jared diamond on economics and sustainability

This is a bit old but I recently returned to it for some reason I can't remember. Link is here, enjoy!

'There is a parallel based on the same fundamental mechanisms of the economic collapse that we’re seeing now and the collapse of past civilisations such as the Maya,' he continues. 'The message is that when you have a large society that consumes lots of resources, that society is likely to collapse once it hits its peak.'

He helps himself to a mouthful of vegetables, bought from the supermarket but as fresh-tasting as if he had dug them from the garden. Chewing slowly, he continues: 'The Maya collapse began in the late 700s, and then simply the most advanced society in the New World collapsed over the course of several decades. They were mostly gone a century later,' he says wistfully. 'When a complex structure like that starts collapsing, you are pulling out dominoes in the whole structure.'

conditions of capitalist development -- supply, demand, or both? interesting new research

One popular and compelling explanation for the Industrial Revolution has framed it in terms of a rapid series technological innovations leading to fundamental social change. Machines and factories, built by those with the money and other resources necessary for large capital investments, were utilized to spur the rapid accumulation of profits. At the same time, these machines and factories changed the most basic aspects of people's lives, leading not only to new social roles for women and children and a new method of organizing work, but also to an increasing role for markets and market behavior, as profits and businesses sought to saturate emerging markets.

The above story speaks essentially of a supply-led phenomenon where technological forces promote changes in demand (i.e., consumption and market demand). It is also a view held by some Marxist historians. In their view, technology growth is a product of class conflict -- that is, a product of conflicting interests in society. As businesses gain power and assert their interests more forcefully, they seek out new markets for the primary purpose of extracting profits in the production process. And thus, markets (and the individual behaviors which compose them) are once again the consequence of forces outside the immediate control of market participants. Notice the chain of logic in the above explanation, because a recent alternative explanation gaining a lot of attention seeks to reverse it.

Proponents of an Industrious Revolution have attempted to show how individuals embraced market forces, making them active participants, rather than passive responders, in the Industrial Revolution. Early on, by working hard and reallocating their time to participate in consumption-led activities (rather than, say, producing at home or bartering for goods they don't produce), individuals' efficient market decisions promoted the efficiency of the broader system of industrial expansion. In buying up all the trinkets, sugar and other "luxury" market consumables, between 1650 and 1800 these consumers became a world within themselves, actively accepting and using the fruits of the market to improve their lives. One of the more well-known proponents of this view is Jan deVries, who studies the Industrious Revolution in Britain, in Industrious Revolution: Consumer Behavior and the Household Economy, 1650 to the Present (Cambridge: Cambridge University Press, 2008).

Even if DeVries isn't seeking to "reverse" the chain of causation and rather only add to the voluminous research on supply-side factors by considering the other side of the market, at the very least, the theoretical framework that DeVries is working under (a combination of Beckerian-style household decision making theory and rational expectations/rational actor models) ought to be considered as an historically appropriate model. In other words, we need to know more about the nature of supposed "Industrious Revolutions" in other contexts before generalization is made.

That is precisely the point of entry for a new article in the Journal of Economic History by Sheilagh Ogilvie, titled "Consumption, Social Capital, and the 'Industrious Revolution' in Early Modern Germany" (JEH, 70:2 June 2010). Ogilvie sets out to show how market behavior was significantly curtailed by social norms and local government (under the traditional notion of police -- a topic discussed elsewhere on this blog) in early modern Germany (roughly the 17th, 18th, and early 19th centuries). In a thorough search of court and town records, she uncovers evidence of significant political control over emerging markets, leading to the conclusion that markets were embraced but not without significant regulations imposed by traditional institutions.

The implications are fundamental to understanding the nature of the Industrial and Industrious Revolutions. In terms of the latter, we gain a richer view of the processes underlying economic development -- a view that discounts the necessity for free, unregulated markets and nuclear households. It "cast[s] doubt on the broader logic of the Industrious and Consumer Revolutions -- the idea that reallocating time and consumption from household to market prepares the way for modern economic growth. Alternatively, late-developing economies may not even have had an Industrious Revolution because it was stifled by institutional constraints" (35).

In other words, traditional institutions matter to the trajectory various Industrial Revolutions took and, in turn, to our understanding of modern economic growth. The fact that traditional institutions may have had a greater impact in the case of early modern Germany, relative to Britain, might say something about long run stability or performance of these economies. Did entrenched interests slow rapid capital accumulation and, further, the evils associated with it, similar to traditional histories of French development?

But there is something even more significant about Ogilivie's suggestions in terms of the former of the above ideas, i.e., the broader literature on the Industrial Revolution. Let's step back and see the Industrial Revolution as a grand social transformation -- encompassing changes in work organization, capital accumulation, familial roles, market integration, and the list of course goes on. Any social transformation is fundamentally about different sets of interests wresting for power -- if it were "so easy" to see it going one way, then why not see it going a different way, such as Germany or France? The political constituencies vying for economic and political power in these areas seems to explain modern Germany pretty well, and there are even elements of this in American economic history.

Well, to address this composition of social transformations, why not consider these traditional institutions as one element of any transformation -- in Britain, early modern Germany, the U.S.? Then the story is not about demand or supply forces working their way through toward social change. Rather, the Industrial Revolution is about how the environment was composed of power interests and how those interests played themselves out in all kinds of institutions central to the development of capitalism -- the market, the legal system, the state more generally, or firms themselves.

And perhaps this is a convincing unification of the supply and demand forces, at least an attempt to solve the either/or view suggested above. The environment, however, is not some market where supply and demand rests in market equilibrium -- it is a contested terrain where change signifies much more than higher wages and a higher standard of living.

A non-gated version of the paper can be found here: http://www.econ.cam.ac.uk/research/econpapers.html?ep=pog24 Enjoy!

D.O.K.

It isn't even the long run yet.

This is my last Keynes post ever. Unlike Jay-Z I won't bring him back on a later blog post, even as a "feat.".

I'm sick of writing about him and I'm sick of this love-hate relationship. I'm laying all my opinions of him out here, fully exposed. I'm wrapping up what has truly been an unbelievably numerous and verbose series of posts with him, extending back to what I still think is my best post on him here, on the mathematical appreciation of his methodology in the context of the history of economic thought. Later attempts introduced the nuanced view of him that I've always had, but nothing was ever resolved. That's what I'm doing here: being explicit about all of the suggestions made in earlier posts.

WHY KEYNES WAS AND WAS NOT FUNDAMENTAL TO THE STUDY OF THE REAL ECONOMY

Keynes' theory is significant for how he proposed to solve the unemployment problem -- by the end of the General Theory it is clear that the policy implications are that the state should maintain investment levels as well as decisions to change those levels when it is deemed appropriate. These are seemingly-radical conclusions that are, nevertheless, perfectly supported by his analysis of investment behavior in capital markets. They are stated toward the end of the General Theory.

What these conclusions give rise to is a feudal state, the main job of which is to maintain full employment and direct resources across the economy as it sees fit, in the interests of optimizing total wealth and employment growth. There is nothing in Keynes' model about shifting political control to workers, or other more fundamental ways of changing social relations in the economy. We are primarily concerned with the changing actions of the state. The only other noteworthy change is the minor point that unions would undoubtedly play a more central role in such an economy. Unions would act as representatives for labor in making decisions about wage and employment levels and so on, communicating issues from the ground level similar to how peasants would set up villages on parts of the lord's estate in feudalism. In other words, this is not an active labor movement.

This is the fundamental contribution of Keynes to understanding the macroeconomy: solving the unemployment problem, pushing for full employment, through state control of investment. This policy proposal links the core findings of his investment theory to the real economy (i.e., resource allocation among the factors of production -- labor, capital, land, entrepreneurship). Now, what about all the other parts of Keynes, such as the Keynes mostly everyone talks about? In order to address those points we turn to the practical and then theoretical implications of the General Theory.

PRACTICAL IMPLICATIONS OF KEYNESIAN THEORY - 'WAS NOT' PT. i

As for the stimulus policies I've discussed recently -- they represent the most relevant mainstream perspective on Keynes' system. In order to appreciate this, I take one of the main ideas which economists of the time took away from the General Theory: his theory of labor markets. Consider the following small (but significant, as it was the first) exchange between Leontief and Keynes in the Quarterly Journal of Economics. In Leontief's review of the General Theory, he identifies the homogeneity postulate as the target of Keynes' alternative system. It is formally stated by Leontief as follows.

All supply and demand functions, with prices taken as independent variables and quantity as a dependent one, are homogeneous functions of the zero degree ("The Fundamental Assumption of Mr. Keynes' Monetary Theory of Unemployment," QJE 51: 1 (1936): pg. 193)

In order to gain a sense of this postulate, envision an economy composed of 2 markets: apples and oranges. You have $40 in your pocket. Apples cost $2, oranges cost $4, and so you decide to buy 10 apples and 5 oranges. Now, suppose both prices as well as your income doubles. Then You have $80, apples are $4 and oranges $8. The homogeneity postulate says that you will still buy 10 apples and 5 oranges. Now, what Keynes said -- his critique of the homogeneity postulate -- is that there is at least one market where things don't go this way. Suppose for some reason when the price of apples increases to $4, you only buy 8 instead of 10, even when your income increases and all the market forces are telling you to buy the same amount of each. Something structurally is wrong with that market, and the entire system is now misallocated. For example, you might buy a little more oranges (or something else, if we admit a third market into our economy) with the $8 you have left over after skipping out on two apples.

The same, of course, may be true in the reverse way: if income goes down from $40 to $20 and prices decrease to $1 for an apple and $2 for an orange, you may want 12 apples instead of what the market forces tell you to demand -- i.e., 10. In Keynes' model, he thought such things can happen in the labor market. Say you have two markets now, but one of them is a labor market and the other is apples. Start again with initial income of $40. Your wage is $2, apples are $4. If income declines to $20, wages decline to $1 and apples to $2, Keynes believed that you will want to work more than 10 hours in this scenario. This, of course, would then cause a misallocation in the demand for apples. A decline in your income and all of your wages will not have you wanting the same hours of labor(apples) that you did before -- for whatever reason, you will probably want more hours at that lower wage. Maybe you are trying to maintain a standard of living or maybe the union is supporting a higher wage, or maybe the actual money which caused the price decrease or increase is now a factor determining your wage (for example, maybe there is a misallocation in some other market which is in turn affecting how business respond in the labor market). But the result, of course, is that there is a fundamental misallocation once again.

So of course, it is the labor supply function which interests Keynes the most as an exception to this homogeneity postulate -- nevertheless, the fact that at least one of the functions is non-homogeneous means the whole system explodes, with monetary neutrality completely absent from the system. ("Monetary neutrality" would be what we saw in the first apples-oranges example -- demand for either didn't change when all prices and income doubled or halved.)

Now, recall the point made above: this idea is one of the mainstream's central focus points on the General Theory. It remains to show how to translate this idea into policy. Since labor markets could be an important example of non-homogeneity, it leaves a key problem for policy makers: what determines supply and demand of labor, and the resulting wage rate? Well, whatever determines it, it is clear that the resulting misallocations, described above, could affect essential aspects of the product market as well as other areas of the economy, leading to widespread crisis. Therefore, it makes perfect sense to stimulate the economy with boosting incomes, leading to less of a misallocation of labor, ideally so that the misallocations are minimized. And there you have it: the central mainstream critique (Leontief's, one year after the release of the General Theory) is converted into a fiscal policy tool still debated over today.

But there is one other point I want to bring up, aside from demonstrating one of the key ideas behind the Keynesian model (as presented in the General Theory) and its relationship to policy.

It is clear that while the stimulus policy was first seen in practice in FDR's early policies (pre-General Theory), and while the stimulus has been viewed as Keynesian, contemporary news reports show that Roosevelt's policies were primarily being driven for other reasons. One is the idea of a corporatist welfare state, a philosophy where the government plays a big role in the economy in order to sustain capitalism. Keynes was a corporatist, but not the Keynes most talked about in the literature. Another reason is the political pressure from labor, which was much stronger at that time than it is today. Union policies and strike threats were central to some of the key institutional changes of the Great Depression.

In other words, the stimulus policy as we know it today is more in line with the orthodox critique, and overall understanding, of Keynes' General Theory. The New Deal was of course Keynesian and was influenced by many of his ideas, but I would still maintain that there were other, more pressing political and economic forces which gave rise to New Deal policy.

THEORETICAL IMPLICATIONS OF KEYNESIAN THEORY - 'WAS NOT' PT. II

Let's switch gears a bit to Keynes' inherent conservatism from a theoretical standpoint. This is how Leontief describes the homogeneity postulate:

Let us modify the set-up of the frictionless, lagless and 'homoegeneous' economic system by assuming that one demand or one supply curve of any single household or enterprise is not homogeneous... A discrepancy would arise incompatible with conditions of general equilibrium. This shows that in a frictionless system with at least one or more non-homoegeneous elements, the quantity of money ceases to be a 'neutral' factor. On the contrary, the equilibrium amount of every commodity or service produced or purchased by any household or business unit must be now considered to be a function of this quantity. ("The Fundamental Assumption of Mr. Keynes' Monetary Theory of Unemployment," QJE 51: 1 (1936): pg. 194, emphasis in the original)

For good measure, this is Keynes' reaction:

"Mr. Leontief is right, I think, in the distinction he draws between my attitude and that of the 'orthodox' theory to what he calls the 'homogeneity postulate'." And as for Leontief's call for empirical disproof of this postulate (i.e., the claim that what is at work here is primarily an empirical verification or disproof of an orthodox conclusion), "I should have thought... that there was abundant evidence from experience to contradict this postulate" ("The General Theory of Employment," QJE 1937, pg. 209).

In other words, Keynes is quite explicit that he agrees with Leontief's framing of the issue. There are no big ideological fights to be had here.

Leontief makes the point near the end of this small piece that the assumptions of the classical system are untouched by Keynes (pg. 197) -- the homogeneity postulate is derived from the assumptions, and so really what Keynes is arguing is that the empirical basis for one of the conclusions of the classical model of the real economy is wrong.

And this is what I've been saying about the weakness of Keynes' approach in several recent posts. The fundamental system of Keynes' theory is classical in nature -- forget about morality differences – they don’t exist if you accept the fundamental conclusions of a system. Keynes accepts the basic model but is looking to link investment climate changes to real economy issues. The result for the system? A misallocation of resources. The policy prescription, from Keynes himself near the end of the General Theory? Government control of capital flows.

D.O.K.

so, if christie romer is out, then...

A nice story about Larry Summers. Thanks to 3Qd for this amazing piece. Fitzgerald quotes in an article economics? My my.

Bucket shops were once operated in many large American cities. Outfitted with a New York Stock Exchange ticker, each shop would post quotations as they came in. Customers, rather than buy stocks, would bet on the tape—for example, 20 shares of sugar at $100—and the shop would take a commission. If the stock went down, the customer lost. Customers could also short a stock. Edwin Lefèvre’s 1923 book, Reminiscences of a Stock Operator, vividly describes the turn-of-the-century bucket shop. They were partially blamed for the Panic of 1907, and states outlawed them soon after that. The New York Stock Exchange, where customers bought the underlying assets, continued to be legal.

The “synthetic” collateralized debt obligation is a revival, 100 years later, of the bucket shop. Could anyone defend the return of gambling shops? Well, yes, President Obama’s principal economic adviser, Lawrence Summers, did. In July 1998, as deputy treasury secretary in the Clinton administration, he explained to Congress that the derivative market “in just a few short years” had become “highly lucrative” and a “magnet for derivative business from around the world.” The market, Summers continued, is developed “on the basis of complex and fragile legal and legislative understandings.” It was true, he said, that “questions have been raised as to whether the derivatives market could exacerbate a large, sudden market decline.” But he didn’t think so, noting that the derivatives supported “higher investment and growth in living standards in the United States and around the world.” There was no reason for concern, he said, since:

the parties to these kinds of contracts are largely sophisticated financial institutions that would appear to be eminently capable of protecting themselves from fraud and counterparty insolvencies and most of which are already subject to basic safety and soundness regulation under existing banking and securities laws.

Summers explained that the market was based on an “implicit consensus that the OTC [over the counter] derivatives market should be allowed to grow and evolve without deciding” the legal issues—i.e., whether derivatives violated laws prohibiting bucket shops, gambling, and trading in unregistered securities, not to mention doing so outside the regulated options exchanges, such as the Chicago Mercantile Exchange. “At the heart of that consensus has been a recognition that ‘swap’ transactions should not be regulated . . . whether or not a plausible legal argument could be made” that the contracts are “illegal and unenforceable,” Summers said.

money quote of the week

From "Everyman's Financial Meltdown" By Ron Chernow, 22 October 2009 NYTimes Op-Ed:

New Deal financial reformers were fortunate that the crash had followed the satisfying script of a morality play, with sin and repentance followed by redemption. The wicked ways of Wall Street in the ’20s could be comfortably told in a fireside chat. Franklin Roosevelt had a bunch of rich rascals to chastise — unscrupulous individuals rather than irresponsible institutions, as in our own recent decline. The blatant stock market abuses were comprehensible to ordinary citizens, quite unlike the exotic credit derivatives and mortgage-backed securities that baffle us today. And the Great Depression that followed the 1929 crash fostered a climate for reform that has proven hard to replicate.

However severe, our current predicament seems mild compared to the calamitous unemployment of the early 1930s. Hence, average Americans, mystified by the complexities of finance today, still await a new season of financial reform.

economic possibilities for our great-great-great-grandchildren?

My jaw dropped when I read this Krugman post from earlier today:

http://krugman.blogs.nytimes.com/2010/08/06/the-defining-moment-2/

Christie Romer is something of an expert on the Depression. She wrote her dissertation on it. Here is some insider info about the debates circling policy circles at the time of the ARRA, a quote from the above link I found particularly astounding. But really, anyone interested in the historical connections here needs to read the above link:

There were sound arguments why the $1.2-trillion figure was too high. First, Emanuel and the legislative-affairs team thought that it would be impossible to move legislation of that size, and dismissed the idea out of hand. Congress was “a big constraint,” Axelrod said. “If we asked for $1.2 trillion, it probably would have created such a case of sticker shock that the system would have locked up there.” He pointed east, toward Capitol Hill. “And the world was watching us, the market was watching us. If we failed to produce a stimulus bill, that in and of itself could have had deleterious effects.”

Really, really? Are we "all Keynesians now"? Or has something fundamental to American capitalism changed in the last 20 or 30 years to cause this sort of these baseless claims for "rapid reform" and "fiscal austerity", terrible politicking? And what about the simple fact that nobody thought to consider the historical evidence seriously? I guess I shouldn't be surprised on that point, but if an expert on the GD is telling you to do something...

NYTimes articles from the 1930s, speeches from Hoover and other naysayers. decried Roosevelt as a socialist, suggesting readers "look over to Russia" for a comparable figure of pro-government might. And the guy STILL had remarkable support, across the board, in all three depression-era elections.

Ridiculous

sunday morning economic history links

Robert Shiller, Yale research economist perhaps best known for his work on investment theory (more recently, his writings on the causes of the financial crisis), writes about historical inspirations for new jobs programs here. (Link thanks to Tyler Cowen MarginalRevolution.) In commenting on the article, Cowen references the Davis-Bacon Act: passed in 1931, Davis-Bacon ensured that government jobs programs use the prevailing market wage when establishing jobs projects in communities.

One particular quote I liked, the old "government can internalize externalities" argument:

Consider one of the most applauded of Roosevelt’s programs, the Civilian Conservation Corps, from 1933 to 1942. The program was open to young men, initially those 18 to 25, a group that was quite vulnerable economically. The C.C.C. emphasized labor-intensive projects like planting trees.

The public appreciated the tree planting because the projects addressed big problems that had been ignored. Major dust storms in and around Oklahoma raged from 1930 to 1936, denuding whole regions of agricultural land. The storms were vivid evidence of an externality that environmentalists had warned about for years, to little avail. Unregulated farming and lumbering had allowed pervasive soil erosion.

Aside from the environmental benefits, the C.C.C. encouraged a sense of camaraderie, taught young men new skills and gave its workers a sense of participation in something historic.

I don't know why jobs programs aren't simply passed right now. I don't know why, for instance, we just use tax credits for employers to hire. As Shiller suggests, the capital is certainly there, slowly rusting away. Job openings are apparently up. I guess we should remind ourselves that there were more "important" things to take care of -- bailing out the financial system (both with direct channeling of public funds as well as taking over the bad assets) being the most important. And now with midterm elections approaching, it's not likely anything will be passed for a while . In a recent speech, Christina Romer (Chair of the CEA) urged Congress to act on the "several" jobs bills currently floating around -- but it's not likely anyone is going to budge.

Moving toward a more relaxing (only because it's almost purely academic) issue, the Boston Globe Ideas blog discusses Michael Valeri's views on the historical origins of American capitalism. (This article is thanks to 3 Quarks Daily.)

Valeri is a church historian who studied how religious groups shifted toward a more positive view of the market in the late seventeenth century England as a means of maintaining community. I thought the quotes at the end are particularly relevant for economists. I'll end with them. Enjoy!

IDEAS: Your book comes out at an interesting moment for America’s relationship with free-market economics--to a lot of people, it looks like everyone in the financial markets has been behaving in defiance of the broader interests of the society.

VALERI: I asked a hedge fund manager I know if he had said to the traders described in [Michael Lewis’s] ”The Big Short,” ”What you’re doing will result in huge financial calamity, unemployment, people losing their homes--isn’t that socially irresponsible?”, what would they have said? He said, ”Their response would be, ’that doesn’t matter, that’s not my concern. My job is to make as much money as I possibly can.’”

My book shows the people who built the capitalist system did not think like that. The people who built the market economy had a whole cluster of deep collective loyalties and moral convictions.

IDEAS: How do economists react to your ideas?

VALERI: They basically say, ”Well that can’t be. People are motivated by rational interests.” My message to them is you’re lacking historical consciousness. You’re not being honest with the way the whole market was envisioned and created and put in place. You’re making a lot of false assumptions that the market is a natural order, when it is a cultural creation. Which explains why economic reality confounds economic theory.