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Graph #1

The Future of Real GDP per Capita

Scott Sumner says "the neoliberal reforms after 1980 helped growth". He writes:

I am not denying that growth in US living standards slowed after 1973, rather I am arguing that it would have slowed more had we not reformed our economy.

One may wonder how much more the economy might have slowed if not for those reforms. Perhaps here we have an answer: 0.76% more.

Graph #1: Natural Log of Real GDP per Capita (black) with Trend lines
2.4% Annual Trend Growth Rate for 1949-1973
2.1% Annual Trend Growth Rate for 1974-2007
1.34% Annual Trend Growth Rate for 2009-2016

Trend growth slowed 0.3% annual after 1973, from 2.4% to 2.1%. When the effects of the neoliberal reforms (or whatever) failed after 2007, trend growth slowed an additional 0.76%, falling to a 1.34% annual rate. The combined decline in the trend growth rate is 1.06%, more than a full percentage point below the 1949-1973 rate.

Based on these numbers, Sumner's story says growth would have slowed 1.06% without the neoliberal reforms, but instead slowed only 0.3% because those reforms were put in place.


In Sumner's next post after the one I quoted above, he considers the question Why did growth slow after 1973? His answer echoes that of Robert Gordon, who says "the life-altering scale of innovations between 1870 and 1970 cannot be repeated." An empty explanation.

Scott Sumner adds to Robert Gordon's story, diluting the meaning with extra words. "Here’s what I think happened," Sumner says:

There were a few underlying technological developments in the late 19th century that dramatically affected living standards in the 1920-70 period, when they were widely adopted in advanced economies. I would certainly include electric power and the internal combustion engine. I also think indoor plumbing is underrated. Imagine having to rely on outhouses in cold climates... Many key products were first invented in the late 1800s or early 1900s (electric lights, home appliances, cars, airplanes, etc) and were widely adopted by about 1973. No matter how rich people get, they really don’t need 10 washing machines. One will usually do the job. So as consumer demand became saturated for many of these products, we had to push the technological frontier in different directions. And that has proved surprisingly difficult to do.

Well, they had indoor plumbing in ancient Rome. But Scott Sumner's "surprisingly difficult to do" tells us no more than Robert Gordon's "cannot be repeated". The question "Why?" remains. And then, "Why 1973?"

More to the point, Sumner's explanation does not account for the second slowdown, the 2007-2009 slowdown. He has a different story for that one. Not enough money, he says. Print more money, he says. Increasing the Fed's balance sheet from 800 billion to 4.5 trillion was not enough, he says.

Two slowdowns, two explanations. But we don't need two explanations. "One will usually do the job."

The greatest weakness in Sumner's story is a weakness he shares with almost all modern-day economists: His argument is a hodgepodge of unrelated tales. In this case, a lack of invention after 1973, plus saturated demand, plus a difficult technological frontier. But then after 2007, tight money was the problem: 4.5 trillion, and still too tight.

The question "Why?" remains.

There is no "big picture" any more, no one overall theory that explains what's wrong with the economy. There has been no big picture since Keynes was rejected by the moderns. Only a hodgepodge of unrelated tales.

What's wrong with our economy is the excessive accumulation of private debt. That was the problem in 2007-09, and in 1973-74, and before, and since. One problem. One problem that never gets better and always gets worse. One problem, ignored by economists who know which side their bread is buttered on.


I can never resist the opportunity to criticize Scott Sumner's economics. But that's not what this post is about. This is not about the decline of economics. It's not even about the reasons for the decline of economic growth. This post is only about how big the decline of growth has been, and how things will look if the decline continues.

It seems there are two ways to think about how things will look if the decline continues. This is the wrong way:

Graph #2: Showing the Most Recent Trend Continuing

If we stay on track with the 2009-2016 trend, by the year 2100 RGDP per Capita will reach the level it would have reached by 2050 if we had stayed on track with the 1949-1973 trend.

But this graph does not show the continuation of decline. It shows only the continuation of the low-growth trend that resulted from the decline. The decline is the change in the rate of growth, from 2.4% to 2.1% to 1.34% and, unless things change, to a growth rate lower than 1.34% in the foreseeable future. That is the decline.

This is the right way to look at the decline:

Graph #3: A Repeating Decline in the Rate of Growth

Two factors affect the up-and-down on this graph: the changing slope of the red lines, and the drop after each red line stops. Two factors affect the left-and-right: the length of the red lines, and the duration of the gap between the red lines. Obviously I made these things up.

The black dots indicate the original source data. After the black dots die out in 2016, it's all just a guess. The last five red lines, including the one that started in 2009, are each shown as 20-year trends. You could change them if you want.

The gaps between the red lines, each is one year longer than the gap before. The gap you can't see (1973-74) is one year. And the 2007-2009 gap is two years. These are actuals. I stuck with the pattern and made the next gap three years, and the next gap four years, and like that. You can change them if you want.

If you change these things, you will stretch the graph out, left-to-right, or shorten it, left-to-right. But you won't change the up-and-down pattern. To change the up-and-down pattern you have to change the growth rates (the slopes of the red lines) or the drops after the red lines stop, or both. You can change those too, if you want, but you should be realistic.

The red line slopes 0.3% less after 1974 than before. Hard to see. After 2009 it slopes 0.76% less than before. Those are actuals. I was going to keep making the number bigger for the future slopes, but I decided against it. Instead, I went with the 0.76% additional decline each time. No one knows what those actuals will turn out to be, but assuming the most recent actual change each time provides a realistic estimate.

For the vertical drop at the end of each red line, I did something similar: Each drop is the same size as the 2007-2009 drop. That's as realistic as I can be here, estimating the future.

// The Excel file

About the gains from our economically viable choices

Responding to Peter J. Boettke's Don’t Be “a jibbering idiot” PDF.

Toward the end of yesterday's post I pointed out that even though only economically viable options are chosen, the choice does not always help to "lift humanity from the miserable condition." Even if only the most viable options are chosen.

Concentrated gains outweigh widely distributed gains. Concentrated gains tend to lift the few and lower the many. Given the increase of inequality, there is a point beyond which the gains from economically viable choices are not sufficiently distributed to permit us to say that "humanity" is lifted. It is only below this determining point that the distribution of gains assures the lifting of humanity.

The location of the determining point will change as inequality changes.

Then too, the gains themselves change as the economy evolves, becoming generally more pecuniary. Gains that are increasingly pecuniary provide less social advantage, and contribute in their own way to greater inequality.

Beyond that, extreme inequality may cause the economy to change in such a way that the most economically viable options seem to promote something other than the advance of civilization.

Feasible but not viable

After quoting James Buchanan on general equilibrium (see yesterday's post) Peter J. Boettke expands on the thought, saying

This is how the price system impresses upon decision makers the essential items of knowledge required for plan coordination. This is how monetary calculation works to guide us amid a sea of economic possibilities and ensures that among the technologically feasible only the economically viable projects are selected.

Chicago Tribune 14 April 1945

I read that far, and a TOYNBEE flag went off in my head. Among the technologically feasible, only the economically viable projects are selected, Boettke says. Yeh. Only the economically viable.

Toynbee, Arnold J. Toynbee, said the construction of roads and viaducts was abandoned after the fall of Rome because, though such projects were still technologically feasible, they were no longer economically viable.

Note that in the Chicago Tribune story from 1945, Toynbee is quoted as saying "Social malady was the cause" of the abandonment of Roman roads. But he also points out that "a road system of the Roman standard would not have paid its way". Would not have paid its way. In other words, not economically viable.

There is one additional sentence in Peter Boettke's paragraph:

... among the technologically feasible only the economically viable projects are selected. This is how wealth is created and humanity is lifted from the miserable condition of extreme poverty to one where human flourishing is even possible.

Yeah, "humanity is lifted from the miserable condition" because economically viable projects are selected. But it doesn't work all the time. When Roman roads stopped being viable, they stopped being built. But choosing a less un-viable alternative did not "lift humanity from the miserable condition." It only slowed the descent toward misery.

Peter Boettke suggests that the market system drives us to the economically viable. I can see that. But the economically viable option is not sure to "lift humanity". Most often, perhaps it does. In the decline phase of the cycle of civilization, it does not.

The business cycle, bigger

Patterns of Growth and Decline in Western Civilization
Source: Greg Stevens                (Click Graph to Enlarge)

Recommended reading: Western civilization will completely collapse in the next 200 years.

Take that "200 years" as conceptual. Stevens does not say May 4, 2217 is the critical date. He says "I have no equation to give you that will spit out a number!" But determining the exact moment of our demise is not really the point. The point is that the cyclic pattern is a useful tool for thinking about the world.

Civilization

Civilization may be seen in the rise and fall of cities, but it is measured in the rise and fall of the standard of value.

A standard of value is not (as Investopedia describes it) a value. It is a standard -- a standard, like the dollar. Not "a" dollar, but "the" dollar. The dollar is not a value; it is a standard of value, as the inch is not a measurement but a standard of measurement.

Beyond that, the phrase "standard of value" encompasses the idea that it is possible to set such a standard. In this sense, then, when Charlemagne put us on silver, and 1200 years later when Nixon took us off gold, both relied on an economic environment that to varying degrees supported the concept of the standard of value.

For several hundred years before Charlemagne, the environment did not support a standard of value. And unless we are most judicious, we will before long discover that for several hundred years after Nixon the economic environment again does not support a standard of value. I know this because civilization is an economic cycle.

Milanovic reviews Bas van Bavel’s theory of rise and fall

In the sidebar at Economist's View, A theory of the rise and fall of economic leadership - Branko Milanovic. How could I resist?

The link is a review of the

recently published “The invisible hand?: How market economies have emerged and declined since AD 500” (Oxford University Press, 2016, 330 pages) by Bas van Bavel

Milanovic:

Van Bavel’s key idea is as follows. In societies where non-market constraints are dominant (say, in feudal societies), liberating factor markets is a truly revolutionary change. Ability of peasants to own some land or to lease it, of workers to work for wages rather than to be subjected to various types of corvées, or of the merchants to borrow at a more or less competitive market rather than to depend on usurious rates, is liberating at an individual level (gives person much greater freedom), secures property, and unleashes the forces of economic growth.

I recently noted the reintroduction of money to the West in the time of Charlemagne and Offa, three or four centuries later England's move from feudal service obligations to cash payments and, three or four centuries after that, England's "An Act Against Usurie" of 1545.

In my conclusion I pointed out "Step four: Debt and interest cause the fall of civilization."

Milanovic:

But the process, Bavel argues, contains the seeds of its destruction. Gradually factor markets cover more and more of the population...

One factor market, though, that of capital and finance, gradually begins to dominate. Private and public debt become most attractive investments, big fortunes are made in finance, and those who originally asked for the level playing field and removal of feudal-like constraints, now use their wealth to conquer the political power and impose a 'serrata', thus making the rules destined to keep them forever on the top.

Bavel is dismissive of a unilinear view that regards the ever widening role of factor markets, including the financial, as leading to ever higher incomes and greater political freedom. His view, although not fully cyclical (on which I will say a bit more at the very end of the review) is “endogenously curvilinear”: things which were good originally, when they hypertrophy, become a hindrance to further growth. It is thus a story of the rise and fall where, like in Greek tragedies, the very same factors that brought the protagonists grandeur, eventually hurl them into the abyss.

Exactly so. At the start, finance boosts economic growth. But long before the end, finance already hinders growth more than it helps.

Milanovic:

It is not only the plausibility of the mechanism of decline that gives strength to Bavel’s thesis; it is also that he lists the manifestation of the decline, observable in all six cases. Financial investments yield much more than investments in the real sector, the economy begins to resemble a casino, the political power of the financiers becomes enormous...
What the ancient writers describe as “decadence” clearly sets it, but, as Bavel is at pains to note, it is not caused by moral defects of the ruling class but by the type of economy that is being created. Extravagant bidding for assets whose quantity is fixed (land and art) is a further manifestation of such an economy: the bidding for fixed assets reflects lack of alternative profitable investments...

The readers will not be remiss in seeing clear analogies to today’s West.

I agree absolutely: The mechanism of decline is finance... Finance provides a better return than the productive ("real") sector... The decadence that sets in is an outgrowth of the economy that has been created.

And also the analogy to the West. But Milanovic's summary neglects to explain the "lack of alternative profitable investments". The reason is that those (real sector) investments bear the cost, the perpetually increasing cost of finance.

The summary also neglects to note the reason finance provides a better return than the 'real' sector. The reason of course is those same financial costs of the 'real' sector, which are income to the financial sector. And the growth of finance only makes the problem worse.

Recommended reading.

Some history of interest

Richard Werner:

... the charging of usury (interest), which until about 300 years ago was illegal in most countries, including throughout Europe.

I didn't know that. How could I not know that?

I did know that at least two major religions that grew up after the fall of Rome did not look kindly on lending at interest. I always thought of this as evidence that debt and interest were at the time held to be responsible for the fall.

Couple tidbits from Wikipedia...

Usury is, as defined today, the practice of making unethical or immoral monetary loans that unfairly enrich the lender. Originally, usury meant interest of any kind.

I'm thinking usury was always thought "unethical or immoral". In other words, charging "interest of any kind" was unethical and immoral, back when. And I'm thinking it was not the ancients but the moderns who changed the meanings of words so that "interest" was generally okay, and that only the extreme we now call "usury" served to "unfairly enrich the lender."

This tidbit supports that view:

Public speaker Charles Eisenstein has argued that the pivotal change in the English-speaking world seems to have come with lawful rights to charge interest on lent money, particularly the 1545 Act, "An Act Against Usurie" of King Henry VIII of England.

Oddly, the law that made it legal to charge interest on money was called an act against usury. It seems the meaning of the word "interest" had become benign already by the year 1545.

There is a "[clarify]" note attached to that sentence at Wikipedia, but it's pretty clear to me: The change in the meaning of the word made interest acceptable, and that was the first step in the rise of financialization. Legal interest was the birth, no, was the moment of conception of capitalism.

About 300 years before Henry VIII,

In 1275, Edward I of England passed the Statute of the Jewry which made usury illegal and linked it to blasphemy, in order to seize the assets of the violators.

Edward I was "Longshanks" in the movie Braveheart.

I read one time that King so-and-so of England was the first to use money to pay the people who worked for him. That seems a real break with the feudal tradition of exchanging labor for protection, and I still remember a fragment of what I read. Looking it up now, at A Comparative Chronology of Money -- nice site! -- I find this:

1159	Scutage tax introduced by Henry II in lieu of military service
The annual 40 days service owed to him by his tenants-in-chief and their retainers is commuted into cash payments and with the proceeds he is able to establish a permanent army of mercenaries or professional soldiers as they commonly became known after this time from the solidus or king's shilling that they earn.

So Henry II chose to receive payments in money rather than service, and he used the money to pay his troops. Circular flow, a hundred years or so before Edward.

Some 300 years before Henry, Charlemagne set up a new monetary standard, as did King Offa of Mercia. "Charlemagne applied the system to much of the European Continent, and Offa's standard was voluntarily adopted by much of England."

I like the way the pieces fit to a timeline:

Step one: Set up a monetary system people can use. Wait 400 years.
Step two: The government itself adopts this monetary system. Wait 400 years.
Step three: Money changes the culture. Interest is no longer a bad thing. Wait 400 years.
Step four: Debt and interest cause the fall of civilization.

300 years ago, charging interest was illegal almost everywhere. Today the global economy is constipated by debt.

Another thread in the fabric of civilization

Three points in time, from A Brief History of Interest by Stephen Zarlenga:

*Charlemagne’s laws flatly forbade usury in 806 AD.
*The Magna Carta placed limits on usury in 1215 AD.
*Most States of the United States enforced usury limits until 1981.

Two moments in the broad sweep

First impressions are sometimes troublesome. A short history of GDP at Reddit caught my eye. I followed the link to Measuring an Economy: Where did GDP Come from? at Thirty is Infinity.

When I got to the site, there, at the top of the page, below the blog name Thirty is Infinity is the line A stat blog for the rest of us. My first impression was that they are dumbing things down really far "for the rest of us" -- from infinity, down to thirty. I like simplifying things, you know, but infinite is infinite.

When I read the article I was torn. They start in the 17th century with William Petty and Charles Davenant and the first attempts at income measurement. Next they move to the 1930s and Dr. Simon Kuznetsk. I've heard of Petty and Kuznets, but not of Davenant or Kuznetsk. That "k" on the end of Kuznets there only strengthens my first impression.

And something else bothers me about the article. Back when I first took an interest in economics, they talked about GNP. Not GDP. That was in the 1970s. In 1991 the government switched from the old GNP to the GDP. But in the Short History of GDP article they say

To see the earliest working of GDP, we need to go back to 17th century England

and, later

After Charles Davenent’s work on gross domestic product, this measurement would not be worked on or even be relevant for over 200 years.

I understand they're trying to simplify the story. But if you simplify too much, you're no longer telling the truth. Charles Davenant didn't work on GDP. He didn't even work on GNP. He tried to estimate the national income or some such thing. There probably wasn't even a name for it back then.

So I was a little hesitant to rely on the article. But I went to their "about" page. They have something on the site-name "Thirty is Infinity".

When working with normally distributed data but in small samples, you use what’s called the student t distribution. When your sample is over thirty, you can just use the normal distribution, which implies an infinite number of samples. So, thirty is infinity.

Suddenly, I like them. They're poking statistics people in the eye. So I guess I don't have to hold it against them, the simplification that says people were working on "GDP" in the 17th century. I can let it go, this time.

Good, because there is something I need from the article.


I need this:

Petty’s work was further developed by Charles Davenent, a Tory member of parliament and mercantilist economist. Continuing the trend of economic thought development from times of war, Davenent developed new methods for the sake of national income accounting. In the end, the government was able to use statistics (incredibly rudimentary statistics) to calculate output of the nation for the purpose of taxation calculation and budget planning in war efforts.

National income accounting was developed to facilitate taxation. Hm, that's probably why statistics are called "statistics". In early times, the meaning was restricted to information about states.

But anyway, in the 17th century the state was starting to think about taxing income. The idea developed further in the 18th century thanks to Adam Smith. Smith said the wealth of a nation was measured by what its people produced -- or by the income generated thereby:

... the annual revenue of every society is always precisely equal to the exchangeable value of the whole annual produce of its industry ...

Smith's view provided an economic theory which supports taxation of income. Stop, stop, stop, I'm not arguing in favor of taxes. I'm describing two points in the cycle of civilization. Two moments in history.

I'm still describing the first of the two, in fact. So, how was Smith's view different from what came before? Good question! Before Smith was mercantilism. From FYO's Gallery, Adam Smith and Self Interest:

Mercantilists believed ... that the wealth of a nation was in the gold and silver (bullion) it possessed, and that trade surpluses were a primary means to accumulating bullion. Smith argued that the wealth of a nation was the real goods it produced, not the money it possessed.

Update 4 October 2018: You can find that quote now at justinleehanks.com. Also at Course Hero and at the Glencoe Online Learning Center

It is not clear to me whether the mercantilist focus was on gold and silver within the borders of the nation, or in the King's treasury specifically. EconLib indicates the latter:

During the mercantilist era it was often suggested, if not actually believed, that the principal benefit of foreign trade was the importation of gold and silver... Adam Smith refuted the idea that the wealth of a nation is measured by the size of the treasury in his famous treatise The Wealth of Nations ...

If that is correct, then before Smith, economics pretty much came down to restocking the King's coffers. If not, economics pretty much came down to restocking everybody's coffers -- or the coffers within the nation's borders, at least.

Either way, the mercantilists were focused on accumulating wealth, wealth in the form of gold and silver. Wealth as opposed to income. Adam Smith, by contrast, focused on income -- on income and the production that generates income.

A huge conceptual difference between the two. In the world of the dark ages, there was little spending. Agreements kept some people bound to the soil and others bound to their lords. But there was little spending. In a time of little spending, there was wealth but not income. There was much wealth, and little income.

In such a time, there would be little benefit in the taxation of income and much in the taxation of wealth. But in the time of William Petty and Charles Davenant and Adam Smith, the economy was waking up. Money was changing hands more often, and there were more hands willing and able to participate in monetary exchange. Income was growing. In such a time the revenue from the taxation of income would also grow. Thus the involvement of Petty and Davenant, and thus the thinking of Adam Smith.

This is the first of two points: By the 17th century income had grown to the point that taxing income produced enough revenue to make it worthwhile. Before the 17th century, it was more productive to get revenue by taxing wealth.

In our time it would again be productive to tax wealth. But this story is not about our time on the cycle of civilization. It is about Smith and Davenant and William Petty, and about a time before them.

Oh, by the way, by the 17th century income had grown to the point that taxing income produced enough revenue to make it worthwhile. How do you suppose that circumstance came about? Here's my guess: In the 13th century, Edward Longshanks -- remember him from the movie Braveheart? -- Longshanks started using money to pay the help.
[edit 12 Feb 2018: Looks like it was King Henry II, a hundred years before Longshanks, who started using money to pay the help. Or maybe Henry I, a tickle in my brain says. But it was some time during that period, that's the point.]

By the 13th century, then, the use of money had grown to the point that people were willing to accept it as payment, but not to the point that enough money was changing hands that taxing income was worth the trouble.

Let us now go a little further back in time to reach our second point. Let us go back to 1086, some years after the Norman Conquest. William the Conqueror, also known as William the Bastard, had the Domesday book assembled.

In Domesday: A Search for the Roots of England, Michael Wood quoted from the Anglo-Saxon Chronicle on the idea for the Domesday book and on William's motivation for assembling it:

Then he sent his men all over England, into every shire, and had them find out how many hundred hides there were in the shire, or what land or cattle the king himself had in the country, or what dues he ought to have each year from the shire.

William wanted to know what dues he ought to have each year -- what revenue he could expect to receive. The bastard!

The point, the second point actually, is that in the 11th century the King's business was to determine the wealth of the nation in order to predict his revenue from a tax on that wealth.

It would be six centuries before anybody thought about taxing income.

I think cyclical

There are two ways of looking at the economy.

One way is to see it as a barrel full of loose ends and disconnected acts. The other is to see the economy's behavior as cyclical. When I read Ferdinand Lot --

In the seventh century, the right of coinage, the royal prerogative par excellence, passed over to the episcopal or monastic churches or to private persons; the treasury perhaps still collected part of the profits of coining. Mints multiplied in the cities, "chateau" (castra), vici, and even mere villas. The history of the coinage shows in a striking fashion the disintegration of the royal power.

I think Fall of Rome. Decentralization of power. Dark Age. I think those who don't learn from history are doomed to repeat it. I think cyclical.

When I read JP Koning --

Let's gradually privatize the issuance of paper currency. If anyone can make cash relevant again, it's innovators in the private sector.

Koning sees the world as loose ends and disconnected acts. I think Fall of Rome...

What Vernengo said

If I was talking I'd be tripping over my tongue. But I'm writing -- writing things out of sequence, because I can't stop to organize my thoughts. I have discovered Matias Vernengo, discovered what fascinates him: Productivity and Demand.

Fascinates me, too. Matias Vernengo says

Technological determinism is widespread. The Solow model basically suggests that it is technological progress, measured incorrectly as Total Factor Productivity (TFP), that drives growth. The same is true of Schumpeterian models...

What is NOT discussed in most analyses of the technological determinism by conventional and more than a few heterodox authors is the role of demand in creating the conditions for technological change. In that case, technological change is not the cause of growth, but the result. As in Adam Smith's story, it is the extent of the market (demand) that limits the division of labor (productivity). In modern parlance the idea is known as the Kaldor-Verdoorn Law.

"Sure enough" Vernengo says, "a demand driven story has space for the sort of external supply-side effects that allow technology and innovations to thrive... [A] demand driven story does not imply that supply side factors are irrelevant, they are simply not the prime movers."

I think he's onto something. That paragraph about technological change got me going. Reminded me of Arnold J. Toynbee. Regarding the abandonment of the irrigation system in the Tigris-Euphrates Basin, Toynbee wrote: "This lapse in a matter of technique was in fact not the cause but the consequence of a decline in population and prosperity..." In other words, the lapse was due to a lack of demand.

Regarding the abandonment of Roman roads, Toynbee wrote:

When a civilization is in decline it sometimes happens that a particular technique, that has been both feasible and profitable during the growth-stage, now begins to encounter social obstacles and to yield diminishing economic returns; if it becomes patently unremunerative it may be deliberately abandoned...

An obvious case in point is the abandonment of the Roman roads in Western Europe....

Matias Vernengo says demand drives technology. Arnold J. Toynbee says the lack of demand drives the decline of technology. These are two expressions of one thought.

The whole of Chapter One

Here it is, the whole chapter, sans footnote, from the Marxists:

I HAVE called this book the General Theory of Employment, Interest and Money, placing the emphasis on the prefix general. The object of such a title is to contrast the character of my arguments and conclusions with those of the classical theory of the subject, upon which I was brought up and which dominates the economic thought, both practical and theoretical, of the governing and academic classes of this generation, as it has for a hundred years past. I shall argue that the postulates of the classical theory are applicable to a special case only and not to the general case, the situation which it assumes being a limiting point of the possible positions of equilibrium. Moreover, the characteristics of the special case assumed by the classical theory happen not to be those of the economic society which we actually live, with the result that its teaching is misleading and disastrous if we attempt to apply it to the facts of experience.

Short and to the point. And it comes first. It's the first chapter in the book. I think that means something. I think that means Keynes thought it important.

Not insignificant because the chapter is short, but clear because the chapter is short, and important because it comes first. What was it Cochrane said?

A good joke or a mystery novel has a long windup to the final punchline. Don’t write papers like that — put the punchline right up front and then slowly explain the joke.

That's what Keynes did: He put the most important thing first.

When I came upon Chapter One just now, what struck me was its brevity. But what I remembered then was the long back-and-forth between Peter L and Philip Pilkington at Pilkington:About. I am thinking in particular of this from Peter L:

We’re discussing what is an extremely minor point (and I am squarely to blame here!). But here’s one last go at clarification:

1. I noticed you say that the reason why the GT is called “general” is because Keynes saw it as applying to all economies regardless of institutional framework and political system.

On this I think there is no room for misunderstanding we agree that you said this and we agree on what you meant by it. We also agree Keynes was attempting a theory of economic behaviour so of course, mutatis mutandis, if that theory is correct in one set of institutional circumstances, it would fit all.

2. Ok next you cite the German preface of GT in support of your contention in 1 above.

3. My argument is that while Keynes may well have seen his theory as being applicable not only to economies with democratic institutions, that was most definitely not his REASON for using the term “general”.

Unless I’ve missed something (altogether possible of course!) I see no scope for misunderstanding.

While I would contend the German preface is not a place to find Keynes’ theory, I do think what he says on page three is definitive, and I’m sure you know this passage well. (My added emphases).

“I have called this book the General Theory of Employment, Interest and Money, placing the emphasis on the prefix GENERAL. The object of such a title is to CONTRAST the character of my arguments and conclusions with those of the CLASSICAL theory of the subject, upon which I was brought up and which dominates the economic thought, both practical and theoretical, of the governing and academic classes of this generation, as it has for a hundred years past. I shall argue that the postulates of the classical theory are applicable to a SPECIAL case only and NOT to the GENERAL case, the situation which IT ASSUMES being a limiting point of the possible positions of equilibrium. Moreover, the characteristics of the SPECIAL case assumed by the classical theory happen not to be those of the economic society in which we actually live, with the result that its teaching is misleading and disastrous if we attempt to apply it to the facts of experience.”

Finally it is surely the case that Keynes really did not think of Marshall et al were simply writing about the Victorian British economy whilst the “general” theory would apply to the Victorian British economy as well as the German totalitarian economy and indeed any others.

His point is that the classical theory applies to NO economy (except in SPECIAL circumstances).

Yes, I made you read the whole of Chapter One twice now. Forgive me. But it's an important paragraph. It's important not to misunderstand it. I think Peter L has it exactly right, emphases and all.

Maynard was telling us that the economy is much bigger than we think, bigger and more of a whole. Economists today argue whether something somebody said a hundred or a hundred and fifty years ago is right or wrong. All else aside, isn't that pathetic? Everybody is wrong sometimes, but most people try to get it right. Any economist who is worth anything tries to get it right. So, taking the best of what someone offers, that part of what they say is probably correct, or close.

So why is it we take these things people said back when, when the economy was different than it is now, why is it we take these things and just call them wrong and reject them? Are we not being most disrespectful? Are we not missing the bigger picture? Are we not dismissing something brief, clear, and important enough to make it into the first chapter of The General Theory?


In Thoughts on Brad’s Thoughts on Economic Theology, Robert Waldmann quotes Joseph Stiglitz (via Brad DeLong):

a peculiar doctrine came to be accepted, the so-called “neoclassical synthesis.” It argued that once markets were restored to full employment, neoclassical principles would apply. The economy would be efficient. We should be clear: this was not a theorem but a religious belief. The idea was always suspect…

Waldmann adds: "Brad notes that the peculiar doctrine is due to Keynes".

DeLong offers a different quote, but that "particular doctrine" is the one Keynes established in the first chapter, which by now you've read at least twice. Stiglitz rejects it. DeLong says "it is not true in practice". And Waldmann rejects it also, saying "I don’t think that, even given full employment, markets are efficient."

I say markets were efficient at the time economists observed efficient markets -- the time of Say and Ricardo and Smith. Today, no -- but that's a different matter.

Here's the thing: Stiglitz and Delong and Waldmann flat-out reject the notion that markets can be efficient even when the "special case" holds true. I think the "special case" is a unique time, a peak in the Cycle of Civilization.

Now really: which view is more interesting?

Let's Go Surfing Now

From Keynes's biographer Robert Skidelsky, this:

The classical economists of the nineteenth century looked forward to what they called a “stationary state,” when, in the words of John Stuart Mill, the life of “struggling to get on…trampling, crushing, elbowing, and treading on each other’s heels” would no longer be needed.

Interesting. The stationary state of the classical economists is the same as Professor Commons' period of stabilization::

Professor Commons... distinguishes three epochs, three economic orders, upon the third of which we are entering.

The first is the Era of Scarcity... In such a period, 'there is the minimum of individual liberty and the maximum of communistic, feudalistic, or governmental control...'" This was, with brief intervals in exceptional cases, the normal economic state of the world up to (say) the fifteenth or sixteenth century.

Next comes the Era of Abundance. 'In a period of extreme abundance there is the maximum of individual liberty...'" During the seventeenth and eighteenth centuries we fought our way out of the bondage of Scarcity into the free air of Abundance, and in the nineteenth century this epoch culminated gloriously in the victories of laissez-faire and historic Liberalism. It is not surprising or discreditable that the veterans of the party cast backward glances on that easier age.

But we are now entering on a third era, which Professor Commons calls the period of Stabilisation... In this period, he says, 'there is a diminution of individual liberty....

"It is not surprising or discreditable that the veterans of the party cast backward glances on that easier age." One still sees this among conservatives today.


I stand by what I said four years ago:

Scarcity... Abundance... and Stabilization. If there are business cycles -- and cycles within cycles -- then there is a Cycle of Civilization. The Dark Age is a Great Depression. The Era of Scarcity is the long, slow, painful recovery. The Era of Abundance is the boom, the peak of the cycle. And the Era of Stabilization is the Professor's optimistic misnomer for crisis-and-decline.

If we're good, if we choose wisely, if we don't proceed blindly, then there is a chance we can ride the downslope of that economic wave like a surfer.

The cycle of civilization is a cycle in the dispersion and concentration of wealth. The inequality that troubles Piketty and the Pope is evidence of that cycle. The growth and decay of cities and nation-states is evidence of that cycle. The saucer-shaped pattern traced by interest rates during the course of ancient civilizations is evidence of that cycle.

Stabilizing the decline of the great cycle is a simple matter of stabilizing the distribution of wealth and income at optimum -- at levels that best drive growth and maximize individual liberty under capitalism.

Basically, in order to give the conservatives what they want, we have to give the liberals what they want.

Ain't it sweet?

I don't so much like the "wealth & income disparity is the cause of our troubles" argument.

I don't so much like the "wealth & income disparity is the cause of our troubles" argument. Bring it up, and somebody is bound to accuse you of stirring up class warfare. You're not, of course. Or I don't know, maybe you are. I do know that I can make the disparity argument without a trace of class concern. So you can, too, I'm sure. But it doesn't matter if our motives are pure. It only matters if our motives have been impugned. Bring up the disparity argument, and your motives are sure to be impugned. So I don't like the argument. I avoid the argument.

For me, though, it doesn't matter so much how other people respond. What matters is how the argument holds up in my own mind. Here again, though, I avoid the argument. For I am not certain I can separate the economics of the disparity argument from the social aspects of that argument. And economics, my economics, has no social aspects.

//

At the Businomics blog, Bill Conerly asks
Should Economists Talk About Redistribution?

An economist has as much right to express statements about value as anyone else does. However, the economist is not doing so from a position of professional expertise. [Rebecca] Blank being an expert on poverty does not mean that she is an expert on the morality of using force to solve social problems. In fact, I doubt that we should grant anyone “expert” status on such philosophical positions.

I like that a lot. But this next quote, I can disagree with:

Economic policy cannot derive strictly from economics. Economics is a set of if-then statements: if this occurs, then that happens. It’s a collection of statements about the way the world works, or at least a world of people. There is nothing within the body of economic thought that, by itself, dictates what policy is best.

I don't know if it's "within" the body of economic thought, but clearly the policy that's best is the one that sustains life as we know it... or, life as we knew it before things started going bad.

Let too few people accumulate too much wealth, and they come to have a new vision of the world, a vision in which nation-states are no longer necessary...

Clair Brown: "Periods of economic growth traditionally are characterized by greater equality of classes."

Every once in a while something just strikes you and, inexplicably, you like it. Clair Brown's American Standards of Living: 1918-1988 struck me that way.

After googling saving by quintile turned up the book (see yesterday's post) I went back and started reading from the beginning. Got all the way to page six before I had to stop and write this new post. Here's the part that did me in:

Periods of economic growth traditionally are characterized by greater equality of classes. Consequently, the growth in real expenditures across classes deviates from the growth in total output, as families in a lower class experience greater growth in consumption than families in a higher class...

Since government policies heavily influence total output and relative incomes, and because each class will try to maintain its relative position, shifts in income inequality tend to have a cyclical nature, as a class that loses out relatively in one period tries to improve its position in the next period. A period of increasing inequality usually follows a period of decreasing inequality.

Now if somebody had written that for Wikipedia, there would be a comment attached to it reading This article needs citations for verification. You know what? It's an important statement for me, so I need citations. I need references. I need verification. I need Emmanuel Saez's graph:

Graph #1: The Top Decile Income Share in the United States, 1917-2007
From Striking it Richer (PDF, 2009) by Emmanuel Saez

Greater equality, 1942-1978. Golden age of growth, 1947-1973. Periods of economic growth traditionally are characterized by greater equality of classes. Evidence? Well, it's a start.

I particularly like the idea that inequality might run in some sort of cyclical pattern. That idea fits right in with my world view. Shows up in the graph, too.

Actually, as Arnold Toynbee may already have said, if there are cyclical patterns on a civilizational scale to be found in our world then we ought to start with that, and always remember that the details probably fit the larger pattern. You don't always need to fit details to the larger pattern. But the pattern can help to resolve ambiguities. It can provide guidance. And it can call some things plain silly, like the idea that economic growth always clings to an invariant trend.


Economists like to think economic growth tends to trend. They say things like GDP is "trend stationary". They speak of an "output gap". The output gap is the gap between where GDP is now and where it would be if it had stayed on trend. People who speak of an output gap think in terms of a long-term trend of growth.

Let me see if I can get this right. "Stochastic" means "random" and is the opposite of "deterministic". At MathWorks they look at a graph of US GDP and identify it as a "nonstationary" (as opposed to stationary) stochastic process. Nonstationary, because "there is a very obvious upward trend" visible on the graph.

MathWorks calls this upward trend a "mean trend" and describes it as a "violation of stationarity". So, it is a nonstationary stochastic process. They identify two such trend types: where the mean trend is deterministic, and where the mean trend is stochastic. Note these two are opposites, per our introductory definitions just above.

So GDP is a nonstationary stochastic process, where the nonstationary part -- the trend part -- might be deterministic, or might be stochastic. If it is deterministic, we have a deterministic nonstationary stochastic process. If it is stochastic, we have a stochastic nonstationary stochastic process. Ain't this fun?

Anyway, the deterministic one is said to be "trend stationary". The other one (according to Eduardo Rossi's PDF, page 4) is said to have a "unit root". And this isn't just boring arithmetic. It's economics with a hard on.


Here's the thing. The path of GDP is something stochastic. The stochastic part means it's random in the sense, I think, that we cannot know whether the next report will be higher or lower than anybody's guess.

That's the "marginal" piece of it, the "next piece of data" part. The other part of it is the long-term piece. You know, the trend. Is it a trend? Or is it as random as the next piece of data? Is it deterministic, or stochastic? That is the question.

But that is their question. Not mine. For me, it's a Toynbee thing. Left to its own devices, the economy will follow a path of growth and decline that encompasses many centuries and many nation-states. Left to its own devices, the economy will conform to the demands of human nature and to the demands of wealth. Left to its own devices, we get what looks to us to be the rise and fall of civilizations.

It doesn't have to be that way, of course. We could understand that what's happening is the result of such forces, and we could choose a different path. But that's a difficult thing to achieve, because everyone clings to their political opinions, even when they damn well know the problems are economic.

It's a catch-22. If we leave our economy to the wiles of human nature, we end up with the decline and fall of civilization. And the only thing we have to prevent that sad end is human nature.

So... How to resolve the deterministic slash stochastic, trend-stationary slash unit-root dilemma? Think big picture. Sometimes it's one way; sometimes the other. When the economy's growing vigorously for twenty years or more, or when a nation is young and vigorous, you've got a deterministic trend.

When economic problems arise faster than we can invent solutions, and growth sucks ass, well, you get lots of people chanting "unit root, unit root, unit root". And you know what? At that moment, they're right.

When in Rome...

From Historical Echoes at Liberty Street Economics, Historical Echoes: Cash or Credit? Payments and Finance in Ancient Rome by Marco Del Negro and Mary Tao:

Imagine yourself a Roman citizen in the 1st Century B.C. You’ve gone shopping with your partner, who’s trying to convince you to buy a particular item. The thing’s pretty expensive, and you demur because you’re short of cash. You may think that back then such an excuse would get you off scot-free. What else can you possibly do: Write a check? Well, yes, writes the poet Ovid...

In ancient Rome, they had something comparable to our checking accounts.

But was there a market for nomina, just like there’s one today in, say, mortgage-backed securities? According to both Barlow and Harris, the answer is yes.

In ancient Rome, there were advanced financial markets.

What if you had to transfer money to somebody in a different part of the globe? As the Roman dominions expanded into Greece, Spain, North Africa, and Asia, Roman finance actually faced this logistical problem....

This is intense. Remember, we're talking ancient Rome here:

It worked as follows: The publicani were private companies in charge of tax collection in the provinces (as well as many other tasks; see “Publicani,” by U. Malmendier). They had a branch in Rome and one in Thapsus. So, you’d give them the silver in Rome (or transfer them some nomina) and they’d divert some of their tax collection in North Africa to Caius. This is also how the Republic would finance its public spending overseas. Since taxes were collected throughout the provinces, by trading claims on taxes Romans could transfer funds across the globe–or at least to the part of the globe they had conquered.

Sort of like Western Union and the IRS rolled up in one. A thousand years (and one dark age) later, the nearest Europe could come to what Rome had was embodied in the Knights Templar.


So if anyone asks whether ancient Rome had an economy that could have been subject to financial strains comparable to those in the world today, the answer is yes.

If anyone wants to know if I think it was finance that toppled Rome, the answer is yes.

"Aristocracy May Be Engendered By Manufactures"

I quoted Smith earlier today, on the three orders:

The whole annual produce of the land and labour of every country, or what comes to the same thing, the whole price of that annual produce, naturally divides itself, it has already been observed, into three parts; the rent of land, the wages of labour, and the profits of stock; and constitutes a revenue to three different orders of people; to those who live by rent, to those who live by wages, and to those who live by profit. These are the three great, original and constituent orders of every civilized society, from whose revenue that of every other order is ultimately derived.

The first order there, those who live by rent: In Smith's time that was the aristocracy.

A while back also, I quoted Smith:

As any particular commodity comes to be more manufactured, that part of the price which resolves itself into wages and profit comes to be greater in proportion to that which resolves itself into rent.

I suggested then that he was describing economic forces that would result in the demise of aristocracy.

I also quoted Will and Ariel Durant a while back, referencing "Plato's reduction of political evolution to a sequence of monarchy, aristocracy, democracy, and dictatorship". At the time, I added: We are well past Aristocracy, near the end of Democracy. Be careful what you wish for.


The title of this post comes from Alexis de Tocqueville, from Democracy in America, from the title of Chapter 20 of Book Two. It's a short chapter. Tocqueville opens by saying "I have shown that democracy is favorable to the growth of manufactures". He ends the chapter thus:

I am of opinion, upon the whole, that the manufacturing aristocracy which is growing up under our eyes is one of the harshest which ever existed in the world; but at the same time it is one of the most confined and least dangerous. Nevertheless the friends of democracy should keep their eyes anxiously fixed in this direction; for if ever a permanent inequality of conditions and aristocracy again penetrate into the world, it may be predicted that this is the channel by which they will enter.

Tocqueville's "manufacturing aristocracy" is the same as Smith's "those who live by profit". In Tocqueville's time, and Smith's, it was "most confined and least dangerous". But Tocqueville warned us to keep our eyes "anxiously fixed", lest those who live by profit should become a new aristocracy. Fair warning.

By the way: Wikipedia describes Tocqueville as "An eminent representative of the classical liberal political tradition".

In any event, these excerpts and these concepts capture a transfer of wealth and power from one segment of society to another -- a turning of the Cycle of Civilization.

Investment

From Webster's New Twentieth Century Dictionary, Second Edition

Surrounding, blocking up, or besieging by an armed force. First on the list.

The "unit root" thing (arcane:)

Unit root? No, I don't understand. Wikipedia says:

In time series models in econometrics (the application of statistical methods to economics), a unit root is a feature of processes that evolve through time that can cause problems in statistical inference if it is not adequately dealt with.

If a "linear stochastic process" has a "unit root" the process is "non-stationary". Otherwise it is "stationary". Something like that (based on the Wikipedia article). Apparently it is something that can be calculated. Sometimes. Maybe.


This rang a bell. From the same article:

The diagram above depicts an example of a potential unit root. The red line represents an observed drop in output. Green shows the path of recovery if the series has a unit root. Blue shows the recovery if there is no unit root and the series is trend stationary. The blue line returns to meet and follow the dashed trend line while the green line remains permanently below the trend. The unit root hypothesis also holds that a spike in output will lead to levels of output higher than the past trend.

Okay: The dotted line is Potential GDP. The red line is actual GDP. The blue and green lines are two possible post-crisis paths. We seem to be on the green path.

This is exactly what James Bullard was talking about, what John Taylor worked out and John Cochrane showed, what David Andolfatto presented, and what I reviewed a few months back. (See especially Cochrane's presentation of Taylor's graphs.)

I was totally fascinated by Bullard's approach. I didn't know it had all this backstory.


Among the ending thoughts of the Wikipedia article:

The issue is particularly popular in the literature on business cycles.

Research on the subject began with Nelson and Plosser whose paper on GNP and other output aggregates failed to reject the unit root hypothesis for these series. Since then, a debate—entwined with technical disputes on statistical methods—has ensued.

While the literature on the unit root hypothesis may consist of arcane debate on statistical methods, the implications of the hypothesis can have concrete implications for economic forecasts and policies.

Arcane debate, indeed.

Paul Krugman (the Wikipedia article links to him) provides a relevant example, which I've highlighted:

March 3, 2009, 9:06 pm

Roots of evil (wonkish)

As Brad DeLong says, sigh. Greg Mankiw challenges the administration’s prediction of relatively fast growth a few years from now on the basis that real GDP may have a unit root — that is, there’s no tendency for bad years to be offset by good years later.

I always thought the unit root thing involved a bit of deliberate obtuseness — it involved pretending that you didn’t know the difference between, say, low GDP growth due to a productivity slowdown like the one that happened from 1973 to 1995, on one side, and low GDP growth due to a severe recession. For one thing is very clear: variables that measure the use of resources, like unemployment or capacity utilization, do NOT have unit roots: when unemployment is high, it tends to fall. And together with Okun’s law, this says that yes, it is right to expect high growth in future if the economy is depressed now.

But to invoke the unit root thing to disparage growth forecasts now involves more than a bit of deliberate obtuseness. How can you fail to acknowledge that there’s huge slack capacity in the economy right now? And yes, we can expect fast growth if and when that capacity comes back into use.

Kling responds:

But the unemployment rate is not trend-stationary either--the "natural rate" tends to wander around.

This all comes up because I came upon a link from besttrousers at Reddit (Reddit links to a PDF, 50+ pages), a paper dated 1989, written by Lawrence J. Christiano and Martin Eichenbaum. From a time before computers, by the look of it.

From the opening of the paper:

Macroeconomists have traditionally viewed movements in aggregate output as representing temporary fluctuations about a deterministic trend. According to this view, innovations [shocks] to real gross national product (GNP) should have no impact on long-run forecasts of aggregate output. Increasingly, however, this view of aggregate fluctuations has been challenged. Following the important work of Nelson and Plosser (1982), numerous economists have argued that real GDP is best characterized as a stochastic process that does not revert to a deterministic trend path.

Let me ask a question: What is this trend that may or may not exist?

It is always an unwavering path, a straight line on a log chart. This straight-line path is the universal, fundamental assumption, whether we think it exists or not.

The straight line is the wrong picture. The long-term trend looks like a sine curve. It looks like a business cycle, only longer than the normal business cycle. Longer than a Kondratieff wave. Longer than David Hackett Fischer's Great Wave. I'm looking at a really long business cycle, what we normally think of as civilization, the rise and fall of civilization.

The cycle of civilization. Change that dotted line to a sine wave with a 2000-year period, and all your assumptions about stationary, non-stationary, and unit root go out the window.