Current Events

A Summary of the Structural Stagnation Hypothesis

Ronald Shereni China, Current Events, Policy, Structural Stagnation 0 Comment

Below is a brief summary of the structural stagnation argument. It’s a condensed argument meant for economists. In my textbook (Chapter 28 of Colander, Economics, 9th edition) I spell out the issues step-by-step in a way that students can understand organizing the discussion around a globally modified AS/AD model.

The story begins in the mid 1990s with the rise of large-scale globalization, which changed the operating features of the U.S. economy. Globalization wasn’t new; what was new is that the two new players on the scene—China and India—had a huge available pool of labor. Instead of a wave of globalization the U.S. economy experienced in the 1970s, it was  a tsunami.

The natural international adjustment to the massive globalization would have been for the value of the dollar to fall, which would have equalized comparative wages and prices. That didn’t happen anywhere near as much as was needed to bring about equilibrium because the United States was able to run trade deficits and the United States had a significant resource with comparative advantage—international traders—those involved in organizing and facilitating trade. Expanded globalization significantly increased the income of these international traders, changing the nature of our trade balance to one that focused on services and profits, not production.

This structure created the American version of the Dutch Disease, which benefited a small group (in this case international traders) while hurting those businesses and workers that lacked a comparative advantage in globally competitive activities (largely manufacturing). Combined with the trade deficit made possible by large international capital flows into the United States, pressure was put on lower wage jobs even as high-income individuals were prospering. In terms of jobs, the high exchange rate and trade deficits increased the natural rate of unemployment in globally competitive activities and constrained U.S. potential output. Put another way, just as China boomed because of export-led growth, the U. S. economy slowed because of import-led stagnation. That slowdown in growth of potential output started in the mid-1990s, but it was hidden by macro policies designed to hold the economy at a higher growth rate than was sustainable in the long run.

For more than a decade it worked. Expansionary monetary and fiscal policy achieved not only 3% annual growth, but even higher growth rates, and unemployment remained low because workers displaced in globally competitive activities found jobs in protected activities such as health care, education, and construction. The expansionary policy that held the economy above its sustainable long-run potential did not result in goods inflation because of the changed institutional structure: wages of U.S. workers in globally competitive activities could not rise, and the United States’ ability to run large trade deficits meant that the exchange rate did not have to adjust.

The downward pressure on tradable goods prices more than offset the increase in prices in those activities that were less globally competitive. So, the result was little to no goods inflation, even as the economy exceeded its potential. The result was two Americas—one with globally competitive sectors that were suffering and another with non-globally competitive sectors that were doing great. Unemployment remained low (at least lower than what it would have been) without causing goods inflation. But the two-Americas reflected a structurally imbalanced unemployment, which is unsustainable in the long run, especially since many of the non-globally competitive activities depended on government spending and expanding credit. But there was a limit to how much government spending could rise since the unwillingness of people to pay their full cost through taxes was leading to higher and higher deficits.

These structural problems—an unsustainably high exchange rate, high unemployment and lowering of potential output—were also hidden through the first decade and a half of the 2000s by loose monetary policy, which pushed up asset prices, creating a positive nominal wealth effect, even as sustainable real wealth did not rise. This wealth effect added to the feeling that the United States had reached a wonderful equilibrium. Unfortunately, as we now know, rising asset prices were creating a bubble that burst in 2008. The bursting of the bubble showed, with painful consequences, that the equilibrium was unsustainable— unemployment rose and growth fell as government attempted to retrench into a sustainable equilibrium not based upon an asset bubble. In the standard view, this was seen as a recession. In the structural stagnation view, this was seen as suppressed depression that would last much longer than the typical post war recession, and not be solved by demand side policies alone. Dealing with it would require difficult structural changes that made U.S production more globally competitive.

If the structural stagnation view is correct, policymakers face a dilemma—implement austerity measures that would allow the structural problems to unwind with its attendant pain or continue expansionary measures to keep those problems at bay as much as possible, putting the pain off to another day. If the root of today’s economic problems are structural, there is no easy answer. The real policy question is: When do we want to face the structural problems? Now or in the future?

No one wants austerity for austerity’s sake, which is often the way calls for spending restraint and less expansionary monetary policy are portrayed. Austerity is in many ways simply facing up to our structural problems. If structural stagnationists are right, at some point the United States is going to have to face up to the problems. Currently, on average, the U.S. cost structure at the current exchange rate is not globally competitive. This means that when global firms ask, “Should we expand production in the United States?” on average they answer, “No,” and funds for investment go abroad. Until these structural problems are met, the slower growth that the United States is currently experiencing is as good as it gets, and even a little bit better than is sustainable, because we still have nominal asset prices/nominal GDP above its long-run steady state ratio, and we are keeping the economy growing only with highly expansionary monetary and fiscal policy that maintains and increases the current asset price bubble. In the long run that is a policy that is  asking for another crash.

As I stated above, in the text I don’t take a position about whether the structural stagnation view is the correct view—that is not the job of a text. I present it because it raises precisely the type issues that I think we should be raising in the macro course, and which the former structure of texts did not allow us to do. This has meant moving international issues up earlier in the text—to give students an understanding of globalization and exchange rates, and changing the discussions of inflation to distinguish goods inflation from asset inflation to better allow a discussion of asset bubbles. But I think discussing the structural stagnation view allows precisely the type debate that we should be teaching our students to understand.

First Published : June 29, 2014

Intro Economics Textbooks Are Changing

Ronald Shereni Current Events, Economic Education, Principles of Economics 0 Comment

If you are interested in teaching economics an excellent resource is the teach-econ listserve. I encourage anyone interested in teaching it to follow it up.   Don Coffin, who is a regular contributor, recently made the following post on it referring to the following Krugman blog entry:

Don writes:

“It’s about a year old, but interesting (although not everyone, obviously, will agree with everything/most/much/any of what Krugman has to say.

I’ve long believed that much of what one reads in intro econ books (particularly in intro macro) reflects the macroeconomic issues that were facing people when they were in grad school.  So, for example, from my generation of grad students (the 1970s), I would have expected (and, I should note, got) a focus on inflation and stagnation and real shocks.  It’ll be interesting (if I’m still around and (capable of) paying attention) to see what intro macro looks like in, say, 2025…”

Here is my response to Don on the Teach-Econ Listserve.

“Actually, intro economics textbooks are already changing. Consider the most recent, and just published, 9th edition of my textbook. In it I have an entire chapter on the structural stagnation policy dilemma. The chapter discusses how the current economic situation differs from previous seemingly similar situations, and why many economists believe the slow growth will continue for years. I call it the structural stagnation view.

In that chapter (you can read here: Structural Stagnation Policy Dilemma Colander 9e)  I contrast that structural stagnation view with the standard Krugman shortage of aggregate demand view that was presented as Keynesian thinking, and also with the Classical self-correcting view that was presented as Classical thinking in what we learned. (Neither of those presentations was satisfactory; both Classicals and Keynesians were both more nuanced than what was presented, but that’s another story.)

The reality is that what students get in graduate school today is all too often simply a math bootcamp with little true discussion of policy. One student when I asked where their views of fiscal policy came from for my book, the Making of an Economist Redux, responded that it didn’t come from classes. He said that monetary policy might have been in one of the variables in the model, but it was lost in the equations. Since graduate students are never trained in discussion of policy that reflect the nuanced views of Keynesians and Classical economists, they find it difficult to teach those nuanced views. Instead, they rely on textbooks to define what they teach. After all they can’t teach what they haven’t learned. That’s sad.”

First Published : April 26, 2013

Wealth Distribution

Ronald Shereni Current Events, Principles of Economics, Wealth Distribution 0 Comment

In the past few years, income and wealth have become more unequally distributed in the United States, which has made them important topics in policy debates. But what are American’s perceptions of current wealth distribution and what do they believe is the ideal distribution?

Recently, a Harvard professor Michael Norton did just that. He polled 5,000 Americans and found that they perceived wealth to be distributed much more equally than is the case. For example, respondents believed that the top 20 percent held 60 percent of the wealth while, in fact, they held 80 percent. Norton also asked about the ideal distribution. Respondents believed that in an ideal world, the top 20 percent should hold 30 percent of the wealth. You might poll your students for their opinions.

You can show this Youtube video for visual presentation of Norton’s work. The Harvard Business Review also published an article about Norton’s work. Note that along with the data, the narrator of the Youtube video expresses strong normative views about wealth distribution. The data along with the normative discussion could be used to launch a class discussion about fairness.

First Published : March 24, 2013

Why the U.S. Unemployment Rate Is So Hard to Reduce?

Ronald Shereni Current Events, Economic Education, Policy 0 Comment

Macro policy has focused on driving the unemployment rate back down to a desired rate, about 5 percent. That policy is, in large part, misplaced. The reason can be explained with some textbook microeconomics. In the microeconomics texts we drill into students that excess supply is meaningful only in relation to price. For example, there could be excess supply at a price of $10 and excess demand at a price of $8.00. In macro we seem to forget this central notion when we talk about the unemployment rate. Unemployment is excess supply so to talk about unemployment, you have to have some achievable equilibrium wage in mind. But that wage is not part of the discussion in macro policy discussions, where we discuss unemployment as if it were independent of the wage rate. If people are holding out for a job at $30 an hour, they may not be able to find one, but they might easily get a job at $9 an hour. Are they unemployed, or are they choosing not to work? You can’t answer that without specifying the equilibrium wage for a person with that skill set.

Historically, the macroeconomic concept of the unemployment rate was developed in reference to a non-globalized world in which the wage/price relationship was assumed to be relatively constant. In such a world, it is possible to define domestic unemployment independently of the wage rate since the wage was a constant reference point. The only relative wage that mattered in a non-globalized world was the wage relative to price, and that was assumed to be constant. In a globalized world, that is not the case. When a company can locate production globally, wages, unemployment, and hence the unemployment rate has to be defined in relationship to wages in other countries. The global relative wage will largely determine the sustainably achievable unemployment rate. If non-wage productivity advantages are not enough to offset wage differentials, then a person’s reservation wage can be too high for the market conditions.

Unfortunately, for many of the unemployed in the United States that is precisely the case. Their wage is above the globally competitive wage for their skill set. Such unemployment is not solvable with increases in domestic demand, and we should stop pretending that it is. There may be global demand for their work at a lower wage, but not at their current reservation wage. Increased demand will simply create jobs abroad, and worsen the U.S. trade deficit. It won’t lower the U.S. unemployment rate.

What will solve the problem? Lower wages, higher skills, a fall in the exchange rate, or in increase in general advantages in U.S. productivity. None is likely to change soon, so it is time for policy makers to accept this reality and stop trying to achieve the unachievable.

First Published : December 4, 2012

Which Fiscal Cliff Do We Want to Jump Off?

Ronald Shereni Current Events, taxes 0 Comment

Policymakers are currently focused what has come to be known as the fiscal cliff. This fiscal cliff was created by the Budget Control Act of 2011 that triggers spending cuts and tax increases in January 2013 that is likely to set the economy into a tailspin. The problem is that the cliff was there long before the Budget Control Act; all the act did was to say, “If you don’t at least start edging your way down the cliff by December 2012, you’ve going to have to do so beginning in 2013.  That part of the story—that the cliff cannot be avoided—has been lost in the fiscal cliff metaphor.

Political posturing, negotiations, recommendations and commentary make it sound as if Congress can avoid the fiscal cliff just by agreeing on some relatively minor spending cuts and tax increases that will replace the relatively small  tax increases and spending cuts that have become known as the fiscal cliff.  That’s not true. The cliff is unavoidable, and it is steeper than policy makers have been willing to admit.  And to get down it, and eventually we must if we are to get the economy back on a sound fiscal and monetary ground, we will have to increase taxes and cut spending much more than the political discussion to date would have you believe. The reason is not the cliffs we currently see. The problem is that there are additional hidden cliffs embedded in existing demography and government accounting practices.   So, the real issue is how and when to jump off the cliff, not whether we have to jump.

What policy makers and economists are not telling the public is that whenever and however we jump, there is going to be a lot of pain. If we jump quickly, the economy will fall into a deep recession, lots of people will be hurt.  If we jump slowly, the economy will remain mired in its current structural stagnation, with slow growth and high unemployment continuing for decades or more.  The most an agreement on the fiscal cliff can do is to spread out that pain, and perhaps cushion the fall somewhat.

What’s keeping us from a recession in the near term is unsustainable fiscal and monetary stimulus—the equivalent to an economic oxycodone—a narcotic to avoid pain. The problem with the narcotic of government stimulus is that, as is true with any “fix”, for the economy to gets off the stimulus fix, it will have to go through withdrawal. We can postpone it, but eventually, withdrawal won’t be a choice. The increasing government debt, and the coming due of government obligations that are aren’t even included in the current measures of the government debt, will force monetary and fiscal authorities to reverse course. As Stein’s Law tells us, “If something cannot go on forever, it will stop.”

The policy debate should not be about whether the United States can avoid the fiscal cliff.  It’s part of the landscape. The question they should be debating is, “How and when should we jump off?”  Do we want to go cold turkey—and take the deep recession that will accompany sudden monetary and fiscal withdrawal, in the hope of a faster recovery?  Or do we want to withdraw more slowly, extending the fall off the cliff for another decade.   Whichever we choose, the pain is going to be a lot greater than politicians on either side of the aisle are preparing people to endure.

First Published : November 30, 2012

 

Deduction Phaseouts and Marginal Tax Rates

Ronald Shereni Current Events 0 Comment

In the current negotiations to raise government revenues, politicians on both sides of the aisle seem to be pushing for phase-outs of deductions and credits rather than raising marginal tax rates. Somehow they seem to think that eliminating phase-outs will not raise marginal tax rates. That is not true. Phaseouts are simply a backdoor method of increasing marginal tax rates. The problem is that phaseouts increase marginal tax rates in a manner that most would consider unfair. Specifically, phaseouts raise the marginal tax rate on the middle class while keeping marginal tax rates lower for the very rich.

That’s not what people have in mind when they call for tax fairness. Most Americans would prefer a flat or progressive tax system. A phase-out of a deduction might sound progressive, but it is actually a regressive marginal tax system. Within the income range where the deductions are phased out the marginal tax rate rises, and at higher income levels when the phase-out is complete, it falls.

To see this, suppose that there is a flat 20 percent rate with various deductions capped at $50,000. If you earn $150,000 you owe $20,000 in taxes, (20% x $150,000-50,000). If you earn $250,000 you’d owe $40,000, (20% x $250,000-50,000). For both, an extra $1,000 of income means $200 more in taxes-the 20% marginal tax rate. Now suppose that the $50,000 deduction is phased out at a rate of 5% per $1,000 beginning with those earning more than $150,000 (that is, the deduction falls by $50 for every thousand dollars earned over $150,000). With this phase-out rate, the deductions will be totally phased out at an income of $250,000. Now consider the marginal tax rate of someone earning between $150,000 and $250,000 compared to the marginal tax rate of someone earning more than $250,000. He or she will be paying the equivalent of a marginal tax rate of 25%–when he earns another $1000 he pays 20%  ($200) in marginal tax, and 5% ($50) in what might be called phase-out marginal tax. Any person earning more than $250,000 only pays a 20% marginal tax rate. So in that range the tax system becomes regressive. That’s not my, and what I think are most people’s, view of what society wants in its tax system.

What’s a better alternative?  To be honest about what you are doing. Increasing tax revenues through tax reform requires an increase in the marginal tax rate on someone. There is no way around it, so don’t pretend you’re not raising marginal tax rates when you are.   If a deduction makes sense, then keep the deduction, and institute higher overall marginal tax rates. If the deduction doesn’t make sense, then dump it totally; don’t phase it out under the pretence of not increasing marginal tax rates.  Because with phase-outs you are increasing marginal tax rates, but you are doing it in a regressive fashion:

First Published: November 30, 2012

 

Why Are Financial Panics Scary?

Ronald Shereni Current Events 0 Comment

Why so much fear about a credit crisis? And why so much effort to keep financial companies afloat? The financial sector got itself into this mess. Why not just let the Wall Street bigwigs go bankrupt? After all, the financial sector is not all that big; we worry far less about the automobile or computer sectors. The answer is simple: We worry about the financial sector not because of its size, but because all the other sectors rely on it to function. The failures of other big sectors would be painful, but, unlike a financial sector collapse, they would not bring all other sectors crashing down with them. That’s why one of the roles of a central bank is to be a lender of last resort. 

Think about what would happen if your credit dried up. Say even though you’re every bit as trustworthy as before, you suddenly find you can no longer borrow money, which means no credit cards. Some things might still work just fine: You could just use cash at the local grocery store. Some things would be harder: If you didn’t have credit, you’d have to pay all your bills in advance. And to do this by check you’d still need a well-functioning financial system. Some things would be downright impossible: Forget about buying anything on the Internet. Paying for college? No problem… as long as you’ve saved enough to pay up front and in full.

The situation is even worse for companies. While they might not use credit cards, they use lines of credit to buy the raw materials for production and to pay their workers. If that credit line disappears, many—perhaps most—companies would essentially be forced to close, leaving their workers out of a job. That’s why a severe financial crisis can bring the entire real economy to a halt.

So when credit freezes up, the real economy can quickly freeze up. It’s not slow like the effect of a contractionary demand shock. It is fast, like a heart attack. Think of credit as financial oil. If the economy were an automobile engine, the financial system would be the motor oil. While oil is a relatively minor part of a working engine, it is absolutely essential. Try driving your car without oil for 10 miles. I can tell you from experience, the engine seizes up and is ruined. It cannot be salvaged. The fear in October 2008 was that the entire credit system would stop. If that happened, what had started as a financial crisis on Wall Street would spread from Wall Street (the financial sector) to Main Street (the real sector), creating not a recession but a depression.

First Published: 08/11/2012