It is now clear that to most observers that the use of monetary policy to stimulate major changes in economic activity in either direction is fraught. Central bankers in many nations have been pulling all sorts of policy ‘rabbits’ out of the hat over the last decade or more and their targets have not moved as much or in many cases in the direction they had hoped. Not only has this shown up the lack of credibility of mainstream macroeconomics but it is now leading to a major shift in policy thinking, which will tear down the neoliberal shibboleths that the use of fiscal policy as a counter-stabilisation tool is undesirable and ineffective. In effect, there is a realignment going on between policy responsibility and democratic accountability, something that the neoliberal forces worked hard to breach by placing primary responsibility onto the decisions of unelected and unaccountable monetary policy committees. And this shift is bringing new players to the fore who are intent on denying that even fiscal policy can stave off major downturns in non-government spending. These sort of attacks from a mainstream are unsurprising given its credibility is in tatters. But they are also coming from the self-proclaimed Left, who seem opposed to a reliance on nation states, and in the British context, this debate is caught up in the Brexit matter, where the Europhile Left are pulling any argument they can write down quickly enough to try to prevent Britain leaving the EU, as it appears it now will (and that couldn’t come quickly enough).
The latest Leftist salvo was published an article – It’s all going pear-shaped (August 24, 2019) – written by one Michael Roberts (who is actually some City of London economist and writes under cover – one of them).
On his blog he refers to himself as marxist economist. Which means what exactly?
I would also say that my career in economics has been inspired by the basic insights about Capitalism provided by Karl Marx (and Friedrich Engels) and the writers that followed in that tradition.
But I would also be sure to disagree with Michael Roberts assertion that “MMTers deny the validity and relevance of Marx’s key contribution to understanding the capitalist system: that is it is a system of production for profit; and profits emerge from the exploitation of labour power – where value and surplus value arises” (Source).
As one of the developers of MMT, I have always made it explicit that Marx’s ideas on class and exploitation lie at the basis of Capitalist dynamics and should be the starting point for a progressive understanding.
So it is hard at times to know what being ‘Marxist’ means, which is especially the case when we consider the post-modern distractions that made ‘Marxism’ appear recondite, to say the least.
So while the pursuit of profits in a class system clearly drives non-government investment behaviour, history shows that a deterministic interpretation and extrapolation of this behaviour independent of government is likely to mislead.
Social democratic movements (political, industrial, social) rose to counter the power of capitalist producers and expressed that counterveiling force in the form of government policy after the Second World War.
Yes, profit expectations drove private business investment, but those expectations became tempered, regulated, conditioned (choose your own word) by government impost.
For sure there was a continual resistance from Capital to the popularism of social democratic governments.
We know from released Australian Cabinet documents that in the 1960s the business lobbies were demanding the then conservative government deliberately create higher unemployment to reduce the capacity of the workers to realise wage demands.
Neoliberalism (as a catch-all term) rose in the 1970s as a political and economic strategy to address what had been summarily termed the ‘profit squeeze’.
And as we explained in detail in our recent book – Reclaiming the State: A Progressive Vision of Sovereignty for a Post-Neoliberal World (Pluto Books, September 2017) – that resistance from Capital was expressed and engendered through the state not by replacing the state.
The state was reconfigured and became an agent for Capital rather than a mediator between capital and labour, as it had been in the ‘full employment’ Post World War 2 period.
That conditions what I think about the role of the state and its capacities in a fiat monetary system.
The basic claim by Michael Roberts in the article cited above is that it is incorrect to think:
… that fiscal stimulus through budget deficits and government spending can stop ‘aggregate demand’ collapsing.
He thinks this idea – which I am calling a move to fiscal dominance – is gaining traction among economists (who mostly have changed their previous views) as it becomes clear that monetary policy “can do little or nothing to sustain capitalist economies in 2019”.
He lumps “Modern Monetary Theory economists” among this group.
Apparently, we “got very excited because Summers seemed to agree with” us about the need for fiscal dominance.
Well, let me say, as one of the original MMT economists I didn’t get excited at all about the attempt by Larry Summers to reinvent himself and cover his past history of myriad failures.
I don’t take anything that Summers says that agrees with what I write as ‘endorsement’ of MMT. He is not qualified to hand out such endorsements.
I just see a man who has a terrible track record in the profession across a number of dimensions (economist, policy advisor, university manager, etc) trying to be relevant when time has passed him by – more pathos really.
But I understand the nature of Michael Robert’s trying a sort-of MMT putdown to condition his readers to accept his argument, which, as you will see, has little substance.
His thesis is that no policy intervention – “nothing will stop the oncoming slump”.
That is categorical.
And his rationale?
That’s because it is not to do with weak ‘aggregate demand’ …
1. Aggregate demand is total spending in the economy.
2. Given the way we measure economic activity (as an aggregate of output and income produced per period), nominal (money) values of spending must equal income as an accounting statement.
3. If inflation is stable, then increased spending equals increased real income.
4. When we talk of ‘slumps’ (or recessions, which would constitute a serious slump) we are talking about a contraction in real spending and income.
5. An “oncoming slump” must therefore be the result of the growth of aggregate spending (‘demand’) falling behind the growth in productive capacity, which leads to cuts to production, unemployment, and, ultimately, recession if not curtailed.
It makes no sense to characterise a recession as being divorced from movements in aggregate spending.
There can be no recession if aggregate spending keeps pace with productive capacity growth and the spending that producers expect, which conditions their production decisions.
Michael Roberts says that “household consumption in most economies is relatively strong as people continue to spend more”, which is questionable – true to a point.
But in the case of Australia, the slowdown in GDP growth is being driven exactly by a slowdown in household consumption in the face of subdued business investment and an austerity obsessed federal government.
Further, in the case of the US, the contribution to real GDP growth from ‘personal consumption expenditures’ has been falling sharply since the middle of last year.
And in the UK, growth in household consumption expenditure has been in trend decline since 2016, with occasional solid quarters.
And in Japan, one could hardly say that household consumption expenditure has been a uniformly strong driver of growth and will slump again if the Government goes ahead with the scheduled increases in sales tax in October 2019.
I could go on.
His next point is curious:
The other part of ‘aggregate demand’, business investment is weak and getting weaker. But that is because of low profitability and now, in the last year or so, falling profits in the US and elsewhere.
Are we to take this to mean that aggregate demand in his analytical framework is the sum of household consumption and business investment?
That is the way it is written – household consumption and the “other part”.
Before we deal with that, it is true that business investment is weak in a number of economies.
This is partly because of in the tepid recoveries after the GFC, firms were uncertain of the continuity and strength of overall spending that they have determined they had enough capacity in place to deal with demand and didn’t want to take the chance in installing extra productive capacity.
Investment spending is asymmetric because it has an irreversibility quality. Once in place it is costly to abandon.
Michael Roberts produces a graph drawn from US national accounts that he says represents “US corporate profit margins” but which is really the “profits as a share of GDP”, which is not really a measure of the margin over sales.
Michael Roberts used GDP as an approximation to corporate final sales which is a fairly rough estimate.
There is some complex definitional issues regarding who gets the corporate profits (resident companies versus foreign subsidiaries) as against the incomes paid to generate them that I won’t go into here.
The point is that using “profits as a share of GDP” to measure profit rates can give some anomalous results.
A better measure for the US is provided within the National Accounts published by the US Bureau of Economic Analysis (BEA), but you have to do some calculations.
Table 1.14 in the Interactive Data app provides detailed data for ‘Gross Value Added of Domestic Corporate Business in Current Dollars and Gross Value Added of Nonfinancial Domestic Corporate Business in Current and Chained Dollars’.
Gross value added of corporate businesses (Line 1 of the Table) is the best measure of final sales of domestic corporations in the US.
This Table also provides data (Line 13) for “Profits after tax with IVA and CCAdj” which is domestic corporate profits after some inventory valuation and Capital Consumption Adjustments.
The following graph shows the more accurate measure of the US corporate profit margins from the March-quarter 1960 to the March-quarter 2019.
As in the graph provided by Michael Roberts, I have added the NBER Recession bands (quarterly) in grey.
A close study shows some material differences.
I could also construct similar graphs for other countries including Australia. Any decline in profit margins is much less apparent in Australia (and non-existent in many industries), but I don’t want to digress to discuss that here.
While there has to be some relationship between declining profit margins (the ‘profit squeeze’) and economic downturns, given the importance of business investment, the graphs (mine and his) show that the timing of this relationship is highly variable and not consistent.
The answer to the puzzle lies in adding the other components of total expenditure which Michael Roberts ignores – government spending and net exports.
His aim in the article (and prior work) is to deny that government spending matters as a determinant of aggregate output and income generation.
The Keynesians, post-Keynesians (and MMT supporters) see fiscal stimulus through more government spending and increased government budget deficits as the way to end the Long Depression and avoid a new slump. But there has never been any firm evidence that such fiscal spending works, except in the 1940s war economy when the bulk of investment was made by government or directed by government, with business investment decisions taken away from capitalist companies.
This statement is a denial of history.
First, what does “fiscal spending works” actually mean?
Does he want us to believe that if the government adds to its net spending when there is idle capacity that there is zero impact on total demand and income?
Second, there are many examples of the use of discretionary fiscal policy stimulus being used outside of the 1940s, to offset declines in non-government spending (particularly business investment spending).
Sometimes, that fiscal intervention is not sufficient – usually because governments are bullied into taking more conservative lines.
In other cases, the fiscal intervention clearly prevents recession even when business investment collapses and/or export revenue declines sharply.
Three cases are within our recent historical grasp.
First, consider China.
Regardless of its political system, China operates a fiat monetary system where the Chinese government is the currency issuer and they demonstrated during the early stages of the GFC that they know exactly what they are doing with respect to using that monetary supremacy to maintain growth as one component of spending collapses.
They sailed through the global crisis even though exports fell dramatically. In this blog – Where the crisis means death! (May 8, 2009) – I discussed the response of the Chinese government to the onset of the crisis and the sharp decline in their export revenue as spending in the advanced nations collapsed.
The IMFs Regional Economic Outlook: Asia and Pacific Report produced the following graph. It split the contribution to growth of public demand (net government spending), private demand and net exports for some selected Asian nations.
China stands out. Most people think of China’s growth coming from its burgeoning export sector. But it has a very strong domestic economy and a large public spending program.
In the text accompanying that graph, the IMF said that:
In China, GDP growth will also slow down notably from the average pace of the recent past. Still, the aggressive policy response is expected to support domestic demand and maintain growth at rates close to the level authorities consider necessary to generate jobs consistent with social stability. In particular, the massive program of public investment initiated late last year is expected to compensate for the decline in private investment and absorb productive resources no longer utilized in the tradable sector.
So the graph highlighted in the early stages of the crisis the importance of very large fiscal interventions.
No economy that trades is immune to the developments of their trading partners and certainly export revenue can fall sharply which creates some possible dislocation for the domestic economic activity.
But when the global financial crisis hit, the Chinese government redirected demand quickly into domestic expansion.
The following graph reproduces Figure 1.9 in the IMF publication and shows the contributions to real GDP growth (2011 and projected) by spending component – that is, next exports, public demand, private domestic spending (consumption and investment).
The IMF note in relation to this graph that:
The fundamentals for domestic demand in the region remain strong and are expected to cushion the impact of weaker external demand on overall growth for the rest of 2011 and in 2012
It is clear that the main driver of real GDP growth is as it was in the early years of the crisis (see graph above) – domestic demand. Net exports contribute a small component of real GDP growth which puts the popular conception that China is an export-led economy into an entirely different light.
Now, Michael Roberts might say that China is an exception because of its state-directed economy. And there is truth in that. Its fiscal interventions were much less open to domestic criticism.
But it doesn’t get away from the fact that fiscal policy worked!
Second, consider Australia next, which was one of few advanced nations to avoid a recession during the GFC.
It produced a large and very early fiscal stimulus package which included cash payments to households and large infrastructure projects.
The Treasury provided the following – Briefing Paper which estimated that in 2008-09 the “contribution of the stimulus to GDP growth” was 1 per cent and in 2009-10 1.6 per cent.
The wrote that:
This translates into a level of GDP that is 23/4 per cent higher in 2009-10 than without the stimulus. The design of the stimulus package involves a staged withdrawal of stimulus, which subtracts 1.2 per cent from GDP growth in 2010-11.
The peak impact of the stimulus packages … was the addition of 210,000 jobs and the level of employment remains higher through to the end of the forecast period.
The following graph shows the number of negative quarters of real GDP growth between June 2008 and December 2010, ranked by number. A recession is considered to be two-consecutive quarters of negative growth.
It is hard to get a coherent view of all the fiscal shifts in that time (given the time I have to write this today). The IMF publication – The Size of the Fiscal Expansion: An Analysis for the Largest Countries – estimated (in 2009) that:
… fiscal policy may have contributed 2–21⁄2 percentage points to PPP-weighted growth of the nine countries in 2008 and may provide 2–21⁄4 percentage points in 2009
The nine countries were Canada, China, France, Germany, India, Italy, Japan, U.K., and the U.S.
My own analysis at the time suggested that the stimulus packages were delayed for too long and were not of a sufficient size to offset the cyclical shifts in non-government spending.
And when the stimulus packages were prematurely withdrawn growth slowed or went backwards as in the case of the Eurozone and the UK.
There is no doubt that even though the fiscal stimulus initiatives were usually too small and withdrawn too soon that they ‘worked’ to attenuate the decline in non-government spending.
In the case of Australia, they allowed our nation to avoid recession altogether.
Michael Roberts concludes by citing the example of Japan:
The irony is that the biggest fiscal spenders globally have been Japan, which has run budget deficits for 20 years with little success in getting economic growth much above 1% a year since the end of the Great Recession …
No irony here at all.
Japan experienced arguably the biggest property collapse in history in the early 1990s. It introduced a rather significant fiscal stimulus response and only experienced one-negative quarter of GDP growth.
I have written about the Japanese experience with sales tax rises before:
1. Japan is different, right? Wrong! Fiscal policy works (August 15, 2017).
2. Japan returns to 1997 – idiocy rules! (November 18, 2014).
3. Japan’s growth slows under tax hikes but the OECD want more (September 16, 2014).
4. Japan – signs of growth but grey clouds remain (May 21, 2015).
5. Japan thinks it is Greece but cannot remember 1997 (August 13, 2012).
Everytime they hike sales taxes, it ends in misery – spending falls and economic activity comes to a crashing halt.
They saw that in 1997. And again in 2014.
In April 2014, the Abe government raised the sales tax from 5 per cent to 8 per cent.
After the sales tax hike, there was a sharp drop in private consumption spending as a direct result of the policy shift. At the time, I predicted it would get worse unless they changed tack.
It certainly did get worse. Consumers stopped spending and the impact of static consumption expenditure was that business investment then lags.
Here is the history of real GDP growth (annualised) since the March-quarter 1994 to the March-quarter 2015. The red areas denote sales tax driven recessions.
In both episodes, these recessions were followed by a renewed bout of fiscal stimulus (monetary policy was ‘loose’ throughout).
In both episodes, there was a rapid return to sustained growth as a result of the fiscal boost.
Nothing could be clearer.
Fiscal policy has been very effective in Japan.
Trying to equate low growth rates in a nation with an ageing population and very high saving ratios with a lack of effectiveness is invalid.
For another view, examine the evolution of the Japanese unemployment rate. In the years after the property crash, the rate rose modestly to around 3.5 per cent, which given the scale of the crash was an incredible testament to the effectiveness of fiscal policy.
And then, later, during the GFC, it only peaked at 5.4 per cent (August 2009) and then fell relatively quickly to its current (low) level of 2.4 per cent.
I could continue to offer countless examples of historical episodes where fiscal intervention works in both directions. But time is out today.
Michael Roberts claims that any renewed fiscal stimulus “won’t work”.
The problem that he ignores history and basic logic.
Spending equals income.
When I go to the shop after work the checkout operator doesn’t ask me whether I work for a public wage or a private wage.
What do you think would happen if, say, the UK government announced it was going to upgrade infrastructure (say school or hospital buildings) throughout the north of England and were calling for tenders? Do you think it is realistic to assume there would be no tenders received at all?
Or that there would be no private leverage off that activity as a result of the renewed construction and procurement?
What do you think would happen if the UK government announced a Job Guarantee – an unconditional job offer to anyone at a socially-inclusive minimum wage? Do you think no one would turn up for a job?
Some of the newly created income would go into imports. Some into increased savings. But there would be growth – undoubted.
In a later post I will consider the import and saving leakages, which are, in themselves, interesting.
That is enough for today!
(c) Copyright 2019 William Mitchell. All Rights Reserved.