Defining Definitions in our Election Discourse

This post’s main purpose is to serve as an outlet of frustration over the muddling of definitions that is particularly prevalent in this election cycle. Prior to 2015, Americans’ understanding of the meaning and beliefs of different political ideologies already seemed confused (in my opinion). However, the rhetoric of political candidates has not helped. In particular, my complaints lie mainly with Bernie (who, for some inexplicable reason, has still not conceded to Clinton’s insurmountable delegate lead in the Democratic nomination). People seem to think he has done a service for the country by helping to “de-stigmatize” the word socialism, which is considered to be a much more prevalent ideology and economic system in Western European countries. However, I think that he has actually made things worse for political discourse by 1) confusing people about what pure, traditional economic socialism really is 2) by confirming the false belief among many that American liberals are actually best defined as socialists, when I’d argued they’re much more pro-capitalism than pro-socialism and 3) Potentially de-emphasizing needed attention on the very real destructiveness that pure socialist economics has historically wrought on societies and the many lessons that they entail. I will begin by laying out the different terms and what I think the definitions truly are before proceeding to the other arguments noted above.

  1. Socialism: Bernie Sanders likens himself as a socialist at heart. But is he really best described as that? My definition of socialism falls along with the economic, traditional definition of socialism. Particularly, it entails the “common ownership and control of the means of production”, typically by the state (although historically, many variations of socialism have appeared in which other entities, institutions, or the masses themselves own and control the means of production). The means of production are any economic inputs (typically tangible and physical) used to create economic value or output. They can include machinery, factories, roads, infrastructure, educational institutions, etc. In my mind, if Bernie Sanders was truly a socialist, he would advocate for the government to both own and control virtually all of the means of production (including businesses, factories, etc.) This would entail a program of large-scale nationalizations of industry. Aside from “nationalizing” (better termed as a national replacement) of health insurance and 100% public funding/control of tertiary education, however, he has no such program, and largely keeps in place private ownership and control of the means of production (e.g., he allows for businesses to continue to be privately owned and operated). Consideration of the fact that all societies have different ratios of private and public ownership of the means of production leads to the important point that these ideologies and policies do lie along a spectrum. But in describing whether he better fits a socialist mold or a capitalist mold, he’s arguably more pro-capitalism than pro-socialism in general. Only his advocacy of nationalized health insurance and tertiary education would make him truly relativelymore socialist than other candidates, per my definition. Instead, his policies reflect interventionism within the confines of a predominantly capitalist economic framework that he’d like to keep intact (e.g. the taxation and regulation of a capitalist economy, with other interventions in the form of government spending). As a result, he’s much better described as a social democrat or an American liberal than a socialist…
  2. Social Democracy/American Liberalism: First, it’s important to note that these two terms are not the same. But they are quite similar. Essentially, both argue, in consideration of my definition of socialism, in a capitalist mixed economy with heavy amounts of government intervention (taxation, spending, regulation). Although these ideologies do entail some elements of pure socialism (e.g. public roads, public schools, national health insurance, etc.), they are far from pure USSR-style socialism, as private industry is still prevalent (indeed, dominate) within their prescribed economic systems. Now, granted, the taxation and regulation of capitalist institutions that they advocate for entails some control of these private means of production by the state. But not full control by any means, and certainly not actual ownership, as pure, traditional socialism would entail. It is also true that social democracy did start out as an ideology of gradual reform of capitalism into a system of socialism via democratic means over time. Now, however, like American liberalism, it’s essentially the definition stated above, with an emphasis on income redistribution and social justice. Therefore, in social democracy and American liberalism, capitalism still reigns, and given Bernie’s proposals, he best fits within these categories (which, by the way, I’m far from the first person to notice or argue).

A few things to derive from above:

1) These terms are all pretty vague and overlapping, even utilizing the narrowest of definitions. There’s technically no 100% correct description to be found for different candidates and economic systems.

2) Economic systems typically contain a mixture of capitalist and socialist elements. In my view, it’s the extent that some elements dominate that truly characterizes systems and people’s political ideologies (e.g., if more common ownership of the means of production prevails in an economy or a person advocates for mostly common ownership, it’s a socialist economy or the person is socialist, respectively). This observation of non-purity can also lend support for a dialogue of relativity (e.g., someone or some economy is relatively more socialist or relatively more capitalist than another).

3) In my opinion, the taxation, regulation, and spending of social democratic and American liberal policy aren’t exactly socialist elements (at least, not pure elements; perhaps quasi-elements). Rather, I would argue they are forms of interventionism within a fundamentally/overwhelmingly capitalist framework (private ownership of the means of production). Thus, Bernie is a social democrat/American liberal, and American liberals are not truly socialists.

4) It should be clear that, even in overwhelmingly capitalist America, true socialist elements do exist that actually serve useful functions. Public roads, public schools, public infrastructure, etc. are indeed prevalent in all overwhelmingly capitalist economies and can technically be characterized as true examples of socialist ownership and control. What really matters is what economic means of production are private versus public and balance of the ratios in determining economic and societal well-being.

All of this is also not to say that the taxation, spending, and regulation advocated for by social democrats and American liberals do not have some negative consequences, even if such interventions are not really “socialism” (e.g. system is still mostly privately owned/controlled). And it’s especially not to say that purely applied, across the board economic socialism is not destructive, when it clearly has been in the past (USSR, China, Vietnam, etc.) The economic misallocation of resources stemming from predominate state socialist ownership and control (and the ensuing incentive and signalling problems) brought upon massive economic hardship and destruction of human well-being in multiple countries throughout the 20th century. That’s what’s truly concerning to me. Although socialism shouldn’t be the taboo word it has been, considering it is found to be functioning within American society at this very moment, people should be very weary of the extent of its application and for which segments of the economy it is applied to. The very same can be said for capitalism, too. Thus, we need to shy away from puritanical, black versus white thinking – with its all-or-nothing propositions – and finally let informed, pragmatic thinking lead the way.

Thesaurus

On America’s “Great Stagnation”

This posting will briefly discuss the historically weak growth since the end of the 2007-2009 “Great Recession” (though a greater period of time, reaching into the 2000’s or “aughts” or even further back, can also be included in the definition).  It argues that, though we may have reason to be alarmed at slower long-run economic growth, by many measures living standards have improved at a rapid rate, and will continue to do so into the foreseeable future.


Since the end of the last business cycle trough in June 2009, countless observers have noted – and lamented – the historically anemic growth rate of America’s economy.  In the 19 quarters since the beginning of the recovery, GDP growth has averaged around 2% annually – well below the 4% average for recoveries after 1960, and barely enough to generate the jobs needed to absorb entries into the labor market.  Indeed, in the first quarter of 2014, the economy logged (at a seasonally adjusted annual rate) of  -1%; in other words, it registered an actual contraction, the first quarter since 2011 to do so.  Although the particular severity of Q1’s stagnation  is likely temporary, it nonetheless does well to highlight the unique sluggishness that has characterized this recovery since the beginning.  Also highlighting the recovery’s weakness is the economy’s failure to quickly return to potential output, reflected in the continued existence of a large output gap (see charts 1& 2).

Real vs. Potential

 

bivens-figure2

It is true that economic growth remains far from normal – especially considering the depth of the preceding recession, which usually are followed by sharp “bounceback” recoveries (as pent-up consumer & investor demand is unleashed).

However, there are a couple of things to keep in mind:

1) This was not a “normal” recession.  Normally, recessions are sparked by mild shocks in aggregate demand or aggregate supply, oftentimes instigated by a contractionary monetary policy.  This time, however, there was an extreme shock to aggregate demand as a plummet in housing prices pushed down household consumption (the “wealth” effect) and the deterioration in the balance sheets of financial institutions caused a freeze in credit markets.  “Balance-sheet” recessions like these are typically severe, and have long-lasting effects.  Growth tends to be much weaker in decade following financial crises than normal recessions as households and institutions “deleverage” their debts to repair their balance sheets.  Since the United States had not, until now, experienced a true financial crisis since the Great Depression, this sluggish recovery can be considered historically unique.

2) Growth and potential growth have been slowing for decades.  When one looks at real GDP and potential GDP over long periods of time (see chart), it becomes clear that long-term growth has been slowing for decades.  Especially recently, after each subsequent recession the recoveries have been weaker than the one preceding them.  Although it only shows data through 2011, the second chart below clearly demonstrates this pattern.

2.1.1-GDP-gap-OPT

screen shot 2013-01-30 at 10.48.29 am

3) As the population continues to age and retire, sluggish growth is only to be expected – unless productivity growth accelerates.  An economy essentially grows for two reasons: the population/labor force is increasing and/or labor productivity (ouput/hour or, more generally, the amount of output with a set of given inputs) grows.  The latter is especially important in helping to boost living standards, as more efficient production allows for more income to be distributed and for goods and services to be produced at lower costs.  Historically, especially during the “golden age of capitalism” from the 1940s-1970s, the economy has benefited from both labor force growth and productivity growth.  Beginning in the 70s, however, the 2nd factor – productivity growth – began a to register a marked slowdown, even as the labor force continued to expand (especially with an increase in the participation of women).  The reasons for this slowdown are unclear.  Was US inflation distorting incentives and resource allocation?  Were technological waves delivering less of an impact as earlier technological waves?  And are these changes driven more by changes in the accumulation of capital stock or total factor productivity (TFP)?  Regardless, this slowdown in productivity has continued to the present day, interrupted only by a brief revival in the late 90s and early 2000s (see neat chart below that I made using data from the Bureau of Labor Statistics; as a note, the data represents quarterly % changes at annualized rates, and labor productivity is defined as output/hour).

Capture

All of this points to a couple of things.  Comparing this recovery to past ones should be used with a grain of salt, because

a) it follows a historically unique financial crisis, unlike other recoveries, and thus can be expected to be slow in the short-term

b) the growth trajectory has long been slowing, making many recoveries naturally more sluggish than those that preceded them, suggesting that, even without the financial crisis, stagnation could have been expected anyway

While some parts of this decline in long-term growth appear natural (such as a decline in labor force participation due to ageing populations), other parts – such as the productivity element – may or may not be.  This is because productivity growth can arguably be more strongly influenced by deliberate policy/non-policy actions than labor force participation can (at least when considering that most older baby boomers will have to retire at some point soon). Should the public and/or private sectors, for instance, be investing more in public and private capital?  Maybe.  But the urgency of that question depends on how much that sluggishness is translating into a stagnation in actual living standards.

Certainly, there are good arguments that American living standards have shown signs of stagnation as of late (and not just following the 2007-2009 recession).  For instance, as the chart below demonstrates, median household income (the income level of the theoretical household in the exact center of a data set of all household incomes) has registered virtually no net growth since the late 1980s.

Capture2

Other trends are worrying as well.  Poverty rates as defined by the Census Bureau have made almost no net progress since the 1970s, and the prevalence of health insurance and retirement plans (think defined-benefit pensions) have evaporated (at least until recently).  Combined with a worrying increase in health care costs and tertiary education tuition, and the typical American household has indeed seemingly experienced a “stagnation” for a fairly long period of time.

However, despite all of this negative “evidence”, I personally would still contend that living standards have still registered marvelous improvements, and will continue to do so.  First of all, GDP & productivity growth figures do not account for a crucial aspect of capitalism that is often under-appreciated: a long-run rapid improvement in product quality and capability.  While such figures may capture value-added in the production process, they cannot completely account for improvements in product capability and the additional satisfaction these new capabilities give to consumers.  For example, think about cars.  Economic statistics may reflect the total output of cars, the efficiency of their production, etc, but they oftentimes may completely ignore how much the typical car has changed.  For example, many cars are now equipped with sensory technology that makes driving smoother and more comfortable.  Anti-lock brakes, air conditioning, and even GPS systems, all once reserved for those with the most cash, are now becoming increasingly widespread and standardized with the industry, improving the driving experience of millions of consumers.

Additionally, I think too much emphasis is placed on incomes when it is often ignored how dramatically consumer costs have actually fallen in many industries.  For example, according to statisticbrain.com, the average price/MB of RAM has decreased from approximately $411 million in 1957 to less than six-thousandths of a dollar in 2013.  This has greatly increased the purchasing power of the typical consumer, and has been replicated in many other sectors of the economy.

While it is true that some very important industries that impact the middle class – namely healthcare and education – have shown rising costs, which is a concern that should be addressed, even here this largely reflects increases in quality.  New (albeit costly) technology and healthcare procedures, for example, have given consumers innovative and state-of-the-art choices.  These technologies and procedures have greatly increased the quality of life of people, something the statistics cannot ever fully reflect.

Overall, while I do think America has entered a “Great Stagnation” (not just in the short-run but over the past couple of decades) in terms of economic growth, I do not think this fact should be assumed to be entirely a bad thing.  Indeed, I think it is somewhat misleading – despite slower growth, many elements of living standards (which I only briefly touched upon) continue to make rapid progress, even if many other components of such standards have stalled (e.g. household income, health insurance coverage, etc.)  While it is certainly no excuse for complacency – we would do well to figure out ways to sustainably boost long-run growth – it is reason to think twice about repeated observations of a supposed “decline” in American affluence and its middle class.  The trends are a bit more complex than that.

Inequality and unemployment: is there really a connection?

Lately I’ve been thinking about the connection between income distribution and unemployment, and I’ve started to question the prominent view among left-leaning economists that full employment is necessary to reduce income gaps.  Their argument is simple and understandable: during periods of high unemployment, workers’ bargaining power are reduced as there is a vast supply of workers willing to work at lower wages.  As a result, wages stagnate or decline among low and middle-skilled workers, while the owners of capital reap large profits.  Ok, that makes sense.  But take a look at the following two standard measures of income inequality and unemployment:

ImageImage

Notice something?  There seems to be little, if any, correlation between income inequality and unemployment.  The current standard definition of “full employment” among economists is an unemployment rate of between 5-5.5%.  Repeatedly during the past 30 years, the unemployment rate has dipped below this figure (indicating an economy operating at or above potential); yet the Gini coefficient continued its upward march.

Perhaps full employment is one of several different prerequisites for a narrowing of the income gap, assuming that is even a desirable policy goal.  However, I question the idea that it is an essential method to do so.

Another interesting (albeit flawed) view of the “recovery”

This graphic (courtesy of the Economic Policy Institute) shows the employment/population ratio since just before the Great Recession started. Interestingly, although the official U2 unemployment rate has fallen to 6.7% from a peak of 10% in late 2009, the E/P ratio has barely budged since the end of the recession, indicating we have a long way to go before we reach pre-recession levels of “employment saturation”. This indicates that much of the fall in U2 has been due to people exiting the labor force, not actual employment gains. However, even the arguably more reliable E/P ratio is misleading; after all, the baby boomers have begun to retire, naturally putting downward pressure on the ratio. It seems that no matter which measure we choose it is hard to find one that accurately reflects the state of the labor market.

Long-Term Economic Cycles

Here’s a blog post I wrote last summer (with the only caveats that I had no blog and thus no where to post).  Enjoy…

George Friedman, in one of my favorite books entitled “The Next 100 Years: A Forecast for the 21st Century” intrigued me by noting a historic pattern he had observed: Every 50 years, the US goes through a major economic/political cycle. For example, during the Great Depression, public policy turned towards stimulating consumption of the lower and middle classes. To correct inadequate demand while taxing the upper classes to contain investment and excess supply. This coincided with a shift in political power towards the urban working class. However, by the 1970s,
There was excess demand in the economy, and supply was being constrained as years of high taxes and overregulation resulted in inadequate investment and a depleted capital stock, lowering productivity and supply increases. This crisis instigated the next cyclical shift in the early 1980s (50 years after the 1930s cycle began), in which taxes and regulations were cut to boost supply, and political power shifted to the suburbs and away from the urban areas.

In my view, while I agree with Friedman that this shift resulted in a new surge in productivity and efficiency, supply again outstripped demand and sowed the seeds for the Great Recession.
As surplus capital accumulated, much of it was used to sustain the borrowing of the lower and middle classes, temporarily sustaining their consumption (as income growth was inadequate for them). Eventually, the bubble popped, and now demand is severely inadequate relative to supply. According to Friedman’s theory, sometime in the 2030s the US will experience another shift. What will this shift be, though? For although this past cycle seems to have undoubtedly favored capital over labor and supply over demand, it did not completely neglect demand; rather, it sought to prop up demand unsustainably. This calls into question current US economic policies. Right now, the US is undertaking an extremely expansionary monetary policy
and a contractionary fiscal policy. Many Keynesian economists want both to be expansionary. However, will higher government spending and, especially, lower interest rates really help to create sustainable demand in the US economy? The latter is meant to encourage borrowing, consumption (and theoretically investment). However, it was heavy borrowing that got the middle and lower classes into the conundrum they, and the entire economy, face today. Household debt is beginning to increase again after years of deleveraging, a deleveraging that, while significant, still left household balance sheets far from repair. Meanwhile, higher government spending could temporarily help prop up demand, but by putting upward pressure on debt to gdp ratios, it seems unsustainable and a risky endeavor to rely on for economic recovery. As for the neoliberal solution of contracting both monetary policy and fiscal policy, such actions will almost surely depress demand even further (at least temporarily).

I believe ultimately that this crisis is a function of diverging productivity levels for different groups of the population. Higher skilled workers have an inherent financial advantage in our increasingly globalized economy; further compounding their advantage was their lack of supply relative to demand, increasing their price. Meanwhile, an oversupply of less skilled workers (who inherently have less of a financial advantage to begin with due to lower productivity) constrained their price. This has resulted in widespread inequality. Our failure as a nation to convert these less skilled workers to higher skilled workers has resulted in insufficient income to support demand.

The Fed Centennial: A Brief Historical Review of the World’s Most Powerful Central Bank

6 years ago to the month, the United States entered its longest and deepest post-war recession.  18 months later, in June of 2009, economic growth finally resumed.  Ever since, barring a few  quarters of “bounceback growth” in late 2009 and blips in 2011 and Q3 2013, the recovery has been extraordinarily sluggish by historical standards.  What does this have to do with the Federal Reserve’s (recent) 100th birthday?  Lots, actually.  But first, let me go all the way back to the beginning.

100 years ago to the month, the United States entered its longest and deepest experiment in centralized banking.  Congress had passed The Federal Reserve Act of 1913 to set up the Federal Reserve System, a quasi-private quasi-governmental central banking system, in response to the many financial panics that had plagued the US since its founding (especially the severe 1907 financial crisis).  It originally started out with three specific mandates: full employment, price stability, and moderate interest rates, each of which would receive particular emphasis during different periods of time.

The Fed got off to a fairly rocky start.  It failed to adequately mitigate the severe early 1920s post-WW1 recession, and exacerbated the Great Depression by attempting to fight non-existent inflation.  After the horrendous 1930s, beginning in the 1940s the Federal Reserve placed heavy emphasis on the “full employment” mandate.  This coincided with the post-war “Keynesian consensus”, in which fiscal policy was also leveraged to support the full-employment mandate.  Growth was generally robust during this time, though during the 50s growth was slower and was repeatedly interrupted by short recessions.  During the 1960s, activist monetary and fiscal policies reached their nadir, with the Fed coming under increasing political pressure to maintain full employment at all costs.  This continuous monetary expansion helped set the stage for the stagflation of the 1970s, where too much money was chasing too few goods.  Further compounding the situation was President Nixon’s removal of the dollar from the gold-standard, putting further downward pressure on the dollar.  By 1980, inflation was running in the double-digits even as unemployment now remained above the “full-employment” level of 5-6% (challenging the Phillips Curve inflation/unemployment tradeoff theory).

It was with the appointment of Paul Volcker as Fed Chairman in 1979 that the Fed’s emphasis on price stability (rather than full employment) can be observed.  Volker enacted an extremely tight monetary policy (selling government bonds to remove money from the economy, depress bond prices, push up bond yields and thus push up interest rates) that led to the double-dip recessions of 1980 and 1981-82′ (the latter being particularly severe).  After the prime rate hit 21% in 1980, it and inflation fell rapidly, as did interest rates.  Growth rebounded strongly.  From then on until the 2008 financial crisis, the Fed maintained a steadfast commitment to lower inflation (sometimes at the price of full employment).  Rates of inflation and interest steadily declined until 2008 (with intermittent spikes now and then).

Either as a cause or effect of the Fed’s actions, savings rates also trended down beginning in the 1980s, following the pattern of interest rates (which makes sense, as depositors have less incentive to save with lower interest rates).  Lower interest rates spurred consumer spending, beginning a quarter-century long consumption boom.  Balance of payments and the federal budget recorded significant deficits for the first time.  Almost all forms of debt – governmental, commercial, and household debt – began to rise as a percentage of GDP and personal income.

This unsustainable situation, as noted, would last until the late 2000s.  Just a few years earlier, after the dot-com bubble burst at the turn of the millennium, the Federal Reserve pursued what was (up until then) one of its most aggressive monetary expansions ever.  The Federal Funds target rate was repeatedly reduced until it reached around 1% until the mid-aughts.  This monetary expansion (characterized, as all monetary expansions are by massive bond buying = higher bond prices = lower bond yields = lower interest rates to hopefully spur investment, borrowing, and spending), however, coincided with the rise of surplus financial capital in other parts of the world.  A surplus of capital almost everywhere looked in vein for investment vehicles to profit from, and safe government bonds, with such low prevailing yields, would not suffice.  As a result, they turned to riskier assets such as mortgage-backed securities (MBS).  These instruments, backed by the value of actual mortgages, would yield investors dividends essentially in the form of monthly mortgage payments – a much higher rate of return than treasury bonds yielded at the time.  The demand provided by the investors of MBS’ increased the demand and funds available for mortgages, which pushed up lending and housing prices.   Of course, we now know that many of these mortgages were sub-prime and extremely risky.

CDO_-_FCIC_and_IMF_Diagram

When the Fed finally began to raise interest rates in the mid-aughts, several things occurred as a result.  Higher interest rates caused a wave of mortgage defaults and foreclosures, especially among risky borrowers.  This reduced the value of MBS’ and weakened investor demand for them, putting downward pressure on the net worth and financial positions of multiple investment banks.  This weakening of investment banks weakened demand for mortgages from mortgage lenders, who thus lent less.  This started the infamous “credit crunch”, which not only lowered mortgage lending and demand for housing (further lowering housing prices) but put pressure on all forms of borrowing.  Higher interest rates also made bonds look more attractive than risky assets, causing further pullback from investors.  Although far more complex than this explanation, this is the essence of the financial crisis that sparked the Great Recession.

The Fed responded to the crisis quickly, purchasing billions worth of “troubled” or “toxic” assets in a bid to stabilize the financial system and money supply.  The Fed funds target rate was lowered to almost zero, and the conventional monetary policy of purchasing short-term bonds was commenced.  However, even with these policies, inflation remained (and still remains) precariously low.  Thus, various “unconventional” monetary policies have also been pursued, notably “quantitative easing” (QE), in which large quantities of long-term financial & commercial assets (including long-term government bonds) are purchased with newly created money to both lower long-term interest rates and raise the quantity of money in the money supply.  As of this writing, the Fed is still purchasing about $85 billion in bonds per month as part of its QE strategy.

So, about the financial crisis and our agonizingly slow economic recovery: can the Fed ultimately be to blame?  You could argue that low interest rates pursued by the Fed ultimately pushed investors into too-risky of assets.  Of course, the Fed wasn’t the only downward pressure on interest rates since 1980 – the emergence of several developing nations has given rise to a global “savings glut” that has pushed down interest rates worldwide.  The Fed may have kept the Fed Funds rate down too long during the mid-aughts – but then again, who can really blame them, considering they were desperately trying to make sure the US didn’t enter a deflationary spiral after the dot-com bubble burst?  As for its role in our slow economic recovery, that is also unclear.  Normally after recessions, an expansionary monetary policy (and the low interest rates that come with it) spur consumer & business borrowing, spending, and investment, increasing short-term economic growth.  However, this time is different, as households and businesses are still trying to deleverage from their debt overhang (a process that requires less consumer spending and increased savings for a time).  Considering that debt deleveraging (so that debt as a percentage of GDP and household income is down to more normal levels) is essential for long-term economic growth and recovery, the downward push exerted by the Fed on interest rates could actually be retarding the process as it makes it more difficult to accumulate savings to pay off debt.  At the same time, an easing of the Fed’s ultra-loose monetary policy right now may not be a good option, either, as it may cut off all sources of growth.  Whatever the Fed’s role in the crisis and its aftermath, it is clear that the crisis has provoked a strong discussion in consideration of which part of the Fed’s mandate (if any) should be emphasized from now on.

To sum up, the Fed has had a tumultuous century.  Though it has had its monetary successes (inflation taming?), its failures weigh heavily.  Ironically, the very cause of its creation  – financial crisis – also marks the end of its first centennial.  Though there has been progress, one can’t help but feel that we’re back to square one.