession with quarterly profits and stock prices. The modern management focus on shareholder value recast the cost of worker training from being an addition to an asset – worker skills being a form of capital – to pure cost. It could then be cut as part of the drive for profit. Short term this is fine. Long term it is a disaster. Slowly the pool of appropriate workers dries up and skill shortages emerge. Making this worse is that the private sector, by getting out of the worker education business, assumed that the public sector would provide the supply of needed skills education. It didn’t. Why? Because the same ideology that drove the shareholder value revolution in management theory, also drove an anti-government spending program in the public sector. Spending on worker skill development shriveled across the board. Everyone imagined that everyone else was training the worker of the future. So everyone imagined they could free ride on top of everyone else’s spending. This is a version of the classic tragedy of the commons. The free market fails. The public sector by trying to accommodate itself to a free market ideology, also fails.

So when people like Richard Florida prattle on about how we don’t have an aggregate demand problem, but that we have a structural skills problem, I get really vexed. Where he sees workers with old skills and unfit for modern work, I see workers abandoned by business and government alike and left to fend for themselves if they need to acquire new skills.

To the extent we have structural unemployment – and I am very far from being convinced we do – I see it as the natural convergence of predictable market failure derived from faulty corporate theory and a right wing shift away from a social focus in government policy. In other words the neglect was at the top, not at the worker level.

Which is why it has been so easy for our elite to move on to other topics. They see unemployment as a deep and intractable issue that will take years to solve. They see global workforce shifts and throw their hands up in despair. They say we are faced with a long slow adjustment where all rich economies, not just ours, will have to reorient themselves to tough new competitive conditions in the labor markets. If workers want to make those high wages they will have to shift to new, less globally exposed, lines of work. Meanwhile, the story goes … tough. We should toughen up and take our medicine. All you unemployed are simply victims of a shift in the world’s economy. Thus there’s not much anyone can do to help.

If they point out historic examples of similar shifts I will scream.

You see, their argument is vapor. It is a mask drawn over inequality.

Let me give you some history.

Great Britain, when it was leading the world into the industrial era suffered from skill shortages and was, simultaneously, a high wage economy. Those high wages, in the face of what was fast becoming a more interconnected economy, could have slowed growth down. They didn’t. Why? Partly because those high wages were in the context of rapidly rising productivity. High wages drove employers to substitute capital for labor. Yet unemployment stayed low because as workers were replaced by machines they were absorbed by the expansion in the economy caused by rising demand. The source of that demand being all those higher wages. This was a classic virtuous cycle. Wages were high yet did no harm. On the contrary, they fed demand and hence drove the need for more workers.

Why are we not seeing that here?

Our wages are high relative to China and other emerging economies, and our productivity, along with a weak currency, should help offset that. Indeed just today we learned that productivity rose 1.6% in the first quarter. But we also learned that real wages fell. The implication is that business is channeling the gains from productivity into shareholder profit and not into wages. Thus we have no virtuous cycle. Wages are left to stagnate. That limits the extent to which demand can rise. That, in turn, pushes the point at which business is forced to hire off into the future. All that productivity gain is coming from extended work weeks, not from capital substitution. This despite business having piles of spare cash to invest in capital if it wanted to. It doesn’t because its expectation is for weak sales.

We are stuck in a negative feedback loop, instead of the positive one I described that worked in Britain during the industrial revolution.

And, in my opinion, to jump from a negative to a positive loop we need to redistribute wealth so that the mass of households can shift gears.

That’s the discussion we should be having.

But we’re not. So our jobs market languishes.

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Round Two

The problem with caving in to a blackmailer is that they are inevitably emboldened to try again. Usually the second extortion effort raises the stakes for both sides. This is where we are with the budget. Obama caved in last week in order to keep the government functioning. In the process he acquiesced to a long litany of right wing demands. The cuts agreed to include all sorts of completely irrelevant attacks on various aspects of long standing social programs. The Republicans littered the proposal with cuts that are minor in dollar terms, but hugely significant to their culturally extreme voter base. So the lunatics won round one. They are now back for more.

The start to round two was signaled yesterday when the Republican leadership announced that it will allow the US to hit its debt ceiling. This is expected to happen sometime in mid-May. After that deficit spending will have to be met either by cutting spending, as the Republicans expect and hope, or simply by printing the money needed – i.e. not through borrowing, an approach I have yet to see endorsed by anyone in our elite on either side of the ideological divide.

This will get ugly. Really ugly.

Let’s all acknowledge the serious nature of what is about to go on. The right has set the game up for themselves: this debate is one they precipitated by deliberately defunding the federal budget by cutting taxes back in 2001 and 2003.They undermined our fiscal stability by enacting tax cuts that deprived Washington of money. At the same time they enacted big increases in government spending. They were the very epitome of recklessness. Yet the voters still perceive them as conservative. The left has failed miserably by not being able to persuade voters of the enormous risks associated with those tax cuts. If – a big if – we are on the road to ruin it is because of Republican fiscal strategies, not purely because of unaffordable programs.

Consequently, we are now discussing what America will look like for the next fifty years. Will there be one America with a solid middle class and relatively less inequality? Or will there be two Americas with the current sharp divide widened further? A top one percent, and then the rest? Please keep this in mind as we debate what to do.

The greatest feature of our economy over the last thirty years has been the systematic attack on democracy by the wealthy. They have used every trick to undermine equality. They have accumulated unprecedented power and wealth by emphasizing notions of freedom and individualism that resonate well with voters, but play to the hand of only the strong. That is to say the wealthy themselves.

The long term failure of the American economy to maintain its post-war growth path opened the door to the revival of these and other anti-social ideas. They took strongest root in the aftermath of the 1970’s stagflation when the wealthy were abetted by zealous and ideologically motivated economists who wanted to overthrow Keynesianism. They subsequently infected business with shareholder value strategies that shortened investment horizons and undermined competitiveness. They fueled the great cost cutting and offshoring movement of the past three decades. They encouraged the steady decline of all forms of collective action to protect the weaker elements of society. They encouraged absurd risk taking in finance. They undermined social programs aimed at lifting the poor. They reduced taxes for themselves. They resisted shareholder control of management. They set up interlocking boards of directors so that like minded people sat in judgement of CEO’s. They neutered all criticism. And they homogenized the world view of our media and elite so that there is no alternative taught in “respectable” or “serious” schools nor reported in the mainstream press.

In short they took power and then censored and gutted or suborned the opposition.

Most of this long list has happened in the past thirty years. Cumulatively the effect has been astonishing. America is now the most divided nation in the industrial world. More so than it has been for a very long time. And it is arguably the least stable because its democracy has been subverted.

In short America was taken over, silently and effectively, by a very small group who now runs the place for itsown benefit.

But even the very rich cannot pull off a coup of this sweeping nature without accomplices. This was the cause of the uneasy alliance the wealthystruck with the populist wing of the Republican party. A wing that grew in power in the aftermath of the contests over desegregation and women’s rights. It is easy to forget just how much hatred was stirred to the surface by the prolonged debate over the Civil Rights Act. It’s echo is in today’s right wing disgust at Obama’s very presence in the White House and the pervasive doubt, within the extremist camp, of his place of birth. The alliance is structured this way: the rich want to rent seek and amass wealth. The populist/libertarians want to roll the clock back to a past era where government didn’t interfere. And by interfere the more extremist Republicans mean the government should no be able to limit their ability to discriminate.

Yes, this fight is that basic.

Yes, it is that venal.

Yes, America is that divided.

And, no, some people have never forgiven government for ending discrimination. For them it was an intrusion into their liberty.

It was, I think, Amartya Sen who said that there are no famines in democracies. The great fight over establishing the safety nets in the industrialized nations was a reflection of this effect of democracy. Voters look after themselves. Sooner or later they will force politicians to make sure that most people are safe from economic disaster. This is why democracy is in opposition to capitalism. The one spreads the wealth. The other concentrates it.

That we, in America, have so weak a safety net, and that we have so many people without health care coverage is testimony, by extension of Sen’s observation, to the weakness of our democracy. Money talks in our politics. The agenda is set by the wealthy. The majority have to accept what little they can get.

It is this pernicious context that now puts a boundary around what is, and what is not acceptable in the debate over the deficit. Our elite assumes the deficit is an existential problem for the nation because it is an existential problem for them. So they have forced us into this discussion. And the libertarians are along for the ride. It is the rentier class who would lose from inflation – which erodes the value of debts – so the Fed watches inflation like a hawk and ignores, relatively, unemployment. This is also why financiers warn about credit markets and debt levels: their assets are at stake, so they force us to act against our own interests in favor of theirs.

In his speech today, Obama presented his view of how to deal with the deficit. He told us that no sensible solution can avoid raising revenues. That means increasing taxes and broadening the tax base by eliminating the plethora of avoidance schemes and loopholes that reduce it. So he proposes allowing the Bush tax increases to go into effect for the top tier of income earners. Also, it is important that any cutting extends to include offense spending. The Pentagon’s long term burden on our budget is unsustainable. It needs reduction. Obama agrees.

The big nut, however remains health care, which means Medicare. The Republicans have done us all a favor by admitting publicly that they want to eliminate Medicare. That was the thrust of the ridiculous plan presented by Paul Ryan last week, and which was vividly attacked by Obama today. The voucher scheme proposed by Ryan is designed to move the burden of health care costs onto the elderly. This effect results from the way in which the voucher’s value would rise independently of, and slower than, health care costs. So a gap would open up that would have to be filled by the elderly themselves. Or, of course, they could forgo treatment. This attack on Medicare opens space for the Democrats to respond to the voter’s fondness for the program. Poll after poll suggests that voters do not want Medicare abolished. Indeed, and ironically, the most vehement opposition to cutting costs in Medicare comes from self-confessed Republican supporters.

One point to keep in mind is that the Republican voucher scheme does nothing to control health care costs themselves. It simply shifts the burden out of the government budget into private budgets. Obama, in contrast has attempted to roll back the steady rise in costs by pushing through his reform law last year and, today, by calling for the beefing up of oversight of Medicare spending and using its market power to force lower prescription costs.

Neither the Ryan plan nor the Obama plan will be passed into law of course They are merely the opening salvo in what promises to be a very hot and protracted war.

Which brings me back to my theme: this is a test of our democracy. If the wealthy win the debate, as they certainly did during the talks over finance reform, we should expect to continue towards a more divided nation. The stakes are high for the wealthy. They will spend a great deal to buy the necessary votes to force the burden of austerity onto the poor, elderly, and sick. Obama’s willingness, and ability, to lead the resistance is crucial. His speech today was encouraging. But his track record is worrisome. He talks a good game, but then negotiates badly. This time he needs to stare down the extremists. He cannot, he must not, he should not, give in to their extortion efforts again. If they want to use the debt ceiling as hostage, then let them. Let’s have the fight that they keep asking for. Make it clear who wants what. Then dig in.

Round two is all about the future of the middle class. It is beleaguered and in retreat. It is suspicious and confused. It is angry. It does not need pretty talk. Nor does it need to be betrayed by weakness in the face of the attack from the wealthy. It needs a strength Obama has so far failed to demonstrate. And it needs an articulation of why this fight is so important. In short, it needs leadership.

Perhaps even more than this: if we lose round two, the cause of democracy will be set back even further.

Inequality must end. The major portion of austerity should fall on those who led us down the fiscal path we have travelled. The responsibility is theirs. They should pay the cost for fixing the mess their policies caused.

Obama has set a partisan tone with his speech. He has set up the fight. Can he carry through?

I wonder.

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Debt Battle Lines Drawn

Given that the Presidential State of the Union Address is simply an opportunity to showcase a preferred direction rather than a time to introduce solid legislation, last night’s effort was predictably dull. So was the response.

My reaction to this theatrical moment is that it sets the stage for the next round of arguing and that much of what was said will slip into the mists of memory rather more quickly than usual. This is because the immediacy of the upcoming fight will rapidly overshadow whatever was said last night.

The one thing that seems clear is that we are now entering the next phase of discussion, if that is the right word for what is going on, about the national debt and the Federal deficit. On the one side we have the administration, and Obama, who acknowledges that our national debt has become a problem, wants to reduce it, but also wants to preserve a few of our more useful social investments like education.

On the other side are the Republicans, now very publicly split between establishment and radical wings, who are in a slash and burn mode. They want to cut away anything that smacks of government intervention in the economy and really don’t see a continuing place for social investment in things like education. After all, for them, the free market is the one and only sensible, efficient and thus “free” provider of such investments.

The ideological divide that appears here is more apparent than real. Obama, by talking about the deficit without placing it firmly in context, has allowed the Republicans to establish the agenda. He is seen as preserving what he can. They are on the attack hacking away at all things social.

Why is the context so important?

Because it was the creation of the Republicans themselves. For decades they have defined anything social as being either nasty, horrible, inefficient, wasteful, overly costly, or downright evil. Thus the huge original investment by the government to invent, nurture, and then launch the internet is conveniently swept under the rug, and we are left to suppose that it sprang fully formed from the innovative minds of Silicon Valley entrepreneurs. This is a lie, but is one that fits nicely within the free market narrative, so we rarely see a proper push back against it. The GOP agenda was clear decades ago: if they could reduce government revenues sufficiently over a long enough period, they could then induce a fiscal crisis under which guise they could implement their anti-government programs. Given enough damage to the nation’s finances this might even include the elimination of Social Security and Medicare the twin towers of evil in the minds of Reagan and his ilk.

Crucial to the success of this long term plan was compliance by the Democrats. And a willingness by everyone in power, business, media, and elsewhere, to adhere to a free market driven approach to policy making. That the entire elite of the US shifted its thinking towards the GOP viewpoint was the most important accomplishment of the Reagan era.

Thus “centrism” is a relative term and now defines a space radically different from that it described three or more decades ago. This is why I distrust centrist politics: it is an attempt to preserve a status quo carefully crafted to the Republican advantage. As I have said here before: so successful has this redefinition of moderation been that Eisenhower would now appear to be to the left of Obama. Odd, but true.

By successfully and successively defunding government during the Reagan era, and by co-opting Democrats along the way, the Republicans can now open an all out assault on government spending. And they can do it wearing the apparently virtuous mantle of fiscal rectitude.

This is absurd.

They have advocated fiscal recklessness ever since Reagan plunged the nation into debt in order to avoid making the cost of his military build up specific. Remember: he was the first American president in history to run large government deficits by choice. All previous deficits were the result of events beyond the immediate control of government: wars, recessions etc. Reagan’s deficit was deliberate. The only other such instance of choosing deficit was when Bush plunged us deeper into red ink as a result of his tax cuts.

So the first true part of the context for the upcoming budget wars is that the Republicans are fiscally reckless, deliberately creating deficits in order to further their own ideological agenda. Their sudden volte face, if allowed to go unchecked, would be an astonishing coup of public media manipulation. I expect them to succeed given the supine nature of the administration.

The next piece of the context is the long term impact of our various social and military programs. There are five major components to our government’s spending: Social Security; Medicare; Medicaid; Military/security; and interest on debt. The rest are a melange of small programs and items like environment; agriculture; food safety; judiciary; energy; and so on. The biggest problem on this list is health care. Our demographic and policy trajectory currently will cause health care to take ever larger shares from our budget. Costs need to be reduced in order to relive this stress. This was the impulse for health care reform last year. Whatever you may think of the reform, no one who has cast an objective eye over it thinks it will add to the deficit. On the contrary it is a first stab at reducing it. Either way, if we are to reduce the deficit, social and military spending are the places to look. This seems to me at least, to require an adult fact based discussion about our priorities, and not some sophomoric bun fight cut free from any reference to reality.

The third aspect of the context of our debate is the recent crisis. It is the yawning, and temporary, gap in the deficit caused by the massive loss of revenues and parallel rise in spending that has captured and animated conservative minds. So disturbed are they that they are best described as in panic mode. Unfortunately this panic seems to have spread across the entire elite. This is not surprising given the homogeneity of views represented there. Let me repeat: the cyclical deficit is a very good, necessary, and socially productive phenomenon. Indeed by adding to it in response to the crisis we have saved ourselves a free fall descent into depression. Thus this aspect of the deficit should be hailed by one and all as being a “good thing”. Not as something we be in any hurry to get rid of it.

All this brings me back to last night’s theatrics.

We are now clearly going to go through a bout of great political import. The fight will have an immense impact on what kind of country, let alone economy, we become. In a sense this is to be encouraged. We need, at long las,t to discuss whether we want an economy bereft of government intervention, the likes of which we have not seen for at least seventy years. Let me put it this way: very few people alive today can readily recall the social and economic realities of the last time the US genuinely had a “small” government. Those peddling a view that small is good are doing so on the basis of imagination and faith, rather than fact. This is, of course, why what they are selling is so alluring to an unsuspecting public. After all whatever we have just experienced didn’t seem so good, so hacking away at it looks like a good idea.

In general terms this is why I abhor our loss of balance. Both socially and economically. My view is that a healthy society is built upon a tension between capitalist and democratic principles. Neither, alone, can provide a level of security, comfort, and health for the maximum number of our citizenry. Thus business should be allowed to get on with what it does best, but should also be severely reined in so that its externalities like pollution, waste, unemployment and so on are mitigated or offset by communal action in the form of government intervention. Further, I also believe that there is ample evidence to support the idea that certain activities within society are best performed by the government acting on our collective behalf. Only screaming libertarians would argue that the government is the best agent for running the nation’s military. I happen to extend that into health care as well based simply on the social benefit we all derive from the lower costs that result from exploiting the largest possible actuarial pool we have available: all of us. There is no logical riposte to this, only ideological ones that are willing to tolerate inefficiency in order to protect a specious so-called freedom.

Lastly, as we get ready to debate, I wish we could stick to facts rather than faith. But America is highly faith based right now, and so I doubt we can keep ourselves away from non fact argument. One instance is already in view: the premiss of last night’s Republican response to Obama’s speech was that we need to avoid the fiscal errors evident in Europe. This assumes there were errors. There weren’t. Indeed neither of the primary examples put forward: Ireland and the UK have experienced a government caused debt crisis. Ireland was the very epitome of fiscal rectitude prior to the collapse of its banks. And the UK, while it was running deficits, was under no pressure in the credit markets to take drastic action. Both suffered from a fiscal implosion, not in the public sector, but in the private sector. The Irish crisis was directly due to the activities of its banks. Not to the recklessness of its government. And the great austerity underway in the UK was a policy choice, not a necessary reaction to crisis.

Thus, just as there there is no foundation to the idea that the Republicans are a party of fiscal skill, there is no foundation thatwe should heed the experience of Europe. On the contrary each of these notions are actually counter-factual examples to be used against the GOP.

Nor is there any need to rush into fiscal balance. We need to avoid cutbacks for a while longer. The UK experience here presents a very important lesson. Far from encouraging us to follow the UK into austerity, the evidence teaches us precisely the opposite. We should be very leery of such a course of action. Why? Because their austerity programs have apparently caused their economy to shrink, as any Keynesian would have suggested they would. Whether the shrinkage continues into full blown recession is yet to be seen, there may be extenuating circumstances, but the lesson is still clear: you cut spending at your own risk. By so doing you drain demand from an already demand light economy; you add to unemployment; you reduce government revenues by reducing your tax base; and you postpone the moment when the recovery reaches a sufficient pace to fix what ails us. Most importantly, and this is not so much economic as social: you define the nation as being less caring, less tolerant, less concerned with its environment, and less concerned with its future. You fragment society and divide it.

During the upcoming argument we need to be very clear about all of this. Otherwise we risk undoing the entire advance since World War II. That might be the objective of the more radical Republicans, but I doubt many voters would go for it. At least I hope not.

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Smith’s Curse

I am not easily swayed by talk of curses. They make for good gossip and a laugh, but have no explanatory legitimacy. All except Smith’s Curse. Adam Smith that is. Here’s why:

Ever since Adam Smith wrote, just once, about the mysteries of the “hidden hand”, economics has had its brains addled by the allure of those magical powers Smith postulated as the reason he saw order rather than chaos around him. His was possibly the first insight into what is now called the self-organizing properties of a complex system.

The problem with this is the absurd lengths to which economists have gone in order to give credence to Smith’s insight. Instead of embracing the muckiness, and infuriatingly indirect nature of complex systems, they have gone the other way entirely. They have been driven to simplify at inordinate and quite ridiculous length in order that they come up with the answer Smith first thought of. Their tools and methods are wrong. Their desire runs deep. That combination makes for some pretty ugly reasoning. This doesn’t mean that complex systems are not comprised of very simple components. It’s just that they are not deterministically thus constructed. Therein lies the big error of orthodox economics. It is still rooted in a mechanical vision where the economy is a vast machine playing out in an orderly fashion from a set of basic assumptions.

When we observe apparent order, such as we see in the confines of a well behaving market, we must be careful not to interpret that observation as implying that the underlying system is, itself, well ordered. Disorderly systems are far more common. In fact they are the norm. Yet sometimes they give rise to patterns that belie their true nature.

This was Smith’s error. And by making such an error he bequeathed economists a long lasting curse.

They imagined that markets are orderly structures. They are not. They have people in them, which means they are can be whimsical, subject to fashion, or tightly ordered and efficient all at the same time. They are human, not magical.

We could simply end at this point by saying that the rest is history. Economics, or at least its orthodox versions, has labored long and hard to detect and theorize about the mystical forces necessary to ensure, not just orderly outcomes, but orderly workings. In a deterministic system the outcome is orderly because the systems itself is precise. It plays out along known and predictable lines. Hence the theories of people like Walras who conceived of the economy as giant machine capable of arriving at a single best solution to the problem of allocating resources. Only his machine needed help. He wasn’t able to solve his equations without the assistance of an external “auctioneer” who directed the traffic to make sure everything resolved itself neatly. Some of us think of this as cheating, but to the orthodox it was simply a challenge to try harder.

As Walrasian thinking became to pervade orthodoxy all sorts of bells an whistles were added to try to get around the fictional auctioneer. The humans within the system were invested with superhuman powers of calculation and information. Gathering information was made costless. What people wanted or needed was crushed into something called utility so it could be fitted within a mathematical structure. Time was reduced to a single point by using the trick of futures markets. And so on. Smith’s curse drove a great many intelligent people to extraordinary and, frankly, almost psychotic, lengths to discover and articulate the magic he imagined lying beneath the surface.

In the end orthodox economics was reduced to getting rid of humans in order to make things work well at all. And even then the prime movers of the final edifice, Arrow and Debreu, were not sure of the relevance or use of the monster they created.

This is because there isn’t any use. It was always a wild goose chase. The order Smith saw was a chimera. A mirage beckoning economists and no one else.

Now here’s the really big problem with Smith’s Curse:

It can make clever people do bad things.

Ever since the 1930’s classical economics has taken on a morally superior tone. It has been preached rather than taught. Free markets are, according to the orthodox, superior because they produce “the right answer” without any intervention by governments. Thus they are untainted by the wants, requirements, and biases of mere mortals. Markets march, so they say, to the beat of immutable forces that are impervious to human intervention. So they are ideals we should strive to achieve. As if Smith was channeling Plato when he devised his curse.

If this sounds vaguely religious, you are not the first to notice the resemblance.

In the hands of folks like Hayek and Friedman classical economics was used as an ideal bulwark against the intrusion of the dark side of human calculation. Hayek meant it when he talked about “The Road To Serfdom”. Friedman meant it when he wrote about being “Free To Choose”. Both imagined that a free society whose economic relations were determined by the forces that drive unfettered markets cannot end up in a bad spot. It just works out that way. It just is. Perhaps a mystery. But it just is. Worse: whenever silly and limited humans get involved things will alwatys go awry. Those of us who a tad more skeptical are told to keep our tawdry questions to ourselves and not to sully the beauty of the free market vision. We should allow the faithful to go on believing. Their faith unquestioned because it is unquestionable.

Such was their fervor, and such was the hold Smith’s Curse held over them, that no amount of foolishness was allowed to sway their thinking. Thus Friedman could write, presumably in earnest, that no matter now ridiculous, absurd, or other worldly the assumptions needed to make a free market systems superior in theory – let alone practice – those assumptions were justified if they drove the theory to the “correct answer”. By which he meant the answer he, like Smith, first thought of. Where there is science in this is questionable. But you have to admire the zealotry.

Now comes the damage I mentioned.

So smitten by Smith’s Curse are orthodox economists that they engage in social engineering. By their own logic people like Hayek and Friedman should aver all attempts at imposing a system upon society. After all that way lies the road to serfdom. And surely we – the rest of us – are free to choose. Yet Friedman in particular, and his army of righteous followers, think nothing of advocating all sorts of changes to society in order to get things ordered the way most conforming to their theoretical views. This is why Friedman was a major, if not the major, force behind establishing a free wheeling derivatives market. You know like the one that just blew up the world economy. This explains the ardor with which orthodox economists advocate deregulation, the dismantling of social safety nets, and other community oriented devices. Their faith drives them to preach and alter anything they deem inappropriate. Like society, or any construct with word word “social” in it.

So in the end Smith’s curse has produced a prodigious paradox: the theorists most stricken by his vision are both the most ardent advocates of freedom, and the most determined social interventionists at the same time. They think nothing of forcing the rest of us to conform to their utopian visions. More to the point: the past few decades have been a prolonged social experiment in free market economics. In any number of places orthodox economists have influenced society in an effort to make reality reflect their theories. Society, as it had evolved by the 1970’s, needed to be saved. It needed to be shunted back into its rightful place. If that meant imposing order and restricting the choices of others, so be it. Nothing should get in the way of the neoclassical crusade.

This is, of course, back to front. In respectable science theory reflects or explains reality.

But then it might not come up with the right answer. And Smith’s Curse would lose its grip.

And it’s such a warm and fuzzy feeling when slip into the dreamworld described by that curse.

It can’t just be a myth can it?

I don’t know. Maybe we should ask the unemployed.

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Lost Balance: Were Is The Anger?

With the steady increase in activity that seems to be characterizing the US economy currently the early frenzy of placing the blame for our crisis is ebbing. Already we are being treated to “year end” articles calling people such as myself, those who view things a little more skeptically, unnecessary naysayers. The improvement in the general economic numbers now being reported is being used as a vehicle to justify yet another round of optimism and good news stories. The market, we are told, is poised for a banner year. With profits on the up, and Wall Street back on its feet, 2011 has all the makings of a good year. So, apparently the skeptics were wrong, and their mediocre forecasts failed to take into sufficient account the remarkable resiliency of the great American money machine. Our problems, we are told, are now more those of mopping up the mess, rather than worrying about sinking under its weight.

Well, I don’t care much about profits. Not unless they are put to good use. Corporate profits have seen banner times in America for over a decade. Shareholders may have been buffeted in the downdraft of 2008, but they have either been bailed out directly by the government or they have benefitted from benign government policies ever since. They can have no gripes at all. Cash is piling up in corporate coffers. Profits are back with a vengeance.

So what?

I care about the general economy, and about rusty boring details like wage and job growth. I care about opportunity. I care about balance. In that context the economy is still festering. Indeed without endless government support there is little evidence that it would yet have recovered much at all. But above all else I fear that the great recession will simply reinforce the pre-existing trends dividing the country between those who have an advantage and those who are left behind. That divide shows up in the enormous income and wealth inequalities that now bedevil society, and the huge discrepancies in expectations now reasonable for the mass of middle and lower class families, and those of the privileged above them.

To this extent I think that the generalized numbers are masking something important. Something we should be angry about, but aren’t. The steady separation of the economy into two distinct economies, one of the rentiers and capitalists and the other of the average workers, is getting more stark every year, and the gap may well have opened even wider with this crisis. Which is really infuriating, to me at least, because it was the folly of financiers that brought the crisis upon us.

I am struck by the constant marginalization of anyone who dares talk about inequality as a core subject for economic discussion. Orthodox economists, or at least the less thoughtful, simply treat inequality as a side product, or after effect, of the workings of capitalism. Periodically the media produces an article or two talking about the income gap that yawns wide nowadays, but they quickly move onto more acceptable mainstream topics like inflation or interest rates, as if the only grown up subjects to discuss are what ails the market.

The New York Times produced such an article recently talking about the pay of “super stars” and how it distorts incentives. Buried in the article, and treated as a minor rather than the main fact, was a revealing statistic. America is less upwardly mobile, in terms of wage earning opportunity, than any other large industrial nation.

Think about that for a moment.

This is the self promoted “land of opportunity”. A very large component of the “American dream” rests squarely on the notion that the US is the place to be if you want to profit from hard work and industrial innovation. Old Europe, in particular, is derided as sclerotic and inept at providing such opportunities. So why is it that a lower wage earning European has a much higher chance of moving upwards than a similarly placed American?

Capitalism.

The more naked the capitalism the more unequal the income. This we all know. What we have ignored is the social corollary: the more naked the capitalism the more rigid the society. Let’s set aside the failed alternatives: we could debate endlessly the merits and demerits of either socialism or communism. I do not intend to, I have a natural distaste for all solutions to problems that rely upon idealistic assumptions about human behavior. There is too much contrary evidence to allow me to view them with anything other than deep mistrust. Capitalism, by contrast has no such flaw: it works exactly the way it comes advertised. It is divisive, abusive, prone to manipulation, and encourages inequality. There is no magic to it: that’s what it is. Unleash capitalism, and that’s what you end up with. Every time.

But human beings may be less rational and messy than utopian economists of either left or right would like to pretend. They, after all, are simply trying to justify their ideologically preferred social arrangement. We, in the middle, know better. We know that there are ways to mitigate capitalism without killing off its energy and wealth production. Our primary weapon is democracy.

As in income redistribution. As in progressive taxation. As in the provision of safety nets. As in affirmative action. As in women’s rights. And so on. We have a whole armory to stop the wealthy from building citadels and extending privilege only to themselves and their kind.

It’s called balance.

All utopian economic systems, from genuine Marxism through to neoclassical economics, make self serving and unreal assumptions about human beings and their behavior. Thus they all produce solutions that need to be enforced against the flow of that behavior. Because they are not based upon real humanity, but upon an idealized version of it – because they are Platonic and not Aristotelian – they also force their advocates to bend society to their wills. Thus they become authoritarian, often despite their advance intentions.

This is the great weakness now breaking the American dream apart.

The dream, such as it was, assumed a balance. It assumed that the lessons of the 1920’s and 1930’s would not be forgotten and that the economy would be managed for the benefit of all. For two or three post-war decades it was. But after the onset of the Reagan illusion and the triumph of neoclassical economic thought, balance was tossed aside as an impediment. Complacency prevented the newly minted middle class from identifying the error in Reaganism and its advocacy of naked capitalism. After all if we can read, as we do, in the introduction to basic economic textbooks that Americans are wealthy because their economy is “market based”, then spotting the error is hard for anyone not grounded in alternative economics to do.

The average American is wealthy not because of free markets, but because those markets were strongly monitored and regulated for decades. Once that monitoring and regulation was re-interpreted as the “dead hand” of government and removed, the path to wealth for the masses dried up.

So why are we not angry about this?

Because we still live within the illusion. We conflate capitalism and democracy. They might both depend on similar core principles, but they are antithetical. The one concentrates power and wealth, the other seeks to diffuse them. They may be symbiotic, but only when we have a clear understanding of their conflict.

It is only when a society enforces itself against the results of naked capitalism, when it makes sure that the elite does not rent seek, and that people like the bankers of 2007/2008 actually pay for their errors, that it can benefit from that capitalism. Every other time, as in the post Reagan decades, including the Clinton years, society will fracture along the lines we are now so aware of. The lower and middle will ossify and lose traction. The upper will scarf up ever more of the rewards.

In this context the contemporary and persistent attack on our safety net seems to me to be an attack on opportunity, and as an attack on the democratic bulwark against the pernicious effects of inequality. So every attempt top enforce austerity in order to assuage markets pains me. The benefit of austerity flows only to the elite while the cost is borne by the less privileged majority. Early industrial nations abandoned classical economics for a reason: it was designed to justify the actions of the new industrial class. In Britain, first Smith then Ricardo attacked the old world in order to foster capitalist growth. A hundred and fifty or so years later Keynes sought to save capitalism from itself by injecting the government into the heart of activity. In between the two, the severity of inequality made it evident that naked capitalism imperiled itself. It was doomed if left unattended. Yet all our current attempts at austerity cut away at what is left of the boundaries of capitalist behavior. Instead of re-estabkishing balance we are deliberately veering further away.

A long time ago I came across models of the economy built by Kaldor. One explicitly encompasses the impact of balance. The more wages take of the fruits of growth the less incentive there is for capitalist innovation, and thus growth slows to everyone’s disadvantage. And, in contrast, when profits take too much, workers become discouraged, unable to maintain advancement, and ultimately impose themselves on capital. In other words society becomes politically unstable at either extreme.

Are we there yet?

I do not know.

But I do know we are headed that way, and that textbook economics is culpable for spreading market myths far enough to help destroy the opportunity it was designed to justify. It ignores balance. It ignores reality.

Let me change my mind. I do care about profits after all. We need less, so that wages can flourish again. We need to get back into balance. Only then will the economic engine hum again.

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