Must-Read: Bill Emmett: Europe’s Confused Attitude to German Leadership

Must-Read: Bill Emmott: Europe’s Confused Attitude to German Leadership: “Why do the other 18 members of the single currency accept Germany’s leadership when it is wrong and yet refuse it when it is right?…

…What I mean by ‘right’ is the view expressed by Wolfgang Schäuble… that Greece should leave the euro, both for its own sake and that of the single currency itself…. The logic of Grexit… comes from the combination of the International Monetary Fund’s analysis of Greece’s sovereign debt burden, which defines it as unsustainable without a big write-off, and the view presented by eurozone countries big and small, rich and poor, which holds that forgiveness of debt by official creditors is incompatible with membership of the single currency….

Having entered the weekend of negotiations of July 11-12 expecting to force Greece out of the euro, neither Chancellor Angela Merkel nor Mr Schäuble can now think that Germany in any sense ‘dominates’ Europe. And yet they have been successful for more than three years now in holding the eurozone to an economic stance that has left the 19 countries’ level of unemployment more than twice as high as that of America. It is hard to find a better definition of ‘wrong’ than the fiscal pact of 2012, which mandates a universally tight fiscal stance… and which simultaneously rejects any idea that countries with large current-account surpluses bear any responsibility for adjustment…. This is… a policy under whose logic America must be seen as having been fiscally reckless in recent years, with its gross public debt exceeding 102 per cent of gross domestic product, and which is shown by its current-account deficit of 2.6 per cent of GDP to be suffering a severe lack of competitiveness that evidently requires urgent structural reform and fiscal austerity…. It is this strange combination, of a right policy that is rejected and a wrong policy that is unchallenged, that is… breeding nationalism all across Europe… a rebellion against the mainstream parties in each country which have colluded with this bizarre situation.

This very combination offers, however, a way forward. Germany can be given its way on Grexit, in exchange for altering its attitude to the fiscal rules that are throttling the European economy. The funny thing is, this is what the IMF has been arguing for several years, at least in its economic analysis. One day, it might even be listened to.

The measurement and future of U.S. productivity growth

Productivity is a hard statistic to pin down. Never mind conceptual distinctions such as the difference between labor productivity and total factor productivity. The actual measurement of productivity itself—defined broadly as the effectiveness of producing a good or service—and its growth in the economy is debatable. The recent slow growth in productivity raises concerns that it is being mismeasured, but that problem may mask other problems in the economy that also may be crimping productivity growth.

But first, let’s look at the mismeasurement argument. The latest angst involving productivity measurement is captured in a Wall Street Journal article by Timothy Appel. Appel talks to several entrepreneurs and innovators in Silicon Valley, including Google Inc. chief economist Hal Varian, most of whom think that the official measurements by the U.S. Bureau of Labor Statistics undervalue many firms’ recent innovations. Varian’s employer is a perfect example: search engines can help workers easily access information that before would have taken much longer to find in a full research library. But these services are provided at no monetary cost to the consumer, thus not reflected in productivity statistics.

How much this “free problem” is biasing down productivity growth is an open question. It’s entirely possible, as Appel notes in his piece, that the seeming mismatch between the innovation and disruption we read about, and the official data is a matter of timing. When Appel quotes Nobel Laureate and Massachusetts Institute of Technology economist Robert Solow back in 1987 noting that “you can see the computer age everywhere but in the productivity statistics” the problem was that the benefits of the computer age hadn’t kicked in yet. Productivity eventually did increase later in the 1990s as the benefits of personal computer spread out to the broader economy.

This “diffusion” explanation just requires some patience on the part of economists and policymakers to wait for the fruits of recent innovation to filter into the broader economy. Eventually the innovations made at vanguard firms will flow outward, and the gains will end up staring back at us in the Bureaus of Labor Statistics data. At least that’s the rosy scenario.

The not so rosy one is this—the ability of productivity to diffuse outward might now be impaired. A recently released book by the Organization for Economic Co-operation and Development shows that productivity growth has been quite quick at many firms operating among its developed- and leading developing-nation members. But these innovations aren’t moving out to the rest of the firms in those economies. In other words, diffusion isn’t working as promised, moving from the innovative firms to the broader economy in the way computers did in the 1990s.

What exactly is impairing this diffusion? First, it’s important to note that economists haven’t exactly locked down a good understanding of how ideas diffuse, as University of Houston economist Dietz Vollrath points out. But one potential culprit, suggested by Timothy Taylor, the managing editor of the Journal of Economic Perspectives, is the slowdown in the rate of start-up firms. He suggests that bevy of new, quickly growing, and highly competitive firms could be one way to get new innovative ideas out into the broader economy. It is certainly the case that despite all the new innovation news out of northern California, the rate at which new firms are started is on the decline. There is no consensus on whether this trend is a cause of slower growth, or is because of slower growth.

Economists aren’t sure what’s causing the slowdown in startups, but their role in the diffusion of new technologies that spur productivity growth is a good reason to figure it out sooner rather than later. There may be some flaws with our current measurement system, but we’d be better served by thinking about the root causes of slower productivity growth rather than tinkering with the productivity calculations.

Fact sheet: What do we know about economic inequality and growth?

Overview: Why this matters for policymakers

Recently available research looks across developing and advanced countries and within the United States to examine the effects of economic inequality on economic growth, well-being, and stability.

Research is beginning to find that economic inequality harms economic growth over the long term and that countries with less income and wealth disparities and a larger middle class boast stronger and more stable economic growth. Yes some studies also suggest that in the short run, greater economic inequality may spur growth before hindering it over the longer term. Overall, however, there is growing evidence that more equitable societies are associated with higher rates of long-run growth.

View full fact sheet here alongside all endnotes

Evidence from across states within the United States

Studies that look at the relationship between inequality and growth in the United States mirror those of international studies—less inequality is associated with long-term growth and is particularly associated with lower income growth for those at the top of the income ladder. But the international results also indicate that in the short run economic growth may not be harmed by inequality even in the United States. Here are some key findings:

  •  Ugo Panizza of the U.N. Conference on Trade and Development finds a negative relationship between inequality and growth across U.S. states. A larger share of income accruing to the middle class is associated with higher growth rates, while higher inequality leads to lower growth rates.[i]
  • Using data for 48 states from 1960 to 2000, Mark Partridge of Ohio State University finds that in the short run inequality is positively related to growth while in the long run the income share of the middle class is positively associated with more robust growth.[ii]
  • Economists Mark Frank and Donald Freeman of Sam Houston State University, using methods focusing on longer run trends, find a strong, negative relationship between inequality and growth.[iii] Though, Mark Frank released a subsequent study using new state-level inequality and growth data from 1945 to 2004 that found higher income concentration increased short-run growth. This second paper by Frank highlights some of the nuances of the relationship between inequality and growth.[iv]
  • In a recent book, “Just Growth: Inclusion and Prosperity in America’s Metropolitan Regions,” Chris Benner, associate professor of community and regional development at University of California-Davis, and Manuel Pastor, professor of American studies and ethnicity at University of Southern California, show that less economic inequality within regional economies is linked to regional prosperity.[v]
  • In a 2014 paper by Roy van der Weide of the World Bank and Branko Milanovic of the City University of New York looks at income growth instead of gross domestic product for inequality measures at different points along the income distribution, using state-level data in the United States. They find that high levels of economic inequality decrease income growth for those at the bottom of the income distribution.[vi]
  • Milanovic and van der Weide also find that high levels of inequality at the bottom of the income ladder is associated with slightly faster income growth at the top of the ladder.[vii]
  • Milanovic and van der Weide’s research is consistent with earlier work by then University of Massachusetts-Amherst economist Jeffrey Thompson (now at the Federal Reserve Board in Washington, DC) and Congressional Budget Office analyst Elias Leight, who look at the effects of inequality on incomes across households. They found that increases in the incomes of those at the top of the income ladder, measured by either the top 10 or 1 percent, are associated with declines in incomes of low and middle-income households.[viii]

International comparisons

In the most recent literature of international comparisons, a new, somewhat nuanced theme is emerging that high inequality is bad for economic growth over long time horizons and that high inequality is particularly bad for those on the bottom of the income spectrum. But in the short run, most of the research agrees that high inequality can be associated with faster economic growth, but the benefits tend to flow to the top for that short period of time. Some of the key findings in this research arena include:

  • In May 2015, the Organisation for Economic Co-operation and Development (comprised of developed and leading developing nations) issued its most recent findings in its report “In it together: Why Less Inequality Benefits Us All.” The OECD found that between 1990 and 2010, gross domestic product per person in 19 core OECD countries grew by a total of 28 percent, but would have grown by 33 percent over the same period if inequality had not increased after 1985. The report concludes that “income inequality has a sizeable and statistically significantnegative impact on growth.”[i]
  • To better understand the time dimension of these trends, International Monetary Fund economists Andrew G. Berg and Jonathan D. Ostry looked at periods of growth instead of duration. They find that “countries with more equal income distributions tend to have significantly longer growth spells.” They also found that inequality was a stronger determinant of the quality of economic growth than many other commonly studied factors such as external demand and price shocks, the initial income of the country (did it start out wealthy or very poor?), the institutional makeup of the country, its openness to trade, and its macroeconomic stability.[ii]
  • In a 2014 extension of this work, Ostry, Berg, and their IMF colleague Charalambos Tsangarides include an analysis of the impacts of income redistribution to ameliorate income inequality as well as market inequality. They find that economic growth is lower and periods of growth are shorter in countries that have high inequality as measured by the Gini coefficient of income after taxes and transfer. (The Gini Coefficient is a common measure of income inequality.) In the same paper, the researchers show that transfers (redistributions of income from upper to lower income individuals) do not harm economic growth—at least up to a point consistent with policies in other wealthy nations.[iii]
  • Diego Grijalva of the University of California-Irvine finds that some economic inequality (not extreme inequality though) may have some positive short- and medium-term effects on economic growth, but in the long run high levels of economic inequality tend to be detrimental to economic growth.[iv]
  • Daniel Halter and Josef Zweimuller of the University of Zurich, and Manuel Oechslin of the University of Bern find that there are methodological differences in the papers that find positive relationship between inequality and growth and those that find a negative relationship. Specifically, those papers that examine inequality’s effect on growth over time within countries tend to find a positive relationship but those that use cross-sectional comparisons find a negative relationship. They posit that the time-difference methods are detecting short-term positive effects to growth, while the cross-sectional methods pick up the long-term negative effects for growth when there is persistently high or growing inequality. [v]
  • In 2011, Dan Andrews of the OECD, Christopher Jencks at Harvard University, and Andrew Leigh at Australian National University looked at inequality in the form of concentration of income at the top of the income spectrum (primarily the top 10 percent, but they also tested the top one percent). The results were somewhat contradictory, leading them to conclude that “inequality at the top of the distribution either benefits or harms everyone and therefore depends on long-term effects that we cannot estimate very precisely even with these data.”[vi]

Conclusion

Economic theory supports conflicting narratives about the potential impact of economic inequality on economic growth. There are some ways that inequality could boost growth and other ways that it could retard growth. Furthermore, there are numerous possible mechanisms that could relate inequality to growth and many of these channels would have conflicting outcomes. Because theory cannot provide strong guidance, it is imperative to use data and analysis to understand the relationships.

Studies that look at the longer-term growth implications of economic inequality find that inequality adversely affects growth rates and the duration of periods of growth, while those that focus on short-term growth find that inequality is not harmful and may be associated with faster growth. Furthermore, studies that look at the impact of inequality on different levels of the income distribution find that inequality is particularly bad for the income growth of those not at the top.

Research on inequality and growth may be approaching a new consensus on the general implications of inequality on economic growth, but more work is needed to fully understand the specifics of how inequality affects growth. In particular, now that the United States is approaching a level of inequality that is very rare among developed economies and more closely resembles a developing economy, which mechanisms apply? These are questions that will require continued updates to the data and methods.

View full fact sheet here alongside all endnotes

[i] OECD, In It Together: Why Less Inequality Benefits All (Paris: OECD Publishing, 2015).

[ii] Andrew Berg and Jonathan Ostry, Inequality and Unsustainable Growth (Washington, DC: International Monetary Fund, 2011).

[iii] Jonathan D. Ostry, Andrew Berg, and Charalambos G. Tsangarides, Redistribution, Inequality, and Growth, Discussion Note, IMF Staff Discussion Note (Washington, D.C.: International Monetary Fund, February 2014), http://www.imf.org/external/pubs/ft/sdn/2014/ sdn1402.pdf.

[iv] Diego F. Grijalva, Inequality and Economic Growth: Bridging the Short-Run and the Long-Run, November 29, 2011, http://escholarship.org/uc/item/4kf1t5pb.

[v] Daniel Halter, Manuel Oechslin, and Josef Zweimüller, “Inequality and Growth: The Neglected Time Dimension,” Journal of Economic Growth 19, no. 1 (March 1, 2014): 81–104, doi:10.1007/s10887-013-9099-8.

[vi] Dan Andrews, Christopher Jencks, and Andrew Leigh, “Do Rising Top Incomes Lift All Boats?,” The BE Journal of Economic Analysis & Policy 11, no. 1 (2011), http:// www.degruyter.com/view/j/bejeap.2011.11.issue-1/ bejeap.2011.11.1.2617/bejeap.2011.11.1.2617.xml.

[i] Ugo Panizza, “Income Inequality and Economic Growth: Evidence from American Data,” Journal of Economic Growth 7, no. 1 (2002): 25–41.

[ii] Mark Partridge, “Does Income Distribution Affect U.S. State Economic Growth,” Journal of Regional Science 45 (2005): 363–94.

[iii] Mark W. Frank and Donald Freeman, “Relationship of Inequality to Economic Growth: Evidence from U.S. StateLevel Data,” Pennsylvania Economic Review 11 (2002): 24–36.

[iv] Mark W. Frank, “Inequality and Growth in the United States: Evidence from a New State-Level Panel of Income and Inequality Measures.” Economic Inquiry 47, no. 1 (January 2009): 55–68.

[v] Chris Benner and Manuel Pastor, Just Growth: Inclusion and Prosperity in America’s Metropolitan Regions (New York: Routledge, 2012).

[vi] Van der Weide, Roy, and Branko Milanovic. “Inequality Is Bad for Growth of the Poor (But Not for That of the Rich).” World Bank Policy Research Working Paper 6963 (July 2014). http://www-wds.worldbank.org/servlet/ WDSContentServer/WDSP/IB/2014/07/02/000158349_2 0140702092235/Rendered/PDF/WPS6963.pdf.

[vii] Ibid.

[viii] Jeffrey Thompson and Elias Leight, Searching for the Supposed Benefits of Higher Inequality: Impacts of Rising Top Shares on the Standard of Living of Low and MiddleIncome Families (Amherst: Political Economy Research Institute – University of Massachusetts, Amherst, 2011), http://www.peri.umass.edu/fileadmin/pdf/working_papers/working_papers_251-30.

Is technological change key in the decline of U.S. labor share of income?

The share of national income going to U.S. workers has been on the decline since 2000 despite long-held economic expectations to the contrary. The reason for this decline has been the source of competing research and fevered debate over the past few years. Purported reasons for the decline range from offshoring and globalization, declining worker bargaining power, and, most famously put forth by Thomas Piketty in his book “Capital in the 21st Century, the idea of capital continuously accruing to the wealthy.

Another theory is that technology may also be key to the decline, not because of the speed of technological change, but rather because of its bias toward one factor: labor. The National Bureau of Economic Research last month published a working paper by economist Robert Z. Lawrence, a professor at the Harvard Kennedy School, who places technological change at the heart of the decline in labor’s share of U.S. income. His findings, however, contradict the idea that “robots” are stealing jobs, a familiar explanation.  His thesis rests on a surprising conclusion—that productivity growth in the U.S. economy has been more tilted toward workers in recent years, even though those workers are not enjoying the fruits of that growth in the form of higher wages.

But before we dive into Lawrence’s paper, let’s step back to remind ourselves of two important factors in the declining share of income going to labor in the United States. The first factor is what economists call the marginal elasticity of substitution between capital and labor. Essentially, this tells us whether a business would use more or less labor if the price of capital declines (or vice versa). An elasticity below one means the two factors are complements, and that a decline in the price of capital would increase demand for labor. But if the elasticity were above one, then more capital would be used, thus lowering demand for labor. Put another way, an elasticity below one means that capital and labor are complements, but if the elasticity is above one then they are substitutes.

And then there is the capital-output ratio in the economy. This is the ratio of the stock of capital previously invested in the economy to the total amount of goods and services produced in the economy in one year. Looking at the movements in the capital-output ratio alongside the marginal elasticity of substitution between capital and labor can tell us about the reasons for the decline in the labor share of income

One way for that share to decline is for the capital-output ratio to rise and the elasticity to be above one. This would be a sign of firms increasingly using capital as the return to capital doesn’t decline. Those with capital would increasingly gain (at the expense of labor) by investing their capital. This interpretation is at the heart of Piketty’s “Capital in the Twenty-First Century.”

The other way would be for the elasticity to be below one and the capital-output ratio to be on the decline. This combination would signal an increasing rate of return to capital, but firms would also be hiring labor as the two are complements. But the return to labor wouldn’t be as high as the return to capital, resulting in income shifting more toward capital. This would be the explanation for a declining labor share of income under a traditional neoclassical model of the economy.

According to Lawrence, the data show an elasticity below one, an increasing capital-output ratio, and a declining share of income going to labor (of course, there is still some debate about this). How does Lawrence explain a declining labor share? Lawrence argues that technological growth has increasingly become biased toward labor. This means that the effective capital-output ratio is actually on the decline and is consistent with a declining labor share.

Lawrence’s analysis contends that technology has increasingly gone toward boosting the productivity of labor rather than capital, resulting in a decline in the effective capital-output ratio. This means the return to capital would go up, as would the demand for labor. Increased productivity of labor is like increasing its supply in that a more productive worker can create more of a good in the same amount of time.

Lawrence also argues that low elasticity of substitution between capital and labor is analogous to the demand for labor being inelastic, meaning that the demand curve for labor is downward sloping and very steep. Movement down that curve—via a shift in the labor-supply curve—results in a decrease in wages that is larger than the increase in employment. So while this isn’t exactly what’s going on, the intuition leads to the same end result: a decline in the share of income going to labor.

Lawrence’s paper is similar to one by economists Ezra Oberfeld at Princeton University and Devesh Raval at the Federal Trade Commission. They also find a declining share of national income going to labor in the presence of an elasticity of substitution explained by technological growth that favors labor. Understanding why U.S. workers are reaping less of the national share of income, then, requires economists and policymakers alike to examine how labor-enhancing technologies are perhaps just as important as globalization and offshoring, the decline in unionization, and the triumph of capital over labor.

Must-Read: Matt Yglesias: The Situation in Greece

Must-Read: Matthew Yglesias: The Situation in Greece: “The truly baffling thing is the Eurogroup’s unwillingness to give a better deal…

…to former Prime Minister Samaras back before the election…. Outside of the coalition you had the Communists, you had Golden Dawn, and you had Syriza. So either the EU was going to have to make Samaras look like a success, or else they were going to have to deal with Syriza, or else they were going to have to deal with something worse…

Must-Read: Noah Smith: His Latest John Cochrane Smackdown: Free-Market Ideology and the Burden of Proof

Must-Read: Noah Smith: His Latest John Cochrane smackdown: Free-Market Ideology and the Burden of Proof: “John writes: ‘My surprise in reading Noah is that he provided no alternative numbers…

…If you don’t think Free Market Nirvana will have 4% growth, at least for a decade as we remove all the level inefficiencies, how much do you think it will produce, and how solid is that evidence?…

I don’t really feel I need to produce an alternative to a number that was made up as a political talking point. Why 4 percent? Why not 5? Why not 8? Why not 782 percent? Where do we get the number for how good we can expect Free Market Nirvana to be? Is it from the sum of point estimates from a bunch of different meta-analyses of research on various free-market policies? No. It was something Jeb Bush tossed out in a conference call because it was “a nice round number”, after James Glassman had suggested “3 or 3.5”. You want me to give you an alternative number, using the same rigorous methodology? Sure, how about 3.1. Wait, no. 3.3. There we go. 3.3 sounds good. Rolls off the tongue.

Must-Read: Dean Baker: The 2001 Recession Actually Was Really Bad News

Must-Read: Dean Baker: The 2001 Recession Actually Was Really Bad News: “I see that I have to disagree with Brad DeLong again…

…Brad wants to see the 2008 downturn as a uniquely bad event due to the overextension of credit and the ensuing financial collapse. I see it as overwhelmingly a story of a burst housing bubble and the resulting fallout in the real sector…. The collapse in the U.S. may have happened first and triggered the collapse in other countries, but this would only be in the sense that the U.S. collapse might have alerted lenders to the possibility that house prices can fall. Presumably the bankers would have discovered this basic economic fact at some point regardless of what happened in the United States. If we recognize that the collapse in Europe and elsewhere had its own dynamic, then we take away some of the drama from Brad’s story of a small bubble causing a massive downturn. But I want to take away some more. First, the bubble was much larger than Brad implies. Second, we have seen this story before, specifically in 2001….

My take-away is to be wary of situations in which a bubble is driving the economy. This was easy to see in the late 1990s, as consumption soared and spending by dot.nonsense pushed investment to its highest share of GDP in two decades. It was also easy to see in the housing bubble years. It is a good idea to crack down on nonsense promulgated by the financial sector, but the basic story really is a simple one. When an asset bubble is causing large and unusual spending patterns, you’ve got a problem.


I would (and do) say: yes, you have a problem. You need to rebalance, but competent policymakers can balance the economy up, near full employment, rather than balancing the economy down. And from late 2005 to the end of 2007 the balancing-up process was put in motion and, in fact, 3/4 accomplished.

There is no reason why moving three million workers from pounding nails in Nevada and support occupations to making exports, building infrastructure, and serving as home-health aides and barefoot doctors needs to be associated with a lost decade and, apparently, permanently reduced employment. A lower value of the currency can boost exports. Loan guarantees and burden-sharing can get state governments into the infrastructure business. A surtax on the rich can employ a lot of home health aides and barefoot doctors. If these roads were foreclosed, they were foreclosed by the laws of American politics, not the laws of economics.

And the lack of successful and rapid rebalancing–the weak post-2001 recovery–was also, overwhelmingly, a matter of choice: to use tax cuts rather than infrastructure and other social capital-building forms of spending on the government side, and to direct the dollar earnings of foreigners selling us imports into funding house construction rather than buying exports on the private-spending side.

Things to Read on the Evening of July 18, 2015

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Must- and Should-Reads:

Over at Equitable GrowthThe Equitablog

And Over Here:

Weekend Reading: Doug Henwood (1998): Europe’s Fateful Monetary Union

Doug Henwood (1998): Europe’s Fateful Union: “In just a bit over nine months, the euro will be born…

…and the next stage in the process of European economic and monetary union (EMU) will begin. Of the fifteen countries that make up the European Union (EU), eleven (Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal, and Spain) will begin a three-year process of dissolving their national currencies into a single continental one. Three (Denmark, Sweden, and the UK) are holding off on this step, and one (Greece) just wasn’t tough enough to make the cut this time around.
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Must-Read: Paul Krugman: The Fed Is Going to Be Wrong When It Eventually Raises Rates

Paul Krugman: The Fed Is Going to Be Wrong When It Eventually Raises Rates: “What we do know is that inflation is still below target…

…and what we also know from the experience of the last eight years is that it is really really hard to get an economy going if interest rates are at zero and you’ve shot your bolt on that…. If the Fed waits too long to raise rates, then we get a little bit of inflation. If the Fed raises rates too soon, we risk getting caught in another lost decade. So the risks are hugely asymmetric. I really find it quite mysterious that the Fed is eager to raise rates given that, they’re going to be wrong one way or the other, we just don’t know which way. But the costs of being wrong in one direction are so much higher than the costs of being the other.