Tuesday, March 12, 2013

Investment not consumption; profitability not demand

by Michael Roberts

Boy, are the Keynesian economists boiling mad!  Jeffrey Sachs is regarded as a ‘liberal’ or progressive economist in favour of government action to boost the economy and employment.  He came out last week with an article attacking the basic tenets of Keynesian economics and their policy prescriptions for the US economy

Sachs denied that there were any beneficial effects for the US economy from the short-term fiscal stimulus packages that Obama introduced.  Indeed Sachs was worried that they would only boost public debt to levels that would stop the economy getting back into long-term sustained growth.
Sachs called the doyen of Keynesianism, Paul Krugman, a ‘crude Keynesian’, for advocating just short-term fiscal stimulus rather than longer-term remedies for the current depression.   Sachs says “I have argued against short-term stimulus packages. Krugman has supported them, and indeed argued that they should have been even larger. I have been against temporary tax cuts and temporary spending programs, believing that instead we need a consistent, planned, decade-long boost in public investments in people, technology, and infrastructure.”   Thus Krugman is a crude Keynesian because, says Sachs, “he takes a simplistic and inadequate version of the Keynesian economic approach as his guide for budget policy. Keynes himself was far subtler. In 1937, with British unemployment still around 10 percent, Keynes wrote: “But I believe that we are approaching, or have reached, the point where there is not much advantage in applying a further general stimulus at the centre.” He believed, for example, that more structural policies were needed to address the continued unemployment.*”

Sachs says that crude Keynesianism has failed because “recovery is impeded by structural factors. These structural components are not susceptible to a Keynesian diagnosis or to a Keynesian remedy…and Krugman seriously and repeatedly downplays these structural changes occurring in the U.S. economy. He repeatedly emphasizes that we suffer a demand shortfall, pure and simple, one easily remedied by more stimulus. Yet it’s increasingly hard to reconcile many features of the U.S. economy with this view.”   Sachs cites the long term problems of the US economy as “large-scale offshoring of jobs, large-scale automation of jobs, decline in demand for low-skilled workers, skill mismatches, broken infrastructure, and rising global energy and food prices. These require various kinds of targeted public investment spending, not simply aggregate demand.”

For Sachs, the problem is that fiscal spending that is not aimed at getting ‘structural’ improvements and just at boosting ‘demand’ will not work and the resulting debt from extra public borrowing will damage the economy ‘down the road’ when interest rates start rising.  Sachs emphasises that “The U.S. needs productive public investments, not wasteful spending. We need to modernize our infrastructure, retool our energy system, make our cities more resilient, and help to train a new productive labor force.

With this approach, Sachs is really expressing the concerns of America’s capitalist sector that Keynesian-type fiscal stimulus will merely drive up debt servicing costs without restoring growth.  If there is to be government spending, let it be on industrial investment and not on welfare payments or public services.   So there is a vested interest behind Sachs’ criticism of Krugman.
It has produced a barrage of responses from leading Keynesian economists.  First, Krugman himself,  taking a line of the innocent victim, answered: “I don’t know what’s happened to Jeff Sachs. He’s been critical of “crude Keynesianism” throughout this crisis, without ever explaining what’s crude about viewing a huge slump in aggregate demand through a Keynesian lens. So his position has been a mystery.” (http://krugman.blogs.nytimes.com/2013/03/08/i-guess-its-a-form-of-flattery/).
Mark Thoma, a strong Krugman publicist, got really upset (http://economistsview.typepad.com/economistsview/2013/03/crude-sachsism.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+typepad%2FKupd+%28Economist%27s+View%29).

Replying to Sachs, point by point, he retorted: “Take your time, no need to hurry (other than the millions of people who are unemployed and struggling to make ends meet). Krugman and others (like me) say that yes, of course, shovel-ready infrastructure is the first choice, and of course we need to make progress on our long-run issues. But while we are getting that done, why the hell wouldn’t we want to do whatever it takes to alleviate the suffering in the shorter-run?…. because of problems that might happen “later this decade” we should let people suffer now.”  And again on Sachs’ position:  “We all agree on the need to address the long-run issues, and I have called for infrastructure spending again, and again, and again as a way to help the economy is both the short and longer runs. But that doesn’t mean we should ignore other policies — money spent on things other than infrastructure — that might help people in the short-run. Short-run multipliers are sufficiently large, there is substantial cyclical unemployment, and our debt problems are not immediate.”

Arch-Keynesian professor at Cambridge University, Simon Wren-Lewis (http://mainlymacro.blogspot.co.uk/2013/03/the-unlikely-friends-of-austerity.html) also weighed in: “perpetuating and mis-diagnosing the crisis is precisely what those who want to use debt scare stories to reduce the size of the state are trying to do.”  Sachs was really taking the old line of neoclassical economics: “More fundamentally, it is the line promoted – consciously or unconsciously – in almost every textbook that economic downturns are ultimately self correcting… what I see at the moment is very simple. We have demand deficiency, and the normal means of correcting it is broken. We luckily have a backup system, but the levers of that system are being pushed in the wrong direction.”   In other words, we need more fiscal stimulus of any sort not less, as Sachs seems to be advocating.

Kevin Drum was equally upset at Sachs, but he was also unsure what to do (http://www.motherjones.com/kevin-drum/2013/03/any-way-you-cut-it-weve-got-big-economic-problems): “our biggest problem going forward is indeed structural. Unfortunately, I have my doubts that we have any solutions for the structural problems that bedevil us. Sachs offers up a fairly conventional liberal prescription—lots of investment in infrastructure and education, paid for by carbon taxes and various taxes on the rich—and I don’t have any problem with that. I don’t think Krugman does either.  I’m all for rebuilding our infrastructure, and a strong focus on renewable energy would certainly help reduce our vulnerability to oil shocks. But it will happen only slowly, and only if the entire rest of the world does the same thing. At the same time, improvements in technology will be good for productivity, but are going to put increasing numbers of people out of work for good. Better infrastructure won’t really help that. I’m not sure what the answers are.”  Oh dear.

Dean Baker, another tireless opponent of austerity, inequality and neoliberal policies, also launched into Sachs ( http://www.cepr.net/index.php/blogs/beat-the-press/the-strange-attack-of-jeffrey-sachs-on-paul-krugman?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+beat_the_press+%28Beat+the+Press%29).

Baker dismissed the argument that fiscal stimulus will lead to a debt problem: “it is just difficult to see the case for the horror story of the debt that Sachs wants to portray. The markets clearly do not see the problem or they would not be lending the government huge amounts of debt at very low interest rates. Furthermore, we know many examples of other countries, or the U.S. at other times, that have been able to have much larger debt to GDP ratios without any notable problem borrowing money.”   And Baker made a telling point on the structural problems that Sachs promoted, claiming that Sachs missed the main one: “The main reason for the projected slowdown in potential GDP is the slowing of labor force growth. This is partly the result of the retirement of the baby boom cohort and in part the end of the period in which women were entering the labor force in large numbers.” 
But Baker then assumed that this demographic deficit poses no problem. “Neither development poses a crisis in any obvious way or suggests a structural flaw in the economy.”   

Yet as Marxist economics would tell you, that should be cause for concern for the capitalist mode of production.  Only labour power can create value, so, other things being equal, a declining labour force will mean less surplus value generation.  As the employed population shrinks so does the total amount of value (unless hour of works are extended or new technology drives up the rate of exploitation).  And in the US, the ratio of employed to those not working in the total population has been falling fast.

This dispute among mainstream Keynesians might seem rather arcane and irrelevant.  But I think it raises some useful pointers on the weaknesses in the Keynesian understanding of the crisis and its policy prescriptions to end the Long Depression in the major capitalist economies.  Can the slump be ended just by more government spending through more borrowing or will that merely boost debt levels and distract from dealing with ‘long term structural problems’ in capitalist economies like the US?

First, as for the efficacy of short-term fiscal stimulus, I refer to my previous post (The smugness multiplier) on the effect of Keynesian-type fiscal multipliers
The evidence shows that the short-run approach is limited, at best.  For example, as I noted in another post, one study found that the relatively tougher fiscal adjustment in the UK compared to the US has contributed slightly less than half the 5% pt difference in real GDP growth between the two countries over the last three years (see G Davies, J Antolin-Diaz, Why is the US economic recovery stronger?, Fulcrum Research, November 2012).  So US fiscal stimulus only did so much.

Second, the Great Recession was not caused by a slump in ‘effective demand’, especially consumption demand.  It was caused by a slump in investment.   As one capitalist chief, Fred Smith, the CEO of FedEx, recently observed “The only thing that’s correlated 100% with job creation – and particularly good job creation – is business investment. It’s our reduced level of capital investment that has produced our low GDP growth rates and our high unemployment.”  And if that is the case, then monetary injections through QE or more welfare spending will do little to help drive investment up.  

Investment analyst John Hussman makes a similar point (http://www.hussmanfunds.com/wmc/wmc130304.htm): “I’ve often noted that recessions aren’t simply a time when total demand falls short. They are usually a time where the mix of goods and services that is demanded becomes out of line with the mix of goods and services supplied by the economy. In order to get that mix back in line, it’s not enough to simply “stimulate demand” – it’s important to encourage innovation and investment in areas where needs aren’t being met, and to allow the transition and reallocation of resources away from areas that are no longer in demand.”  

As Hussman points out, the correlation between 8-quarter growth in US gross domestic investment and 8-quarter growth in non-farm payroll employment is 80%, with payroll growth lagging investment growth by about 6 months. Notably, that correlation is not driven by linear trends, but instead by a close match between cyclical movements of both, with employment lagging investment activity.  But growth in gross domestic investment has turned lowerand so is moving in the wrong direction if job creation is an objective of economic policy. “All of the QE in the world will not help this situation, but will instead continue to distort investment decisions away from productive allocation of capital and toward brute speculation in financial assets”.
Hussman singles out a key flaw in the Keynesian approach: ” Because savings and investment must be equal, and Keynes has already assumed that investment is fixed, the attempt by individuals to save a greater portion of their income cannot actually result in a greater amount of total savings. Instead, other things being equal, GDP must fall. There may be a million individual private decisions that produce this result, but in the end, savings must equal investment.  The Keynesian solution to this is to offset the desired increase in private savings with a decrease in government savings. Keynesians typically want savings rates to be as low as possible, on the assumption that spending automatically generates production. Keynesian theory really doesn’t embody the notion of scarcity and economic tradeoffs very well, and both government spending and investment enter the model like any other class of spending, with little attention to the productivity of that spending over time.  

So Keynesian “attempts to “stimulate” the economy by suppressing savings and increase consumption, or by pursuing “beggar thy neighbor” exchange rate policies are weak options compared to policies that encourage productive investment, research, and development. A nation’s “standard of living” is reflected by the amount of goods and services that its people can consume as a result of their efforts. A nation’s “productivity” is reflected by the amount of goods and services that its people can produce as a result of their efforts. Ultimately, one cannot increase for long without the other. Robust domestic investment provides the foundation for both.  The only sustainable course to a higher standard of living is to encourage productive investment. “

In an excellent series of articles (http://socialisteconomicbulletin.blogspot.co.uk/),
Michael Burke has shown exactly how a slump in investment has been the main reason for the failure of the UK economy to recover.  The UK government’s policies of austerity have played their role precisely because they have been mainly aimed at reducing government investment.  Unless long-term productive investment is restored, modern capitalist economies will not recover however much extra money is injected or extra government spending takes place.  This is the point behind Sachs’ criticism, however badly put.  He was more perceptive in a recent article in the FT (Today’s challenges go beyond Keynes, 17 December 2012), when he said: “Unlike the Keynesian model that assumes a stable growth path hit by temporary shocks, our real challenge is that the growth path itself needs to be very different from even the recent past.”

But what do Hussman or Sachs mean by ‘productive investment’.  Under capitalism, productive investment is not aimed at delivering extra output for an economy to use; instead productive investment must deliver more profit, with extra output as a secondary outcome.  The Marxist theory of crisis reckons that slumps or recessions are caused by a collapse of investment, an investment strike.  The investment strike happens because it has been no longer profitable for capitalist to invest and so they stop, lay off labour and reduce production and that ‘multiplies’ through the economy as workers lose their jobs and incomes.  Until sufficient profitability returns, capitalist will hoard their cash or increase dividends to their shareholders or buy back shares rather than invest in new equipment or employ more staff.

That is the missing ingredient from both the analysis of Sachs and his Keynesian opponents: profitability.  The evidence that profits drive investment is now well documented.  See the excellent analysis of Tapia Granados, often mentioned in this blog (see http://thenextrecession.wordpress.com/2012/06/26/profits-call-the-tune/).  Recognise the close connection between past profitability and future expectations of profit on investment, as analysed for the US economy in Andrew Kliman’s book, The failure of capitalist production.  See the recent paper by Andrew Kliman and Shannon Williams on US profitability and investment (http://akliman.squarespace.com/writings/).  And in my book, The Great Recession, even I managed to present evidence for profits driving investment.  This is ignored by neoclassical and Keynesian economics alike.

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