It's Wednesday, and today I discuss the latest US inflation data, which shows a significant…
It is a busy day today with meetings in one capital city, then a presentation a bit later in the day in another city – so time is short. Over the weekend, I watched an episode of the recent Ken Burns’ documentary – The Dust Bowl – which traces the events surrounding the drought during the Great Depression in the so-called – Dust Bowl – of the United States. It is worth watching if only for the stark reminder of how the main body of my profession is so deluded. I should add that as a strict vegetarian the title of my blog is rather offensive but it is faithful to history and that has value in itself. While the neo-liberal historical revisionist teams relentlessly attempt to airbrush all fact out of the Great Depression the inescapable truth is that thousands of American adults and their children would have died during the Dust Bowl crisis had not the American government intervened with food parcels and then major public sector job creation schemes such as the Civilian Conservation Corps (CCC) and later the Works Progress Administration (WPA). Government fiscal stimulus saved America. No “chickens” were put in “pots” by the “market” during that time. Rather it was the government that fed and clothed the people. Nothing has changed since.
Last night I went to a concert in Melbourne featuring the great Shuggie Otis (with Taj Mahal and Robert Cray as additional bands on the bill). Shuggie was excellent. But the point of noting that is that during his set, Robert Cray sang a number off his new record – I’m Done Cryin’ – which has a second verse with lyrics:
I used to have a job
but they shut it down
put the blame on the union (like they always do)
and now it’s some fore in town
I am done crying
I’ve got no more tears
You can’t use me anymore
At least now I know where I stand
but you won’t take away my dignity
cause I am still a man
That sort of completed the day for me because earlier in the day I had watched an Dust Bowl episode. I would note that Robert Cray should probably consult with the psychologists and sociologists who will tell him that unemployment does take away a person’s dignity – slowly but surely.
That was very evident during the Dust Bowl crisis. Men would refuse, initially to seek the aid that was forthcoming from the various government programs. The areas around the Oklahoma panhandle remain the most extreme Republican electorates in America, which shows how disconnected peoples’ political views are with their actual circumstances. The Tea Party support policies which will render the most harm to their members. But that is the topic of another blog.
In the 1928 Presidential election campaign Herbert Hoover had campaigned on the “Vote for Prosperity” ticket and there was one paid advertisement which was placed in newspapers by the Republican National Committee – which indicated that faith in the market (notwithstanding the GOPs pro-tariff wall position! – don’t worry about minor inconsistencies eh!), would put a “chicken in every pot” and a “car in every backyard, to boot.” The advertisement made it clear that the pro-market approach by Hoover would ensure America remained prosperous.
You can see the advertisement in question – HERE.
The pro-market forces eschewed government intervention into the Great Depression in general and the Dust Bowl crisis in particular.
However, the evidence is incontestable in my view. The Dust Bowl crisis exemplified why people and their communities need a strong interventionist government to ensure there are enough jobs being created and national income being generated then that was it.
Millions of workers were employed in these schemes and the incomes paid meant that firms could supply more goods and services including food to those affected by the crisis.
Without that income generation, many Americans would have starved. The market would not have saved them.
Further, it was clear that the CCC and the WPA were “more expensive” ways of distributing money to the unemployed and failed farmers. But, reflecting back on the Robert Cray lyrics, the view that was taken was that employment was more than just a wage.
This was expressed in the famous quote by the Director of the WPA – Harry Hopkins – who said:
Give a man a dole, and you save his body and destroy his spirit. Give him a job and you save both body and spirit.
That message still holds even if we would make the concept gender inclusive.
The provision of government agricultural research services, which changed the ways the “dry-land” farmers utilised their lands was also important. Prior to the crisis, the farmers had ignored the efforts of Henry Howard Finnell – the soil agronomist who in the 1920s tried to change the farming methods in the region via the work he did as director of the Panhandle A & M Experiment Station.
He was an enlightened soul who predicted the environmental catastrophe that would follow around a decade later.
During the 1920s, the “market” conditions were strong (and the rain better than usual) and so the farmers driven solely by market outcomes ignored the research and advice that Henry Finnell provided.
Things changed when – Hugh Bennett – the director of the newly created (in 1934) Soil Conservation Service initiated “Operation Dustbowl” with Henry Finnell in charge.
His program of water retention and deep plowing worked and by 1937 had reduced the proportion of “dangerously eroded land” by more than 50 percent.
I should add that I am sympathetic to the claims that it was government planning rules (size of farm plots etc and a denial of sustainable homesteading) that created farm allotments out in the panhandles of Texas and Oklahoma that contributed to the difficulty that the farmers eventually faced. But to then say the Dust Bowl crisis was an example of government failure and the solution requires less government is not sustainable.
Over the weekend, I also read this Bloomberg Op Ed – The Insupportable Equilibrium of Economic Thought – although I am not sure the author, who is a “theoretical physicist”, is fully across the nuanced debate about the concept of equilibrium in economics.
It resonates with the thoughts about the Dust Bowl.
The author, Mark Buchanan, distinguishes between he calls a “stable equilibrium” and an “unstable equilibrium”, the latter being represented, for argument sake, by a pencil lying “upright, with either the eraser or the graphite tip touching the table and the rest pointing into the air”.
The latter state is easily disturbed and “will change rapidly if given the tiniest shock from the physical world”.
The stable equilibrium – “a pencil lying on its side” on a table will, if disturbed, “stay in that position or bounce around momentarily and then go back to it”.
We can agree on all that.
The question then is to determine, in any particular situation, whether the state is stable.
The argument then focuses on the economics discipline and we read that:
For several decades, academics have assumed that the economy is in a stable equilibrium. Distilled into a few elegant lines of mathematics by the economists Kenneth Arrow and Gerard Debreu back in the 1950s, the assumption has driven most thinking about business cycles and financial markets ever since. It informs the idea, still prevalent on Wall Street, that markets are efficient — that the greedy efforts of millions of individuals will inevitably push prices toward some true fundamental value.
Problem is, all efforts to show that a realistic economy might actually reach something like the Arrow-Debreu equilibrium have met with failure. Theorists haven’t been able to prove that even trivial, childlike models of economies with only a few commodities have stable equilibria. There is no reason to think that the equilibrium so prized by economists is anything more than a curiosity.
Which, from one perspective is a valid observation. But, by using the broad brush term “economists”, the author ignores the massive debates within economics about the concept of equilibrium and also conflates the divergent discussions, in this regard, between microeconomists and macroeconomists.
The author suggests that
We’ll never understand economies and markets until we get over the nutty idea that they alone — unlike almost every other complex system in the world — are inherently stable and have no internal weather. It’s time we began learning about the socioeconomic weather, categorizing its storms, and learning either how to prevent them or how to see them coming and protect ourselves against them.
I thought the tie in with the weather tied in with my thinking about the Dust Bowl.
While the dominant paradigm in economics constructs equlibrium in the way that Mark Buchanan depicts, there are, in fact two broad concepts of equilibrium that can be found in the economics literature.
The Principles of Economics was a highly influential work and, interestingly, Marshall moved from being a student of Physics into economics via philosophy. Alfred Marshall defined the neo-classical economics tradition in the English-speaking world. This tradition is an intrinsic part of what we now term neo-liberalism.
In Chapter 3 Equilibrium of Normal Demand and Supply, Marshall investigates “the equilibrium of normal demand and normal supply in their most general form” in broad terms.
His discussion is couched in terms of some explicit assumptions:
Thus we assume that the forces of demand and supply have free play; that there is no close combination among dealers on either side, but each acts for himself, and there is much free competition; that is, buyers generally compete freely with buyers, and sellers compete freely with sellers. But though everyone acts for himself, his knowledge of what others are doing is supposed to be generally sufficient to prevent him from taking a lower or paying a higher price than others are doing. This is assumed provisionally to be true both of finished goods and of their factors of production, of the hire of labour and of the borrowing of capital. We have already inquired to some extent, and we shall have to inquire further, how far these assumptions are in accordance with the actual facts of life. But meanwhile this is the supposition on which we proceed; we assume that there is only one price in the market at one and the same time; it being understood that separate allowance is made, when necessary, for differences in the expense of delivering goods to dealers in different parts of the market; including allowance for the special expenses of retailing, if it is a retail market.
He was aware – as implied in the quote – that these “competitive” assumptions might not be “in accordance with the actual facts of life”. That was an important qualifying note in his work and that is often lost when economists apply these concepts to actual problems in the real world. Often we will be left with the view that some of the “actual facts of life” are meagre annoyances – ephemeral in nature – that will disappear in the “long-run” if competitive forces are left to play out.
So we think of trade unions, government welfare policies, market power to be transitory disturbances to “equilibrium” despite these institutions being core parts of history, culture and have functionality that can not easily be abandoned.
For a neo-classical economist, the institutional fundamentals of society are just transitory annoyances to an otherwise freely competitive world.
Based on these highly restrictive assumptions, Alfred Marshall defined equilibrium in this way:
When therefore the amount produced (in a unit of time) is such that the demand price is greater than the supply price, then sellers receive more than is sufficient to make it worth their while to bring goods to market to that amount; and there is at work an active force tending to increase the amount brought forward for sale. On the other hand, when the amount produced is such that the demand price is less than the supply price, sellers receive less than is sufficient to make it worth their while to bring goods to market on that scale; so that those who were just on the margin of doubt as to whether to go on producing are decided not to do so, and there is an active force at work tending to diminish the amount brought forward for sale. When the demand price is equal to the supply price, the amount produced has no tendency either to be increased or to be diminished; it is in equilibrium.
So equilibrium, in this context, is commensurate with a point where supply equals demand. It is also construed as being a point at which the economy will remain at rest if no disturbances to supply or demand occur.
Importantly, this equilibrium will maintained if prices are flexible. So, this lead, for example, Classical employment theory to consider unemployment to be a dis-equilibrium phenomenon which could not persist if real wage flexibility was left free to restore the balance between the demand for and the supply of labour.
The only way the dis-equilibrium could persist is if, for example, the government imposed rigidities on the labour market (say, a minimum wage) that held the real wage above the full employment level. Otherwise, the flexible price labour market would always ensure the full employment equilibrium was sustained.
This concept of equilibrium is tied in with the definition of full employment. The neo-classical economists considered the level of employment that was consistent with the Marshallian equilibrium point, to represent full employment because at the relevant, market-clearing real wage level, all firms that wanted to employ labour could find sufficient workers and all workers who desired to work could find a firm willing to employ them.
In other words, there could be no mass unemployment (beyond a recognition of a small amount of frictional unemployment arising from people moving between jobs) in a state of equilibrium.
The neo-classical economists also cconsidered this would be the state that the labour market would gravitate to if the real wage was flexible. Even during the Great Depression, departures from this “fully employed” state were only considered to be possible if the real wage was not allowed to move to the equilibrium level.
This is why the major policy advocacy at the time from the neo-classical economists who dominated the policy-making ranks of government was geared towards wage cutting. As the historical record shows, wage cuts were introduced early in the Great Depression, wtih catastrophic consequences.
This concept of equilibrium has also infested modern thinking in finance. A dominant view in financial economics leading up to the financial crisis was the – efficient markets hypothesis.
This is a hypothesis that asserts that financial markets are driven by individuals who on average are correct and so the market allocates resources in the most efficient pattern possible. There are various versions of the efficient markets hypothesis (weak to strong) but all suggest that excess returns are impossible because information is efficiently imparted to all “investors”. Investors are assumed to be fully informed so that they can make the best possible decisions.
Efficiency and equilibrium in this context go together.
Recall the extraordinary – Interview with Eugene Fama – that the New Yorker’s John Cassidy published on January 13, 2010. Eugene Fama is an economist at the University of Chicago and is most known for his work promoting the efficient markets hypothesis.
Fama told John Cassidy that the financial crisis was not caused by a break down in financial markets and denied that asset price bubbles exist. He also claimed that the proliferation of sub-prime housing loans in the US “was government policy” – referring to Fannie Mae and Freddie Mac who he claims “were instructed to buy lower grade mortgages”.
When it was pointed out that these agencies were a small part of the market as a whole and that the “the subprime mortgage bond business overwhelmingly a private sector phenomenon”, Fama claimed that the collapse in housing prices was nothing to do with the escalation in sub-prime mortgages but rather:
What happened is we went through a big recession, people couldn’t make their mortgage payments, and, of course, the ones with the riskiest mortgages were the most likely not to be able to do it. As a consequence, we had a so-called credit crisis. It wasn’t really a credit crisis. It was an economic crisis.
John Cassidy checked if he had heard it right asking “surely the start of the credit crisis predated the recession?” to which Fama replied:
I don’t think so. How could it? People don’t walk away from their homes unless they can’t make the payments. That’s an indication that we are in a recession.
Once again he was prompted to think about that – “So you are saying the recession predated August 2007″, to which Fama replied:
Yeah. It had to, to be showing up among people who had mortgages.
He was then asked “what caused the recession if it wasn’t the financial crisis”?
(Laughs) That’s where economics has always broken down. We don’t know what causes recessions. Now, I’m not a macroeconomist so I don’t feel bad about that. (Laughs again.) …
Fama asserted that “the financial markets were a casualty of the recession, not a cause of it”.
Later, in defending the efficiency of financial markets, Fama wondered how many economists:
… would argue that the world wasn’t made a much better place by the financial development that occurred from 1980 onwards. The expansion of worldwide wealth-in developed countries, in emerging countries-all of that was facilitated, in my view, to a large extent, by the development of international markets and the way they allow saving to flow to investments, in its most productive uses. Even if you blame this episode on financial innovation, or whatever you want to blame, would that wipe out the previous thirty years of development?
While Fama claims that the deregulated financial markets expanded wealth he doesn’t mention that they also destroyed wealth and the same logic has led to fiscal austerity (distaste for government action), which is further eroding the well-being of nations.
But the point is that Mark Buchanan’s depiction of equilibrium matches that of the neo-classical school of economics.
However, other economists such as Marx and later Keynes, Kalecki and the tradition that has been built on their insights, constructed a very different view of equilibrium to the neo-classical tradition that still dominates.
For example, the concept of involuntary unemployment that Keynes introduced into the literature was consistent with the concept of equilibrium as being a state of rest. But it was in sharp contradistinction to the idea that equilibrium also required a balance between demand for and supply of labour.
Keynes advanced an argument that said that mass unemployment was an equilibrium state that the capitalist monetary economy tended towards and could remain in that state indefinitely without government intervention.
This notion arises from an understanding of the role of effective demand rather than real wages in determining employment in a monetary economy. It also is based on an understanding of how employers reach their decisions to produce and employ.
Firms set prices and production levels based on their expectations of revenue in the forthcoming period. They operate in an uncertain world and have to rely on guesses about what the future market conditions might be even though they use advertising etc to try to manage the environment they are selling into.
They commit to paying wages to the workers they hire based on this guess work. If they are optimistic and require to increase scale they will expand employment. Pessimism has the opposite effect.
However, if their expectations are realised then their current strategy is considered to have succeeded irrespective of the state of the macroeconomy.
This is an important aspect and helps us understand why Keynes, for example, thought that equilibrium could coincide with mass unemployment. When the firms produce (and employ) based on what they consider to be the state of the market and their profit expectations are realised, they have no incentive to change.
The only event that might lead them to change their current production levels is if they sense there is something different in the markets they supply into.
Keynes suggested that the introduction of a government stimulus would represent one such change factor. It would lead firms to revise their expected sales upwards and, once started, would multiply into higher production and employment levels throughout the economy.
An unfettered market would not possess that dynamic and as Keynes observed would become stuck in a state of rest with mass unemployment after a period of firm insolvencies.
Therefore, the Classical approach saw unemployment as a temporary disequilibrium state, which would be soon corrected as real wages adjusted to the demand and supply imbalance, whereas Keynes saw unemployment as being an equilibrium state, which would persist unless effective demand was stimulated.
This distinction also influences the way Keynes defined full employment. For the neo-classical economist in the 1920s, full employment occurred whenever labour demand and labour supply were equal, irrespective of the level of employment that coincided with that balance. They denied the existence of unemployment so that even if the employment level achieved was well below the current labour force, they would consider the difference to reflect voluntary choices by workers not to work.
For Keynes, full employment was a special point that required that effective demand (total spending) was sufficient to ensure that there were enough jobs offered to match the willing labour supply at the current money wage level. It was a state that the capitalist system might achieve (as a special case) but there was no general tendency within the dynamics of the system to move the economy to this state.
Thus, there are two very broad and strikingly different conceptualisations of equilibrium that have been used in the literature. The former was a microeconomic concept that was then applied to macroeconomics. It failed to reflect how an economy could become stuck in a state of mass unemployment and recession because it fell foul of what we term the fallacy of composition – the inapplicability of specific to general reasoning.
But it went beyond the issue of aggregation. But that is for another day when I have more time.
So think back to the Dust Bowl. There were many people at the time who resented the introduction of the CCC and the WPA. Some of the free market advocates claimed that the government should have done nothing. Just like now, their recommendations would have made matter much worse than they already were.
People would have starved to death out their in the plains of the US. Only the government programs saved them whether they liked that or not.
The sames goes for today. The market-clearing concepts of equilibrium are lethal when applied to real world public policy. We could eliminate most of the unemployment in a very short-time if the government adopted the CCC/WPA mentality and understood that it is an equilibrium we are in that will not change unless there is a kickstart from government.
I did some calculations and if the government introduced the equivalent to the WPA now the financial outlay would have been much less than the actual stimulus that the Obama Administration did introduce but the job quotient would have been far greater.
You shouldn’t take from that that I would be concerned about the “financial outlay”. Just like in the times of the Dust Bowl there is massive idle capacity willing to be productively deployed. The market didn’t do it then and it won’t do it now.
My flight is being called. So …. tomorrow!
That is enough for today!
(c) Copyright 2013 Bill Mitchell. All Rights Reserved.