Saturday, December 16, 2017

Reversal of fortune

Yesterday, looking at compensation and current-dollar output for the business sector, I said "we are looking at income and cost."

I was thinking of compensation as income, and the purchase of output as a cost.

I'm pretty sure economists have it the other way around.

Friday, December 15, 2017

Intuitive, but only after I saw it

Starting with the "productivity versus compensation" thing, I decided to look at aggregate totals rather than "per hour" numbers, and switched from "real" to "nominal" data. We're not looking at growth now, but we are looking at income and cost.

I figured compensation as a percent of current dollar output. Guess what it looks like: Labor share.

Graph #1: Compensation as a Percent of Output, nominal Business Sector index values
Exactly like labor share:

Graph #2: The Graph #1 Data (blue) and Labor Share (red)
I had no idea. I love it when that happens.

Thursday, December 14, 2017

Since when? The Productivity–Pay Gap

Noah Smith at Bloomberg: Workers Get Nothing When They Produce More? Wrong. Noah shows this graph:

Graph #1: Employee Compensation is Falling Behind Already by 1962
Noah's article is about the way people interpret the graph. As he puts it, some people see compensation falling behind output and ask:

If productivity improvements don’t actually get translated into wages, what’s the point of making the economy more efficient?

They say the graph shows there is no sense in boosting productivity. Noah disagrees, as you can tell from the title of his article. He cites a study that looks at short-term changes and sees "a correlation between productivity and wages -- when productivity rises, wages also tend to rise." But over the longer term, compensation falls behind productivity because of "forces pushing in the other direction" he says.

That's interesting. It leads to questions: What forces? And: Why? And: What can be done about this? It opens doors.

Before we come up with a solution to the problem of lagging compensation, we have to know the cause of the problem. We don't yet know the cause. We don't even know when the problem started, so how can we know the cause?

If you don't know when the problem started, how can you possibly know the cause? And if you don't know the cause, how can you possibly know the solution?

How can you have any pudding if you don't eat yer meat?

When did the problem start? Noah doesn't say:

Since the end of World War II, productivity, in terms of economic output per hour, has grown by a factor of five, while compensation has only tripled. Since 1980 the divergence has been especially stark ...

More stark divergence may indicate a new phase, but does not mark the start of the problem. In any case, on Noah's graph I don't see a more stark divergence beginning around 1980. I see a kink in both lines shortly after 1972, and a kink in both lines around 1997. Nothing around 1980, other than a brief dip in productivity. Not even a wiggle in compensation. Look at the graph.

It looks to me that, for Noah's data at least, productivity and compensation ran neck-and-neck from 1947 to just before 1962. Call it 1960. A gap opens after 1960. This is where the problem begins. Not 1980.

There is a kink around 1973, and then compensation slows more than productivity. Maybe the second stage of the problem begins in 1973.

There is another kink around 1997, after which productivity accelerates upward and compensation does not. This would be the third stage.

If you hover a mouse over Graph #1 you will see the trends I'm looking at.

Around 1980 or 1982 there is nothing but a wiggle in productivity which is surely the result of the double-dip recession that occurred at that time. No wiggle is visible in the compensation data for those years.

Perhaps Noah sees stark divergence since 1980 because he has heard people speak of it a million times. Or perhaps he is thinking of this graph from Robert Reich:

Graph #2. Source: the Preservation Institute Blog.
Ritholtz at The Big Picture shows this graph as part of a larger image
and links to an article by Robert Reich at the New York Times.
Reich puts a white stripe down the graph at 1980. The white stripe is a conclusion imposed on the data, a conclusion that intrudes upon unbiased evaluation. The data on Robert Reich's graph is not the same as that shown on Noah Smith's graph, yet both graphs show productivity and compensation running together from 1947 to about 1960, and productivity gaining on compensation since that time.

You could say that Robert Reich put the white stripe at the point where compensation peaks and starts to fall. This would explain why the white stripe appears at 1980. But by 1980, compensation had been falling behind productivity for 20 years, as you can plainly see on Reich's graph.

Noah's data is not the same as Robert Reich's. Noah's graph shows a change around 1973, and a change around 1997. It shows nothing but a recession-related wiggle in productivity around 1980. And yet Noah's "stark divergence" begins in 1980, at the same moment that Robert Reich's white stripe appears. Why?

Our views are influenced by the views of others. Perhaps Noah sees stark divergence since 1980 because he has heard people say it a million times, or has seen it on Reich's graph.

At the Preservation Institute where I found Reich's graph, the evaluation of the graph is based more on the white stripe than on the data:

From 1947 to 1979, the compensation of non-supervisory workers increased by almost as much as productivity.

From 1980 to the present, compensation stagnated as productivity continued to grow - partly because of deliberate economic policies that were adopted by the Reagan administration ...

Indeed, pointing the finger at Reagan may be the real reason for locating that white stripe at 1980. But even if that is not the case, Reich's white stripe evaluates the data for us, before we can evaluate it for ourselves. No thank you, Mr. Reich.

I don't see a "more stark divergence" after 1980. But don't think that I am defending Ronald Reagan. Reagan's policies did nothing to close the gap between compensation and productivity. Reagan did his share to keep the gap growing. But Reagan did not do more than his share. Not according to Noah's graph.

Now comes the part where I duplicate the original graph so I can examine the data.

I wasn't sure what data series Noah used in his graph, but he does say Source: Federal Reserve Bank of St. Louis so I'm thinkin FRED. FRED doesn't have a lot of data series that match "Real output per hour" or "Real compensation per hour" and go all the way back to 1947. I only find data for the "business sector" and the "nonfarm business sector". So I could throw darts at this, blindfolded, and not be very far off.

I duplicated Noah's graph once for "business" and once for "nonfarm business". Both were close, but neither exactly matched what Noah showed. Maybe there was a recent revision? No matter. I'll go with "business sector" and index the values on the first quarter of 1947. That'll be close enough.

Here's what I got:

Graph #3: My Attempt to Duplicate Noah's Graph -- A Pretty Good Match
My lines both start at 100, like Noah's. One line ends at 300 and the other at 500, as Noah shows. And I got colors comparable to his. So far, so good. The gap on my graph starts just after 1960 and shows trend changes around 1973 and 1997, just like Noah's graph. But the wedge opens up more slowly on my graph. Between 1960 and 1970 I show a narrow gap between the two lines; Noah's gap looks wider. Or maybe it's just my eyes. Whatever, I'm going with this data.

Data in hand, I want to look at the gap between productivity and compensation. A simple way to do that is to subtract compensation from productivity. If productivity is higher than compensation -- which it is -- then the graph will show how much higher the productivity number is. It will show the difference, the gap.

Here's what I get:

Graph #4: The Size of the Productivity-Compensation Gap
"Since 1980," Noah says, "the divergence has been especially stark". I don't see it. The gap is obviously bigger in the later years. But there is no "kink" in the blue line around 1980, and no acceleration thereafter. The line just goes up, the same after 1980 as before.

Just after the year 2000, yeah, there does seem to be a kink there. And the line goes up faster after that, for a while. But it's 20 years too late. You can't blame Reagan. There is no kink and no acceleration around 1980 on this graph. There is no sudden change in the growth of the gap. What was Noah thinkin?

Nor is there a dramatic increase since 1973, contrary to what EPI claims. The line is obviously higher after 1973 than before, but there is no sudden change in the upward trend. The pace is constant since 1961.

Hey, when you're looking at the gap between two jiggy lines, it is difficult to see exactly the size of the gap. But when you subtract the one line from the other, as on Graph #4, there is nothing left to look at but the gap. And then it is easy to see the size and shape of the gap.

The gap opens around 1961, or possibly earlier. The gap shows consistent increase. There is no sudden acceleration after 1973. There is no sudden acceleration after 1980. There is just consistent increase. I moved the data into Excel and put a trend line on it:

Graph #5: A Trend Line Added to the Data from Graph #4
If anything, the line looks a little low in the 1980s and '90s, relative to trend.

No sudden surge around 1980. No sudden surge around 1973. Only a continuous and stable increase in the gap since 1961.

What are the forces pushing compensation down while productivity rises? The Reagan revolution may be part of the problem. The economic slowdown after 1973 may be part of it. But the problem didn't begin in the 1970s or '80s. It began in the 1960s, or before. To discover the troublesome forces, we have to look to that earlier time.

Wednesday, December 13, 2017

Labor Productivity since 1988

I like this graph of labor productivity. The red and blue data lines look like trend lines for the jiggy green:

Graph #1: Labor Productivity
See how productivity has been really low most of the time since 2010? You know about that.

It was very low like that for two or three years before 1995. Then all of a sudden it went high and the economy was good for a while. Yeah, I expect that to happen again soon and I think we're getting there now.

What else do you see on the graph? Productivity always goes high after a recession. After the 1991 recession on this graph, and after the 2001 recession, and even after the Great Recession. A good big fat spike after the Great Recession. And then nothing.

Any minute now it will go up, like in the mid-90s. If you run that red line out to the end of the graph, it's going up.

Any minute now ...

Tuesday, December 12, 2017

Recommended reading: Steve Denning

Prior to 1982, large stock buybacks were illegal because they constituted obvious stock price manipulation. But the SEC in the Reagan administration introduced a new rule—Rule 10b-18—which creates “a safe harbor” for firms to buy back as many shares as they like. This effectively opened the floodgates.

Monday, December 11, 2017

Well that was quick!

Goldilocks is back -- The Economist, 17 October 2017

Time is running out on 'Goldilocks' -- CNBC, 5 December 2017

Sunday, December 10, 2017

Twin Peaks

It’s no mere coincidence that over the last century the top earners’ share of the nation’s total income peaked in 1928 and 2007 — the two years just preceding the biggest downturns.

Saturday, December 9, 2017

Quantum Unemployment

Call me the duplicator: See a graph, make a graph.

Look up Okun's Law, and this graph comes up:

Graph #1: Okun's Law. Source: Wikipedia
I always want to see how it works: What is the data? What are the units? Can I duplicate the graph? It's an automatic process. I don't decide that I want to do it. I just do it. I don't know why. But anyway, the data series are Real GDP, and UNRATE at FRED. The values are quarterly. The unit for GDP growth is "percent change", and the unit for unemployment is just "change" because it starts as percent. So yeah, I can do that.

Here's what I got:

Graph #2: Okun's Law at FRED
The horizontal black line on the second graph is the X-axis, not the trend. Ignore it. Look at the shape of the cluster of blue dots: high on the left, low on the right. A "best fit" trend line would run from high on the left to low on the right, just like the trend line on the first graph. So I'm satisfied: I duplicated the graph.

I even got blue dots! My dots are all the same color, all faint blue. Some of them look dark because they overlap. There are more dots in the middle of the cluster than elsewhere, and they overlap and it makes them look dark blue. If you look at the first graph, there are more dots in the middle of the cluster there, too.

So that's what I saw when I looked at my graph. And then I noticed something odd: My dots are all arranged in columns, with blank space between the columns. You probably noticed it before I did. It's like unemployment always makes a quantum leap from one level to the next, as you go from left to right.

The other graph doesn't show that.

No, I know what it is: FRED rounded the unemployment numbers to one decimal place. You can see it, from the way the columns are spaced. And sure enough, if you hover over the graph at FRED it shows the unemployment values rounded to one decimal place.

Damn, I thought I was on to something with "quantum" unemployment!

Friday, December 8, 2017

Ricardo's Law

Brad DeLong, back in 2010, looked into The "General Glut" of Thomas Robert Malthus. DeLong offers some thoughts, then follows up with "Malthus on 'glut': all the mentions I have found". Wow, what a great resource that is!

At one point DeLong has Malthus quoting David Ricardo:

If men ceased to consume, they would cease to produce.

Supply is limited by demand.

Thursday, December 7, 2017

Say's Law and Say's Other Law

From Chapter II of the General Theory by Keynes:

From the time of Say and Ricardo the classical economists have taught that supply creates its own demand; meaning by this in some significant, but not clearly defined, sense that the whole of the costs of production must necessarily be spent in the aggregate, directly or indirectly, on purchasing the product.

Supply creates its own demand.

From Book III of A Treatise on Political Economy
by J. B. Say:

production cannot be effected without consumption.

Demand creates its own supply.

Wednesday, December 6, 2017



We cannot, as a community, provide for future consumption by financial expedients but only by current physical output.


It is better to have a permanent income than to be fascinating.

Tuesday, December 5, 2017

In Low Orbit

The classical theory "is best regarded as a theory of distribution in conditions of full employment", Keynes said. "If the classical theory is only applicable to the case of full employment, it is fallacious to apply it to the problems of involuntary unemployment".

... Sorry. What?

They used to say, I see they still do, that an atom has one or more electrons orbiting the nucleus. Like moons orbiting a planet. But electrons sometimes jump to a higher or lower orbit. The "orbit" level for the electron is like the equilibrium level for the economy. That's the level where the electron (or the economy) wants to stay. But sometimes something happens to push the electron (or the economy) far enough away from its "happy place" that it doesn't go back. Instead, it finds a new level where it wants to stay.

When an electron changes its orbit level, they say, it absorbs or radiates energy. I say that when an economy changes its equilibrium level, it absorbs or radiates jobs.

When an electron jumps to a lower level it gives off energy. When an economy jumps to a lower level it gives off jobs. When it gives off jobs, there is less employment. When an economy jumps to a higher level it absorbs jobs, and there is more employment.

People have said the economy has a "new normal". They mean it has jumped to a lower orbit and given off jobs. This change created more "involuntary unemployment". The top "orbit" level for the economy, according to Keynes, is the "full employment" level. The lower orbits produce various levels of involuntary unemployment.

The classical theory only applies in high orbit, Keynes said.

Monday, December 4, 2017

24 years, Borio says. It's not a coincidence.

Zero Hedge 4 December 2017: BIS Issues An Alert: Tightening "Paradoxically" Leading To Excessive Risk Taking; Reminds What Happened Last Time:

Valuations in asset markets are “frothy” and investors are basking in the “light and warmth” of the “Goldilocks economy” ...

The Goldilocks economy? It's right on schedule. I've been predicting it since March 2016, the same month Zero Hedge told you "The world economy is on the precipice of another Great Depression."

Oh, and if asset markets are "frothy" it just means we need a small tax on asset market transactions. Or, if we already have a tax like that, it means increase the rate a little. Just like the Fed would increase interest rates. It's not rocket science.

The Zero Hedge post links to BIS Quarterly Review, December 2017 - media briefing where Claudio Borio says:

The expansion broadened and gained momentum. Above all, despite vanishing economic slack, inflation - central banks' lodestar - generally remained remarkably subdued.

Vanishing economic slack? No, it's way too early for that. Borio probably uses the wrong measure, like everyone else. Financial slack must be measured as the size of accumulated debt relative to the size of the circulating money which is used to make payments against that debt. Or accumulated debt relative to Federal debt held by Federal Reserve banks. Or accumulated debt relative to base money. Any measure that shows how far a dollar has to stretch to cover all the debt it has to cover.

Scott Sumner has often said the economy is bad because money is tight. He's right about that, but he doesn't know how to show tight money. To see tight money, look at spending-money relative to accumulated private debt -- or relative to total public and private debt. Look at narrow money relative to broad money. Look at the total cost of finance relative to the money available to make the payments. Work with me here.

Borio says:

Even as the Fed has proceeded with its tightening, overall financial conditions have eased. For instance, a standard indicator of such conditions, which combines information from various asset classes, points to an overall easing regardless of the precise date at which the tightening is assumed to have started. Indeed, that indicator touched a 24 year low.

I can show you the 24 years:

Graph #1: Credit Market Debt per Dollar of Circulating Money
This is my debt-per-dollar graph. The higher the blue line, the faster a dollar has to move to cover all the debt it has to cover. When the line goes up, money gets tighter. When the line goes down, the financial system gets more slack.

24 years ago it was the end of 1993 and the economy was just getting ready to start its "Goldilocks" phase. And things are just now ready to start improving, again.

BIS is right to worry, because the blue line on the graph is going to go up again until we get in trouble again. But we still have time to prevent a recurrence of the problem.

We need to make sure debt (especially private debt) does not accumulate too rapidly. That means people have to pay down debt faster. Instead of having policies that encourage people to accumulate debt, we need policies that encourage people to pay down debt. Instead of letting people deduct their mortgage interest, for example, give people a tax deduction for making an extra mortgage payment or two each year. You can even design the new policy to create the same amount of tax advantage as the old policy.

We must make debt grow more slowly. That's crucial. As a bonus, a policy that gets us paying down debt faster is a policy that fights inflation. Why should interest rates have to do all the work?

Oh, and it's no coincidence, that "24 years" thing.

H/T Tom Hickey

The trend of long term growth

Two images, not quite at random.

This, from Revisionguru, showing a rock-hard erectile trend:
And this, from CaixaBank Research, showing a more flaccid trend:
Economists always show the boner, but the other is more honest.

I think I'm done here.

Sunday, December 3, 2017

A comparison of Adam Smith and Jean-Baptiste Say, based on their "Lotteries" paragraphs

Adam Smith

Smith looked at who gets the money from lottery ticket sales, and pointed out that lotteries are not "perfectly fair". If they were, he said, "the undertaker could make nothing by it".

From this observation he draws the conclusion that

There is not ... a more certain proposition in mathematics, than that the more tickets you [buy], the more likely you are to be a loser. [Buy] all the tickets in the lottery, and you lose for certain ...

That doesn't stop me from buying the occasional lottery ticket. I've never hit the big one, though, so on net I'd have to say Smith is right: I've lost more than I've gained by the lottery.

Other than that, Smith makes use of the lottery to look at aspects of human nature. We love the chance of gain, he said:

That the chance of gain is naturally over-valued, we may learn from the universal success of lotteries.

And we are dazzled by the big prize:

The soberest of people scarce look upon it as folly to pay a small sum for the chance of gaining ten or twenty thousand pounds; though they know that even that small sum is perhaps twenty or thirty percent more than the chance is worth. In a lottery in which no prize exceeded twenty pounds, though in other respects it approached much nearer to a perfectly fair one than the common state lotteries, there would not be the same demand for tickets.

Smith is fine with the idea that a laborer should get his wages, and an entrepreneur his profits. But if the entrepreneur is in the lottery business, Smith says, his cut is unfair... And the entrepreneur becomes an "undertaker"!

In this one particular case, the entrepreneur's profit is not "fair" to his customers. I don't know why Smith says that, unless he really didn't like the lottery. But if you accept Smith's premise, you have to accept his whole paragraph. It's all one argument. It all hangs together.

Jean-Baptiste Say

"[T]he chances are manifestly against" lottery players, Say says. Smith said the same, but Smith at least did the math. J.B. Say only makes the assertion.

Say's assertion makes a good conclusion to his paragraph. But it is not a conclusion to an argument about the chances of winning a lottery. Say's argument is not about the chances of winning a lottery. His argument is that lotteries are bad.

Say says that lotteries are an unprofitable use of capital. That's in contrast to Smith's view that the undertaker's profit is unfair or excessive. Say also says that lotteries cannot possibly contribute much to the Treasury, and that they are like a tax that falls heavily on the needy.

In addition, he points out that lotteries are a "vast" waste of time, and that they teach people to trust chance more than their own talents and to favor zero-sum gain over productive activity.

None of Say's assertions are backed up the way Smith backs up his "not perfectly fair" assertion. And half of Say's remarks are moralistic generalizations focused on harmful effects of the lottery on human character.

Smith was a great thinker. Say was a petty man.

Saturday, December 2, 2017

Adam Smith didn't like lotteries, either

I had to go looking for it, but memory did serve. This is the paragraph I remember:

That the chance of gain is naturally over-valued, we may learn from the universal success of lotteries. The world neither ever saw, nor ever will see, a perfectly fair lottery; or one in which the whole gain compensated the whole loss; because the undertaker could make nothing by it. In the state lotteries the tickets are really not worth the price which is paid by the original subscribers, and yet commonly sell in the market for twenty, thirty, and sometimes forty per cent. advance. The vain hope of gaining some of the great prizes is the sole cause of this demand. The soberest people scarce look upon it as a folly to pay a small sum for the chance of gaining ten or twenty thousand pounds; though they know that even that small sum is perhaps twenty or thirty per cent. more than the chance is worth. In a lottery in which no prize exceeded twenty pounds, though in other respects it approached much nearer to a perfectly fair one than the common state lotteries, there would not be the same demand for tickets. In order to have a better chance for some of the great prizes, some people purchase several tickets, and others, small shares in a still greater number. There is not, however, a more certain proposition in mathematics, than that the more tickets you adventure upon, the more likely you are to be a loser. Adventure upon all the tickets in the lottery, and you lose for certain; and the greater the number of your tickets the nearer you approach to this certainty.

Smith is quite definitely opposed to lotteries. But in this paragraph and others, he uses the lottery to observe human behavior, and as a metaphor to describe aspects of other economic activity. By contrast, J.B. Say took the opportunity of a footnote to say the most unkind things about lotteries, as we saw in the previous post.

Friday, December 1, 2017

J.B. Say did NOT like lotteries

In Jean-Baptiste Say's A Treatise on Political Economy, paragraph III.VIII.55 refers the reader to footnote 88:

Lotteries and games of hazard, besides occupying capital unprofitably, involve the waste of a vast deal of time, that might be turned to useful account, and this item of expenditure can never redound to the profit of the exchequer. They have the further mischievous effect of accustoming mankind to look to chance alone for what their own talents or enterprise might attain; and to seek for personal gain, rather in the loss of others, than in the original sources of wealth. The reward of active energy appears paltry beside the bait of a capital prize. Moreover, lotteries are a sort of tax, that, however voluntarily incurred, falls almost wholly upon the necessitous; for nothing, but the pressure of want can drive mankind to adventure, with the chances manifestly against them.

Good grief! And today's winning numbers are ...

Thursday, November 30, 2017

Say's Law of Taxes

Those who are too lightly taxed, are not likely to cry out for an increase; and those who are too heavily taxed, are seldom regular in their payments. The public revenue suffers in both ways.

Wednesday, November 29, 2017

No, that's not it

Searching thru Keynes quotes, I found this:

It's not right.

I know what they did. They "fixed" the quote. They pruned the words. They changed the meaning. It's not right. What Keynes actually said was

The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds.

Keynes was not a philosopher telling us that coming up with an idea is easier than you think. He was an economist, telling us that the particular ideas he was presenting were really rather simple.

The BrainyQuote version bothers me because it suggests that one solution to economic problems is as good as another. That is surely not true. Moreover, we may not have to "develop a new idea" to fix the economy. What we need, Keynes knew, is the right idea.

And it is difficult to find the right idea when one's mind is littered with garbage.

Tuesday, November 28, 2017

What's crucial is to know why growth has been slowing.

I don't know who Boffins is, but The Register back in September reported that Boffins fear we might be running out of ideas.

The opening:
Innovation, fetishized by Silicon Valley companies and celebrated by business boosters, no longer provides the economic jolt it once did.

In order to maintain Moore's Law – by which transistor density doubles every two years or so – it now takes 18 times as many scientists as it did in the 1970s.

That means each researcher's output today is 18 times less effective in terms of generating economic value than it was several decades ago.

"18 times less". I can stop reading the Boffins article right there. I guess we'll never know who Boffins is -- or, are.

I saw that stat before, the number of scientists required to accommodate Moore's Law, like angels fitting on the head of a pin. Back in September, maybe. Saw it three or four times, under different and apparently unrelated headings. All the sightings reported the same statistic, though not all in such anti-mathematical terms. 18 times less?? For the record, "times" means multiply and "less" means subtract. What are we supposed to do with 18 -- multiply it or subtract it? Eh, forget Boffins.

I am never impressed when an article draws a conclusion from one statistic. But when three or four articles all draw a conclusion from the same statistic, you will find that I am, well, three or four times less impressed.

Do the math.

It's not only Boffins the "number of scientists" stat that leads to the "out of ideas" idea. There is also Tyler Cowen's "low hanging fruit". There is no more low-hanging fruit, Cowen says: We've already plucked all the good ideas that were easy to reach. That's quite an insult to every innovator going back to Newton, Descartes, and the guy who invented three field rotation.

And there is Robert J Gordon, of course, whose mournful soliloquy suggests that faltering innovation is the cause of declining economic growth. Gordon writes of "six headwinds", problems we cannot solve. He seems to think our innovators are plumb out of ideas.

This reminds me of Arnold J. Toynbee's "challenge and response": Civilization faces repeated challenges, but will survive as long as the response to the challenge is adequate. If we're out of ideas, though, our response may turn out to be inadequate. You should be concerned.

The NBER summary of Robert Gordon's view tells us that economic growth "gradually accelerated after 1750, reached a peak in the middle of the 20th century, and has been slowing down since."

If you want to know why growth accelerated, you need to look back to 1750 and before. Some of that history is fascinating stuff. Fascinating, but not crucial.

What's crucial is to know why growth has been slowing. What's crucial is to know the correct response, the response that will allow civilization to survive.

Timothy Taylor asks Will Artificial Intelligence Recharge Economic Growth? He writes:

Of course, the transition to the artificial intelligence economy will have some bumps and some pain, as did the transitions to electrification and the automobile. But the rest of the world is moving ahead. And history teaches that countries which stay near the technology frontier, and face the needed social adjustments and tradeoffs along the way, tend to be far happier with the choice in the long run than countries which hold back.

It's coming anyway, Taylor says. And because he compares it to "electrification and the automobile" I have to think he sees the AI transition as a way to increase economic growth. That makes sense, at least if you think economic growth has lost its "charge" due to a lack of ideas, and that AI is an idea whose time has come.

But if a lack of good ideas is not the problem, then the advance of artificial intelligence may be no better for us than for Sarah Connor and her son John. So maybe we want to spend a little more time thinking about the cause of the decline of growth.

What if we pick the wrong response? I mean, most people say we have to reduce the Federal debt. Some people say we have to increase the Federal debt. And a few people, myself among them, say we have to reduce private debt. All those ideas are out there. Will any of them work?

Toynbee was right. We have to pick the right response, or it's all for naught. What's crucial is to know why growth has been slowing.

Monday, November 27, 2017

J.S. Mill ignores the internal factor

Keynes quotes J.S. Mill:

What constitutes the means of payment for commodities is simply commodities. Each person’s means of paying for the productions of other people consist of those which he himself possesses. All sellers are inevitably, and by the meaning of the word, buyers. Could we suddenly double the productive powers of the country, we should double the supply of commodities in every market; but we should, by the same stroke, double the purchasing power. Everybody would bring a double demand as well as supply; everybody would be able to buy twice as much, because every one would have twice as much to offer in exchange. [Principles of Political Economy, Book III, Chap. xiv. § 2.]

But we do not exchange commodities for commodities. We exchange commodities for money, and money for commodities.

Does it matter? Yes, because if somebody saves a dollar, it means that someone else will fail to sell a dollar's worth of their commodities. That puts a small wrinkle in Mill's picture of the economy.

As the economy "matures", more and more dollars are saved. Instead of showing one small wrinkle, the economy comes to look like a crumpled ball of waste paper. And at that point, that's about all it is.

Sunday, November 26, 2017

Debt per Dollar, inverted

One of the graphs I look at all the time is "Debt per Dollar": Total debt, relative to the quantity of circulating money. Total (public and private) debt, because debt has to be serviced. Circulating money, because that's the money used to service debt.

Today for some reason I inverted the ratio. Here is the graph:

Graph #1: The Money We Have for Paying Our Debts (and our other expenses) per Dollar of Debt
We had about 20 cents of money (per dollar of debt) just before the 1960s when the economy was good.

We had about 2 cents of money (per dollar of debt) just before the financial crisis, when the economy was not so good.

Internal factors arose that destroyed the economy. It's right there on the graph.

Saturday, November 25, 2017

Behold: Internal Factors

Suppose we have a tiny economy in equilibrium. An economy similar to an early medieval, non-monetary economy. Ten people each producing 12 per year of whatever it is they produce. Each guy takes one of what he produces as his profit, barters nine, and pays the remaining 2 to the lord of the manor as taxes.

This little society can run at that speed forever. You can assume barter conditions that make it fail, of course. But for purposes of equilibrium, we assume barter conditions that make it not fail: Everybody trades one-for-one with nine of his neighbors.

The equilibrium could be upset by an external factor: One guy dies, for example, or a mutant fungus kills his crop. Or somebody revises these sentences.

But there are no internal factors that might arise to destroy the equilibrium. By this I mean the numbers work. Each year 10 people produce 120 things and consume 100 of them, and the lord of the manor consumes the other 20. There are no excesses, no shortages, nothing to upset the apple cart.

We could plug money into this model and it will still work just as well: Each year 10 people produce $120 of things, 10 people consume $100 worth, and one person consumes $20 worth. There are no excesses and no shortages.

But in this case, to make it work, we also have to assume that nobody does any saving. Maybe the lord of the manor is getting fat because he consumes twice as much as everybody else. So he goes on a diet. He decides to save $10 each year, and only consume $10 worth like everybody else.

So now the tiny economy could still produce just as much as ever, but it doesn't, because the people can't afford to buy it all because they don't have the money. Ten dollars disappeared. Ten dollars disappears every year. This can't go on forever. Our little economy will soon run out of money.

You could fix the problem by setting up a system of lending and borrowing. Now it appears that this economy can again go on forever.

But things are going on here that we cannot see. To see them we need more columns in the table. We need a category for accumulated savings and another for accumulated debt. And if our system of lending and borrowing requires that interest be paid, we need a column for that, too.

Everything is fine now, as long as everybody can borrow all they need. They still need to borrow $10 every year to bring consumption up to $120, plus now they need to borrow a little more to cover the interest owed.

But that means people have to borrow more each year than the year before. Before long they will have to borrow more each year than they produce!

And the amount they have to borrow still keeps getting bigger every year. At some point the lord of the manor, the guy with all the savings, decides it's just not worth the risk any more. He says "That's it! No more borrowing! Everybody pay up!" But how can you pay up when you owe $234 and have no savings?

So life as we know it comes to an end.

It is not the "real" economy that's the problem here. Everyone can still produce just as much as before. But they don't, because the equilibrium has collapsed.

The problem is in the money. The money problem crashed the "real" economy.

An internal factor crashed the economy.

Friday, November 24, 2017

Grab a Barf Bag!

Here's a quote that would make Lars Syll retch:

Because DSGE models start from microeconomic principles of constrained decision-making, rather than relying on historical correlations, they are more difficult to solve and analyze. However, because they are also based on the preferences of economic agents, DSGE models offer a natural benchmark for evaluating the effects of policy change.

"... based on the preferences of economic agents, DSGE models offer a natural benchmark for evaluating the effects of policy change.

I think this is one of Syll's pet peeves! DSGE models are not "based on the preferences of" actual economic agents, but on simplified agents arising from "deductivist" assumptions. And, as Syll puts it:

When addressing real economies, the idealizations and abstractions necessary for the deductivist machinery to work simply don’t hold.

I like the MathWorks quote because it is a little bit of evidence that Syll is right. I have no idea who might be right about such things until I see a few bits of evidence like that.

I also like the MathWorks quote because it describes the alternative to DSGE models as "relying on historical correlations", which is the thing that makes sense to me.

// see also: Lucas critique?
// see also: Rethinking the same damn thought

Thursday, November 23, 2017

Sources of Income 1929-2016

Stacked FRED Graph showing Relative Shares of Income since 1929
Top to bottom: Interest income
Rental Income
Proprietor's income
Compensation of Employees

Source: FRED Table 2.1. Personal Income and Its Disposition: Annual

Wednesday, November 22, 2017

Hey Tom

Remember when I said

I predict a boom of "golden age" vigor, beginning in 2016 and lasting eight to ten years. It has already begun. In two years everyone will be predicting it.

Tom, you said

Art goes out on the limb.

Remember? That was 19, almost 20 months ago. Have you noticed that the mood is more upbeat now? Rather than predicting recession, people seem to think we can get 3% growth.

We'll beat 3%.

Tuesday, November 21, 2017

Six years ago at Asymptosis...

Concise, clear, and correct:
Ultimately, of course, private debt and interest charges on that debt needs to be paid off from real-economy income. Asset prices can’t rise forever.

Economists will tell you that gross debt levels don’t matter because one person’s debt is another’s holdings. (Net: zero.) They ignore it.

But if the gross private debt is too large, the real assets in the real economy can’t generate enough income to pay it off. Not really complicated, conceptually.

Monday, November 20, 2017

The return and maintenance of economic vigor

I started predicting vigor in March of 2016. Then in July 2016 I showed a graph of Household Debt Service Payments at a low point and ready to rise:
I called vigor because financial costs are down:
Graph #4: The Fall and Rise of Household Debt Service Payments
Financial costs have fallen from 13% to 10% of Disposable Personal Income. And now consumers have 3% of DPI to play with. Look at the extreme right end of the blue line on the graph: The line is starting to go up again. Already.

In March I said "We are at the bottom now, ready to go up." Four months later I showed it going up. Debt service is starting to go up again already, I said.

But then, a year after my original prediction of vigor, commenting in March 2017 on the graph shown above, I said

The uptick at the end of Graph #4 seems to have fizzled out. The link shows TDSP thru the end of 2016:

Unfortunately, I wasn't clever enough to capture the graph as an image, and TDSP has since changed. The link in my comment doesn't show what I was looking at in March of 2017, which was something like the red line here:

Graph #1: Household Debt Service as of March 2016 (blue) and March 2017 (red)
The tiny uptick at the right end of the blue line was gone (or perhaps just slightly lower, now that I see this comparison!) and the newer data was flat. But I was still confident. "Vigor will come," I said.

When I looked just now at the graph linked in my March comment, it was the current version. The data had been revised, and the flat end was gone. Debt service is rising again. It is struggling to rise (as you might expect following a debt crisis, while people remain cautious) but it is rising. I marked up an interesting similarity:

Graph #2: Household Debt Service as of October 6 2017
Two very brief, very tiny maximums in the data, one after each major decline.

I expect what happens after the second tiny maximum will look a lot like what happened after the first: uptrend, a sign of economic vigor. And since the more recent major decline is much bigger, I expect the uptrend will also be bigger this time. We will see economic vigor again, for perhaps a decade.

All that remains is for us to take advantage of the good years: Use the time to prevent another decade of bad years. All we need to do is limit debt growth to something sustainable. Better yet, we should seek the debt-to-GDP ratio that's most conducive to growth. We want to be like a surfer riding a wave of debt, where the wave carries us forward at speed but does not grow to the size of a mountain.

It can be done. To have a vigorous economy, we need lots of borrowing (and that day is coming). But lots of borrowing creates lots of debt. The obvious solution is to pay down debt: to pay down debt faster than we have done in the past. We need policy to make that happen.

Accelerating the repayment of debt may slow the economy some. But so does raising interest rates. We can use accelerated repayment of debt as an anti-inflation policy, along with the interest rate hikes that policymakers already rely on. If accelerated repayment is used, rate hikes will be needed less. And debt will be lower.

But there is something else: Raising interest rates affects all new borrowing, and that curtails economic growth. That's not the best outcome. Accelerated repayment of debt, on the other hand, affects people who have already borrowed. It only slows the economy for those people. People planning to borrow are not hindered by this new approach to inflation control, so economic growth is less severely reduced.

The new policy has to allow for the fact that we're starting with a high level of debt. It must reduce debt gradually, so that people are not thrown into crisis by it. That may seem to defeat the purpose, but it does not. As long as debt is going down, we're on the right track. And almost immediately after the level of debt begins to fall, the economy will begin to improve.

We never had policy that accelerates the repayment of debt. That's the reason private debt got so big. We have lots of policies that encourage the use of credit, and none to encourage repayment. To make policy more balanced, more sensible, we need policies that accelerate the repayment of debt. This way we can keep policies that encourage credit use (and enjoy the growth that results from those policies) but avoid having debt grow to an unsustainable level.

We still do have a mountain of debt to deal with. Some people might worry that "accelerated repayment" would make life difficult for debtors. But there is no reason the policy should be punitive. At the start, the new policy must help us reduce our debt: It must not be punitive. Once debt falls back to a level that is compatible with a vigorous economy (and stabilizes there) the policy can be made neutral. It need never be punitive.

Sunday, November 19, 2017

Financial Cost (4): F over N

Table 1.14 shows "Gross value added of corporate business" along with a list of the component parts of GVA. The table also shows GVA of "financial corporate business" and of "nonfinancial corporate business". There's no list of components for financial corporate, but there is one for nonfinancial corporate.

Add financial and nonfinancial GVA together on a graph, and they completely cover over the "corporate business" GVA. It's a near perfect match. So I'm thinking I can take the "corporate business" component list and subtract the "nonfinancial corporate" component values, and this will give me the "financial" components. Then I can compare the financial and nonfinancial corporate data.

I'll remind you that what they call "nonfinancial" I call "productive" business, and that what they call "financial" I call "nonproductive". For some reason, they put financial ahead of nonfinancial in Table 1.14. I'd put them the other way around, and use my labels. I guess it depends what you think is more important.

Here's financial-relative-to-nonfinancial GVA (red) nicely centered on corporate-minus-nonfinancial-relative-to-nonfinancial GVA (blue):

Graph #1: Financial GVA relative to Nonfinancial GVA
Since using "corporate less nonfinancial" gives me a perfect "financial", I'll just call it "financial" when I do the "corporate minus nonfinancial" calculation. Less messy. And then, to make sense of the descriptions of what the graphs show, I want to use abbreviations. I'll use a prefix letter, either F for financial or N for nonfinancial. And to describe the data, I'll follow the prefix with one of these:

 CE  Compensation of Employees 
 OS  Operating Surplus 
 GVA  Gross Value Added 

So, for example, the above graph is abbreviated as FGVA/NGVA, the ratio of financial to nonfinancial Gross Value Added.

For Compensation of Employees, financial gained on nonfinancial from 1945 to 1980, and then gained on it even faster:

Graph #2: Compensation of Employees, Financial relative to Nonfinancial: FCE/NCE
The graph starts at 1929, so there is not much to go on regarding the run-up to the Great Depression. But it looks as if FCE was high and gaining on NCE before and during the Great Depression, fell during the "correction", then rose again to the crisis. Looks like a high level of finance (F relative to N) is a sign of trouble. This reminds me of my Debt-per-Dollar graph.

In part (3) of this series of posts I had in mind to subtract net interest from corporate profits, but I found out that net interest is not included in corporate profits, so I threw that idea away. For the graph below, I went the other way: I used Operating Surplus, which is profits plus net interest plus some other thing.

Graph #3: Operating Surplus, Financial relative to Nonfinancial: FOS/NOS
For Operating Surplus, financial gained on nonfinancial consistently, with an interruption every 20 years or so. Some kind of cycle, maybe? It looks like the interruptions are getting longer and longer. I wonder if that's a good thing or a bad thing. Maybe it depends on how high the line is getting. Maybe low and short and good go together; and then high and long and bad go together. That could be useful policy guidance (if true).

I noticed that coming out of WWII, compensation of employees (Graph #2) increases from 0.04 to something over 12 by the end of the graph. But the operating surplus (Graph #3) increases to maybe 25 by the end. I got the impression that the operating surplus (net interest and profit) is increasing quite a bit faster than employee compensation.

Is it? Look at the CE ratio relative to the OS ratio, Graph #2 divided by Graph #3:

Graph #4: Compensation of Employees F/N Ratio relative to Operating Surplus F/N Ratio
Looks pretty flat to me, bottoming repeatedly at the 0.5 level. So I have to think the employee compensation and operating surplus F-to-N ratios are increasing at about the same rate. The one big anomaly occurs at the Great Recession. And, possibly, there are cyclical highs where Graph #3 shows cyclical lows. But there is no reliable up- or down-trend that I can see. So it looks to me that the operating surplus is neither gaining ground nor losing it relative to employee compensation. At least not in the financial relative to nonfinancial corporate data.

So I'm left thinking that the problem, if one is visible in this data, the problem is not found in the increase of profit and interest relative to employee compensation. Rather, the problem would have to be in the growth of corporate finance in general, relative to nonfinancial corporate business. That problem is clearly visible in Graph #1.

// The Excel file

Saturday, November 18, 2017

Financial Cost (3), aborted

I want to take "net interest" out of corporate profits, and compare what's left to "gross" interest paid.

If you look at National income: Domestic business: Corporate business: Compensation of employees at FRED, down near the bottom of the page they show RELEASE TABLES. Clicking the link for Table 1.14 brings up a page that identifies the hierarchy of components of "Gross Value Added of Domestic Corporate Business in Current Dollars".

The table shows that net interest is not counted in corporate profits. So then, I don't have to subtract it out.

Friday, November 17, 2017

Financial Cost (2): Inspection

I want to use GVA (gross value added) as the context for profits and interest expense. Better than GDP in this case, I think, because the GVA I'm using is "Gross value added of corporate business". The Financial Times lexicon says

GDP is commonly estimated using one of three theoretical approaches: production, income or expenditure. When using production or income approaches, the contribution to an economy of a particular industry or sector is measured using GVA.

So the GVA number I'm using measures the part of GDP produced by corporate business. I think that's a good context number for corporate profits and corporate interest expense.

The data I downloaded for mine of the 12th (the data I'm using here) includes GDP and RGDP. (From these I can get price deflator values if needed.) Also: interest paid and compensation of employees for "domestic corporate business"; GVA for "corporate business"; and "corporate" profits. I'm pretty sure these data series (except GDP and RGDP) are all numbers for "domestic corporate business", but I don't know for sure. If you know something I don't, let me know.

First graph shows employee compensation, monetary interest paid, and corporate profit, each as a percent of corporate GVA:

Graph #1:
I should say right away that "monetary interest paid" is not a component of corporate GVA. It is a measure of all the interest expense of corporations, or gross interest. Only "net" interest is included in GVA. The reason for this, no doubt, is to avoid "double counting" of income. But cost is cost, so I'm looking at the bigger number. More on this later.

Employee compensation (blue) as a share of corporate GVA runs pretty stable (more stable than Labor Share, which seems to show decline since 1960), running above 60% until the year 2000, when it starts to drop.

Corporate profits (green) decline from about 25% of corporate GVA to just over 10%. They run low in the Reagan years (interesting!) but pick up a bit in the latter 1990s, then start rising just as labor share starts to drop. Profits are now running above 20% again.

Total corporate Interest paid (red) is shown as a percent of GVA for purposes of comparison. Interest starts out low, less than 2.5% of corporate GVA, but rises to 10% by 1970. It peaks at 27.4% of GVA in 1982, runs high while corporate profits run low (the Reagan years), and peaks at 28.5% in 1989. Thereafter, the trend is slowly downward, but with increasing volatility.

It appears that interest gained at the expense of profits in the 1980s, and that after 2000 profits gained on employee compensation ("labor"). For what that's worth.

To see the relative changes in the three series on the first graph, I divided each series by its 1947 value so all three series start with the value 1.0:

Graph #2:
Indexing the values that way really magnifies the "interest paid" numbers, because that data starts at such a low level. And because employee compensation was so high on the first graph and shows relatively little change, the variation in that series is reduced to almost nothing; here, the blue line is almost straight. The green line, not so high on the first graph and varying more than the blue, still shows some variation on the second graph.

The first graph emphasized the different sizes of the three data series. The second emphasizes the changes in size. The red line really stands out here, but the extreme flatness of the blue is equally noteworthy.

I took profits and employee compensation from Graph #1, and subtracted them from total corporate GVA to see how much of GVA remains for other corporate spending. That's the blue line here:

Graph #3:
I put the red line from Graph #1 on this graph for comparison. It starts significantly lower than the blue line, but catches up by around 1980, and doesn't drop off much after that.

"Interest paid" is a big number. Big, and mostly unnecessary.

Thursday, November 16, 2017

Financial Cost (1): Overview of the data

This graph shows "percent change" rates for the data downloaded for my post of 12 November. Annual data, so the graph shows "percent change from prior year".

The first tall spike we come to, above 40%, between 1948 and 1952, that yucky blue line shows corporate profits. Corporate profits are pretty volatile: The line peaks repeatedly, both upward and downward, and this behavior is consistent for the whole 1948-2016 period shown on the graph.

That volatility is the reason I'm doing this follow-up to mine of the 12th. In that post I looked at corporate data for 1955 through 1958, a brief period during which the growth of profits began by increasing 26% over the previous year, and ended by falling 12% below the previous year.

Those growth rates suggest that corporate profits were well above trend in '55 and well below trend in '58. I wasn't thinking about that when I wrote the post. I was working with those years because those were the years Samuelson and Solow considered in particular in their 1960 paper.

The differences from trend no doubt exaggerated the movements of my "interest cost relative to profits" ratio, giving me the ten-point increase in interest cost (from 15% to 25%) relative to profits. So I'm thinking my numbers exaggerated the situation, perhaps significantly. That's why I'm taking another look.

After the yucky blue line, the red line stands out as also highly volatile. That's the interest cost. This one shows more variation than do profits, across the whole 1948-2016 period. The red line is pretty tame before the mid-1960s, staying generally between 10% and 20%. Then from the mid-1960s to the early 1980s the red peaks grow increasingly higher, and the down-pointing peaks increasingly lower. The growing volatility in this period likely reflects the inflation of the time. Finally, since the mid-1980s the red line seems to show some increase over time, but I'd say the main feature is that the movements here are very much bigger than those before the mid-1960s. They are about equal in size to movements during the 1970s and early '80s, but run lower: During the Great Inflation the red line didn't want to go below zero; since the mid-80s it has been centered on the zero level.

The next  line that catches my eye is the gold one, Corporate Gross Value Added (GVA). This line shows little volatility, little vertical motion. It's chief function on this graph seems to be to hide the other lines that display little volatility: nominal GDP (purple) and Employee Compensation (dark blue).

The one line so far omitted from my review of the graph is the greenish line, which shows the growth of GDP with inflation removed from the numbers. This line is mostly hidden by the gold line, except during the years from the mid-1960s to the early 1980s. Again, this is the time of the so-called Great Inflation so we should expect to see the green line run low in these years. And the fact that it does run low supports the view that the growing volatility of the red line in those years "reflects the inflation of the time.

Notice that the gold line and the lines that it hides show a hint of uptrend during the years of inflation. This isn't news. But I want to mention it now so that maybe I won't be fooled by it when I'm lost in the details of my analysis of the numbers.

Sunday, November 12, 2017

Comparative advantage, economies of scale, and the cost of finance

Paul Krugman has an old paper titled How I Work which might be worth your time to read. I want to repeat a fragment of it here, for my own purposes. Krugman writes of his early days as an economist:

What had I found? The point of my trade models was not particularly startling once one thought about it: economies of scale could be an independent cause of international trade, even in the absence of comparative advantage. This was a new insight to me ...

"... within a few days," Krugman says, "I realized that I had hold of something that would form the core of my professional life." It was important to him, this little fragment which said not only comparative advantage, but also economies of scale drive international trade. It was important to him for personal reasons.

It is important to me because I read it this way:

not only comparative advantage, but other things also drive international trade.

It is important to me because it opens a door, the other things also door. And I know what I must bring through that door: the cost of finance.

That shouldn't surprise you. I always look at things in terms of the cost of finance.

Conservatives always gripe about the cost of labor. Liberals always grumble about profits. To my mind you need both wages and profits, if you are to have an economy. And, certainly, you also need finance.

But how much finance do you need? These days, we need a lot. Or, as I see it, we don't really need a lot of finance, but we sure do have a lot. And because we have a lot of finance, the cost of finance is high.

No, not just the rate of interest. Rather, the rate of interest applied to every dollar of debt. If there is not much debt, the cost of finance is low. If there is a lot of debt the cost of finance can be high, even when interest rates are low.

On the consumption side, the cost of finance reduces aggregate demand. On the production side, the cost of finance reduces profits and increases prices. A high cost of finance reduces demand and profits, both, and creates an economy in decline, the kind of decline we have endured now for decades. The cost of finance is a crucial consideration. That's why I talk about it all the time. But set all that aside.

In addition to reducing demand and reducing profits, the cost of finance also adds to the cost of products. It contributes to the increase of prices. (And this does not consider the effect finance has on the quantity of money, and the "inflation is always a monetary phenomenon" thing. But set that phenomenon aside.)

When the cost of finance is rising, it increases costs. It makes output more costly.

In Krugman's "How I Work" paper he says he doesn't worry that his assumptions might be unrealistic. He worries about not knowing what his assumptions are. There are some problems with that approach, but I'll go with it for now. I'll assume that the level of finance was at its best around 1955. You might think 1955 is an unrealistic date. I think it's not far off. But if it makes the reading easier, you can assume I picked a more reasonable date -- still decades ago, but not so many decades ago. That would make the latter 1950s a premonition of what was to come. I can live with that.

By "the level of finance was at its best" I mean that when finance was less, it hindered economic growth more, and that when finance was more it also hindered growth more. I imagine something like a "Laffer curve" for the optimum size of finance. If my Laffer curve comparison doesn't make sense to you, don't worry about it.

In 1960, looking back at the latter 1950s, Samuelson and Solow wrote:
... just by the time that cost-push was becoming discredited as a theory of inflation, we ran into the rather puzzling phenomenon of the 1955-58 upward creep of prices, which seemed to take place in the last part of the period despite growing overcapacity, slack labor markets, slow real growth, and no apparent great buoyancy in over-all demand.

In the end, Samuelson and Solow could not reject the cost-push explanation:
We have concluded that it is not possible on the basis of a priori reasoning to reject either the demand-pull or cost-push hypothesis ...

Ten years later, Federal Reserve Chairman Arthur Burns was pointing to the increases in employee compensation as the driver of inflation. Robert Hetzel quotes from the Board of Governors Minutes for November 1970, that Burns thought in terms of "cost-push inflation generated by union demands."

Perhaps by 1970 union demands were driving inflation. But in the latter 1950s? In the latter 1950s, the rising cost of finance was squeezing profits.

Growing financial cost got the inflation ball rolling. Union demands took the hit for it later, and perhaps rightly so. But union demands did not create the initial problem. The rising cost of finance got inflation going, and kept it going until a wage-price spiral emerged.

For domestic corporate business, financial cost increased faster than the compensation of employees:

Graph #1: Interest Costs Increased Faster Than Compensation of Employees
Consider the 1955-1958 period, the years that concerned Samuelson and Solow. For every dollar corporations paid out as employee compensation in 1955, they paid out five cents for interest costs. By 1958 that number was seven cents. For every dollar of employee compensation they paid out, corporate business spent two cents more on interest in 1958 than in 1955. Financial costs gained on labor costs.

Financial costs also gained on profits:

Graph #2: Interest Costs Increased Faster Than Corporate Profits
For domestic corporate business, financial costs increased faster than profits. Between 1955 and 1958, corporate interest costs rose from 15 cents to 25 cents per dollar of corporate profits: a ten-cent increase in interest costs, ten cents for every dollar of profit.

If financial costs had grown more slowly, if they had grown at the same rate as profits, say, how would the world have been different?

In 1955, corporate business interest paid totaled $7.3 billion, something less that 15% of profits. In 1958, interest paid came to $11.4 billion, something more than 25% of profits. Other things unchanged, if interest paid in 1958 remained at the 1955 percentage, the cost of interest would have been about $6.4 billion. This is $5 billion less than the actual 1958 cost of interest.

If this $5 billion expenditure had not happened, other things unchanged, corporate profits would have been $5 billion higher.

But I can't add that $5 billion to corporate profit, because it changes my interest-to-profit ratio. It throws the calculation off. In order to work thru the calculation cleanly, we cannot add the $5 billion of interest savings to corporate profits, nor to any corporate spending category. The only way to dispose of the $5 billion is to reduce gross corporate revenue by reducing the price of the corporate product.

In 1958, the gross value added (GVA) to the economy by corporate business amounted to $256.9 billion. If we reduce the price of GVA by $5 billion, the reduced number is $251.9 billion. The reduced GVA number is 98% of the actual number. So, to make the calculation work we have to reduce the price of corporate output by 2%.

If corporate interest costs in 1958 remained in the same proportions as 1955, corporations could have reduced their prices by 2% without reducing their profits and without reducing the wages and benefits paid to their employees. Without reducing any of their spending, other than interest.

This is an exercise in "other things unchanged". Ceteris paribus. The assumption is not realistic. But the numbers tell an honest tale: The cost of interest increased faster than other corporate business costs, fast enough to push prices up 2% between 1955 and 1958.

This suggests a different conclusion for the Samuelson-Solow paper: identification of cost-push as the cause of the 1955-1958 inflation.

How did the rising cost of finance affect the economy?

In 1962, President Kennedy was "jawboning" the steel companies, trying to talk them out of raising prices. They raised prices anyway. In response then,

Kennedy launched investigations by the FTC and Justice Department into collusion and price rigging by the steel companies [and] threatened to break Pentagon contracts with U.S. Steel.

The steel companies acquiesced, rolling back the price hike. But they raised prices anyway the following year. This cannot have been simply

a tiny handful of steel executives whose pursuit of private power and profit exceeds their sense of public responsibility

as Kennedy claimed. The price increase was driven by financial cost pressures that Kennedy could not see. "Operating cost" pressures, according to

Profits were being squeezed between rising operating costs and relatively stable prices, and in April 1962 U.S. Steel unexpectedly announced an across-the-board price increase ...

Kennedy was looking for a wage-price spiral. The steel price hike was not part of a wage-price spiral. In March of 1962 the Steelworkers accepted a contract that gave them no wage increase. In April, the price of steel increased 3.5%. The source of the cost pressure was not labor, but finance.

In 1965, on the last day of the year, in its renowned We Are All Keynesians Now article, Time magazine wrote:

First the U.S. economists embraced Keynesianism, then the public accepted its tenets. Now even businessmen, traditionally hostile to Government's role in the economy, have been won over—not only because Keynesianism works but because Lyndon Johnson knows how to make it palatable. They have begun to take for granted that the Government will intervene to head off recession or choke off inflation, no longer think that deficit spending is immoral. Nor, in perhaps the greatest change of all, do they believe that Government will ever fully pay off its debt, any more than General Motors or IBM find it advisable to pay off their long-term obligations; instead of demanding payment, creditors would rather continue collecting interest.

The "greatest change of all" was acceptance of the view that government would act more like business, rolling debt over rather than paying it off.

That change didn't last. Already in 1964, Ronald Reagan had spoken on behalf of Presidential candidate Barry Goldwater. Reagan:

Today, 37 cents of every dollar earned in this country is the tax collector's share, and yet our government continues to spend $17 million a day more than the government takes in. We haven't balanced our budget 28 out of the last 34 years. We have raised our debt limit three times in the last twelve months ...

In 1980, Reagan himself was elected President in a landslide. "We don’t have a trillion-dollar debt because we haven’t taxed enough," he said; "we have a trillion-dollar debt because we spend too much." By 1980, the greatest change of all was that people had come to believe the Federal debt must be reduced. So much for being all Keynesian.

But notice what was not a change in 1965: businesses did not "find it advisable to pay off their long-term obligations". Accumulating debt was standard practice. For the longest time, people thought it was okay if private debt increased. I guess that did finally change, about ten years back. But here's the thing: Corporate interest costs ran neck-and-neck with profits in 2003-2005. Other than that, interest costs were higher than corporate profits from 1980 to the crisis.

Corporate business interest costs were only 15% as much as profits in 1955. By 1980, interest costs were more than profits. The growth of financial cost, a trend visible in the late 1950s, continued to 1980 and continued on to the crisis.

By 1970 one could easily see that wage hikes were driving inflation, because employee compensation is a far larger number than the cost of interest. And by 1970, everyone was trying to catch up with everyone else. Inflation had become self-sustaining. But how, in the latter 1950s, with "no apparent great buoyancy in over-all demand", how is "the 1955-58 upward creep of prices" to be explained? And then in the early 1960s, the price of steel? These were not stories of demand-pull inflation. They were cost-push stories. But the driving force was not compensation of employees or union demands or wages. The driving force was rising financial cost.

"Comparative advantage" makes some domestic products an international bargain, and this, as Paul Krugman writes, is a "cause of international trade". But the point of Krugman's trade models was to show that economies of scale can also make some products a bargain in foreign markets. The lesson we learn from Paul Krugman is that costs affect trade: Low costs increase trade. High costs reduce it.

In the US we rely on credit. Credit has a cost. The use of credit in the productive sector raises the prices of US products. If we rely more on credit than other nations, our financial costs will be higher than theirs. Those costs are reflected in the higher prices of our products. High prices make our products less competitive in international markets.

Increasing financial costs, by raising prices, may be to blame for a significant share of US trade deficits going all the way back to the 1970s.

The point of this essay is not particularly startling once one thinks about it: Despite the best comparative advantage and the greatest economies of scale, high financial costs can be an impediment to the export trade.

// The Excel file