I read an interesting briefing yesterday (October 13, 2010) from the latest Morgan Stanley “Daily Downunder” report Money for Nothing. I cannot link to it because it is a subscription service. The briefing is notable because while it is thoroughly mainstream in its tack, it does present for the first time an awareness that the underlying national income distribution in favour of an ever increasing profit share is problematic and will not sustain a stable recovery. The report also clearly demonstrates that fiscal policy promoted real income growth over the last few years – the only source of private income growth – but this growth has been captured by profits without commensurate growth in employment. The argument resonates with earlier blogs that I have written and confirms two things: (a) the deficit terrorists who want to push for increasing fiscal austerity are dangerous and if successful will push the world economy back into recession; and (b) apart from sustaining the fiscal support for aggregate demand and private saving there needs to be a comprehensive redistribution of income towards the wage share. As a first step a major policy intervention focused on job creation will help achieve that desired redistribution. But more structural policy interventions are required to reverse the neo-liberal attack on the wage share. Once we realise that we have to reject the whole logic of neo-liberalism. That is the challenge – and the necessity – in the period ahead – if broadly shared prosperity is to return.
The Morgan Stanley briefing is focuses on trends in the US and they conclude that:
Business was the biggest beneficiary of policy stimulus: it didn’t have to pay for the recovery. Consequently, the profit recovery was strong even though the growth recovery was weak. If corporates don’t start ‘paying’ – hiring and, to a lesser extent, investing – then expect a double-dip. If they do start to pay, the recovery will continue, but it won’t be as profitable as the first phase of the expansion. The Great Swap that ended the Great Recession involved a big transfer of income from the public sector to the private sector. The ultimate beneficiary was corporates …
I found this interesting because it is rare that a mainstream research unit will ever make that sort of admission. It also resonates with arguments that I made for several years – that while the origins of the economic crisis are many (and interrelated) the underlying income distribution dynamics that the neo-liberal era promoted were unsustainable and remain so.
Please read my blog from early last year – The origins of the economic crisis– for more discussion on this point.
In the long period of growth leading up to the crash, there was a systematic, government-aided redistribution of national income from the wage share to the profit share which in itself allowed for several destructive and ultimately catastrophic dynamics to emerge.
Here is some background to the Morgan Stanley analysis from an Australian perspective. The trends outlined have been replicated in most advanced nations over the same period (with nuances of-course).
The following graph shows the evolution of the profit share in Australia since 1959 (per cent of GDP). The data is available from the Australian Bureau of Statistics.
The next graph shows the evolution of real wages (indexed to 100 in December 1978) and GDP per hour worked (in the market sector) – that is, labour productivity for Australia. I could produce similar looking graphs for most advanced countries over this era which show the common trend towards an increasing gap between real wages growth and labour productivity growth. In Australia, real wages fell under the Hawke Labor government Accord era which was the beginning of the government-sponsored fraud against the workers.
Recall, that the Labor government argued that the boost to the wage share in the mid-1970s had “caused” the sharp rise in unemployment in the second-half of the 1970s – which meant they had bought the mainstream lie – the so-called “real wage overhang” argument. They argued that by redistributing national income back to profits within the Accord incomes policy framework the private sector would increase investment and solve the malaise. It was based on flawed logic.
The private sector did not respond in real terms but pocketed the largesse being redistributed to them by the government policy. Further, the centralised nature of the incomes policy only reinforced the bargaining position of firms by effectively undermining the traditional trade union movement skills – those practised by shop stewards at the coalface. The rot had set in.
Under the conservative Howard years (1996-2007) there was some modest growth in real wages overall but nothing like that which would have justified by the growth in labour productivity. In addition, the harsh industrial relations legislation that the conservatives introduced further weakened the trade unions and reinforced the trend towards an ever-increasing profit share at the expense of the workers.
In March 1996, the real wage index was 103.4 while the labour productivity index was 132.7 (Index = 100 at December 1978). By the onset of the crisis (February 2008), the real wage index had climbed to 119.3 (that is, around 16 per cent growth in just over 12 years) but the labour productivity index was 170. So the long growth period after the 1991 recession had been associated with the ever-increasing gap between labour productivity growth and real wages growth.
In the most recent period (June 2010), the real wage index was at 125.3 while the labour productivity index was at 174.3 .
I have constructed the indexes to start at 1978 but that was about when the trend emerged. Prior to this gap emerging in the late 1970s real wages growth kept track with the growth in labour productivity which ensured there would be no “realisation” crisis – that is, to ensure that the consumption demand could keep pace with actual output and the goods produced were sold.
As the gap started to increase the capitalist system encountered a problem. What happened to the gap between labour productivity and real wages? The gap represents profits and shows that during the neo-liberal years there was a dramatic redistribution of national income towards capital. The Australian government (aided and abetted by the state governments) helped this process in a number of ways: privatisation; outsourcing; pernicious welfare-to-work and industrial relations legislation; the National Competition Policy to name just a few of the ways.
Governments around the world introduced similar variants which were designed to ensure an increasing share of real income landed in the hands of capital.
The question then arose: If the output per unit of labour input (labour productivity) is rising so strongly yet the capacity to purchase (the real wage) is lagging badly behind – how does economic growth which relies on growth in spending sustain itself? This is especially significant in the context of the increasing fiscal drag coming from the public surpluses which started to squeeze purchasing power in the private sector over the same period (more or less depending which country we are talking about).
This munificence (income redistribution towards profits) manifested as the ridiculous executive pay deals that we have read about constantly over the last decade or so. It also provided the financial sector with its gambling stakes that exploded into an array of increasingly risky products. The “financialisation” of the global economy would not have been possible if real wages had have grown in line with productivity.
As noted, the realisation dilemma of capitalism was in the past moderated by the fact that the firms had to keep real wages growing in line with productivity to ensure that the consumptions goods produced were sold. But in the recent period, capital has found a new way to accomplish this which allowed them to suppress real wages growth and pocket increasing shares of the national income produced as profits.
The trick was found in the rise of “financial engineering” which pushed ever increasing debt onto the household sector. The capitalists found that they could sustain purchasing power and receive a bonus along the way in the form of interest payments. This seemed to be a much better strategy than paying higher real wages. The household sector, already squeezed for liquidity by the obsession in building national government surpluses were enticed by the lower interest rates and the vehement marketing strategies of the financial engineers.
The financial planning industry fell prey to the urgency of capital to push as much debt as possible to as many people as possible to ensure the “profit gap” grew while the output produced was continually being sold. And greed got the better of the industry as they sought to broaden the debt base. Riskier loans were created and eventually the relationship between capacity to pay and the size of the loan was stretched beyond any reasonable limit. This is the origins of the sub-prime crisis.
The fact that governments were able to run surpluses in this period is no indicator of their financial acumen. Rather, it was because the economic growth was being driven by ever-increasing private indebtedness. It was a folly to think we could sustain that growth strategy. As we know it imploded with severe consequences for the very cohort that has been squeezed by the income redistribution – the workers.
Anyway, that is the background to the Morgan Stanley briefing. They are focused on what has been happening in the recovery.
The Morgan Stanley briefing provides the following graph (their Exhibit 1) which “shows how saving was swapped in the US. Private sector saving (households and business) has increased as public sector saving fell. (The net effect, by the way, was to reduce total saving. America had never saved so little at end-2009”.
You will note the mainstream bias in the depiction of the national accounts underpinning Exhibit 1. The “public saving” is really the budget outcome (so a surplus is positive and deficit negative – in relation to the zero line on the vertical axis).
It bears repeating – Modern Monetary Theory (MMT) does not construct budget outcomes in this way. It makes no sense to call a budget surplus a contribution to “national saving”.
To see why it is an erroneous description of the monetary implications of a sovereign government running a budget surplus think about what saving means to a household. When individuals (households) save they postpone current consumption because they want to have higher future consumption. Saving is a time machine for non-government entities to allow them to transfer consumption across time. The obvious motivation is that they face a budget constraint – as users of the currency – and have to forgo consumption now if they want to save.
For the monopoly issuer of the currency – the sovereign government – there is no such financial constraint on spending. It does not have to forgoe spending now to spend in the future. It can always spend what it desires at any point in time irrespective of what it did last period or any previous periods.
Further, when the government runs a budget surplus the purchasing power it extracts from the non-government sector doesn’t go anywhere – it is not stored in any account to use for later purposes. Just as a budget deficit (excess of spending over tax revenue) creates net financial assets (in the currency of issue) a budget surplus destroys net financial assets.
There is no store of purchasing power when the government runs a surplus nor does it make any sense for a government to think in those terms. It can always spend what it likes.
So it is nonsensical to characterise a budget surplus as being “saving”. It is more correctly described as the destruction of non-government purchasing power and non-government net financial assets (wealth).
Once you think of budget surpluses as “national saving” in an analogous way to private saving you are sliding into the slippery and false world of the theory of loanable funds, which is a aggregate construction of the way financial markets are meant to work in mainstream macroeconomic thinking. This myth underpins the erroneous theories of financial crowding out and is a central implication of the false household-government budget analogy that is at the core of the mainstream approach.The original conception was designed to explain how aggregate demand could never fall short of aggregate supply because interest rate adjustments would always bring investment and saving into equality.
So the “total” saving line (blue) in the graph is a false construction.
But if we can go beyond that, the Morgan Stanley Exhibit can be interpreted in the MMT way – a government surplus (deficit) has to be equal to the non-government deficit (surplus) – $-for-$, Yen-for-Yen, Euro-for-Euro. It is not my opinion or prediction – it is an accounting fact. If you want the government to run a surplus (and can engineer that) then you have to be also wanting the non-government sector to be running a deficit (in a flow sense).
That also means that in a stock sense, you have to be supporting ever-increasing non-government sector indebtedness which is distributed between the external and private domestic sectors depending on the balance on the external account. As noted above, pushing the private domestic sector into ever-increasing levels of indebtedness it is not a sustainable growth strategy.
The Morgan Stanley briefing says:
The external deficit fell because private investment spending fell to a post-war low share of GDP. A financing problem had been swapped for an under-investment problem.) Much of the decline in public saving (the larger deficit) fed into household income. Part of this was passive, part discretionary policy.
What do they mean by that?
They show in their Exhibit 2 (reproduced below) “the contributions to disposable household income from labour income, non-labour income, and the public sector”. The trends for Australia that I outlined above are evident in this US graph in the period leading up to the crisis. But if you examine the “recovery” period you can see that “The public sector was the household sector’s only source of income last year.”
So this is a mainstream outfit testifying (empirically) that the fiscal stimulus was the only source of growth in private disposable income in 2009. That is a powerful statement of the effectiveness of fiscal policy in itself.
Where do the deficit terrorists go with that conclusion? Answer: nowhere – they should just go away. Imagine what would have happened without the public stimulus? It would have been an unmitigated catastrophe. The problem is that the move to fiscal austerity is evidence that the deficit terrorists are winning the public debate and this support will disappear – long before the private economy is capable (willing) of filling the gap. A double-dip recession in countries that implement fiscal austerity is almost inevitable now.
The Morgan Stanley briefing then asks how did the fiscal support “help business”. They conclude that:
It meant that business could take out costs – notably labour – without wearing the consequence of ongoing recession. There was a recovery, but corporates didn’t have to pay for it.
They then produce Exhibit 3 (for the US), which is an alternative way of expressing the second graph I provided above (showing the evolution of the real wage and labour productivity indexes in Australia). Exhibit 3 shows “a long-term view of wages as a share of GDP and consumer spending as a share of GDP”. They suggest the declining wage share has been “presumably due to structural factors (globalization, the opening up of the Asian labour force, labour market deregulation, labour-saving technology etc)”. All these factors have been influential but we cannot understand the role that government policy has played in allowing the “market” sector to undermine working conditions unfettered by regulation and protections.
The Morgan Stanley briefing concludes:
What made this labour cost decline so profitable for corporate America is that consumer demand remained strong even though the wage share was falling. In fact, consumer spending as a share of GDP is now near all-time highs. Put another way, corporate America was able to reduce labour costs, but not face the consequence in terms of weaker consumer spending.
As noted above this spectacular coup was facilitated by the growth of the financial sector aided by the massive deregulation and reduction in responsible oversight by the financial authorities in government. The financial sector was only able to grow in the way it did because of the lack of appropriate oversight by the government. The government under the spell of the neo-liberals ultimately caused the crisis. And … the brief return of active fiscal policy intervention – which was eschewed during the deregulation period – was the only thing that saved the world from a worse meltdown that we have had.
Those lessons are very clear from a correct understanding of the period leading up to the crisis and what has ensued since. The mainstream economics profession are missing in action when it comes to these insights. The only consistent body of macroeconomic thought in this regard – both before and after the crisis – is MMT (sorry! I only deal in facts). The problem is that the mainstream macroeconomics profession, blithely unaware of their ignorance are now back in the business of advising us on what should now happen. Their prognostication and advice will be destructive as it was in the period prior to the crisis.
The Morgan Stanley briefing notes that the “trend decline in the household saving rate, which commenced in the early 1980s” provided a:
… a major tailwind for corporate margins (because consumer spending is the largest demand-side component of GDP, while wages are in aggregate the corporate sector’s largest cost).
Yes, but this sort of growth strategy is ephemeral and an attempt to restore those trends will bring the recovery unstuck fairly quickly.
The Morgan Stanley briefing understands this and also the role that fiscal policy has played in providing a temporary reprieve to the underlying destructive trends:
Over the past 18 months, however, the household sector has seemingly achieved an impossible trinity: the wage share fell, consumer spending remained elevated, while the saving rate increased. What happened? This was possible because of the Great Swap from the government. Direct cash payments from the government now exceed direct taxes paid by consumers. Households now get the government for ‘free’.
Note their reference to households getting “government for free” which is in contradistinction to the Ricardian nonsense that usually comes from the conservatives and claims that the households “know” they will have to pay for the deficits sooner or later via higher taxes and so they try to save more now to provide the means to meet the higher future imposts.
The reality is as the Morgan Stanley briefing depicts it. No deficit is ever “paid back” with higher future taxes. The injection of liquidity by the deficit in this period does not have to be funded now or in the future – it is a net creation of financial assets from the government sector (a flow) which provides a boost for aggregate demand and hence income growth and provides the capacity for the household sector to enjoy increased capacity to save. If tax rates rise in the future it will only be because governments want the private sector to have less purchasing power (perhaps to control inflation pressures). They would have nothing to do with paying back any past deficits
The other point that is that the fiscal stimulus has allowed the corporate sector to enjoy a surge in profits without any substantial pressure on costs.
They provide Exhibit 4 (reproduced next) to show this point.
The Morgan Stanley briefing concludes:
This was a boon for business. Corporates enjoy operational leverage – rising sales being spread over fixed costs – so the amplitude of the profit cycle is always larger than the GDP cycle. Exhibit 4 shows GDP growth and top-down profits … this profit recovery has been more than just operational leverage. The profit recovery was largely a ‘cost out’ story. Top-line revenue rose, but the spectacular rise in margins was due to cost control. Hours worked kept falling until December 2009 quarter. There was an exceptionally strong profit recovery despite the exceptionally weak GDP recovery because business enjoyed a recovery that it didn’t have to pay for.
Further “(a)ll of America’s income growth last year accrued to corporates” which has “never happened before”.
That observation should be understood in the context of real “gross domestic income excluding profits in the June 2010 quarter remains below year ago levels”. This allows you to understand – to some extent – why unemployment in the US remains persistently anchored to the 10 per cent level with little employment growth evident.
The fiscal policy intervention has clearly increased real income but it has all been expropriated by the private sector in the form of a recovery in profits.
This is an example of how the design of the fiscal intervention matters. The first thing the US government (and all governments) should have done as the crisis was becoming evident was to offer a minimum wage job in the public sector to anyone who wanted one. That is, implement a Job Guarantee.
By implementing this “automatic stabiliser” in the form of a flexible buffer stock of jobs the government would have ensured that at least a minimum (socially desirable and adequate) income could be available to all workers irrespective of what happened in the private sector. In that sense, the government would have underpinned the capacity for the workers to continue to enjoy a minimum consumption level without increasing debt. This policy would have put a much higher floor in the fall in aggregate demand. The deflationary consequences of the huge rise in unemployment should never be underestimated.
By allowing unemployment to rise so substantially, governments have ensured that workers in general are being excluded from the benefits of the fiscal intervention.
The Morgan Stanley briefing summarise this outcome in this way:
… corporates will not enjoy another year of recovery that they don’t have to pay for. With the public sector’s support for consumers now fading, the consumer will only be able to sustain the recovery if private income growth recovers – and the largest component of that is labour-related. Put another way, if corporate America doesn’t start to hire, profits will suffer in a double-dip. If they do hire – the base case – tepid recovery continues, but margin improvement will be much less substantial that last year. This, in my view, points to current earning forecasts being too high under almost any scenario. In a more-of-the-same growth scenario, too high; in a double-dip scenario, far too high.
So it is clear what is going on now. If the fiscal stimulus declines under the political pressure being applied by the deficit terrorists then the growth support disappears. What will replace it? Answer: more broadly motivated private spending growth.
How will that occur? Answer: there needs to be a strong recovery in employment which means that firms have to start hiring rather than pocketing the profits that have risen courtesy of their increasing proportionate claims on national income.
The problem is that the proponents of fiscal austerity are also the same lobby that has lobbied governments to introduce policy structures that have suppressed real wages growth and which have have undermined full-time employment and, instead, promoted an increasing incidence of precarious low-wage employment. All these trends are interconnected and causal.
So what is needed is a comprehensive change in policy direction. Fiscal policy has to be used to provide continued support for aggregate demand. Industrial relations legislation has to reverse the trend towards an increasing profit sector. Financial regulation and wholesale restructuring and reform of the financial sector has to be introduced to reduce the size of that sector and to force banks to serve public purposes.
I provide some ideas in the following blogs – Operational design arising from modern monetary theory and Asset bubbles and the conduct of banks – on how financial sector reform should proceed.
The problem is that I see no trend towards this emerging. I only see more of the same which pushed the world economy into this mess.
There has to be a much more vocal public opposition to the distributional dynamics of neo-liberalism. To restore stable economic growth there has to be a major redistribution away from profits back to the wage share. That will require a reversal of some of the more pernicious legislative attacks on wages and conditions. Mechanisms which allow workers to proportionally enjoy the fruits of labour productivity growth will have to be restored or reconstructed. In the past, strong unions played this role. What will play this role in the future remains unclear.
I now have a busy day ahead in London – my second last day here. The weather is pretty dank and cold but dry.
Last night I saw a play – War Horse – at the National Theatre in London, which was one of the most creative experiences I have had the pleasure of witnessing. I believe it is heading to the US – in March 2011 it begins at the Vivian Beaumont Theatre at the Lincoln Center, New York. I recommend it highly – a fantastic night and the puppetry is something to see.
That is enough for today!