Category Archives: Economics 101

Real Facts about Tariffs. Trump’s plan brings a gun to a knife fight, a gun aimed at his foot – Greg Jericho.

It wasn’t a total surprise that Australia was spared the steel and aluminium tariffs as Trump’s bluster of levelling tariffs for everyone is weakening.

This week saw leaders around the world trying to remember whether they were meant to take Donald Trump seriously, but not literally, or literally but not seriously, and also wondering if they have a Greg Norman somewhere they could use.

When US president Trump announced early in the week he was going to levy a 25% tariff on steel and a 15% tariff on aluminium imports, he suggested it was in order to protect national security. As with most Trump utterances, it left everyone trying to decipher just what he meant, because the US imports nearly half its steel from four nations Canada, Brazil, South Korea and Mexico which are hardly enemies of the US.

Was he doing this to attack China? He did write a series of tweets that suggested trade with China is in his sights, but while China is the biggest producer of steel, it only exports a small percentage of it to the US.

Some of his other tweets suggested that Trump was instead targeting Europe, but again, hitting steel imports was an odd way to go about it, given Europe made it quickly obvious that it would retaliate with tariffs of its own and the European Union is one of the few economies with enough grunt not to get pushed around by the US.

Then came the suggestion that Trump was using this to negotiate with Canada and Mexico over Nafta but that was also odd because that shot down his national security reasoning and opened the US up to retaliation under the World Trade Organisation rules (which would be likely anyway, given his national security reasoning was clearly bogus).

And using the threat of increasing tariffs in free trade negotiations is a weird way to go about things.

The tariffs do hurt the countries that export steel and aluminium to the US, because they force them to charge more for their product, thereby giving American steel companies an advantage, but they also hurt the US.

Tariffs are effectively consumption taxes designed to give local industries an advantage (or at least an equal footing with international competitors), and they work by raising the price of imports. Now that is great for the owners and possibly workers of those industries, but not so good for anyone else who wants to buy those goods, because now they have to pay more.

A tariff on steel and aluminium imports might help create a few extra jobs in the steel industry, but it also increases the price of all things made with steel and aluminium. That leads to job losses in those industries and also reduces the living standards for everyone because suddenly they have to pay more for things like canned goods, beer, and cars.

One study suggested that for every job gained in the steel and aluminium industries, five would be lost elsewhere.

That does not mean all free trade is a win for everyone and international trade does not occur in a textbook, but rather in the real world where governments subsidise and assist industries. But the general rule is that the costs to the economy increase with the size of the tariff and the number of industries affected (and similarly the benefits of lowering them reduce as the tariff gets closer to zero). A 25% tariff on steel is thus a rather hefty whack.

Trump is in effect going to the negotiating table with a massive weapon, a bit like taking a gun to a knife fight. The only problem is he has the gun aimed at his own foot.

And so it wasn’t a total surprise to see Trump back down and exempt Canada and Mexico, and then later give one to Australia. As the trade minister, Steve Ciobo noted this week, our steel exports to the US amount to about 0.800 of the US market and our aluminium exports account for about 1.5% so exempting Australia makes little difference.

To that end, reports that we have engaged Greg Norman to do some lobbying on our behalf seem eminently sensible. Not because Norman is some master trade negotiator, but because when dealing with Trump, nations always need to realise he is an insecure, ego driven fool who needs praise for doing the most ordinary of activities, and who sees every discussion and issue through the prism of how it makes him look.

Norman is probably the only Australian Trump has heard of, and the fact that Norman is famous and successful and would be seeking a favour from Trump would appeal to Trump’s vanity.

We could bemoan the fact that America’s electoral college system has selected this vainglorious ignoramus, or we can suck it up and use it to our advantage.

For now it appears his bluster of levelling tariffs for everyone is weakening. Trump clearly believes this the best way to negotiate trade deals, like any good swindler he’ll ignore the costs and talk only of the benefits.

The danger for Australia has always been not from a direct US tariff but should retaliation come from Europe and China. The last thing a small open economy needs is for the large economies of the world to start playing like it is 1930.

For now everyone is trying to work out just what Trump is after, mostly he is after things that he can call a win (even if they are really not). So I; nations will be thinking of things they give Trum that don’t matter in order for him to claim victory in the negotiation.

Or they can see if Greg Norman is available for hire.

The Guardian

Inequality and Economic Growth – Joseph Stiglitz.

“Even if we act to erase material poverty, there is another greater task, it is to confront the poverty of satisfaction – purpose and dignity – that afflicts us all.

Too much and for too long, we seemed to have surrendered personal excellence and community values in the mere accumulation of material things. Our Gross National Product, now, is over $800 billion dollars a year, but that Gross National Product – if we judge the United States of America by that – that Gross National Product counts air pollution and cigarette advertising, and ambulances to clear our highways of carnage.
It counts special locks for our doors and the jails for the people who break them. It counts the destruction of the redwood and the loss of our natural wonder in chaotic sprawl.

It counts napalm and counts nuclear warheads and armored cars for the police to fight the riots in our cities. It counts Whitman’s rifle and Speck’s knife, and the television programs which glorify violence in order to sell toys to our children. Yet the gross national product does not allow for the health of our children, the quality of their education or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials.
It measures neither our wit nor our courage, neither our wisdom nor our learning, neither our compassion nor our devotion to our country, it measures everything in short, except that which makes life worthwhile.
And it can tell us everything about America except why we are proud that we are Americans.
If this is true here at home, so it is true elsewhere in the world

Bobby Kennedy, 1968


In the middle of the twentieth century, it came to be believed that ’a rising tide lifts all boats’: economic growth would bring increasing wealth and higher living standards to all sections of society. At the time, there was some evidence behind that claim. In industrialised countries in the 1950s and 1960s every group was advancing, and those with lower incomes were rising most rapidly.

In the ensuing economic and political debate, this ’rising-tide hypothesis’ evolved into a much more specific idea, according to which regressive economic policies, policies that favour the richer classes, would end up benefiting everyone. Resources given to the rich would inevitably ‘trickle down’ to the rest.

It is important to clarify that this version of old-fashioned ‘trickle-down economics’ did not follow from the postwar evidence. The ’rising-tide hypothesis’ was equally consistent with a ’trickle-up’ theory, give more money to those at the bottom and everyone will benefit; or with a ’build-out from the middle’ theory-help those at the centre, and both those above and below will benefit.

Today the trend to greater equality of incomes which characterised the postwar period has been reversed. Inequality is now rising rapidly. Contrary to the rising-tide hypothesis, the rising tide has only lifted the large yachts, and many of the smaller boats have been left dashed on the rocks. This is partly because the extraordinary growth in top incomes has coincided with an economic slowdown.

The trickle-down notion, along with its theoretical justification, marginal productivity theory, needs urgent rethinking. That theory attempts both to explain inequality, why it occurs, and to justify it, why it would be beneficial for the economy as a whole. This essay looks critically at both claims.

It argues in favour of alternative explanations of inequality, with particular reference to the theory of rent-seeking and to the influence of institutional and political factors, which have shaped labour markets and patterns of remuneration. And it shows that:

Far from being either necessary or good for economic growth, excessive inequality tends to lead to weaker economic performance.

In light of this, it argues for a range of policies that would increase both equity and economic well-being.

The great rise of inequality

Let us start by examining the ongoing trends in income and wealth. In the past three decades, those at the top have done very well, especially in the US. Between 1980 and 2014, the richest 1 per cent have seen their average real income increase by 169 per cent (from $469,403, adjusted for inflation, to $1,2b0508) and their share of national income more than double, from 10 per cent to 21 per cent. The top 0.1 per cent have fared even better. Over the same period, their average real income increased by 281 per cent (from $1,597, 080, adjusted for inflation, to $6,087,113) and their share of national income almost tripled, from 3.4 to l0 3 per cent.

Over the same thirty-four years, median household income grew by only 11 per cent. And this growth actually occurred only in the very first years of the period: by 2014 it was only .7 per cent higher than in 1989, after peaking in 1999. But even this underestimates the extent to which those at the bottom have suffered, their incomes have only done as well as they have because hours worked have increased. Median hourly compensation (adjusted for inflation) increased by only 9 per cent from 1973 to 2014, even though at the same time productivity grew by 72.2 per cent.

To understand how significant this divergence of productivity and wages is, consider that from 1948 to 1973 both increased at the same pace, about doubling over the period.

And these statistics underestimate the true deterioration in workers’ wages, for education levels have increased (the percentage of Americans who are college graduates has nearly doubled since 1980, to more than 30 per cent), so that one should have expected a significant increase in wage rates. In fact, average real hourly wages for all Americans with only a high school diploma have decreased in the past three decades.

In the first three years of the so-called recovery from the Great Recession of 2008-2009, in other words, since the US economy returned to growth, fully 91 per cent of the gains in income went to the top 1 per cent.

By 2014, the rest of the income distribution had experienced a bit more of a boost, but even accounting for that, 58 per cent of the gains in total income have gone to the top 1 per cent since 2009. During that period, the income of the bottom 99 per cent has grown by just 4 per cent.

Presidents Bush and Obama both tried a trickle-down strategy, giving large amounts of money to the banks and the bankers. The idea was simple: by saving the banks and bankers, all would benefit. The banks would restart lending: The wealthy would create more jobs. This strategy, it was argued, would be far more efficacious than helping homeowners, businesses or workers directly.

The US Treasury typically demands that when money is given to developing countries, conditions be imposed on them to ensure not only that the money is used well, but also that the country adopts economic policies that, according to the Treasury’s economic theories, will lead to growth. But no conditions were imposed on the banks, not even, for example, requirements that they lend more or stop abusive practices. The rescue worked in enriching those at the top; but the benefits did not trickle down to the rest of the economy.

The Federal Reserve, too, tried trickle-down economics. One of the main channels by which quantitative easing was supposed to rekindle growth was by leading to higher stock market prices, which would generate higher wealth for the very rich, who would then spend some of that, which in turn would benefit the rest.

As Yeva Nersisyan and Randall Wray argue in their chapter in this volume, both the Fed and the Administration could have tried policies that more directly benefited the rest of the economy: helping homeowners, lending to small and medium-sized enterprises and fixing the broken credit channel. These trickle-down policies were relatively ineffective, one reason why seven years after the US slipped into recession, the economy was still not back to health.

Wealth is even more concentrated than income, by one estimate more than ten times so. The wealthiest 1 per cent of Americans hold 41.8 per cent of the country’s wealth; the top 0.1 per cent alone control more than 22 per cent of total wealth. Just one example of the extremes of wealth in America is the Walton family: the six heirs to the Walmart empire command a wealth of $145 billion, which is equivalent to the net worth of 1,782,020 average American families.”

Wealth inequality too is on the upswing. For the four decades before the Great Recession, the rich were getting wealthier at a more rapid pace than everyone else. Between 1978 and 2013 the share of wealth owned by the top I per cent rose dramatically, from less than 25 per cent to its current level above 40 per cent; the share of the top 10 per cent from about two-thirds to well over three-quarters! By 2010, the crisis had depleted some of the richest Americans’ wealth because of the decline in stock prices, but many Americans also had had their wealth almost entirely wiped out as their homes lost value. After the crisis, the average wealthiest l per cent of households still had 165 times the wealth of the average American in the bottom 90 per cent, more than double the ratio of thirty years ago.

In the years of ‘recovery’, as stock market values rebounded (in part as a result of the Fed’s lopsided efforts to resuscitate the economy through increasing the balance sheet of the rich), the rich have regained much of the wealth that they had lost; the same did not happen to the rest of the country.

Inequality plays out along ethnic lines in ways that should be disturbing for a country that had begun to see itself as having won out against racism. Between 2005 and 2009, a huge number of Americans saw their wealth drastically decrease. The net worth of the typical white American household was down substantially, to $113,149 in 2009, a 16 per cent loss of wealth from 2005. But the recession was much worse for other groups.

The typical African American household lost 53 per cent of its wealth, putting its assets at a mere 5 per cent of the median white American’s. The typical Hispanic household lost 66 per cent of its wealth.”

Probably the most invidious aspect of America’s inequality is that of opportunities: in the US a young person’s life prospects depend heavily on the income and education of his or her parents, even more than in other advanced countries. The ’American dream’ is largely a myth.

A number of studies have noted the link between inequality of outcomes and inequality of opportunities. When there are large inequalities of income, those at the top can buy for their offspring privileges not available to others, and they often come to believe that it is their right and obligation to do so. And, of course, without equality of opportunity those born in the bottom of the distribution are likely to end up there: inequalities of outcomes perpetuate themselves. This is deeply troubling: given our low level of equality of opportunity and our high level of inequality of income and wealth, it is possible that the future will be even worse, with still further increases in inequality of outcome and still further decreases in equality of opportunity.

A generalised international trend

While the US has been winning the race to be the most unequal country (at least within developed economies), much of what has just been described for it has also been going on elsewhere. In the past twenty-five to thirty years the Gini index, the widely used measure of income inequality, has increased by roughly 29 per cent in the United States, 17 per cent in Germany, 9 per cent in Canada, 14 per cent in UK, 12 per cent in Italy and ll per cent in Japan.”

The more countries follow the American economic model, the more the results seem to be consistent with what has occurred in the United States. The UK has now achieved the second highest level of inequality among the countries of Western Europe and North America, a marked change from its position before the Thatcher era. Germany, which had been among the most equal countries within the OECD, now ranks in the middle.

The enlargement of the share of income appropriated by the richest 1 per cent has also been a general trend, and in Anglo-Saxon countries it started earlier and it has been more marked than anywhere else. In rich countries, such as the US, the concentration of wealth is even more pronounced than that of income, and has been rising too. For instance, in the UK the income share of the top 1 per cent went up from 5.7 per cent in 1978 to 14.7 per cent in 2010, while the share of wealth owned by the top 1 per cent surged from 22.6 per cent in 1970 to 28 per cent in 2010 and the top 10 per cent’s wealth share increased from 64 per cent to 70.5 per cent over the same period.

Also disturbing are the patterns that have emerged in transition economies, which at the beginning of their movement to a market economy had low levels of inequality in income and wealth (at least according to available measurements). Today, China’s inequality of income, as measured by its Gini coefficient, is roughly comparable to that of the United States and Russia. Across the OECD, since 1985 the Gini coefficient has increased in seventeen of twenty two countries for which data is available, often dramatically.

Moreover, recent research by Piketty and his co-authors has found that the importance of inherited wealth has increased in recent decades, at least in the rich countries for which we have data. After displaying a decreasing trend in the first postwar period, the share of inheritance flows in disposable income has been increasing in the past decades.

Explaining inequality

Marginal Productivity Theory

How can we explain these worrying trends? Traditionally, there has been little consensus among economists and social thinkers on what causes inequality. In the nineteenth century, they strived to explain and either justify or criticise the evident high levels of disparity. Marx talked about exploitation. Nassau Senior, the first holder of the first chair in economics, the Drummond Professorship at All Souls College, Oxford, talked about the returns to capital as a payment for capitalists’ abstinence, for their not consuming. It was not exploitation of labour, but the. just rewards for their forgoing consumption. Neoclassical economists developed the marginal productivity theory, which argued that compensation more broadly reflected different individuals’ contributions to society.

While exploitation suggests that those at the top get what they get by taking away from those at the bottom, marginal productivity theory suggests that those at the top only get what they add. The advocates of this View have gone further: they have suggested that in a competitive market, exploitation (eg. as a result of monopoly power or discrimination) simply couldn’t persist, and that additions to capital would cause wages to increase, so workers would be better off thanks to the savings and innovation of those at the top.

More specifically, marginal productivity theory maintains that, due to competition, everyone participating in the production process earns remuneration equal to her or his marginal productivity.

This theory associates higher incomes with a greater contribution to society. This can justify, for instance, preferential tax treatment for the rich: by taxing high incomes we would deprive them of the ’just deserts’ for their contribution to society, and, even more importantly, we would discourage them from expressing their talent?‘ Moreover, the more they contribute, the harder they work and the more they save, the better it is for workers, whose wages will rise as a result.

The reason why these ideas justifying inequality have endured is that they have a grain of truth in them. Some of those who have made large amounts of money have contributed greatly to our society, and in some cases what they have appropriated for themselves is but a fraction of what they have contributed to society.

But this is only a part of the story: there are other possible causes of inequality. Disparity can result from exploitation, discrimination and exercise of monopoly power. Moreover, in general, inequality is heavily influenced by many institutional and political factors: industrial relations, labour market institutions, welfare and tax systems, for example, which can both work independently of productivity and affect productivity.

That the distribution of income cannot be explained just by standard economic theory is suggested by the fact that the before-tax and transfer distribution of income differs markedly across countries. France and Norway are examples of OECD countries that have managed by and large to resist the trend of increasing inequality. The Scandinavian countries have a much higher level of equality of opportunity, regardless of how that is assessed.

Marginal Productivity Theory is meant to have universal application. Neoclassical theory taught that one could explain economic outcomes without reference, for instance, to institutions. It held that a society’s institutions are simply a facade; economic behaviour is driven by the underlying laws of demand and supply, and the economist’s job is to understand these underlying forces. Thus, the standard theory cannot explain how countries with similar technology, productivity and per capita income can differ so much in their before-tax distribution.

The evidence, though, is that institutions do matter. Not only can the effect of institutions be analysed, but institutions can themselves often be explained, sometimes by history, sometimes by power relations and sometimes by economic forces (like information asymmetries) left out of the standard analysis.

Thus, a major thrust of modern economics is to understand the role of institutions in creating and shaping markets. The question then is: what is the relative role and importance of these alternative hypotheses? There is no easy way of providing a neat quantitathe answer, but recent events and studies have lent persuasive weight to theories putting greater focus on rent-seeking and exploitation. We shall discuss this evidence in the next section, before turning to the institutional and political factors which are at the root of the recent structural changes in income distribution.

Rent-seeking and top incomes

The term ’rent’ was originally used to describe the returns to land, since the owner of the land receives these payments by virtue of his or her ownership and not because of anything he or she does. The term was then extended to include monopoly profits (or monopoly rents), the income that one receives simply from control of a monopoly and, in general returns due to similar ownership claims.

Thus, rent-seeking means getting an income not as a reward for creating wealth but by grabbing a larger share of the wealth that would have been produced anyway. Indeed, rent-seekers typically destroy wealth, as a by-product of their taking away from others. A monopolist who overcharges for her or his product takes money from those whom she or he is overcharging and at the same time destroys value. To get her or his monopoly price, she or he has to restrict production.

Growth in top incomes in the past three decades has been driven mainly in two occupational categories: those in the financial sector (both executives and professionals) and non-financial executives.” Evidence suggests that rents have contributed on a large scale to the strong increase in the incomes of both.

Let us first consider executives in general. That the rise in their compensation has not reflected productivity is indicated by the lack of correlation between managerial pay and firm performance. As early as 1990 Jensen and Murphy, by studying a sample of 2,505 CEOs in 1,400 companies, found that annual changes in executive compensation did not reflect changes in corporate performance. Since then, the work of Bebchuk, Fried and Grinstein has shown that the huge increase in US executive compensation since 1993 cannot be explained by firm performance or industrial structure and that, instead, it has mainly resulted from flaws in corporate governance, which enabled managers in practice to set their own pay. Mishel and Sabadish examined 350 firms, showing that growth in the compensation of their CEOs largely outpaced the increase in their stock market value. Most strikingly, executive compensation displayed substantial positive growth even during periods when stock market values decreased?“

There are other reasons to doubt standard marginal productivity theory. In the United States the ratio of CEO pay to that of the average worker increased from around 20 to 1 in 1965 to 354 to 1 in 2012. There was no change in technology that could explain a change in relative productivity of that magnitude, and no explanation for why that change in technology would occur in the US and not in other similar countries. Moreover, the design of corporate compensation schemes has made it evident that they are not intended to reward effort: typically, they are related to the performance of the stock, which rises and falls depending on many factors outside the control of the CEO, such as market interest rates and the price of oil. It would have been easy to design an incentive structure with less risk, simply by basing compensation on relative performance, relative to a group of comparable companies. The struggles of the Clinton administration to introduce tax systems encouraging so-called performance pay (without imposing conditions to ensure that pay was actually related to performance) and disclosure requirements (which would have enabled market participants to better assess the extent of stock dilution associated with CEO stock option plans) clarified the battle lines: those pushing for favourable tax treatment and against disclosure understood well that these arrangements would have facilitated greater inequalities in income.

For specifically the rise in top incomes in the financial sector, the evidence is even more unfavourable to explanations based on marginal productivity theory. An empirical study by Philippon and Reshef shows that in the past two decades workers in the financial industry have enjoyed a huge ’pay-premium’ with respect to similar sectors, which cannot be explained by the usual proxies for productivity (such as the level of education or unobserved ability). According to their estimates, financial sector compensations have been about 40 per cent higher than the level that would have been expected under perfect competition.

It is also well documented that banks deemed ’too big to fail’ enjoy a rent due to an implicit state guarantee. Investors know that these large financial institutions can count, in effect, on a government guarantee, and thus they are willing to provide them funds at lower interest rates. The big banks can thus prosper not because they are more efficient or provide better service but because they are in effect subsidised by taxpayers.

There are other reasons for the super-normal returns to the large banks and their bankers. In certain of the activities of the financial sector, there is far from perfect competition. Anti competitive practices in debit and credit cards have amplified pro-existing market power to generate huge rents. Lack of transparency (e.g. in over-the-counter Credit Default Swaps (CD55) and derivatives too have generated large rents, with the market dominated by four players. It is not surprising that the rents enjoyed in this way by big banks translated into higher incomes for their managers and shareholders.

In the financial sector even more than in other industries, executive compensation in the aftermath of the crisis provided convincing evidence against marginal productivity theory as an explanation of wages at the top: the bankers who had brought their firms and the global economy to the brink of ruin continued to receive high rates of pay compensation which in no way could be related either to their social contribution or even their contribution to the firms for which they worked (both of which were negative).

For instance, a study that focused on Bear Stems and Lehman Brothers in 2000-2008 has found that the top executive managers of these two giants had brought home huge amounts of ‘performance-based’ compensations (estimated at around $1 billion for Lehman and $1.4 billion for Bear Stearns), which were not clawed back when the two firms collapsed.

Still another piece of evidence supporting the importance of rent-seeking in explaining the increase in inequality is provided by those studies that have shown that increases in taxes at the very top do not result in decreases in growth rates. If these incomes were a result of their efforts, we might have expected those at the top to respond by working less hard, with adverse effects on GDP.

The Increase in rents

Three striking aspects of the evolution of most rich countries in the past thirty-five years are (a) the increase in the wealth-to-income ratio; (b) the stagnation of median wages; and (c) the failure of the return to capital to decline.

Standard neoclassical theories, in which ’wealth’ is equated with ’capital’, would suggest that the increase in capital should be associated with a decline in the return to capital and an increase in wages. The failure of unskilled workers’ wages to increase has been attributed by some (especially in the 1990s) to skill-biased technological change, which increased the premium put by the market on skills. Hence, those with skills would see their wages rise, and those without skills would see them fall. But recent years have seen a decline in the wages paid even to skilled workers. Moreover, as my recent research shows,” average wages should have increased, even if some wages fell. Something else must be going on.

There is an alternative, and more plausible, explanation. It is based on the observation that rents are increasing (due to the increase in land rents. intellectual property rents and monopoly power). As a result, the value of those assets that are able to provide rents to their owners-such as land, houses and some financial claims, is rising proportionately. So overall wealth increases, but this does not lead to an increase in the productive capacity of the economy or in the mean marginal productivity or average wage of workers. On the contrary, wages may stagnate or even decrease, because the rise in the share of rents has happened at the expense of wages.

The assets which are driving the increase in overall wealth, in fact, are not produced capital goods. In many cases, they are not even ’productive’ in the usual sense; they are not directly related to the production of goods and services?” With more wealth put into these assets, there may be less invested in real productive capital. In the case of many countries where we have data (such as France) there is evidence that this is indeed the case:

A disproportionate part of savings in recent years has gone into the purchase of housing, which has not increased the productivity of the ‘real’ economy.

Monetary policies that lead to low interest rates can increase the value of these ’unproductive’ fixed assets, an increase in the value of wealth that is unaccompanied by any increase in the flow of goods and services. By the same token, a bubble can lead to an increase in wealth, for an extended period of time, again with possible adverse effects on the stock of ’real’ productive capital Indeed, it is easy for capitalist economies to generate such bubbles (a fact that should be obvious from the historical record, but which has also been confirmed in theoretical models.) While in recent years there has been a ’correction’ in the housing bubble (and in the underlying price of land), we cannot be confident that there has been a full correction. The increase in the wealth-income ratio may still have more to do with an increase in the value of rents than with an increase in the amount of productive capital. Those who have access to financial markets and can get credit from banks (typically those already well off) can purchase these assets, using them as collateral. As the bubble takes off, so does their wealth and society’s inequality. Again, policies amplify the resulting inequality: favourable tax treatment of capital gains enables especially high after-tax returns on these assets and increases the wealth especially of the wealthy, who disproportionately own such assets (and understandably so, since they are better able to withstand the associated risks).

The role of institutions and politics

The large influence of rent-seeking in the rise of top incomes undermines the marginal productivity theory of income distribution, The income and wealth of those at the top comes at least partly at the expense of others, just the opposite conclusion from that which emerges from trickle-down economics. When, for instance, a monopoly succeeds in raising the price of the goods which it sells, it lowers the real income of everyone else. This suggests that institutional and political factors play an important role in influencing the relative shares of capital and labour.

As we noted earlier, in the past three decades wages have grown much less than productivity, a fact which is hard to reconcile with marginal productivity theory” but is consistent with increased exploitation. This suggests that the weakening of workers’ bargaining power has been a major factor. Weak unions and asymmetric globalisation, where capital is free to move while labour is much less so, are thus likely to have contributed significantly to the great surge of inequality.

The way in which globalisation has been managed has led to lower wages in part because workers’ bargaining power has been eviscerated. With capital highly mobile and with tariffs low, firms can simply tell workers that if they don’t accept lower wages and worse working conditions, the company will move elsewhere. To see how asymmetric globalisation can affect bargaining power, imagine, for a moment, what the world would be like if there was free mobility of labour, but no mobility of capital. Countries would compete to attract workers. They would promise good schools and a good environment, as well as low taxes on workers. This could be financed by high taxes on capital. But that’s not the world we live in.

In most industrialised countries there has been a decline in union membership and influence; this decline has been especially strong in the Anglo-Saxon world. This has created an imbalance of economic power and a political vacuum.

Without the protection afforded by a union, workers have fared even more poorly than they would have otherwise. Unions’ inability to protect workers against the threat of job loss by the moving of jobs abroad has contributed to weakening the power of unions. But politics has also played a major role, exemplified in President Reagan’s breaking of the air traffic controllers” strike in the US in 1981 or Margaret Thatcher’s battle against the National Union of Mineworkers in the UK.

Central bank policies focusing on inflation have almost certainly been a further factor contributing to the growing inequality and the weakening of workers’ bargaining power. As soon as wages start to increase, especially if they increase faster than the rate of inflation, central banks focusing on inflation raise interest rates. The result is a higher average level of unemployment and a downward ratcheting effect on wages: as the economy goes into recession, real wages often fall; and then monetary policy is designed to ensure that they don’t recover.

Inequalities are affected not just by the legal and formal institutional arrangements (such as the strength of unions) but also by social custom, including whether it is viewed as acceptable to engage in discrimination.

At the same time, governments have been lax in enforcing anti-discrimination laws. Contrary to the suggestion of free-market economists, but consistent with even casual observation of how markets actually behave, discrimination has been a persistent aspect of market economies, and helps explain much of what has gone on at the bottom. The discrimination takes many forms-in housing markets, in financial markets (at least one of America’s large banks had to pay a very large fine for its discriminatory practices in the run-up to the crisis) and in labour markets. There is a large literature explaining how such discrimination persists.

Of course, market forces, the demand and supply for skilled workers, affected by changes in technology and education, play an important role as well, even if those forces are partially shaped by politics. But instead of these market forces and politics balancing each other out, with the political process dampening the increase in inequalities of income and wealth in periods when market forces have led to growing disparities, in the rich countries today the two have been working together to increase inequality.

The price of inequality

The evidence is thus unsupportive of explanations of inequality solely focused on marginal productivity. But what of the argument that we need inequality to grow?

A first justification for the claim that inequality is necessary for growth focuses on the role of savings and investment in promoting growth, and is based on the observation that those at the top save, while those at the bottom typically spend all of their earnings. Countries with a high share of wages will thus not be able to accumulate capital as rapidly as those with a low share of wages. The only way to generate savings required for longterm growth is thus to ensure sufficient income for the rich.

This argument is particularly inapposite today, where the problem is, to use Bernanke’s term, a global savings glut. But even in those circumstances where growth would be increased by an increase in national savings, there are better ways of inducing savings than increasing inequality. The government can tax the income of the rich, and use the funds to finance either private or public investment; such policies reduce inequalities in consumption and disposable income, and lead to increased national savings (appropriately measured).

A second argument centres on the popular misconception that those at the top are the job creators, and giving more money to them will thus create more jobs. Industrialised countries are full of creative entrepreneurial people throughout the income distribution. What creates jobs is demand: when there is demand, firms will create the jobs to satisfy that demand (especially if we can get the financial system to work in the way it should, providing credit to small and medium-sized enterprises).

In fact, as empirical research by the IMF has shown, inequality is associated with economic instability. In particular, lMF researchers have shown that growth spells tend to be shorter when income inequality is high. This result holds also when other determinants of growth duration (like external shocks, property rights and macroeconomic conditions) are taken into account:

On average, a 10 percentile decrease in inequality increases the expected length of a growth spell by one half.

The picture does not change if one focuses on medium-term average growth rates instead of growth duration. Recent empirical research released by the OECD shows that income inequality has a negative and statistically significant effect on medium-term growth. It estimates that in countries like the US, the UK and Italy, overall economic growth would have been six to nine percentage points higher in the past two decades had income inequality not risen.”

There are different channels through which inequality harms the economy:

First, inequality leads to weak aggregate demand. The reason is easy to understand: those at the bottom spend a larger fraction of their income than those at the top. The problem may be compounded by monetary authorities’ flawed responses to this weak demand. By lowering interest rates and relaxing regulations, monetary policy too easily gives rise to an asset bubble, the bursting of which leads in turn to recession.

Many interpretations of the current crisis have indeed emphasised the importance of distributional concems. Growing inequality would have led to lower consumption but for the effects of loose monetary policy and lax regulations, which led to a housing bubble and a consumption boom. It was, in short, only growing debt that allowed consumption to be sustained. But it was inevitable that the bubble would eventually break. And it was inevitable that, when it broke, the economy would go into a downturn.

Second, inequality of outcomes is associated with inequality of opportunity. When those at the bottom of the income distribution are at great risk of not living up to their potential, the economy pays a price not only with weaker demand today, but also with lower growth in the future. With nearly one in four American children growing up in poverty?” many of them facing not just a lack of educational opportunity but also a lack of access to adequate nutrition and health, the country’s long-term prospects are being put into jeopardy.

Third, societies with greater inequality are less likely to make public investments which enhance productivity, such as in public transportation, infrastructure, technology and education. If the rich believe that they don’t need these public facilities, and worry that a strong government, which could increase the efficiency of the economy, might at the same time use its powers to redistribute income and wealth, it is not surprising that public investment is lower in countries with higher inequality. Moreover, in such countries tax and other economic policies are likely to encourage those activities that benefit the financial sector over more productive activities.

In the United States today returns on long-term financial speculation (capital gains) are taxed at approximately half the rate of labour, and speculative derivatives are given priority in bankruptcy over workers. Tax laws encourage job creation abroad rather than at home. The result is a weaker and more unstable economy. Reforming these policies-and using other policies to reduce rent-seeking would not only reduce inequality; it would improve economic performance.

It should be noted that the existence of these adverse effects of inequality on growth is itself evidence against an explanation of today’s high level of inequality based on marginal productivity theory. For the basic premise of marginal productivity is that those at the top are simply receiving just deserts for their efforts, and that the rest of society benefits from their activities. lf that were so, we should expect to see higher growth associated with higher incomes at the top. In fact, we see just the opposite.

Reversing inequality

A wide range of policies can help reduce inequality. Policies should be aimed at reducing inequalities both in market income and in the post-traumatic and-transfer incomes. The rules of the game play a large role in determining market distribution, in preventing discrimination, in creating bargaining rights for workers, in curbing monopolies and the powers of CEOs to exploit firms’ other stakeholders and the financial sector to exploit the rest of society. These rules were largely rewritten during the past thirty years in ways which led to more inequality and poorer overall economic performance. Now they must be rewritten once again, to reduce inequality and strengthen the economy, for instance, by discouraging the short-termism that has become rampant in the financial and corporate sector.

Reforms include more support for education, including pre-school; increasing the minimum wage; strengthening earned-income tax credits; strengthening the voice of workers in the workplace, including through unions; and more effective enforcement of anti-discrimination laws. But there are four areas in particular that could make inroads in the high level of inequality which now exists.

First, executive compensation (especially in the US) has become excessive, and it is hard to justify the design of executive compensation schemes based on stock options. Executives should not be rewarded for improvements in a firm’s stock market performance in which they play no part. If the Federal Reserve lowers interest rates, and that leads to an increase in stock market prices, CEOS should not get a bonus as a result. If oil prices fall, and so profits of airlines and the value of airline stocks increase, airline CEOs should not get a bonus.

There is an easy way of taking account of these gains (or losses) which are not attributable to the efforts of executives: basing performance pay on the relative performance of firms in comparable circumstances, the design of good compensation schemes that do this has been well understood for more than a third of a century, and yet executives in major corporations have almost studiously resisted these insights. They have focused more on taking advantage of deficiencies in corporate govemance and the lack of understanding of these issues by many shareholders, to try to enhance their earnings, getting high pay when share prices increase, and also when share prices fall. In the long run, as we have seen, economic performance itself is hurt?

Second, macroeconomic policies are needed that maintain economic stability and full employment. High unemployment most severely penalises those at the bottom and the middle of the income distribution. Today, workers are suffering thrice over: from high unemployment, weak wages and cutbacks in public services, as government revenues are less than they would be if economies were functioning well.

As we have argued, high inequality has weakened aggregate demand. Fuelling asset price bubbles through hyper-expansive monetary policy and deregulation is not the only possible response. Higher public investment, in infrastructures, technology and education, would both revive demand and alleviate inequality, and this would boost growth in the long-run and in the short-run. According to a recent empirical study by the IMF, we’ll designed public infrastructure investment raises output both in the short and long term, especially when the economy is operating below potential. And it doesn’t need to increase public debt in terms of GDP: well implemented infrastructure projects would pay for themselves, as the increase in income (and thus in tax revenues) would more than offset the increase in spending.

Third, public investment in education is fundamental to address inequality. A key determinant of workers’ income is the level and quality of education. If govemments ensure equal access to education, then the distribution of wages will reflect the distribution of abilities (including the ability to benefit from education) and the extent to which the education system attempts to compensate for differences in abilities and backgrounds. If, as in the United States, those with rich parents usually have access to better education, then one generation’s inequality will be passed on to the next, and in each generation, wage inequality will reflect the income and related inequalities of the last.

Fourth, these much needed public investments could be financed through fair and full taxation of capital income. This would further contribute to counteracting the surge in inequality: it can help bring down the net return to capital, so that those capitalists who save much of their income won’t see their wealth accumulate at a faster pace than the growth of the overall economy, resulting in growing inequality of wealth. Special provisions providing for favourable taxation of capital gains and dividends not only distort the economy, but, with the vast majority of the benefits going to the very top, increase inequality.

At the same time they impose enormous budgetary costs: 2 trillion dollars from, 2013 to 2023 in the US, according to the Congressional Budget Office. The elimination of the special provisions for capital gains and dividends, coupled with the taxation of capital gains on the basis of accrual, not just realisations, is the most obvious reform in the tax code that would improve inequality and raise substantial amounts of revenues. There are many others, such as a good system of inheritance and effectively enforced estate taxation.

Conclusion: redefining economic performance

We used to think of there being a trade-off: we could achieve more equality, but only at the expense of overall economic performance. It is now clear that, given the extremes of inequality being reached in many rich countries and the manner in which they have been generated, greater equality and improved economic performance are complements.

This is especially true if we focus on appropriate measures of growth. If we use the wrong metrics, we will strive for the wrong things. As the international Commission on the Measurement of Economic Performance and Social Progress argued, there is a growing global consensus that GDP does not provide a good measure of overall economic performance. What matters is whether growth is sustainable, and whether most citizens see their living standards rising year after year.

Since the beginning of the new millennium, the US economy, and that of most other advanced countries, has clearly not been performing. In fact, for three decades, real median incomes have essentially stagnated. Indeed, in the case of the US, the problems are even worse and were manifest well before the recession: in the past four decades average wages have stagnated, even though productivity has drastically increased.

As this chapter has emphasised, a key factor underlying the current economic difficulties of rich countries is growing inequality. We need to focus not on what is happening on average, as GDP leads us to do, but on how the economy is performing for the typical citizen, reflected for instance in median disposable income. People care about health, fairness and security, and yet GDP statistics do not reflect their decline. Once these and other aspects of societal well-being are taken into account, recent performance in rich countries looks much worse.

The economic policies required to change this are not difficult to identify. We need more investment in public goods; better corporate governance, antitrust and anti-discrimination laws; a better regulated financial system; stronger workers’ rights; and more progressive tax and transfer policies. By ’rewriting the rules’ goveming the market economy in these ways, it is possible to achieve greater equality in both the pre and post tax and transfer distribution of income, and thereby stronger economic performance.

Joseph Stiglitz

The Great Slump of 1930 – John Maynard Keynes.

The world has been slow to realize that we are living this year in the shadow of one of the greatest economic catastrophes of modern history.

But now that the man in the street has become aware of what is happening, he, not knowing the why and wherefore, is as full to-day of what may prove excessive fears as, previously, when the trouble was iirst coming on, he was lacking in what would have been a reasonable anxiety. He begins to doubt the future. Is he now awakening from a pleasant dream to face the darkness of facts? Or dropping off into a nightmare which will pass away?

He need not be doubtful. The other was not a dream. This is a nightmare, which will pass away with the morning. For the resources of nature and men’s devices are just as fertile and productive as they were. The rate of our progress towards solving the material problems of life is not less rapid. We are as capable as before of affording for everyone a high standard of life, high, I mean, compared with, say, twenty years ago, and will soon learn to afford a standard higher still.

We were not previously deceived. But to-day we have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand. The result is that our possibilities of wealth may run to waste for a time, perhaps for a long time.

I doubt whether I can hope, in these articles, to bring what is in my mind into fully effective touch with the mind of the reader. I shall be saying too much for the layman, too little for the expert. For, though no one will believe it, economics is a technical and difficult subject. It is even becoming a science. However, I will do my best, at the cost of leaving out, because it is too complicated, much that is necessary to a complete understanding of contemporary events.

First of all, the extreme violence of the slump is to be noticed. In the three leading industrial countries of the world, the United States, Great Britain, and Germany, 10,000,000 workers stand idle. There is scarcely an important industry anywhere earning enough profit to make it expand, which is the test of progress. At the same time, in the countries of primary production the output of mining and of agriculture is selling, in the case of almost every important commodity, at a price which, for many or for the majority of producers, does not cover its cost. In 1921, when prices fell as heavily, the fall was from a boom level at which producers were making abnormal profits; and there is no example in modern history of so great and rapid a fall of prices from a normal figure as has occurred in the past year. Hence the magnitude of the catastrophe.

The time which elapses before production ceases and unemployment reaches its maximum is, for several reasons, much longer in the case of the primary products than in the case of manufacture. In most cases the production units are smaller and less well organized amongst themselves for enforcing a process of orderly contraction; the length of the production period, especially in agriculture, is longer; the costs of a temporary shut-down are greater; men are more often their own employers and so submit more readily to a contraction of the income for which they are willing to work; the social problems of throwing men out of employment are greater in more primitive communities; and the financial problems of a cessation of production of primary output are more serious in countries where such primary output is almost the whole sustenance of the people. Nevertheless we are fast approaching the phase in which the output of primary producers will be restricted almost as much as that of manufacturers; and this will have a further adverse reaction on manufacturers, since the primary producers will have no purchasing power wherewith to buy manufactured goods; and so on, in a vicious circle.

In this quandary individual producers base illusory hopes on courses of action which would benefit an individual producer or class of producers so long as they were alone in pursuing them, but which benefit no one if everyone pursues them. For example, to restrict the output of a particular primary commodity raises its price, so long as the output of the industries which use this commodity is unrestricted; but if output is restricted all round, then the demand for the primary commodity falls off by just as much as the supply, and no one is further forward. Or again, if a particular producer or a particular country cuts wages, then, so long as others do not follow suit, that producer or that country is able to get more of what trade is going. But if wages are cut all round, the purchasing power of the community as a whole is reduced by the same amount as the reduction of costs; and, again, no one is further forward.

Thus neither the restriction of output nor the reduction of wages serves in itself to restore equilibrium.

Moreover, even if we were to succeed eventually in re-establishing output at the lower level of money-wages appropriate to (say) the pre-war level of prices, our troubles would not be at an end. For since 1914 an immense burden of bonded debt, both national and international, has been contracted, which is fixed in terms of money. Thus every fall of prices increases the burden of this debt, because it increases the value of the money in which it is fixed.

For example, if we were to settle down to the prewar level of prices, the British National Debt would be nearly 40 per cent. greater than it was in 1924 and double what it was in 1920; the Young Plan would weigh on Germany much more heavily than the Dawes Plan, which it was agreed she could not support; the indebtedness to the United States of her associates in the Great War would represent 40-50 per cent. more goods and services than at the date when the settlements were made; the obligations of such debtor countries as those of South America and Australia would become insupportable without a reduction of their standard of life for the benefit of their creditors; agriculturists and householders throughout the world, who have borrowed on mortgage, would find themselves the victims of their creditors.

In such a situation it must be doubtful whether the necessary adjustments could be made in time to prevent a series of bankruptcies, defaults, and repudiations which would shake the capitalist order to its foundations.

Here would be a fertile soil for agitation, seditions, and revolution. It is so already in many quarters of the world. Yet, all the time, the resources of nature and men’s devices would be just as fertile and productive as they were. The machine would merely have been jammed as the result of a muddle. But because we have magneto trouble, we need not assume that we shall soon be back in a rumbling waggon and that motoring is over.

We have magneto trouble. How, then, can we start up again? Let us trace events backwards:

1. Why are workers and plant unemployed? Because industrialists do not expect to be able to sell without loss what would be produced if they were employed.

2. Why cannot industrialists expect to sell without loss? Because prices have fallen more than costs have fallen-indeed, costs have fallen very little.

3. How can it be that prices have fallen more than costs? For costs are what a business man pays out for the production of his commodity, and prices determine what he gets back when he sells it. It is easy to understand how for an individual business or an individual commodity these can be unequal. But surely for the community as a whole the business men get back the same amount as they pay out, since what the business men pay out in the course of production constitutes the incomes of the public which they pay back to the business men in exchange for the products of the latter? For this is what we understand by the normal circle of production, exchange, and consumption.

4. No! Unfortunately this is not so; and here is the root of the trouble.

It is not true that what the business men pay out as costs of production necessarily comes back to them as the saleproceeds of what they produce. It is the characteristic of a boom that their sale-proceeds exceed their costs; and it is the characteristic of a slump that their costs exceed their sale-proceeds. Moreover, it is a delusion to suppose that they can necessarily restore equilibrium by reducing their total costs, whether it be by restricting their output or cutting rates of remuneration; for the reduction of their outgoings may, by reducing the purchasing power of the earners who are also their customers, diminish their sale-proceeds by a nearly equal amount.

5. How, then, can it be that the total costs of production for the world’s business as a whole can be unequal to the total sale-proceeds? Upon what does the inequality depend? I think that I know the answer. But it is too complicated and unfamiliar for me to expound it here satisfactorily. (Elsewhere I have tried to expound it accurately.) So I must be somewhat perfunctory.

Let us take, first of all, the consumption-goods which come on to the market for sale. Upon what do the profits (or losses) of the producers of such goods depend? The total costs of production, which are the same thing as the community’s total earnings looked at from another point of view, are divided in a certain proportion between the cost of consumption-goods and the cost of capital-goods. The incomes of the public, which are again the same thing as the community‘s total earnings, are also divided in a certain proportion between expenditure on the purchase of consumption-goods and savings.

Now if the first proportion is larger than the second, producers of consumption-goods will lose money; for their sale proceeds, which are equal to the expenditure of the public on consumption-goods, will be less (as a little thought will show) than what these goods have cost them to produce. If, on the other hand, the second proportion is larger than the first, then the producers of consumption-goods will make exceptional gains. It follows that the profits of the producers of consumption goods can only be restored, either by the public spending a larger proportion of their incomes on such goods (which means saving less), or by a larger proportion of production taking the form of capital-goods (since this means a smaller proportionate output of consumption-goods).

But capital-goods will not be produced on a larger scale unless the producers of such goods are making a profit. So we come to our second question, upon what do the profits of the producers of capital-goods depend? They depend on whether the public prefer to keep their savings liquid in the shape of money or its equivalent or to use them to buy capital-goods or the equivalent. If the public are reluctant to buy the latter, then the producers of capital-goods will make a loss; consequently less capital-goods will be produced; with the result that, for the reasons given above, producers of consumption goods will also make a loss. In other words, all classes of producers will tend to make a loss; and general unemployment will ensue. By this time a vicious circle will be set up, and, as the result of a series of actions and reactions, matters will get worse and worse until something happens to turn the tide.

This is an unduly simplified picture of a complicated phenomenon. But I believe that it contains the essential truth. Many variations and fugal embroideries and orchestrations can be superimposed; but this is the tune.

If, then, I am right, the fundamental cause of the trouble is the lack of new enterprise due to an unsatisfactory market for capital investment. Since trade is international, an insufficient output of new capital-goods in the world as a whole affects the prices of commodities everywhere and hence the profits of producers in all countries alike.

Why is there an insuflicient output of new capital-goods in the world as a whole? It is due, in my opinion, to a conjunction of several causes. In the first instance, it was due to the attitude of lenders, for new capital-goods are produced to a large extent with borrowed money. Now it is due to the attitude of borrowers, just as much as to that of lenders.

For several reasons lenders were, and are, asking higher terms for loans, than new enterprise can afford:

First, the fact, that enterprise could afford high rates for some time after the war whilst war wastage was being made good, accustomed lenders to expect much higher rates than before the war.

Second, the existence of political borrowers to meet Treaty obligations, of banking borrowers to support newly restored gold standards, of speculative borrowers to take part in Stock Exchange booms, and, latterly, of distress borrowers to meet the losses which they have incurred through the fall of prices, all of whom were ready if necessary to pay almost any terms, have hitherto enabled lenders to secure from these various classes of borrowers higher rates than it is possible for genuine new enterprise to support.

Third, the unsettled state of the world and national investment habits have restricted the countries in which many lenders are prepared to invest on any reasonable terms at all. A large proportion of the globe is, for one reason or another, distrusted by lenders, so that they exact a premium for risk so great as to strangle new enterprise altogether.

For the last two years, two out of the three principal creditor nations of the world, namely, France and the United States, have largely withdrawn their resources from the international market for long-term loans.

Meanwhile, the reluctant attitude of lenders has become matched by a hardly less reluctant attitude on the part of borrowers. For the fall of prices has been disastrous to those who have borrowed, and anyone who has postponed new enterprise has gained by his delay. Moreover, the risks that frighten lenders frighten borrowers too.

Finally, in the United States, the vast scale on which new capital enterprise has been undertaken in the last five years has somewhat exhausted for the time being, at any rate so long as the atmosphere of business depression continues, the profitable opportunities for yet further enterprise. By the middle of 1929 new capital undertakings were already on an inadequate scale in the world as a whole, outside the United States. The culminating blow has been the collapse of new investment inside the United States, which today is probably 20 to 30 per cent less than it was in 1928. Thus in certain countries the opportunity for new profitable investment is more limited than it was; whilst in others it is more risky.

A wide gulf, therefore, is set between the ideas of lenders and the ideas of borrowers for the purpose of genuine new capital investment; with the result that the savings of the lenders are being used up in financing business losses and distress borrowers, instead of financing new capital works.

At this moment the slump is probably a little overdone for psychological reasons. A modest upward reaction, therefore, may be due at any time. But there cannot be a real recovery, in my judgment, until the ideas of lenders and the ideas of productive borrowers are brought together again; partly by lenders becoming ready to lend on easier terms and over a wider geographical field, partly by borrowers recovering their good spirits and so becoming readier to borrow.

Seldom in modern history has the gap between the two been so wide and so diflicult to bridge. Unless we bend our wills and our intelligences, energized by a conviction that this diagnosis is right, to find a solution along these lines, then, if the diagnosis is right, the slump may pass over into a depression, accompanied by a sagging price level, which might last for years, with untold damage to the material wealth and to the social stability of every country alike. Only if we seriously seek a solution, will the optimism of my opening sentences be confirmed, at least for the nearer future.

It is beyond the scope of this article to indicate lines of future policy. But no one can take the first step except the central banking authorities of the chief creditor countries; nor can any one Central Bank do enough acting in isolation. Resolute action by the Federal Reserve Banks of the United States, the Bank of France, and the Bank of England might do much more than most people, mistaking symptoms or aggravating circumstances for the disease itself, will readily believe.

In every way the more effective remedy would be that the Central Banks of these three great creditor nations should join together in a bold scheme to restore confidence to the international long-term loan market; which would serve to revive enterprise and activity everywhere, and to restore prices and profits, so that in due course the wheels of the world’s commerce would go round again. And even if France, hugging the supposed security of gold, prefers to stand aside from the adventure of creating new wealth, I am convinced that Great Britain and the United States, like-minded and acting together, could start the machine again within a reasonable time; if, that is to say, they were energized by a confident conviction as to what was wrong. For it is chiefly the lack of this conviction which today is paralyzing the hands of authority on both sides of the Channel and of the Atlantic.

How Economics Survived the Economic Crisis – Robert Skidelsky * Good enough for government work? Macroeconomics since the crisis – Paul Krugman.

Unlike the Great Depression of the 1930s, which produced Keynesian economics, and the stagflation of the 1970s, which gave rise to Milton Friedman’s monetarism, the Great Recession has elicited no such response from the economics profession. Why?

The tenth anniversary of the start of the Great Recession was the occasion for an elegant essay by the Nobel laureate economist Paul Krugman, who noted how little the debate about the causes and consequences of the crisis have changed over the last decade. Whereas the Great Depression of the 1930s produced Keynesian economics, and the stagilation of the 1970s produced Milton Friedman’s monetarism, the Great Recession has produced no similar intellectual shift.

This is deeply depressing to young students of economics, who hoped for a suitably challenging response from the profession.

Why has there been none?

Krugman’s answer is typically ingenious: the old macroeconomics was, as the saying goes, “good enough for government work.” It prevented another Great Depression. So students should lock up their dreams and learn their lessons.

A decade ago, two schools of macroeconomists contended for primacy: the New Classical or the “freshwater” School, descended from Milton Friedman and Robert Lucas and headquartered at the University of Chicago, and the New Keynesian, or “saltwater,” School, descended from John Maynard Keynes, and based at MIT and Harvard.

Freshwater-types believed that budgets deficits were always bad, whereas the saltwater camp believed that deficits were beneficial in a slump. Krugman is a New Keynesian, and his essay was intended to show that the Great Recession vindicated standard New Keynesian models.

But there are serious problems with Krugman’s narrative. For starters, there is his answer to Queen Elizabeth II’s nowfamous question: “Why did no one see it coming?” Krugman’s cheerful response is that the New Keynesians were looking the other way. Theirs was a failure not of theory, but of “data collection.” They had “overlooked” crucial institutional changes in the financial system. While this was regrettable, it raised no “deep conceptual issue” that is, it didn’t demand that they reconsider their theory.

Faced with the crisis itself, the New Keynesians had risen to the challenge. They dusted off their old sticky-price models from the 1950s and 1960s, which told them three things. First, very large budget deficits would not drive up near zero interest rates. Second, even large increases in the monetary base would not lead to high inflation, or even to corresponding increases in broader monetary aggregates. And, third, there would be a positive national income multiplier, almost surely greater than one, from changes in government spending and taxation.

These propositions made the case for budget deficits in the aftermath of the collapse of 2008. Policies based on them were implemented and worked “remarkably well.” The success of New Keynesian policy had the ironic effect of allowing “the more inflexible members of our profession [the New Classicals from Chicago] to ignore events in a way they couldn’t in past episodes.” So neither school, sect might be the better word, was challenged to re-think first principles.

This clever history of pre- and post-crash economics leaves key questions unanswered.

First, if New Keynesian economics was “good enough,” why didn’t New Keynesian economists urge precautions against the collapse of 2007-2008? After all, they did not rule out the possibility of such a collapse a priori.

Krugman admits to a gap in “evidence collection.” But the choice of evidence is theory-driven. In my view, New Keynesian economists turned a blind eye to instabilities building up in the banking system, because their models told them that financial institutions could accurately price risk. So there was a “deep conceptual issue” involved in New Keynesian analysis: its failure to explain how banks might come to “underprice risk worldwide,” as Alan Greenspan put it.

Second, Krugman fails to explain why the Keynesian policies vindicated in 2008-2009 were so rapidly reversed and replaced by fiscal austerity. Why didn’t policymakers stick to their stodgy fixed-price models until they had done their work? Why abandon them in 2009, when Western economies were still 4-5% below their precrash levels?

The answer I would give is that when Keynes was briefly exhumed for six months in 2008-2009, it was for political, not intellectual, reasons. Because the New Keynesian models did not offer a sufficient basis for maintaining Keynesian policies once the economic emergency had been overcome, they were quickly abandoned.

Krugman comes close to acknowledging this: New Keynesians, he writes, “start with rational behavior and market equilibrium as a baseline, and try to get economic dysfunction by tweaking that baseline at the edges.” Such tweaks enable New Keynesian models to generate temporary real effects from nominal shocks, and thus justify quite radical intervention in times of emergency. But no tweaks can create a strong enough case to justify sustained interventionist policy.

The problem for New Keynesian macroeconomists is that they fail to acknowledge radical uncertainty in their models, leaving them without any theory of what to do in good times in order to avoid the bad times. Their focus on nominal wage and price rigidities implies that if these factors were absent, equilibrium would readily be achieved. They regard the financial sector as neutral, not as fundamental (capitalism’s “ephor,” as Joseph Schumpeter put it).

Without acknowledgement of uncertainty, saltwater economics is bound to collapse into its freshwater counterpart. New Keynesian “tweaking” will create limited political space for intervention, but not nearly enough to do a proper job. So Krugman’s argument, while provocative, is certainly not conclusive. Macroeconomics still needs to come up with a big new idea.


Robert Skidelsky, Professor Emeritus of Political Economy at Warwick University and a fellow of the British Academy in history and economics, is a member of the British House of Lords. The author of a three-volume biography of John Maynard Keynes.

Project Syndicate

Oxford Review of Economic Policy, 2018

Good enough for government work? Macroeconomics since the crisis

Paul Krugman


This paper argues that when the financial crisis came policy-makers relied on some version of the Hicksian sticky-price IS-LM as their default model; these models were ”good enough for government work’.

While there have been many incremental changes suggested to the DSGE model. there has been no single ‘big new idea” because the even simpler lS-LM type models were what worked well. In particular, the policy responses based on lS-LM were appropriate.

Specifically, these models generated the insights that large budget deficits would not drive up interest rates and, while the economy remained at the zero lower bound, that very large increases in monetary base wouldn’t be inflationary, and that the multiplier on government spending was greater than 1.

The one big exception to this satisfactory understanding was in price behaviour. A large output gap was expected to lead to a large fall in inflation, but did not. If new research is necessary. it is on pricing behaviour. While there was a failure to forecast the crisis, it did not come down to a lack of understanding of possible mechanisms, or of a lack of data, but rather through a lack of attention to the right data.

I. Introduction

It’s somewhat startling, at least for those of us who bloviate about economics for a living, to realize just how much time has passed since the 2008 financial crisis. Indeed, the crisis and aftermath are starting to take on the status of an iconic historical episode, like the stagflation of the 1970s or the Great Depression itself, rather than that of freshly remembered experience. Younger colleagues sometimes ask me what it was like during the golden age of economics blogging, mainly concerned with macroeconomic debates, which they think of as an era that ended years ago.

Yet there is an odd, interesting difference, both among economists and with a wider audience, between the intellectual legacies of those previous episodes and what seems to be the state of macroeconomics now.

Each of those previous episodes of crisis was followed both by a major rethinking of macroeconomics and, eventually, by a clear victor in some of the fundamental debates. Thus, the Great Depression brought on Keynesian economies, which became the subject of fierce dispute, and everyone knew how those disputes turned out: Keynes, or Keynes as interpreted by and filtered through Hicks and Samuelson, won the argument.

In somewhat the same way, stagflation brought on the Friedman Phelps natural rate hypothesis, yes, both men wrote their seminal papers before the 1970s, but the bad news brought their work to the top of the agenda. And everyone knew, up to a point anyway, how the debate over that hypothesis ended up: basically everyone accepted the natural rate idea, abandoning the notion of a long-run trade-off between inflation and unemployment. True, the profession then split into freshwater and saltwater camps over the effectiveness or lack thereof of short-run stabilization policies, a development that I think presaged some of what has happened since 2008. But I’ll get back to that.

For now, let me instead just focus on how different the economics profession response to the post-2008 crisis has been from the responses to depression and stagflation. For this time there hasn’t been a big new idea, let alone one that has taken the profession by storm. Yes, there are lots of proclamations about things researchers should or must do differently, many of them represented in this issue of the Oxford Review. We need to put finance into the heart of the models! We need to incorporate heterogeneous agents! We need to incorporate more behavioural economics! And so on.

But while many of these ideas are very interesting, none of them seems to have emerged as the idea we need to grapple with. The intellectual impact of the crisis just seems far more muted than the scale of crisis might have led one to expect. Why?

Well, I’m going to offer what I suspect will be a controversial answer: namely, macroeconomics hasn’t changed that much because it was. in two senses, what my father’s generation used to call ‘good enough for government work”. On one side, the basic models used by macroeconomists who either practise or comment frequently on policy have actually worked quite well, indeed remarkably well. On the other, the policy response to the crisis, while severely lacking in many ways, was sufficient to avert utter disaster, which in turn allowed the more inflexible members of our profession to ignore events in a way they couldn‘t in past episodes.

In what follows I start with the lessons of the financial crisis and Great Recession, which economists obviously failed to predict. I then move on to the aftermath, the era of fiscal austerity and unorthodox monetary policy, in which I’ll argue that basic macroeconomics, at least in one version, performed extremely well. I follow up with some puzzles that remain. Finally, I turn to the policy response and its implications for the economics profession.

II. The Queen’s question

When all hell broke loose in financial markets, Queen Elizabeth II famously asked why nobody saw it coming. This was a good question but maybe not as devastating as many still seem to think.

Obviously, very few economists predicted the crisis of 2008-9; those who did, with few exceptions I can think of, also predicted multiple other crises that didn’t happen. And this failure to see what was coming can’t be brushed aside as inconsequential.

There are, however, two different ways a forecasting failure of this magnitude can happen, which have very different intellectual implications. Consider an example from a different field, meteorology. In 1987 the Met Office dismissed warnings that a severe hurricane might strike Britain; shortly afterwards, the Great Storm of 1987 arrived, wreaking widespread destruction. Meteorologists could have drawn the lesson that their fundamental understanding of weather was fatally flawed which they would presumably have done if their models had insisted that no such storm was even possible. Instead, they concluded that while the models needed refinement, the problem mainly involved data collection that the network of weather stations, buoys, etc. had been inadequate, leaving them unaware of just how bad things were looking.

How does the global financial crisis compare in this respect? To be fair, the DSGE models that occupied a lot of shelf space in journals really had no room for anything like this crisis. But macroeconomists focused on international experience, one of the hats I personally wear, were very aware that crises triggered by loss of financial confidence do happen, and can be very severe. The Asian financial crisis of 1997-9, in particular, inspired not just a realization that severe l930s-type downturns remain possible in the modern world, but a substantial amount of modelling of how such things can happen.

So the coming of the crisis didn’t reveal a fundamental conceptual gap. Did it reveal serious gaps in data collection? My answer would be, sort of, in the following sense: crucial data weren’t so much lacking as overlooked.

This was most obvious on the financial side. The panic and disruption of financial markets that began in 2007 and peaked after the fall of Lehman came as a huge surprise, but one can hardly accuse economists of having been unaware of the possibility of bank runs. lf most of us considered such runs unlikely or impossible in modern advanced economies, the problem was not conceptual but empirical: failure to take on board the extent to which institutional changes had made conventional monetary data inadequate.

This is clearly true for the United States, where data on shadow banking on the repo market, asset-backed commercial paper, etc. were available but mostly ignored. In a less obvious way, European economists failed to pay sufficient intention to the growth of interbank lending as a source of finance. In both cases the institutional changes undermined the existing financial safety net, especially deposit insurance. But this wasn’t a deep conceptual issue: when the crisis struck, I’m sure I wasn’t the only economist whose reaction was not ‘How can this be happening?” but rather to yell at oneself, ‘Diamond Dybvig, you idiot!’

(The Diamond-Dybvig model is an influential model of bank runs and related financial crises. The model shows how banks’ mix of illiquid assets (such as business or mortgage loans) and liquid liabilities (deposits which may be withdrawn at any time) may give rise to selffulfilling panics among depositors.)

In a more subtle way, economists were also under-informed about the surge in housing prices that we now know represented a huge bubble, whose bursting was at the heart of the Great Recession. In this case, rising home prices were an unmistakable story. But most economists who looked at these prices focused on broad aggregates say, national average home prices in the United States. And these aggregates, while up substantially, were still in a range that could seemingly be rationalized by appealing to factors like low interest rates. The trouble, it turned out, was that these aggregates masked the reality, because they averaged home prices in locations with elastic housing supply (say, Houston or Atlanta) with those in which supply was inelastic (Florida or Spain); looking at the latter clearly showed increases that could not be easily rationalized.

Let me add a third form of data that were available but largely ignored: it’s fairly remarkable that more wasn’t made of the sharp rise in household debt, which should have suggested something unsustainable about the growth of the 2001-7 era. And in the aftermath of the crisis macroeconomists, myself included (Eggertsson and Krugman, 2012) began taking private-sector leverage seriously in a way they should arguably have been doing before.

So did economists ignore warning signs they should have heeded? Yes. One way to summarize their (our) failure is that they ignored evidence that the private sector was engaged in financial overreach on multiple fronts, with financial institutions too vulnerable, housing prices in a bubble, and household debt unsustainable. But did this failure of observation indicate the need for a fundamental revision of how we do macroeconomics? That’s much less clear.

First, was the failure of prediction a consequence of failures in the economic framework that can be fixed by adopting a radically different framework? It’s true that a significant wing of both macroeconomists and financial economists were in the thrall of the efficient markets hypothesis, believing that financial overreach simply cannot happen or at any rate that it can only be discovered after the fact, because markets know what they are doing better than any observer. But many macroeconomists, especially in policy institutions, knew better than to trust markets to always get it right especially those who had studied or been involved with the Asian crisis of the 1990s. Yet they (we) also missed some or all of the signs of overreach. Why?

My answer may seem unsatisfying, but I believe it to be true: for the most part what happened was a demonstration of the old line that predictions are hard, especially about the future. It’s a complicated world out there, and one’s ability to track potential threats is limited. Almost nobody saw the Asian crisis coming, either. For that matter, how many people worried about political disruption of oil supplies before 1973? And so on. At any given time there tends to be a set of conventional indicators everyone looks at, determined less by fundamental theory than by recent events, and big, surprise crises almost by definition happen due to factors not on that list. If you like, it’s as if meteorologists with limited resources concentrated those resources in places that had helped track previous storms, leading to the occasional surprise when a storm comes from an unusual direction.

A different question is whether, now that we know whence the 2008 crisis came, it points to a need for deep changes in macroeconomic thinking. As I’ve already noted, bank runs have been fairly well understood for a long time; we just failed to note the changing definition of banks. The bursting of the housing bubble, with its effects on residential investment and wealth, was conceptually just a negative shock to aggregate demand.

The role of household leverage and forced deleveraging is a bigger break from conventional macroeconomics, even as done by saltwater economists who never bought into efficient markets and were aware of the risk of financial crises. That said, despite the impressive empirical work of Mian and Sufi (2011) and my own intellectual investment in the subject, I don’t think we can consider incorporating debt and leverage a fundamental new idea, as opposed to a refinement at the margin.

It’s true that introducing a role for household debt in spending behaviour makes the short-run equilibrium of the economy dependent on a stock variable, the level of debt. But this implicit role of stock variables in short-run outcomes isn‘t new: after all, nobody has ever questioned the notion that investment flows depend in part on the existing capital stock, and I’m not aware that many macroeconomists consider this a difficult conceptual issue.

And I’m not even fully convinced that household debt played that large a role in the crisis. Did household spending fall that much more than one would have expected from the simple wealth effects of the housing bust?

My bottom line is that the failure of nearly all macroeconomists, even of the saltwater camp, to predict the 2008 crisis was similar in type to the Met Office failure in 1987, a failure of observation rather than a fundamental failure of concept. Neither the financial crisis nor the Great Recession that followed required a rethinking of basic ideas.

III. Not believing in (confidence) fairies

Once the Great Recession had happened, the advanced world found itself in a situation not seen since the 1930s, except in Japan, with policy interest rates close to zero everywhere. This raised the practical question of how governments and central banks should and would respond, of which more later.

For economists, it raised the question of what to expect as a result of those policy responses. And the predictions they made were, in a sense, out-of-sample tests of their theoretical framework: economists weren’t trying to reproduce the historical time-series behaviour of aggregates given historical policy regimes, they were trying to predict the effects of policies that hadn’t been applied in modern times in a situation that hadn’t occurred in modern times.

In making these predictions, the deep divide in macroeconomics came into play, making a mockery of those who imagined that time had narrowed the gap between saltwater and freshwater schools. But let me put the freshwater school on one side, again pending later discussion, and talk about the performance of the macroeconomists, many of them trained at MIT or Harvard in the 1970s, who had never abandoned their belief that activist policy can be effective in dealing with short-run fluctuations. I would include in this group Ben Bernanke, Olivier Blanchard, Christina Romer, Mario Draghi, and Larry Summers, among those close to actual policy, and a variety of academics and commentators, such as Simon Wren-Lewis, Martin Wolf, and, of course, yours truly, in supporting roles.

I think it’s fair to say that everyone in this group came into the crisis with some version of Hicksian sticky-price IS-LM as their default, back-of-the-envelope macroeconomic model. Many were at least somewhat willing to work with DSGE models, maybe even considering such models superior for many purposes. But when faced with what amounted to a regime change from normal conditions to an economy where policy interest rates couldn’t fall, they took as their starting point what the Hicksian approach predicted about policy in a liquidity trap. That is, they did not rush to develop new theories, they pretty much stuck with their existing models.

These existing models made at least three strong predictions that were very much at odds with what many inhuential figures in the political and business worlds (backed by a few economists) were saying.

First. Hicksian macroeconomics said that very large budget deficits, which one might normally have expected to drive interest rates sharply higher, would not have that effect near the zero lower bound.

Second, the same approach predicted that even very large increases in the monetary base would not lead to high inflation, or even to corresponding increases in broader monetary aggregates.

Third, this approach predicted a positive multiplier, almost surely greater than 1, on changes in government spending and taxation.

These were not common-sense propositions. Non-economists were quite sure that the huge budget deficits the US ran in 2009-10 would bring on an attack by the ‘bond vigilantes’. Many financial commentators and political figures warned that the Fed’s expansion of its balance sheet would ‘debase the dollar’ and cause high inflation. And many political and policy figures rejected the Keynesian proposition that spending more would expand the economy, spending less lead to contraction.

In fact, if you‘re looking for a post-2008 equivalent to the kinds of debate that raged in the 1930s and again in the 1970s, a conflict between old ideas based on pre-crisis thinking, and new ideas inspired by the crisis, your best candidate would be fiscal policy. The old guard clung to the traditional Keynesian notion of a government spending multiplier somewhat limited by automatic stabilizers, but still greater than 1. The new economic thinking that achieved actual real-world influence during the crisis and aftermath-as opposed, let’s be honest, to the kind of thinking found in this issue mostly involved rejecting the Keynesian multiplier in favour of the doctrine of expansionary austerity, the argument that cutting public spending would crowd in large amounts of private spending by increasing confidence (Alesina and Ardagna, 2010). (The claim that bad things happen when public debt crosses a critical threshold also played an important real-world role, but was less a doctrine than a claimed empirical observation.)

So here, at least, there was something like a classic crisis-inspired confrontation between tired old ideas and a radical new doctrine. Sad to say, however, as an empirical matter the old ideas were proved right, at least insofar as anything in economics can be settled by experience, while the new ideas crashed and burned. Interest rates stayed low despite huge deficits. Massive expansion in the monetary base did not lead to infiation. And the experience of austerity in the euro area, coupled with the natural experiments created by some of the interregional aspects of the Obama stimulus, ended up strongly supporting a conventional, Keynesian view of fiscal policy, Even the magnitude of the multiplier now looks to be around 1.5, which was the number conventional wisdom suggested in advance of the crisis.

So the crisis and aftermath did indeed produce a confrontation between innovative new ideas and traditional views largely rooted in the 1930s. But the movie failed to follow the Hollywood script: the stodgy old ideas led to broadly accurate predictions, were indeed validated to a remarkable degree, while the new ideas proved embarrassingly wrong. Macroeconomics didn’t change radically in response to crisis because old-fashioned models, confronted with a new situation, did just fine.

IV. The case of the missing deflation

I’ve just argued that the lack of a major rethinking of macroeconomics in the aftermath of crisis was reasonable, given that conventional, off-the-shelf macroeconomics performed very well. But this optimistic assessment needs to be qualified in one important respect: while the demand side of economy did just about what economists trained at MIT in the 1970s thought it would, the supply side didn’t.

As I said, the experience of stagflation effectively convinced the whole profession of the validity of the natural-rate hypothesis. Almost everyone agreed that there was no long-run inflation unemployment trade-off. The great saltwater freshwater divide was, instead, about whether there were usable short-run trade-offs.

But if the natural-rate hypothesis was correct, sustained high unemployment should have led not just to low inflation but to continually declining inflation, and eventually deflation. You can see a bit of this in some of the most severely depressed economies, notably Greece. But deflation fears generally failed to materialize.

Put slightly differently, even saltwater, activist-minded macroeconomists came into the crisis as ‘accelerationists’: they expected to see a downward-sloping relationship between unemployment and the rate of change of inflation. What we’ve seen instead is, at best, something like the 1960s version of the Phillips curve, a downward-sloping relationship between unemployment and the level of inflation and even that relationship appears weak.

Obviously this empirical failure has not gone unnoticed. Broadly, those attempting to explain price behaviour since 2008 have gone in two directions. One side, e.g. Blanchard (2016), invokes ‘anchored’ inflation expectations: the claim that after a long period of low, stable inflation, price-setters throughout the economy became insensitive to recent inflation history, and continued to build 2 per cent or so inflation into their decisions even after a number of years of falling below that target. The other side. e.g. Daly and Hobijn (2014), harking back to Tobin (1972) and Akerlof er a1. (1996), invokes downward nominal wage rigidity to argue that the natural rate hypothesis loses validity at low inflation rates.

In a deep sense, I’d argue that these two explanations have more in common than they may seem to at first sight. The anchored-expectations story may preserve the outward form of an accelerationist Phillips curve, but it assumes that the process of expectations formation changes, for reasons not fully explained, at low inflation rates. The nominal rigidity story assumes that there is a form of money illusion. opposition to outright nominal wage cuts, that is also not fully explained but becomes significant at low overall inflation rates.

Both stories also seem to suggest the need for aggressive expansionary policy when inflation is below target: otherwise there’s the risk that expectations may become unanchored on the downward side, or simply that the economy will suffer persistent, unnecessary slack because the downward rigidity of wages is binding for too many workers.

Finally. I would argue that it is important to admit that both stories are ex post explanations of macroeconomic behaviour that was not widely predicted in advance of the post-2008 era. Pre-2008, the general view even on the saltwater side was that stable inflation was a sufficient indicator of an economy operating at potential output, that any persistent negative output gap would lead to steadily declining inflation and eventually outright deflation. This view was, in fact, a key part of the intellectual case for inflation targeting as the basis of monetary policy. If inflation will remain stable at, say, 1 per cent even in a persistently depressed economy. it’s all too easy to see how policymakers might give themselves high marks even while in reality failing at their job.

But while this is a subjective impression, I haven’t done a statistical analysis of recent literature, it does seem that surprisingly few calls for a major reconstruction of macroeconomics focus on the area in which old-fashioned macroeconomics did, in fact, perform badly post-crisis.

There have, for example, been many calls for making the financial sector and financial frictions much more integral to our models than they are, which is a reasonable thing to argue. But their absence from DSGE models wasn’t the source of any major predictive failures. Has there been any comparable chorus of demands that we rethink the inflation process, and reconsider the natural rate hypothesis? Of course there have been some papers along those lines, but none that have really resonated with the profession.

Why not? As someone who came of academic age just as the saltwater freshwater divide was opening up, I think I can offer a still-relevant insight: understanding wage and price-setting is hard, basically just not amenable to the tools we as economists have in our kit. We start with rational behaviour and market equilibrium as a baseline, and try to get economic dysfunction by tweaking that baseline at the edges; this approach has generated big insights in many areas, but wages and prices isn’t one of them.

Consider the paths followed by the two schools of macroeconomics.

Freshwater theory began with the assumption that wage and price-setters were rational maximizers, but with imperfect information, and that this lack of information explained the apparent real effects of nominal shocks. But this approach became obviously untenable by the early 1980s, when inflation declined only gradually despite mass unemployment. Now what?

One possible route would have been to drop the assumption of fully rational behaviour, which was basically the New Keynesian response. For the most part, however, those who had bought into Lucas-type models chose to cling to the maximizing model, which was economics as they knew how to do it, despite attempts by the data to tell them it was wrong. Let me be blunt: real business cycle theory was always a faintly (or more than faintly) absurd enterprise, a desperate attempt to protect intellectual capital in the teeth of reality.

But the New Keynesian alternative, while far better, wasn’t especially satisfactory either. Clever modellers pointed out that in the face of imperfect competition the aggregate costs of departures from perfectly rational price-setting could be much larger than the individual costs. As a result, small menu costs or a bit of bounded rationality could be consistent with widespread price and wage stickiness.

To be blunt again. however, in practice this insight served as an excuse rather than a basis for deep understanding. Sticky prices could be made respectable just allowing modellers to assume something like one-period-ahead price-setting, in turn letting models that were otherwise grounded in rationality and equilibrium produce something not too inconsistent with real-world observation. New Keynesian modelling thus acted as a kind of escape clause rather than a foundational building block.

But is that escape clause good enough to explain the failure of deflation to emerge despite multiple years of very high unemployment? Probably not. And yet we still lack a compelling alternative explanation, indeed any kind of big idea. At some level, wage and price behaviour in a depressed economy seems to be a subject for which our intellectual tools are badly fitted.

The good news is that if one simply assumed that prices and wages are sticky, appealing to the experience of the 1930s and Japan in the 1990s (which never experienced a true deflationary spiral), one did reasonably well on other fronts.

So my claim that basic macroeconomics worked very well after the crisis needs to be qualified by what looks like a big failure in our understanding of price dynamics but this failure didn’t do too much damage in giving rise to bad advice, and hasn’t led to big new ideas because nobody seems to have good ideas to offer.

V. The system sort of worked

In 2009 Barry Eichengreen and Kevin O’Rourke made a splash with a data comparison between the global slump to date and the early stages of the Great Depression; they showed that at the time of writing the world economy was in fact tracking quite close to the implosion that motivated Keynes’s famous essay ‘The Great Slump of 1930’ (Eichengreen and O’Rourke, 2009)

Subsequent updates, however, told a different story. Instead of continuing to plunge as it did in 1930, by the summer of 2009 the world economy first stabilized, then began to recover. Meanwhile, financial markets also began to normalize; by late 2009 many measures of financial stress were more or less back to pre-crisis levels.

So the world financial system and the world economy failed to implode. Why?

We shouldn’t give policy-makers all of the credit here. Much of what went right, or at least failed to go wrong, refiected institutional changes since the 1930s. Shadow banking and wholesale funding markets were deeply stressed, but deposit insurance still protected at good part of the banking system from runs. There never was much discretionary fiscal stimulus, but the automatic stabilizers associated with large welfare states kicked in, well, automatically: spending was sustained by government transfers, while disposable income was buffered by falling tax receipts.

That said, policy responses were clearly much better than they were in the 1930s. Central bankers and fiscal authorities officials rushed to shore up the financial system through a combination of emergency lending and outright bailouts; international cooperation assured that there were no sudden failures brought on by shortages of key currencies. As a result, disruption of credit markets was limited in both scope and duration. Measures of financial stress were back to pre-Lehman levels by June 2009.

Meanwhile, although fiscal stimulus was modest, peaking at about 2 per cent of GDP in the United States, during 2008-9 governments at least refrained from drastic tightening of fiscal policy, allowing automatic stabilizers, which, as I said, were far stronger than they had been in the 1930s to work.

Overall, then, policy did a relatively adequate job of containing the crisis during its most acute phase. As Daniel Drezner argues (2012), ‘the system worked’-well enough, anyway, to avert collapse.

So far, so good. Unfortunately, once the risk of catastrophic collapse was averted, the story of policy becomes much less happy. After practising more or less Keynesian policies in the acute phase of the crisis, governments reverted to type: in much of the advanced world, fiscal policy became Hellenized, that is, every nation was warned that it could become Greece any day now unless it turned to fiscal austerity. Given the validation of Keynesian multiplier analysis, we can confidently assert that this turn to austerity contributed to the sluggishness of the recovery in the United States and the even more disappointing, stuttering pace of recovery in Europe.

Figure 1 sums up the story by comparing real GDP per capita during two episodes: Western Europe after 1929 and the EU as a whole since 2007. In the modern episode, Europe avoided the catastrophic declines of the early 1930s, but its recovery has been so slow and uneven that at this point it is tracking below its performance in the Great Depression.

Now, even as major economies turned to fiscal austerity, they turned to unconventional monetary expansion. How much did this help? The literature is confusing enough to let one believe pretty much whatever one wants to. Clearly Mario Draghi’s “whatever it takes’ intervention (Draghi, 2012) had a dramatic effect on markets, heading off what might have been another acute crisis, but we never did get a clear test of how well outright monetary transactions would have worked in practice, and the evidence on the effectiveness of Fed policies is even less clear.

The purpose of this paper is not, however, to evaluate the decisions of policy-makers, but rather to ask what lessons macroeconomists should and did take from events. And the main lesson from 2010 onwards was that policy-makers don’t listen to us very much, except at moments of extreme stress.

This is clearest in the case of the turn to austerity, which was not at all grounded in conventional macroeconomic models. True, policy-makers were able to find some economists telling them what they wanted to hear, but the basic Hicksian approach that did pretty well over the whole period clearly said that depressed economies near the zero lower bound should not be engaging in fiscal contraction. Never mind, they did it anyway.

Even on monetary policy, where economists ended up running central banks to a degree I believe was unprecedented, the influence of macroeconomic models was limited at best. A basic Hicksian approach suggests that monetary policy is more or less irrelevant in a liquidity trap. Refinements (Krugman, 1998; Eggertsson and Woodford, 2003) suggested that central banks might be able to gain traction by raising their inflation targets, but that never happened.

The point, then, is that policy failures after 2010 tell us relatively little about the state of macroeconomics or the ways it needs to change, other than that it would be nice if people with actual power paid more attention. Macroeconomists aren’t, however, the only researchers with that problem; ask climate scientists how it’s going in their world.

Meanwhile, however, what happened in 2008-9, or more precisely, what didn’t happen, namely utter disaster, did have an important impact on macroeconomics. For by taking enough good advice from economists to avoid catastrophe, policy-makers in turn took off what might have been severe pressure on economists to change their own views.

VI. That 80s show

Why hasn’t macroeconomics been transformed by (relatively) recent events in the way it was by events in the 1930s or the 1970s? Maybe the key point to remember is that such transformations are rare in economics, or indeed in any field. ‘Science advances one funeral at a time,’ quipped Max Planck: researchers rarely change their views much in the light of experience or evidence. The 1930s and the 1970s, in which senior economists changed their minds, eg. Lionel Robbins converting to Keynesianism, were therefore exceptional.

What made them exceptional? Each case was marked by developments that were both clearly inconsistent with widely held views and sustained enough that they couldn’t be written off as aberrations. Lionel Robbins published The Great Depression, a very classical/Austrian interpretation that prescribed a return to the gold standard, in 1934. Would he have become a Keynesian if the Depression had ended by the mid-1930s? The widespread acceptance of the natural-rate hypothesis came more easily, because it played into the neoclassical mindset, but still might not have happened as thoroughly if stagflation had been restricted to a few years in the early 1970s.

From an intellectual point of view, I’d argue, the Great Recession and aftermath bear much more resemblance to the 1979-82 Volcker double-dip recession and subsequent recovery in the United States than to either the 1930s or the 1970s. And here I can speak in part from personal recollection.

By the late 1970s the great division of macroeconomics into rival saltwater and freshwater schools had already happened, so the impact of the Volcker recession depended on which school you belonged to. But in both cases it changed remarkably few minds.

For saltwater macroeconomists, the recession and recovery came mainly as validation of their pre-existing beliefs. They believed that monetary policy has real effects, even if announced and anticipated; sure enough, monetary contraction was followed by a large real downturn. They believed that prices are sticky and inflation has a great deal of inertia, so that monetary tightening would produce a ‘clockwise spiral’ in unemployment and inflation: unemployment would eventually return to the NAIRU (non-accelerating inflation rate of unemployment) at a lower rate of inflation, but only after a transition period of high unemployment. And that’s exactly what we saw.

Freshwater economists had a harder time: Lucas-type models said that monetary contraction could cause a recession only if unanticipated, and as long as economic agents couldn’t distinguish between individual shocks and an aggregate fall in demand. None of this was a tenable description of 1979-82. But recovery came soon enough and fast enough that their worldview could, in effect, ride out the storm. (I was at one conference where a freshwater economist, questioned about current events, snapped ‘I’m not interested in the latest residual.’)

What I see in the response to 2008 and after is much the same dynamic. Half the macroeconomics profession feels mainly validated by events-correctly, I’d say, although as part of that faction I would say that, wouldn’t I? The other half should be reconsidering its views but they should have done that 30 years ago, and this crisis, like that one, was sufficiently well-handled by policy-makers that there was no irresistible pressure for change. (Just to be clear, I’m not saying that it was well-handled in an objective sense: in my view we suffered huge, unnecessary losses of output and employment because of the premature turn to austerity. But the world avoided descending into a full 1930s-style depression, which in effect left doctrinaire economists free to continue believing what they wanted to believe.)

If all this sounds highly cynical, well, I guess it is. There’s a lot of very good research being done in macroeconomics now, much of it taking advantage of the wealth of new data provided by bad events. Our understanding of both fiscal policy and price dynamics are, I believe, greatly improved. And funerals will continue to feed intellectual progress: younger macroeconomists seem to me to be much more flexible and willing to listen to the data than their counterparts were, say, 20 years ago.

But the quick transformation of macroeconomics many hoped for almost surely isn’t about to happen, because events haven’t forced that kind of transformation. Many economists myself included are actually feeling pretty good about our basic understanding of macro. Many others, absent real-world catastrophe, feel free to take the blue pill and keep believing what they want to believe.

What happened when the US last introduced tariffs? – Dominic Rushe.


Willis Hawley and Reed Smoot were reviled for a bill blamed for triggering the Great Depression. Will Trump follow their lead?

America inches towards a potential trade war over steel prices, can Donald Trump hear whispering voices?

Alone in the Oval Office in the wee dark hours, illuminated by the glow of his Twitter app, does he feel the sudden chill flowing from those freshly hung gold drapes? It is the shades of Smoot and Hawley.

Willis Hawley and Reed Smoot have haunted Congress since the 1930s when they were the architects of the Smoot Hawley tariff bill, among the most decried pieces of legislation in US history and a bill blamed by some for not only for triggering the Great Depression but also contributing to the start of the second world war.

Pilloried even in their own time, their bloodied names have been brought out like Jacob Marley’s ghost every time America has taken a protectionist turn on trade policy. And America has certainly taken a protectionist turn.

Successful presidents including Barack Obama and Bill Clinton have campaigned on the perils of free trade only to drop the rhetoric once installed in the White House. Trump called Mexicans “rapists” on the campaign trail. And China? “There are people who wish I wouldn’t refer to China as our enemy. But that’s exactly what they are,” Trump said.

As commander in chief he has shown no signs of softening and this week took major action announcing steel imports would face a 25% tariff and aluminium 10%.

Canada and the EU said they would bring forward their own countermeasures. Mexico, China and Brazil have also said they are considering retaliatory steps.

Trump doesn’t seem worried. “Trade wars are good,” he tweeted even as the usually friendly Wall Street Journal thundered that “Trump’s tariff folly ”is the “biggest policy blunder of his Presidency”.

It is not his first protectionist move. In his first days in office the president has vetoed the Trans Pacific Partnership (TPP), the biggest trade deal in a generation, said he will review the North American Free Trade Agreement (Nafta), a deal he has called “the worst in history”, and had his visit with Mexico’s president cancelled over his plans to make them pay for a border wall.

Free traders may have become complacent after hearing tough talk on trade from so many presidential candidates on the campaign trail only to watch them furiously back pedal when they get into ofhce, said Dartmouth professor and trade expert Douglas Irwin. “Unfortunately that pattern may have been broken,” he says. “It looks like we have to take Trump literally and seriously about his threats on trade.”

Not since Herbert Hoover has a US president been so down on free trade. And Hoover was the man who signed off on Smoot and Hawley’s bill.

Hawley, an Oregon congressman and a professor a history and economics, became a stock figure in the textbooks of his successors thanks to his partnership with the lean, patrician figure of Senator Reed Smoot, a Mormon apostle known as the “sugar senator” for his protectionist stance towards Utah’s sugar beet industry.

Before he was shackled to Hawley for eternity Smoot was more famous for his Mormonism and his abhorrence of bawdy books, a disgust that inspired the immortal headline “Smoot Smites Smut” after he attacked the importation of Lady’s Chatterley’s Lover, Robert Burns’ more risque poems and similar texts as “worse than opium I would rather have a child of mine use opium than read these books.”

But it was imports of another kind that secured Smoot and Hawley’s place in infamy.

The US economy was doing well in the 1920s as the consumer society was being born to the sound of jazz. The Tariff Act began life largely as a politically motivated response to appease the agricultural lobby that had fallen behind as American workers, and money, consolidated in the cities.

Foreign demand for US produce had soared during the first world war, and farm prices doubled between 1915 and 1918. A wave of land speculation followed and farmers took on debt as they looked to expand production. By the early 1920s farmers had found themselves heavily in debt and squeezed by tightening monetary policy and an unexpected collapse in commodity prices.

Nearly a quarter of the American labor force was then employed on the land, and Congress could not ignore heartland America. Cheap foreign imports and their toll on the domestic market became a hot issue in the 1928 election. Even bananas weren’t safe. Irwin quotes one critic in his book Peddling Protectionism: Smoot Hawley and the Great Depression: “The enormous imports of cheap bananas into the United States tend to curtail the domestic consumption of fresh fruits produced in the United States.”

Hoover won in a landslide against Albert E Smith, an out of touch New Yorker who didn’t appeal to middle America, and soon after promised to pass “limited” tariff reforms.

Hawley started the bill but with Smoot behind him it metastasized as lobby groups shoehorned their products into the bill, eventually proposing higher tariffs on more than 20,000 imported goods.

Siren voices warned of dire consequences. Henry Ford reportedly told Hoover the bill was “an economic stupidity”.

Critics of the tariffs were being aided and abetted by “internationalists” willing to “betray American interests”, said Smoot. Reports claiming the bill would harm the US economy were decried as fake news. Republican Frank Crowther, dismissed press criticism as “demagoguery and untruth, scandalous untruth”.

In October 1929 as the Senate debated the tariff bill the stock market crashed. When the bill finally made it to Hoover’s desk in June 1930 it had morphed from his original “limited” plan to the “highest rates ever known”, according to a New York Times editorial.

The extent to which Smoot and Hawley were to blame for the coming Great Depression is still a matter of debate. “Ask a thousand economists and you will get a thousand and five answers,” said Charles Geisst, professor of economics at Manhattan College and author of Wall Street: A History.

What is apparent is that the bill sparked international outrage and a backlash. Canada and Europe reacted with a wave of protectionist tariffs that deepened a global depression that presaged the rise of Hitler and the second world war. A myriad other factors contributed to the Depression, and to the second world war, but inarguably one consequence of Smoot Hawley in the US was that never again would a sitting US president be so avowedly anti trade. Until today.

Franklin D Roosevelt swept into power in 1933 and for the first time the president was granted the authority to undertake trade negotiations to reduce foreign barriers on US exports in exchange for lower US tariffs.

The backlash against Smoot and Hawley continued to the present day. The average tariff on dutiable imports was 45% in 1930; by 2010 it was 5%.

The lessons of Smoot Hawley used to be taught in high schools. Presidents from Lyndon Johnson to Ronald Reagan have enlisted the unhappy duo when facing off with free trade critics. “I have been around long enough to remember that when we did that once before in this century, something called Smoot Hawley, we lived through a nightmare,” Reagan, who came of age during the Great Depression, said in 1984.

They even got a mention in Ferris Bueller’s Day Off when actor Ben Stein’s teacher bores his class with it. “I don’t think the current generation are taught it. It’s in the past and we are more interested in the future.”

But that might be about to change. “The main lesson is that you have to worry about what other countries do. Countries will retaliate,” said Irwin. “When Congress was considering Smoot Hawley in the 1930s they didn’t consider what other countries might do in reaction. They thought other countries would remain passive. But other countries don’t remain passive.”

The consequences of a trade war today are far worse than in the 1930s. Exports of goods and services account for about 13% of US gross domestic product (GDP) the broadest measure of an economy. It was roughly 5% back in 1920.

“The US is much more engaged in trade, it’s much more a part of the fabric of the country, than it was in the 1920s and 1930s. That means the ripple effects are widespread. Many more industries will be hit by it and the scope for foreign retaliation, which in the case of Smoot Hawley was quite limited, is going to be much more widespread if a trade war was to start.”

“When you start talking about withdrawing from trade agreements or imposing tariffs of 35%, if you are doing that as a protectionist measure, that would be blowing up the system.”

That the promise of “blowing up the system” got Trump elected may be why the ghosts of Smoot and Hawley are once again walking the halls of Congress.

The Guardian

Adults in the room. My battle with Europe’s Deep Establishment – Yanis Varoufakis.

What happens when you take on the establishment? In this blistering, personal account, world-famous economist Yanis Varoufakis blows the lid on Europe’s hidden agenda and exposes what actually goes on in its corridors of power.

Varoufakis sparked one of the most spectacular and controversial battles in recent political history when, as finance minister of Greece, he attempted to re-negotiate his country’s relationship with the EU. Despite the mass support of the Greek people and the simple logic of his arguments, he succeeded only in provoking the fury of Europe’s political, financial and media elite. But the true story of what happened is almost entirely unknown not least because so much of the EU’s real business takes place behind closed doors.

In this fearless account, Varoufakis reveals all: an extraordinary tale of brinkmanship, hypocrisy, collusion and betrayal that will shake the deep establishment to its foundations.

As is now clear, the same policies that required the tragic and brutal suppression of Greece’s democratic uprising have led directly to authoritarianism, populist revolt and instability throughout the Western world.

Adults In The Room is an urgent wake-up call to renew European democracy before it is too late.

Yanis Varoufakis is the former finance minister of Greece and now the figurehead of an international grassroots movement, DiEM25, campaigning for the revival of democracy in Europe. He speaks to audiences of thousands worldwide and is the author of the international bestseller And the Weak Suffer What They Must? Born in Athens in 1961, he was for many years a professor of economics in Britain, Australia and the USA before he entered government. He is currently Professor of Economics at the University of Athens.


A Note on Quoted Speech

In a book of this nature, in which so much depends on who said what to whom, I have made every effort to ensure the accuracy of quoted speech. To this end, l have been able to draw on audio recordings that I made on my phone, as well as on notes I made at the time, of many of the official meetings and conversations that appear in this book. Where my own recordings or notes are unavailable, I have relied on memory and, where possible, the corroboration of other witnesses.

The reader should note that many of the discussions reported in this book took place in Greek. This includes all conversations that occurred with my staff at the finance ministry, in parliament, on the streets of Athens, with the prime minister, in cabinet, and between my partner Danae and me. Necessarily, l have translated those conversations into English.

The only discussions I report that took place in neither Greek nor English were those I had with Michel Sapin, the French finance minister. Indeed, Mr Sapin was the only member of the Eurogroup not to address the meetings in English. Either we communicated through translators or, quite often, he would address me in French and I would reply in English, our grasp of the other’s language being good enough to carry on those conversations.

In every instance I have confined my account strictly to exchanges that are in the public interest and have therefore included only those that shed important light on events that affected the lives of millions.


My previous book, And the Weak Suffer What They Must?: Europe, Austerity and the Threat to Global Stability, offered an historical explanation of why Europe is now in the process, decades in the making, of losing its integrity and forfeiting its soul. Just as l was finishing it in January 2015 I became finance minister of Greece and found myself thrust into the belly of the beast I had been writing about. By accepting the position of finance minister of a chronically indebted European country in the midst of a tumultuous clash with its creditors, Europe’s most powerful governments and institutions, I witnessed first hand the particular circumstances and immediate causes of our continent’s descent into a morass from which it may not escape for a long, long while.

This new book tells that story. It could be described as the story of an academic who became a government minister for a while before turning whistle-blower. Or as a kissand-tell memoir featuring powerful personages such as Angela Merkel, Mario Draghi, Wolfgang Schauble, Christine Lagarde, Emmanuel Macron, George Osborne and Barack Obama. Or as the tale of a small bankrupt country taking on the Goliaths of Europe in order to escape from debtors’ prison before suffering a crushing if fairly honourable defeat. But none of these descriptions convey my real motivation for writing this book.

Shortly after the ruthless suppression of Greece’s rebellion in 2015, also known as the Greek Spring or the Athens Spring, the leftwing party Podemos lost its momentum in Spain; no doubt many potential voters feared a fate similar to ours at the hands of a ferocious EU. Having observed the EU’s callous disregard for democracy in Greece, many supporters of the Labour Party in Britain then went on to vote for Brexit. Brexit boosted Donald Trump. Donald Trump’s triumph blew fresh wind into the sails of xenophobic nationalists throughout Europe and the world.

Vladimir Putin must be rubbing his eyes in disbelief at the way the West has been undermining itself so fabulously.

The story in this book is not only symbolic of what Europe, Britain and the United States are becoming; it also provides real insights into how and why our polities and social economies have fractured. As the so-called liberal establishment protests at the fake news of the insurgent alt-right, it is salutary to be reminded that in 2015 this same establishment launched a ferociously effective campaign of truth-reversal and character assassination against the pro-European, democratically elected government of a small country in Europe.

But as useful as I hope insights such as this may be, my motivation for writing this book goes deeper. Beneath the specific events that I experienced, I recognised a universal story, the story of what happens when human beings find themselves at the mercy of cruel circumstances that have been generated by an inhuman, mostly unseen network of power relations.

This is why there are no ‘goodies’ or ‘baddies’ in this book. Instead, it is populated by people doing their best, as they understand it, under conditions not of their choosing. Each of the persons I encountered and write about in these pages believed they were acting appropriately, but, taken together, their acts produced misfortune on a continental scale. Is this not the stuff of authentic tragedy? Is this not what makes the tragedies of Sophocles and Shakespeare resonate with us today, hundreds of years after the events they relate became old news?

At one point Christine Lagarde, managing director of the International Monetary Fund, remarked in a state of exasperation that to resolve the drama we needed ‘adults in the room’. She was right. There was a dearth of adults in many of the rooms where this drama unfolded.

As characters, though, they fell into two categories: the banal and the fascinating. The banal went about their business ticking boxes on sheets of instructions handed down to them by their masters. In many cases though, their masters, politicians such as Wolfgang Schauble and functionaries like Christine Lagarde and Mario Draghi were different. They had the ability to reflect on themselves and their role in the drama, and this ability to enter into dialogues with themselves made them fascinatingly susceptible to the trap of self-fulfilling prophecy.

Indeed, watching Greece’s creditors at work was like watching a version of Macbeth unfold in the land of Oedipus. Just as the father of Oedipus, King Laius of Thebes, unwittingly brought about his own murder because he believed the prophecy that he would be killed by his son, so too did the smartest and most powerful players in this drama bring about their own doom because they feared the prophecy that foretold it. Keenly aware of how easily power could slip through their fingers, Greece’s creditors were frequently overpowered by insecurity. Fearing that Greece’s undeclared bankruptcy might cause them to lose political control over Europe, they imposed policies on that country that gradually undermined their political control, not just over Greece but over Europe.

At some point, like Macbeth, sensing their power mutate into insufferable powerlessness, they felt compelled to do their worst. There were moments I could almost hear them say

I am in blood

Stepped in so far that, should I wade no more, Returning were as tedious as go o’er. Strange things I have in head, that will to hand; Which must be acted ere they may be scann’d.

Macbeth, iii. iv.

An account by any one of the protagonists in a cut-throat drama such as this cannot escape bias nor the desire for vindication. So, in order to be as fair and impartial as possible, I have tried to see their actions and my own through the lens of an authentic ancient Greek or Shakespearean tragedy in which characters, neither good nor bad, are overtaken by the unintended consequences of their conception of what they ought to do. I suspect that l have come closer to succeeding in this task in the case of those people whom I found fascinating and rather less so in the case of those whose banality numbed my senses. For this I find it hard to apologize, not least because to present them otherwise would be to diminish the historical accuracy of this account.


Winters of our discontent


The only colour piercing the dimness of the hotel bar was the amber liquid flickering in the glass before him. As I approached, he raised his eyes to greet me with a nod before staring back down into his tumbler of whiskey. I sank onto the plush sofa, exhausted.

On cue, his familiar voice sounded imposingly morose. ‘Yanis,’ he said, ‘you made a big mistake.’

In the deep of a spring night a gentleness descends on Washington, DC that is unimaginable during the day. As the politicos, the lobbyists and the hangers-on melt away, the air empties of tension and the bars are abandoned to the few with no reason to be up at dawn and to the even fewer whose burdens trump sleep. That night, as on the previous eighty-one nights, or indeed the eighty-one nights that were to follow, I was one of the latter.

It had taken me fifteen minutes to walk, shrouded in darkness, from 700 19th Street NW, the International Monetary Fund’s building, to the hotel bar where l was to meet him. I had never imagined that a short solitary stroll in nondescript DC could be so restorative. The prospect of meeting the great man added to my sense of relief: after fifteen hours across the table from powerful people too banal or too frightened to speak their minds, l was about to meet a figure of great influence in Washington and beyond, a man no one can accuse of either banality or timidity.

All that changed with his acerbic opening statement, made more chilling by the dim light and shifting shadows.

Faking steeliness, I replied, ‘And what mistake was that, Larry?’

‘You won the election!’ came his answer.

It was 16 April 2015, the very middle of my brief tenure as finance minister of Greece. Less than six months earlier I had been living the life of an academic, teaching at the Lyndon B. Johnson School of Public Affairs at the University of Texas at Austin while on leave from the University of Athens. But in January my life had changed utterly when l was elected a member of the Greek parliament. I had made only one campaign promise: that I would do everything I could to rescue my country from the debt bondage and crushing austerity being imposed on it by its European neighbours and the IMF. It was that promise that had brought me to this city and with the assistance of my close team member Elena Paraniti, who had brokered the meeting and accompanied me that night to this bar.

Smiling at his dry humour and to hide my trepidation, my immediate thought was, Is this how he intends to stiffen my resolve against an empire of foes? I took solace from the recollection that the seventy-first secretary of the United States Treasury and twenty-seventh president of Harvard is not known for his soothing style.

Determined to delay the serious business ahead of us a few moments more, I signalled to the bartender for a whiskey of my own and said, ‘Before you tell me about my “mistake”, let me say, Larry, how important your messages of support and advice have been in the past weeks. I am truly grateful. Especially as for years I have been referring to you as the Prince of Darkness.’

Unperturbed, Larry Summers replied, ‘At least you called me a prince. l have been called worse.’

For the next couple of hours the conversation turned serious. We talked about technical issues: debt swaps, fiscal policy, market reforms, ‘bad’ banks. On the political front he warned me that I was losing the propaganda war and that the ‘Europeans’, as he called Europe’s powers that be, were out to get me. He suggested, and I agreed, that any new deal for my long-suffering country should be one that Germany’s chancellor could present to her voters as her idea, her personal legacy.

Things were proceeding better than I had hoped, with broad agreement on everything that mattered. It was no mean feat to secure the support of the formidable Larry Summers in the struggle against the powerful institutions, governments and media conglomerates demanding my government’s surrender and my head on a silver platter. Finally, after agreeing our next steps, and before the combined effects of fatigue and alcohol forced us to call it a night, Summers looked at me intensely and asked a question so well rehearsed that I suspected he had used it to test others before me.

‘There are two kinds of politicians,’ he said: ‘insiders and outsiders. The outsiders prioritize their freedom to speak their version of the truth. The price of their freedom is that they are ignored by the insiders, who make the important decisions. The insiders, for their part, follow a sacrosanct rule: never turn against other insiders and never talk to outsiders about what insiders say or do. Their reward? Access to inside information and a chance, though no guarantee, of influencing powerful people and outcomes.’ With that Summers arrived at his question. ‘So, Yanis,’ he said, ‘which of the two are you?’

Instinct urged me to respond with a single word; instead I used quite a few.

‘By character I am a natural outsider,’ I began, ‘but,’ I hastened to add, ‘I am prepared to strangle my character if it would help strike a new deal for Greece that gets our people out of debt prison. Have no doubt about this, Larry: I shall behave like a natural insider for as long as it takes to get a viable agreement on the table for Greece, indeed for Europe. But if the insiders I am dealing with prove unwilling to release Greece from its eternal debt bondage, I will not hesitate to turn whistleblower on them to return to the outside, which is my natural habitat anyway.’

‘Fair enough,’ he said after a thoughtful pause.

We stood up to leave. The heavens had opened while we were talking. As I saw him to a taxi, the downpour soaked my spring clothes in seconds. With his taxi speeding away, I had the opportunity to realize a wild dream of mine, one that had kept me going during the interminable meetings of the previous days and weeks: to walk alone, unnoticed, in the rain.

Powering through the watery curtain in pristine solitude, I took stock of the encounter. Summers was an ally, albeit a reluctant one. He had no time for my government’s left-wing politics, but he understood that our defeat was not in America’s interest. He knew that the eurozone’s economic policies were not just atrocious for Greece but terrible for Europe and, by extension, for the United States too. And he knew that Greece was merely the laboratory where these failed policies were being tested and developed before their implementation everywhere across Europe.

This is why Summers offered a helping hand. We spoke the same economic language, despite different political ideologies, and had no difficulty reaching a quick agreement on what our aims and tactics ought to be. Nevertheless, my answer had clearly bothered him, even if he did not show it. He would have got into his taxi a much happier man, I felt, had I demonstrated some interest in becoming an insider. As this book’s publication confirms, that was never likely to happen.

Back at my hotel, getting dry and with two hours to go before the alarm clock would summon me back to the front line, I pondered a great anxiety: how would my comrades back home, the inner circle of our government, answer Summers’s question in their hearts? On that night l was determined to believe that they would answer it as I had done.

Less than two weeks later I began to have my first real doubts.

Super black boxes

Yiorgos Chatzis went missing on 29 August 2012. He was last sighted at the social security office in the small northern Greek town of Siatista, where he was told that his monthly disability allowance of €280 had been suspended. Eyewitnesses reported that he did not utter a word of complaint. ‘He seemed stunned and remained speechless,’ a newspaper said. Soon after, he used his mobile phone for the last time to call his wife. No one was at home, so he left a message: ‘I feel useless. I have nothing to offer you any more. Look after the children.’ A few days later his body was found in a remote wooded area, suspended by the neck over a cliff, his mobile phone lying on the ground nearby.

The wave of suicides triggered by the great Greek depression had caught the attention of the international press a few months earlier after Dimitris Christoulas, a seventy-seven-year-old retired pharmacist, shot himself dead by a tree in the middle of Athens’s Syntagma Square, leaving behind a heart-wrenching political manifesto against austerity. Once upon a time the silent, dignified grief of Christoulas’s and Chatzis’s loved ones would have shamed into silence even the most hardened bailiff, except that in Bailoutistan, my satirical term for post-2010 Greece, our bailiffs keep their distance from their victims, barricading themselves in five-star hotels, whizzing around in motorcades and steadying their occasionally flagging nerves with baseless statistical projections of economic recovery.

During that same year, 2012, three long years before Larry Summers was to lecture me on insiders and outsiders, my partner Danae Stratou presented an art installation at a downtown Athens gallery. She called it, It is time to open the black boxes! The work comprised one hundred black metal boxes laid out geometrically on the floor. Each contained a word selected by Danae from the thousands that Athenians had contributed through social media in response to her question, ‘In a single word, what are you most afraid of, or what is the one thing you want to preserve?’

Danae’s idea was that unlike, say, the black box of a downed aircraft, these boxes would be opened before it was too late. The word that Athenians had chosen more than any other was not jobs, pensions or savings. What they feared losing most was dignity. The island of Crete, whose inhabitants are renowned for their pride, experienced the highest number of suicides once the crisis hit. When a depression deepens and the grapes of wrath grow ‘heavy for the vintage’, it is the loss of dignity that brings on the greatest despair.

In the catalogue entry I wrote for the exhibition I drew a comparison with another kind of black box. In engineering terms, I wrote, a black box is a device or system whose inner workings are opaque to us but whose capacity to turn inputs into outputs we understand and use fluently. A mobile phone, for instance, reliably converts finger movements into a telephone call or the arrival of a taxi, but to most of us, though not to electrical engineers, what goes on within a smartphone is a mystery. As philosophers have noted, other people’s minds are the quintessential black boxes: ultimately we can have no idea of precisely what goes on inside another’s head. (During the 162 days that this book chronicles I often caught myself wishing that the people around me, my comrades-in-arms in particular, were less like black boxes in this regard.)

But then there are what I called ‘super black boxes’, whose size and import is so great that even those who created and control them cannot fully understand their inner workings: for example, financial derivatives whose effects are not truly understood even by the financial engineers who designed them, global banks and multinational corporations whose activities are seldom grasped by their CEOs, and of course governments and supranational institutions like the International Monetary Fund, led by politicians and influential bureaucrats who may be in office but are rarely in power. They too convert inputs money, debt, taxes, votes into outputs profit, more complicated forms of debt, reductions in welfare payments, health and education policies. The difference between these super black boxes and the humble smartphone or even other humans is that while most of us have barely any control over their inputs, their outputs shape all our lives.

This difference is encapsulated in a single word: power. Not the type of power associated with electricity or the crushing force of the ocean’s waves, but another, subtler, more sinister power: the power held by the ‘insiders’ that Larry Summers referred to but which he feared I would not have the disposition to embrace, the power of hidden information.

During and after my ministry days people constantly asked me, ‘What did the IMF want from Greece? Did those who resisted debt relief do so because of some illicit hidden agenda? Were they working on behalf of corporations interested in plundering Greece’s infrastructure its airports, seaside resorts, telephone companies and so on?’ If only matters were that straightforward.

When a large-scale crisis hits, it is tempting to attribute it to a conspiracy between the powerful. Images spring to mind of smoke-filled rooms with cunning men (and the occasional woman) plotting how to profit at the expense of the common good and the weak. These images are, however, delusions. If our sharply diminished circumstances can be blamed on a conspiracy, then it is one whose members do not even know that they are part of it. That which feels to many like a conspiracy of the powerful is simply the emergent property of any network of super black boxes.

The keys to such power networks are exclusion and opacity. Recall the ‘Greed is great’ ethos of Wall Street and the City of London in the years before the 2008 implosion. Many decent bank employees were worried sick by what they were observing and doing. But when they got their hands on evidence or information foreshadowing terrible developments, they faced Summers’s dilemma: leak it to outsiders and become irrelevant; keep it to themselves and become complicit; or embrace their power by exchanging it for other information held by someone else in the know, resulting in an impromptu two-person alliance that turbocharges both individuals’ power within the broader network of insiders. As further sensitive information is exchanged, this two-person alliance forges links with other such alliances. The result is a network of power within other pre-existing networks, involving participants who conspire de facto without being conscious conspirators.

Whenever a politician in the know gives a journalist an exclusive in exchange for a particular spin that is in the politician’s interest, the journalist is appended, however unconsciously, to a network of insiders. Whenever a journalist refuses to slant their story in the politician’s favour, they risk losing a valuable source and being excluded from that network. This is how networks of power control the flow of information: through co-opting outsiders and excluding those who refuse to play ball. They evolve organically and are guided by a supraintentional drive that no individual can control, not even the president of the United States, the CEO of Barclays or those manning the pivotal nodes in the IMF or national governments.

Once caught in this web of power it takes an heroic disposition to turn whistle-blower, especially when one cannot hear oneself think amid the cacophony of so much money-making. And those few who do break ranks end up like shooting stars, quickly forgotten by a distracted world.

Fascinatingly, many insiders, especially those only loosely attached to the network, are oblivious to the web that they reinforce, courtesy of having relatively few contacts with it. Similarly, those embedded in the very heart of the network are usually too far inside to notice that there is an outside at all. Rare are those astute enough to notice the black box when they live and work inside one. Larry Summers is one such rare insider. His question to me was in fact an invocation to reject the lure of the outside. Underpinning his belief system was the conviction that the world can only be made better from within the black box.

But this was where, I thought, he was very wrong.

Theseus before the labyrinth

Before 2008, while the super black boxes functioned stably, we lived in a world that seemed balanced and self-healing. Those were the times when the British chancellor Gordon Brown was celebrating the end of ‘boom and bust’ and the soon-to-be-chairman of the Federal Reserve Ben Bernanke was heralding the Great Moderation. Of course it was all an illusion generated by the super black boxes whose function no one understood, especially not the insiders running them. And then, in 2008, they broke down spectacularly, generating our generation’s 1929, not to mention little Greece’s fall.

It is my view that the 2008 financial crisis, which is still with us almost a decade later, is due to the terminal breakdown of the world’s super black boxes of the networks of power, the conspiracies without conspirators, that fashion our lives. Summers’s blind faith that the remedies to this crisis will spring from those same broken down networks, through the normal operations of insiders, struck me even at the time as touchingly naive. Perhaps that is not surprising. After all, three years earlier I had written in Danae’s catalogue that ‘opening these super black boxes has now become a prerequisite to the survival of decency, of whole strata of our fellow humans, of our planet even. Put simply, we have run out of excuses. It is, therefore, time to open the black boxes!’ But in real terms, what would this entail?

First, we need to acquire a readiness to recognize that we may very well, each one of us, already be a node in the network; an ignorant de facto conspirator. Secondly, and this is the genius of Wikileaks, if we can get inside the network, like Theseus entering the labyrinth, and disrupt the information flow; if we can put the fear of uncontrollable information leaking in the mind of as many of its members as possible, then the unaccountable, malfunctioning networks of power will collapse under their own weight and irrelevance. Thirdly, by resisting any tendency to substitute old closed networks with new ones.

By the time I entered that Washington bar three years later I had tempered my stance. My priority was not to leak information to outsiders but to do whatever it took to get Greece out of debtors’ prison. If that meant pretending to be an insider, so be it. But the instant the price of admission to the insiders’ circle became acceptance of Greece’s permanent incarceration, I would leave. Laying down an Ariadne’s thread inside the insiders’ labyrinth and being ready to follow it to the exit is, I believe, a prerequisite for the dignity on which the Greek people’s happiness relies.

The day after my meeting with Larry Summers I met Jack Lew, the incumbent US Treasury secretary. After our meeting at the Treasury, an official seeing me out startled me with a friendly aside: ‘Minister, I feel the urge to warn you that within a week you will face a character assassination campaign emanating from Brussels.’ Larry’s pep talk about the importance of staying inside the proverbial tent, along with his warning that we were losing the media war, suddenly came into sharp focus.

Of course, it was no great surprise. Insiders, I had written in 2012, would react aggressively to anyone who dared open up their super black box to the outsiders’ gaze: ‘None of this will be easy. The networks will respond violently, as they are already doing. They will turn more authoritarian, more closed, more fragmented. They will become increasingly preoccupied with their own “security” and monopoly of information, less trusting of common people.

The following chapters relate the networks’ violent reaction to my stubborn refusal to trade Greece’s emancipation for a privileged spot inside one of their black boxes.

Sign here!

It all boiled down to one small doodle on a piece of paper whether I was prepared to sign on the dotted line of a fresh bailout loan agreement that would push Greece further into its labyrinthine jail of debt.

The reason why my signature mattered so much was that, curiously, it is not presidents or prime ministers of fallen countries that sign bailout loan agreements with the IMF or with the European Union. That poisoned privilege falls to the hapless finance minister. It is why it was crucial to Greece’s creditors that I be bent to their will, that I should be co-opted or, failing that, crushed and replaced by a more pliant successor. Had I signed, another outsider would have turned insider and praise would have been heaped upon me. The torrent of foul adjectives directed at me by the international press, arriving right on cue only a little more than a week after that Washington visit, just as the US official had warned me it would, would never have descended onto my head. I would have been ‘responsible’, a ‘trustworthy partner’, a ‘reformed maverick’ who had put his nation’s interests above his ‘narcissism’.

Judging by his expression as we walked out of the hotel and into the pouring rain, Larry Summers seemed to understand. He understood that the ‘Europeans’ were not interested in an honourable deal with me or with the Greek government. He understood that, in the end, I would be pressurised inordinately to sign a surrender document as the price of becoming a bona fide insider. He understood that l was not willing to do this. And he believed that this would be a pity, for me at least.

For my part I understood that he wanted to help me secure a viable deal. I understood too that he would do what he could to help us, provided it did not violate his golden rule: insiders never turn against other insiders and never talk to outsiders about what insiders do or say. What I was not sure about was whether he would ever understand why there was no chance in heaven or hell for that matter that I would sign a non-viable new bailout loan agreement. It would have taken too long to explain my reasons, but even if there had been time I feared that our backgrounds were too different for my explanation to make any sense to him.

My explanation, had I offered it, would have come in the form of a story or two.

The first would have probably begun inside an Athenian police station in the autumn of 1946, when Greece was on the brink of a communist insurgency and the second phase of its catastrophic civil war. A twenty-year-old chemistry student at Athens University named Yiorgos had been arrested by the secret police, roughed up and left in a cold cell for a few hours until a higher-ranking officer took him to his office ostensibly to apologize. I am sorry for the rough treatment, he said. You are a good boy and did not deserve this. But you know these are treacherous times and my men are on edge.

Forgive them. Just sign this and off you go. With my apologies.

The police officer seemed sincere and Yiorgos was relieved that his earlier ordeal at the hands of the thugs was at an end. But then, as he read the typewritten statement the officer was asking him to sign, a cold chill ran down his spine. The page read, I hereby denounce, truly and in all sincerity, communism, those who promote it, and their various fellow travellers.

Trembling with fear, he put the pen down, summoned all the gentleness that his mother Anna had instilled in him over the years, and said, Sir, I am no Buddhist but I would never sign a state document denouncing Buddhism. I am not a Muslim but I do not think the state has the right to ask me to denounce Islam. Similarly, I am not a communist but I see no reason why I should be asked to denounce communism.

Yiorgos’s civil liberty argument stood no chance. Sign or look forward to systematic torture and indefinite detention the choice is yours! shouted the enraged officer. The officer’s ire was based on perfectly reasonable expectations. Yiorgos had all the makings of a good boy, a natural insider. He had been born in Cairo to a middle-class family within the large Greek community, itself embedded in a cosmopolitan European enclave of French, Italian and British expats, and raised alongside sophisticated Armenians, Jews and Arabs. French was spoken at home, courtesy of his mother, Greek at school, English at work, Arabic on the street and Italian at the opera.

At the age of twenty, determined to connect with his roots, Yiorgos had given up a cushy job in a Cairo bank and moved to Greece to study chemistry. He had arrived in Athens in January 1945 on the ship Corinthia only a month after the conclusion of the first phase of Greece’s civil war, the first episode of the Cold War. A fragile détente was in the air, and so it had seemed reasonable to Yiorgos when student activists of both the Left and the Right had approached him as a compromise candidate for president of his school’s students’ association.

Shortly after his election, however, the university authorities had increased tuition fees at a time when students wallowed in absolute poverty. Yiorgos had paid the dean a visit, arguing as best as he could against the fee hike. As he left, secret policemen had manhandled him down the school’s marble steps and into a waiting van. and he had ended up with a choice that makes Summers’s dilemma seem like a walk in the park.

Given the young man’s bourgeois background, the police had every expectation that Yiorgos would either sign gladly or break quickly once torture began. However, with every beating Yiorgos felt less able to sign, end the pain and go home. As a result, he ended up in a variety of cells and prison camps that he could have escaped at any point simply by putting his signature on a single sheet of paper. Four years later, a shadow of his former self, Yiorgos emerged from prison into a grim society that neither knew of his peculiar choice nor really cared.

Meanwhile, during the period of Yiorgos’s incarceration, a young woman four years his junior had become the first female student to gain admittance to the University of Athens Chemistry School, despite their best efforts to keep her out. Eleni, for that was her name, began university as a rebellious proto-feminist but nevertheless felt a powerful dislike for the Left: during the years of the Nazi occupation she had been abducted as a very young girl by left-wing partisans who mistook her for a relative of a Nazi collaborator. Upon enrolling at the University of Athens, a fascist organization called X recruited her on the strength of her anticommunist feelings. Her first and, as it would turn out, her last mission for them was to follow a fellow chemistry student who had just been released from the prison camps.

This, in a nutshell, is the story of how I came about. For Yiorgos is my father, and Eleni, who ended up a leading member of the 1970s feminist movement, was my mother. Blessed with this history, signing on the dotted line in return for the mercy shown to insiders was never on the cards for me. Would Larry Summers have understood? I don’t think so.

Not for me

The other story is as follows. I met Lambros in the Athens apartment I share with Danae a week or so before the January 2015 election that brought me to office. It was a mild winter’s day, the campaign was in full swing, and I had agreed to give an interview to lrene, a Spanish journalist. She came to the apartment accompanied by a photographer and by Lambros, an Athens-based Greek-Spanish translator. On that occasion Lambros’s services were unnecessary as lrene and I talked in English. But he stayed, watching and listening intensely. After the interview, as Irene and the photographer were packing up their gear and heading for the door, Lambros approached me. He shook my hand, refusing to let go while addressing me with the concentration of a man whose life depends on getting his message across: ‘I hope you did not notice it from my appearance. I do my best to cover it up, but in fact I am a homeless person.’ He then told me his story as briefly as he could.

Lambros used to have a flat, a job teaching foreign languages and a family. In 2010, when the Greek economy tanked, he lost his job, and when they were evicted from their flat he lost his family. For the past year he had lived on the street. His only income came from providing translation services to visiting foreign journalists drawn to Athens by yet another demonstration in Syntagma Square which turned ugly and thus newsworthy. His greatest concern was finding a few euros to recharge his cheap mobile phone so that the foreign news crews could contact him.

Feeling he needed to wrap up his soliloquy, he rushed to the one thing he wanted from me:

I want to implore you to promise me something. l know you will win the election. I talk to people on the street and there is no doubt that you will. Please, when you win, when you are in office, remember those people. Do something for them. Not for me! I am finished. Those of us whom the crisis felled, we cannot come back. It is too late for us. But, please, please do something for those who are still on the verge. Who are clinging by their fingernails. Who have not fallen yet. Do it for them. Don’t let them fall. Don’t turn your back to them. Don’t sign what they give you like the previous ones did. Swear that you won’t. Do you swear?

‘I swear,’ was my two-word answer to him.

A week later I was taking my oath of office as the country’s finance minister. During the months that followed, every time my resolve weakened I had only to think back to that moment. Lambros will never know of his influence during the bleakest hours of those 162 days.


By early 2010, some five years before I took office, the Greek state was bankrupt. A few months later the European Union, the International Monetary Fund and the Greek government organized the world’s greatest bankruptcy cover-up. How do you cover up a bankruptcy? By throwing good money after bad. And who financed this cover-up? Common people, ‘outsiders’ from all over the globe.

The rescue deal, as the cover-up was euphemistically known, was signed and sealed in early May 2010. The European Union and the IMF extended to the broke Greek government around €110 billion, the largest loan in history. Simultaneously a group of enforcers known as the troika so called because they represent three institutions: the European Commission (EC), which is the EU’s executive body, the European Central Bank (ECB) and the International Monetary Fund (IMF) was dispatched to Athens to impose measures guaranteed to reduce Greece’s national income and place most of the burden of the debt upon the weakest Greeks. A bright eight-year-old would have known that this couldn’t end well. Forcing new loans upon the bankrupt on condition that they shrink their income is nothing short of cruel and unusual punishment.

Greece was never bailed out. With their ‘rescue’ loan and their troika of bailiffs enthusiastically slashing incomes, the EU and lMF effectively condemned Greece to a modern version of the Dickensian debtors’ prison and then threw away the key.

Debtors’ prisons were ultimately abandoned because, despite their cruelty, they neither deterred the accumulation of new bad debts nor helped creditors get their money back. For capitalism to advance in the nineteenth century, the absurd notion that all debts are sacred had to be ditched and replaced with the notion of limited liability. After all, if all debts are guaranteed, why should lenders lend responsibly? And why should some debts carry a higher interest rate than other debts, reflecting the higher risk of going bad?

Bankruptcy and debt write-downs became for capitalism what hell had always been for Christian dogma unpleasant yet essential but curiously bankruptcy denial was revived in the twenty-first century to deal with the Greek state’s insolvency. Why? Did the EU and the IMF not realize what they were doing?

They knew exactly what they were doing. Despite their meticulous propaganda, in which they insisted that they were trying to save Greece, to grant the Greek people a second chance, to help reform Greece’s chronically crooked state and so on, the world’s most powerful institutions and governments were under no illusions. They appreciated that you could squeeze blood out of a stone more easily than make a bankrupt entity repay its loans by lending it more money, especially if you shrink its income as part of the deal. They could see that the troika, even if it managed to confiscate the fallen state’s silverware, would fail to recoup the money used to refinance Greece’s public debt. They knew that the celebrated ‘rescue’ or ‘bailout’ package was nothing more than a one-way ticket to debtors’ prison.

How do I know that they knew? Because they told me.

Prisoners of their own device

As finance minister five years later, I heard it straight from the horse’s mouth. From top IMF officials, from Germany’s finance minister, from leading figures in the ECB and the European Commission they all admitted, each in their own way, that it was true: they had dealt Greece an impossible hand. But having done so, they could see no way back.

Less than a month after my election, on 11 February 2015, in one of those spirit-numbing, windowless, neon-lit meeting rooms that litter the EU’s Brussels buildings, I found myself sitting opposite Christine Lagarde, the lMF’s managing director, France’s ex-finance minister and a former Washington-based high-flying lawyer. She had waltzed into the building earlier that day in a glamorous leather jacket, making me look drab and conventionally attired. This being our first encounter, we chatted amicably in the corridor before moving into the meeting room for the serious discussion.

Behind closed doors, with a couple of aides on each side, the conversation turned serious but remained just as friendly. She afforded me the opportunity to present my basic analysis of the causes and nature of the Greek situation as well as my proposals for dealing with it, and nodded in agreement for much of the time. We seemed to share a common language and were both keen to establish a good rapport. At the meeting’s end, walking towards the door, we got a chance for a short, relaxed but telling téte-a-téte. Taking her cue from the points I had made, Christine seconded my appeals for debt relief and lower tax rates as prerequisites for a Greek recovery. Then she addressed me with calm and gentle honesty: You are of course right, Yanis. These targets that they insist on can’t work. But, you must understand that we have put too much into this programme. We cannot go back on it. Your credibility depends on accepting and working within this programme.

So, there I had it. The head of the IMF was telling the finance minister of a bankrupt government that the policies imposed upon his country couldn’t work. Not that it would be hard to make them work. Not that the probability of them working was low. No, she was acknowledging that, come hell or high water, they couldn’t work.

With every meeting, especially with the troika’s smarter and less insecure officials, the impression grew on me that this was not a simple tale of us versus them, good versus bad. Rather, an authentic drama was afoot reminiscent of a play by Aeschylus or Shakespeare in which powerful schemers end up caught in a trap of their own making. In the real-life drama I was witnessing, Summers’s sacred rule of insiders kicked in the moment they recognized their powerlessness. The hatches were battened down, official denial prevailed, and the consequences of the tragic impasse they’d created were left to unfold on autopilot, imprisoning them yet further in a situation they detested for weakening their hold over events.

Because they, the heads of the IMF, of the EU, of the German and French governments, had invested inordinate political capital in a programme that deepened Greece’s bankruptcy, spread untold misery and led our young to emigrate in droves, there was no alternative: the people of Greece would simply have to continue to suffer.

As for me, the political upstart, my credibility depended on accepting these policies, which insiders knew would fail, and helping to sell them to the outsiders who had elected me on the precise basis that I would break with those same failed policies.

It’s hard to explain, but not once did I feel animosity towards Christine Lagarde. I found her intelligent, cordial, respectful. My view of humanity would not be thrown into turmoil were it to be shown that she actually had a strong preference for a humane Greek deal. But that is not relevant. As a leading insider, her top priority was the preservation of the insiders’ political capital and the minimization of any challenge to their collective authority.

Yet credibility, like spending, comes with tradeoffs. Every purchase means an alternative opportunity lost. Boosting my standing with Christine and the other figures of power meant sacrificing my credibility with Lambros, the homeless interpreter who had sworn me to the cause of those people who, unlike him, had not yet been drowned in the torrent of bankruptcy ravaging our land. This trade-off never came close to becoming a personal dilemma. And the powers that be realized this early on, making my removal from the scene essential.

A little more than a year later, in the run-up to the UK referendum on 23 June 2016, I was travelling across Britain giving speeches in support of a radical remain platform, the argument that the UK ought to stay within the EU to oppose this EU, to save it from collapse and to reform it. It was a tough sell. Convincing Britain’s outsiders to vote remain was proving an uphill struggle, especially in England’s north, because even my own supporters in Britain, women and men closer in spirit and position to Lambros than to Christine, were telling me they felt compelled to deliver a drubbing to the global establishment. One evening I heard on the BBC that Christine Lagarde had joined the heads of the world’s other top financial institutions (the World Bank, the OECD, the ECB, the Bank of England and so on) to warn Britain’s outsiders against the lure of Brexit. I immediately texted Danae from Leeds, where l was speaking that night, ‘With such allies, who needs Brexiteers?’

Brexit won because the insiders went beyond the pale. After decades of treating people like me as credible in proportion to our readiness to betray the outsiders who had voted for us, they still confused outsiders with people who gave a damn about their counsel. Up and down America, in Britain, in France and in Germany everywhere the insiders are feeling their authority slip away. Prisoners of their own device, slaves to the Summers dilemma, they are condemned, like Macbeth, to add error upon error until they realize that their crown no longer symbolizes the power they have but the power that has slipped away. In the few months I spent dealing with them, I caught glimpses of that tragic realization.

It was the (French and German) banks, stupid!

Friends and journalists often ask me to describe the worst aspect of my negotiations with Greece’s creditors. Not being able to shout from the rooftops what the high and mighty were telling me in private was certainly frustrating, but worse was dealing with creditors who did not really want their money back. Negotiating with them, trying to reason with them, was like negotiating a peace treaty with generals hell-bent on continuing a war safe in the knowledge that they, their sons and their daughters are out of harm’s way.

What was the nature of that war? Why did Greece’s creditors behave as if they did not want their money back? What led them to devise the trap in which they now found themselves? The riddle can be answered in seconds if one takes a look at the state of France’s and Germany’s banks after 2008.

Greece’s endemic underdevelopment, mismanagement and corruption explain its permanent economic weakness. But its recent insolvency is due to the fundamental design faults of the EU and its monetary union, the euro.

The EU began as a cartel of big business limiting competition between central European heavy industries and securing export markets for them in peripheral countries such as Italy and, later, Greece. The deficits of countries like Greece were the reflection of the surpluses of countries like Germany. While the drachma devalued, these deficits were kept in check. But when it was replaced by the euro, loans from German and French banks propelled Greek deficits into the stratosphere.

The Credit Crunch of 2008 that followed Wall Street’s collapse bankrupted Europe’s bankers who ceased all lending by 2009. Unable to roll over its debts, Greece fell into its insolvency hole later that year.

Suddenly three French banks faced losses from peripheral debt at least twice the size of the French economy. Numbers provided by the Bank of International Settlements reveal a truly scary picture: for every thirty euros they were exposed to, they had access to only one. This meant that if only 3 per cent of that exposure went bad that is, if €106 billion of the loans they had given to the periphery’s governments, households and firms could not be repaid then France’s top three banks would need a French government bailout.

The same three French banks’ loans to the Italian, Spanish and Portuguese governments alone came to 34 per cent of France’s total economy, €627 billion to be exact. For good measure, these banks had in previous years also lent up to €102 billion to the Greek state. If the Greek government could not meet its repayments, money men around the globe would get spooked and stop lending to the Portuguese, possibly to the Italian and Spanish states as well, fearing that they would be the next to go into arrears.

Unable to refinance their combined debt of nearly €1.76 trillion at affordable interest rates, the Italian, Spanish and Portuguese governments would be hard pressed to service their loans to France’s top three banks, leaving a black hole in their books. Overnight, France’s main banks would be facing a loss of 19 per cent of their ‘assets’ when a mere 3 per cent loss would make them insolvent.

To plug that gap the French government would need a cool €562 billion overnight. But unlike the United States federal government, which can shift such losses to its central bank (the Fed), France had dismantled its central bank in 2000 when it joined the common currency and had to rely instead on the kindness of Europe’s shared central bank, the European Central Bank. Alas, the ECB was created with an express prohibition: no shifting of Graeco-Latin bad debts, private or public, onto the ECB’s books. Full stop. That had been Germany’s condition for sharing its cherished Deutschmark with Europe’s riff-raff, renaming it the euro.

It’s not hard to imagine the panic enveloping President Sarkozy of France and his finance minister, Christine Lagarde, as they realized that they might have to conjure up €562 billion from thin air. And it’s not difficult to picture the angst of one of Lagarde’s predecessors in France’s finance ministry, the notorious Dominic Strauss-Kahn, who was then managing director of the IMF and intent on using that position to launch his campaign for France’s presidency in two years’ time.

France’s top officials knew that Greece’s bankruptcy would force the French state to borrow six times its total annual tax revenues just to hand it over to three idiotic banks.

It was simply impossible. Had the markets caught a whiff that this was on the cards, interest rates on France’s own public debt would have been propelled into the stratosphere, and in seconds €1.29 trillion of French government debt would have gone bad. In a country which had given up its capacity to print banknotes the only remaining means of generating money from nothing that would mean destitution, which in turn would bring down the whole of the European Union, its common currency, everything.

In Germany, meanwhile, the chancellor’s predicament was no less taxing. In 2008, as banks in Wall Street and the City of London crumbled, Angela Merkel was still fostering her image as the tight-fisted, financially prudent Iron Chancellor. Pointing a moralizing finger at the Anglosphere’s profligate bankers, she made headlines in a speech she gave in Stuttgart when she suggested that America’s bankers should have consulted a Swabian housewife, who would have taught them a thing or two about managing their finances. Imagine her horror when, shortly afterwards, she received a barrage of anxious phone calls from her finance ministry, her central bank, her own economic advisers, all of them conveying an unfathomable message:

“Chancellor, our banks are bust too! To keep the ATMs going, we need an injection of €406 billion of those Swabian housewives’ money by yesterday!”

It was the definition of political poison. How could she appear in front of those same members of parliament whom she had for years lectured on the virtues of penny-pinching when it came to hospitals, schools, infrastructure, social security, the environment, to implore them to write such a colossal cheque to bankers who until seconds before had been swimming in rivers of cash? Necessity being the mother of enforced humbleness, Chancellor Merkel took a deep breath, entered the splendid Norman Foster designed federal parliament in Berlin known as the Bundestag, conveyed to her dumbfounded parliamentarians the bad news and left with the requested cheque. At least it’s done, she must have thought. Except that it wasn’t. A few months later another barrage of phone calls demanded a similar number of billions for the same banks.

Why did Deutsche Bank, Finanzbank and the other Frankfurt-based towers of financial incompetence need more? Because the €406 billion cheque they had received from Mrs Merkel in 2009 was barely enough to cover their trades in USbased toxic derivatives. It was certainly not enough to cover what they had lent to the governments of Italy, Ireland, Portugal, Spain and Greece a total of €477 billion, of which a hefty €102 billion had been lent to Athens. lf Greece lost its capacity to meet its repayments? German banks faced another loss that would require of Mrs Merkel another cheque for anything between €340 billion and €406 billion, but consummate politician that she is, the chancellor knew she would be committing political suicide were she to return to the Bundestag to request such an amount.

Between them, the leaders of France and Germany had a stake of around €1 trillion in not allowing the Greek government to tell the truth; that is, to confess to its bankruptcy.

Yet they still had to find a way to bail out their bankers a second time without telling their parliaments that this was what they were doing. As Jean-Claude Juncker, then prime minister of Luxembourg and later president of the European Commission, once said, ‘When it becomes serious, you have to lie.’

After a few weeks they figured out their fib: they would portray the second bailout of their banks as an act of solidarity with the profligate and lazy Greeks, who while unworthy and intolerable were still members of the European family and would therefore have to be rescued. Conveniently, this necessitated providing them with a further gargantuan loan with which to pay off their French and German creditors, the failing banks.

There was, however, a technical hitch that would have to be overcome first: the clause in the eurozone’s founding treaty that banned the financing of government debt by the EU. How could they get round it? The conundrum was solved by a typical Brussels fudge, that unappetizing dish that the Europeans, especially the British, have learned to loathe.

First, the new loans would not be European but international, courtesy of cutting the IMF into the deal. To do this would require the IMF to bend its most sacred rule: never lend to a bankrupt government before its debt has had a ‘haircut’, been restructured. But the lMF’s then managing director, Dominic Strauss-Kahn, desperate to save the banks of the nation he planned to lead two years down the track, was on hand to persuade the IMF’s internal bureaucracy to turn a blind eye. With the IMF on board, Europeans could be told that it was the international community, not just the EU, lending to the Greeks for the higher purpose of underpinning the global financial system. Perish the thought that this was an EU bailout for an EU member state, let alone for German and French banks!

Second, the largest portion of the loans, to be sourced in Europe, would not come from the EU per se; they would be packaged as a series of bilateral loans that is to say, from Germany to Greece, from Ireland to Greece, from Slovenia to Greece, and so on with each bilateral loan of a size reflecting the lender’s relative economic strength, a curious application of Karl Marx’s maxim ‘from each according to his capacity to each according to his need’.

So, of every €1000 handed over to Athens to be passed on to the French and German banks, Germany would guarantee €270, France €200, with the remaining €530 guaranteed by the smaller and poorer countries.

This was the beauty of the Greek bailout, at least for France and Germany: it dumped most of the burden of bailing out the French and German banks onto taxpayers from nations even poorer than Greece, such as Portugal and Slovakia. They, together with unsuspecting taxpayers from the lMF’s co-funders such as Brazil and Indonesia, would be forced to wire money to the Paris and Frankfurt banks.

Unaware of the fact that they were actually paying for the mistakes of French and German bankers, the Slovaks and the Finns, like the Germans and the French, believed they were having to shoulder another country’s debts. Thus, in the name of solidarity with the insufferable Greeks, the Franco-German axis planted the seeds of loathing between proud peoples.

From Operation Offload to bankruptocracy

As soon as the bailout loans gushed into the Greek finance ministry, ‘Operation Offload’ began: the process of immediately siphoning the money off back to the French and German banks. By October 2011, the German banks’ exposure to Greek public debt had been reduced by a whopping €27.8 billion to €91.4 billion. Five months later, by March 2012, it was down to less than €795 million. Meanwhile the French banks were offloading even faster: by September 2011 they had unburdened themselves of €63.6 billion of Greek government bonds, before totally eliminating them from their books in December 2012. The operation was thus completed within less than two years. This was what the Greek bailout had been all about.

Were Christine Lagarde, Nicolas Sarkozy and Angela Merkel naive enough to expect the bankrupt Greek state to return this money with interest? Of course not. They saw it precisely as it was: a cynical transfer of losses from the books of the FrancoGerman banks to the shoulders of Europe’s weakest taxpayers. And therein lies the rub:

The EU creditors I negotiated with did not prioritize getting their money back because, in reality, it wasn’t their money. Socialists, Margaret Thatcher liked to say, are bound to make a mess of finance because at some point they run out of other people’s money. How would the iron Lady have felt if she’d known that her dictum would prove so fitting a description of her own self-proclaimed disciples, the neoliberal apparatchiks managing Greece’s bankruptcy? Did their Greek bailout amount to anything other than the socialization of the French and German banks’ losses, paid for with other people’s money?

In my book The Global Minotaur, which I was writing in 2010 while Greece was imploding, I argued that free-market capitalist ideology expired in 2008, seventeen years after communism kicked the bucket.

Before 2008 free-market enthusiasts portrayed capitalism as a Darwinian jungle that selects for success among heroic entrepreneurs. But in the aftermath of the 2008 financial collapse, the Darwinian natural selection process was stood on its head: the more insolvent a banker was, especially in Europe, the greater his chances of appropriating large chunks of income from everyone else: from the hard-working, the innovative, the poor and of course the politically powerless.

Bankruptocracy is the name I gave to this novel regime.

Most Europeans like to think that American bankruptocracy is worse than its European cousin, thanks to the power of Wall Street and the infamous revolving door between the US banks and the US government. They are very, very wrong. Europe’s banks were managed so atrociously in the years preceding 2008 that the inane bankers of Wall Street almost look good by comparison. When the crisis hit, the banks of France, Germany, the Netherlands and the UK had exposure in excess of $30 trillion, more than twice the United States national income, eight times the national income of Germany, and almost three times the national incomes of Britain, Germany, France and Holland put together.

A Greek bankruptcy in 2010 would have immediately necessitated a bank bailout by the German, French, Dutch and British governments amounting to approximately $10,000 per child, woman and man living in those four countries. By comparison, a similar market turn against Wall Street would have required a relatively tiny bailout of no more than $258 per US citizen.

If Wall Street deserved the wrath of the American public, Europe’s banks deserved 38.8 times that wrath.

But that’s not all. Washington could park Wall Street’s bad assets on the Federal Reserve’s books and leave them there until either they started performing again or were eventually forgotten, to be discovered by the archaeologists of the future. Put simply, Americans did not need to pay even that relatively measly $258 per head out of their taxes. But in Europe, where countries like France and Greece had given up their central banks in 2000 and the ECB was banned from absorbing bad debts, the cash needed to bail out the banks had to be taken from the citizenry.

If you have ever wondered why Europe’s establishment is so much keener on austerity than America’s or Japan’s, this is why. It is because the ECB is not allowed to bury the banks’ sins in its own books, meaning European governments have no choice but to fund bank bailouts through benefits cuts and tax hikes.

Was Greek’s unholy treatment a conspiracy? If so, it was one without conscious conspirators, at least at the outset. Christine Lagarde and her ilk never set out to found Europe’s bankruptocracy. When the French banks faced certain death, what choice did she have as France’s finance minister, alongside her European counterparts and the IMF, but to do whatever it took to save them even if this entailed lying to nineteen European parliaments at once about the purpose of the Greek loans? But having lied once and on such a grand scale, they were soon forced to compound the deceit in an attempt to hide it beneath fresh layers of subterfuge. Coming clean would have been professional suicide. Before they knew it, bankruptocracy had enveloped them too, just as surely as it had enveloped Europe’s outsiders.

This is what Christine was signalling to me when she confided that ‘they’ had invested too much in the failed Greek programme to go back on it. She might as well have used Lady Macbeth’s more graceful words: ‘What’s done cannot be undone.’

‘National traitor’ the origins of a quaint charge

My career as ‘national traitor’ has its roots in December 2006. In a public debate organized by a former prime minister’s think tank I was asked to comment on the 2007 Greek national budget. Looking at the figures, something compelled me to dismiss them as the pathetic window-dressing exercise that they were:

“Today we are threatened by the bubble in American real estate and in the derivatives market If this bubble bursts, and it is certain it will, no reduction in interest rates is going to energize investment in this country to take up the slack, and so none of this budget’s figures will have a leg to stand on. The question is not whether this will happen but how quickly it will result in our next Great Depression.”

My fellow panellists, who included two former finance ministers, looked at me the way one looks at an inconvenient fool.

Over the next two years I would encounter that look time and again. Even after Lehman Brothers went belly up, Wall Street crumpled, the credit crunch hit and a great recession engulfed the West, Greece’s elites were living in a bubble of self-deluded bliss. At dinner parties, in academic seminars, at art galleries they would harp on about Greece’s invulnerability to the ‘Anglo disease’, secure in the conviction that our banks were sufficiently conservative and the Greek economy fully insulated from the storm.

In pointing out that nothing could have been further from the truth I sounded a jarring dissonance, but it would only get worse.

In reality, states never repay their debt. They roll it over, meaning they defer repayment endlessly, paying only the interest on the loans. As long as they can keep doing this, they remain solvent.

It helps to think of public debt as a hole in the ground next to a mountain representing the nation’s total income. Day by day the hole gets steadily deeper as interest accrues on the debt, even if the state does not borrow more. But during the good times, as the economy grows, the income mountain is steadily getting taller. As long as the mountain rises faster than the debt hole deepens, the extra income added to the mountain’s summit can be shovelled into the adjacent hole, keeping its depth stable and the state solvent. Insolvency beckons when the economy stops growing or starts to contract: recession then eats into a country’s income mountain, doing nothing to slow the pace at which the debt hole continues to grow. At this point alarmed money men will demand higher interest rates on their loans as the price for continuing to refinance the state, but increased rates operate like overzealous excavators, digging yet faster and making the debt hole even deeper.



Adults in the room. My battle with Europe’s Deep Establishment

by Yanis Varoufakis

get it at

The New Keynesian fiscal rules that mislead British Labour – Bill Mitchell.

The British Labour Party is currently leading the Tories in the latest YouGov opinion polls (February 19-20, Tories 40 per cent (and declining), Labour 42 per cent (and rising). They should be further in front, given the disarray of the Conservatives as they try to negotiate within their own party something remotely acceptable about Brexit.

When there is this degree of political capital available, in this case for the Labour Party, a party should use it to redefine policy agendas that have gone awry. To build a narrative that will advance their cause for the future decades.

British Labour has a chance to break out of its recent Blairite neoliberal past and present a truly progressive manifesto to the British people that will force the Tories to move closer to the centre and squeeze the extreme right-wing elements.

In part, under Jeremy Corbyn and John McDonnell, Labour is making progressive noises on a number of fronts. But ultimately, where it really matters, the macroeconomic narrative, they are remaining firmly neoliberal and this will blight their chances of pursuing a truly progressive agenda.

One of the glaring mistakes the Labour Party has made is to accept advice from neoliberal economists (so-called New Keynesians) who have instilled in them a need for fiscal rules. This is an analysis of the sort of advice that Jeremy Corbyn and John McDonnell are getting and why they should ignore it.

l have written about fiscal rules in the past. There is only one fiscal rule that a progressive government should adhere to and I outlined that in this blog post The full employment fiscal deficit condition (April 13, 2011).

See also the suite of blog posts Fiscal sustainability 101 Part 1 Fiscal sustainability 101 Part 2 Fiscal sustainability 101 Part 3 to learn how Modern Monetary Theory (MMT) constructs the concept of fiscal sustainability.

The discussion in those blog posts rejects fiscal rules that are defined exclusively in terms of financial ratios, the type that the neoliberals use to reduce the scope of government and bias policy towards austerity and elevated levels of labour underutilisation.

I wrote about the madness in the British Labour Party signing up to neoliberal ’fiscal rules’ in this blog post, British Labour Party is mad to sign up to the ’Charter of Budget Responsibility’ (September 28, 2015).

One discussion paper that seems to have influenced the Shadow Chancellor in entering these type of neoliberal agreements was published on May 20, 2014 as Discussion Paper No. 429 from the National Institute of Economic and Social Research.

The NIESR paper Issues in the Design of Fiscal Policy Rules was written by Jonathan Portes (who is the Director of the NIESR) and an Oxford academic, Simon Wren-Lewis.

l have noticed that SWL seems to get involved with vituperative exchanges with Twitter participants who challenge him on matters relating to Modern Monetary Theory (MMT). He seems to think it is smart to label people, who refuse to accept his New Keynesian blather on Twitter, as being plain dumb.

SWL was a member of Labour’s economic advisory committee that John McDonnell formed after becoming the Shadow Chancellor. He later fell out with Corbyn it seems and urged the Party to dump Corbyn as leader and install Owen Smith instead.

On July 26, 2016, he wrote that “What seems totally clear to me is that given recent events a Corbyn-led party cannot win in 2020, or even come close.”

Well that prediction might still be relevant in 2020, but the last national election outcome, where Corbyn went close (even with many of the Blairites in his own party whiteanting him) suggested that SWL hasn’t much grip on reality.

Anyway, we digress.

In their discussion of issues that arise in the design of fiscal rules, Portes and SWL fail to mention the concept of full employment in the NIESR article. Their discussion is pitched entirely in terms of ‘financial ratios’.

It is hard to see that the general public will be enamoured with a government that delivers a target fiscal deficit (for example) but at the expense of elevated levels of unemployment and poverty. Fiscal policy has to relate to things that matter.

The belief (assertion) that by running fiscal surpluses or getting a public debt below some threshold will automatically deliver prosperity (jobs for all, growing real wages, first-class public services, etc) is one of the greatest con jobs that mainstream economists have foisted upon us. Fiscal policy has to relate to targets that matter like jobs, wages growth, and the like.

Depending on what the external and the private domestic sectors are doing (with respect to spending and saving), a fiscal deficit of 10 per cent of GDP might be appropriate just as a fiscal deficit of 2 per cent, or even a fiscal surplus of 4 per cent. Context matters not some particular ratio.

As an aside, the NIESR was a foremost Keynesian research group after being founded in 1938, as the academy was embracing the rejection of neoclassical thinking (which has morphed into the modern day neoliberalism) and recognising the positive role that government fiscal policy could play.

lts capacity to engage in quantitative research to support policy was valuable.

In more recent times, it has declined and is part of the neoliberal misinformation machine. The Keynesian roots has become New Keynesian, which eliminates all the meaningful insights of the original.

I have been asked by a lot of people to comment on the NIESR paper (cited above) and I have been reluctant to do so, given how flawed it is.

But given it has been so influential in framing the way in which the British Labour Party hierarchy thinks about macroeconomics, l have decided to consider it. It is hard to discuss the paper though in non-technical terms accessible to my broad readership, given the way it is framed. So at times, this essay will disappear into jargon. Not much though. I am trying to bring the message as fairly and simply as I can, so as to demonstrate the stupidity of the analysis but not be unfair (misrepresent) the authors.

Generally, the NIESR paper falls into the realm of what I call fake knowledge.

The simple response is that it spends several pages outlining the theory of optimal debt and fiscal policy then admits such a thesis “undeveloped”.

Not to be discouraged by the inability of the ‘optimal theory’ to say anything definitive about the real world, the authors, then proceed to draw conclusions from the theory anyway, which just amount to standard assertions.

Wren-Lewis just should stick to Twitter. He seems to like that. It would save us the time reading the other stuff. in effect, the substantive conclusions from the paper have no basis in theory and could have been tweets.

Let me explain why.

The motivation of the authors is to discuss what might be a “simple rule to guide fiscal policymakers”.

They point out that central bankers have used the “Taylor rule for monetary policy”, which is a simplification in itself. But I won’t get bogged down in discussing whether decision-making in central banks has or had become so mechanistic. It has not been but that is another story.

Mainstream monetary economists certainly teach students that central banks operate in the mechanistic way described by the Taylor rule, which is just a formula the textbooks claim is used to set interest rates.

But then these characters also teach students that central banks can control the money supply, that the money multiplier is responsible for determining how the monetary base scales up into the broad money supply, that expanding bank reserves will allow banks to make loans more easily, that expanding bank reserves is inflationary and al st of the litany of lies.

None of the central propostions that are taught to macroeconomics students in this regard are valid. They are fake knowledge, a stylised world of how these neoliberal economists want to imagine the real world works because they can then derive their desired policy regimes from it.

In the real world central banks and commercial banks do not function in this way.

Some of these monetary myths spill over into the analysis presented by Portes and SWL, which I will indicate presently.

Their motivation is to “search for such a rule” that might apply to fiscal policy, although they conclude at the outset that “one single simple rule to guide fiscal policy may never be found”.

They surmise that this is because:

1. “basic theory suggests that fiscal policy actions should be very different when monetary policy is constrained in a fundamental way. They cite the case of the so-called zero lower bound” as constraining fiscal policy options. In fact, no such constraint exists. Whether interest rates are zero or something else, the currency-issuing government has the same capacities and options.

There is no evidence that monetary policy suddenly becomes effective as a counter-stabilising tool at some positive target policy rate and should be preferred over fiscal policy.

The authors also suggest that the exchange rate regime will constrain fiscal policy. This is correct, which is why Modern Monetary Theory (MMT) theorists argue against pegged arrangements, they reduce the sovereignty of the government.

If a nation pegs its exchange rate then it strictly loses its sovereignty because the central bank has to conduct monetary policy with a view of stabilising the external value of the currency, which then limits the flexibility of domestic policy.

That is why the Bretton Woods fixed exchange rate system collapsed in August 1971. It biased nations running external deficits towards elevated levels of unemployment and crippling interest rates, which proved to be politically unsustainable.

2. Portes and SWL then say: “The second reason why a fiscal equivalent of a Taylor rule may be elusive also reflects national differences, but in this case differences in political structure.”

Here we get the bizarre notion introduced that theory describes an “optimal policy” but that ”there may be a trade-off between rules that mimic optimal policy, and rules that are effective in countering deficit bias” because politicians cannot be trusted to exhibit the ‘correct’ degree of austerity and instead become drunk on net spending (their concept of a “deficit bias”).

These ‘deficit drunk’ governments are labelled “non benevolent” because they allegedly trash the future of our children. Heard that one before? Sure you have, along with ‘governments running out of money’, ‘tipping points’, etc. To solve the problem of these ‘deficit drunk’ governments, Portes and SWL think technocratic constraints are needed to prevent governments responding to the desires of the population as represented by their mandate.

Of course, imposing technocratic constraints against a democratically elected government has become a major characteristic of the neoliberal era. Portes and SWL fit right in with that trend.

All this is part of the ‘depoliticisation’ trend that has seen elected governments shed political responsibility for key decisions that have damaged the well-being of the vast majority of people in their nations by appealing to ‘external’ authorities.

The ‘we had to do it, we had no choice’ ruse, the ‘Dennis Healey, we had to borrow from the IMF because we were running out of money‘ ruse, the ‘we need to outsource fiscal policy to economic experts because politicians just want votes’ ruse.

These external authorities might be so-called independent central banks (even though they are not independent see later), the IMF, and fiscal boards (such as the Office of Budget Responsibility in the UK).

We examine that trend in our new book Reclaiming the State: A Progressive Vision of Sovereignty for a Post-Neoliberal World (Pluto Books, September 2017)

Further, the term ‘deficit bias’ is loaded. Portes and SWI would claim that continuous fiscal deficits illustrate this bias. However, in most nations, such continuity is necessary to support the saving desires of the non-government sector, while sustaining full employment.

There would be no ‘bias’ there. Just responsible fiscal practice. I will discuss that in more detail presently. Refer back to the blog post The full employment fiscal deficit condition.

Further, the so-called New Keynesian ‘optimum‘ is unlikely to have any relevance for the well-being of the population, and, in particular, the most disadvantaged citizens in society.

The standard New Keynesian ‘model’ didn’t even have unemployment in it.

If you understand the dominant New Keynesian framework, which has become the basis for a new consensus emerging among orthodox macroeconomists like Portes and SWL, then you will know the following.

1. The basic New Keynesian approach has three equations which in themselves are problematic. They claim authority based on the microfoundations that are alleged to represent rigourous optimising behaviour by all agents (people, firms, etc) captured by the model structure.

2. Because the ‘optimal’ theory, specified in the basic structure (Calvo pricing, rational expectations, intertemporal utility maximising behaviour by consumers, who face a trade-off between consumption and leisure, etc) cannot say anything much about real world data, the empirical models are modified (adjustment lags are added, etc). As a result ad hocery enters the applied domain where substantive results that are meant to apply to policy are generated.

3. But it is virtually impossible to builds these ‘modifications’ into their theoretical models from the first principles (intertermporal optimisation, etc) that they start with.

4. Which means that like most of the mainstream body of theory the claim to micro-founded ‘rigour’ is unsustainable once they respond to real world anomalies (of their theory) with ad hoc (non rigourous) tack ons.

5. The results they end up producing in empirical papers are not ‘derivable’ from first-order, microfounded principles at all. Their claim to theoretical rigour fails, At the end of the process there is no rigour at all. It becomes a false authority that they hide behind to justify their assertions.

The Portes-SWL paper is no exception.

Further, the ’Great Moderation’ was considered a move closer to the New Keynesian utopia (‘the business cycle’ was declared ‘dead’, for example).

Yet all we witnessed during this period in the 1990s and up to the onset of the GFC, was the redistribution of national income capital as real wages failed to keep pace with productivity growth, increased inequality and private debt, elevated levels of unemployment, the emergence of underemployment, and the dynamics being put in place which manifested as the GFC.

And, the burden of the GFC was not borne by the banksters or the top-end-of-town. Their criminality largely escaped unscathed while millions of workers lost their jobs and many became impoverished.

The belief that one can derive ‘optimal’ rules from a New Keynesian model that have any relevance to people or the world we live in is another characteristic of the neoliberal era. My profession basically went from bad to worse over this period.

However, none of that reality discourages Portes and SWL, who begin their analytical section by outlining this so-called New Keynesian “Optimal debt policy”.

Two propositions enter immediately:

1. taxes impose costs in terms of social welfare because they “are distortionary”. This means that they prevent people from making ‘optimal’ decisions.

The microeconomic theory these authors rely on claims that tax distortions include workers not working hard enough because the imposition of taxes create incentives for them to take more leisure.

This is a body of theory that also says unemployment is a choice workers make when the real wage (after tax) is so high that they prefer to take leisure instead of working. No problem, the workers are ‘optimising real income’ by being unemployed leisure is part of this ‘real’ income measure in these models.

If you thought that sounded like nonsense then you are right. Quits do not behave countercyclically, which would be required if unemployment was a choice made by workers.

Further, the research evidence suggests that the imposition of taxes does not alter the desire of workers to offer hours off work in any significant way.

For a start, most workers do not have continuous (hours) choices available to them. They work 40 hours (or whatever) or not at all.

But this is a digression.

Further what about carbon taxes and other similar taxes, which, even in the mainstream theory, correct market failure and enhance efficiency?

2. Then we read the “government would like to minimise these costs [from the taxes] but they need taxes to pay for government spending and any interest on debt.

Which is an absolute lie in terms of the intrinsic nature of a monetary system where the national government issues its own currency.

It is a convenient lie because they rely on it to derive the results in their paper. They also need this ‘optimality’ smokescreen to persuade politicians to take the results seriously as if their ‘assumptions’ are, in reality, natural constraints on governments.

The lie also implicitly biases the reader to accepting the ‘lower’ taxes are better than higher taxes, a proposition that depends on other assumptions they choose not to disclose because they are smart enough to know that that would push the discussion into the ideological domain and these characters want us to pretend that economics is ‘value free’ and everything they are writing is derivable from ‘optimal’ theory.

One of the first lectures an economics student is forced to endure contains assertions that there is a divide between what mainstream economists call ‘positive’ economics (value free) and ‘normative’ statements (value laden).

Mainstream theory holds itself out as being ‘positive’ and then blames dysfunctional outcomes on the ‘normative’ interventions of policy makers, who choose to depart from the ‘optimal’ world of positive economics.

If you thought this was an elaborate joke played on the students then you would be correct.

And in terms of the above, the correct statement would be that governments impose voluntary constraints on themselves, engineered by conservative ideologues. They have created accounting processes that ‘account‘ for tax receipts into, say Account A, which they then ‘account’ for their spending from. A sort of administrative fiction to give the impression that the tax receipts provide the wherewithal for government spending.

But anyone knows that these institutional practices can be altered by the government whenever they choose (unless they are embedded in constitutions and then it takes more time).

The reality is that unlike the assertion on of Portes and SWL (which drive their overall results):

Governments do not need taxes to pay for government spending. That is an ideological constraint designed to limit spending. Intrinsically, a sovereign government is never revenue constrained because it is the monopoly issuer of the currency.

Modern Monetary Theory (MMT) tells us that taxation serves to create real resource space (idle non-government productive resources), which governments can then bring into productive use to fulfill its elected socio-economic mandate. That taxation reduces the inflation risk of such spending but does not ‘fund’ it.

The fact is that a currency-issuing government can purchase anything that is for sale in its own currency including all idle labour.

MMT also recognises other roles for taxation such as taxes on bads designed to divert consumers or producers away from these goods and services. But that is another story.

Further, a government never needs to issue debt to ‘fund’ deficits.

That is another institutional practice that carries over from the fixed-exchange rate, gold standard days. It is no longer necessary and an understanding of MMT leads one to realise it is largely an exercise in the provision of corporate welfare that should be abandoned.

The point is that if you build ‘economic models’ based on these voluntary constraints, as if they are intrinsic constraints, then the results turn out radically different to the outcomes of an analytical exercise where you assume, correctly, that the government does not need taxes to ‘fund’ spending or to issue debt to fund deficits. Then the mainstream results largely collapse.

I suspect the authors in question implicitly know this. If they don’t then you can draw your own conclusions.


The paper I am using to represent the New Keynesian approach has, by all indications, been somewhat influential in the formation of the macroeconomic approach currently being espoused by the British Labour Party. In that sense, the critique aims to disabuse the Labour politicians and their apparatchiks of building policy options based on fake economic knowledge, and, instead, embrace the principles of Modern Monetary Theory (MMT), which provides an accurate depiction of how the monetary system actually operates and the policy options for a currency-issuing government such as in Britain, and the likely consequences of deploying these options.

The one major lesson that comes out is that the New Keynesian approach is an elaborate fraud. It plays around with so-called ‘optimising’ models asserting human behaviour that no other social scientist believes remotely captures the essence of human decision-making, and then derives conclusions from these models that are claimed to apply to the world we live in. Prior to the GFC, these ‘models’ didn’t even consider the financial sector.

The fact is that nothing of value in terms of specifying what a government should do can be gleaned from a New Keynesian approach. It is barren.

Above, we noted that one discussion paper that seems to have influenced the Shadow British Chancellor was published on May 20, 2014 as Discussion Paper No. 429 from the National Institute of Economic and Social Research.

The NIESR paper Issues in the Design of Fiscal Policy Rules was written by Jonathan Portes (who at the time of writing was the Director of the NIESR before he was ‘let go’) and an Oxford academic, Simon Wren-Lewis.

Here I begin by examining the way that the authors try to use the New Keynesian theory as an authority for specific policy conclusions, which they essentially admit (not in those words) cannot, in fact, be derived from the ‘optimal’ theory.

To specify what they call the ‘optimal’ state, Portes and SWL write out some simple mathematical expressions and note: that the government must satisfy its budget constraint (there is no default), and we ignore financing through printing money.

It is interesting that in defending the New Keynesian position against say Modern Monetary Theory (MMT), proponents make a claim for superiority based on their mathematical reasoning and the apparent absence of such optimising mathematics in MMT.

When useful, MMT uses formal language (mathematics) sparingly. Mostly, propositions can be established without resort to mathematics, which avoids creating a wall of comprehension that most people cannot break down.

Further, there is nothing sophisticated about the mathematics that New Keynesians use. It is just simple calculus really, the sort that I learned as an undergraduate studying mathematics. Hardcore mathematicians laugh at the way economists deploy these tools and parade them as if they are generating something deep and meaningful.

We move on.

Note that while the imposition of taxes is deemed a “cost” by Portes and SWL (discussed in earlier), their ‘model’ doesn’t allow the interest payments on the debt to be a ‘beneflt’. They are silent on that. Conveniently so.

Anyway, the equation they write out which captures the constrained optimisation process is claimed to be an ex ante financial constraint, akin to the financial constraints facing a household that must earn income, borrow, reduce savings or sell assets in order to spend.

As we know, the ‘household budget analogy’ applied to a currency-issuing government is wrong at the most elemental level.

Nothing relating to the experience of a household (the currency user) is relevant to assessing the capacities of or the choices available to such a government (currency issuer).

Further, why do they ignore “financing through printing money”? Not that “printing money” is a term that could be associated with the real world practice of government spending anyway.

They ignore it because it would not allow them to generate the results they desire.

The reality is that these so-called ‘budget constraints’ do not depict real ex ante financial constraints. They are, at best, ex post accounting statements, meaning they have to add up. There is nothing much more about them than that.

They may also reflect current institutional practice which is a political rather than an intrinsic financial artifact.

But, if the authors were to be stock-flow (accounting) consistent (which most mainstream models are not meaning they deliberately leave things out and that flows do not accumulate properly into the corresponding stocks), then they would have to include the change in bank reserves arising from central bank monetary operations associated with fiscal policy (for example, crediting banks accounts on behalf of the government).

But those operations are absent in their approach, which means their analysis is incomplete in an accounting sense. Conveniently so.

Of course, one of the glaring omissions of the New Keynesian models that people learned about after the GFC was that they didn’t even have a financial sector embedded in their basic structure. But that is also another story again.

The upshot of Portes and SWL’s mathematical gymnastics, simple though they are, is that the ‘optimal’ fiscal policy requires “tax smoothing”, so that:

if for a period government spending has to be unusually high (classically a war, but also perhaps because of a recession or natural disaster), it would be wrong to try and match this higher spending with higher tax rates. Instead taxes should only be raised by a small amount, with debt increasing instead, but taxes should stay high after government spending has come back down, to at least pay the interest on the extra debt and perhaps also to bring debt back down again.

So, they are saying:

1. Taxes are necessary to fund government spending but temporary deficits (to cope with wars or deep recessions) should be funded by debt.

2. When economic activity improves, there should be a primary fiscal surplus (”taxes at least pay the interest on the extra debt”) and spending should be cut to allow that outcome.

3. Public debt should be a target policy variable (the lower the better) but in the short-term is a “shock absorber to avoid sharp movements in taxes or government spending”.

4. This is a ‘deficit dove’ construction. We will have austerity but it will be delayed.

The questions one needs to ask is under what conditions would a primary surplus be a responsible state for a government to achieve? Portes and SWL want the primary surpluses to be a target goal for government. But such a target is unlikely to be a desirable state.

Remember, a primary fiscal balance is the difference between government spending and taxation flows less payments on outstanding public debt.

One could imagine a situation where a government would sensibly run a primary surplus or even an overall fiscal surplus (inclusive of interest payments on public debt) if it was accompanied by a robust external surplus, which was pumping net spending in the economy and financing the desire of the private domestic sector to save overall.

Then a fiscal surplus would be required to prevent inflationary pressures from emerging. But it would also be consistent with full employment, the provision of first-class public services, and the fulfillment of the overall saving desires by the private domestic sector. Think Norway.

That is not remotely descriptive of where the UK (or most nearly all nations) are at or have been at in recent decades.

The absurdity of the reasoning that arises from the sort of economic framework that Portes and SWL deploy is illustrated when they start tinkering with the parameters of the ‘model’ to see what transpires.

The exercise is trivial. The model has some equations with parameters that link the variables that describe the equation structures. The parameters are conceptual but to get certain results one has to make assumptions about their values (at the most basic level whether they are positive or negative or above or below unity, etc).

Then one muses about what specific assumptions imply for the results.

One such tinkering by Portes and SWL generates an interpretation that taxes:

gradually fall to zero. How can this happen, given that the government has spending to finance? The answer is that debt gradually declines to zero, and then the government starts to build up assets. Eventually it has enough assets that it can finance all its spending from the interest on those assets, and so taxes can be completely eliminated.

Which then raises the question of how the government gets access to any of the real resources that are available for productive use in the society.

If taxes are zero, why would people offer their labour (and other resources) for the public use? And, how will government make non-inflationary real resource space in order for them to spend (command real resources from the non-government sector)?

But discussing those issues will take us away from the main focus.

In essence, none of their mathematical ‘cases’ (the scenarios they defined with differing parameter values) can be established in reality. This is a common problem of this sort of economic reasoning.

What happens next? They ditch the ‘optimal’ results derived from the calculus and start making stuff up asserting their ‘priors’.

So as not to spoil their story, the authors just assert that “there are two reasons for believing that policy should aim to steadily reduce debt in normal times” even if the ‘optimal’ condition indicates the opposite.

First, they introduce the standard argument that “shocks may be asymmetric” with “large negative shock”(s) not being offset in the other direction.

This is a sort of ‘war chest’ argument. That a government will not be able to respond fully in a major downturn if it starts with high levels of public debt.

Why? It will not be attractive to bond investors, it will run out of money, etc.

Tell that to Japan! Fake knowledge.

Second, they write that:

large negative shocks like a financial crisis might mean that we enter a liquidity trap, so that fiscal expansion is required to assist monetary policy, while large positive shocks could be dealt with by monetary rather than fiscal contraction. There is no equivalent upper bound for interest rates, so prudent policy would reduce debt in normal times to make room for the liquidity trap possibility.

This is the standard mainstream claim that monetary policy is the more effective counter-stabilising (and preferred) policy, except in a deep recession when interest rates are cut to zero and have no further room to fall.

So to counter that ineffectiveness when rates are zero, fiscal policy has to be used. But, in general, monetary policy should be prioritised.

But then the same assertion follows. So that fiscal policy can be on standby for those times when interest rates are zero, the government should have low levels of outstanding debt.

Why? The same argument. It will not be able to fund a new fiscal stimulus if it hasn’t eliminated the impacts from a previous stimulus exercise.

That is a plain lie.

The authors just assert that the capacity of a government to net spend is inversely related to the current stock of outstanding debt.

Why? No reason can be derived from their ‘optimal’ models to justify that assertion.

And, again, tell that to Japan!

The post-GFC period has demonstrated that ’monetary policy’ is not a very effective counter-stabilising tool. Governments that used fiscal policy aggressively in the GFC resumed growth much more quickly than those that didn’t. The stimulatory effects of monetary policy are, at best, ambiguous.

Further, the truth is that the capacity of the government to spend is in no way constrained by its past fiscal stance whether it be surplus, balance or deficit.

A surplus today does not mean that the government is better placed to run a deficit tomorrow. It can always run a deficit if the non-government spending and saving decisions push it that way.

The same goes for outstanding debt, which under current institutional arrangements, will be influenced by the shifts in the flows that make up fiscal policy.

But the level of debt doesn’t constrain or alter the government’s ability to net spend.

The authors might claim that bond markets will rebel and stop funding the deficits. Even if the recipients of this corporate welfare decided to cut off their noses to spite their faces and stopped buying the debt that would not alter the government’s capacity to spend.

First, if it persisted in the unnecessary practice of issuing debt, it could instruct the central bank to set the yield and buy all the debt that the private bond markets didn’t want at that (low to zero) yield. Including all of it!

In other words, the government can always play the private bond markets out of the game if it chooses. Even in the Eurozone, where the Member States are not sovereign, the ECB has demonstrated it can set yields at whatever level it chooses. It can drive yields on long-term public debt into the negative! Who would have thought? No New Keynesian that is for sure. They think deficits ‘crowd out’ private investment spending via higher rates (see below).

Second, the government can also alter a rule or two or change legislation that embodies these voluntary accounting constraints that I noted earlier. That is the right of the legislature and beyond the power of bond markets!

In another one of their musings about parameter values, Portes and SWL tell us that:

there is an additional reason why it might be desirable to eliminate government debt completely, and that is because it crowds out productive capital. In simple overlapping generation models, agents save to fund their retirement, and this determines the size of the capital stock. If agents have an alternative means of saving, which is to invest in government debt, then this debt displaces productive capital.

Really now!

Again, the authors are just rehearsing the standard and deeply flawed mainstream macroeconomic theory, which has the loanable funds model of financial markets embedded.

According to this specious approach, savings are finite and investment competes for the scarce resources. The ‘interest rate’ on loans then brings the two into balance.

The logic then says if there is a shift in the investment demand outwards (capturing in this instance the entry of the government bond to compete with corporate bonds), then the interest rate has to rise to ration off the higher demand for loans, given the finite supply (savings). Wrong at the most elemental level.

First, savings are not finite. They rise with income and if net public spending increases (rising deficit) then national income will rise and so will saving.

Second, and more importantly, real world banks do not remotely operate in a loanable funds way. They will generally extend loans to creditworthy borrowers. This lending is not reserve constrained. Banks do no wait around for depositors to drop their cash off, which they can then on lend.

Loans create deposits (liquidity). Not the other way around, as is assumed by the ‘crowding out’ argument which these authors introduce to their analysis.

So even if the government is selling debt to the non-government sector, the banks still have the capacity (under our current system) to increase private investment.

Further, there is the standard ideological assertion that public spending is ‘less efficient’ (unproductive) compared to “productive capital” (private investment).

The research evidence doesn’t support that assertion. it is just a made up claim to justify privatisation and cuts to government activities.

It has been used to justify the handing out of millions of dollars of public funds to investment bankers, lawyers, accountants etc to sell off public assets at well below market prices to grasping private investors.

We have a long record now of how disastrous most of these selloffs have been from the perspective of the quality, scope and affordability of services that were previously provided by the state.

The next furphy that Portes and SWL introduce is the intergenerational equity argument aka government debt imposes burdens on our grand kids claim.

They claim that lower debt will mean that “Future generations will enjoy a world with lower distortionary taxes, while the current generation will bear the cost of achieving that goal.”

Again, this conclusion follows their assumption that taxes pay back the debt so deficits today force future generations to incur higher costs.

Refer to the previous discussion of the actual role of taxes in a flat monetary system.

The reality is that each generation chooses its own tax and public spending profile via the political process. The way in which intergenerational inequities occur is via real resource utilisation.

We can kill the planet and the kids will then miss out. Alternativelv. we can ensure the kids get access to first-class public infrastructure (education, health, recreation, etc) and have jobs to go to when they develop their skills and knowledge.

Then the kids benefit from today’s fiscal deficits.

But after all of their tinkering with mathematical coefficients (which I have only skimmed here), the authors admit that the “analysis of the optimum long run target for government debt is undeveloped” but:

the case for aiming for a gradual reduction in debt levels seems to be reasonably strong in practice, particularly given the currently high levels of debt in most countries

In other words, the mathematical reasoning leads to nothing definitive so we will just assert things anyway.

It helps economists like this gain promotion as academics and other status that they might enjoy such as picking up ’Inside Job’ type commissions and misrepresenting ideological reports as independent research.

Remember Mishkin in Iceland?

Please read my blog Universities should operate in an ethical and socially responsible manner for more discussion on this point.

I make that comment generally rather than specifically about the authors (Portes and SWL) in question. I don’t know what they do on the side.

So, after all that, what have Portes and SWL to fall back on? Not much. Assertion based on false assumptions.

That doesn’t stop them though.

In Section 3, they still claim ‘authority’ from the discussion on optimal fiscal rules to make the following assertion:

It follows from the previous section that a welfaremaximising government would in general be expected to follow fiscal policies which broadly satisfied the following conditions: a gently declining path of debt over the medium term, but with blips in response to shocks broadly stable tax rates and recurrent government consumption.

Noting it doesn’t follow at all from any results about “welfaremaximising” behaviour that they present. The simple optimising model presented, by the authors’ own admission, is “undeveloped” and incapable of any definitive result.

The results that they claim were derived from the “previous section” are assertions.

But their point is clear. They claim that OECD governments (in general) have not followed these rules and instead the public debt ratios have “steadily increased since the 1970s”, which is evidence of what they call “deficit bias”.

Their claim then is that for various reasons, governments have been acting contrary to “welfare-maximising” behaviour meaning they are acting badly.

Simple isn’t it. Make up a benchmark using flawed assumptions that you know does not apply in the real world. Then label any departures from that fantasy world ‘bad’ and QED, you can then claim in the ‘real world’ that the government is behaving badly.

However, one can contest the benchmark.

If public debt is such an issue, why is the 10-year bond yield for Japanese government bonds at 0.058 per cent (at the time of writing) and why did ‘investors’ pay the Japanese government for the privilege of buying that debt (negative yields) at certain times last year?

Moreover, why are ‘investors’ agreeing to negative yields on all government bond maturities from 1-Year to 8-Years at present.

Further, back in the 1990s, the financial commentators and mainstream macroeconomists were claiming the outstanding Japanese government debt was the mother of all ticking time bombs and they have used this scare tactic long and hard for decades across all nations.

I recall reading some commentator claiming long ago Japan was facing the “mother of all debt-bunnies”, whatever that meant. I guess the ‘bunnies’ hopped away somewhere.

I have gone back through the records I keep and found regular references over the last 27 years to the impending insolvency of Japan because it is violating the economists’ notion of welfare maximising’ debt behaviour.

Across the Pacific, the US was apparently “near to insolvency” on Thursday, September 26, 1940.

Here is an Associated Press story from The Portsmouth Times (Ohio), which was headlines in the New York Times on the same day.

The story quotes one Robert M. Hanes, who at the time was the President of the American Bankers’ Association:

“The evangelists of the new social order are undermining the confidence of the American people in political and economic freedom.

It is a matter of grave concern that we have come to accept deficit financing as a permanent fiscal policy. We not only proceed from year to year on an unbalanced federal budget, but we have permitted the compounding of the federal debt to a huge total which threatens the entire country.

Unless we put an end to deficit financing, to profligate spending, and to indifference to the nature and extent of government borrowing, we shall surely take the road to dictatorship.

By subtle propaganda, special pleading and similar devious device The American people are being persuaded to surrender more and more of their independence to the direction and control of government. This is an evil that feeds on itself.

Deficits and borrowings call for continually larger taxation, which must be met by private enterprise.”

We can find similar remarks throughout history. And, yet, nothing happens. I guess you can cut the Americans some slack such is their penchant for OTT way of doing things.

The point is these economic models that claim public debt should be minimised to prevent costly tax burdens are pie-in-the-neoliberaI-sky sort of stuff.

Further, higher public debt to GDP ratios means that the nongovernment sector has more risk free debt as a proportion of GDP than previously and corresponding income flows.

A Superpower Trade War Looms – Liam Dann. 

“If America, China relations become very difficult, our position becomes tougher because then we will be coerced to choose.”

It’s a nightmare scenario for a small trading nation with historic cultural and political links to the US, but an increasing economic reliance on China. A full blown trade war between China and the US could have devastating political consequences for us all.

In this case, it’s not New Zealand’s Prime Minister doing the worrying, it’s Singaporean leader Lee Hsien Loong.

His simple, blunt assessment of the risk posed by Donald Trump’s anti-China trade rhetoric caused a minor uproar in the diplomatically cautious Asian nation.

Here in New Zealand, where we face the same risks, we’re yet to officially confront the issue. And as issues go, it’s a big one: in the year to June 2016, New Zealand’s total trade (imports and exports) with China was $22.86 billion, compared to $16.25b with the US.

Reserve Bank governor Graeme Wheeler has spoken most openly about his fears for the economic risk to New Zealand if the Trump Administration does some of the things it has threatened to do.

In a speech last month, Wheeler suggested that Trump’s Administration represents the greatest source of uncertainty for our economy – both in terms of his impact on the domestic economy and his potential to increase global trade protectionism. “Rationally speaking, there shouldn’t be a reason we should go into a trade war. But we have to be prepared,” says Auckland University Business School trade economist Dr Asha Sandra. China and the US are like Siamese twins, she says. In other words, their economies are now so intertwined that doing damage to one must hurt the other.

“I think they both know that if they start this, they will both go down. So I don’t think it should be a big risk. But the thing with Donald Trump, is you just don’t know. He has been running the most incoherent Administration we have seen,” Sandaram says. “What he says today is not correlated with what he says tomorrow … and what he’ll actually do. So we have to consider the possibility of an escalating trade war.”

For anyone who relies on global trade, Trump has said some frightening things. On the campaign trail, he talked about hitting Chinese imports with 45 per cent tariffs and accused China of currency manipulation. Since becoming President, he has pulled the US out of the Trans-Pacific Partnership free trade agreement. In a leaked recording, he has talked about imposing 10 per cent tariffs on all imports and is said to be considering border taxes.

His key trade adviser has been China hawk Peter Navarro, author of Death by China: Confronting the Dragon. And he has nominated Robert Lighthizer – who has accused China of unfair trade practices – as his US Trade Representative. Bloomberg has surfaced an article Lighthizer wrote in 2011 praising Ronald Reagan’s aggressive trade stance when Japan’s economic rise threatened the US.

There are concerns that Trump may look to follow those Reagan-era tactics, invoking section 301 of the US Trade Act, which allows a President to bestow “unfavourable trading status” on certain nations. It’s a measure the US hasn’t used since it adopted World Trade Organisation rules in 1995. And, as the many critics have warned, the world has changed. China is not like Japan, politically and militarily dependent on the US.

Last month, Wheeler told the Herald that his trade concerns deepened after visiting Washington DC at the start of the year. “I was in Washington recently talking to a number of senior people – very well connected to the Trump Administration. They were saying that the concerns around China are deeply felt. In other words, the Trump Administration has very strong views about currency manipulation and trade practices out of China. I found that deeply worrying.” Wheeler warns that the Trump risk comes on top of a protectionist trend which is already dampening global trade and threatening growth.

Long-time New Zealand trade advocate Stephen Jacobi agrees. “Undoubtedly it is a concern,” he says of Trump’s protectionist rhetoric. “It was already a concern. Protection was already on the rise and we had seen a slowing in trade growth as well.” The advent of the Trump Administration has thrown the spotlight on this he says. Jacobi, who was head of the NZ US Council as executive director from 2005 to 2014, is now executive director of the NZ China Council, so has a good perspective on New Zealand’s relationship with both economies.

“It is early days for the [Trump] Administration,” he says. “In fact the Administration isn’t even in place yet. We just have to withhold our judgment for a bit, however much it might pain us to do so, to see what actually happens.” From discussions he has had in Wellington, Jacobi believes New Zealand officials are very much taking that wait and see approach. That said, the Government has been working on a new trade policy strategy and is expected to release it this month. It will have to acknowledge the growing risks and look at alternatives to the TPP, Jacobi says. “But I doubt whether they will have given up on the US just yet. “So concern, yes. Panic no,”

Professor Natasha Hamilton-Hart, with the Department of Management and International Business at Auckland University, says one of the direct risks to New Zealand is the prospect that Trump scores an own goal with his economic policies. “I know the markets seem to be pricing in good times on the horizon but I’m pretty sceptical that that is going to last. She doesn’t see a sustainable growth trajectory coming out of either the tax or infrastructure programme.

Things like border taxes and tariffs would be distortionary and depress consumer spending, she says. “We will see an increase in military spending and with the tax cut will start to see an increase in the deficit, which is going to have implications for US interest rates. “There are potentially quite contractionary processes in the medium term. They just don’t seem to have a coherent, workable plan.”

Then there are the diplomatic risks around a President who tweets his midnight thoughts to the world.. Trump’s impact on Asia-Pacific trading relationships is a serious concern. “This might be overly optimistic,” Hamilton-Hart says. “I’m doubtful that it will come to a 45 per cent tariff on Chinese exports because that would be so disrupting and damaging to US firms and US consumers. It’s going to double the price of everything in Walmart.”

“What I think is more likely is that we will see a stronger line of creeping protectionism … so cancelling the TPP, looking at alternatives to dispute settlements outside the WTO, that kind of thing. I imagine we’ll see a lot more of that. And I imagine that is what China is gearing up for. So yeah, a less rule based trading system.”

The irony of Trump’s trade deficit obsession is that running big deficits is what actually gives you power on the global economic stage, Hamilton-Hart says. In other words, a big net importer is the customer and the customer is always right. “So if you stop running those trade deficits, then you no longer have the ability to throw your weight around. If Donald Trump were to significantly withdraw the US from world trade by putting up barriers and shrinking the US economy … that can only go with a reduction in US influence.”

China, for its part, doesn’t appear keen on a trade war and isn’t rushing to fill the trade leadership void left by the US . For example, it appears to be carefully maintaining the strength of the Renminbi to avoid inflaming US currency hawks. “They certainly do not want a trade war,” Jacobi says. “They’ve got enormous economic interests with the United States. And I think you can rely on the Chinese to manage all of that in a very sensible way.”

What worries Jacobi more is the risk of America over-playing its hand on security and sovereignty issues – like Taiwan. “That’s much more worrying because you can’t always guarantee how a nationalistic China might react,” he says. “When you touch on issues of national sovereignty with the Chinese, you don’t get the same sort of reaction that you do on other things.”

Jacobi does have faith that the US system, with its constitutional checks and balances on executive power, will work – in time. “But he [Trump] has a lot of power to do things in the short term. While congress catches up.” Likewise, there will be powerful lobbying forces in the US business community who will push back at things he might want to do. “But they also take time,” Jacobi says. “I’m confident that over time the right decisions should be made. But what damage will be done in the meantime is a bit of an unknown. And the world has lost a whole lot of leadership around open markets and free trade.”

So where does that leave the New Zealand and its Asia-Pacific trading partners?

The remaining TPP signatories head to Chile later this month to discuss what, if anything, is salvageable without America. The Americans have said they will send a representative to that meeting, although it’s not clear who that will be or what level of interest they will take, say Jacobi. “And China will also be around. Because there is a Pacific Alliance meeting [a Latin American trading bloc] and the Chinese have been invited to that.”

There is a need for quiet diplomacy behind the scenes and New Zealand could play a key role in that, says Jacobi. But we need to be careful not to upset the other members of the TPP. Particularly the Japanese who, says Jacobi, “are in a very invidious position”. “They had this ballistic missile sent from North Korea the other day. They have got real security concerns, for which they have to rely on the US. They are not going to be drawn to take issue with the United States unnecessarily.”

China is already a member of an alternative multilateral trade group – the Regional Comprehensive Economic Partnership (RCEP), which also includes New Zealand. If completed, that free trade agreement (FTA) would include the 10 member states of ASEAN (Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand, Vietnam) and the six states with which ASEAN has existing free trade agreements (Australia, China, India, Japan, South Korea and New Zealand).

There have been suggestions that China may look to push this deal as a TPP alternative. But China hasn’t yet shown any signs of taking the lead, says Jacobi. On the one hand, we’ve heard rhetoric from Chinese President Xi Jinping about China’s global leadership, but the reality is that they haven’t taken a major role in multilateral negotiations yet, Jacobi says. “Maybe it’s time. They do have an enormous ability now to fill a vacuum.”

It is a different game now, says Hamilton-Hart, who believes the TPP is effectively dead. “So do we make a much better effort to get on board with RCEP?” she says. “Or are we going to hang in there and hope that we could do a bilateral with the US … which I think would be a bad thing to do as we’d be massively disadvantaged in the negotiations.” 

Jacobi agrees that the bilateral path is problematic. “We can’t afford not to push on any open door,” he says. “But the reality is that is bloody hard going. Look at the experience we had with Korea, very complicated.”

Trump has said he’ll do bilateral deals with TPP partners. But we would want dairy concessions and the US would want a lot of movement on medicines, says Jacobi. And neither would play well politically for either nation. “We’ve got to talk, but will we be high up on the list? And will it be better than TPP? Most unlikely”

“I don’t want to be too pessimistic,” says Auckland University’s Sandaram. “There may be some opportunities as a small country where you could fly under the radar. It’s harder for a big country to be non-aligned.” This could be a unique opportunity, she says. “We could try and stay neutral and expand into both markets.” Sandaram, who has been based in New Zealand for only a year, feels New Zealand is sometimes overly cautious about Chinese sensitivities. “It’s not a traditional link like the UK or Australia, so maybe it is because it is new that we are so cautious.”

Jacobi believes the Chinese have a good understanding of our deep political and economic ties with the Western nations, and particularly the US. “In fact, one of the positive aspects they see in our relationship is that we are an interesting interlocutor because of our attachment to the West,” he says. “But they also know our trade and economic ties are towards China. So whether that will amount to cutting slack … I’m not sure.”

Both Sandaram and Jacobi believe we have more options than we did a generation ago. “We need to diversify,” says Sandaram. “China is decelerating. But we have Asian powers that are fast growing economies. India, Malaysia, Indonesia – with the emerging middle class there is going to be demand for goods that New Zealand exports. “That’s a great opportunity I think we’re uniquely placed.”

New Zealand, both at a government and a business level, has to be proactive about trade, now more so than ever, says Jacobi. “This is not something that New Zealand can just sit back and observe. We don’t have that luxury. This is about our economic livelihood and we have to have a say in it.”

NZ Herald 

“Better decision-making for the planet” by Yasemin Saplakoglu – “Richard Thaler Explains How ‘Choice Architecture’ Makes the World a Better Place by Phil Rockrohr. 

Better decision-making for the planet – Yasemin Saplakoglu 

We might think we have control of the mix of decisions we make during the day. But it turns out that our brain gives us subconscious nudges, preferring some choices over others.

Elke Weber, the Gerhard R. Andlinger Professor in Energy and the Environment, studies how the science of human behavior can inform policies that encourage people to make good choices for the environment.

“For far too long, we’ve assumed that people’s decisions are rational,” said Weber, who is also a professor of psychology and public affairs in the Woodrow Wilson School of Public and International Affairs.

“My research asks, in what ways can we understand what goes on in the brain and use that knowledge to help us all make better decisions?”

Weber researches how to design solutions to society’s greatest problems, such as climate change. “It turns out we can do some psychological jiujitsu to convert seemingly negative choices into something positive,” Weber said.

In the psychology field this is called “choice architecture.”

For example, merely renaming a choice to avoid negative associations can make an impact on people’s decisions. Weber and colleagues found that airline passengers were far more willing to pay a surcharge to combat climate change if the fee was called a “carbon offset” instead of a “carbon tax.”

Another aspect of choice architecture comes into play when talking about present versus future activities. Climate change seems far off to many people. But people tend to make choices based on the present or the immediate future, which psychologists call presence bias. “We focus on the here and now, which makes evolutionary sense,” Weber said. “If you might not survive until tomorrow, what’s the point of planning for next year?”

One way to combat presence bias is by tapping into people’s desires to be remembered in a positive light, Weber and colleagues at Columbia University and the University of Massachusetts-Amherst found. If first prompted with questions about how they would like to be remembered, individuals are more likely to think about their future rather than their present selves, and therefore make pro-environmental choices. The research, funded in part by the National Science Foundation, was published in Psychological Science in 2015.

Then there’s our inability to concentrate on more than one option at a time when we are presented with a choice. Weber and her colleague Eric Johnson, a business and marketing professor at Columbia, coined the “query theory” to explain how people internally generate more arguments favoring the first option they consider, temporarily inhibiting arguments in favor of all other options.

When a “default” option is given, it becomes the option we think of first, which puts it at an advantage. Weber gives the example of a hypothetical electric utility company that offers customers the opportunity to switch to “green” energy.  Typically, fossil fuel energy is the default option, and few customers end up switching to the cleaner though somewhat more expensive green power. In contrast, when in lab and field studies the company made it the default option to choose “green” energy, a large majority of customers did just that. “In terms of what influences people’s decisions, the million-dollar question is which option gets considered first,” Weber said.

Weber’s research demonstrates that changing the way choices are presented can play a role in conserving the environment through influencing people, the instigators of our warming planet.

Princeton University 


Richard Thaler Explains How “Choice Architecture” Makes the World a Better Place – Phil Rockrohr 

Because of limitations in neoclassical economic theory, the world needs to nudge people toward the right choices to make their lives better, said Richard Thaler, Ralph and Dorothy Keller Distinguished Service Professor of Behavioral Science and Economics.

“Although libertarianism and paternalism appear to be two of the most reviled terms in America, both of these terms are actually lovable,” Thaler said. Thaler spoke at the 56th Annual Management Conference, which drew nearly 1,000 alumni and friends of Chicago GSB to his luncheon address at the Chicago Marriott Hotel and a series of panel discussions at Gleacher Center on May 16.

Thaler and fellow author Cass Sunstein, Karl N. Llewellyn Distinguished Service Professor of Jurisprudence at the Law School, coined the phrase “libertarian paternalism” to describe their approach, which they outline in their book Nudge.

“By libertarianism we mean protecting peoples’ right to choose,” Thaler said. “By paternalism, all we mean is caring about peoples’ outcomes. We want to devise policies that will make people better off, not worse off, as judged by them. It’s not that Cass and I think we know what’s best for you or anyone else. It’s that we think we can help people make choices that they themselves think are better.”

That goal can be achieved with “choice architecture,” or the careful design of the environments in which people make choices, he said. “If anything you do influences the way people choose, then you are a choice architect,” Thaler said. “If you remember one thing from this lecture, remember the following: Choice architects must choose something. You have to meddle. For example, you can’t design a neutral building. There is no such thing. A building must have doors, elevators, restrooms. All of these details influence choices people make.

“Three key features of choice architecture are the default, giving feedback, and expecting error, he said. “Default is what happens if you do nothing, such as leaving your computer unused until the screen saver appears,” Thaler said. “The main lesson from psychology on this is that default options are sticky.

Whatever you choose as the default has a very good chance of being selected. If you are the choice architect, you need to spend a lot of time thinking about what those default options should be. “People respond to feedback; for instance, someone designed light bulbs that glow darker shades of red as homes use higher levels of energy. 

Such devices helped reduce energy use in peak periods by 40 percent in Southern California. By expecting error, Thaler points to the design of the Paris subway card, which allows users to insert it into an electronic turnstile in any of four ways to gain entrance to the subway. “Compare that to exiting the parking garages of Chicago,” he said. “You have to put your credit card in and there are four possible ways up, down, left, right and exactly one works. This is the difference between good and bad design.” Google is developing choice architecture to remind Gmail users when they forget an attachment or may be about to send a rude email, Thaler said.

“If you mention the word attachment in the text of your email and you don’t include an attachment, it would prompt you,” he said. “Even better would be an emotion detection system that will send you a warning if you are about to send an angry email.”

More important economic applications of choice architecture include the Save More Tomorrow program, which helps employees set aside future pay hikes for retirement.

“Save More Tomorrow is based on the same principle of expecting error,” he said. “We ask people if they want to commit now to saving more later, because all of us have more self-control in the future. The first company that adopted it tripled savings rates, and the program is now spreading worldwide.

“Thaler and Sunstein’s newest idea, can be applied to many domains, including credit cards, mortgages, Medicare, and cell phone contracts, Thaler said. Called Record, Evaluate, and Compare Alternative Prices, or RECAP, it would require credit card issuers to provide each customer with an annual spread sheet showing the formulas for each way they bill and a second spread sheet of the ways in which the customer incurred charges during the previous year, he said.”What would people do with these spreadsheets?” Thaler said.

“We predict that websites would emerge immediately that would analyze these spreadsheets. In one click you could upload these to, say,, which would explain to you what your credit card company is doing to you and suggest three other providers if you plan to continue to use your credit card in the same ways.”

Chicago Booth



Research from the field of behavioral economics has shown that individuals tend to be subject to predictable biases that may lead to decision errors. The following sections describe these biases and describe the ways that they can be minimized by changing decision context through choice architecture.

Reducing choice overload

Classical economics predicts that providing more options will generally improve consumer utility, or at least leave it unchanged. However, each additional choice demands additional time and consideration to evaluate, potentially outweighing the benefits of greater choice. Behavioral economists have shown that in some instances presenting consumers with many choices can lead to reduced motivation to make a choice and decreased satisfaction with choices once they are made.[7] This phenomenon is often referred to as choice overload,[11] Overchoice or the tyranny of choice.[12] However, the importance of this effect appears to vary significantly across situations.[7] Choice architects can reduce choice overload by either limiting alternatives or providing decision support tools.

Choice architects may choose to limit choice options; however, limits to choice may lead to reductions of consumer welfare. This is because the greater the number of choices, the greater the likelihood that the choice set will include the optimal choice for any given consumer. As a result, the ideal number of alternatives will depend upon the cognitive effort required to evaluate each option and the heterogeneity of needs and preferences across consumers.[7] There are examples of consumers faring worse with many options rather than fewer in social-security investments[4] and Medicare drug plans[13]

As consumption decisions increasingly move online, consumers are relying upon search engines and product recommendation systems to find and evaluate products and services. These types of search and decision aids both reduce the time and effort associated with information search, but also have the power to subtly shape decisions dependent upon what products are presented, the context of the presentation, and the way that they are ranked and ordered. For example, research on consumer goods like wine has shown that the expansion of online retailing has made it simpler for consumers to gather information on products and compare alternatives, making them more responsive to price and quality information.[14]


A large body of research has shown that, all things being equal, consumers are more likely to choose options that are presented as a default.[15] A default is defined as a choice frame in which one selection is pre-selected so that individuals must take active steps to select another option.[16] Defaults can take many forms ranging from the automatic enrollment of college students in university health insurance plans to forms which default to a specific option unless changed.

Several mechanisms have been proposed to explain the influence of defaults. For example, individuals may interpret defaults as policymaker recommendations, cognitive biases related to loss aversion like the status quo bias or endowment effect might be at work, or consumers may fail to opt out of the default due to associated effort.[15] It is important to note that these mechanisms are not mutually exclusive and their relative influence will likely differ across decision contexts.

Types of default include simple defaults where one choice is automatically selected for all consumers, forced choice in which a product or service is denied until the consumer makes a proactive selection, and sensory defaults in which the choice is pre-selected based upon other information that was gathered about specific consumers. Choices that are made repeatedly may also be affected by defaults, for instance persistent defaults may be continually reset regardless of past decisions, whereas reoccurring defaults “remember” past decisions for use as the default, and predictive defaults use algorithms to set defaults based upon other related behavior.[7]

One of the most commonly cited studies on the power of defaults is the example of organ donation. One study found that donor registration rates were twice as high when potential donors had to opt out versus opt into donor registration.[3] However, the influence of defaults has been demonstrated across a range of domains including investment[4][17] and insurance[18]

Choice over time

Choices with outcomes that manifest in the future will be influenced by several biases. For example, individuals tend to be myopic, preferring positive outcomes in the present often at the expense of future outcomes. This may lead to behaviors like overeating or overspending in the short-term at the expense of longer term health and financial security outcomes. In addition, individual projections about the future tend to be inaccurate. When the future is uncertain they may overestimate the likelihood of salient or desirable outcomes,[19][20] and are generally overly optimistic about the future, for example assuming that they will have more time and money in the future than they will in actuality.[21][22]

However research indicates that there are several ways to structure choice architecture to compensate for or reduce these biases. For example, researchers demonstrated improved decision-making by drawing attention to the future outcomes of decisions[23] or by emphasizing second best options.[20] In addition, limited time offers can be successful in reducing procrastination.[7]

Partitioning options and attributes

The ways in which options and attributes are grouped influence the choices that are made. Examples of such partitioning of options include the division of a household budget into categories (e.g. rent, food, utilities, transportation etc.), or categories of investments within a portfolio (e.g. real estate, stocks, bonds, etc.), while examples of partitioning attributes include the manner in which attributes are grouped together for example a label may group several related attributes together (e.g. convenient) or list them individually (e.g. short running time, little cleanup, low maintenance). The number and type of these categories is important because individuals have a tendency to allocate scarce resources equally across them. People tend to divide investments over the options listed in 401K plans[24] they favor equal allocation of resources and costs across individuals (all else being equal),[25] and are biased to assign equal probabilities to all events that could occur.[26][27] As a result, aggregate consumption can be changed by the number and types of categorizations. For instance, car buyers can be nudged toward more responsible purchases by itemizing practical attributes (gas mileage, safety, warranty etc.) and aggregating less practical attributes (i.e. speed, radio, and design are grouped together as “stylishness”).[28]

Avoiding attribute overload

Consumers would optimally consider all of a product’s attributes when deciding between options. However, due to cognitive constraints, consumers may face similar challenges in weighing many attributes to those of evaluating many choices. As a result, choice architects may choose to limit the number of attributes, weighing the cognitive effort required to consider multiple attributes[29] against the value of improved information. This may present challenges if consumers care about different attributes, but online forms that allow consumers to sort by different attributes should minimize the cognitive effort to evaluate many options without losing choice.

Translating attributes

The presentation of information about attributes can also reduce the cognitive effort associated with processing and reduce errors. This can generally be accomplished by increasing evaluability and comparability of attributes.[7] One example is to convert commonly used metrics into those that consumers can be assumed to care about. For example, choice architects might translate non-linear metrics (including monthly credit payments or miles per gallon) into relevant linear metrics (in this case the payback period associated with a credit payment or the gallons per 100 miles).[2] Choice architects can also influence decisions by adding evaluative labels (e.g. good versus bad or high versus low) to numerical metrics,[30] explicitly calculating consequences(for instance translating energy consumption into greenhouse gas emissions), or by changing the scale of a metric (for instance listing monthly cost versus yearly cost).[31]

The Economists Who Stole Christmas – Yanis Varoufakis. 

To welcome the New Year with a cheeky take on the clash of economic ideologies, how might opposing camps’ representatives view Christmas presents? Levity aside, the answer reveals the pompousness and vacuity of each and every economic theory.

Neoclassicists: Given their view of individuals as utility-maximizing algorithms, and their obsession with a paradigm of purely utility-driven transactions, neoclassical economists can see no point in such a fundamentally inefficient form of exchange as Christmas gift-giving. When Jill receives a present from Jack that cost him $X, but which gives her less utility than she would gain from commodity Y, which retails for $Y (that is less than or equal to $X), Jill is forced either to accept this utility loss or to undertake the costly and usually imperfect business of exchanging Jack’s gift for Y. Either way, there is a deadweight loss involved.

In this sense, the only efficient gift is an envelope of cash. But, because Christmas is about exchanging gifts, as opposed to one-sided offerings, what would be the purpose in Jack and Jill exchanging envelopes of cash? If they contain the same amounts, the exercise is pointless. If not, the exchange is embarrassing to the person who has given less and can damage Jack and Jill’s relationship irreparably. The neoclassicist thus endorses the Scrooge hypothesis: the best gift is no gift.

Keynesians: To prevent recessions from turning into depressions, a fall in aggregate demand must be reversed through increased investment, which requires that entrepreneurs believe that increased consumption will mop up the additional output that new investments will bring about. The neoclassical elimination of Christmas gift exchange, or even the containment of Christmas largesse, would be disastrous during recessionary periods.

Indeed, Keynesians might go so far as to argue that it is the government’s job to encourage gift exchanges (as long as the gifts are purchased, rather than handcrafted or home produced), and even to subsidize gift giving by reducing sales taxes during the holiday season. And why stop at just one holiday season? During recessionary times, two or three Christmases might be advisable (preferably spaced out during the year).

But Keynesians also stress the importance of reining in the government deficit, as well as overall consumption, when the economy is booming. To that end, they might recommend a special gift or sales tax during the festive season once growth has recovered, or even canceling Christmas when the pace of GDP growth exceeds that consistent with full employment.

Monetarists: Convinced that the money supply should be the government’s sole economic-policy tool, and that it should be used solely to maintain price stability through equilibration of the money supply vis-á-vis aggregate production, the central bank should gradually increase nominal interest rates once summer ends and reduce them sharply every January. The changes in nominal interest rates they recommend depend on the central bank’s inflation target and the economy’s underlying real interest rate, and must reflect the rates necessary to keep the pace of change in consumption demand and large retailers’ inventories balanced. (Yes, it’s true: Monetarists are the dullest economists to ever have walked the planet!)

Rational Expectations: These Chicago School economists disagree with both Keynesians and monetarists. Unlike the Keynesians, they think a fiscal stimulus of Christmas gift spending in recessionary festive seasons will not encourage gift producers to boost output. Entrepreneurs will not be fooled by government intervention, and will foresee that the current increase in demand for gifts will be offset in the long run by a sharp drop (as government subsidies turn into increased taxation and fewer Christmases are observed during the good times). With output and employment remaining flat, government subsidies and additional Christmases will merely produce more debt and higher prices.

Austrian School libertarians: Supporters of Friedrich von Hayek and Ludwig von Mises have two major objections to Christmas. First, there is the illiberal aspect of the holiday season: the state has no right, and no reason, to force entrepreneurs to close down, against their will (for four days December 25 and 26, and January 1 and 2) over the course of a fortnight. Second, the ever-lengthening pre-Christmas consumption boom tends to expand credit, thus causing bubbles in the toy and electronics market during the fall that will burst in January, with potentially damaging consequences for the rest of the year.

Empiricists: Convinced that observation is our only tool against economic ignorance, empiricists are certain that the only defensible theoretical propositions are those derived from discerning patterns whereby changes in exogenous variables constantly precede changes in endogenous variables, thus establishing empirically (for example, through Granger tests) the direction of causality. This perspective leads empiricists to the safe conclusion that Christmas, and a spurt in gift exchanges, is caused by a prior increase in the money supply and, ceteris paribus, a drop in savings.

Marxists: In societies in which profit is derived exclusively from surplus value “donated” (as part of the capitalist labor process) by workers, and which reflects the capitalists’ extractive power (bequeathed to them by one-sided property rights over the means of production), the Christmas tradition of gift exchange packs dialectical significance.

On one hand, Christmas gift giving is an oasis of non-market exchange that points to the possibility of a non-capitalist system of distribution. On the other hand, it offers capital another opportunity to harness humanity’s finest instincts to profit maximization, through the commodification of all that is pure and good about the festive season. And purists – those who still defend the “law of the falling (long-term) rate of profit” – would say that capital’s capacity to profit from Christmas diminishes from year to year, thus giving rise to social and political forces which, in the long run, will undermine the festive season.

Obviously, none of these theories can possibly account for why people participate, year in and year out, in the ritual of holiday gift giving. For that, we should be grateful.


Yanis Varoufakis, a former finance minister of Greece, is Professor of Economics at the University of Athens.

Project Syndicate 

Capitalism without Capital, the rise of the Intangible Economy – Jonathan Haskel and Stian Westlake. 


Valuation, the Old-Fashioned Way: or, a Thousand Years in Essex. 

Colin Matthews was vexed. To have valuers crawling all over his airport was the last thing he wanted. But after three years, it could no longer be stopped. It was the summer of 2012. For three years he had been fighting the UK competition authorities’ attempts to break up British Airports Authority (BAA), the company he ran and which owned most of Britain’s large airports.

He had exhausted his legal options and was giving up. So now the men and women with suits and spreadsheets and high-viz vests were going round his airports, working out how much they were worth to potential buyers. Accountants and lawyers and surveyors and engineers measured and counted, and bit by bit, they came up with a value for the whole of Stansted, Britain’s fourth-busiest airport, to the northeast of London.

They priced up the tarmac, the terminal, the baggage equipment. There was an agreed value for the parking lots, the bus station, and the airport hotel. There was some argument about the underground fuel pumps, but the calculation was not out of the ordinary for BAA’s accountants: the cost of the asset less its depreciation, with some adjustment for inflation.

Sure enough, when Stansted was sold in 2013 (for £ 1.5 billion), the price was pretty close to what the accountants had valued the business at.

In one sense, the valuation of Stansted looked like a quintessentially twenty-first-century scene. There was the airport itself. What could be a better emblem of globalized high modernity than an airport? There was the troupe of accountants and lawyers, those ubiquitous servants of financial capitalism. And, of course, there was the economic logic of the process: from the privatization that put BAA in the private sector in the first place, to the competition policy that caused the breakup, to the infrastructure funds that circled to buy the assets after breakup; all very modern.

But at the same time, the valuation of Stansted was the kind of thing that had been going on for centuries. The business of working out how much something was worth by counting up and measuring physical stuff has a long and noble tradition.

Nine and a quarter centuries before, Stansted, then just another country village, had played host to a similar scene. Reeves and messengers, the eleventh-century forerunners of the accountants and lawyers that had so vexed Colin Matthews, had converged on the place to assess its value for Domesday Book, the vast survey of England’s wealth carried out by William the Conqueror. Using tally-sticks rather than laptops, they carried out their own valuation. They talked to people and counted things. They recorded that Stansted had a mill, sixteen cows, sixty pigs, and three slaves. Then they measured what they counted and valued the manor of Stansted at £11 per year.

And although the value they put on the medieval village of Stansted was rather less than the £ 1.5 billion BAA got for selling the airport in 2013, the reeves and envoys who did the measuring for William the Conqueror were doing something fundamentally similar to what Colin Matthews’s accountants were doing.

For centuries, when people wanted to measure how much something ought to be worth—an estate, a farm, a business, a country—they counted and measured physical stuff. In particular, they measured things with lasting value. These things became the fixed assets on accountants’ balance sheets and the investments that economists and national statisticians counted up in their attempts to understand economic growth.

Over time, the nature of these assets and investments changed: fields and oxen became less important, animals gave way to machinery and factories and vehicles and computers. But the idea that assets are for the most part things you could touch, and that investment means building or buying physical things was as true for twentieth-century accountants and economists as it was for the scribes of Domesday Book.

Why Investment Matters

The nature of investment is important to all sorts of people, from bankers to managers. Economists are no exception: investment occupies a central place in much economic thought. Investment is what builds up capital, which, together with labor, constitutes the two measured inputs to production that power the economy, the sinews and joints that make the economy work.

Gross domestic product is defined as the sum of the value of consumption, investment, government spending, and net exports;

Of these four, investment is often the driver of booms and recessions, as it tends to rise and fall more dramatically in response to monetary policy and business confidence.

The investment element of GDP is where the animal spirits of the economy bark, and where a recession first bites. As a result, the statisticians whose job it is to work out national income have put long and sustained efforts into measuring how much businesses invest, year after year, quarter after quarter. Since the 1950s, national statistical agencies have sent out regular questionnaires to businesses to find out how much businesses are investing. Periodic studies are done to understand how long particular assets last and, especially for high-tech investments like computers, how much they are improving over time.

Until very recently, the investments that national statistical offices measured were all tangible assets. Although these investments represented the modern age in all its industrial glory (in 2015 in the UK, for example, businesses invested £ 78bn in new buildings; £ 60bn in IT, plant, and machinery; and £ 17bn in vehicles), the basic principle that investment was about physical goods would have made sense to William the Conqueror’s reeves.

The Dark Matter of Investment

But, of course, the economy does not run on tangible investment alone. Stansted Airport, for example, owned not just tarmac and terminals and trucks, but also things that were harder to see or touch: complex software; valuable agreements with airlines and retailers; internal know-how. All these things had taken time and money to build up and had a lasting value to whoever owned the airport, but they consisted not of physical stuff but of ideas, knowledge, and social relations. In the language of economists, they were intangible.

The idea that an economy might come to depend on things that were immaterial was an old one. Futurists like Alvin Toffler and Daniel Bell had begun to talk about the “post-industrial” future as long ago as the 1960s and 1970s. As the power of computers and the Internet became more apparent in the 1990s, the idea that immaterial things were economically important became increasingly widely accepted. Sociologists talked of a “network society” and a “post-Fordist” economy. Business gurus urged managers to think about how to thrive in a knowledge economy. Economists began to think about how research and development and the ideas that resulted from it might be incorporated into their models of economic growth, an economy parsimoniously encapsulated by the title of Diane Coyle’s book The Weightless World.

Authors like Charles Leadbeater suggested we might soon be “living on thin air.”

The bursting of the dot-com bubble in 2000 dampened some of the wilder claims about a new economy, but research continued among economists to understand what exactly was changing.

It was in this context that a group of economists assembled in Washington in 2002 at a meeting of the Conference on Research in Income and Wealth to think about how exactly to measure the types of investment that people were making in what they were calling “the new economy.” At this conference and afterwards, Carol Corrado and Dan Sichel of the US Federal Reserve Board and Charles Hulten of the University of Maryland developed a framework for thinking about different types of investment in the new economy.

To get an idea of what these sorts of investment are, consider the most valuable company in the world at the time of the conference: Microsoft. Microsoft’s market value in 2006 was around $ 250bn. If you looked at Microsoft’s balance sheet, which records its assets, you would find a valuation of around $70bn, $60bn of which was cash and various financial instruments. The traditional assets of plant and equipment were only $3bn, a trifling 4 percent of Microsoft’s assets and 1 percent of its market value.

By the conventional accounting of assets then, Microsoft was a modern-day miracle. This was capitalism without capital.

Not long after the conference, Charles Hulten combed through Microsoft’s accounts to explain why it was worth so much (Hulten 2010). He identified a set of intangible assets, assets that “typically involve the development of specific products or processes, or are investments in organizational capabilities, creating or strengthening product platforms that position a firm to compete in certain markets.”

Examples included the ideas generated by Microsoft’s investments in R&D and product design, the value of its brands, its supply chains and internal structures, and the human capital built up by training. Although none of these intangible assets are physical in the way that Microsoft’s office buildings or servers are, they all share the characteristics of investments: the company had to spend time and money on them up-front, and they delivered value over time that Microsoft was able to benefit from.

But they were typically hidden from company balance sheets and, not surprisingly, from the nation’s balance sheet in the official National Accounts. Corrado, Hulten, and Sichel’s work provided a big push to develop ways to estimate intangible investment across theeconomy, using surveys, existing data series, and triangulation.

A Funny Thing Happened on the Way to the Future

And so the intangibles research program developed. In 2005 Corrado, Hulten, and Sichel published their first estimates of how much American businesses were investing in intangibles. In 2006 Hulten visited the UK and gave a seminar on their work at Her Majesty’s Treasury, which immediately commissioned a team (that included one of this book’s authors) to extend the work to the UK. Work also began in Japan. Agencies like the Organisation for Economic Co-operation and Development (OECD), which were very early on the intangible scene (see, e.g., Young 1998), promoted the idea of intangible investment in policy and political circles, and the idea attracted some attention among commentators and the emerging economic blogosphere.

As figure 1.1 shows, mention of “intangible” became steadily more fashionable even in dry academic journals. Figure 1.1.

“Intangibles” references in scientific journals. Data are the number of mentions of the word “intangible” in the Abstract, Title, or Keyword in academic journals in the field “Economics, Econometrics and Finance” recorded in the database ScienceDirect. Source: authors’calculations from ScienceDirect.

But then something happened that changed the economic agenda: the global financial crisis. Economists and economic policymakers were, quite reasonably, less interested in understanding a purported new economy than in preventing the economy as a whole from collapsing into ruin. Once the most dangerous part of the crisis had been averted, a set of new and rather bleak problems came to dominate economic debate: how to fix a financial system that had so calamitously failed, the growing awareness that inequality of wealth and income had risen sharply, and how to respond to a stubborn stagnation in productivity growth.

To the extent that the idea of the new economy was still discussed, it was mostly framed in pessimistic, even dystopian terms: Had technological progress irreversibly slowed, blasting our economic hopes? Would technology turn bad, producing robots that would steal everyone’s jobs, or give rise to malign and powerful forms of artificial intelligence?

But while these grim challenges were dominating public debate on economics in op-ed columns and blogs, the project to measure new forms of capital was quietly progressing. Surveys and analyses were undertaken to produce data series of intangible investment, first for the United States, then for the UK, and then for other developed countries. Finance ministries and international organizations continued to support the work, and national statistical agencies began to include some types of intangibles, notably R&D, in their investment surveys. Historical data series were built, estimating how intangible investment had changed over time.

And, as we shall see, intangible investment has, in almost all developed countries, been growing more and more important. Indeed, in some countries, it now outweighs tangible investment.

Why Intangible Investment Is Different

Now, there is nothing inherently unusual or interesting from an economic point of view about a change in the types of things businesses invest in. Indeed, nothing could be more normal: the capital stock of the economy is always changing. Railways replaced canals, the automobile replaced the horse and cart, computers replaced typewriters, and, at a more granular level, businesses retool and change their mix of investments all the time.

Our central argument in this book is that there is something fundamentally different about intangible investment, and that understanding the steady move to intangible investment helps us understand some of the key issues facing us today: innovation and growth, inequality, the role of management, and financial and policy reform.

We shall argue there are two big differences with intangible assets.

First, most measurement conventions ignore them. There are some good reasons for this, but as intangibles have become more important, it means we are now trying to measure capitalism without counting all the capital.

Second, the basic economic properties of intangibles make an intangible-rich economy behave differently from a tangible-rich one.

Measurement: Capitalism without Capital

As we will discuss, conventional accounting practice is to not measure intangible investment as creating a long-lived capital asset. And this has something to be said for it. Microsoft’s investment in a desk and an office building can be observed, and the market for secondhand office equipment and renting office space tells you more or less daily the value of that investment. But there is no market where you can see the raw value of its investment in developing better software or redesigning its user interface. So trying to measure the “asset” that’s associated with this investment is a very, very hard task, and accountants, who are cautious people, typically prefer not to do so, except in limited circumstances (typically when the program has been successfully developed and sold, so there is an observable market price).

This conservative approach is all very well in an economy where there is little investment in this type of good. But as such investment starts to exceed tangible investment, it leaves larger and larger areas of the economy uncharted.

Properties of Intangibles: Why the Economy Is Becoming So Different

The shift to intangible investment might be a relatively minor problem if all that was at stake was mismeasurement. It would be as if we were counting most of the new trucks in the economy but missing some of them: an interesting issue for statistics bureaus, but little more.

But there is, we will argue, a more important consequence of the rise of intangibles: intangible assets have, on the whole, quite different economic characteristics from the tangible investment that has traditionally predominated.

First of all, intangible investment tends to represent a sunk cost. If a business buys a tangible asset like a machine tool or an office block, it can typically sell it should it need to. Many tangible investments are like this, even large and unusual ones. If you’ve ever fancied one of those giant Australian mining tractors, you can buy them secondhand at an online auction site called Machinery Zone; World Oils sells gently used drilling rigs; and a business called UVI Sub-Find deals in secondhand submarines.

Intangible assets are harder to sell and more likely to be specific to the company that makes them. Toyota invests millions in its lean production systems, but it would be impossible to separate these investments from their factories and somehow sell them off. And while some research and development gives rise to patents that can in some cases be sold, far more of it is tailored to the specific needs of the business that invests in it, certainly sufficiently so to make intellectual property markets very limited.

The second characteristic of intangible investments is that they generate spillovers. Suppose you run a business that makes flugelbinders, and you own a tangible asset in the form of a factory, and an intangible asset in the form of an excellent new design for a flugelbinder. It’s almost trivially easy to make sure that your firm gets most of the benefits from the factory: you put a lock on the door. If someone asks to use your factory for free, you politely refuse; if they break in, you can call the police and have them arrested; in most developed countries, this would be an open-and-shut case. Indeed, making sure you get the benefit from tangible assets you own, like a factory, is so simple that it seems a silly question to ask.

The designs, however, are a different business altogether. You can keep them secret to prevent their being copied, but competitors may be able to buy some flugelbinders and reverse-engineer them. You might be able to obtain a patent to discourage people from copying you, but your competitors may be able to “invent around” it, changing just enough aspects of the product that your patent offers no protection. Even if your patent is secure, getting redress against patent infringement is far more complicated than getting the police to sling intruders out of your factory—you may be in for months or years of litigation, and you may not win in the end.

After their world-leading first flight, the Wright brothers spent much of their time not developing better aircraft, but fighting rival developers who they felt were infringing on their patents. The tendency for others to benefit from what were meant to be private investments—what economists call spillovers—is a characteristic of many intangible investments.

Intangible assets are also more likely to be scalable. Consider Coke: the Coca Cola Company, based in Atlanta, Georgia, is responsible for only a limited number of the things that happen to produce a liter of Coke. Its most valuable assets are intangible: brands, licensing agreements, and the recipe for how to make the syrup that makes Coke taste like Coke. Most of the rest of the business of making and selling Coke is done by unrelated bottling companies, each of which has signed an agreement to produce Coke in its part of the world. These bottlers typically own their own bottling plants, sales forces, and vehicle fleets.

The Coca Cola Company of Atlanta’s intangible assets can be scaled across the whole world. The formula and the Coke brand work just the same whether a billion Cokes are sold a day or two billion (the actual number is currently about 1.7 billion). The bottlers’ tangible assets scale much less well. If Australians dramatically increase their thirst for Coke, Coca Cola Amatil (the local bottler) will likely need to invest in more trucks to deliver it, bigger production lines, and eventually new plants.

Finally, intangible investments tend to have synergies (or what economists call complementarities) with one another: they are more valuable together, at least in the right combinations. The MP3 protocol, combined with the miniaturized hard disk and Apple’s licensing agreements with record labels and design skills created the iPod, a very valuable innovation.

These synergies are often unpredictable. The microwave oven was the result of a marriage between a defense contractor, which had accidentally discovered that microwaves from radar equipment could heat food, and a white goods manufacturer, which brought appliance design skills.

Tangible assets have synergies too—between the truck and the loading bay, say, or between a server and a router, but typically not on the same radical and unpredictable scale.


These unusual economic characteristics mean that the rise of intangibles is more than a trivial change in the nature of investment.

Because intangible investments, on average, behave differently from tangible investments, we might reasonably expect an economy dominated by intangibles to behave differently too. In fact, once we take into account the changing nature of capital in the modern economy, a lot of puzzling things start to make sense.

In the rest of this book, we’ll look at how the shift to intangible investment helps us understand four issues of great concern to anyone who cares about the economy: secular stagnation, the long-run rise in inequality, the role of the financial system in supporting the nonfinancial economy, and the question of what sort of infrastructure the economy needs to thrive.

Armed with this understanding we then see what these economic changes mean for government policymakers, businesses, and investors. Our journey will take us past the appraisers of old into the unmapped territory that is modern intangible investment.



The Rise of the Intangible Economy

Capital’s Vanishing Act

Investment is one of the most important activities in the economy. But over the past thirty years, the nature of investment has changed. This chapter describes the nature of that change and considers its causes. In chapter 3, we look at how this change in investment can be measured. In chapter 4, we explore the unusual economic properties of these new types of investment, and why they might be important.

Investment is central to the functioning of any economy. The process of committing time, resources, and money so that we can produce useful things in the future is, from an economic point of view, a defining part of what businesses, governments, and individuals do.

The starting point of this book is an observation: Over the last few decades, the nature of investment has been gradually but significantly changing.

The change isn’t primarily about information technology. The new investment does not take the form of robots, computers, or silicon chips, although, as we will see, they all play supporting roles in the story.

The type of investment that has risen inexorably is intangible: investment in ideas, in knowledge, in aesthetic content, in software, in brands, in networks and relationships. This chapter describes this change and why it has happened.

A Trip to the Gym

Our story begins in the gym, or rather in two gyms. We’re going to step inside a commercial gym in 2017 and in 1977 and look at some of the differences. As we will see, gyms provide a vivid but typical example of how even industries that are not obviously high-tech have subtly changed the types of investment they make.

Gyms are an interesting place to begin our search for the intangible economy because at first glance there’s nothing much intangible about them. Even if you avoid gyms like the plague, you probably have an idea of the sort of things you would find there.

Our gym in 2017 is full of equipment that the business needs to run: a reception desk with a computer and maybe a turnstile, exercise machines, some weights, shower fittings, lockers, mats, and mirrors (“the most heavily used equipment in the gym,” as one gym owner joked).

All this kit is reflected in the finances of businesses that own and run gyms: their accounts typically contain lots of assets that you can touch and see, from the premises they operate in to the treadmills and barbells their customers use.

Now, consider a gym from forty years ago. By 1977 the United States was full of gyms. Arnold Schwarzenegger’s breakout movie Pumping Iron had just been released, featuring scenes of him training in Gold’s Gym in Venice Beach, Los Angeles, which had been established in 1965 and was widely franchised across America. Other gyms contained machines like the Nautilus, the original fixed-weight machine, invented by Arthur Jones in the late 1960s.

If you were to look around a gym of the time, you might be surprised to see many similarities to today’s gym. Granted, there might be fewer weight machines and they would be less advanced. Membership would be recorded on index cards rather than on a computer; perhaps the physical fittings would be more rough-and-ready, but otherwise many of the business’s visible assets would look the same: some workout rooms, some changing rooms, some equipment.

But if we return to our 2017 gym and look more closely, we’ll notice a few differences. It turns out that the modern gym has invested in a range of things that its 1977 counterpart hasn’t. There is the software behind the computer on the front desk, recording memberships, booking classes, and scheduling the staff roster, linked to a central database.

The gym has a brand, which has been built up through advertising campaigns whose sophistication and expense dwarf those of gyms in the 1970s.

There’s an operations handbook, telling the staff how to do various tasks from inducting new members to dealing with delinquent customers. Staff members are trained to follow the handbook and are doing things with a routinized efficiency that would seem strange in the easygoing world of Pumping Iron.

All these things—software, brands, processes, and training—are all a bit like the weight machines or the turnstile or the building the gym sits in, in that they cost money in the short run, but over time help the gym function and make money. But unlike the physical features, most of these things can’t be touched—certainly no risk of dropping them on your foot.

Gym businesses are still quite heavy users of assets that are physical (all of the UK’s four biggest gyms are owned by private equity firms, which tend to like asset-intensive businesses), but compared to their counterparts of four decades ago, they have far more assets that you cannot touch.

And the transformation goes deeper than this. In one of its rooms, the gym puts on regular exercise classes for its members; one of the most popular is called Bodypump, or, as the sign on the door significantly puts it “Bodypump®.” It turns out the company that runs the gym is not the only business operating in the premises—and this second business is even more interesting from an economic point of view.

Bodypump is a type of exercise called “high-intensity interval training”(HIIT), where participants move about vigorously and lift small weights in time to music, but this description does not do justice to the intensity of the workouts or the adrenaline-induced devotion that well-run HIIT classes engender in their customers.

The reason for the registered trademark sign is that Bodypump is designed and owned by the other company at work in the building, a business from New Zealand called Les Mills International. Les Mills was an Olympic weightlifter who set up a small gym in Auckland three years after Joe Gold opened his first gym in Los Angeles. His son Philip, after a visit to LA, saw the potential for merging music with group exercise: he brought it back to New Zealand and added weights to the routines to produce Bodypump in 1997.

He realized that by writing up the routines and synchronizing them with compilations of up-to-date, high-energy music, he had a product that could be sold to other gyms.

By 2005 Les Mills classes like Bodypump and Bodycombat were being offered in some 10,000 venues in 55 countries with an estimated 4 million participants a week (Parviainen 2011); the company’s website now estimates 6 million participants per week.

Les Mills’s designers create new choreography for their programs every three months. They film them and dispatch the film with guidance on the choreography notes and the music files to their licensed instructors. At the time of writing, they have 130,000 such instructors. To become an instructor, you have to complete three days of training, currently costing around £ 300, after which you can start teaching, but to proceed further you have to submit a video of a complete class to Les Mills, which checks your technique, choreography, and coaching.

The things that a business like Les Mills uses to make money look very different from the barbells and mats of a 1977 Gold’s Gym. True, some of their assets are physical—recording equipment, computers, offices—but most of them are not. They have a set of very valuable brands (gym customers have been known to mutiny if their gym stops offering Bodypump), intellectual property (IP) protected by copyrights and trademarks, expertise on designing exercise classes, and proprietary relationships with a set of suppliers and partners (such as music distributors and trainers).

The idea of making money from ideas about how to work out is not new—Charles Atlas was selling bodybuilding courses a decade before Les Mills was born—but the scale on which Les Mills International operates, and the way it combines brands, music, course design, and training is remarkable.

Our excursion into the world of gyms suggests that even a very physical business—literally, the business of physiques—has in the last few decades become a lot more dependent on things that are immaterial.

This is not a story of Internet-driven disruption of the kind we are familiar with from a hundred news stories: gyms were not replaced with an app the way record shops were replaced by Napster, iTunes, and Spotify. Software does not replace the need to lift weights. But the business has nevertheless changed in two different ways. The part that looks superficially similar to how it did in the 1970s—the gym itself—has become shot through with systems, processes, relationships, and software. This is not so much innovation, but innervation—the process of a body part being supplied with nerves, making it sensate, orderly, and controllable.

And new businesses have been set up that rely almost entirely for their success on things you cannot touch. In the rest of this chapter, we will look at how the changes in investment and in assets that took place in the gym industry can be seen throughout the economy, and the reasons for these changes. But first, let us look more rigorously at what investment actually is.

What Are Investment, Assets, and Capital?

When we looked at the things that gyms bought or developed to run and make money, we were talking about assets and investments. Investment is very important to economists because it builds up what they call the “capital stock” of the economy: the tools and equipment that workers use to produce the goods and services that together make up economic output. But “investment,” “assets,” and “capital” can be confusing terms.

Take “investment.” Financial journalists typically refer to people who buy and sell securities as “investors,” and nervously diagnose the “mood of investors.” The same journalist might call a long-term financier like Warren Buffett an “investor” and his short-term rivals “speculators.” Someone considering going to college might be advised that “education is the best investment you can make.” The terms “assets” and “capital” are also used in a confusing variety of ways.

In his justly famous Capital in the Twenty-First Century, Thomas Piketty (2014) defined capital as “all forms of wealth that individuals  .  .  . can own.”

Marxist writers commonly ascribe to “capital” not just an accounting definition, but an entire exploitative system. “Assets” also have different definitions. Many firms think of their business assets as their stock of plant and equipment. For an accountant, business assets commonly include the cash in the firm’s bank account and bills its customers have yet to pay, which don’t seem to be machines used in the business production but rather the results of doing that business.

Because of these multiple meanings, and because we’ll be coming back to these terms frequently, it will be helpful to establish working definitions for investment, capital, and assets. We will stick to the internationally agreed definition of investment used by statistics agencies the world over when they measure the performance of national economies. This has the benefit of being standardized and the fruit of much thought, and of being directly linked to figures like GDP that we are used to seeing in news bulletins.

According to the UN’s System of National Accounts, the bible of national accounting, “investment is what happens when a producer either acquires a fixed asset or spends resources (money, effort, raw materials) to improve it.”

This is a quite dense statement, so let’s unpack what it means.

First of all, let’s look at the definition of assets.

An asset is an economic resource that is expected to provide a benefit over a period of time. If a bank buys a new server or a new office building, it expects to get a benefit that lasts for some time—certainly longer than just a year. If it pays its electricity bill quarterly, the benefit lasts for three months. So the server and the building are assets, but neither the electricity nor the fact of having paid the bill is.

Second, consider the word fixed. A fixed asset is an asset that results from using up resources in the process of its production. A plane or a car or a drug patent all have to be produced—someone has to do work to create something from nothing. This can be distinguished from a financial asset, like an equity stake in a public company. An equity stake is not produced (except in the trivial sense that a share certificate might be printed to represent the claim).

This means that when economists talk about investment they are not talking about investing in the personal finance sense, that is, buying stocks and shares. And because they are talking about fixed assets they are not talking about the accountancy concept of cash in a company bank account.

Third, there is the idea of spending resources. To be deemed an investment, the business doing the investing has to either acquire the asset from somewhere else or incur some cost to produce it themselves.

Finally, there is the word producers. National accounts measure production by firms or government or the third sector. Production by households (say, doing the laundry or cooking at home) is not included, and so neither is investment by a household, say, in a washing machine or stove. This is a definitional feature of the way national accounts are calculated, and it is one of the reasons people criticize GDP (not least because it is large, and because it excludes from the record a part of the economy that has historically been run primarily by women).

Perhaps one day “production” will have a broader definition in national accounts; for our purposes, most of the changes we describe in this book would, we believe, apply to the household sector as well as to so-called producers. So, in this book when we talk about “investment” we are not talking about the buying or selling of pieces of paper on a stock market or households paying university tuition. Rather, we are talking about spending by business, government, or the third sector that creates a fixed (i.e., nonfinancial) asset, that is, resources spent that create a long-lived stream of productive services. We shall call such a fixed asset providing these long-lived productive services “capital.”

Because both capital and labor produce such productive services, economists refer to them as “factors of production.”

Not All Investments Are Things You Can Touch

One of the examples of an investment in the section above was a drug patent, say, one owned by a pharmaceutical company. The pharmaceutical company is obviously a producer, not a household; the company has to expend resources to produce the patent or acquire it; the patent arises from a process of production—in this case, the work of scientists in a lab—and if the patent is any good, it will have a long-term value, since the company can develop it for future use and perhaps sell medicines based on it.

The patent is an example of an intangible asset, created by a process of intangible investment. So too were the various assets in the gym story, from the gym’s membership software to Les Mills International’s Bodypump brand. They arose from a process of production, were acquired or improved by producers, and provide a benefit over time.

These kinds of investments can be found throughout the economy. Suppose a solar panel manufacturer researches and discovers a cheaper process for making photovoltaic cells: it is incurring expense in the present to generate knowledge it expects to benefit from in the future. Or consider a streaming music start-up that spends months designing and negotiating deals with record labels to allow it to use songs the record labels own—again, short-term expenditure to create longer-term gain. Or imagine a training company pays for the long-term rights to run a popular psychometric test: it too is investing.

Some of these investments are new technological ideas. Some are other sorts of ideas that have less to do with high technology: new product designs or new business models. Some take the form of lasting or proprietary relationships, such as a taxi app’s network of drivers. Some are codified information, like a customer loyalty card database. What they have in common is that they are not physical. Hence we call them intangible investment.



Capitalism without Capital, the rise of the Intangible Economy


Jonathan Haskel and Stian Westlake.

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Cognitive Economics: How Self-Organization and Collective Intelligence Works – Geoff Mulgan. 

First an Introduction – Sarah Sloan. 

What Is Cognitive Economics? Understanding the World Through New Types of Data. 

Economics isn’t just a number’s game. Human irrationality is so intrinsically tied up in the human need to rationalize that financial decisions are often made when our conscious brains are held for ransom by our emotions. Because of this, the study of money has specific branches devoted to the study of Homo sapiens interacting with money. The dismal science has genetic, experimental, and neurological branches. 

Then there is Cognitive Economics, the economics of what is going on in people’s minds.

Cognitive economics is characterized by its unique use of data. Rather than skimming from markets or hooking up sensors to subjects, cognitive economists rely on surveys, interviews, and attitudes. Still, the internal dynamics of cognitive economics still hinges more on the numbers-side of economics, rather than psychology. This area of study can help researchers understand what people are looking for, whether it’s a successful retirement or just general happiness and how policy can shape or reshape that search.

Inverse spoke with Miles Kimball, professor of economics and survey research at the University of Michigan, about his chosen field. A research affiliate at the Populations Studies Center and research associate at the National Bureau of Economic Research, Kimball sometimes moonlights as a columnist for Quartz. He spends a lot of time thinking about the role of cognition in our internal and financial systems.

This interview has been edited and condensed, but not too much because Kimball is super interesting.

Why is this field of study called cognitive economics and how is it an analogy to cognitive psychology?

The definition that I came up with is that cognitive economics is what is in people’s minds. This is basically a branch of behavioral economics. 

Behavioral economics is a very broad area of studying all the things that shouldn’t happen according to traditional economic theory. 

Economists are trained to identify when someone is doing something strange — their behavior seems confused, they don’t quite understand the situation. The goal of the economist is to talk about people’s motivations, what they’re trying to accomplish; their preferences.

Historically, the first thing that a behavioral economist did was try to document the things people do when their actions look strange from the standpoint of standard economic theory. My way, as a cognitive economist, is to look at the reasons why they have these preferences. The first category of explanation is that standard economics is fine, but there may be something deeper going on that you just didn’t see, even though what you’re doing makes perfect sense according to standard economic theory. Like any scientific discipline, one of the jobs of economics is to understand how the world works. Trying to understand why people do what they do, how society fits together, and how that fits into a policy point of view — economics has taken on the job of helping people get more of what they want. And we can use data to actually get a good idea of what that is. For example, a goal would be to use this data to influence public policy so that people understand when to claim their social security benefits.

So, is the job of cognitive economics, in part, to figure out what people want and then try to help them achieve that?

That’s certainly an element. If people don’t know something — what economists call imperfect information — we now have models that are very good with dealing with that imperfect information processing. There are certainly many choices in life that are really tough, especially in the financial market, that you may not figure out correctly. Deception doesn’t necessarily rely on lying — you can reveal everything in the fine print and still deceive people. How many of us have clicked yes on user agreements without understanding the real cost of what’s happening? Certain institutions of the government, like the Consumer Financial Protection Bureau, incorporates cognitive economics to deliver good results to people who may not have a handle on the complications of financial products.

It’s interesting because the image that people have of companies is that they have tricky products, and from there are able to make big profits off of people. It’s actually trickier than that. It is possible to make profits by tricking people, which will cause more firms to make profits in the industry. At the end of the day what happens is that people who are smarter than average get these products cheaper, and the people who are easily tricked are paying through the nose. You see this with credit card grace periods. People who are really smart about how they use their credit card actually get the zero interest loans. But this is at the expense of the people who go in thinking they’re going to be sensible using their credit card, but then don’t realize how many things are going to come up, that are going to make that hard to do. That’s a simple example, but there are plenty more you can go through! Companies may come off like they’re just trying to make a profit by tricking people, but interestingly enough it ends up being less smart people subsidizing smart people.

In what ways is cognitive economics different than other fields of economic research?

Different branches of economics have different characteristic data types. There is a field called neuroeconomics where you do brain scans on people. You have them make economic decisions, and you utilize scull caps that will record brain activity with EEGs. Somewhat more modestly, cognitive economics is a survey. It can be combined with lab data and neuroeconomics, but its bread and butter is survey data. You ask people what they’re thinking, what they’re feeling, and you have access to their minds by asking.

So surveys are the key?

Well, cognitive economics is all about humans! It’s a branch of behavioral economics, and economics itself is really on the border with psychology. In fact, some people wanted to call this “psychology and economics” but I think cognitive economics is more descriptive. I don’t want to downplay the influence of psychology in economics, I’m just saying that if somehow economists have never read psychology literature, behavioral economics would have still emerged

How do you conduct your research?

By designing surveys and analyzing the answers with a team. Dan Benjamin and I started this initiative and we just finished designing a survey about how people rate presidential candidates and use a scale in a sophisticated way. The idea is to compare whether you would rather have, say, Bernie Sanders become president for sure or wake up on election day with an election between Hillary Clinton and Donald Trump, in which either has a real chance to win.

We work very hard to make the question understandable — it’s a balancing act. On the one hand we have an economic concept we want to get. This is called an expected utility rating. We’re trying to get a rating of exactly, in between your best and worst candidate, where the other candidates are. This is economic theory in a powerful way and we can’t compromise on that. You could maybe think of a question that is worded in an easier way, but then we wouldn’t have an economic concept at the end. Trying to get survey questions that have a certain precision to them is quite a trick.

If you’re only surveying people about what they did or if you’re using data from firms about what they bought, that’s considered standard economics, not cognitive economics. But if you’re asking them about what they’re thinking about, what they want, then it gets to be cognitive economics. We sometimes end up working on one question for a week.

On your blog you have one section titled “So You Want to Save the World.” What role do you think cognitive economics has in making society a more fruitful place for everyone?

The initiative that I mentioned earlier is the Wellbeing Measurement Initiative. We view the economics of happiness as a part of cognitive economics. When asking about what is in people’s minds, it’s not just the math they’re doing, but their feelings while they do this. There has been quite a big push by many governments to essentially have a national well-being measurement. There’s wide recognition that gross domestic product is inadequate in representing the things that people care about. We have to incorporate things like people’s relationship with their family, their romantic relationships, the want to have meaning in life — we could go on and on. For these projects, we sit down and try to design survey questions for everything we can think of that is somewhat at the abstract level. Right now we have a list of 120 — there are a lot of things that people want!

In regard to what governments have done so far, the United Kingdom, for example, has questions that look at how happy you are, how satisfied you are with your life, how anxious you have been, do you feel your life is worthwhile, etcetera. They’ve collected a lot of data on that, but we don’t think those few questions are enough to cover the waterfront. We’re hoping that 120 will do an okay job at measuring how well somebody is.

People look at how money is spent, because money creates data. But this is only one element — that score card needs to include factors like if the person feels they’re doing better than last year; how they feel affected by different government policies. You also need to do randomized trials and try different options to see what makes people feel better off.

You’ve got to face the facts that most government policies, if you have an A/B001FSJCOQ test, doing it one way is going to make it better for some people, and worse for other people — especially when you think about something like taxes. There are only a few ways of making everybody better off, and even then you’ll probably have a few individuals who end up worse off. However, things do get better in society when individuals have statistical agency — you start identifying the subtle ways that can make everybody better off.


Cognitive Economics: How Self-Organization and Collective Intelligence Works – Geoff Mulgan. 

The study of self-organizing groups points toward what could be called a cognitive economics. 

The organization of thought as a series of nested loops, each encompassing the others, is a general phenomenon. It can be found in the ways in which intelligence is organized in our bodies and within the groups we’re part of. The efficient deployment of energy to intelligence depends on a similar logical hierarchy that takes us from the automatic and mindless (which require little energy) to the intensely mindful (which require a lot). With each step up from raw data, through information to knowledge, judgment, and wisdom, quantity is more integrated with qualitative judgment, intelligence becomes less routine and harder to automate, and crucially, the nature of thought becomes less universal and more context bound. With each step up the ladder, more energy and labor are required.

What Is the Organization in Self-Organization?

Seeing large-scale thought through this lens provides useful insights into the idea of self-organization. The popularity of this idea reflects the twentieth- century experience of the limits of centralized, hierarchical organizations— even if the world is still dominated by them, from Walmart and Google to the People’s Liberation Army and Indian Railways. We know that a central intelligence simply can’t know enough, or respond enough, to plan and manage large, complex systems.

Widely distributed networks offer an alternative. As with the Internet, each link or node can act autonomously, and each part of the network can be a fractal, self-similar on multiple scales.

There are obvious parallels in human systems. The term stigmergy has been coined to describe the ways in which communities—such as Wikipedia editors or open-software programmers—pass tasks around in the form of challenges until they find a volunteer, a clear example of a community organizing itself without the need for hierarchy.

Friedrich Hayek gave eloquent descriptions of the virtues of self- organization, and counterposed the distributed wisdom of the network to the centralized and hierarchical wisdom of science or the state: “It is almost heresy to suggest that scientific knowledge is not the sum of all knowledge. But there is a body of very important but unorganized knowledge: the knowledge of the particular circumstances of time and place. Practically everyone has some advantage over all others because he possesses unique information of which beneficial use might be made, but of which use can be made only if the decisions depending on it are left to him or are made with his . . . cooperation.” 

More recently, Frederick Laloux wrote the following lines, capturing a widely held conventional wisdom: “Life in all its evolutionary wisdom, manages ecosystems of unfathomable beauty, ever evolving towards wholeness, complexity and consciousness. Change in nature happens everywhere, all the time, in a self-organizing urge that comes from every cell and every organism, with no need for central command and control to give orders or pull levers.” Here we find the twenty-first- century version of the late nineteenth-century notion of the élan vital, a mystical property to be found in all things.

It’s an appealing view. But self-organization is not an altogether-coherent concept and has often turned out to be misleading as a guide to collective intelligence. It obscures the work involved in organization and in particular the hard work involved in high-dimensional choices. If you look in detail at any real example—from the family camping trip to the operation of the Internet, open-source software to everyday markets, these are only self-organizing if you look from far away. Look more closely and different patterns emerge. You quickly find some key shapers—like the designers of underlying protocols, or the people setting the rules for trading. There are certainly some patterns of emergence. Many ideas may be tried and tested before only a few successful ones survive and spread. To put it in the terms of network science, the most useful links survive and are reinforced; the less useful ones wither. The community decides collectively which ones are useful. Yet on closer inspection, there turn out to be concentrations of power and influence even in the most decentralized communities, and when there’s a crisis, networks tend to create temporary hierarchies—or at least the successful ones do—to speed up decision making. As I will show, almost all lasting examples of social coordination combine some elements of hierarchy, solidarity, and individualism.

From a sufficient distance, almost anything can appear self-organizing, as variations blur into bigger patterns. But from close-up, what is apparent is the degree of labor, choice, and chance that determines the difference between success and failure. The self-organization in any network turns out to be more precisely a distribution of degrees of organization.

Cognitive Economics

The more detailed study of apparently self-organizing groups points toward what could be called a cognitive economics: the view of thought as involving inputs and outputs, costs and trade-offs. This perspective is now familiar in the evolutionary analysis of the human brain that has studied how the advantages of an energy-hungry brain, which uses a quarter of all energy compared to a tenth in most other species, outweighed the costs (including the costs of a prolonged childhood, as children are born long before they’re ready to survive on their own, partly an effect of their large head size).

Within a group or organization, similar economic considerations play their part. Too much thought, or too much of the wrong kind of thought, can be costly. A tribe that sits around dreaming up ever more elaborate myths may be easy pickings for a neighboring one more focused on making spears. A city made up only of monks and theologians will be too. A company transfixed by endless strategy reviews will be beaten in the marketplace by another business focused on making a better product.

Every thought means another thought is unthought. So we need to understand intelligence as bounded by constraints. Cognition, memory, and imagination depend on scarce resources. They can be grown through use and exercise, and amplified by technologies. But they are never limitless.

This is apparent in chaotic or impoverished lives, where people simply have little spare mental energy beyond what’s needed for survival. As a result, they often make worse choices (with IQ falling by well over ten points during periods of intense stress—one of the less obvious costs of poverty). But all of us in daily life also have to decide how much effort to devote to different tasks—more for shopping or your job; more time finding the ideal spouse, career or holiday, frequently with options disappearing the longer you take.

So we benefit from some types of decision becoming automatic and energy free, and using what Kahneman called System 1 and 2. Walking, eating, and driving are examples that over time become automatic. With the passage of time, we pass many more skills from the difficult to the easy by internalizing them. We think without thinking—how and when to breathe, instinctive responses to danger, or actions learned in childhood like how to swim. We become more automatically good at playing a tune on the piano, kicking a football, or riding a bicycle. Learning is hard work, but once we’ve learned the skill, we can do these things without much thought. There are parallels for organizations that struggle to develop new norms and heuristics that then become almost automatic—or literally so when supported by algorithms. This is why so much effort is put into induction, training, and inculcating a standardized method.

Life feels manageable when there is a rough balance between cognitive capacity and cognitive tasks. We can cope if both grow in tandem. But if the tasks outgrow the capacity, we feel incapable. Similarly, we’re in balance if the resources we devote to thinking are proportionate to the environment we’re in. The brain takes energy that would otherwise be used for physical tasks like moving around. In some cases, evolution must have gone too far and produced highly intelligent people who were too weak to cope with the threats they faced. What counts as proportionate depends on the nature of the tasks and especially how much time is a constraint. Some kinds of thought require a lot of time, while others can be instantaneous. Flying aircraft, fighting battles and responding to attack, and flash trading with automated algorithmic responses are all examples of quick thought. They work because they have relatively few variables or dimensions, and some simple principles can govern responses.

Compare personal therapy to work out how to change your life, a multistakeholder strategy around a new mine being built in an area lived in by aboriginal nomads, or the creation of a new genre of music. All these require by their nature a lot of time; they are complex and multilayered. They call out for many options to be explored, before people can feel as well as logically determine which one should be chosen.

These are much more costly exercises in intelligence. But they happen because of their value and because the costs of not doing them are higher.

Here we see a more common pattern. The more dimensional any choice is, the more work is needed to think it through. If it is cognitively multidimensional, we may need many people and more disciplines to help us toward a viable solution. If it is socially dimensional, then there is no avoiding a good deal of talk, debate, and argument on the way to a solution that will be supported. And if the choice involves long feedback loops, where results come long after actions have been taken, there is the hard labor of observing what actually happens and distilling conclusions. The more dimensional the choice in these senses, the greater the investment of time and cognitive energy needed to make successful decisions.

Again, it is possible to overshoot: to analyze a problem too much or from too many angles, bring too many people into the conversation, or wait too long for perfect data and feedback rather than relying on rough-and-ready quicker proxies. All organizations struggle to find a good enough balance between their allocation of cognitive resources and the pressures of the environment they’re in. But the long-term trend of more complex societies is to require ever more mediation and intellectual labor of this kind.

This variety in types of intelligence, the costs they incur, and the value they generate (or preserve) gives some pointers to what a more developed cognitive economics might look like. It would have to go far beyond the simple frames of transaction costs, or traditional comparisons of hierarchies, markets, and networks. It would analyze the resources devoted to different components of intelligence and different ways of managing them—showing some of the trade-offs (for example, between algorithmic and human decision making) and how these might vary according to the environment. More complex and fast-changing environments would tend to require more investment in cognition. It would also analyze how organizations change shape in moments of crisis—for instance, moving to more explicit hierarchy, with less time to consult or discuss, or investing more in creativity in response to a fast-changing environment.

Economics has made significant progress in understanding the costs of finding information, such as in Herbert Simon’s theories of “satisficing,” which describe how we seek enough information to make a good enough decision. But it has surprisingly thin theories for understanding the costs of thought. Decision making is treated largely as an informational activity, not a cognitive one (though greater attention to concepts such as “organization capital” is a move in the right direction).

A more developed cognitive economics would also have to map the ways in which intelligence is embodied in things—the design of objects, cars, and planes—and in systems—water, telecommunications, and transport systems—in ways that save us the trouble of having to think.

It would need to address some of the surprising patterns of collective intelligence in the present, too, many of which run directly counter to conventional wisdom. For example, organizations and individuals appear to be investing a higher, not lower, proportion of their wealth and income in the management of intelligence in all its forms, particularly those operating in competitive environments. Digital technologies disguise this effect because they have dramatically lowered the costs of processing and memory. But this rising proportion of spending appears close to an iron law, and may be a hallmark of more advanced societies and economies. Much of the spending helps to orchestrate the three dimensions of collective intelligence: the social (handling multiple relationships), cognitive (handling multiple types of information and knowledge), and temporal (tracking the links between actions and results).

A related tendency is toward a more complex division of labor to organize advanced forms of collective intelligence. More specialized roles are emerging around memory, observation, analysis, creativity, or judgment, some with new names like SEO management or data mining. Again, this effect has been disguised by trends that appear to make it easier for anyone to be a pioneer and for teenagers to succeed at creating hugely wealthy new companies. Linked to this is a continuing growth in the numbers of intermediaries helping to find meaning in data or link useful knowledge to potential users. This trend has been disguised by the much-vaunted trends toward disintermediation that have cut out a traditional group of middlepersons, from travel agencies to bookshops. But another near iron law of recent decades—the rising share in employment of intermediary roles, and the related rise of megacompanies based on intermediary platforms such as Amazon or Airbnb—shows no signs of stopping. In each case, there appear to be higher returns to investment in tools for intelligence.

A cognitive economics might also illuminate some of the debates under way in education, as education systems grapple with how to prepare young people for a world and labor market full of smart machines able to perform many more mundane jobs. Schools have not yet adopted Jerome Bruner’s argument that the primary role of education is to “prepare students for the unforeseeable future.” Most prefer the transmission of knowledge—and in some cases rightly so, because many jobs do require deep pools of knowledge. But some education systems are concentrating more on generic abilities to learn, collaborate, and create alongside the transmission of knowledge, in part because the costs of acquiring these traits later on are much higher than the costs of accessing knowledge. Th traits generally associated with innovation—high cognitive ability, high levels of task commitment, and high creativity—which were once thought to be the preserve of a small minority, may also be the ones needed in much higher proportions in groups seeking to be collectively intelligent.

An even more ambitious goal for cognitive economics would be to unravel one of the paradoxes that strikes anyone looking at creativity and the advance of knowledge. On the one hand, all ideas, information, and thoughts can be seen as expressions of a collective culture that finds vehicles—people or places that are ready to provide fertile soil for thoughts to ripen. This is why such similar ideas or inventions flower in many places at the same time. It is why, too, every genius who, seen from afar, appears wholly unique looks less exceptional when seen in the dense context of their time, surrounded by others with parallel ideas and methods. Viewed in this way, it is as odd to call the individual the sole author of their ideas as it is to credit the seed for the wonders of the flowers it produces. That some upbringings, places, and institutions make people far more creative and intelligent than others proves the absurdity of ascribing intelligence solely to genes or individual attributes.

But to stop there is also untenable. All thought requires work—a commitment of energy and time that might otherwise have been spent growing crops, raising children, or having a drink with friends. Anyone can choose whether to do that work or not, where to strike the balance between activity and inertia, engagement and indolence. So thought is always both collective and individual, both a manifestation of a wider network and something unique, both an emergent property of groups and a conscious choice by some individuals to devote their scarce time and resources. The interesting questions then center on how to understand the conditions for thought. How does any society or organization make it easier for individuals to be effective vehicles for thought, to reduce the costs and increase the benefits? Or to put it in noneconomic language, how can the collective sing through the individual, and vice versa?

The current state of understanding these dynamics is limited. We know something about clusters and milieus for innovation and thought. It’s clearly possible for the creative and intellectual capability of a place to grow quickly, and using a combination of geography, sociology, and economics, it is easy to describe the transformation of, say, Silicon Valley, Estonia, or Taiwan. Yet there are few reliable hypotheses that can make predictions, and many of the claims made in this area—for example, about what causes creativity—have not stood up to rigorous analysis. For now, this is a field with many interesting claims but not much solid knowledge.


Banks create money from nothing. And it gets worse – Jackson Stiles. 

Richard Werner, the German professor famous for inventing the term ‘quantitative easing’, says the world is finally waking up to the fact that “banks create money out of nothing” – but warns this realisation has given rise to a new “Orwellian” threat.

Professor Werner says the recent campaigns around the world, including in India and Australia, to get rid of cash are coordinated attempts by central bankers to monopolise money creation.

“This sudden global talk by the usual suspects about the ‘need to get rid of cash’, ostensibly to fight tax evasion etc, has been so coordinated that it cannot but be part of another plan by central bankers, this time to stay in charge of any emerging reform agenda, by trying to control, and themselves run, the ‘opposition’,” he says

“Essentially, the Bank of England and others are saying: okay, we admit it, you guys were right, banks create money out of nothing. So now we need to make sure that you guys will not be able to set the agenda of what happens in terms of reforms.”

Professor Werner (pronounced ‘Verner’), currently the Chair of International Banking at the University of Southampton, is one of the first academics in the world to bring attention to the fact that banks loan money into existence. He has been arguing this for more than two decades, and has published several papers on the subject.

Two Australian economists, Steve Keen and Bill Mitchell, have also led the charge.

The old theory, taught in high school economics classes and to university undergrads, is that banks receive deposits and loan out of a percentage of that money, while keeping some in reserve.

The truth, according to Professor Werner, is closer to the following: A bank receives $100 from a depositor, keeps that $100 in reserve, and then creates $9900 worth of new loans and deposits. It may also create $15,000 in new deposits through its lending.

This is a rough approximation. The main point is that the banks do not lend existing money, but add to deposits and the money supply when they ‘lend’. And when those loans are repaid, money is removed from circulation.

Thus, the supply of money is constantly being expanded and contracted by banks – which may explain why the ‘credit crunch’ of the global financial crisis was so devastating. Banks weren’t lending, so there was a shortage of money.

By some estimates, the banks create upwards of 97 per cent of money, in the form of electronic funds stored in online accounts. Banknotes and coins? They are just tokens of value, printed to represent the money already created by banks.

Most of the money in circulation is electronic, and created by banks. It is not in banknotes or coins.

This theory is now widely accepted as fact. In 2014, the Bank of England published a bulletin confirming it is its official position.

Mervyn King, former Bank of England governor, explains the process – and its dangers – in his 2016 book, The Alchemy of Money.

“During the 20th century, governments allowed the creation of money to become the byproduct of the process of credit creation. Most money today is created by private sector institutions – banks. This is the most serious fault-line in the management of money in our societies today,” Baron King writes.

He goes on: “Banks are part of our daily life. Most of us use them regularly, either to obtain cash, pay bills or take out loans. But banks are also dangerous. They are at the heart of the alchemy of our financial system. Banks are the main source of money creation. They create deposits as a byproduct of making loans to risky borrowers. Those deposits are used as money.”

Journalistic writers like Felix Martin have also tried their hand at explaining the magic of money creation.

In Money: The Unauthorised Biography, first published in 2013, Mr Martin explains that “almost all of [a bank’s] assets are nothing but promises to pay, and almost all its liabilities likewise”.

In effect, a deposit at a bank is a promise to pay you, the customer, and a home loan is a promise by you to pay the bank. By balancing when these promises are likely to come due, a bank can effectively create money by juggling all the balls in the air at once. Only a fraction will ever be demanded in cash at any one time, but all of the debts can be used as money.

This is what Mr Martin calls “the essence of the banker’s art”. He writes: “It is nothing more than ensuring the synchronisation, in the aggregate, of incoming and outgoing payments due on his assets and liabilities.”

Former Bank of England governor Mervyn King agrees that banks create most of our money – and that it is a problem. 

Professor Werner is pleased the world is waking up to the truth of how money is created, but is very displeased with what he sees as the central bankers’ reaction: the death of cash and the rise of central bank-controlled digital currency.

This will further centralise what he describes as the “already excessive and unaccountable powers” of centrals banks, which he argues has been responsible for the bulk of the more than 100 banking crises and boom-bust cycles in the past half-century.

“To appear active reformers, they will push the agenda to get rid of bank credit creation. This suits them anyway, as long as they can fix the policy recommendation of any such reform, to be … that the central banks should be the sole issuers of money.”

The professor also fears the global push for ‘basic income’, which is being trialled parts of Europe and widely discussed in the media, will form part of the central bankers’ attempt to kill off cash.

‘Basic income’ is a popular idea that can be traced back to Sydney and Beatrice Webb, founders of the London School of Economics. It proposes we abolish all welfare payments and replace them with a single ‘basic income’ that everyone, from billionaires to unemployed single mothers, receives.

Either we accept the digital currency issued by central banks, or we miss out on basic income payments. That is Professor Werner’s theory of what might happen.

His solution to this “Orwellian” future is decentralisation, in the form of lots of non-profit community banks, as exist in his native Germany.

“We need to push for the opposite of this massive and Orwellian increase in centralisation, by decentralising money power. Hence the creation of community banks across countries, operated and controlled locally, accountable to local communities, and not-for-profit.

“The best working example is Germany, where for the past almost 200 years about 70 per cent of banking has been in the hands of not-for-profit community banks.”

Professor Werner’s predictions have been right before. He invented the term ‘quantitative easing’ in a 1995 paper, in which he argued that struggling economies could boost GDP by using their central banks to relieve commercial banks of their bad debts, thus freeing them to make new loans (i.e. new money).

The US followed his definition the closest. The Federal Reserve purchased non-performing assets from banks, and the economy is recovering.

Japan and the Eurozone did virtually the opposite. Instead of buying bad debts, their central banks bought corporate bonds and other financial assets. This, he argues, explains why Europe and Japan have remained mired in recession.

We can only hope his “Orwellian” prediction of central bank control is less accurate.

The New Daily 

What Mainstream Economists Get Wrong About Secular Stagnation – Servaas Storm. 

Forget the myth of a savings glut causing near-zero interest rates. We have a shortage of aggregate demand, and only public spending and raising wages will change that.


Nine years after the Great Financial Crisis, U.S. output growth has not returned to its pre-recession trend, even after interest rates hit the ‘zero lower bound’ (ZLB) and the unconventional monetary policy arsenal of the Federal Reserve has been all but exhausted. It is widely feared that this insipid recovery reflects a ‘new normal’, characterized by “secular stagnation” which set in already well before the global banking crisis of 2008 (Summers 2013, 2015).

This ‘new normal’ is characterized not just by this slowdown of aggregate economic growth, but also by greater income and wealth inequalities and a growing polarization of employment and earnings into high-skill, high-wage and low-skill, low-wage jobs—at the expense of middle-class jobs (Temin 2017; Storm 2017). The slow recovery, heightened job insecurity and economic anxiety have fueled a groundswell of popular discontent with the political establishment and made voters captive to Donald Trump’s siren song promising jobs and growth (Ferguson and Page 2017).

What are the causes of secular stagnation? What are the solutions to revive growth and get the U.S. economy out of the doldrums?

If we go by four of the papers commissioned by the Institute for New Economic Thinking (INET) at its recent symposium to explore these questions, one headline conclusion stands out: the secular stagnation is caused by a heavy overdose of savings (relative to investment), which is caused by higher retirement savings due to declining population growth and an ageing labour force (Eggertson, Mehotra & Robbins 2017; Lu & Teulings 2017; Eggertson, Lancastre and Summers 2017), higher income inequality (Rachel & Smith 2017), and an inflow of precautionary Asian savings (Rachel & Smith 2017). All these savings end up as deposits, or ‘loanable funds’ (LF), in commercial banks. In earlier times, so the argument goes, banks would successfully channel these ‘loanable funds’ into productive firm investment — by lowering the nominal interest rate and thus inducing additional demand for investment loans.

But this time is different: the glut in savings supply is so large that banks cannot get rid of all the loanable funds even when they offer firms free loans—that is, even after they reduce the interest rate to zero, firms are not willing to borrow more in order to invest. The result is inadequate investment and a shortage of aggregate demand in the short run, which lead to long-term stagnation as long as the savings-investment imbalance persists. Summers (2015) regards a “chronic excess of saving over investment” as “the essence of secular stagnation”. Monetary policymakers at the Federal Reserve are in a fix, because they cannot lower the interest rate further as it is stuck at the ZLB. Hence, forces of demography and ageing, higher inequality and thrifty Chinese savers are putting the U.S. economy on a slow-moving turtle — and not much can be done, it seems, to halt the resulting secular stagnation.

This is clearly a depressing conclusion, but it is also wrong.

To see this, we have to understand why there is a misplaced focus on the market for loanable funds that ignores the role of fiscal policy that is plainly in front of us. In other words, we need to step back from the trees of dated models and see the whole forest of our economy.

The Market for Loanable Funds

In the papers mentioned, commercial banks must first mobilise savings in order to have the loanable funds (LF) to originate new (investment) loans or credit. Banks are therefore intermediaries between “savers” (those who provide the LF-supply) and “investors” (firms which demand the LF). Banks, in this narrative, do not create money themselves and hence cannot pre-finance investment by new money. They only move it between savers and investors.

We apparently live in a non-monetary (corn) economy—one that just exchanges a real good that everybody uses, like corn. Savings (or LF-supply) are assumed to rise when the interest rate R goes up, whereas investment (or LF-demand) must decline when R increases. This is the stuff of textbooks, as is illustrated by Greg Mankiw’s (1997, p. 63) explanation:

“In fact, saving and investment can be interpreted in terms of supply an demand. In this case, the ‘good’ is loanable funds, and its ‘price’ is the interest rate. Saving is the supply of loans—individuals lend their savings to investors, or they deposit their saving in a bank that makes the loan for them. Investment is the demand for loanable funds—investors borrow from the public directly by selling bonds or indirectly by borrowing from banks. [….] At the equilibrium interest rate, saving equals investment and the supply of loans equals the demand.”

But the loanable funds market also forms the heart of complicated dynamic stochastic general equilibrium (DSGE) models, beloved by ‘freshwater’ and ‘saltwater’ economists alike (Woodford 2010), as should be clear from the commissioned INET papers as well. Figure 1 illustrates the loanable funds market in this scheme. The upward-sloping curve tells us that savings (or LF-supply) goes up as the interest rate R increases. The downward-sloping curve shows us that investment (or LF-demand) declines if the cost of capital (R) goes up. In the initial situation, the LF-market clears at a positive interest rate R0 > 0. Savings equal investment, which implies that LF-supply matches LF-demand, and in this—happy—equilibrium outcome, the economy can grow along some steady-state path.

To see how we can get secular stagnation in such a loanable-funds world, we introduce a shock, say, an ageing population (a demographic imbalance), a rise in (extreme) inequality, or an Asian savings glut, due to which the savings schedule shifts down. Equilibrium in the new situation should occur at R1 which is negative. But this can’t happen because of the ZLB: the nominal interest cannot decline below zero. Hence R is stuck at the ZLB and savings exceed investment, or LF-supply > LF-demand. This is a disequilibrium outcome which involves an over-supply of savings (relative to investment), in turn leading to depressed growth.

Ever since Knut Wicksell’s (1898) restatement of the doctrine, the loanable funds approach has exerted a surprisingly strong influence upon some of the best minds in the profession. Its appeal lies in the fact that it can be presented in digestible form in a simple diagram (as Figure 1), while its micro-economic logic matches the neoclassical belief in the ‘virtue of thrift’ and Max Weber’s Protestant Ethic, which emphasize austerity, savings (before spending!) and delayed gratification as the path to bliss.

The problem with this model is that it is wrong (see Lindner 2015; Taylor 2016). Wrong in its conceptualisation of banks (which are not just intermediaries pushing around existing money, but which can create new money ex nihilo), wrong in thinking that savings or LF-supply have anything to do with “loans” or “credit,” wrong because the empirical evidence in support of a “chronic excess of savings over investment” is weak or lacking, wrong in its utter neglect of finance, financialization and financial markets, wrong in its assumption that the interest rate is some “market-clearing” price (the interest rate, as all central bankers will acknowledge, is the principal instrument of monetary policy), and wrong in the assumption that the two schedules—the LF-supply curve and the LF-demand curve—are independent of one another (they are not, as Keynes already pointed out).

I wish to briefly elaborate these six points. I understand that each of these criticisms is known and I entertain little hope that that any of this will make people reconsider their approach, analysis, diagnosis and conclusions. Nevertheless, it is important that these criticisms are raised and not shoveled under the carpet. The problem of secular stagnation is simply too important to be left mis-diagnosed.

First Problem: Loanable Funds Supply and Demand Are Not Independent Functions

Let me start with the point that the LF-supply and LF-demand curve are not two independent schedules. Figure 1 presents savings and investment as functions of only the interest rate R, while keeping all other variables unchanged. The problem is that the ceteris paribus assumption does not hold in this case. The reason is that savings and investment are both affected by, and at the same time determined by, changes in income and (changes in) income distribution. To see how this works, let us assume that the average propensity to save rises in response to the demographic imbalance and ageing. As a result, consumption and aggregate demand go down. Rational firms, expecting future income to decline, will postpone or cancel planned investment projects and investment declines (due to the negative income effect and for a given interest rate R0). This means that LF-demand curve in Figure 1 must shift downward in response to the increased savings. The exact point was made by Keynes (1936, p. 179):

“The classical theory of the rate of interest [the loanable funds theory] seems to suppose that, if the demand curve for capital shifts or if the curve relating the rate of interest to the amounts saved out of a given income shifts or if both these curves shift, the new rate of interest will be given by the point of intersection of the new positions of the two curves. But this is a nonsense theory. For the assumption that income is constant is inconsistent with the assumption that these two curves can shift independently of one another. If either of them shift, then, in general, income will change; with the result that the whole schematism based on the assumption of a given income breaks down … In truth, the classical theory has not been alive to the relevance of changes in the level of income or to the possibility of the level of income being actually a function of the rate of the investment.”

Let me try to illustrate this using Figure 2. Suppose there is an exogenous (unexplained) rise in the average propensity to save. In reponse, the LF-supply curve shifts down, but because (expected) income declines, the LF-demand schedule shifts downward as well. The outcome could well be that there is no change in equilibrium savings and equilibrium investment. The only change is that the ‘natural’ interest is now R1 and equal to the ZLB. Figure 2 is, in fact, consistent with the empirical analysis (and their Figure of global savings and investment) of Rachel & Smith. Let me be clear: Figure 2 is not intended to suggest that the loanable funds market is useful and theoretically correct. The point I am trying to make is that income changes and autonomous demand changes are much bigger drivers of both investment and saving decisions than the interest rate. Market clearing happens here—as Keynes was arguing—because the level of economic activity and income adjust, not because of interest-rate adjustment

Second Problem: Savings Do Not Fund Investment, Credit Does…

The loanable funds doctrine wrongly assumes that commercial bank lending is constrained by the prior availability of loanable funds or savings.  The simple point in response is that, in real life, modern banks are not just intermediaries between ‘savers’ and ‘investors’, pushing around already-existing money, but are money creating institutions. Banks create new money ex nihilo, i.e. without prior mobilisation of savings. This is illustrated by Werner’s (2014) case study of the money creation process by one individual commercial bank. What this means is that banks do pre-finance investment, as was noted by Schumpeter early on and later by Keynes (1939), Kaldor (1989), Kalecki, and numerous other economists.  It is for this reason that Joseph Schumpeter (1934, p. 74) called the money-creating banker ‘the ephor of the exchange economy’—someone who by creating credit (ex nihilo) is pre-financing new investments and innovation and enables “the carrying out of new combinations, authorizes people, in the name of society as it were, to form them.” Nicholas Kaldor (1989, p. 179) hit the nail on its head when he wrote that “[C]redit money has no ‘supply function’ in the production sense (since its costs of production are insignificant if not actually zero); it comes into existence as a result of bank lending and is extinguished through the repayment of bank loans. At any one time the volume of bank lending or its rate of expansion is limited only by the availability of credit-worthy borrowers.” Kaldor had earlier expressed his views on the endogeneity of money in his evidence to the Radcliffe Committee on the Workings of the Monetary System, whose report (1959) was strongly influenced by Kaldor’s argumentation. Or take Lord Adair Turner (2016, pp. 57) to whom the loanable-funds approach is 98% fictional, as he writes:

“Read an undergraduate textbook of economics, or advanced academic papers on financial intermediation, and if they describe banks at all, it is usually as follows: “banks take deposits from households and lend money to businesses, allocating capital between alternative capital investment possibilities.” But as a description of what modern banks do, this account is largely fictional, and it fails to capture their essential role and implications. […] Banks create credit, money, and thus purchasing power. […]  The vast majority of what we count as “money’ in modern economies is created in this fashion: in the United Kingdom 98% of money takes this form ….”

We therefore don’t need savings to make possible investment—or, in contrast to the Protestant Ethic, banks allow us to have ‘gratification’ even if we have not been ‘thrifty’ and austere, as long as there are slack resources in the economy.

It is by no means a secret that commercial banks create new money. As the Bank of England (2007) writes, “When bank make loans they create additional deposits for those that have borrowed” (Berry et al. 2007, p. 377).  Or consider the following statement from the Deutsche Bundesbank (2009): “The commercial banks can create money themselves ….”  Across the board, central bank economists, including economists working at the Bank for International Settlements (Borio and Disyatat 2011), have rejected the loanable funds model as a wrong description of how the financial system actually works (see McLeay et al. 2014a, 2014b; Jakab and Kumhof 2015). And the Deutsche Bundesbank (2017) leaves no doubt as to how the banking system works and money is created in actually-existing capitalism, stating that the ability of banks to originate loans does not depend on the prior availability of saving deposits. Bank of England economists Zoltan Jakab and Michael Kumhoff (2015) reject the loanable-funds approach in favour of a model with money-creating banks. In their model (as in reality), banks pre-finance investment; investment creates incomes; people save out of their incomes; and at the end of the day, ex-post savings equal investment. This is what Jakab and Kumhoff (2015) conclude:

“…. if the loan is for physical investment purposes, this new lending and money is what triggers investment and therefore, by the national accounts identity of saving and investment (for closed economies), saving. Saving is therefore a consequence, not a cause, of such lending. Saving does not finance investment, financing does. To argue otherwise confuses the respective macroeconomic roles of resources (saving) and debt-based money (financing).”

Savings are a consequence of credit-financed investment (rather than a prior condition) — and we cannot draw a savings-investment cross as in Figure 1, as if the two curves are independent. They are not. There exists therefore no ‘loanable funds market’ in which scarce savings constrain (through interest rate adjustments) the demand for investment loans. Highlighting the loanable funds fallacy, Keynes wrote in “The Process of Capital Formation” (1939):

“Increased investment will always be accompanied by increased saving, but it can never be preceded by it. Dishoarding and credit expansion provides not an alternative to increased saving, but a necessary preparation for it. It is the parent, not the twin, of increased saving.”

This makes it all the more remarkable that some of the authors of the commissioned conference papers continue to frame their analysis in terms of the discredited loanable funds market which wrongly assumes that savings have an existence of their own—separate from investment, the level of economic activity and the distribution of incomes.

Third Problem: The Interest Rate Is a Monetary Policy Instrument, Not a Market-Clearing Price

In loanable funds theory, the interest rate is a market price, determined by LF-supply and LF-demand (as in Figure 1). In reality, central bankers use the interest rate as their principal policy instrument (Storm and Naastepad 2012). It takes effort and a considerable amount of sophistry to match the loanable funds theory and the usage of the interest rate as a policy instrument. However, once one acknowledges the empirical fact that commercial banks create money ex nihilo, which means money supply is endogenous, the model of an interest-rate clearing loanable funds market becomes untenable.  Or as Bank of England economists Jakab and Kumhof (2015) argue:

“modern central banks target interest rates, and are committed to supplying as many reserves (and cash) as banks demand at that rate, in order to safeguard financial stability. The quantity of reserves is therefore a consequence, not a cause, of lending and money creation. This view concerning central bank reserves […] has been repeatedly described in publications of the world’s leading central banks.”

What this means is that the interest rate may well be at the ZLB, but this is not caused by a savings glut in the loanable funds market, but the result of a deliberate policy decision by the Federal Reserve—in an attempt to revive sluggish demand in a context of stagnation, subdued wage growth, weak or no inflation, substantial hidden un- and underemployment, and actual recorded unemployment being (much) higher than the NAIRU (see Storm and Naastepad 2012). Seen this way, the savings glut is the symptom (or consequence) of an aggregate demand shortage which has its roots in the permanent suppression of wage growth (relative to labour productivity growth), the falling share of wages in income, the rising inequalities of income and wealth (Taylor 2017) as well as the financialization of corporations (Lazonick 2017) and the economy as a whole (Storm 2018). It is not the cause of the secular stagnation—unlike in the loanable funds models.

Fourth Problem: The Manifest Absence of Finance and Financial Markets

What the various commissioned conference papers do not acknowledge is that the increase in savings (mostly due to heightened inequality and financialization) is not channeled into higher real-economy investment, but is actually channeled into more lucrative financial (derivative) markets. Big corporations like Alphabet, Facebook and Microsoft are holding enormous amounts of liquidity and IMF economists have documented the growth of global institutional cash pools, now worth $5 to 6 trillion and managed by asset or money managers in the shadow banking system (Pozsar 2011; Pozsar and Singh 2011; Pozsar 2015). Today’s global economy is suffering from an unprecedented “liquidity preference”—with the cash safely “parked” in short-term (over-collateralized lending deals in the repo-market. The liquidity is used to earn a quick buck in all kinds of OTC derivatives trading, including forex swaps, options and interest rate swaps. The global savings glut is the same thing as the global overabundance of liquidity (partying around in financial markets) and also the same thing as the global demand shortage—that is: the lack of investment in real economic activity, R&D and innovation.

The low interest rate is important in this context, because it has dramatically lowered the opportunity cost of holding cash—thus encouraging (financial) firms, the rentiers and the super-rich to hold on to their liquidity and make (quick and relatively safe and high) returns in financial markets and exotic financial instruments. Added to this, we have to acknowledge the fact that highly-leveraged firms are paying out most of their profits to shareholders as dividends or using it to buy back shares (Lazonick 2017). This has turned out to be damaging to real investment and innovation, and it has added further fuel to financialization (Epstein 2018; Storm 2018). If anything, firms have stopped using their savings (or retained profits) to finance their investments which are now financed by bank loans and higher leverage. If we acknowledge these roles of finance and financial markets, then we can begin to understand why investment is depressed and why there is an aggregate demand shortage. More than two decades of financial deregulation have created a rentiers’ delight, a capitalism without ‘compulsions’ on financial investors, banks, and the property-owning class which in practice has led to ‘capitalism for the 99%’ and ‘socialism for the 1%’ (Palma 2009; Epstein 2018) For authentic Keynesians, this financialized system is the exact opposite of Keynes’ advice to go for the euthanasia of the rentiers ( policies to reduce the excess liquidity).

Fifth Problem: Confusing Savings with “Loans,” or Stocks with Flows

“I have found out what economics is,’ Michał Kalecki once told Joan Robinson, “it is the science of confusing stocks with flows.” If anything, Kalecki’s comment applies to the loanable funds model. In the loanable fund universe, as Mankiw writes and as most commissioned conference papers argue, saving equals investment and the supply of loans equals the demand at some equilibrium interest rate. But savings and investment are flow variables, whereas the supply of loans and the demand for loans are stock variables. Simply equating these flows to the corresponding stocks is not considered good practice in stock-flow-consistent macro-economic modelling. It is incongruous, because even if we assume that the interest rate does clear “the stock of loan supply” and “the stock of loan demand”, there is no reason why the same interest rate would simultaneouslybalance savings (i.e. the increase in loan supply) and investment (i.e. the increase in loan demand). So what is the theoretical rationale of assuming that some interest rate is clearing the loanable funds market (which is defined in terms of flows)?

To illustrate the difference between stocks and flows: the stock of U.S. loans equals around 350% of U.S. GDP (if one includes debts of financial firms), while gross savings amount to 17% of U.S. GDP. Lance Taylor (2016) presents the basic macroeconomic flows and stocks for the U.S. economy to show how and why loanable funds macro models do not fit the data—by a big margin. No interest rate adjustment mechanism is strong enough to bring about this (ex-post) balance in terms of flows, because the interest rate determination is overwhelmed by changes in loan supply and demand stocks. What is more, and as stated before, we don’t actually use ‘savings’ to fund ‘investment’. Firms do not use retained profits (or corporate savings) to finance their investment, but in actual fact disgorge the cash to shareholders (Lazonick 2017). They finance their investment by bank loans (which is newly minted money).  Households use their (accumulated) savings to buy bonds in the secondary market or any other existing asset. In that case, the savings do not go to funding new investment — but are merely used to re-arrange the composition of the financial portfolio of the savers.

Final Problem: The Evidence of a Chronic Excess of Savings Over Investment is Missing

If Summers claims that there is a “chronic excess of savings over investment,” what he means is that ex-ante savings are larger than ex-ante investment. This is a difficult proposition to empirically falsify, because we only have ex-post (national accounting) data on savings and investment which presume the two variables are equal. However, what we can do is consider data on (global) gross and net savings rates (as a proportion of GDP) to see if the propensity to save has increased. This is what Bofinger and Ries (2017) did and they find that global saving rates of private households have declined dramatically since the 1980s. This means, they write, that one can rule out ‘excess savings’ due to demographic factors (as per Eggertson, Mehotra & Robbins 2017; Eggertsson, Lancastre & Summers 2017; Rachel & Smith 2017; and Lu & Teulings 2017). While the average saving propensity of household has declined, the aggregate propensity to save has basically stayed the same during the period 1985-2014. This is shown in Figure 3 (reproduced from Bofinger and Reis 2017) which plots the ratio of global gross savings (or global gross investment) to GDP against the world real interest rate during 1985-2014. A similar figure can be found in the paper by Rachel and Smith (2017). What can be seen is that while there has been no secular rise in the average global propensity to save, there has been a secular decline in interest rates. This drop in interest rates to the ZLB is not caused by a savings glut, nor by a financing glut, but is the outcome of the deliberate decisions of central banks to lower the policy rate in the face of stagnating economies, put on a ‘slow-moving turtle’ by a structural lack of aggregate demand which—as argued by Storm and Naastepad (2012) and Storm (2017)—is largely due to misconceived macro and labour-market policies centered on suppressing wage growth, fiscal austerity, and labour market deregulation

To understand the mechanisms underlying Figure 3, let us consider Figure 4 which plots investment demand as a negative function of the interest rate. In the ‘old situation’, investment demand is high at a (relatively) high rate of interest (R0); this corresponds to the data points for the period 1985-1995 in Figure 3. But then misconceived macro and labour-market policies centered on suppressing wage growth, fiscal austerity, and labour market deregulation began to depress aggregate demand and investment—and as a result, the investment demand schedule starts to shift down and to become more steeply downward-sloping at the same time. In response to the growth slowdown (and weakening inflationary pressure), central banks reduce R—but without any success in raising the gross investment rate. This process continues until the interest rate hits the ZLB while investment has become practically interest-rate insensitive, as investment is now overwhelmingly determined by pessimistic profit expectations; this is indicated by the new investment schedule (in red). That the economy is now stuck at the ZLB is not caused by a “chronic excess of savings” but rather by a chronic shortage of aggregate demand—a shortage created by decades of wage growth moderation, labour market flexibilization, and heightened job insecurity as well as the financialization of corporations and the economy at large (Storm 2018).


The consensus in the literature and in the commissioned conference papers that the global decline in real interest rates is caused by a higher propensity to save, above all due to demographic reasons, is wrong in terms of underlying theory and evidence base.  The decline in interest rates is the monetary policy response to stalling investment and growth, both caused by a shortage of global demand. However, the low interest rates are unable to revive growth and halt the secular stagnation, because there is little reason for firms to expand productive capacity in the face of the persistent aggregate demand shortage. Unless we revive demand, for example through debt-financed fiscal stimulus or a drastic and permanent progressive redistribution of income and wealth in favour of lower-income groups (Taylor 2017), there is no escape from secular stagnation. The narrow focus on the ZLB and powerless monetary policy within the framing of a loanable-funds financial system blocks out serious macroeconomic policy debate on how to revive aggregate demand in a sustainable manner. It will keep the U.S. economy on the slow-moving turtle — not because policymakers cannot do anything about it, but we choose to do so. The economic, social and political damage, fully self-inflicted, is going to be of historic proportions.

It is not a secret that the loanable funds approach is fallacious (Lindner 2015; Taylor 2016; Jakab and Kumhof 2015). While academic economists continue to refine their Ptolemaic model of a loanable-funds market, central bank economists have moved on—and are now exploring the scope of and limitations to monetary policymaking in a monetary economy. Keynes famously wrote that “Practical men who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.”  In 2017, things seem to happen the other way around: academic economists who believe themselves to be free thinkers are caught in the stale theorizing of a century past. The puzzle is, as Lance Taylor (2016, p. 15) concludes “why [New Keynesian economists] revert to Wicksell on loanable funds and the natural rate while ignoring Keynes’s innovations. Maybe, as [Keynes] said in the preface to the General Theory, “‘The difficulty lies not in the new ideas, but in escaping from the old ones …..’ (p. viii)”

Due to our inability to free ourselves from the discredited loanable funds doctrine, we have lost the forest for the trees. We cannot see that the solution to the real problem underlying secular stagnation (a structural shortage of aggregate demand) is by no means difficult: use fiscal policy—a package of spending on infrastructure, green energy systems, public transportation and public services, and progressive income taxation—and raise (median) wages. The stagnation will soon be over, relegating all the scholastic talk about the ZLB to the dustbin of a Christmas past. 

Institute For New Economic Thinking 


Servaas Storm

Servaas Storm is a Dutch economist and author who works on macroeconomics, technological progress, income distribution & economic growth, finance, development and structural change, and climate change.

Reclaiming the State. A Progressive Vision of Sovereignty for a Post-Neoliberal World –  William Mitchell and Thomas Fazi. 


Make the Left Great Again 

The West is currently in the midst of an anti-establishment revolt of historic proportions. The Brexit vote in the United Kingdom, the election of Donald Trump in the United States, the rejection of Matteo Renzi’s neoliberal constitutional reform in Italy, the EU’s unprecedented crisis of legitimation: although these interrelated phenomena differ in ideology and goals, they are all rejections of the (neo) liberal order that has dominated the world –and in particular the West –for the past 30 years. 

Even though the system has thus far proven capable (for the most part) of absorbing and neutralising these electoral uprisings, there is no indication that this anti-establishment revolt is going to abate any time soon. Support for anti-establishment parties in the developed world is at the highest level since the 1930s –and growing. At the same time, support for mainstream parties –including traditional social-democratic parties –has collapsed. 

The reasons for this backlash are rather obvious. The financial crisis of 2007–9 laid bare the scorched earth left behind by neoliberalism, which the elites had gone to great lengths to conceal, in both material (financialisation) and ideological (‘the end of history’) terms. 

As credit dried up, it became apparent that for years the economy had continued to grow primarily because banks were distributing the purchasing power –through debt –that businesses were not providing in salaries. To paraphrase Warren Buffett, the receding tide of the debt-fuelled boom revealed that most people were, in fact, swimming naked

The situation was (is) further exacerbated by the post-crisis policies of fiscal austerity and wage deflation pursued by a number of Western governments, particularly in Europe, which saw the financial crisis as an opportunity to impose an even more radical neoliberal regime and to push through policies designed to suit the financial sector and the wealthy, at the expense of everyone else. 

Thus, the unfinished agenda of privatisation, deregulation and welfare state retrenchment –temporarily interrupted by the financial crisis –was reinstated with even greater vigour. Amid growing popular dissatisfaction, social unrest and mass unemployment (in a number of European countries), political elites on both sides of the Atlantic responded with business-as-usual policies and discourses. 

As a result, the social contract binding citizens to traditional ruling parties is more strained today than at any other time since World War II –and in some countries has arguably already been broken. 

Of course, even if we limit the scope of our analysis to the post-war period, anti-systemic movements and parties are not new in the West. Up until the 1980s, anti-capitalism remained a major force to be reckoned with. The novelty is that today –unlike 20, 30 or 40 years ago –it is movements and parties of the right and extreme right (along with new parties of the neoliberal ‘extreme centre’, such as the new French president Emmanuel Macron’s party En Marche!) that are leading the revolt, far outweighing the movements and parties of the left in terms of voting strength and opinion-shaping. 

With few exceptions, left parties –that is, parties to the left of traditional social-democratic parties –are relegated to the margins of the political spectrum in most countries. 

Meanwhile, in Europe, traditional social-democratic parties are being ‘pasokified’–that is, reduced to parliamentary insignificance, like many of their centre-right counterparts, due to their embrace of neoliberalism and failure to offer a meaningful alternative to the status quo –in one country after another. 

The term refers to the Greek social-democratic party PASOK, which was virtually wiped out of existence in 2014, due to its inane handling of the Greek debt crisis, after dominating the Greek political scene for more than three decades. A similar fate has befallen other former behemoths of the social-democratic establishment, such as the French Socialist Party and the Dutch Labour Party (PvdA). Support for social-democratic parties is today at the lowest level in 70 years –and falling. 

How should we explain the decline of the left –not just the electoral decline of those parties that are commonly associated with the left side of the political spectrum, regardless of their effective political orientation, but also the decline of core left values within those parties and within society in general? 

Why has the anti-establishment left proven unable to fill the vacuum left by the collapse of the establishment left? More broadly, how did the left come to count so little in global politics? Can the left, both culturally and politically, become a major force in our societies again? And if so, how? 

These are some of the questions that we attempt to answer in this book. Though the left has been making inroads in some countries in recent years –notable examples include Bernie Sanders in the United States, Jeremy Corbyn in the UK, Podemos in Spain and Jean-Luc Mélenchon in France –and has even succeeded in taking power in Greece (though the SYRIZA government was rapidly brought to heel by the European establishment), there is no denying that, for the most part, movements and parties of the extreme right have been more effective than left-wing or progressive forces at tapping into the legitimate grievances of the masses –disenfranchised, marginalised, impoverished and dispossessed by the 40-year-long neoliberal class war waged from above. 

In particular, they are the only forces that have been able to provide a (more or less) coherent response to the widespread –and growing –yearning for greater territorial or national sovereignty, increasingly seen as the only way, in the absence of effective supranational mechanisms of representation, to regain some degree of collective control over politics and society, and in particular over the flows of capital, trade and people that constitute the essence of neoliberal globalisation. Given neoliberalism’s war against sovereignty, it should come as no surprise that ‘sovereignty has become the master-frame of contemporary politics’, as Paolo Gerbaudo notes. 

After all, as we argue in Chapter 5, the hollowing out of national sovereignty and curtailment of popular-democratic mechanisms –what has been termed depoliticisation –has been an essential element of the neoliberal project, aimed at insulating macroeconomic policies from popular contestation and removing any obstacles put in the way of economic exchanges and financial flows. 

Given the nefarious effects of depoliticisation, it is only natural that the revolt against neoliberalism should first and foremost take the form of demands for a repoliticisation of national decision-making processes. 

The fact that the vision of national sovereignty that was at the centre of the Trump and Brexit campaigns, and that currently dominates the public discourse, is a reactionary, quasi-fascist one –mostly defined along ethnic, exclusivist and authoritarian lines –should not be seen as an indictment of national sovereignty as such. History attests to the fact that national sovereignty and national self-determination are not intrinsically reactionary or jingoistic concepts –in fact, they were the rallying cries of countless nineteenth- and twentieth-century socialist and left-wing liberation movements.

Even if we limit our analysis to core capitalist countries, it is patently obvious that virtually all the major social, economic and political advancements of the past centuries were achieved through the institutions of the democratic nation state, not through international, multilateral or supranational institutions, which in a number of ways have, in fact, been used to roll back those very achievements, as we have seen in the context of the euro crisis, where supranational (and largely unaccountable) institutions such as the European Commission, Eurogroup and European Central Bank (ECB) used their power and authority to impose crippling austerity on struggling countries. 

The problem, in short, is not national sovereignty as such, but the fact that the concept in recent years has been largely monopolised by the right and extreme right, which understandably sees it as a way to push through its xenophobic and identitarian agenda. It would therefore be a grave mistake to explain away the seduction of the ‘Trumpenproletariat’ by the far right as a case of false consciousness, as Marc Saxer notes; the working classes are simply turning to the only movements and parties that (so far) promise them some protection from the brutal currents of neoliberal globalisation (whether they can or truly intend to deliver on that promise is a different matter). 

However, this simply raises an even bigger question: why has the left not been able to offer the working classes and increasingly proletarianised middle classes a credible alternative to neoliberalism and to neoliberal globalisation? More to the point, why has it not been able to develop a progressive view of national sovereignty? 

As we argue in this book, the reasons are numerous and overlapping. For starters, it is important to understand that the current existential crisis of the left has very deep historical roots, reaching as far back as the 1960s. If we want to comprehend how the left has gone astray, that is where we have to begin our analysis. 

Today the post-war ‘Keynesian’ era is eulogised by many on the left as a golden age in which organised labour and enlightened thinkers and policymakers (such as Keynes himself) were able to impose a ‘class compromise’ on reluctant capitalists that delivered unprecedented levels of social progress, which were subsequently rolled back following the so-called neoliberal counter-revolution. 

It is thus argued that, in order to overcome neoliberalism, all it takes is for enough members of the establishment to be swayed by an alternative set of ideas. However, as we note in Chapter 2, the rise and fall of Keynesianism cannot simply be explained in terms of working-class strength or the victory of one ideology over another, but should instead be viewed as the outcome of the fortuitous confluence, in the aftermath of World War II, of a number of social, ideological, political, economic, technical and institutional conditions. 

To fail to do so is to commit the same mistake that many leftists committed in the early post-war years. By failing to appreciate the extent to which the class compromise at the base of the Fordist-Keynesian system was, in fact, a crucial component of that history-specific regime of accumulation –actively supported by the capitalist class insofar as it was conducive to profit-making, and bound to be jettisoned once it ceased to be so –many socialists of the time convinced themselves ‘that they had done much more than they actually had to shift the balance of class power, and the relationship between states and markets’. 

Some even argued that the developed world had already entered a post-capitalist phase, in which all the characteristic features of capitalism had been permanently eliminated, thanks to a fundamental shift of power in favour of labour vis-à-vis capital, and of the state vis-à-vis the market. Needless to say, that was not the case. 

Furthermore, as we show in Chapter 3, monetarism –the ideological precursor to neoliberalism –had already started to percolate into left-wing policymaking circles as early as the late 1960s. Thus, as argued in Chapters 2 and 3, many on the left found themselves lacking the necessary theoretical tools to understand –and correctly respond to –the capitalist crisis that engulfed the Keynesian model in the 1970s, convincing themselves that the distributional struggle that arose at the time could be resolved within the narrow limits of the social-democratic framework. 

The truth of the matter was that the labour–capital conflict that re-emerged in the 1970s could only have been resolved one way or another: on capital’s terms, through a reduction of labour’s bargaining power, or on labour’s terms, through an extension of the state’s control over investment and production. As we show in Chapters 3 and 4, with regard to the experience of the social-democratic governments of Britain and France in the 1970s and 1980s, the left proved unwilling to go this way. This left it (no pun intended) with no other choice but to ‘manage the capitalist crisis on behalf of capital’, as Stuart Hall wrote, by ideologically and politically legitimising neoliberalism as the only solution to the survival of capitalism. 

In this regard, as we show in Chapter 3, the Labour government of James Callaghan (1974–9) bears a very heavy responsibility. In an (in) famous speech in 1976, Callaghan justified the government’s programme of spending cuts and wage restraint by declaring Keynesianism dead, indirectly legitimising the emerging monetarist (neoliberal) dogma and effectively setting up the conditions for Labour’s ‘austerity lite’ to be refined into an all-out attack on the working class by Margaret Thatcher. 

Even worse, perhaps, Callaghan popularised the notion that austerity was the only solution to the economic crisis of the 1970s, anticipating Thatcher’s ‘there is no alternative’(TINA) mantra, even though there were radical alternatives available at the time, such as those put forward by Tony Benn and others. These, however, were ‘no longer perceived to exist’. 

In this sense, the dismantling of the post-war Keynesian framework cannot simply be explained as the victory of one ideology (‘neoliberalism’) over another (‘Keynesianism’), but should rather be understood as the result of a number of overlapping ideological, economic and political factors: the capitalists’response to the profit squeeze and to the political implications of full employment policies; the structural flaws of ‘actually existing Keynesianism’; and, importantly, the left’s inability to offer a coherent response to the crisis of the Keynesian framework, let alone a radical alternative. 

These are all analysed in-depth in the first chapters of the book. Furthermore, throughout the 1970s and 1980s, a new (fallacious) left consensus started to set in: that economic and financial internationalisation –what today we call ‘globalisation’–had rendered the state increasingly powerless vis-à-vis ‘the forces of the market’, and that therefore countries had little choice but to abandon national economic strategies and all the traditional instruments of intervention in the economy (such as tariffs and other trade barriers, capital controls, currency and exchange rate manipulation, and fiscal and central bank policies), and hope, at best, for transnational or supranational forms of economic governance. 

In other words, government intervention in the economy came to be seen not only as ineffective but, increasingly, as outright impossible. This process –which was generally (and erroneously, as we shall see) framed as a shift from the state to the market –was accompanied by a ferocious attack on the very idea of national sovereignty, increasingly vilified as a relic of the past. As we show, the left –in particular the European left –played a crucial role in this regard as well, by cementing this ideological shift towards a post-national and post-sovereign view of the world, often anticipating the right on these issues. 

One of the most consequential turning points in this respect, which is analysed in Chapter 4, was Mitterrand’s 1983 turn to austerity –the so-called tournant de la rigueur –just two years after the French Socialists’ historic victory in 1981. Mitterrand’s election had inspired the widespread belief that a radical break with capitalism –at least with the extreme form of capitalism that had recently taken hold in the Anglo-Saxon world –was still possible. By 1983, however, the French Socialists had succeeded in ‘proving’ the exact opposite: that neoliberal globalisation was an inescapable and inevitable reality. As Mitterrand stated at the time: ‘National sovereignty no longer means very much, or has much scope in the modern world economy. …A high degree of supra-nationality is essential.’ 

The repercussions of Mitterrand’s about-turn are still being felt today. It is often brandished by left-wing and progressive intellectuals as proof of the fact that globalisation and the internationalisation of finance has ended the era of nation states and their capacity to pursue policies that are not in accord with the diktats of global capital. The claim is that if a government tries autonomously to pursue full employment and a progressive/redistributive agenda, it will inevitably be punished by the amorphous forces of global capital. 

This narrative claims that Mitterrand had no option but to abandon his agenda of radical reform. To most modern-day leftists, Mitterrand thus represents a pragmatist who was cognisant of the international capitalist forces he was up against and responsible enough to do what was best for France. In fact, as we argue in the second part of the book, sovereign, currency-issuing states –such as France in the 1980s –far from being helpless against the power of global capital, still have the capacity to deliver full employment and social justice to their citizens. 

So how did the idea of the ‘death of the state’come to be so ingrained in our collective consciousness? 

As we explain in Chapter 5, underlying this post-national view of the world was (is) a failure to understand –and in some cases an explicit attempt to conceal –on behalf of left-wing intellectuals and policymakers that ‘globalisation’ was (is) not the result of inexorable economic and technological changes but was (is) largely the product of state-driven processes. All the elements that we associate with neoliberal globalisation –delocalisation, deindustrialisation, the free movement of goods and capital, etc. –were (are), in most cases, the result of choices made by governments. 

More generally, states continue to play a crucial role in promoting, enforcing and sustaining a (neo) liberal international framework –though that would appear to be changing, as we discuss in Chapter 6 –as well as establishing the domestic conditions for allowing global accumulation to flourish. The same can be said of neoliberalism tout court. 

There is a widespread belief –particularly among the left –that neoliberalism has involved (and involves) a ‘retreat’, ‘hollowing out’ or ‘withering away’ of the state, which in turn has fuelled the notion that today the state has been ‘overpowered’ by the market. However, as we argue in Chapter 5, neoliberalism has not entailed a retreat of the state but rather a reconfiguration of the state, aimed at placing the commanding heights of economic policy ‘in the hands of capital, and primarily financial interests’. 

It is self-evident, after all, that the process of neoliberalisation would not have been possible if governments –and in particular social-democratic governments –had not resorted to a wide array of tools to promote it: the liberalisation of goods and capital markets; the privatisation of resources and social services; the deregulation of business, and financial markets in particular; the reduction of workers’ rights (first and foremost, the right to collective bargaining) and more generally the repression of labour activism; the lowering of taxes on wealth and capital, at the expense of the middle and working classes; the slashing of social programmes; and so on. 

These policies were systemically pursued throughout the West (and imposed on developing countries) with unprecedented determination, and with the support of all the major international institutions and political parties. 

As noted in Chapter 5, even the loss of national sovereignty –which has been invoked in the past, and continues to be invoked today, to justify neoliberal policies –is largely the result of a willing and conscious limitation of state sovereign rights by national elites. 

The reason why governments chose willingly to ‘tie their hands’ is all too clear: as the European case epitomises, the creation of self-imposed ‘external constraints’ allowed national politicians to reduce the politics costs of the neoliberal transition –which clearly involved unpopular policies –by ‘scapegoating’ institutionalised rules and ‘independent’ or international institutions, which in turn were presented as an inevitable outcome of the new, harsh realities of globalisation. 

Moreover, neoliberalism has been (and is) associated with various forms of authoritarian statism –that is, the opposite of the minimal state advocated by neoliberals –as states have bolstered their security and policing arms as part of a generalised militarisation of civil protest. In other words, not only does neoliberal economic policy require the presence of a strong state, but it requires the presence of an authoritarian state (particularly where extreme forms of neoliberalism are concerned, such as the ones experimented with in periphery countries), at both the domestic and international level (see Chapter 5). 

In this sense, neoliberal ideology, at least in its official anti-state guise, should be considered little more than a convenient alibi for what has been and is essentially a political and state-driven project. Capital remains as dependent on the state today as it was under ‘Keynesianism’–to police the working classes, bail out large firms that would otherwise go bankrupt, open up markets abroad (including through military intervention), etc. 

The ultimate irony, or indecency, is that traditional left establishment parties have become standard-bearers for neoliberalism themselves, both while in elected office and in opposition. 

In the months and years that followed the financial crash of 2007–9, capital’s –and capitalism’s –continued dependency on the state in the age of neoliberalism became glaringly obvious, as the governments of the US, Europe and elsewhere bailed out their respective financial institutions to the tune of trillions of euros/dollars. 

In Europe, following the outbreak of the so-called ‘euro crisis’ in 2010, this was accompanied by a multi-level assault on the post-war European social and economic model aimed at restructuring and re-engineering European societies and economies along lines more favourable to capital. This radical reconfiguration of European societies –which, again, has seen social-democratic governments at the forefront –is not based on a retreat of the state in favour of the market, but rather on a reintensification of state intervention on the side of capital. 

Nonetheless, the erroneous idea of the waning nation state has become an entrenched fixture of the left. As we argue throughout the book, we consider this to be central in understanding the decline of the traditional political left and its acquiescence to neoliberalism. 

In view of the above, it is hardly surprising that the mainstream left is, today, utterly incapable of offering a positive vision of national sovereignty in response to neoliberal globalisation. To make matters worse, most leftists have bought into the macroeconomic myths that the establishment uses to discourage any alternative use of state fiscal capacities. 

For example, they have accepted without question the so-called household budget analogy, which suggests that currency-issuing governments, like households, are financially constrained, and that fiscal deficits impose crippling debt burdens on future generations –a notion that we thoroughly debunk in Chapter 8. 

This has gone hand in hand with another, equally tragic, development. As discussed in Chapter 5, following its historical defeat, the left’s traditional anti-capitalist focus on class slowly gave way to a liberal-individualist understanding of emancipation. Waylaid by post-modernist and post-structuralist theories, left intellectuals slowly abandoned Marxian class categories to focus, instead, on elements of political power and the use of language and narratives as a way of establishing meaning. This also defined new arenas of political struggle that were diametrically opposed to those defined by Marx. 

Over the past three decades, the left focus on ‘capitalism’ has given way to a focus on issues such as racism, gender, homophobia, multiculturalism, etc. Marginality is no longer described in terms of class but rather in terms of identity. The struggle against the illegitimate hegemony of the capitalist class has given way to the struggles of a variety of (more or less) oppressed and marginalised groups: women, ethnic and racial minorities, the LGBTQ community, etc. As a result, class struggle has ceased to be seen as the path to liberation. 

In this new post-modernist world, only categories that transcend Marxian class boundaries are considered meaningful. Moreover, the institutions that evolved to defend workers against capital –such as trade unions and social-democratic political parties –have become subjugated to these non-class struggle foci. What has emerged in practically all Western countries as a result, as Nancy Fraser notes, is a perverse political alignment between ‘mainstream currents of new social movements (feminism, anti-racism, multiculturalism, and LGBTQ rights), on the one side, and high-end “symbolic” and service-based business sectors (Wall Street, Silicon Valley, and Hollywood), on the other’. 

The result is a progressive neoliberalism ‘that mix[es] together truncated ideals of emancipation and lethal forms of financialization’, with the former unwittingly lending their charisma to the latter. 

As societies have become increasingly divided between well-educated, highly mobile, highly skilled, socially progressive cosmopolitan urbanites, and lower-skilled and less educated peripherals who rarely work abroad and face competition from immigrants, the mainstream left has tended to consistently side with the former. Indeed, the split between the working classes and the intellectual-cultural left can be considered one of the main reasons behind the right-wing revolt currently engulfing the West. 

As argued by Jonathan Haidt, the way the globalist urban elites talk and act unwittingly activates authoritarian tendencies in a subset of nationalists. In a vicious feedback loop, however, the more the working classes turn to right-wing populism and nationalism, the more the intellectual-cultural left doubles down on its liberal-cosmopolitan fantasies, further radicalising the ethno-nationalism of the proletariat. 

As Wolfgang Streeck writes: Protests against material and moral degradation are suspected of being essentially fascist, especially now that the former advocates of the plebeian classes have switched to the globalization party, so that if their former clients wish to complain about the pressures of capitalist modernization, the only language at their disposal is the pre-political, untreated linguistic raw material of everyday experiences of deprivation, economic or cultural. This results in constant breaches of the rules of civilized public speech, which in turn can trigger indignation at the top and mobilization at the bottom. 

This is particularly evident in the European debate, where, despite the disastrous effects of the EU and monetary union, the mainstream left –often appealing to exactly the same arguments used by Callaghan and Mitterrand 30–40 years ago –continues to cling on to these institutions and to the belief that they can be reformed in a progressive direction, despite all evidence to the contrary, and to dismiss any talk of restoring a progressive agenda on the foundation of retrieved national sovereignty as a ‘retreat into nationalist positions’, inevitably bound to plunge the continent into 1930s-style fascism. 

This position, as irrational as it may be, is not surprising, considering that European Economic and Monetary Union (EMU) is, after all, a brainchild of the European left (see Chapter 5). However, such a position presents numerous problems, which are ultimately rooted in a failure to understand the true nature of the EU and monetary union. 

First of all, it ignores the fact that the EU’s economic and political constitution is structured to produce the results that we are seeing –the erosion of popular sovereignty, the massive transfer of wealth from the middle and lower classes to the upper classes, the weakening of labour and more generally the rollback of the democratic and social/economic gains that had previously been achieved by subordinate classes –and is designed precisely to impede the kind of radical reforms to which progressive integrationists or federalists aspire to. 

More importantly, however, it effectively reduces the left to the role of defender of the status quo, thus allowing the political right to hegemonise the legitimate anti-systemic –and specifically anti-EU –grievances of citizens. This is tantamount to relinquishing the discursive and political battleground for a post-neoliberal hegemony –which is inextricably linked to the question of national sovereignty –to the right and extreme right. It is not hard to see that if progressive change can only be implemented at the global or even European level –in other words, if the alternative to the status quo offered to electorates is one between reactionary nationalism and progressive globalism –then the left has already lost the battle. 

It needn’t be this way, however. As we argue in the second part of the book, a progressive, emancipatory vision of national sovereignty that offers a radical alternative to both the right and the neoliberals –one based on popular sovereignty, democratic control over the economy, full employment, social justice, redistribution from the rich to the poor, inclusivity and the socio-ecological transformation of production and society –is possible. Indeed, it is necessary. 

As J. W. Mason writes: Whatever [supranational] arrangements we can imagine in principle, the systems of social security, labor regulation, environmental protection, and redistribution of income and wealth that in fact exist are national in scope and are operated by national governments. By definition, any struggle to preserve social democracy as it exists today is a struggle to defend national institutions.  

As we contend in this book, the struggle to defend the democratic sovereign from the onslaught of neoliberal globalisation is the only basis on which the left can be refounded (and the nationalist right challenged). However, this is not enough. 

The left also needs to abandon its obsession with identity politics and retrieve the ‘more expansive, anti-hierarchical, egalitarian, class-sensitive, anti-capitalist understandings of emancipation’ that used to be its trademark (which, of course, is not in contradiction with the struggle against racism, patriarchy, xenophobia and other forms of oppression and discrimination). 

Fully embracing a progressive vision of sovereignty also means abandoning the many false macroeconomic myths that plague left-wing and progressive thinkers. One of the most pervasive and persistent myths is the assumption that governments are revenue-constrained, that is, that they need to ‘fund’ their expenses through taxes or debt. This leads to the corollary that governments have to ‘live within their means’, since ongoing deficits will inevitably result in an ‘excessive’ accumulation of debt, which in turn is assumed to be ‘unsustainable’ in the long run. 

In reality, as we show in Chapter 8, monetarily sovereign (or currency-issuing) governments –which nowadays include most governments –are never revenue-constrained because they issue their own currency by legislative fiat and always have the means to achieve and sustain full employment and social justice. 

In this sense, a progressive vision of national sovereignty should aim to reconstruct and redefine the national state as a place where citizens can seek refuge ‘in democratic protection, popular rule, local autonomy, collective goods and egalitarian traditions’, as Streeck argues, rather than a culturally and ethnically homogenised society. 

This is also the necessary prerequisite for the construction of a new international( ist) world order, based on interdependent but independent sovereign states. It is such a vision that we present in this book. 



The Great Transformation Redux: From Keynesianism to Neoliberalism –and Beyond 

1 Broken Paradise: A Critical Assessment of the Keynesian ‘Full Employment’ Era 


Looking back on the 30-year-long economic expansion that followed World War II, Adam Przeworski and Michael Wallerstein concluded that ‘by most criteria of economic progress the Keynesian era was a success’. 

It is hard to disagree: throughout the West, from the mid-1940s until the early 1970s, countries enjoyed lower levels of unemployment, greater economic stability and higher levels of economic growth than ever before. That stability, particularly in the US, also rested on a strong financial regulatory framework: on the widespread provision of deposit insurance to stop bank runs; strict regulation of the financial system, including the separation of commercial banking from investment banking; and extensive capital controls to reduce currency volatility. 

These domestic and international restrictions ‘kept financial excesses and bubbles under control for over a quarter of a century’. 

Wages and living standards rose, and –especially in Europe –a variety of policies and institutions for welfare and social protection (also known as the ‘welfare state’) were created, including sustained investment in universally available social services such as education and health. Few people would deny that this was, indeed, a ‘golden age’ for capitalism. 

However, when it comes to explaining what made this exceptional period possible and why it came to an end, theories abound. Most contemporary Keynesians subscribe to a quasi-idealist view of history –that is, one that stresses the central role of ideas and ideals in human history. This is perhaps unsurprising, considering that Keynes himself famously noted: ‘Practical men who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.’ 

According to this view, the social and economic achievements of the post-war period are largely attributable to the revolution in economic thinking spearheaded by the British economist John Maynard Keynes. 

Throughout the 1920s and 1930s, Keynes overturned the old classical (neoclassical) paradigm, rooted in the doctrine of laissez-faire (‘let it be’) free-market capitalism, which held that markets are fundamentally self-regulating. The understanding was that the economy, if left to its own devices –that is, with the government intervening as little as possible –would automatically generate stability and full employment, as long as workers were flexible in their wage demands. 

The Great Depression of the 1930s that followed the stock market crash of 1929 –where minimal financial regulation, little-understood financial products and overindebted households and banks all conspired to create a huge speculative bubble which, when it burst, brought the US financial system crashing down, and with it the entire global economy –clearly challenged traditional laissez-faire economic theories. 

This bolstered Keynes’ argument –spelled out at length in his masterpiece, The General Theory of Employment, Interest, and Money, published in 1936 –that aggregate spending determined the overall level of economic activity, and that inadequate aggregate spending could lead to prolonged periods of high unemployment (what he called ‘underemployment equilibrium’). Thus, he advocated the use of debt-based expansionary fiscal and monetary measures and a strict regulatory framework to counter capitalism’s tendency towards financial crises and disequilibrium, and to mitigate the adverse effects of economic recessions and depressions, first and foremost by creating jobs that the private sector was unable or unwilling to provide. 

The bottom line of Keynes’ argument was that the government always has the ability to determine the overall level of spending and employment in the economy. In other words, full employment was a realistic goal that could be pursued at all times. 

Yet politicians were slow to catch on. When the speculative bubbles in both Europe and the United States burst in the aftermath of the Wall Street crash of 1929, various countries (to varying degrees, and more or less willingly) turned to austerity as a perceived ‘cure’ for the excesses of the previous decade. 

In the United States, president Herbert Hoover, a year after the crash, declared that ‘economic depression cannot be cured by legislative action or executive pronouncements’ and that ‘economic wounds must be healed by the action of the cells of the economic body –the producers and consumers themselves’. 

At first Hoover and his officials downplayed the stock market crash, claiming that the economic slump would be only temporary. When the situation did not improve, Hoover advocated a strict laissez-faire policy, dictating that the federal government should not interfere with the economy but rather let the economy right itself. He counselled that ‘every individual should sustain faith and courage’ and ‘each should maintain self-reliance’. 

Even though Hoover supported a doubling of government expenditure on public works projects, he also firmly believed in the need for a balanced budget. As Nouriel Roubini and Stephen Mihm observe, Hoover ‘wanted to reconcile contradictory aims: to cultivate self-reliance, to provide government help in a time of crisis, and to maintain fiscal discipline. This was impossible.’ In fact, it is widely agreed that Hoover’s inaction was responsible for the worsening of the Great Depression. 

If the United States’ reaction under Hoover can be described as ‘too little, too late’, Europe’s reaction in the late 1920s and early 1930s actively contributed to the downward spiral of the Great Depression, setting the stage for World War II. 

Austerity was the dominant response of European governments during the early years of the Great Depression. The political consequences are well known. Anti-systemic parties gained strength all across the continent, most notably in Germany. While 24 European regimes had been democratic in 1920, the number was down to eleven in 1939. 

Various historians and economists see the rise of Hitler as a direct consequence of the austerity policies indirectly imposed on Germany by its creditors following the economic crash of the late 1920s. Ewald Nowotny, the current head of Austria’s national bank, stated that it was precisely ‘the single-minded concentration on austerity policy’ in the 1930s that ‘led to mass unemployment, a breakdown of democratic systems and, at the end, to the catastrophe of Nazism’. 

Historian Steven Bryan agrees: ‘During the 1920s and 1930s it was precisely the refusal to acknowledge the social and political consequences of austerity that helped bring about not only the depression, but also the authoritarian governments of the 1930s.



Reclaiming the State. A Progressive Vision of Sovereignty for a Post-Neoliberal World


William Mitchell and Thomas Fazi.

get it at

The Tax Bill That Inequality Created – NYTimes. 

THE EDITORIAL Board, December 16, 2017

Most Americans know that the Republican tax bill will widen economic inequality by lavishing breaks on corporations and the wealthy while taking benefits away from the poor and the middle class. What many may not realize is that growing inequality helped create the bill in the first place.

As a smaller and smaller group of people cornered an ever-larger share of the nation’s wealth, so too did they gain an ever-larger share of political power. They became, in effect, kingmakers; the tax bill is a natural consequence of their long effort to bend American politics to serve their interests.

As things stand now, the top 1 percent of the population by wealth — the group that would primarily benefit from the tax bill — controls nearly 40 percent of the country’s wealth. The bottom 90 percent has just 27 percent, according to the economists Thomas Piketty, Emmanuel Saez and Gabriel Zucman.  Just three decades ago these numbers were almost exactly the reverse: The bottom 90 percent owned nearly 40 percent of all wealth. To find a time when such a tiny minority was so dominant, you have to go back to the Great Depression.

As kingmakers, rich families have supported candidates who share their hostility to progressive taxation, welfare programs and government regulation of any kind. These big-money donors have pushed the Republican Party in particular further to the right by threatening well-funded primary challenges against anybody who doesn’t toe the line on tax cuts for the rich and other pro-aristocracy policies. The power of donors has contributed to political polarization and made the federal government less responsive to the needs of most voters, a new book by Benjamin Page of Northwestern University and Martin Gilens of Princeton University argues.

The power of the one-percenters may help explain why President Trump, who ran as a populist, has not only abandoned any pretense of fighting for the working class but also joined Republicans in Congress in ripping up regulations that protect families and the environment — in order to help business tycoons. Together, they’ve tried to repeal the Affordable Care Act. Its repeal would have deprived millions of people of health insurance while trimming taxes for high-income families. Now, they want to cut taxes on corporations and offer new loopholes to the rich, even if that means hurting their own constituents by limiting the ability of middle-class families to deduct state and local taxes on their tax returns.

Most political campaigns now rely on a small group of wealthy donors who give tens of thousands of dollars or more per election cycle. About 40 percent of contributions to campaigns during the 2016 federal election came from an elite group of 24,949 donors, equivalent to 0.01 percent of the adult population. In 1980, the top 0.01 percent accounted for only 15 percent of all contributions, according to an analysis by Adam Bonica, a Stanford professor, and his collaborators.

Of course, the growing importance of wealthy donors is not exclusively a Republican phenomenon. Democratic candidates have also benefited from the largess of wealthy donors like George Soros, Tom Steyer and James Simons. But on economic and tax issues, big-money liberal donors have not really shoved their party to the far left. Donations from Wall Street and corporate America have, in fact, pushed many Democrats to the center or even to the right on issues like financial regulation, international trade, antitrust policy and welfare reform.

Further, liberal donors have been nowhere near as skillful at coordinating their giving as conservative donors have been. No liberal organization comes close to rivaling the network of donors and political activists created by the conservative Koch brothers, says Theda Skocpol, a professor at Harvard, who has written extensively about these issues. The Koch network has spent years methodically pushing state and federal lawmakers to cut regulations, taxes and government programs for the poor and the middle class. The leading donor network on the left, the Democracy Alliance, is smaller and much less successful.

Even allowing for money “wasted” on losing candidates and failed causes, the donor class has notched many impressive wins. Tax rates have fallen substantially, with the top marginal income tax rate now just below 40 percent, from 70 percent when Ronald Reagan won the presidency. The top corporate tax rate has dropped to 35 percent, from 46 percent in 1980, and many businesses pay an effective rate that is much lower than that. While supply-side economics remain mostly a Republican fiction, politicians from both parties have supported the effort to reduce taxes on capital — profits, capital gains and dividends — on the grounds that this would spur investment and make American businesses more competitive.

But the cuts have done little to bolster the economy or the working class. In fact, incomes have stagnated, and workers have been forced to part with a larger share of their pretax earnings in the form of payroll taxes.

Meanwhile, where are the political champions of poor Americans? Whoever they are, they haven’t been producing results. Wages for the poorest have languished, partly because Congress has been so slow to raise the minimum wage — $7.25 an hour since 2009 — that its purchasing power is now about 10 percent less than it was in 1968. Lawmakers and conservative judges have also undermined workers by making it harder for them to unionize, so they are not in a position to demand better pay and better working conditions.

This tax bill would exacerbate all these trends. The Urban-Brookings Tax Policy Centre and the Joint Committee on Taxation. both respected, both nonideological, say the bill would primarily benefit the wealthy and would leave most poor and middle-class Americans worse off over the long run. That’s without Congress doing anything else to widen the gap. But even now, Mr. Trump and Republicans in Congress are talking about cutting government programs like Medicare, Medicaid and Social Security next year to help make up for the more than $1 trillion the tax bill would add to the federal deficit.

Inequality in America does not have to be self-perpetuating. When people turn up at the polls, as they did recently in Alabama, they can produce unexpected results. That’s why Republican lawmakers might want to think again about whether they want to be the means through which their wealthy donors pull off this heist.

New York Times

Institute For New Economic Thinking: Why Stopping Tax “Reform” Won’t Stop Inequality – Lance Taylor. 

The past four decades, American household incomes have become strikingly more unequal, along an unsustainable path. But as of late 2017, prospects for attacking inequality are bleak, whether or not the Republican-controlled U.S. Congress manages to pass a tax cut favoring businesses and high-income households. 

Fundamental changes in income and wealth distribution will require equally fundamental changes in the way the economy generates and distributes pre-tax incomes.

What is required are policies that go beyond the tax code to shift the very balance of power between workers and employers. Doing so would allow real wages to catch up to productivity and capital gains to be more equitably shared among the population. It would shrink inequality for years to come. 

This paper looks at several key topics that relate to our country’s growing inequality and the ways in which it can be remedied.

First, it’s worth examining the likely macroeconomic effects of the tax package. They will be visible but small. Republican efforts will push up the federal deficit as a means to transfer funds to business and rich households. Growth dynamics sketched below suggest that the deficit and incomes of the rich cannot rise indefinitely. This analysis also shows how, over time, rising income inequality creates greater concentration of wealth, which is almost certainly on the cards. For rich households, wealth accumulation is driven by high saving rates from high incomes, capital gains on existing assets, and receipts from initial public offerings which are highly visible but quantitatively not so important. Over the past few decades, capital gains have been a main driver for wealth concentration.

Crucially, this analysis looks to answer why inequality has grown so steadily since around 1980. The principal cause is that wealthy “capitalist” households have benefitted from rising business profits while wage-earning “worker” households have fallen behind. Are higher profits the consequence of greater power of firms to raise prices against wages, or else their ability to hold down wages against prices? Analysis of producing sectors suggests the latter based upon the creation and extension of a vast low wage labor market. 

Growth of Income Inequality

The Cambridge University economist José Gabriel Palma has proposed a helpful measure of inequality – the ratio of the average household income for a wealthy group (for example, the wealthiest one percent) over that of a poorer group (or groups). Based on data from the well-known 2016 Congressional Budget Office study of inequality, rescaled to fit the national accounts, Figure 1 shows Palma ratios for the top one percent vs. households between the 61st and 99th percentiles of the size distribution (the “middle class”) and the sixty percent at the bottom.

The upper diagram presents ratios for total (or pre-tax) income; the lower focuses on disposable income. Either way, rising inequality stands out, although taxes and transfers cut back on the extreme ratios shown in the diagram at the top. Even for disposable income, the ratio of the rich against the middle class grew at 3.85% per year. Against the bottom group, the growth rate was 3.54%. Such rising inequality is unprecedented. These rates are a full percentage point higher than output growth, and are not sustainable in the long run. The reason is that the share of any variable (say the income of the top one percent) in the total cannot increase indefinitely. Herbert Stein’s Law “that if something cannot grow forever, it will stop” always applies in macroeconomics. 

Minimal Macro Impacts

As of this writing, precise estimates of the effects of the Republican tax cuts on household incomes are not available. Ballpark numbers show an increase of more than five percent of mean disposable income for the top one percent (more for the top 0.1 percent) with blips of less than one percent for most of the rest, all front-loaded toward early years of a ten-year program. The 2014 Palma ratio of 13 for the middle class might rise above 14, an insulting jump atop an inglorious trend. 

In round numbers, the annual disposable income of all rich households is $2 trillion. Their consumption is $1 trillion in an economy with overall demand of $20 trillion. Their extra consumption from the tax windfall might be less than $40 billion, about 0.2% of total demand. Through this channel at least, the macroeconomic boost from upper income tax reduction would be barely visible.

Business tax reductions have been sold as a means to stimulate economic growth. One way to assess possibilities is to look at how much firms are willing to spend on new capital goods (“net investment” in economists’ jargon). The US output/capital ratio is stable in the medium run so that the level of the capital stock regulates the size of the macro system. In other words, output increases track capital. Its growth also stimulates increasing labor productivity, with effects on employment and the real wage. 

Will the Republicans’ ballyhooed corporate tax cuts boost net investment? Business net acquisition of new assets (capital, cash, reduction in debt, etc.) runs in the range of a few percent of the existing capital stock. Figure 2 shows data on profits and changes in assets beginning in 1998 (the first year for which capital estimates consistent with the national accounts are readily available).

In the national accounts, “profits”’ (or “operating surplus” or “earnings’) are the difference between corporate revenue and costs of intermediate inputs, direct taxes, and labor pay. They are an income flow originating from production, as opposed to returns to holding financial claims such as stocks and bonds as discussed below. The relevant rates of return do not move together, contrary to much mainstream economic doctrine. 

Overall business profits relative to capital run between 15% and 20% (plotted in red). The green schedule shows profits net of depreciation (also called a capital consumption allowance or CCA). The yellow illustrates a further subtraction from operating surplus due to corporate taxes. Compared to depreciation, the tax bite is minimal, one or two percent of capital or four percent of value-added. Finally, payments of interest and dividends, over 40% of which flow to rich households, limit net asset accumulation (blue) to one or two percent of capital, especially in wake of the financial crisis. 

Will reducing the corporate tax bite strongly boost the ratio of net business investment to capital and so feed into higher output? No doubt a substantial proportion of higher available profits would be distributed as interest, dividends, and share buybacks. In Figure 2, the band between the green and yellow schedules represents the corporate tax burden. The yellow might shift upward by 0.01 from proposed tax cuts, shrinking the band. If in response net investment relative to capital increases by 0.005 (very much on the high side), then medium-term output expansion could go up by a similar amount – well less than the growth rate increases touted by tax cutters. 

Finally, a word on deficits and debt. Again in round numbers, Federal debt is $20 trillion and the deficit is $500 billion. The ratio implies a debt growth rate of 2.5%, similar to output growth. If the tax package initially reduces receipts by $150 billion per year but (optimistically) draws in $50 billion in extra revenue due to higher output, then the growth rate of debt would rise by 0.3%. If the output growth rate does not rise as much (as is likely) and/or interest rates go up, Stein’s Law for the debt/GDP ratio could kick in. An unsustainable debt burden would match unsustainably rising inequality. 

Root causes of Inequality 

In sum, in the short to medium run, regressive Republican tax reductions would have barely visible macroeconomic effects while providing an income fillip at the top. In the longer run, the weight of the debt burden could rise. 

As discussed later, the other side of the coin is that progressive tax/transfer policies would not strongly affect the macro situation but could ameliorate income inequality slightly. They would stimulate consumer demand because lower income households have low or negative saving rates. The trends illustrated in Figure 1 will not easily be reversed. 

To explore the possibilities, we need background on sources of pre-tax income. The upper diagram in Figure 1 shows that rich households, with a mean income exceeding $2 million per year, have 40 times the income of the bottom 60% and 13.5 times payments going to the middle class. Figure 3 shows where the one percent’s money has been coming from. 

Starting from the bottom of the bars, labor compensation has increased dramatically. It is not the main source for the top one percent, although earnings exceeding $500,000 per year in Figure 3 are not be sneezed at. To a degree they represent income from capital because they include bonuses and stock options. In the macroeconomic scheme of things, the top one percent’s labor income is not of central importance because it amounts to “only” nine percent of the total. For the top 1% it is also less than income of business proprietors, rents, CCA, etc. (second from the bottom). 

The third major component of incomes in Figure 3 is made up of financial transfers including interest and dividends deriving from holdings of financial claims. They are nourished by business profits but as noted above the linkage is not necessarily close. Labor pay, profits, and proprietors’ income etc. all enter into the national accounts. Capital gains also put money into households’ pockets but because they are not a cost of production they do not enter the national accounts. Figure 3 shows that they have added substantially to income since the 1990s (see further discussion below). 

The middle class and households with lower incomes are in different economic boats. Over 70% of middle class mean income of $180,000 comes from wages and salaries. Labor earnings and transfers each provide around 45% of the lower group’s $65,000 per year. To use traditional terms, the top one percent are close to being “capitalists;” the rest of us are “workers” subsidized by fiscal transfers. 

After the 1970s profits moved upward, as shown in Figure 4 which is based on total capital stock (periods of recession are shaded). As noted above, the output/capital ratio is fairly stable over business cycles. Both the profit share and profit rate have trended steadily up since the Reagan recession of the early 1980s. Given that the bulk of income of the top one percent comes from profits through one channel or another, the obvious inference is that the rising Palma ratios in Figure 1 were fueled by an ongoing shift away from wages in the “functional” income distribution between labor and capital. 

Lagging Real Wages 

One common explanation for the distributional shift is that real wages have not grown as fast as labor productivity. Figure 5 is an illustration. Clearly, growth of output per household has outpaced labor income. The increases in payments to labor that did occur flowed predominantly to high income households. 

The question is why wages of ordinary households lagged. Changes in institutional norms (laws, unionization and other of the game) surely played a role. Robert Solow (2015) from MIT, the doyen of mainstream macroeconomics, observes that labor suffered for reasons including “the decay of unions and collective bargaining, the explicit hardening of business attitudes, the popularity of right-to-work laws, and the fact that the wage lag seems to have begun at about the same time as the Reagan presidency all point in the same direction: the share of wages in national value added may have fallen because the social bargaining power of labor has diminished.” 

Divide-and-rule in a “fissuring” labor market, as described by David Weil (2014) is one aspect of this process. Globalization, which came to the forefront in the 2016 Presidential election, also played a role. Perhaps one-quarter of job losses in US manufacturing (the sector most open to international trade) can be explained by import competition. It bears note, however, that manufacturing provides less than ten percent of total employment. 

Goods and Services Markets vs. Labor Markets 

In macroeconomics, the crucial big market involves labor and capital. On the“sell-side,” business firms may have power to push up prices of goods and services against wages as the main source of demand. On the “buy-side,” they can hold down wages against prices. Solow, Weil, and other commentators adopt a buy-side interpretation. Many mainstream economists, however, concentrate on firms’ “monopoly power” to set prices. Looking at behavior of profits and rents in detail provides a means to assess their position 

Presumably, monopoly would show up in different profit performances across broad sectors of the economy – they would have different levels of power. The buy-side interpretation suggests that profits across sectors would trend up together. Eschewing econometrics for present purposes, we can look at the evidence graphically. 

Figure 6 shows ratios of total and sectoral business profits to total capital and value-added. The main sources of profits are manufacturing and services, trailed by trade and transport. The widely discussed information and finance and insurance sectors are lesser contributors to total profits.

Figure 7 shows ratios of the total and sectors to their own levels of capital and value-added. Ratios to capital for manufacturing and trade and transport cluster in the same range. They have an upward trend, consistent with the wage-lag interpretation of rising inequality. Finance and insurance was obviously affected strongly by the Great Recession but its ratio at the end of the period was higher than at the start. The information sector includes an anachronistic mix of publishing, movies, internet portals, and data processing. Its steady increase in profits after the dotcom crash probably does incorporate an element of monopoly power.

Compared to value-added, manufacturing, trade and transport, and (recession aside) finance and insurance show consistent upward trends. Information has enjoyed hearty profits growth. Services lag, possibly reflecting a lack of monopoly power. Taken together, at the broad sectoral level the diagrams do not provide strong support for the monopoly hypothesis. 

Real Estate and Rents 

A second strand of mainstream discussion attributes inequality to higher rents. If you want to confront that idea with macroeconomic data, you have to look at real estate. 

Somewhat confusingly, the national accounts include separate treatments of commercial real estate on one hand and consumers’ “housing services” on the other. The former shows up in the accounts for production and the latter is included in personal consumption expenditure. As noted in footnote 6, profits in real estate are estimated as a residual. They amount to about 95% of the sector’s value-added. An upward trend is consistent with wage repression. The ratio of profits to capital fell with the recession, but then recovered to a bit less than 10%. 

“Consumption of housing services” is fairly stable at a GDP share of a bit more than ten percent, trending slowly upward. Its level is inferred from visible real estate data. Three-quarters of the total is made up of “imputed” costs of owner-occupied housing. Subtracting costs gives an estimate of rents. Because it is estimated as a residual the rental share of GDP went up by around two percentage points in wake of the financial crisis due to the sharp reduction in interest payments that the Fed engineered. 

For more than two centuries, economists have recognized that rents (as well as housing services) respond to demand derived from other income flows. American income has become highly concentrated but the bulk still goes to the lower classes, explaining why ratios of real estate profits and housing consumption to capital and GDP are stable (billionaires’ towers along Manhattan’s 58th street notwithstanding). But we are talking about big numbers here, on the order of 10% of GDP, far larger than any proposed tax cuts. Over time their accumulation contributes to more concentration of wealth. 

Rising Wealth 

Wealth or net worth is the difference between the values of an economic actor’s assets and liabilities. It rises in response to positive saving and increases in prices of assets or decreases in prices of liabilities (“capital gains,” in a phrase). The accounting underlying GDP and financial tabulations sets private sector net worth equal to the sum of the value of capital, government debt, and a country’s net foreign assets. Private sector wealth can be further split between households and corporate business. Claims (stocks and bonds) issued by business are its “liabilities” and households’ or the rest of the world’s assets.

The share of wealth held by affluent households is the topic at hand. Putting together time series on the distribution of wealth is not easy. The share of the top one percent of households as estimated from expenditure survey or income tax data was around 50% just prior to the Great Depression, fell to 25% in the 1960s, and is now in the vicinity of 40%.

As shown in Figure 3, in the recent period, a main source of growth for household income has been capital gains. They feed into rising wealth. The impact can be seen from a couple of angles. One is the time path of the ratio of a share price index to business capital, emphasized by the late Yale economist James Tobin and conventionally called q. Figure 8 shows how q has varied over time. Its increase beginning in the early 1990s contributed to the large capital gains of the top one percent of households shown in Figure 3. One reason why Stein’s Law may apply to household wealth is that qwill “revert to mean” or a value close to one.

The other viewpoint is from the side of business. Because of the accounting conventions described above, households’ capital gains are corporations’ capital losses. Recall that after-tax business profits break down into financial transfers to households, CCA, and net saving (there is also a “discrepancy” due to minor transfers). Figure 9 illustrates this decomposition over time. The discrepancy is small, and takes both signs. As we have seen net business saving is also “small” – well less than a trillion dollars per year.

The Federal Reserve publishes estimates of business “holding losses” on outstanding liabilities, basically equity. The solid line shows their levels over almost 30 years. Pretty clearly, business holding losses have exceeded net saving so there has been a substantial transfer of corporate wealth to households. That is, households got more money to save while corporations suffered paper losses. 

What Is To Be Done? 

Figure 1 shows clearly it took 30 or 40 years for the present distributional mess to emerge. It may well take a similar span of time to clean it up. Progressive tax changes of $100 billion here or $50 billion there are not going to impact overall inequality. The same is true of once-off interventions such as raising the minimum wage by a few dollars per hour. 

Long-term improvement requires changes to the present situation that can cumulate over time. Following a simulation model described in an earlier paper, it is clear that the growth rate of the real wage will have to exceed productivity growth (pegged at 1.4% per year) if Palma ratios are to be forced downward. In a baseline simulation, setting wage and productivity growth rates equal holds Palmas constant. The baseline also assumes that capital gains are equal to business net asset accumulation, holding q constant. 

To do better, we can assume that real wage growth is 1.75% per year for the bottom two household groups with zero growth for the top one percent. 

Shifting economic power from business toward labor would be essential to make these changes happen.

An additional assumption is that there is a one percent annual decrease in the coefficient tying rich proprietors’ incomes to output. Tax reform would be needed to assure this result. 

Similarly, there is a one percent annual decrease in the coefficient relating financial transfers to the upper one percent to profits, i.e. firms invest more and distribute less. 

These numbers are arbitrary, but illustrative. Over 40 years, such changes would reduce disposable income Palmas by about 50%, more or less reversing the trends in Figure 1. Their effect on wealth, however, would be minimal. 

As we have seen, owners of wealth maintain their positions because their large stocks of assets generate big capital gains along with interest and dividend payments from which their saving rate is high. 

A public wealth fund could become an alternative vehicle for accumulation. Perhaps the best-known proposal is still the one put forward 65 years ago by the Swedish trade union economists Gösta Rehn and Rudolf Meidner, who wanted to extract money from firms to support workers’ pensions. An American version might be financed by a 50% tax on capital gains. It could transfer two percent of its assets each year to households with low incomes. 

The transfer would mimic a GUARANTEED MINIMUM INCOME, subject over time to asset price fluctuations. 

Figure 10 shows how the institutional changes mentioned above combined with a wealth fund would affect the economy over time. Palma ratios would steadily shift downward. With its high saving rate, an aggressive public fund could make a real dent in the concentration of wealth.

It is by no means obvious that all these progressive changes could come into place. If not, and if Republican tax plans for the rich materialize, the distributional mess will only get worse.

Final Word 

Congress’s budget and legislative proposals could only work for President Donald Trump’s “struggling families” and “forgotten people” if they would generate strong trickle-down growth. 

Structural constraints on income distribution and wealth dynamics won’t let trickle-down happen. Trump’s slogan about making America great again is for the top one percent of the income distribution – effectively a “capitalist” class – not for “workers” in the middle of the distribution or the struggling, forgotten households further down. 

I have outlined a feasible progressive alternative, which would generate broad-based progress. Progressive changes may not take hold. If not, and if Trump-style interventions materialize, the distributional mess and his “American carnage” will only get worse until Stein’s Law enters into force.

Institute for New Economic Thinking 

We’re being hurt by the fixation on economic growth at all costs – Larry Elliott. 

There had never been anything quite like the thick “pea-souper” fog that blanketed London 65 years ago. The wind dropped and the air grew damp. For five days, smoke from coal fires and power stations was trapped, making it hard to breathe. For the frail and elderly what became known as the Great Smog was deadly. Initial estimates put the death toll at 4,000.

The coal burned in the capital in 1952 turned the city into a deathtrap, but it was good for growth. It was cold and damp as well as foggy, and the more fuel that was bought, the better it was for the economy.

The same applies today. A thinktank, the New Weather Institute, estimates there will already have been 8,700 premature UK deaths this year caused by air pollution by the time of next week’s 65th anniversary. Some of them would have been avoided had more people worked from home or shared cars to the office. That would have meant fewer cars on the roads and less money spent at petrol stations. It would be good for the nation’s health but would reduce gross domestic product. As currently calculated, it would be bad for growth.

This is perverse. It is clear from the great smogs that engulfed Beijing in 2015 and New Delhi earlier this month that not all growth is good. Globally, one person dies ahead of their time every five seconds due to poor air quality. Yet the idea that success can only be measured by gross domestic product has become a fetish. When growth accelerates, it is a time for national celebration. When growth remains unchanged it is a cause for concern. When growth falls it is a time for the newsreaders to put on a long face.

Hence the response to last week’s budget, in which the Office for Budget Responsibility shaved around half a percentage point off its growth forecasts in each of the next five years. This was seen, unambiguously, as a very bad thing indeed. Commentators (me included, I hasten to add) vied with each other to find new ways of describing just how terrible it was.

Now, make no mistake, when it comes to the UK economy there is plenty to be concerned about. It is a worry that for the past decade Britain has had to work so hard just to stand still. It matters that people are taking on more debt to finance their spending habits. It is not a great idea to be investing so little and importing so much.

But it is absurd to believe that GDP provides the best – or even an accurate – picture of how well the country is really doing. Since the financial crisis, GDP has been going up, largely due to the increase in the size of the population. GDP per head is a better measure, but even then takes no account of how the growth is being divvied up. In recent decades the fruits of growth have largely been snaffled by those at the top.

GDP acts as a yardstick for things that can be measured in monetary terms, so it goes up if the defence sector exports more arms, if the City embarks on an orgy of speculation, or if betting shops double the number of fixed odds terminals. Simon Kuznets, the economist who first came up with the idea of GDP, had a point when he said it should exclude harmful things, such as military spending and advertising.

Bobby Kennedy agreed. On the campaign stump in 1968, he famously said GDP measured everything except that which made life worthwhile. “It counts special locks for our doors and the jails for the people who break them. It counts the destruction of the redwood and the loss of our natural wonder in chaotic sprawl. It counts napalm and counts nuclear warheads and armoured cars for the police to fight the riots in our cities.”

The latest GDP figure shows Britain’s economy grew by 0.4% in the third quarter of 2017. The figure includes all the things Kuznets and Kennedy abhorred, but excludes quite a lot of good things that are not counted because they are done for free.

The government could increase the size of the economy by 50% at a stroke if it included all the cleaning, cooking, childcare and other tasks around the house that are done for free. If your neighbour pays you to mow his lawn, that counts as GDP. If you mow your own lawn, it doesn’t.

At one level, the strange way in which success or failure is measured doesn’t matter all that much. As the chief economist at the Bank of England, Andy Haldane, noted in a speech earlier this week, only 10% of the public can actually define GDP. What’s more, it doesn’t seem to care too much about whether it is going up or down.

In the year or so since the EU referendum, the debate about Brexit has been framed by what the vote has meant for GDP. In the first six months, the Brexiteers thought they had the upper hand because growth averaged 0.5% a quarter. In the first half of 2017, remainers thought the pendulum had swung their way because growth slowed to 0.3%.

Both sides were assuming that people can differentiate between an economy growing by 2% a year and one growing by 1%, which they almost certainly can’t. A more relevant guide to attitudes was the recent official survey showing that the public (in England at least) got a bit happier in the year after the referendum. This probably has something to do with the continued fall in unemployment, which research has shown is more closely linked to personal wellbeing than inflation. It is, of course, possible that happiness would have been still higher had the referendum gone the other way.

But the constant use of GDP does matter because it creates a “growth at all costs” mindset. A report by the Institute for New Economic Thinking at the Oxford Martin School suggests that the upshot is the depletion of the natural world, which is not being measured or valued properly. “There is clear evidence of widespread ecosystem degradation and declining resilience in food and water systems,” it says.

In recent years there has been some recognition of the need to find a better way of measuring how things are going. There are now alternative measures of wellbeing, including national accounts that consider environmental damage. But they have not gone nearly far enough to challenge the tyranny of GDP, which is why the clincher in any argument about the economy is still that something is “bad for growth”.

As American writer Edward Abbey put it in his 1977 book The Journey Home: “Growth for the sake of growth is the ideology of the cancer cell.” He could not have been more right.

The Guardian

Rescuing Economics from Neoliberalism – Dani Rodrik. 

As even its harshest critics concede, neoliberalism is hard to pin down. In broad terms, it denotes a preference for markets over government, economic incentives over social or cultural norms, and private entrepreneurship over collective or community action. It has been used to describe a wide range of phenomena—from Augusto Pinochet to Margaret Thatcher and Ronald Reagan, from the Clinton Democrats and Britain’s New Labour to the economic opening in China and the reform of the welfare state in Sweden. 

The term is used as a catchall for anything that smacks of deregulation, liberalization, privatization, or fiscal austerity. Today it is reviled routinely as a short-hand for the ideas and the practices that have produced growing economic insecurity and inequality, led to the loss of our political values and ideals, and even precipitated our current populist backlash.

We live in the age of neoliberalism, apparently. But who are neoliberalism’s adherents and disseminators—the neoliberals? Oddly, you would almost have to go back to the early 1980s to find anyone explicitly embracing neoliberalism. In 1982, Charles Peters, the longtime editor of The Washington Monthly, published an essay called “A Neo-Liberal’s Manifesto.” It makes for interesting reading thirty-five years later, since the neoliberalism it describes bears little resemblance to today’s target of derision. The politicians whom Peters names as exemplifying the movement are not Thatcher and Reagan, but Bill Bradley, Gary Hart, and Paul Tsongas. The journalists and academics whom he lists include James Fallows, Michael Kinsley, and Lester Thurow. Peters’s neoliberals are liberals (in the U.S. sense of the word) who have dropped their prejudices in favor of unions and big government and against markets and the military.

The use of the term “neoliberal” exploded in the 1990s, when it became closely associated with two developments, neither of which Peters mentions. One was financial deregulation, which would culminate in the 2008 financial crash—the first that the United States had experienced since the interwar period—and in the still-lingering euro debacle. The second was economic globalization, which accelerated thanks to free flows of finance and to a new, more ambitious type of trade agreement. Financialization and globalization have become the most overt manifestations of neoliberalism in today’s world.

That neoliberalism is a slippery, shifting concept, with no explicit lobby of defenders, does not mean that it is irrelevant or unreal. Who can deny that the world has experienced a decisive shift toward markets from the 1980s on? Or that center-left politicians—Democrats in the United States, Socialists and Social Democrats in Europe—enthusiastically adopted some of the central creeds of Thatcherism and Reaganism, such as deregulation, privatization, financial liberalization, and individual enterprise? Much of our contemporary policy discussion remains infused with norms and principles supposedly grounded in homo economicus.

But the looseness of the term neoliberalism also means that criticism of it often misses the mark. There is nothing wrong with markets, private entrepreneurship, or incentives—when deployed appropriately. Their creative use lies behind the most significant economic achievements of our time. As we heap scorn on neoliberalism, we risk throwing out some of neoliberalism’s useful ideas.

The real trouble is that mainstream economics shades too easily into ideology, constraining the choices that we appear to have and providing cookie-cutter solutions. A proper understanding of the economics that lies behind neoliberalism would allow us to identify—and to reject—ideology when it masquerades as economic science. Most importantly it would help us develop the institutional imagination we badly need to redesign capitalism for the twenty-first century.   

Neoliberalism is typically understood as based on key tenets of mainstream economic science. To see those tenets, without the ideology, consider a thought experiment.

A well-known and highly regarded economist lands in a country he has never visited and knows nothing about. He is brought to a meeting with the country’s leading policymakers. “Our country is in trouble,” they tell him. “The economy is stagnant, investment is low, and there is no growth in sight.” They turn to him expectantly: “Please tell us what we should do to make our economy grow.”

The economist pleads ignorance and explains that he knows too little about the country to make any recommendations. He would need to study the history of the economy, to analyze the statistics, and to travel around the country before he could say anything. But his hosts are insistent. “We understand your reticence and we wish you had the time for all that,” they tell him. “But isn’t economics a science, and aren’t you one of its most distinguished practitioners? Even though you do not know much about our economy, surely there are some general theories and prescriptions you can share with us to guide our economic policies and reforms.”

The economist is now in a bind. He does not want to emulate those economic gurus he has long criticized for peddling their favorite policy advice. But he feels challenged by the question. Are there universal truths in economics? Can he say anything valid (and possibly useful)?

So he begins. The efficiency with which an economy’s resources are allocated is a critical determinant of the economy’s performance, he says. Efficiency, in turn, requires aligning the incentives of households and businesses with social costs and benefits. The incentives faced by entrepreneurs, investors, and producers are particularly important when it comes to economic growth. Growth needs a system of property rights and contract enforcement that will ensure those who invest can retain the returns on their investments. And the economy must be open to ideas and innovations from the rest of the world.

But economies can be derailed by macroeconomic instability, he goes on. Governments must therefore pursue a sound monetary policy, which means restricting the growth of liquidity to the increase in nominal money demand at reasonable inflation. They must ensure fiscal sustainability, so that the increase in public debt does not outpace national income. And they must carry out prudential regulation of banks and other financial institutions to prevent the financial system from taking excessive risk.

Now he is warming up to his task. Economics is not just about efficiency and growth, he adds. Economic principles also carry over to equity and social policy. Economics has little to say about how much redistribution a society should seek. But it does tell us that the tax base should be as broad as possible and that social programs should be designed in a way that does not encourage workers to drop out of the labor market.

By the time the economist stops, it appears as if he has laid out a full-fledged neoliberal agenda. A critic in the audience will have heard all the code words: efficiency, incentives, property rights, sound money, fiscal prudence. Yet the universal principles that the economist describes are in fact quite open-ended. They presume a capitalist economy—one in which investment decisions are made by private individuals and firms—but not much beyond that. They admit—indeed they require—a surprising variety of institutional arrangements.

So has the economist just delivered a neoliberal screed? We would be mistaken to think so, and our mistake would consist of associating each abstract term—incentives, property rights, sound money—with a particular institutional counterpart. And therein lies the central conceit, and the fatal flaw, of neoliberalism: the belief that first-order economic principles map onto a unique set of policies, approximated by a Thatcher–Reagan-style agenda.  

Consider property rights. They matter insofar as they allocate returns on investments. An optimal system would distribute property rights to those who would make the best use of an asset and afford protection against those most likely to expropriate the returns. Property rights are good when they protect innovators from free riders, but they are bad when they protect them from competition. Depending on the context, a legal regime that provides the appropriate incentives can look quite different from the standard U.S. style regime of private property rights.

This may seem like a semantic point with little practical import; but China’s phenomenal economic success is largely due to its orthodox-defying institutional tinkering. China turned to markets, but did not copy Western practices in property rights. Its reforms produced market-based incentives through a series of unusual institutional arrangements that were better adapted to the local context. Rather than move directly from state to private ownership, for example, which would have been stymied by the weakness of the prevailing legal structures, the country relied on mixed forms of ownership that provided more effective property rights for entrepreneurs in practice. Township and Village Enterprises (TVEs), which spearheaded Chinese economic growth during the 1980s, were collectives owned and controlled by local governments. Even though they were publicly owned, entrepreneurs received the protection against expropriation they needed. Local governments had a direct stake in the profits of the firms and hence did not want to kill the goose that lays the golden eggs.

China relied on a range of such innovations, each delivering the economist’s higher-order economic principles in unfamiliar institutional arrangements. Dual-track pricing, which retained compulsory grain deliveries to the state but allowed farmers to sell excess produce in free markets, provided supply-side incentives while insulating public finances from the adverse effects of full liberalization. The so-called Household Responsibility System gave farmers the incentive to invest in and improve the land they worked on, while obviating the need for explicit privatization. Special economic zones provided export incentives and attracted foreign investors without removing protection for state firms (and hence safeguarding domestic employment). In view of such departures from orthodox blueprints, calling China’s economic reforms a neoliberal turn, as critics are inclined to do, distorts more than it reveals. If we are to call this neoliberalism, we must surely look more kindly on the ideas behind the most dramatic poverty reduction in history.

One might protest that China’s institutional innovations were purely transitional. Perhaps it will have to converge on Western-style institutions to sustain its economic progress. But this common line of thinking overlooks the diversity of capitalist arrangements that still prevails among advanced economies, despite the considerable homogenization of our policy discourse.

What, after all, are Western institutions? The importance of the public sector, for example, in the club of rich Organization For Economic Cooperation and Development (OECD) countries varies from a third of the economy in Korea to nearly 60 percent in Finland. In Iceland, 86 percent of workers are members of a trade union; the comparable number in Switzerland is just 16 percent. In the United States firms can fire workers almost at will; French labor laws require employers to jump through many hoops first. Stock markets have grown to nearly one-and-a-half times national income in the United States; in Germany, they are only a third as large, representing one-half of national income.

The idea that any one of these models of taxation, labor relations, or financial organization is inherently superior to the others is belied by the varying economic fortunes that each of these economies have experienced over recent decades. The United States has gone through successive periods of angst in which its economic institutions were judged inferior to those in Germany, Japan, China, and now possibly Germany again. Certainly comparable levels of wealth and productivity can be produced under very different models of capitalism. We might even go a step further: today’s prevailing models probably come nowhere near exhausting the range of what might be possible (and desirable) in the future. 

The visiting economist in our thought experiment knows all this and recognizes that the principles he has enunciated need to be filled in with institutional detail before they become operational. Property rights? Yes, but how? Sound money? Of course, but how? It would perhaps be easier to criticize his list of principles for being vacuous than to denounce it as a neoliberal screed.

Still, these principles are not entirely content free. China, and indeed all countries that managed to develop rapidly, demonstrate their utility once they are properly adapted to local context. Conversely, too many economies have been driven to ruin courtesy of political leaders who chose to violate them. We need look no further than Latin American populists or Eastern European communist regimes to appreciate the practical significance of sound money, fiscal sustainability, and private incentives.

Of course economics goes beyond a list of abstract, largely common sense principles. Much of the work of economists consists of developing stylized models of how actual economies work and then confronting those models with evidence. Economists tend to think of what they do as progressively refining their understanding of the world: their models are supposed to get better and better as they are tested and revised over time. But progress in economics happens differently.

Economists study a social reality that is unlike the physical universe of natural scientists. It is completely man-made, highly malleable, and operates according to different rules across time and space. Economics advances not by settling on the right model or theory to answer such questions, but by improving our understanding of the diversity of causal relationships. Neoliberalism and its customary remedies—always more markets, always less government—are in fact a perversion of mainstream economics. Good economists know that the correct answer to any question in economics is: it depends.

Does an increase in the minimum wage depress employment? Yes, if the labor market is really competitive and employers have no control over the wage they must pay to attract workers; but not necessarily otherwise. Does trade liberalization increase economic growth? Yes, if it increases the profitability of industries where the bulk of investment and innovation takes place; but not otherwise. Does more government spending increase employment? Yes, if there is slack in the economy and wages do not rise; but not otherwise. Does monopoly harm innovation? Yes and no, depending on a whole host of market circumstances.

In economics, new models rarely supplant older models. The basic competitive-markets model dating back to Adam Smith has been modified over time by the inclusion, in rough historical order, of monopoly, externalities, scale economies, incomplete and asymmetric information, irrational behavior, and many other real world features. Yet the older models remain as useful as ever. Understanding how real markets operate necessitates different lenses at different times.

Perhaps maps offer the best analogy. Just like economic models, maps are highly stylized representations of reality. They are useful precisely because they abstract from many real world details that would get in the way. Realistic full-scale maps would be hopelessly impractical artifacts, as Jorge Luis Borges described in a short story that remains the best and most succinct explication of the scientific method. But abstraction also implies that we need a different map depending on the nature of our journey. If we are traveling by bike, we need a map of bike trails. If we are to go on foot, we need a map of foot paths. If a new subway is constructed, we will need a subway map—but we wouldn’t throw out the older maps.      

Economists tend to be very good at making maps, but not good enough at choosing the one most suited to the task at hand. When confronted with policy questions of the type our visiting economist faces, too many of them resort to “benchmark” models that favor laissez-faire. Knee-jerk solutions and hubris replace the richness and humility of the discussion in the seminar room. John Maynard Keynes once defined economics as the “science of thinking in terms of models joined to the art of choosing models which are relevant.” Economists typically have trouble with the “art” part.

I have illustrated this too with a parable. A journalist calls an economics professor for his view on whether free trade is a good idea. The professor responds enthusiastically in the affirmative. The journalist then goes undercover as a student in the professor’s advanced graduate seminar on international trade. He poses the same question: Is free trade good? This time the professor is stymied. “What do you mean by ‘good?’” he responds. “And good for whom?” The professor then launches into an extensive exegesis that will ultimately culminate in a heavily hedged statement: “So if the long list of conditions I have just described are satisfied, and assuming we can tax the beneficiaries to compensate the losers, freer trade has the potential to increase everyone’s well being.” If he is in an expansive mood, the professor might add that the effect of free trade on an economy’s long-term growth rate is not clear either and would depend on an altogether different set of requirements.

This professor is rather different from the one the journalist encountered previously. On the record, he exudes self-confidence, not reticence, about the appropriate policy. There is one and only one model, at least as far as the public conversation is concerned, and there is a single correct answer regardless of context. Strangely, the professor deems the knowledge that he imparts to his advanced students to be inappropriate (or dangerous) for the general public. Why?

The roots of such behavior lie deep in the sociology and the culture of the economics profession. But one important motive is the zeal to display the profession’s crown jewels in untarnished form—market efficiency, the invisible hand, comparative advantage—and to shield them from attack by self-interested barbarians, namely the protectionists. Unfortunately, these economists typically ignore the barbarians on the other side of the issue—financiers and multinational corporations whose motives are no purer and who are all too ready to hijack these ideas for their own benefit.

As a result, economists’ contributions to public debate are often biased in one direction, in favor of more trade, more finance, and less government. That is why economists have developed a reputation as cheerleaders for neoliberalism, even if mainstream economics is very far from a paean to laissez-faire. The economists who let their enthusiasm for free markets run wild are in fact not being true to their own discipline.


How then should we think about globalization in order to liberate it from the grip of neoliberal practices? We must begin by understanding the positive potential of global markets. Access to world markets in goods, technologies, and capital has played an important role in virtually all of the economic miracles of our time. China is the most recent and powerful reminder of this historical truth, but it is not the only case. Before China, similar miracles were performed by South Korea, Taiwan, Japan, and a few non-Asian countries such as Chile and Mauritius. All of these countries embraced globalization rather than turn their backs on it, and they benefited handsomely.

Defenders of the existing economic order will quickly point to these examples when globalization comes into question. What they will fail to say is that almost all of these countries joined the world economy by violating neoliberal strictures. China shielded its large state sector from global competition, establishing special economic zones where foreign firms could operate with different rules than in the rest of the economy. South Korea and Taiwan heavily subsidized their exporters, the former through the financial system and the latter through tax incentives. All of them eventually removed most of their import restrictions, long after economic growth had taken off. But none, with the sole exception of Chile in the 1980s under Pinochet, followed the neoliberal recommendation of a rapid opening­-up to imports. Chile’s neoliberal experiment eventually produced the worst economic crisis in all of Latin America. While the details differ across countries, in all cases governments played an active role in restructuring the economy and buffeting it from a volatile external environment. Industrial policies, restrictions on capital flows, and currency controls—all prohibited in the neoliberal playbook—were rampant.

By contrast, countries that stuck closest to the neoliberal model of globalization were sorely disappointed. Mexico provides a particularly sad example. Following a series of macroeconomic crises in the mid-1990s, Mexico embraced macroeconomic orthodoxy, extensively liberalized its economy, freed up the financial system, sharply reduced import restrictions, and signed the North American Free Trade Agreement (NAFTA). These policies did produce macroeconomic stability and a significant rise in foreign trade and internal investment. But where it counts—in overall productivity and economic growth—the experiment failed. Since undertaking the reforms, overall productivity in Mexico has stagnated, and the economy has underperformed even by the undemanding standards of Latin America.

These outcomes are not a surprise from the perspective of sound economics. They are yet another manifestation of the need for economic policies to be attuned to the failures to which markets are prone, and to be tailored to the specific circumstances of each country. No single blueprint fits all.


Before globalization took a turn towards what we might call hyper-globalization, the rules were flexible and recognized this fact. Keynes and his colleagues viewed international trade and investment as a means for achieving domestic economic and social goals—full employment and broad-based prosperity—when they designed the global economic architecture in Bretton Woods in 1944. From the 1990s on, however, globalization became an end in itself. Global economic arrangements were now driven by a single-minded focus on reducing impediments to the flows of goods, capital, and money across national borders—though not of workers, where the economic gains in fact would have been much larger. 

This perversion of priorities revealed itself in the way trade agreements began to reach behind borders and remake domestic institutions. Investment regulations, health and safety rules, environmental policies, and industrial promotion schemes all became potential targets for abolition if they were deemed to stand in the way of foreign trade and investment. Large international firms, rendered footloose by the new rules, acquired special privileges. Corporate taxes had to be lowered to attract investors (or prevent them from leaving). Foreign enterprises and investors were given the right to sue national governments in special offshore tribunals when changes in domestic regulations threatened to reduce their profits. Nowhere was the new deal more damaging than in financial globalization, which produced not greater investment and growth, as promised, but one painful crash after another.

Just as economics must be saved from neoliberalism, globalization has to be saved from hyper-globalization. An alternative globalization, more in keeping with the Bretton Woods spirit, is not difficult to imagine: a globalization that recognizes the multiplicity of capitalist models and therefore enables countries to shape their own economic destinies. Instead of maximizing the volume of trade and foreign investment and harmonizing away regulatory differences, it would focus on traffic rules that manage the interface of different economic systems. It would open up policy space for advanced countries as well as developing ones—the former so they can reconstruct their social bargains through better social, tax, and labor market policies, and the latter so they can pursue the restructuring they need for economic growth. It would require more humility on the part of economists and policy technocrats about appropriate prescriptions, and hence a much greater willingness to experiment.


As Peters’s early manifesto attests, the meaning of neoliberalism has changed considerably over time as the label has acquired harder-line connotations with respect to deregulation, financialization, and globalization. But there is one thread that connects all versions of neoliberalism, and that is the emphasis on economic growth. Peters wrote in 1982 that the emphasis was warranted because growth is essential to all our social and political ends—community, democracy, prosperity. Entrepreneurship, private investment, and removing obstacles (such as excessive regulation) that stand in the way were all instruments for achieving economic growth. If a similar neoliberal manifesto were penned today, it would no doubt make the same point.

Critics often point out that this emphasis on economics debases and sacrifices other important values such as equality, social inclusion, democratic deliberation, and justice. Those political and social objectives obviously matter enormously, and in some contexts they matter the most. They cannot always, or even often, be achieved by means of technocratic economic policies; politics must play a central role.

But neoliberals are not wrong when they argue that our most cherished ideals are more likely to be attained when our economy is vibrant, strong, and growing. Where they are wrong is in believing that there is a unique and universal recipe for improving economic performance to which they have access. The fatal flaw of neoliberalism is that it does not even get the economics right. It must be rejected on its own terms for the simple reason that it is bad economics.

Boston Review 

The General Theory at 80: Reflections on the History and Enduring Relevance of Keynes’ Economics – Matias Vernengo. 

New paper by Thomas Palley. From the abstract:

This paper reflects on the history and enduring relevance of Keynes’ economics. Keynes unleashed a devastating critique of classical macroeconomics and introduced a new replacement schema that defines macroeconomics. The success of the Keynesian revolution triggered a counter-revolution that restored the classical tradition and now enforces a renewed classical monopoly. That monopoly has provided the intellectual foundations for neoliberalism which has produced economic and political conditions echoing the 1930s. Openness to Keynesian ideas seems to fluctuate with conditions, and current conditions are conducive to revival of the Keynesian revolution. However, a revival will have to overcome the renewed classical monopoly.

Read full paper here.

Naked Capitalism 

The Moral Identity of Homo Economicus – Ricardo Hausmann.

Two recent books indicate that a quiet revolution is challenging the foundations of the dismal science, promising radical changes in how we view many aspects of organizations, public policy, and even social life. As with the rise of behavioral economics, this revolution emanates from psychology.


CAMBRIDGE – Why do people vote, if doing so is costly and highly unlikely to affect the outcome? Why do people go above and beyond the call of duty at their jobs?

Two recent books – Identity Economics by Nobel laureate George Akerlof and Rachel Kranton and The Moral Economy by Sam Bowles – indicate that a quiet revolution is challenging the foundations of the dismal science, promising radical changes in how we view many aspects of organizations, public policy, and even social life. As with the rise of behavioral economics (which already includes six Nobel laureates among its leaders), this revolution emanates from psychology. But while behavioral economics relies on cognitive psychology, this one is rooted in moral psychology.

As with most revolutions, this one is not happening because, as Thomas Huxley surmised, a beautiful old theory has been killed by ugly new facts. The ugly facts have been apparent for a while, but people cannot abandon one mental framework unless another one can take its place: in the end, beautiful old theories are killed only by newer, more powerful theories.

For a long time, economic theory aspired to the elegance of Euclidean geometry, where all true statements can be derived from five apparently incontrovertible axioms, such as the notion that there is only one line that connects two points in space. In the nineteenth century, mathematicians explored the consequences of relaxing one of those axioms and discovered the geometries of curved spaces, where an infinite number of longitudinal lines can pass through the poles of a sphere.

The axioms underpinning traditional economics embody a view of human behavior known as homo economicus: we choose among the available options that which we want or prefer the most. But what makes us want or prefer something?

Economics has long assumed that whatever informs our preferences is exogenous to the issue at hand: de gustibus non est disputandum, as George Stigler and Gary Becker argued. But with a few reasonable assumptions, such as the idea that more is better than less, you can make many predictions about how people will behave.

The behavioral economics revolution questioned the idea that we are good at making these judgments. In the process, they subjected the assumptions underlying homo economicus to experimental tests and found them wanting. But this led at most to the idea of nudging people into better decisions, such as forcing them to opt out of rather than into better choices.

The new revolution may have been triggered by an uncomfortable finding of the old one. Consider the so-called ultimatum game, in which a player is given a sum of money, say, $100. He must offer a share of that money to a second player. If the latter accepts the offer, both get to keep the money. If not, they both get nothing.

Homo economicus would give $1 to the second player, who should accept the offer, because $1 is better than zero dollars. But people throughout the world tend to reject offers below $30. Why?

The new revolution assumes that when we make choices, we do not merely consider which of the available options we like the most. We are also asking ourselves what we ought to do.

In fact, according to moral psychology, our moral sentiments, on which Adam Smith wrote his other famous book, evolved to regulate behavior. We are the most cooperative species on earth because our feelings evolved to sustain cooperation, to put “us” before “me.” These feelings include guilt, shame, outrage, empathy, sympathy, dread, disgust, and a whole cocktail of other sentiments. We reject offers in the ultimatum game because we feel they are unfair.

Akerlof and Kranton propose a simple addition to the conventional economic model of human behavior. Besides the standard selfish elements that define our preferences, they argue that people see themselves as members of “social categories” with which they identify. Each of these social categories – for example, being a Christian, a father, a mason, a neighbor, or a sportsman – has an associated norm or ideal. And, because people derive satisfaction from behaving in accordance with the ideal, they behave not just to acquire, but also to become.

Bowles shows that we have distinct frameworks for analyzing situations. In particular, giving people monetary incentives may work in market-like situations. But, as a now-famous study of Haifa daycare centers showed, imposing fines on people who picked up their kids late actually had the opposite effect: if a fine is like a price, people may find that it is a price worth paying.

But without the fine, coming late constitutes impolite, rude, or disrespectful behavior toward the caregivers, which self-respecting people would avoid, even without fines. Unfortunately, this other-regarding view of behavior has been de-emphasized both in the corporate and the public domain. Instead, strategies have been derived from the view that all our behaviors are selfish, with the intellectual challenge being to design “incentive-compatible” mechanisms or contracts, an effort that has also been recognized with Nobel Prizes.

But, as George Price showed long ago, Darwinian evolution may have made us altruistic, at least toward people we perceive as members of the group we call “us.” The new revolution in economics may find a place for strategies based on affecting ideals and identities, not just taxes and subsidies. In the process, we may understand that we vote because that is what citizens ought to do, and we excel at our jobs because we strive for respect and self-realization, not just a raise.

If successful, the new revolution may lead to strategies that make us more responsive to our better angels. Economics and our view of human behavior need not be dismal. It may even become inspirational.


Ricardo Hausmann, a former minister of planning of Venezuela and former Chief Economist of the Inter-American Development Bank, is Director of the Center for International Development at Harvard University and a professor of economics at the Harvard Kennedy School.

Project Syndicate

How the actual magic money tree works – Zoe Williams.

Shock data shows that most UK MPs do not know how money is created. Responding to a survey commissioned by Positive Money just before the June election, 85% were unaware that new money was created every time a commercial bank extended a loan, while 70% thought that only the government had the power to create new money.

The results are only a shock if you didn’t see the last poll of MPs on exactly this topic, in 2014, revealing broadly the same level of ignorance. Indeed, the real shock is that MPs still, without embarrassment, answer surveys.

Yet almost all our hot-button political issues, from social security to housing, relate back to the meaning and creation of money; so if the people making those choices don’t have a clue, that isn’t without consequence.

How is money created?

Some is created by the state, but usually in a financial emergency. For instance, the crash gave rise to quantitative easing – money pumped directly into the economy by the government. The vast majority of new money (97%) comes into being when a commercial bank extends a loan. Meanwhile, 27% of bank lending goes to other financial corporations; 50% to mortgages (mainly on existing residential property); 8% to high-cost credit (including overdrafts and credit cards); and just 15% to non-financial corporates, that is, the productive economy.

What’s wrong with that?

On the corporate financial side, bank-lending inflates asset prices, which concentrates wealth in the hands of the wealthy. On the mortgage side, house prices rise to meet the amount the lender is prepared to lend, rather than being moored to wages. The lender benefits enormously from larger mortgages and longer periods of indebtedness; the homeowner benefits slightly from a bigger asset, but obviously spends longer in debt servitude; the renter loses out completely.

Is there a magic money tree?

All money comes from a magic tree, in the sense that money is spirited from thin air. There is no gold standard. Banks do not work to a money-multiplier model, where they extend loans as a multiple of the deposits they already hold. Money is created on faith alone, whether that is faith in ever-increasing housing prices or any other given investment. This does not mean that creation is risk-free: any government could create too much and spawn hyper-inflation. Any commercial bank could create too much and generate over-indebtedness in the private economy, which is what has happened. But it does mean that money has no innate value, it is simply a marker of trust between a lender and a borrower. So it is the ultimate democratic resource. The argument marshalled against social investment such as education, welfare and public services, that it is unaffordable because there is no magic money tree, is nonsensical. It all comes from the tree; the real question is, who is in charge of the tree?

What could we do instead?

We could do QE for the people, overt monetary financing in which a government creates money for social benefit, such as green infrastructure or education. Or helicopter money, a central bank distributing it to everyone, either in a one-off citizen’s dividend or a regular citizen’s basic income. The nature of centrally created money should itself be opened up for debate, whose starting point is: if we agree that commercially created money is skewing the economy, can we then agree that it should be created by a public authority, even if we don’t yet know what that authority would look like.

The Guardian


New Zealanders like to think that we are, in most respects, up with – if not actually ahead of – the play. Sadly, however, as a new government is about to emerge, there is no sign that our politicians and policymakers are aware of recent developments in a crucial area of policy, and that, as a result, we are in danger of missing out on opportunities that others have been ready to take.


The story starts, at least in its most recent form, with two important developments. First, there is the now almost universal recognition that the vast majority of money in circulation is not – as most people once believed – notes and coins issued on behalf of the government by the Reserve Bank, but is actually created by the commercial banks through the credit they advance, using bank entries rather than cash, and usually on mortgage.


The truth of this proposition, so long denied, is now explicitly accepted by the Bank of England, and was – as long ago as 1994 – explained in a letter written by our own Reserve Bank to an enquirer, and stating in terms that 97% of the money included in the usually used definition of money known as M3 is created by the commercial banks.


The proposition is endorsed by the world’s leading monetary economists – Lord Adair Turner, the former chair of the UK’s Financial Services Authority and Professor Richard Werner of Southampton University, to name but two. These men are not snake-oil salesmen, to be easily dismissed. They have been joined by leading financial journalists, such as Martin Wolf of the Financial Times.


The second development was the use by western governments around the world of “quantitative easing” in the aftermath of the Global Financial Crisis. “Quantitative easing” was a sanitised term to describe what is often pejoratively termed “printing money” – but, whatever it is called, it was new money created at the behest of the government and used to bail out the banks by adding it to their balance sheets.


These two developments, not surprisingly, generated a number of unavoidable questions about monetary policy. If banks could create billions in new money for their own profit-making purposes, (they make their money by charging interest on the money they create), why could governments not do the same, but for public purposes, such as investment in new infrastructure and productive capacity?


And if governments were indeed to create new money through “quantitative easing”, why could that new money not be applied to purposes other than shoring up the banks?


The conventional answer to such questions (and the one invariably given in New Zealand by supposed experts in recent times) is that “printing money” will be inflationary – though it is never explained why it is miraculously non-inflationary when the new money is created by bank loans on mortgage or is applied to bail out the banks.


But, in any case, the master economist, John Maynard Keynes, had got there long before the closed minds and had carefully explained that new money could not be inflationary if it was applied to productive purposes so that new output matched the increased money supply. Nor was there any reason why the new money should not precede the increased output, provided that the increased output materialised in due course.


Those timorous souls who doubt the Keynesian argument might care to look instead at practical experience. Franklin Delano Roosevelt used exactly this technique to increase investment in American industry in the year or two before the US entered the Second World War. It was that substantial boost to American industrial capacity that was the decisive factor in allowing the Allies to win the war.


And the great Japanese (and Keynesian) economist, Osamu Shimomura, (almost unknown in the West), took the same approach in advising the post-war Japanese government on how to re-build Japanese industry in a country devastated by defeat and nuclear bombs.


The current Japanese Prime Minister, Shinzo Abe, is a follower of Shimomura. His policies, reapplied today, have Japan growing, after years of stagnation, at 4% per annum and with minimal inflation.


Our leaders, however, including luminaries of both right and left, some with experience of senior roles in managing our economy – and in case it is thought impolite to name them I leave it to you to guess who they are – prefer to remain in their fearful self-imposed shackles, ignoring not only the views of experts and the experience of braver leaders in other countries and earlier times, but – surprisingly enough – denying even our own home-grown New Zealand experience.


Many of today’s generation will have forgotten or be unaware of the brave and successful initiative taken by our Prime Minister in the 1930s – the great Michael Joseph Savage. He created new money with which he built thousands of state houses, thereby bringing an end to the Great Depression in New Zealand and providing decent houses for young families (my own included) who needed them.


Who among our current leaders would disown that hugely valuable legacy?


Bryan Gould, 2 October 2017



Shares v houses. The winner is clear – Mary Holm.

You will no doubt have read Brian Gaynor’s recent column in which he says: “Thirty years ago, on Friday, September 18, 1987, the long-standing NZX benchmark index reached an all-time high of 3968.89. This capital index, which is now called the S&P/NZX 50 index, has never returned to this level and is still 8 per cent below its 1987 high.”
This doesn’t quite fit with your mantra that you have to be in the share market for at least 10 years to avoid the lows, does it? However, there have been good dividends on a lot of shares along the way, so all is not totally lost.
Will you admit now that property (including rents) has been the better investment over the past four decades?
Still, I wouldn’t be putting any bets on the property market continuing the ridiculous run of the past few years over the next decade. For the sake of our children, I hope it levels out for a while and gets back to a reasonable ratio to median income.


No, I won’t “admit” any such thing. As you say, the index Gaynor writes about doesn’t include dividends. And that makes a bigger difference than you apparently realise.

Our graph shows this clearly. Although the New Zealand share index excluding dividends (S&P NZX50 Capital) has indeed gone nowhere since the 87 crash, the index that includes dividends (S&P NZX50 Gross) has quadrupled. And it would have grown a bit more if there had been an index that included dividends in the 1980s. We had only the Barclays Top 40 – which excluded dividends – until 1991.

Why on earth would you exclude dividends in share returns? Some people spend dividends rather than reinvesting them, but they’re still part of the return. Excluding dividends is like excluding rent in rental property returns.

But hang on a minute. Isn’t that what the graph does? The QV Housing Index shows growth of detached housing valuations. Why haven’t we included rent?

When you stop to think about it, that’s not doable. There’s data on average rents. But unlike shares, rental property comes with ongoing expenses such as rates, insurance and maintenance, which can be huge when you have to replace a roof or something.

Also, most landlords – except those who have owned a rental for many years – pay mortgage interest. In fact, many landlords find that expenses including interest total more than rent, and they make ongoing losses. And the tendency for that to happen will increase when mortgage interest rises. Their investments make sense only when they sell the property at a profit.

Taking all this into account, there’s no way to come up with representative numbers for net rental income. On average they will probably be positive, but how big?

All we can say is that the graph shows total returns on New Zealand shares since the end of 1979 are twice as big as house price increases. Shares look a better bet to me.

Okay, you might say, but the graph also shows that shares are much more volatile, adding to risk.

True, most landlords take on a different sort of risk, by borrowing to invest – something that few share investors do.

Borrowing ups the ante. If the investment goes well, you get gains on the bank’s money as well as your own. But what if you’re forced to sell – perhaps because you lose your job – when house prices are down? If your mortgage is bigger than the proceeds of your sale, you can end up with no investment and owing the bank. It happens.

Even if you sell the property at a gain, does it more than cover your losses over the years because of interest and expenses?

The added risk from borrowing can certainly make rental property a bigger worry than shares.

And there are other ways that shares are less risky:

• If you also own your home, your investments are in a different market.

• It’s much easier to spread your risk by owning many different shares than many different properties.

• It’s also much easier to invest offshore, which also spreads risk.

• You can easily drip-feed money into shares, removing the risk that you invest the lot at the top of a cycle.

• If you need some money, you can sell any portion of your share investments. Even if you own several rental properties, you can cash them in only in big lumps.

On top of all that, investing in a wide range of shares or a share fund – the best way to do it – is much less hassle than a rental property. You’re not going to get the 2am phone call from the tenants saying the washing machine has flooded the house, or the news that your tenants have used the house as a P lab.

Then there are the disputes. In 2016, 16,600 landlords and 2300 tenants made complaints to the Tenancy Tribunal, and many more were resolved in mediation. You don’t get that with shares.

Our graph also shows:

• Sometimes the New Zealand and international share markets (MSCI World Accumulated Index) move roughly together, but sometimes they are quite different. New Zealand had the 1980s boom and bust, and world markets had the turn-of-the-century tech bubble bursting. It’s wise to have some of your share investments in local shares and some offshore.

• You write of my “mantra” that nearly always a share market will gain over a 10-year period. In the graph that’s generally true, but with some exceptions. If you invest just before a crash – in the local market in 1987, or the world market in 2000 – you are barely ahead a decade later, although things come right quite soon after.

You can get around this problem by drip-feeding money into shares over time, as happens automatically with KiwiSaver. Then only a small proportion of your money will “fail” the 10-year test.

NZ Herald


Stealing From Our Children. The real dilemma of growth and the need for New Economics – Kamal K. Kothari & Chitra Chandrasekhar. 

“In a very rapidly changing scenario, with a burgeoning population, fast-changing demographic profile, and growth aspirations of people around the world putting pressure on natural resources, our economic thoughts and practices have to change.”



In the beginning there was nothing, no human beings, no animals, no trees, no oceans, no earth, no sun, no stars, not even space or time. A quantum fluctuation leading to the Big Bang almost 14 billion years ago sowed the seeds of the Universe and space and time, as we know it. In the initial phase, stars, black holes, and galaxies were formed. The Earth, our home planet, was born almost 10 billion years later, about 4 billion years ago. It was then a fiery ball and took almost 1 billion years to cool down. Seeds of life sprouted about 3 billion years ago, some say spontaneously, while others hold a view through panspermia, no one knows for sure.

While the earth was cooling, life forms were evolving and the planet was undergoing cataclysmic changes. Continents were shifting and breaking apart, ocean floors were rising and sinking, volcanoes were erupting. Forests, animals, fishes, amphibians came and disappeared, so much so that according to some, 99.9% of the species in existence since beginning of life on Earth have ceased to exist. These changes, over a period of hundreds of millions of years, left us the legacy of natural resources—coal, crude oil, natural gas— and minerals so necessary for industrial processes and evolution of a technological civilisation.

Life forms continued to evolve. Humans came on the scene. No one is sure, but it is said that human sub-species evolved about half a million years ago in the African Savannah. With human civilisations, human aspiration too continued to develop and grow, perhaps slowly, if we were to compare it with the developments in the last 100 years.

The advent of the Industrial Revolution, which started in Europe around 1760, brought in its wake a transformation. Progress brought about by technology encouraged a shift from primarily an agricultural world to an industrial one. Rapid shifts took place in many parts of the world, mainly Europe and North America, and in the earlier part of the last century, in Japan. Such shifts are now taking place in parts of Asia, mainly India and China, Latin America, and Africa. These changes, by themselves great achievements for mankind, have led to a burgeoning population and major demographic changes. An off-shoot of this technological progress has been that more intensive and concentrated methods of food production are required for supporting technological societies and longer human life spans, stemming from better healthcare. 

About the time of the birth of Jesus Christ, the planet supported a population of about 200 million human beings, which, by the early 19th century i.e. in a period of about 1,830 years touched a billion people. In another 185 years, we have expanded 7-fold to over 7.2 billion people and we are still continuing to expand. The advent of technological changes and exploitation of natural resources has improved the living conditions of human beings, and on an average a human being lives better, is better fed, and better educated than any other time in the history of mankind.

All this has been brought about by scientific advances in different fields such as Quantum Physics, Relativity, Material Sciences, Chemistry, Agricultural Sciences, and so on and so forth.

The list is endless.

However, a large population and better living standards have created their own challenges in fields as diverse as economics, social sciences, ecology, and environment. At the heart of these is the rapid exploitation of natural resources, be it in the form of energy-generating resources like coal or crude oil, mineral resources like ores, or environmental resources, which are being degraded in the pursuit of economic growth.

These issues are well known, and have been discussed in various fora for decades now. The first Club of Rome report, Limits to Growth, which was published in 1972, raises many issues pertinent to these changes. That landmark report and subsequent Club of Rome reports, which generated extensive debates in the 1970s, now lie peacefully buried in the archives of libraries around the world. While these issues are still relevant, it is not the intent of this book to reiterate them. 

Along with technological progress, economic theories evolved as well. A key aspect of economic theories was better and more efficient utilisation of resources, be it capital, land or labour. These concepts and theories optimized utilisation of resources and went a long way in improving the living standards of mankind across the world.

These economic theories, which have served us well for many decades now, need a relook, particularly from the point of view of sustainability. If we lived in a world where resources were infinite or virtually limitless in relation to our consumption, we would have had no issues. But that is indeed not the case, more so, as our population and resource consumption have been expanding exponentially. Using current methods of economic analysis, capital allocation really promotes gross long-term inefficiencies in our resource utilisation. If we continue with these approaches, our societies would become unsustainable.

The authors have long held the view that not only do our economic theories lead to unsustainable development, but really amount to stealing from our future generations. We compare our society to a rich man who sells his family silver to sustain his lifestyle and in the end leaves practically nothing for his children. What is worse in our case is that we would leave our children a huge debt, which they would have to pay. This book will provide enough evidence that our economic and capital allocation models do the same thing: promote current consumption at the cost of future generations. The problem is further compounded by the short-sightedness of the political class in most nations of the world where the focus seems to be the next year, the next election, or in non-democratic societies, growth in personal wealth or stature. Similarly, the corporate world around us generally thinks of the next quarter, the next shareholders’ meet, and the bonuses, which the top managers can persuade the Boards and shareholders to pay them. Few think of the long-term strategies for the company, and fewer still about long-term sustainability issues.

Most businesses use capital allocation models to optimise their working. Similar concepts are, at least theoretically, used by countries (where their leaders are not driven by political considerations, which is not often) to utilise national resources. Few realise the pitfalls of such models.  So wide is the use of these models that working of all banks would come to a standstill if somehow these formulae were to be erased from their computers.

Capital allocation models are generally skewed in favour of current consumption. They place a premium on current consumption and earlier use of the resources vis-à-vis saving them for the future generations. For example, if we can pump a barrel of oil now and its price is US$100, our benefit (less the pumping out cost, which we for the sake of simplicity assume to be zero) is US$100. But if we leave the same barrel of oil underground so that someone else can use it 50 years later at a 10% cost of capital, the value of the same barrel of oil today is 85 cents. If we were more farsighted and do not use it for 100 years, the present value falls to 0.7 cents. So our incentive is in using the resource as fast as possible. Of course, in doing this analysis we conveniently forget that nature took several hundred million years to generate the same barrel of oil.

Another way of looking at the same situation is, if, for the sake of argument, through some technological breakthrough it is possible to extract 100 barrels of oil after 50 years, but if the field were to be exploited now, only 1 barrel could be extracted and the remaining 99 barrels are lost forever. Managers would still find it desirable to extract that one barrel of oil now, notwithstanding the fact that future generations would lose 99 barrels of oil. This example may sound extreme, but analogous decisions are routinely taken globally. As a result, the rate of consumption of natural resources is so high that the world reserves of many key resources would be exhausted in a couple of generations. As these resources get exhausted, their availability would decline, although this fall would be generally gradual. But a fall in resource availability would impact industrial production as well as all the consequences that would inevitably result from it.

Everybody would be impacted. No one would be spared. But youngsters in their twenties and thirties, with 30 to 40 years of working life remaining, would be most affected. Their hopes, aspiration and dreams of a comfortable and peaceful retirement after years and years of hard work would stand shattered as money, not backed by availability of goods and services, would lose value as its purchasing power falls.

The aim of this book is to bring out the deep lacunae in our economic thought and practices. The existing economic practices were developed when natural resources were plentiful, the global population small, and natural resource consumption minuscule in relation to the reserves. But in a very rapidly changing scenario, with a burgeoning population, fast-changing demographic profile, and growth aspirations of people around the world putting pressure on natural resources, our economic thoughts and practices have to change.

No change is without associated pain. We are all comfortable with the present thought processes, which predict steady and sustained growth based on the implicit assumption that resources are unlimited. But the reality is that we live in a finite world with limited resources, and after that reality is factored in, none of these projections hold true. And the sooner we realise this, the better it is and perhaps less painful too.

This book is divided into two sections. The first section, The Context, highlights the world we live in and how fast we are consuming our resources and impacting the environment. Some readers may find The Context grim and depressing, but we have painted the picture as we see it based on the best available information. We would request such readers bear with us or simply move on to the next part, The New Economic Paradigm, and then come back to The Context. In the second part, The New Economic Paradigm, we have suggested a new approach to our economic theories, which would lead to a more sustainable world.


“Humans are extremely intelligent and yet extremely foolish. They have failed to perceive the inter-linkages in the Web of Life; remove a few links and the Web could collapse, threatening their own existence.”


Stealing From Our Children. The real dilemma of growth and the need for New Economics – Kamal K. Kothari and Chitra Chandrasekhar. 

get it from

The new American Dream: rent your home from a hedge fund – Simon Black. 

About a month ago I joined the Board of Directors of a publicly-traded company that invests in US real estate.

The position brings a lot of insight into what’s happening in the US housing market. And from what I’m seeing, the transformation that’s taking place today is extraordinary.

Buying and renting out single-family homes has long been the mainstay investment of small, individual investors.

The big banks and hedge funds pretty much monopolize everything else. They own the stock market. They own the bond market. They own all the commercial real estate. They even own the farmland.

Single-family homes were one of the last bastions of investment freedom for the little guy.

But all that’s changing now.

Last week a huge merger was announced between Invitation Homes (owned by private equity giant Blackstone Group) and Starwood Waypoint Homes (owned by real estate giant Starwood Capital).

If the deal goes through, the combined entity would be the largest owner of single-family homes in the United States with a portfolio worth over $20 billion.

And this is only the latest merger in an ongoing trend.

Three years ago, for example, American Homes 4 Rent bought Beazer Pre-Owned Rental Homes, creating another enormous player. A few months later, Starwood Waypoint bought Colony American Homes.

And of course, Blackstone was one of the first institutional investors to start buying distressed homes, forking over around $10 billion on houses since the Great Financial Crisis.

At one point, Blackstone was reportedly spending $150 million a week on houses.

There are some medium-tier players coming into the market as well. A friend of mine runs a fund that owns about 2,000 rental homes in Texas, and he’s buying every property he can find.

I called him for his perspective on what’s happening in the housing market. Here’s what he told me:

There are lots of little guys assembling portfolios of 10-100 homes. And I like to buy these guys out because they have much higher funding costs than us.

And, eventually, as we get larger, medium-sized funds like mine will get bought out by Blackstone and the other mega players.

In short, medium-sized funds are buying up all the little guys. And mega-funds like Blackstone are buying up all the medium-sized funds.

This means there’s essentially an ‘arms race’ building among the world’s biggest funds to control the market, squeezing small, individual investors out of the housing market.

Then there’s the situation for renters.

US Census Bureau statistics show that, over the past decade, the number of rental households has been rising steadily while the number of homeowner households has been falling.

In other words, the American Dream of owning your own home has been fading.

It’s easy to understand why:

US consumer debt is at an all-time high of over $1 trillion (mostly credit card debt), with an additional $1.3 trillion in federal student loans.

Americans… especially younger people, are far too heavily indebted to be able to save any money for a down payment.

Moreover, despite all the hoopla about the low unemployment rate in the US, wages are totally stagnant.

(Plus bear in mind that most of the jobs created have been for waiters and bartenders!)

So the average guy isn’t making any more money, or able to save anything… all while home prices soar to record levels as major funds gobble up the supply.

This means that the new reality in America, especially for young people, is that if you’re lucky enough to not be living in your parents’ basement, you’ll be relegated to renting your house from Blackstone.

But… there is some interesting opportunity in all of this.

With a supply of more than 17 million rental homes in the United States, there’s a LONG way to go for this trend to play out. We’re still in the early stages of the mega-fund consolidation.

And some savvy little guys are figuring out how to cash in on this trend.

Think about it: mega-funds don’t have the capacity to buy up homes one at a time. They just don’t have the time.

They need to buy homes in big volume… hundreds, even thousands at a time. And they’re willing to pay a premium if they can buy in bulk.

That’s why medium-sized funds like the one my friend runs in Texas are basically assembling large portfolios with the sole purpose of flipping everything to the mega-funds.

But smaller investors can play this game too.

Medium-sized funds need to buy in bulk as well. They don’t have the time or resources to buy up homes one at a time.

This creates a unique, niche opportunity for individual investors to assemble small portfolios, say, 10 properties, with the sole purpose of flipping to medium-sized funds.

We know some people already doing this. They essentially put several single-family homes under contract simultaneously (with only a small deposit on each home).

But, BEFORE they close, they make arrangements to flip the entire package of homes to a medium-sized fund through a double-escrow closing.

This structure guarantees a neat profit to the small investor while requiring limited up-front capital.

And like most great investment opportunities, it’s been very lucrative so far because very few people are doing it.

Why a capital gains tax should capture the family home – Mark Lister. 

A capital gains tax is back on the agenda by the sound of it, if we see a change of government. This should worry property owners more than share investors, as they probably have more to lose.

Shares are misunderstood in New Zealand. Many people think the market is somewhat of a lottery, and the only way to do well is by being lucky enough to pick a few winners that go up in value.

The reality is quite different. Over the past 20 years’ NZ shares have delivered a return of 8.5 per cent per annum. However, most of that return is from boring old dividends rather than capital gains, 71 per cent, to be precise.

That’s important, because it means a capital gains tax would only impact the other bit. The vast bulk of the return already attracts income tax at the investors’ marginal rate. In short, share investors are already paying tax on more than two thirds of their return, which is probably a lot more than many property investors.

It’s harder to quantify how the returns for property are split between rental income and capital gain, but I suspect they are skewed much more toward the latter.

The gross dividend yield for the NZX 50 index is 5.5 per cent, whereas the average rental yield across New Zealand is just 3.8 per cent. In Auckland, it’s even lower at only 2.8 per cent, according to QV.

Contrary to popular belief, it seems shares are often the asset class of choice for investors looking for steady income. Property arguably holds more appeal to those after a quick capital gain and looking to make use of easy leverage.

Most share investors I come across are investing for income, rather than chasing big capital gains. They want a passive earnings stream that will grow steadily and keep pace with the cost of living.

Fortuitously, the local market is quite useful in this regard. It is dominated by predictable businesses that generate strong cash flows and pay a good portion of these out as dividends.

These companies have already paid tax on their profits so rather than be taxed a second time, investors get something called an imputation credit. This means the cash dividend they receive is, for the most part, tax paid. It’s actually a very good system, and we are one of the few countries to do things this way.

A capital gains tax might have some merit. It would certainly force people to focus more on the cash flows an asset generates, which theoretically should mean things are valued more appropriately.

It would need to be implemented sensibly though. That means making it free from exclusions (including the family home), otherwise such loopholes leave it open to exploitation and accounting trickery.

Labour leader Jacinda Arden, however, has ruled out including the family home in any capital gains tax policy.

It should also go hand-in hand with a corresponding decrease in our income tax rates. That’s the whole point right? To tilt things away from the wage and income earners, and shift more of the burden onto those focussing solely on capital gains?

– Mark Lister is Head of Private Wealth Research at Craigs Investment Partners. 

NZ Herald 

What Does Gareth Morgan Really Believe? – Bryan Bruce. 

Last Friday I sat down with Gareth Morgan to talk about why he had started The Opportunities Party and to try to gain a better understanding of his policies.

It’s the first of what I intend will be a series of conversations with politicians leading up to this year’s General Election.

I use the word “conversations” rather than “interviews” because as you will see the style is that I listen to what the person has to say for quite a long time before asking some searching questions.

If you don’t want to watch my  whole conversation with Gareth here are some highlights.

Gareth ultimately wants to give everyone, rich or poor, $200 a week unconditionally as a basic income. He acknowledges he cannot do this all in one go, so he wants to start with 18 to 25 year olds and families with young children.

He says no one would be short changed. If you are on a benefit that is more than $200 you would continue to get it.

Where does he propose to get the money for the UBI for young people from? By taxing the superannuation of over 65 year olds.

All pensioners would get the first $10,000 as of right, the next $10,000 would be subject to a means test. So if you are a wealthy oldie you won’t get the second $10,000 – that money instead would go to younger people as a UBI. 

He also proposes to tax people every year for living in a house they own because he wants to tax the total equity of a person i.e. a wealth tax.

During the conversation you will hear me raise a number of issues which I think are flaws in Gareth’s scheme – but he doesn’t.

For instance , if you are over 65 , receiving the superannuation and living in your own house you would have to pay tax each year on the estimated value of your property.

Now, unlike Gareth a great many superannuitants are not wealthy and will not be unable to pay the tax because they don’t earn enough each year.

No problem says Gareth.

The yearly house tax owed would roll over until you die. The trouble is, if you live for a long time then the State could end up owning your house and you would have nothing to leave to your children or grand children.

Do you think that’s fair?

Gareth thinks so, because he “doesn’t believe in inheritance”. 

He also says that he doesn’t have any preferred coalition partners. He will work with any government that will instigate some of his flagship policies.

I put it to him that if voters cast their vote for TOP then it is a vote for uncertainty (as it is with NZ First) because they will not know what government he is prepared cooperate with until after the election.

He doesn’t see that as a problem.

I of course do see it as a problem because I think voters want to have a very good idea of what kind of coalition government they are electing before they vote.

As you will hear – while I understand why Gareth wants to propose this radical tax reform I do think there are more than a few fish hooks in his plan –  some of which I raise with him on camera and some I didn’t because if people don’t buy into his main proposals then arguing about details that would then  never happen would have been a waste of his time and mine.

I appreciate Gareth took the time to have this conversation and  I have to say, I did enjoy it.

Bryan Bruce talks with Gareth Morgan

How to Use Fiscal and Monetary Policy to Make Us Rich Again – Tom Streithorst. 

The easiest way to return to Golden Age tranquility and equality is to empower fiscal policy.

During the post war Golden Age, from 1950 to 1973, US median real wages more than doubled. Today, they are lower than they were when Jimmy Carter was president. If you want an explanation why Americans are pessimistic about their future, that is as good a reason as any. In a recent article, Noah Smith examines the various causes of the slide in labor’s share of national income and finds most explanations wanting. With a blind spot common amongst economists he doesn’t even investigate the most obvious: politics.

Take a look at this chart. From the end of World War II, productivity rose steadily. Until the 1972 recession wages went up alongside it. Both dipped, both recovered and then, right around the time Ronald Reagan became President, productivity continued its upward trajectory but wages stopped following. If wages had continued to track productivity increases, the average American would earn twice as much as he does today and America would undoubtedly be a calmer and happier nation.

Collectively we are richer than we were 40 years ago, as we should be, considering the incredible advances in technology since them, but today the benefits of productivity increases no longer go to workers but rather to owners of stocks, bonds, and real estate. Wages don’t go up, but asset prices do. Rising productivity, that is to say the ability to make more goods and services with fewer inputs of labor and capital should make us all more prosperous. That it hasn’t can only be a distributional issue.

The timing suggests Ronald Reagan had something to do stagnating wages. That makes sense. Reagan cut taxes on the rich, deregulated the economy, eviscerated the labor unions and created the neoliberal order that still rules today. But perhaps an even more significant change is the tiny, technical and tedious shift from fiscal to monetary policy.

Government has two ways of affecting the economy: monetary and fiscal policy. The first involves the setting of interest rates, the other government tax and spending policy. Both fiscal and monetary policy work by putting money in people’s pockets so they will spend and thereby stimulate the economy but fiscal focuses on workers while monetary mostly benefits the already rich. Since Ronald Reagan, even under Democratic presidents, monetary has been the policy of choice. No wonder wages stopped going up but real estate, stock and bond prices have gone through the roof. During the Golden Age we shared the benefits of technological progress through wages gains. Since Reagan, we have allocated them through asset price inflation.

Fiscal policy, by increasing government spending, creates jobs and so raises wages even in the private sector. Monetary policy works mostly through the wealth effect. Lower interest rates almost automatically raise the value of stocks, bonds, and other real assets. Fiscal policy makes workers richer, monetary policy makes rich people richer. This, I suspect, explains better than anything else why monetary policy, even extreme monetary policy remains more respectable than even conventional monetary policy.

During the Golden Age, fiscal was king. Wages rose steadily and everybody was richer than their parents. Recessions were short and shallow. Economic policy makers’ primary task was insuring full unemployment. Anytime unemployment rose over a certain level, a government spending boost or tax cut would get the economy going again. And since firms were confident the government would never allow a steep downturn, they were ready and willing to invest in new technology and increased productive capacity. The economy grew faster (and more equitably) than it ever has before or since.

During the 1960s, Keynesian economists thought they could “fine tune” the economy, using Philips curve trade offs between inflation and unemployment. Stagflation in the 1970s shattered that optimism. Inflation went up but so did unemployment. New Classical economists decided in the long run, Keynesian stimulus couldn’t increase GDP, it could only accelerate inflation. Keynesianism stopped being cool. According to Robert Lucas, graduate students, would “snicker” whenever Keynesian concepts were mentioned.

In policy circles, Keynesians were replaced by monetarists, acolytes of Milton “Inflation is always and everywhere a monetary phenomenon” Friedman. Volcker in America and Thatcher in Britain decided the only way to stomp out inflationary expectations was to cut the money supply. This, despite their best efforts, they were unable to do. Controlling the money supply proved almost impossible but monetarism gave Volcker and Thatcher the cover to manufacture the deepest recession since the Great Depression.

By raising interest rates until the economy screamed Volcker and Thatcher crushed investment and allowed unemployment to rise to levels unthinkable just a few years before. Businessmen, union leaders, and politicians pleaded for a rate cut but the central bankers were implacable. Ending inflationary expectations was worth the cost, they insisted. Volcker and Thatcher succeed in crushing inflation, not by cutting the money supply, but rather with an old fashioned Phillips curve trade off. Workers who fear for their jobs don’t ask for cost of living increases. Inflation was history.

The Federal Funds Rate hit 20% in 1980. Now even after a few hikes, it is barely over 1%. The story of the past 30 years is of the most stimulative monetary policy in history. Anytime the economy stumbled, interest rate cuts were the automatic response. Other than military Keynesianism and tax cuts, fiscal policy was relegated to the ash heap of history. Reagan of course combined tax cuts with increased military spending but traditional peacetime infrastructure stimulus was tainted by the 1970s stagflation and for policymakers remained beyond the pale.

Fiscal stimulus came back, momentarily, at the peak of the financial crisis. China’s investment binge combined with Obama’s stimulus package probably stopped the Great Recession from being as catastrophic as the Great Depression but by 2010, fiscal stimulus was replaced by its opposite, austerity. According to elementary macroeconomics, when the private sector is cutting back its spending, as it was still doing in the wake of the financial crisis, government should increase its spending to take up the slack. But Obama in America, Cameron in Britain and Merkel in the EU insisted that government cut spending, even as the private sector continued to retrench.

It is rather shocking, for anyone who has taken Econ 101 that in 2010, when the global economy had barely recovered from the worst recession since the Great Depression, politicians and pundits were calling for lower deficits, higher taxes and less government spending even as monetary policy was maxed out. Rates were already close to zero so central banks had no more room to cut.

So, instead of going to the tool box and taking out their tried and tested fiscal kit, which would have created jobs and had the added benefit of improving infrastructure, policymakers instead invented Quantitative Easing, which in essence is monetary policy on steroids. Central Banks promised to buy bonds from the private sector, increasing their price, thereby shoveling money towards bond owners. The idea was that by buying safe assets they would push the private sector to buy riskier assets and by increasing bank reserves they would stimulate lending but the consequence of all the Quantitative Easings is that all of the benefits of growth since the financial crisis have gone to the top 5% and most of that to the top 0.1%.

A feature or a bug? The men who rule the planet are happy that most of us think economics is boring, that we would much rather read about R Kelly’s sexual predilections than about the difference between fiscal and monetary policy but were we to remember that spending money on infrastructure or health care or education would create jobs, raise wages, and create demand which the economy craves, we would have a much more equitable world.

One cogent objection to stimulative fiscal policy is that it has the potential to be inflationary. Indeed the fundamental goal of macroeconomic policy is to match the economy’s demand to its ability to supply. If fiscal policy gets out of hand (as arguably it did in the 1960s when Lyndon Johnson tried to fund both his Great Society and the Vietnam war without raising taxes), demand could outstrip supply, creating inflation. But should that happen, we have the monetary tools to cure any inflationary pressure. Rates today are still barely above zero. Should inflation threaten, central banks can raise interest rates and nip it in the bud.

Fiscal and monetary policy both have a place in policymakers’ toolkits. Perhaps the ideal combination would be to use fiscal to stimulate the economy and monetary to cool it down. Both Brexit and Trump should have told elites that unless they share the benefits of growth, a populist onslaught could threaten all our prosperity. The easiest way to return to Golden Age tranquility and equality is to empower fiscal policy to invest in our future and create jobs today.

2017 August 6

Democracy in Chains: The Deep History of the Radical Right’s Stealth Plan for America – Nancy Maclean. 

In 1955 the U.S. Supreme Court issued its second Brown v. Board of Education ruling, calling for the dismantling of segregation in public schools with “all deliberate speed.”

Thirty-seven-year-old James McGill Buchanan liked to call himself a Tennessee country boy. No less a figure than Milton Friedman had extolled Buchanan’s potential. As Colgate Whitehead Darden Jr., the president of the University of Virginia reviewed the document, he might have wondered if the newly hired economist had read his mind. For without mentioning the crisis at hand, Buchanan’s proposal put in writing what Darden was thinking: Virginia needed to find a better way to deal with the incursion on states’ rights represented by Brown.

States’ rights, in effect, were yielding in preeminence to individual rights. It was not difficult for either Darden or Buchanan to imagine how a court might now rule if presented with evidence of the state of Virginia’s archaic labor relations, its measures to suppress voting, or its efforts to buttress the power of reactionary rural whites by underrepresenting the moderate voters of the cities and suburbs of Northern Virginia. Federal meddling could rise to levels once unimaginable.

What the court ruling represented to Buchanan was personal. Northern liberals—the very people who looked down upon southern whites like him, he was sure—were now going to tell his people how to run their society. And to add insult to injury, he and people like him with property were no doubt going to be taxed more to pay for all the improvements that were now deemed necessary and proper for the state to make.

Find the resources, he proposed to Darden, for me to create a new center on the campus of the University of Virginia, and I will use this center to create a new school of political economy and social philosophy. It would be an academic center, rigorously so, but one with a quiet political agenda: to defeat the “perverted form” of liberalism that sought to destroy their way of life, “a social order,” as he described it, “built on individual liberty,” a term with its own coded meaning but one that Darden surely understood. The center, Buchanan promised, would train “a line of new thinkers” in how to argue against those seeking to impose an “increasing role of government in economic and social life.”

Buchanan fully understood the scale of the challenge he was undertaking and promised no immediate results. But he made clear that he would devote himself passionately to this cause.

Buchanan’s team had no discernible success in decreasing the federal government’s pressure on the South all the way through the 1960s and ’70s. But take a longer view—follow the story forward to the second decade of the twenty-first century—and a different picture emerges, one that is both a testament to Buchanan’s intellectual powers and, at the same time, the utterly chilling story of the ideological origins of the single most powerful and least understood threat to democracy today: the attempt by the billionaire-backed radical right to undo democratic governance.

A quest that began as a quiet attempt to prevent the state of Virginia from having to meet national democratic standards of fair treatment and equal protection under the law would, some sixty years later, become the veritable opposite of itself: a stealth bid to reverse-engineer all of America, at both the state and the national levels, back to the political economy and oligarchic governance of midcentury Virginia, minus the segregation.

The goal of all these actions was to destroy our institutions, or at least change them so radically that they became shadows of their former selves?

This, then, is the true origin story of today’s well-heeled radical right, told through the intellectual arguments, goals, and actions of the man without whom this movement would represent yet another dead-end fantasy of the far right, incapable of doing serious damage to American society.

When I entered Buchanan’s personal office, part of a stately second-floor suite, I felt overwhelmed. There were papers stacked everywhere, in no discernible order. Not knowing where to begin, I decided to proceed clockwise, starting with a pile of correspondence that was resting, helter-skelter, on a chair to the left of the door. I picked it up and began to read. It contained confidential letters from 1997 and 1998 concerning Charles Koch’s investment of millions of dollars in Buchanan’s Center for Study of Public Choice and a flare-up that followed.

Catching my breath, I pulled up an empty chair and set to work. It took me time—a great deal of time—to piece together what these documents were telling me. They revealed how the program Buchanan had first established at the University of Virginia in 1956 and later relocated to George Mason University, the one meant to train a new generation of thinkers to push back against Brown and the changes in constitutional thought and federal policy that had enabled it, had become the research-and-design center for a much more audacious project, one that was national in scope. This project was no longer simply about training intellectuals for a battle of ideas; it was training operatives to staff the far-flung and purportedly separate, yet intricately connected, institutions funded by the Koch brothers and their now large network of fellow wealthy donors. These included the Cato Institute, the Heritage Foundation, Citizens for a Sound Economy, Americans for Prosperity, FreedomWorks, the Club for Growth, the State Policy Network, the Competitive Enterprise Institute, the Tax Foundation, the Reason Foundation, the Leadership Institute, and more, to say nothing of the Charles Koch Foundation and Koch Industries itself.

I learned how and why Charles Koch first became interested in Buchanan’s work in the early 1970s, called on his help with what became the Cato Institute, and worked with his team in various organizations. What became clear is that by the late 1990s, Koch had concluded that he’d finally found the set of ideas he had been seeking for at least a quarter century by then—ideas so groundbreaking, so thoroughly thought-out, so rigorously tight, that once put into operation, they could secure the transformation in American governance he wanted. From then on, Koch contributed generously to turning those ideas into his personal operational strategy to, as the team saw it, save capitalism from democracy—permanently.

In his first big gift to Buchanan’s program, Charles Koch signaled his desire for the work he funded to be conducted behind the backs of the majority. “Since we are greatly outnumbered,” Koch conceded to the assembled team, the movement could not win simply by persuasion. Instead, the cause’s insiders had to use their knowledge of “the rules of the game”—that game being how modern democratic governance works—“to create winning strategies.” A brilliant engineer with three degrees from MIT, Koch warned, “The failure to use our superior technology ensures failure.” Translation: the American people would not support their plans, so to win they had to work behind the scenes, using a covert strategy instead of open declaration of what they really wanted.

Future-oriented, Koch’s men (and they are, overwhelmingly, men) gave no thought to the fate of the historical trail they left unguarded. And thus, a movement that prided itself, even congratulated itself, on its ability to carry out a revolution below the radar of prying eyes (especially those of reporters) had failed to lock one crucial door: the front door to a house that let an academic archive rat like me, operating on a vague hunch, into the mind of the man who started it all.

What animated Buchanan, what became the laser focus of his deeply analytic mind, was the seemingly unfettered ability of an increasingly more powerful federal government to force individuals with wealth to pay for an increasing number of public goods and social programs they had had no personal say in approving. Better schools, newer textbooks, and more courses for black students might help the children, for example, but whose responsibility was it to pay for these improvements? The parents of these students? Others who wished voluntarily to help out? Or people like himself, compelled through increasing taxation to contribute to projects they did not wish to support? To Buchanan, what others described as taxation to advance social justice or the common good was nothing more than a modern version of mob attempts to take by force what the takers had no moral right to: the fruits of another person’s efforts. In his mind, to protect wealth was to protect the individual against a form of legally sanctioned gangsterism. Where did this gangsterism begin? Not in the way we might have expected him to explain it to Darden: with do-good politicians, aspiring attorneys seeking to make a name for themselves in constitutional law, or even activist judges. It began before that: with individuals, powerless on their own, who had figured out that if they joined together to form social movements, they could use their strength in numbers to move government officials to hear their concerns and act upon them.

The only fact that registered in his mind was the “collective” source of their power—and that, once formed, such movements tended to stick around, keeping tabs on government officials and sometimes using their numbers to vote out those who stopped responding to their needs. How was this fair to other individuals? How was this American?

Even when conservatives later gained the upper hand in American politics, Buchanan saw his idea of economic liberty pushed aside. Richard Nixon expanded government more than his predecessors had, with costly new agencies and regulations, among them a vast new Environmental Protection Agency. George Wallace, a candidate strongly identified with the South and with the right, nonetheless supported public spending that helped white people. Ronald Reagan talked the talk of small government, but in the end, the deficit ballooned during his eight years in office.

Had there not been someone else as deeply frustrated as Buchanan, as determined to fight the uphill fight, but in his case with much keener organizational acumen, the story this book tells would no doubt have been very different. But there was. His name was Charles Koch. An entrepreneurial genius who had multiplied the earnings of the corporation he inherited by a factor of at least one thousand, he, too, had an unrealized dream of liberty, of a capitalism all but free of governmental interference and, at least in his mind, thus able to achieve the prosperity and peace that only this form of capitalism could produce. The puzzle that preoccupied him was how to achieve this in a democracy where most people did not want what he did.

Ordinary electoral politics would never get Koch what he wanted. Passionate about ideas to the point of obsession, Charles Koch had worked for three decades to identify and groom the most promising libertarian thinkers in hopes of somehow finding a way to break the impasse. He subsidized and at one point even ran an obscure academic outfit called the Institute for Humane Studies in that quest. “I have supported so many hundreds of scholars” over the years, he once explained, “because, to me, this is an experimental process to find the best people and strategies.”

The goal of the cause, Buchanan announced to his associates, should no longer be to influence who makes the rules, to vest hopes in one party or candidate. The focus must shift from who rules to changing the rules. For liberty to thrive, Buchanan now argued, the cause must figure out how to put legal—indeed, constitutional shackles on public officials, shackles so powerful that no matter how sympathetic these officials might be to the will of majorities, no matter how concerned they were with their own reelections, they would no longer have the ability to respond to those who used their numbers to get government to do their bidding. There was a second, more diabolical aspect to the solution Buchanan proposed, one that we can now see influenced Koch’s own thinking. Once these shackles were put in place, they had to be binding and permanent. The only way to ensure that the will of the majority could no longer influence representative government on core matters of political economy was through what he called “constitutional revolution.”

By the late 1990s, Charles Koch realized that the thinker he was looking for, the one who understood how government became so powerful in the first place and how to take it down in order to free up capitalism—the one who grasped the need for stealth because only piecemeal, yet mutually reinforcing, assaults on the system would survive the prying eyes of the media, was James Buchanan.

The Koch team’s most important stealth move, and the one that proved most critical to success, was to wrest control over the machinery of the Republican Party, beginning in the late 1990s and with sharply escalating determination after 2008. From there it was just a short step to lay claim to being the true representatives of the party, declaring all others RINOS—Republicans in name only. But while these radicals of the right operate within the Republican Party and use that party as a delivery vehicle, make no mistake about it: the cadre’s loyalty is not to the Grand Old Party or its traditions or standard-bearers. Their loyalty is to their revolutionary cause.

Our trouble in grasping what has happened comes, in part, from our inherited way of seeing the political divide. Americans have been told for so long, from so many quarters, that political debate can be broken down into conservative versus liberal, pro-market versus pro-government, Republican versus Democrat, that it is hard to recognize that something more confounding is afoot, a shrewd long game blocked from our sight by these stale classifications.

The Republican Party is now in the control of a group of true believers for whom compromise is a dirty word. Their cause, they say, is liberty. But by that they mean the insulation of private property rights from the reach of government, and the takeover of what was long public (schools, prisons, western lands, and much more) by corporations, a system that would radically reduce the freedom of the many. In a nutshell, they aim to hollow out democratic resistance. And by its own lights, the cause is nearing success.

The 2016 election looked likely to bring a big presidential win with across-the-board benefits. The donor network had so much money and power at its disposal as the primary season began that every single Republican presidential front-runner was bowing to its agenda. Not a one would admit that climate change was a real problem or that guns weren’t good, and the more widely distributed, the better. Every one of them attacked public education and teachers’ unions and advocated more charter schools and even tax subsidies for religious schools. All called for radical changes in taxation and government spending. Each one claimed that Social Security and Medicare were in mortal crisis and that individual retirement and health savings accounts, presumably to be invested with Wall Street firms, were the best solution.

Although Trump himself may not fully understand what his victory signaled, it put him between two fundamentally different, and opposed, approaches to political economy, with real-life consequences for us all. One was in its heyday when Buchanan set to work. In economics, its standard-bearer was John Maynard Keynes, who believed that for a modern capitalist democracy to flourish, all must have a share in the economy’s benefits and in its governance. Markets had great virtues, Keynes knew—but also significant built-in flaws that only government had the capacity to correct.

As a historian, I know that his way of thinking, as implemented by elected officials during the Great Depression, saved liberal democracy in the United States from the rival challenges of fascism and Communism in the face of capitalism’s most cataclysmic collapse. And that it went on to shape a postwar order whose operating framework yielded ever more universal hope that, by acting together and levying taxes to support shared goals, life could be made better for all.

The most starkly opposed vision is that of Buchanan’s Virginia school. It teaches that all such talk of the common good has been a smoke screen for “takers” to exploit “makers,” in the language now current, using political coalitions to “vote themselves a living” instead of earning it by the sweat of their brows. Where Milton Friedman and F. A. Hayek allowed that public officials were earnestly trying to do right by the citizenry, even as they disputed the methods, Buchanan believed that government failed because of bad faith: because activists, voters, and officials alike used talk of the public interest to mask the pursuit of their own personal self-interest at others’ expense. His was a cynicism so toxic that, if widely believed, it could eat like acid at the foundations of civic life. And he went further by the 1970s, insisting that the people and their representatives must be permanently prevented from using public power as they had for so long. Manacles, as it were, must be put on their grasping hands.

Is what we are dealing with merely a social movement of the right whose radical ideas must eventually face public scrutiny and rise or fall on their merits? Or is this the story of something quite different, something never before seen in American history? Could it be—and I use these words quite hesitantly and carefully—a fifth-column assault on American democratic governance?

The term “fifth column” has been applied to stealth supporters of an enemy who assist by engaging in propaganda and even sabotage to prepare the way for its conquest.

This cause is different. Pushed by relatively small numbers of radical-right billionaires and millionaires who have become profoundly hostile to America’s modern system of government, an apparatus decades in the making, funded by those same billionaires and millionaires, has been working to undermine the normal governance of our democracy. Indeed, one such manifesto calls for a “hostile takeover” of Washington, D.C. That hostile takeover maneuvers very much like a fifth column, operating in a highly calculated fashion, more akin to an occupying force than to an open group engaged in the usual give-and-take of politics. The size of this force is enormous. The social scientists who have led scholars in researching the Koch network write that it “operates on the scale of a national U.S. political party” and employs more than three times as many people as the Republican committees had on their payrolls in 2015.

For all its fine phrases, what this cause really seeks is a return to oligarchy, to a world in which both economic and effective political power are to be concentrated in the hands of a few. It would like to reinstate the kind of political economy that prevailed in America at the opening of the twentieth century, when the mass disfranchisement of voters and the legal treatment of labor unions as illegitimate enabled large corporations and wealthy individuals to dominate Congress and most state governments alike, and to feel secure that the nation’s courts would not interfere with their reign. The first step toward understanding what this cause actually wants is to identify the deep lineage of its core ideas. And although its spokespersons would like you to believe they are disciples of James Madison, the leading architect of the U.S. Constitution, it is not true.

Their intellectual lodestar is John C. Calhoun. He developed his radical critique of democracy a generation after the nation’s founding, as the brutal economy of chattel slavery became entrenched in the South, and his vision horrified Madison.


Democracy in Chains: The Deep History of the Radical Right’s Stealth Plan for America 

by Nancy Maclean

Nancy K. MacLean is an American historian. She is the William H. Chafe Professor of History and Public Policy at Duke University and the author of numerous books and articles on various aspects of twentieth-century United States history.

get it from Amazon

How the Postal System and the Printing Press Transformed European Markets – Prateek Raj. 

In the sixteenth century, the Northwest European region of England and the Low Countries underwent transformational change. In this region, a bourgeois culture emerged and cities like Antwerp, Amsterdam, and London became centers of institutional and business innovation, whose accomplishments have influenced the modern world.

For example, one of the first permanent commodity bourses was established in Antwerp in 1531, the first stock exchange emerged in Amsterdam in 1602, and joint stock companies became a promising form of organizing business in London in the late sixteenth century. The sixteenth century transformation was followed by the seventeenth century Dutch Golden Age, and the eighteenth century English Industrial Revolution. What made the Northwest region of Europe so different? The question remains a central concern in social sciences, with scholars from diverse fields researching the subject.

The medieval power of merchant guilds

Markets don’t function well if they are ridden with frictions like lack of information, lack of trust, or high transaction costs. In the presence of frictions, business is often conducted via relationships.

Until the end of the fifteenth century, impartial institutions like courts and police that serve all parties generally—so ubiquitous today in the developed world—weren’t well developed in Europe. In such a world without impartial institutions, trade often was (is) heavily dependent on relationships and conducted through networks like merchant guilds. Such relationship-based trade through dense networks of merchant guilds reduced concerns of information access and reliability. Not surprisingly, because the merchant guild system was an effective system in the absence of strong formal institutions, it sustained in Europe for several centuries. In developing countries like India, lacking in developed formal institutions, networked institutions like castes still play an important role in business.

Before the fourteenth century, merchant guild networks were probably less hierarchical, more voluntary, and more inclusive. But, with time, merchant guilds started to become exclusive monopolies, placing high barriers to entry for outsiders, and they began to resemble cartels with close involvement in local politics. There were two reasons why these guilds erected such tough barriers to entry:

  • Repeated committed interaction was the key to effectiveness of merchant guilds. Uncommitted outsiders could behave opportunistically and undermine the reliability of the system. Therefore, outsiders faced restrictions.
  • Outsiders threatened the position of existing businessmen by increasing competition. So, even genuinely committed outsiders could be restricted to enter as they threatened the domination of existing members.

But, in the sixteenth century, the merchant guild system began to lose its significance as more impersonal markets, where traders could directly trade without the need of an affiliation, began to emerge and rulers stopped granting privileges to merchant guilds. The traders began to rely less on networked and collective institutions like merchant guilds, and directly initiated partnerships with traders who they may not have known well. For example, in Antwerp the domination of intermediaries (called hostellers) who would connect foreign traders declined. Instead, the foreign traders began to conduct such trades directly with each other in facilities like bourses.

Emergence of markets in the 16th century

In a new working paper, I study the emergence of impersonal markets in Europe during the sixteenth century. I survey the 50 largest European cities during the fourteenth through sixteenth centuries and codify the nature of sixteenth century economic institutions in each of the cities. In the survey, I find that merchant guilds were declining in the Northwest region of Europe, while elsewhere in Europe they continued to dominate commerce until much later, although there were some reforms underway in the Milanese and Viennese regions of Italy.

What explains the observed pattern of emergence of impersonal markets in sixteenth century Europe? I focus on the interaction between the commercial and communication revolutions of the late fifteenth century Europe. In the paper, I argue that the Northwest European region uniquely benefited from both of these revolutions due to its unique geography.

Commercial revolution at the Atlantic coast

What motivated traders to seek risky opportunities beyond close networks? If traders found partnerships with unfamiliar traders beyond their business networks to be highly beneficial, that would provide good incentives for the rise of impersonal markets. The Northwest Region was close to the sea, notably the Atlantic coast, which was at the time undergoing a commercial revolution with the discovery of new sea routes to Asia and the Americas. So, the region became a hub for long distance trade, attracting unfamiliar traders who came to its coast looking for business opportunity. I find that all cities where merchant guild privileges declined were at the sea, along the Atlantic or North Sea coast. Moreover, all cities where merchant guilds underwent reform (but didn’t decline) were within 150km of a sea port.

The communication revolution of the postal system and the printing press

What made traders feel confident about the reliability of such risky impersonal partnerships? If availability of trade-related information and business practices improved, it could increase confidence traders had in such unfamiliar partnerships. In the sixteenth century, the postal system improved across Europe. The postal system made communication between distant traders easier as traders could correspond regularly with each other and gain more accurate information. This helped expand long distance trade across Europe.

While the Northwest European region didn’t have a particular advantage over other regions in postal communication, it had an advantage in early diffusion of printed books. The Northwest European region was close to Mainz, the city where Johannes Gutenberg invented the movable type printing press in the mid fifteenth century showed how cities close to Mainz adopted printing sooner than many other regions of Europe in the first few decades of its introduction. So, trade-related books and new (or unknown) business practices like double-entry bookkeeping diffused early and rapidly in the region.

Such a high penetration of printed material reduced information barriers and improved business practices. I find that all cities where guild privileges declined or merchant guilds underwent reform in the sixteenth century enjoyed high penetration of printed material in the fifteenth century. Among cities within a 150km distance from a sea port, cities where merchant guilds declined or reformed had more than twice the number of diffused books per capita than cities where merchant guilds continued to dominate.

As a comparison, there were four major Atlantic port cities where merchant guilds declined: Hamburg, London, Antwerp, and Amsterdam; while there were four guild-based Atlantic cities: Lisbon, Seville, Rouen, and Bordeaux in the sixteenth century. The fifteenth century per capita printing penetration of the cities would stack as: Lisbon < Bordeaux < Hamburg < Seville < Rouen < London < Amsterdam < Antwerp.

The combination of both the commercial revolution along the sea coast, especially the Atlantic coast, and the communication revolution, especially near Mainz, uniquely benefited Northwest Europe, as it began to attract traders who favored impersonal market-based exchange over exchange conducted via guild networks. Rulers began to disfavor privileged monopolies when they realized the feasibility of impersonal exchange and that they could have superior sources of revenue from impersonal markets. In the region, trade democratised, as more people could participate in business.

Regions like Spain and Portugal that benefited only from the commercial revolution of trade through the sea to Asia and Americas had low levels of printing penetration. In contrast, regions like Germany, Italy, and France benefited from the communication and print revolution but didn’t enjoy a bustling Atlantic coast. Thus, no other region enjoyed the unique combination of both benefits of the commercial and communication revolution.

Takeaway for policy makers: democratize the market

If information access is poor (lack of transparency) or businesses don’t adopt reliable business practices (poor financial reporting or opaque quality standards), these deficiencies at the business level can make customers and investors question the reliability of new businesses. Politicians, like medieval rulers, may be more willing to enter into a nexus with dominant businesses, like medieval merchant guilds, if 1) market frictions or 2) lack of incentives make the economy dependent on such businesses.

This was the case with the taxi industry for a long time, where customers were willing to pay a high fee to get reliable taxi services as supply of drivers was low (new drivers in cities like London had to pay a high license fee and fulfill tough training requirements). But, better taxi hailing mobile apps like Lyft and Uber, by giving customers access to real time GPS tracking, have revolutionized the industry, much like the communication revolution did in late fifteenth and sixteenth century. Another area where information access has improved reliability in business is the tourism and travel industry.

While in the past the tourism sector was dominated by travel agents and their recommended offerings, now an influx of providers and travel comparison websites, such as and AirBnB, has increased the reliability of small unknown hospitality service providers. Today, many prefer to stay at a stranger’s home over a reputed hotel chain. Such a revolution in the taxi or the travel industry is following the old historical trend where disruption in how information is made available changes how businesses are organized.

‘These problems will not be fixed by the market’ – Bruce Plested. 

Over the years I’ve had a variety of bosses. In seeking to recognise a good boss from one not so good, I asked this question: ‘Would they make a good foreman?

  • Could they ask the workers to do a difficult or unpleasant job and expect them to do it?
  • Could they do the job themselves?
  • Could they take their people with them?
  • Did they get the job done every day, week and year?

With 2017 being an election year in New Zealand it is worth asking these questions of our politicians.  Too many of them fail the test and are lost in platitudes, jokes, jibes, foxy words and sheer procrastination.


Our houses, through most parts of New Zealand, cost some ten times the net annual income of the family seeking to buy them.

These high prices (three times annual income was normal for many years prior to the early 2000s) have been progressively increasing for the past 15 years, and all governments have been aware of the problem. No government or local government has taken any meaningful action against this rising tide.

As the New Zealand Initiative has stated, “There are not enough homes being built to meet the demand.”


  • Planning restrictions make it difficult to increase population directly within the city boundaries.
  • Cities are prevented from growing outwards because of rural and urban boundaries.
  • New developments require infrastructure investment from local councils, which can only pay for such investment by rates increases.

Politicians, both local and national, must take action on this very fixable social disgrace. “The market” cannot sort out this problem. Real leadership and intestinal fortitude is needed now.


Measured by some standards, our education is at satisfactory levels on a global average scale. However only 30% of children from lower decile school areas are reaching the New Zealand average for level 3 NCEA.

This low level of success continues the establishment of a permanent socio-economic group of under-achievers in education, and it is our Māori and Pacific Island people who make up most of this group.

This group of under-achievers are more displaced than ever by rising housing and rent prices. Without educational success they will continue to make a lesser contribution to society.

Business can play a bigger role in attempting to sustain and assist educational development. If businesses and schools, particularly in lower decile areas, get together in a meaningful way, benefits will evolve. The more children understand how a business (from a farm, to a fruit shop, to an engineering factory, to a quarry) works and interacts, the more they can understand the possibilities. Business people may be able to inspire children and parents to strive for success, and may be able to contribute to financing school wish lists, from computers to sports equipment, books to bus trips.

Can electorate and local politicians help make this happen?


Pollution and degradation of our environment is another area requiring strong political will.

Most cities provide bins for rubbish and bins for recycling. There is however no education, or ongoing exhortation, on how to recycle, why to recycle and whether it works. Is an unwashed bottle or can recyclable, or does it go into landfill? Should we recycle bottles with the lid left on? Should wine bottles have the lead seal removed? What happens to polystyrene, what happens to plastic bottles with pumps attached, what about empty aerosol cans? Much of this stuff is going to landfill because our local authorities don’t tell us what is required. If recycling is just a myth, let us know, otherwise teach us to recycle for the benefit of the planet.

Our lack of respect for water and water quality is an indictment of governments going back decades. Various businesses and pressure groups have been allowed to pour chemical waste, animal entrails, milk, and human and animal effluent into our streams, rivers and sea. Freshwater rights for irrigation have been given, to the extent that some rivers run dry most years. And now we are giving water rights to export freshwater in plastic bottles.

Regulators could have stood against many of these past and present excesses, but chose to do nothing and leave the problems to our children and grandchildren.

A couple of years ago I heard a European billionaire being interviewed. When the slightly irritable reporter asked “Well, how much money do you want?” the billionaire answered “Just a wee bit more.”

And it is the “wee bit more” that has done so much to damage our environment – just a few more cows per acre, just a wee bit more water for irrigation, just another water bore in case it doesn’t rain, just a wee bit more sewerage mixed with a wee bit more storm water, just a few more years hitting our already depleted fish stocks.

The problems mentioned here are not fixed by the market. They are like law and order – the local and national politicians should be dealing with them and committing to solutions before the next elections.


Bruce Plested, Mainfreight founder. 

The Spinoff

The Rise And Fall Of The American Middle Class – William Lazonick. 

Social Europe

William Lazonick is a Professor at the University of Massachusetts Lowell, where he directs the Center for Industrial Competitiveness. He is also a Visiting Professor at the University of Ljubljana where he teaches a PhD course on the theory of innovative enterprise. Previously he was an Assistant and Associate Professor of Economics at Harvard University, Professor of Economics at Barnard College of Columbia University, and Visiting Scholar and then Distinguished Research Professor at INSEAD.

The ‘fountain pen of money’ – Bryan Gould. 

Steven Joyce, NZ Minister of Finance, has recommended the formal establishment of a committee to help the Governor of the Reserve Bank decide on where to take interest rates, thereby following the example of other central banks around the world.

Also Grant Robertson, Labour’s shadow Finance Minister, has made a similar recommendation concerning a Monetary Policy Committee to help the Governor, but has also followed another overseas example by supporting an extension of the Governor’s remit, so that he would, in addition to restraining inflation, be required to take account of the desirability of full employment.

Most people believe, and it is a belief assiduously promoted by the banks themselves, that the banks act as intermediaries between those wishing to save and those wishing to borrow, usually on mortgage.

In this view, the banks are benefactors, bringing together those with money to spare and to deposit with them, and those who wish to borrow, often for house purchase.

The banks make their money, so it is said, by charging a higher rate of interest to the borrowers than they pay to the depositors, the equivalent of a small fee for the administrative costs of bringing the parties together.

But this benign view of their operations is inaccurate and misleading. The banks do not lend you on mortgage money deposited with them by someone else.

They lend you money that they themselves create out of nothing, through the stroke of a pen or, today, a computer entry.

The banks make their money, in other words, by charging interest on money that they themselves create. Not surprisingly, they are keen to lend as much as possible.

But the consequences of this bizarre scenario go much further. It is the willingness, not to say keenness, of the banks to lend on mortgage that provides the virtually limitless purchasing power that is constantly bidding up the prices of homes in Auckland and, now, elsewhere.

It is the banks that are fuelling the housing unaffordability crisis, a crisis that is leaving families homeless and widening the gap between rich and poor.

So far, the government has washed its hands of this aspect of the crisis.

It is content to leave the crucial decisions on monetary policy to the Reserve Bank.  That way, it can disclaim responsibility and leave the Governor, himself a banker, to carry the can.

Leaving monetary policy (which is usually just a matter of setting interest rates) to the Reserve Bank is usually applauded as ensuring that it does not become a political football. But monetary policy should have a much greater role than simply restraining inflation and has a huge influence on so many aspects of our national life.

Why should the Government be able to hide behind the Governor of the Reserve Bank and duck responsibility for a policy of the greatest importance to so many Kiwis?  Why should ministers not be held to account in Parliament and to the country for failing to deliver outcomes they were elected to deliver?

It is no surprise a former Governor of the Reserve Bank should seek to defend the banking system from its critics. But in denying the accuracy of points I made in the Herald about how the banks operate, Don Brash accused me of “peddling nonsense”.

I made two basic points. First, I asserted the banks do not, as usually believed, simply act as intermediaries, bringing together savers (or depositors) and borrowers to their mutual benefit.

Secondly, I said the vast majority of new money in circulation is created by the banks “by the stroke of a pen”, and they then make their profits by charging interest on the money they create.

If this is “nonsense”, the “peddlers” include some very distinguished economists.

In my original piece, I referred to a Bank of England research paper, published in the bank’s first Quarterly Bulletin 2014, which describes in detail the process by which banks create money.

“One common misconception is that banks act simply as intermediaries, lending out the deposits that savers place with them. That ignores the fact that, in reality in the modern economy, commercial banks are the creators of deposit money. Rather than banks lending out deposits that are placed with them, the act of lending creates deposits – the reverse of the sequence typically described in textbooks.

Bank deposits make up the vast majority – 97 per cent of the amount of money currently in circulation. And in the modern economy, those bank deposits are mostly created by commercial banks themselves.

Another common misconception is that the central bank determines the quantity of loans and deposits in the economy by controlling the quantity of central bank money – the so-called ‘money multiplier’ approach, but that is not an accurate description of how money is created in reality.

Banks first decide how much to lend depending on the profitable lending opportunities available to them – which will, crucially, depend on the interest rate set. It is these lending decisions that determine how many bank deposits are created by the banking system.

The amount of bank deposits in turn influences how much central bank money banks want to hold in reserve (to meet withdrawals by the public, make payments to other banks, or meet regulatory liquidity requirements), which is then, in normal times, supplied on demand by the Central Bank.

Commercial banks create money, in the form of bank deposits, by making new loans. When a bank makes a loan, for example to someone taking out a mortgage to buy a house, it does not typically do so by giving them thousands of pounds worth of banknotes. Instead, it credits their bank account with a bank deposit of the size of the mortgage. At that moment, new money is created.

For this reason, some economists have referred to bank deposits as ‘fountain pen money’, created at the stroke of bankers’ pens when they approve loans.”

Commercial banks create money, in other words, by placing loans [or credits] into the bank accounts of borrowers. They then charge interest on, and demand security for and repayment of, those loans.

They have no capacity to create money in any other way or for any other purpose [though the central bank can pursue “quantitative easing” to increase the money supply if it thinks that is needed].

Is it wise to entrust such wide-ranging powers – so significant in their impact on the whole economy – to the banks, and then to arrange that the only person able to regulate that impact was himself a banker – the Governor of the Reserve Bank.

Bryan Gould

Modern Money Theory: Deadly Innocent Fraud #7: It’s a bad thing that higher deficits today mean higher taxes tomorrow. – Warren Mosler. 

Fact: I agree – the innocent fraud is that it’s a bad thing, when in fact it’s a good thing!!!

Why does government tax? Not to get money, but instead to take away our spending power if it thinks we have too much spending power and it’s causing inflation.

Why are we running higher deficits today? Because the “department store”has a lot of unsold goods and services in it, unemployment is high and output is lower than capacity. The government is buying what it wants and we don’t have enough after-tax spending power to buy what’s left over. So we cut taxes and maybe increase government spending to increase spending power and help clear the shelves of unsold goods and services.

And why would we ever increase taxes? Not for the government to get money to spend – we know it doesn’t work that way. We would increase taxes only when our spending power is too high, and unemployment has gotten very low, and the shelves have gone empty due to our excess spending power, and our available spending power is causing unwanted inflation.

So the statement “Higher deficits today mean higher taxes tomorrow” in fact is saying, “Higher deficits today, when unemployment is high, will cause unemployment to go down to the point we need to raise taxes to cool down a booming economy.” Agreed!