"There is no spoon"

Yesterday I reviewed one of Noah's posts. He linked to one by Mark Thoma. Today I'm looking at Thoma's post.

Thoma asks: Will the Economy Return To the Old Normal?

I don't know if that is "passive voice" or what, but it sure leaves out any participation by economists, don't you think?

Thoma writes:

This is a debate, in part, about whether the economy returns to trend after a shock, i.e. whether shocks are permanent or temporary. It is also a debate about the nature of the trend itself...

Oh... See? This is what economists do. Thoma is asking whether there is some metaphysical driving force that makes the economy always "return to trend." As if what happens to the economy has nothing to do with policy. It's a crock.


The nature of the trend itself?? There is no trend. The trend is an observation. It is an observation of what happened up to now. The trend is a figment, a conceptual tool. It's not in the economy. It's in the mind.

...the nature of the trend itself, i.e. whether the trend rate of economic growth is a smooth process that can be approximated by a trend line (with demand shocks responsible for most of the variation around the trend), or if the trend is a variable series subject to both permanent and temporary shocks (so that a substantial part of the variation in output over time comes from the trend itself...

Reject this.

If "the trend rate of economic growth is a smooth process" then we don't have to do anything by smile, and the economy will recover.

If "the trend is a variable series subject to both permanent and temporary shocks" then there is nothing that can be done to help the economy recover.

Nothing that can be done, or nothing that need be done. These are our only options?

I reject this.


Thoma quotes Mankiw:

According to the conventional view of the business cycle, fluctuations in output represent temporary deviations from trend.

The business cycle is the result of human interaction in a world of finite resources, or what economists call scarcity. Human nature is fixed and unchanging, but a sloppy fit. The position human nature takes, the "fit" of it, varies over the cycle. Sometimes we are more political, sometimes more social, sometimes more religious, sometimes more militant. Why we act as we do is not a question for economics. But we tend to act in certain ways at certain points on the cycle. That is what makes the pattern a cycle.

There are many cycles, or many interacting and overlapping trends. If we think of these cycles as waves, and it we think of sound as waves, we may compare them. Waves can be added together, or subtracted. More accurately perhaps, the effects of overlapping waves combine to produce a unified effect.

The longest business cycle I know of is the cycle of civilization, which is driven by the concentration and distribution of wealth.

Now, how does one look at the cycle of civilization and reduce it to temporary deviations from a trend of perpetual increase? Only near the economic peak of the cycle could such a concept even exist. Only after the peak would perpetual increase be such a pressing concern. Only in the decline would it matter.


Almost fell for it.

Thoma presents two graphs near the end of his post. One shows GDP varying about its long-term trend. The other, the "plucking model", shows GDP running at or near its long-term trend except when some shock or "pluck" pulls it down from trend.

Interesting. Indeed, that's why I almost fell for it. The plucking model shows GDP (after the pluck) returning to trend. The other model shows GDP always returning to trend.

But there is no trend.

There is no trend.

Controversy

In a recent post, Noah reviews the hopes of economists for economic recovery. "Past performance is no guarantee of future results," he says. "I am not reassured by a long-term plot of United States gross domestic product," he says. "The kinda-sorta stability of the long-term U.S. GDP growth rate is not a law of the Universe," he says. "The assumption that the dip in U.S. output that we call the 'Great Recession' will be made up for by fast growth in the future is unfounded."

Mmm.

Noah's conclusion, with an update, reads as follows:

Past performance is no guarantee of future results. It may well be that a return to our "trend" growth rate, and/or a return to our "trend" level of output, may be contingent on our policy choices. At least, I am not willing to assume that that is not the case...

What "policy choices," you may ask? Well, the answer is that I don't know.

Noah quotes Mark Thoma: "...historically we've always recovered from recessions." Doesn't mean it'll happen again, Noah says. Then, in an update:

Mark Thoma writes a very long and good post about the "return to trend" controversy, which also cites other long and good posts by Brad DeLong, Greg Mankiw, and Paul Krugman. Definitely read it! And, of course, it almost goes without saying that I think we should try our best to boost output back to the "trend," whether or not that would happen on its own.

Wow. "Return to trend" is a controversy?

Thoma, DeLong, Mankiw, Krugman. Four economists -- five, counting Noah -- focus on a 'controversy' about predicting the future.

Is anybody focused on the policy choices? Wait... Strike that. Is anybody focused on the economic problem? On pinpointing the problem? For we cannot make good policy choices if we do not understand the problem to its origin.

My first OpenOffice graph

From NIPA Table 1.14

Line 16 (Gross value added of financial corporate business) relative to
Line 1 (Gross value added of corporate business)

Below 4% in 1944 ...above 14% in 2010. And come to think of it, above 7% in 1929.

Not sure how "gross value added" relates to GDP, but it must be pretty well-defined. Ah yes, it is.

//

But once again there is a great similarity of our time to the onset of the Great Depression. Our recent V-shaped drop-and-recovery of finance looks a lot like the 1929-1932 drop-and-recovery. But the recovery of finance is not the same as recovery of the economy. It took until the end of the second world war for finance to reach a bottom, and a couple years more before our "golden age" began.

Our peak was twice as high this time, and our 'V' near twice as deep. And if last time it took more than 15 years from crisis to recovery, this time it could take more than thirty.

If this thing started in 2007, we're already four years in.

//

Oh, see that flat spot in the '60s on the graph? That's where finance needs to be.

The Growth of Finance: Homework

Domestic financial debt as a percent of total debt:

Graph #1

DODFS = Debt Outstanding Domestic Financial Sectors
TCMDO = Total Credit Market Debt Owed
The graph above shows the persistent growth of the financial sector, as financial debt grew from less than three percent of total debt to more than 30 percent -- and then suddenly stopped growing for a decade before our recent crisis.

As I understand it, financial debt does not include mortgages and credit-card debt and like that. That debt is part of the other 65 or 70 percent of debt, which is called "non-financial" debt. Financial debt is debt that facilitates lending to the non-financial part of the economy.


Domestic financial debt as a percent of GDP:

Graph #2

Graph #2 shows financial debt again, this time in the context of GDP. Again we see the persistent upward trend of debt. The plateau of the 2000s, visible on Graph #1, appears here as much less of a slowdown because context #1 (total debt) grew much faster than context #2 (GDP) in that decade.

Note on Graph #2 that financial debt reaches 120% of GDP before it begins to decline. That's 20 percent more than all of GDP.


Domestic financial debt compared to the gross federal debt:

Graph #3

The blue line on Graph #3 is financial debt as a percent of GDP, the same as on Graph #2. The red line is the Gross Federal Debt as a percent of GDP.

For the record, the red is the whole federal debt. The blue line is only about 30% of total debt, as Graph #1 shows.

Explaining the growth of finance...

This is from BizStats.

By following this path through the options --

Home: Industry Financial Benchmark Reports: Corporations: Finance-Insurance
and then the top item, again Finance-Insurance

-- I came upon this interesting table:

I narrowed'er down to fit the blog, but I didn't make up those numbers! Here, for comparison, is the table for manufacturing:

Nonfinancial Profits in the Context of GDP

The other day I showed you total corporate profits relative to GDP:

Graph #1

At first I said GDP was not a good context for profits. A friend disagreed, and I took a second look:

Graph #2

The two trend-lines are quite close, and they move up and down together. In other words, using GDP as a context for profits is comparable to using corporate deductions as a context.

That's good, because I want to use GDP as the context, again.


Yesterday I showed you a graph comparing corporate profit of the financial sector to that of the "nonfinancial" or productive sector. This graph:

Graph #3

Over the past 60 years, financial sector profits have grown from about 10% of total corporate profits to about half.

That is a significant change, I think.


Considering that financial-sector profits are a cost to the productive sector, and "nonfinancial" profits are the engine that drives production, I want to look at productive-sector profits in the context of GDP.

Here (again) is total corporate profits as a percent of GDP, in blue:

Graph #1 (repeated)

Now I add to the graph in red, total nonfinancial corporate profits relative to GDP:

Graph #4

It is a bit difficult to see, because both lines wander up and down, but the gap between the lines widens as time goes by.

Here is the same graph again, adding financial profits (again as a percent of GDP) in green, to show the growth of finance:

Graph #5

Finance is our growth industry. The product of finance is debt.

Luap the Mystic

Luap speaks:

I find myself believing, more and more, that this failure has deep roots – that we were in some sense doomed to go through this. Specifically, I now suspect that the kind of moderate economic policy regime Brad and I both support ... is inherently unstable. It’s something that can last for a generation or so, but not much longer.

Luap has spoken.

Corporate Profits: The Growth of Finance

EDIT 16 March 2020
There is a problem with this post: My analysis examines the financial and nonfinancial components of "corporate business profits" as portions of "corporate profits". I now think I should have shown them as portions of "corporate business profits", to exclude something which must be considered "corporate non-business profits" though I still have no idea what that might be: the profits of "non-profit" corporations, maybe?

This post needs to be revised, and I hope to revise it soon. In the meanwhile please understand that it is incorrect as it stands.

See also: Arthurian Profit Study 1.0
End of edit.



Corporate profits after tax, from FRED (as before):

Graph #1

The blue line is total corporate profits after tax, as above. The red line is the total for "nonfinancial" corporate business, the productive subset of corporations.

Graph #2

Showing the growth of financial-sector profit as a percent of total corporate profit:

Graph #3

Finally, comparing corporate profit of the financial sector to that of the "nonfinancial" or productive sector:

Graph #4

Here, the down-sloping blue line indicates the profits of productive (or "nonfinancial") corporations as a share of total corporate profit. The red, up-sloping line indicates the share accruing to the financial sector.

Over the past 60 years, financial sector profits have grown from about 10% of total corporate profits to almost half.

"Corporate profits have soared"

Once again, this is "Corporate Profits After Tax" from FRED:

Graph #1

Let's look at slopes. Well, I'm lazy, so let's imagine some slopes.

A slope is a straight line that suggests the general trend of a wiggly line.

• In the 1950s, flat.
• In the 1960s, a slight uptrend.
• In the '70s, more of an uptrend than the '60s.
• From about 1985 to 1997, a greater slope than in the '70s.
• From 2004 to 2006 or so, a steeper increase even than in the '90s.
• And after the plunge of the recent recession, the slope is almost vertical.

The slope of the line shows continual increase. But once it goes vertical, no further increase is possible.


Before the recent recession, the general trend of corporate profit was one of exponential increase. Like many trends in our economy, it was a result of growth and the passage of time.

If we look not at total corporate profit, but at the quarter-to-quarter change in corporate profit --

Graph #2

-- exponential increase is still visible. Later spikes tend to be larger than earlier ones.

But if we look instead at the percent change in quarterly corporate profits, the exponential effect is gone:

Graph #3

What we see instead is a scattered, seemingly random pattern of up- and down-spikes. The largest, indeed, do occur during the most recent recession. Those recent spikes, however, reflect not soaring profit but rather the severity of that recession, as well as the strength of the policy reaction to it -- a necessary reaction, certainly.

And, granted, there are two up-spikes close together in the decade of the mid-2000s. This corresponds to the anomalous increase in other graphs of corporate profits.

That said, the seemingly random pattern of Graph #3 cannot be completely random; for as yesterday's graph shows, there was a general downtrend in the profit rate until 1982, and a general uptrend since.

Yesterday's graph