Sunday, January 27, 2013

Krugman's Inequality and Recovery (1): First Things First

Greg's been writing lately. A good thing.

Greg's new post has some great insights into who is and who isn't underconsuming. In the post Greg also considers "the toxicity of debt" and presents a medical analogy. Let me summarize his analogy:

  • A human body is the economy.
  • A cell in the body is an economic unit: a person or a family, say.
  • Blood flow to the cell is income.
  • Blood flow from the cell is spending & bill paying.
  • Cellular acid is debt.

Greg follows through, comparing cellular and economic processes: Like cellular acids, "debts must be cleared or they will reach toxic levels".

You know I had to love the post.

Along the way, Greg links to Paul Krugman's Inequality and Recovery. Krugman has a way about him: he writes, and you just have to respond to him. So, like Greg, I want to look at Krugman's post now for a bit.

Tomorrow, maybe I'll tear him a new asshole. Today, I write in praise of Krugman. His post opens with these words:

Joe Stiglitz has an Opinionator piece arguing that inequality is a big factor in our slow recovery. Joe is an insanely great economist, so everything he says should be taken seriously. And given my political views and general concerns about inequality, I’d like to agree.
But — you knew there was a “but” coming — I’ve thought about these issues a lot, and haven’t been able to persuade myself that this particular morality tale is right.

"Given my political views and general concerns about inequality, I’d like to agree."

Krugman likes where Stiglitz is coming from, but the economics does not compute. So it doesn't matter to Krugman that Stiglitz's heart is in the right place. It doesn't matter to him that what Stiglitz says is something that Krugman wishes he could also say. If Krugman cannot work through the economics of it, Krugman cannot accept it.

That's the right way to do economics. It's the only way to do economics. Bravo.


So am I saying that you can have full employment based on purchases of yachts, luxury cars, and the services of personal trainers and celebrity chefs? Well, yes. You don’t have to like it, but economics is not a morality play, and I’ve yet to see a macroeconomic argument about why it isn’t possible.

"You don’t have to like it, but economics is not a morality play".

Right again. If you want to fix the economy, you have to understand that you must first understand the economy. You don't get there by saying I'm concerned first and foremost about unemployment, or first and foremost about inflation, or first and foremost about inequality. You don't get there any other way than by being concerned first and foremost about understanding the economy. And only after you get close do you begin to apply your knowledge to the problems.

Krugman gets it.

Enough!! Now I'll go off-topic, and do some economics of my own.

Krugman says "yes" you can have full employment based on the aggregate demand of the one percent alone. I can't wait till tomorrow. The tearing begins now.

Sure, you can have full employment based on the spending of the 1%. But to do it you must first redefine "full employment" to higher and higher levels of unemployment -- something we have been working on since the 1960s. And then you have to abandon capitalism for some form of aristocratic feudalism.

No: You can't get full employment by depending on hoarders to spend. It doesn't work. We tried it, actually, for 500 years and more. That experiment was winding down in the first hundred years shown on this graph of UK GDP:

Graph #2, data from Measuringworth

By Okun's law, there is a parallel between employment and output. Rely on the 1% to drive aggregate demand, and you drive employment and output to zero.


Greg said...

Thanks for the kind words Art.

I wasnt sure that Krugman was claiming that the spending of the 1% alone could lead to full employment. He may have been but I think he was guilty of a greater sin, using a model of loanable funds where savers, via banks, get their extra money to the borrowers as long as monetary policy is getting it right.

He sees the total stock of money as the operative tool in determining pricing, investment, spending etc. Its a simple Quantity Theory of Money idea where prices of goods/services just equals Total $/ Total of Goods and services for sale...... in the long run of course.

Its because he totally gets banking wrong, as does Sumner and Rowe, that he misses what looks like obvious to you, I and many others.

Using my body/blood analogy, its like thinking every
problem in the body can just be cured by giving more blood. "If we just give enough of it, flow will happen!!" Banks are like the heart and we just need to give them enough and they will pump it. But the heart only works when it has LIVING cells asking for the blood. Dead cells dont ask for anything, they have stopped demanding. Dying cells are sometimes asking for more as they are dying but they are also releasing toxins that must be cleared if the system is to stay alive.

In reality the heart is very benevolent whereas banks are not. Banks are looking out only for them selves and their shareholders profits. If hearts acted like banks we would all be dead by 25-30 yrs old, if not sooner. The money system NEEDS to act more like the cardiovascular system. Cardiovascular system knows it need the cells. Its there to serve the cells.

Greg said...

My first comment needs further development I think.

Krugman, according to the model he is using, is likely saying that the 1%, via their preferences, are saying that chasing all these luxury goods is what they desire. Furthermore, he might be saying that, in some world, these preferences could be met. We COULD have a large percentage of the unemployed respond to these investment preferences of the rich and start building more yachts or competing to staff the yachts. Or design new gold jewelry ( a kid who graduated with my son is doing very well designing and selling his own jewelry mostly over the internet)
That all the unemployed could just gravitate to markets which just pamper the rich...... and he's right they COULD. But I also thinks he knows that would be a silly, unproductive and very unlikely thing to do.

Krugman may be trying to point out the facile end point of much of the current economic thinking by saying "Yes, our models prove that no matter the level of income inequality, if those "without" are willing to do what ever is necessary to meet the investment/spending desires of those "with" we can always have full employment." and then just stand there........smiling!

The Arthurian said...

Greg, am I getting a preview of the next Wondering Aloud post? :)

From your post:
[Krugman] suggests that there is little evidence that the rich are underconsuming...
I dont think the underconsumption is from the rich. Its from the non rich who are losing incomes TO the rich. I think Paul is making the wrong assumption about where the underconsumption is coming from. He seems to think that distribution doesnt matter much...

I thought that was brilliant.

Krugman's post is kinda scattered, I think. I had trouble when I tried to summarize it, trouble arising from his touching many topics. Perhaps because he is summarizing and replying to some other post... Yeah, probably that.

Reviewing it now. Krugman writes:
Joe offers a version of the “underconsumption” hypothesis, basically that the rich spend too little of their income. This hypothesis has a long history — but it also has well-known theoretical and empirical problems.

He says what you said he says. But his next paragraph was a disappointment. I wanted something tangible on the "well-known theoretical and empirical problems" but there was just a vague reference to Milton Friedman (as there often is, when I find myself disappointed) and some really unclear exposition.

My focus snagged on the disappointing part of his post. I never got back to Krugman's remark on underconsumption. So your capture of it was a pleasant surprise for me.

In other matters... Yes, your addendum resolved a question I had with your first comment. It makes more sense that he expects the borrowing of the masses to resume with some vigor. It makes little sense to think that the spending of the 1% could generate the GDP we expect... Particularly as the 1% are savers, not spenders, pretty much by definition.