Conversable Economist

In December 1938, one of the most eminent economists of the time, Alvin E. Hansen, delivered the Presidential Address, titled \”Economic Progress and Declining Population Growth,\” at the annual meetings of the American Economic Association. Looking at the economy of the late 1930s, Hansen wrote:\”This is the essence of secular stagnation–sick recoveries which die in their infancy and depressions which feed on themselves and leave a hard and seemingly immovable core of unemployment.\” The idea of \”secular stagnation\” has received considerable attention in the last month after it was involved in a talk given by Larry Summers at an IMF conference as a framework for thinking about the discomfiting state of the economic recovery. A round-up of some commentary and responses to the Summers talk is available here. In this post, I\’ll sketch out what Hansen actually said, give a sense of why the \”secular stagnation\” hypothesis was widely disregarded in recent decades, and suggest how I see the modern lessons.

(Note: Hansen\’s speech was published in the American Economic Review in March 1939. The AER isn\’t freely available on-line, but many readers will have access through a library subscription to JSTOR or through their own membership in the American Economic Association. Full disclosure: I have worked since 1986 as the Managing Editor of the Journal of Economic Perspectives, which is another journal published by the AEA.)

Hansen argued that an economy needed strong and healthy levels of investment if it was to maintain full employment. He wrote: \”For it is an indisputable fact that the prevailing economic system has never been able to reach reasonably full employment or the attainment of its currently realizable real income without making large investment expenditures.\”

Hansen listed three factors that he thought had been especially important in encouraging the needed levels of investment in earlier decades of U.S. history: \”[F]or our purpose we may say that the constituent elements of economic progress are (a) inventions, (b) the discovery and development of new territory and new resources, and (c) the growth of population. Each of these in turn, severally and in combination, has opened investment outlets and caused a rapid growth of capital
formation.\” Hansen pointed out that population growth had slowed down and that US territory was no longer expanding. Thus, he argued: \”We are thus rapidly entering a world in which we must fall back upon a more rapid advance of technology than in the past if we are to find private investment
opportunities adequate to maintain full employment. … It is my growing conviction that the combined effect of the decline in population growth, together with the failure of any really important innovations of a magnitude sufficient to absorb large capital outlays, weighs very heavily as an explanation for the failure of the recent recovery to reach full employment.\”

Indeed, Hansen argued that in some cases, new technologies might even lead to less need for invention: \”Moreover it is possible that capital-saving inventions may cause capital formation in many industries to lag behind the increase in output.\” In a modern context, one can imagine certain ways in which the growth of information technology makes capital investment more effective and efficient–and thus reduces the need for certain other kinds of investment spending.

Further, Hansen was skeptical about whether either monetary or fiscal policy could provide a long-lasting answer. He was skeptical that lower interest rates could encourage the large and vigorous investment levels that he felt were needed: \”Less agreement can be claimed for the role played by the rate of interest on the volume of investment. Yet few there are who believe that in a period of investment stagnation an abundance of loanable funds at low rates of interest is alone adequate to produce a vigorous flow of real investment. I am increasingly impressed with the analysis made by Wicksell who stressed the prospective rate of profit on new investment as the active, dominant, and controlling factor, and who viewed the rate of interest as a passive factor, lagging behind the profit rate. This view is moreover in accord with competent business judgment. … I venture to assert that the role of the rate of interest as a determinant of investment has occupied a place larger than it deserves in our thinking. If this be granted, we are forced to regard the factors which underlie economic progress as the dominant determinants of investment and employment.\”

Hansen also considered the possibility of what we would today call expansionary fiscal policy: tax cuts and increased government spending, especially on infrastructure. While he cautiously favored such steps, he also worried that continual rises in government debt were troublesome, too. \”Consumption may be strengthened by the relief from taxes which drain off a stream of income which otherwise would flow into consumption channels. Public investment may usefully be made in human and natural resources and in consumers\’ capital goods of a collective character designed to serve the physical, recreational and cultural needs of the community as a whole. But we cannot afford to be blind to the unmistakable fact that a solution along these lines raises serious problems of economic workability and political administration. … Public spending is the easiest of all recovery methods, and therein lies its danger. If it is carried too far, we neglect to attack those specific
maladjustments without the removal of which we cannot attain a workable cost-price structure, and therefore we fail to achieve the otherwise available flow of private investment.\” 

Thus, a short summary of Hansen\’s theme was that a healthy full-employment economy needs strong profit-oriented incentives for investment spending, and  because he was not confident that the economy of his time could produce such incentives, secular stagnation was the result.
When we look back at Hansen\’s speech of late 1938, we see the issues of his time a little differently. Of course, Hansen does not have access to the luxuries of 20:20 historical hindsight and modern economic statistics. For example, Hansen discusses a slowdown in population growth, which was certainly a fair reading of the trends at that time, but completely missed that US fertility rates were about to take off less than a decade later at the start of what we call the \”baby boom.\” 

Hansen was concerned that technological progress had slowed in the 1930s, and that the age of new inventions driving forward the economy was over. In retrospect, the notion that technological innovation stopped in the 1930s seems clearly incorrect. Indeed, Alexander Field makes a very plausible case in his 2012 book, A Great Leap Forward: 1930s Depression and U.S. Economic Growth, that the 1930s experienced a great deal of technological growth. At a macro level, Field points out that essentially the same number of people were employed in 1941 as in 1929, using what seems to be the same value of capital stock, and yet real output was one-third or more higher in 1941 than in 1929–implying substantial productivity growth even with the period of the Great Depression taken into account. If one just looks from 1933 to 1941, real U.S. GDP gained 90% over those eight years. At the micro level, Field points to high and rising R&D investment during the 1930s, dramatic improvements in roads and rail, and a long list of technological improvements in areas like chemicals, electricity generation, cars, planes, and many more. Here\’s an readable interview with Field laying out his views.

In contrast, Hansen seemed to perceive the later 1930s as nothing but the long aftermath of the the Great Depression. But current dating of business cycles suggests that that the Great Depression ended in March 1933. After a few years of fairly vigorous recovery, the Federal Reserve, chasing a premonition of a shadow of a ghost of possible inflation that no one else could see, decided to raise interest rates, triggering a severe recession starting in May 1937 that lasted through June 1938. Field and others have argued that the U.S. economy was on a strong and healthy path of recovery before and after the Fed-induced recession of 1937-38. By the late 1960s, when unemployment was less than 5% from March 1965 through June 1970, the idea that the U.S. economy was necssarily trapped in secular stagnation looked plain unrealistic. 

Yet here we are in late 2013, more than four years after the Great Recession technically ended in mid-2009, but without a real resurgence of catch-up economic growth that has followed other recessions. We also have the disturbing example of Japan\’s economy, which suffered a financial crisis and melt-down in real estate prices back in the early 1990s, and has now been stuck in slow growth for more than two decades. Hansen\’s spirit would surely point out that a surge of population growth or an expansion of territory are unlikely. Thus, much turns on investment spending. 

Here\’s a figure generated by the ever-useful FRED website maintained by the St. Louis Fed. It shows Gross Private Domestic Investment (GDPI) divided by GDP. Investment often drops during recessions, and sometimes between recessions, but the investment drop during the Great Recession was especially severe, and the bounceback even to usual levels is not yet complete. Moreover, the investment surge of the mid-2000s was largely in residential real estate, and whatever the other virtues of such investments, additional houses don\’t do much to raise future rates of productivity growth. 



From Hansen\’s secular stagnation point of view, the key problem of the U.S. economy is how to make it more likely that firms will invest heavily in expectation of large profit opportunities. This perspective doesn\’t rule out using monetary or fiscal policy to stimulate the economy in the short run, but neither does it see these as long-term answers. Such an economy would of course rely on strong government support of R&D spending and educational achievement. It would also be an economy where a large share of profits flowing to the financial sector would be troubling, because it suggests that nonfinancial firms are not perceiving profitable opportunities for real investments in plant, equipment and technology. It\’s an economy where we would think seriously about finding ways to ease the tax and regulatory burdens on investment. Here are some words from Hansen\’s 1938 speech that ring true to me today:

\”The problem of our generation is, above all, the problem of inadequate private investment outlets. What we need is not a slowing down in the progress of science and technology, but rather an acceleration of that rate. Of first-rate importance is the development of new industries. There is certainly no basis for the assumption that these are a thing of the past. But there is equally no basis for the assumption that we can take for granted the rapid emergence of new industries as rich in investment opportunities as the railroad, or more recently the automobile, together with all the related developments, including the construction of public roads, to which it gave rise. Nor is there any basis, either in history or in theory, for the assumption that the rise of new industries proceeds inevitably at a uniform pace. The growth of modern industry has not come in terms of millions of small increments of change giving rise to a smooth and even development. Characteristically it has come by gigantic leaps and bounds. Very often the change can best be described as discontinuous, lumpy, and jerky … And when giant new industries have spent their force, it may take a long time before something else of equal magnitude emerges. … [A] vigorous recovery is not just spontaneously born from the womb of the preceding depression. Some small recovery must indeed arise sooner or later merely because of the growing need for capital replacement. But a full-fledged recovery calls for something more than the mere expenditure of depreciation allowances. It requires a large outlay on new investment, and this awaits the development of great new industries and new techniques. But such new developments are not currently available in adequate volume …\” 

I worry that the current U.S. economic policy agenda is all about fiscal and monetary policy, along with financial regulation and health insurance. I hear relatively little discussion focused directly on an agenda for creating a supportive environment for private domestic investment.

The U.S. unemployment rate has been dropping, from its peak of 10% in October 2009 to 7% in November 2013. But the labor force participation rate–that is, the share of U.S. adults who either have jobs or are actively looking for jobs–has also been dropping. It was 66.4% in January 2007 before the start of the recession, and has now fallen to 63%. Thus, is the fall of three percentage points in the unemployment rate really showing that roughly three percentage points of adults have become so discouraged by the dismal labor market prospects of the last few years that they have stopped looking for work?  Shigeru Fujita offers some facts and trends in \”On the Causes of Declines in the Labor Force Participation Rate,\” a \”Research Rap\” from the Federal Reserve Bank of Philadelphia.

To orient oneself among the arguments here, consider this graph showing the unemployment rate and the labor force participation rate since 1995. The fact that both have decline in the last few years is apparent on the right-hand side of the graph. But what is also apparent is that the decline in the labor force participation rate seems to speed up in the aftermath of the Great Recession, but it actually started back in the late 1990s.

Just to be clear about these concepts, measures of unemployment always have some fuzziness because it\’s necessary to separate out those who lack jobs and want jobs from those who lack jobs and aren\’t looking for a job. In some cases this distinction is quite clear: a happy 75 year-old retiree who isn\’t looking for work, or someone who is choosing to be a stay-at-home parent, is clearly out of the labor force. But in other cases, the distinction can be fuzzy. Maybe someone decides to retire a year or two earlier than expected, or to apply for disability payments, or just to stop looking for a job, because the job market in their area looks so dismal. The person would then not be technically counted as \”unemployed,\” but only \”out of the labor market.\” However, their choices were clearly shaped by the poor labor market.

What\’s the evidence on why adults are not participating in the labor market, and how it has changed over time? This figure shows that retirement doesn\’t account for a lower rate of labor force participation up to about 2010,when it starts rising. Disability has been accounting for a highe rate of labor force participation since the late 1990s, as has \”other.\”

The \”other\” can include a lot of  possibilities, from a contented stay-at-home parent, to someone with health or transportation problems, or someone who has become too discouraged by the poor labor market even to look for work. But one way to divide up the \”other\” category is to ask them whether they want a job. The figure shows that the share of those in the \”other\” category who want a job is mostly declining from 1995 to the start of the recession in late 2007, and bumps up only slightly after that.

So what conclusions can be drawn from this?

1) If one looks back at the drop in labor force participation rates from 1995 to the present, the main factors during most of that period are the rise in the \”other\” category that isn\’t looking for work–which presumably is not a public policy problem–and the rise in disability claims. I\’ve posted fairly recently with some thoughts on the \”The Disability-Industrial Complex\” (October 23, 2013).

2) If one focuses on just the recent drop in the labor force participation rate, only a modest share can be accounted for by those who are out of the labor force but say they want a job. Fujita writes: \”[I]t is true that there were more discouraged workers during the post-Great Recession period than before the recession (roughly 0.5 percentage point more in terms of the working age-population). However, the size of this group has been roughly flat since 2011. In this sense, it is misleading to attribute the decline in the unemployment rate in the last few years to discouragement.\”

3) It\’s not obvious how to think about the interaction between more retirees and the falling labor force participation rate. Fujita writes: \”[T]he decline in the [labor force] participation rate since the beginning of 2012 is entirely due to retirement.\” Surely, some of these retirees are premature, in the sense that the people would have preferred to work a few more years but couldn\’t find jobs. On the other hand, the \”Baby Boom\” generation started right after World War II, and as members of that generation reach their mid-60s, it\’s been obvious for a long time that labor force participation rates were likely to fall starting around 2010 or so.

The bottom line, as I see it, is that the drop in the unemployment rate is not just a smokescreen for a labor market that hasn\’t really improved since 2008. Relatively few of those who are retired, disabled, or too discouraged to seek a job are likely to return to the labor force. Instead, most of the drop in the unemployment rate in the last few years is a meaningful indicator that the U.S. economy is gradually improving and returning to health.

Homelessness in America has apparently declined in the last few years despite the effects of the Great Recession. This unexpectedly welcome news is from the annual Point-in-Time survey of homeless carried out by Abt Associates for the U.S. Department of Housing and Urban Development, and reported in  \”The 2013  Annual Homeless  Assessment  Report (AHAR)  to Congress.\” A national survey of homeless across the country is conducted for a single night in late January. Here\’s one figure summarizing the results:

The report includes lots more detail of the survey results: for example, nearly one out of every five homeless people are either in Los Angeles or New York. About one-third of the homeless are children About 109,000 of the homeless are classified as \”chronically\” homeless.

But the survey results raise an obvious puzzle. The number of \”sheltered\” homeless people is essentially the same in 2007 as in 2013. All of the decline is in the category of \”unsheltered\” homeless people. It seems obvious that when the Great Recession hit in late 2007, one should see a substantial rise in homelessness, whether sheltered or unsheltered. The report carefully points to a 2010 \”Federal Strategic Plan to Prevent and End Homeless\” called \”Opening Doors.\” The date of this report is why the year 2010 is shaded in the figure above. But the survey data clearly shows a large change in the \”unsheltered\” homeless before the 2010 plan in 2008 and 2009, in the worst of the Great Recession, before the 2010 plan took effect.

The fact that homelessness has substantially declined does not seem especially controversial. For example, here\’s a chart from the National Alliance to End Homelessness in its April 2013 report, \”The State of Homelessness in America 2013.\” The report uses data from a variety of government sources, including the HUD data, and thus is similar but not identical to the previous report.

This graph shows that if one projects back just a little further, there is a substantial decline in homelessness from 2006-2007. (The AHAR report for 2009 shows the decline from 2006 to 2007, but annual reports since then start with 2007, which seems to me a dubious practice.)

Why has homelessness declines? Of course, it\’s easy enough to make up stories about how the survey might have been done differently over time, or about how the focus on a single night in January might lead to variability in the survey results depending on weather conditions and other factors. But the year-to-year survey results aren\’t showing a lot of variability, and advocacy groups like the National Alliance to End Homelessness are not arguing that the official statistics are misleading or incorrect.

Instead, a more common argument seems to be that policies to reduce homeless have been effective. For example, the drop in homelessness after 2006 has been attributed to a Bush administration \”housing first\” policy that focused on getting the homeless into housing first, and then seeking to address their addiction or health problems. The 2009 fiscal stimulus bill included a $1.5 billion Homelessness Prevention and Rapid Re-Housing Program. Various other government programs to assist those with low incomes, as well as a greater willingness of those with low incomes to \”double up\” in housing, have made a difference, too. Here\’s a figure from the National Alliance to End Homelessness report:

Notice in particular that the number of poor adults accessing safety net resources went way up during the Great Recession, as one might expect. The dark blue line showing the number of \”People Living Doubled Up\” also rises dramatically. Both of these factors have likely helped to hold down the rise in homelessness, too. All this said, it still strikes me as quite remarkable that the number of homeless did not rise much more substantially during the Great Recession and its aftermath.

International portfolio investment is sometimes called \”hot money.\” In contrast with foreign direct investment, where a foreign investor takes some management responsibility for ownership, portfolio investment is a purely financial transaction that can be expanded or liquidated quickly. The IMF publishes the results of its annual Coordinated Portfolio Investment Survey each November. There\’s no big report to accompany this data, but there are summary tables and, if you like, you can easily generate specific tables for different countries in various years back to 1997.

Here\’s an overview of the top players in international portfolio flows.  International holdings of portfolio investment were about $43 trillion in 2012. Just to be clear, this represents international holdings of stock and debt. It doesn\’t include other international financial flows like bank loans, central banks holding reserves, or foreign direct investment.

When I look over this table, part of what catches my eye is the identify of who is listed in the rows and columns–and who is not listed.

For example, it\’s no big surprise that the U.S. economy both receives by far the largest amount of portfolio investment and also sends both the largest amount. The financial sector offers a potentially promising for the U.S. economy in the globalizing world economy, because it combines the sheer size of the domestic US financial markets with a set of legal and regulatory institutions and private-sector expertise concerning financial markets that is open to the world.

It\’s a modest surprise to me that the United Kingdom ranks second in both portfolio investment sent and received. After all, the U.S. GDP is more than six times as large as that of the UK. This data suggests that international finance is a much more important part of the UK economy than the US economy. It\’s no surprise that Japan, as the main financial center for Asia, ranks so highly.

But then I start seeing some unexpected entries. Luxembourg has a GDP of about $57 billion in 2012. But international portfolio investment in Luxembourg was $2.3 trillion, while international portfolio investment holdings from Luxembourg total $3 trillion. About $2 trillion of foreign portfolio investment is in the Cayman Islands, which has with a GDP of about $2 billion. Aruba, Guernsey, Isle of Man, Malta, Vanuatu, and few others also show up as places where the size of international portfolio investment vastly outstrips the size of their national economies. Clearly, these locations offer certain regulatory features (or the lack of them) that are desirable to substantial numbers of investors.

The other striking feature about this kind of table is the countries that aren\’t included. China, which now has the second-largest GDP in the world, about half the size of the U.S.,  apparently doesn\’t participate in this survey. Brazil has the 7th largest GDP in the world, Russia is 8th, and India is 10th. They aren\’t yet showing up among the top origins and destinations for foreign portfolio investment, but in the next decade or so, I suspect that they will. Here\’s a table from the World Bank showing the size of the 20 biggest economies in 2012.

In a speech earlier this week on economic mobility, President Barack Obama quoted Adam Smith in support of a higher minimum wage. Given that minimum wage laws were not a hot topic in 1776 when The Wealth of Nations was published, I went looking for context.

Here\’s the comment from the transcript of President Obama\’s speech:

[I]t’s well past the time to raise a minimum wage that in real terms right now is below where it was when Harry Truman was in office. (Applause) This shouldn’t be an ideological question. It was Adam Smith, the father of free-market economics, who once said, “They who feed, clothe, and lodge the whole body of the people should have such a share of the produce of their own labor as to be themselves tolerably well fed, clothed, and lodged.” And for those of you who don’t speak old-English — (laughter) — let me translate. It means if you work hard, you should make a decent living.

The quotation appears in Book I, Chapter 8, of The Wealth of Nations. I quote here from the ever-useful version of the book at the Library of Economics and Liberty website. At no point in the chapter is Smith considering the advantages of a minimum wage; however, he points out that in the politics of the time, there were occasionally political proposals to hold wages lower. He argues that the real standard of living for common workers–that is, what a common worker can afford to buy–has been rising, in large part due to technological improvements. Obama\’s proffered quotation comes up when Smith is explaining that this increase in real wages over time should not be viewed as a cause for concern. Here\’s the full passage:

The real recompence of labour, the real quantity of the necessaries and conveniencies of life which it can procure to the labourer, has, during the course of the present century, increased perhaps in a still greater proportion than its money price. Not only grain has become somewhat cheaper, but many other things, from which the industrious poor derive an agreeable and wholesome variety of food, have become a great deal cheaper. Potatoes, for example, do not at present, through the greater part of the kingdom, cost half the price which they used to do thirty or forty years ago. The same thing may be said of turnips, carrots, cabbages; things which were formerly never raised but by the spade, but which are now commonly raised by the plough. All sort of garden stuff too has become cheaper. The greater part of the apples and even of the onions consumed in Great Britain were in the last century imported from Flanders. The great improvements in the coarser manufactures of both linen and woollen cloth furnish the labourers with cheaper and better cloathing; and those in the manufactures of the coarser metals, with cheaper and better instruments of trade, as well as with many agreeable and convenient pieces of houshold furniture. Soap, salt, candles, leather, and fermented liquors, have, indeed, become a good deal dearer; chiefly from the taxes which have been laid upon them. The quantity of these, however, which the labouring poor are under any necessity of consuming, is so very small, that the increase in their price does not compensate the diminution in that of so many other things. The common complaint that luxury extends itself even to the lowest ranks of the people, and that the labouring poor will not now be contented with the same food, cloathing and lodging which satisfied them in former times, may convince us that it is not the money price of labour only, but its real recompence, which has augumented. 

Is this improvement in the circumstances of the lower ranks of the people to be regarded as an advantage or as an inconveniency to the society? The answer seems at first sight abundantly plain. Servants, labourers and workmen of different kinds, make up the far greater part of every great political society. But what improves the circumstances of the greater part can never be regarded as an inconveniency to the whole. No society can surely be flourishing and happy, of which the far greater part of the members are poor and miserable. It is but equity, besides, that they who feed, cloath and lodge the whole body of the people, should have such a share of the produce of their own labour as to be themselves tolerably well fed, cloathed and lodged. 

With his characteristic hard-headedness, Smith is in no doubt that employers want to hold wages low, and are making continual efforts to do so.

Masters are always and every where in a sort of tacit, but constant and uniform combination, not to raise the wages of labour above their actual rate. To violate this combination is every where a most unpopular action, and a sort of reproach to a master among his neighbours and equals. We seldom, indeed, hear of this combination, because it is the usual, and one may say, the natural state of things which nobody ever hears of. 

However, Smith argues that wages for common workers are largely determined by whether the economy is in a \”progressive\” state of expanding, a stationary state, or a declining state.

It deserves to be remarked, perhaps, that it is in the progressive state, while the society is advancing to the further acquisition, rather than when it has acquired its full complement of riches, that the condition of the labouring poor, of the great body of the people, seems to be the happiest and the most comfortable. It is hard in the stationary, and miserable in the declining state. The progressive state is in reality the cheerful and the hearty state to all the different orders of the society. The stationary is dull; the declining melancholy.

Smith grapples here with a difficult question for his time. England was richer than the North American settlements at this time, but wages for common workers  (measured in terms of what they could buy) were much higher in North America. Thus, Smith formulates an argument that when an economy is rapidly expanding, common workers are better off, but if an economy has slow growth–even if that economy has high overall per capita income–then wages for common workers will be flat or even declining.  Smith writes:

It is not, accordingly, in the richest countries, but in the most thriving, or in those which are growing rich the fastest, that the wages of labour are highest. England is certainly, in the present times, a much richer country than any part of North America. The wages of labour, however, are much higher in North America than in any part of England. In the province of New York, common labourers earn three shillings and sixpence currency, equal to two shillings sterling, a day; ship carpenters, ten shillings and sixpence currency, with a pint of rum worth sixpence sterling, equal in all to six shillings and sixpence sterling; house carpenters and bricklayers, eight shillings currency, equal to four shillings and sixpence sterling; journeymen taylors, five shillings currency, equal to about two shillings and ten pence sterling. These prices are all above the London price; and wages are said to be as high in the other colonies as in New York. The price of provisions is every where in North America much lower than in England. A dearth has never been known there. In the worst seasons, they have always had a sufficiency for themselves, though less for exportation. If the money price of labour, therefore, be higher than it is any where in the mother country, its real price, the real command of the necessaries and conveniencies of life which it conveys to the labourer, must be higher in a still greater proportion. 

 But though North America is not yet so rich as England, it is much more thriving, and advancing with much greater rapidity to the further acquisition of riches. The most decisive mark of the prosperity of any country is the increase of the number of its inhabitants. In Great Britain, and most other European countries, they are not supposed to double in less than five hundred years. In the British colonies in North America, it has been found, that they double in twenty or five-and-twenty years. Nor in the present times is this increase principally owing to the continual importation of new inhabitants, but to the great multiplication of the species. Those who live to old age, it is said, frequently see there from fifty to a hundred, and sometimes many more, descendants from their own body. Labour is there so well rewarded that a numerous family of children, instead of being a burthen is a source of opulence and prosperity to the parents. The labour of each child, before it can leave their house, is computed to be worth a hundred pounds clear gain to them. A young widow with four or five young children, who, among the middling or inferior ranks of people in Europe, would have so little chance for a second husband, is there frequently courted as a sort of fortune. The value of children is the greatest of all encouragements to marriage. We cannot, therefore, wonder that the people in North America should generally marry very young. Notwithstanding the great increase occasioned by such early marriages, there is a continual complaint of the scarcity of hands in North America. The demand for labourers, the funds destined for maintaining them, increase, it seems, still faster than they can find labourers to employ. 

Smith\’s argument is that in a stationary economy, even a stationary economy with high per capita income on average, the demand for common workers won\’t be strong, and even may fall because employers have already hired all the lower-class workmen that they need. He raises the possibility that there might be \”a country where the funds destined for the maintenance of labour were sensibly decaying\”–what we would in modern times refer to as labor\’s declining share of total income. Smith explains:

\”Though the wealth of a country should be very great, yet if it has been long stationary, we must not expect to find the wages of labour very high in it. The funds destined for the payment of wages, the revenue and stock of its inhabitants, may be of the greatest extent; but if they have continued for several centuries of the same, or very nearly of the same extent, the number of labourers employed every year could easily supply, and even more than supply, the number wanted the following year. There could seldom be any scarcity of hands, nor could the masters be obliged to bid against one another in order to get them. The hands, on the contrary, would, in this case, naturally multiply beyond their employment. There would be a constant scarcity of employment, and the labourers would be obliged to bid against one another in order to get it. …\”

There is always an embarrassingly high risk of anachronism when applying eighteenth-century writing to modern policy arguments. After all, Adam Smith was writing before the start of the Industrial Revolution and the two centuries of transformative economic growth that have followed, and he was writing before the development of arguments about how wages are linked to the marginal productivity of labor. But frankly, it is ridiculous to cite Adam Smith in support of minimum wage legislation. A more plausible argument, although still running a real risk of anachronism, would be that Adam Smith believed that rapid economic growth and a tight labor market–say, the situation of the U.S. economy in the mid to late 1990s–was the way to benefit ordinary workers.

For a post on minimum wages in different countries, see my May 2013 post on \”Some International Minimum Wage Comparisons.\” For a post on how the minimum wage affects employment and prices, see my February 2013 post on \”Minimum Wage and the Law of Many Margins.\”  For a post on proposals to raise the minimum wage, see my November 2012 post on\”Minimum Wage to $9.50? $9.80? $10?\” 

For those who like some facts to go with their arguments over redistribution and tax policy, the Congressional Budget Office has just published \”The Distribution of Household Income and
Federal Taxes, 2010.\” Here is some of what caught my eye.

There are several main categories of federal taxes: individual income tax, the social insurance taxes that fund Social Security and Medicare, corporate income tax (which is ultimately paid by individuals), and excise taxes on gasoline, cigarettes and alcohol. This chart shows the average tax rates paid in each category, broken down by income group.

A few observations here:

1) It\’s important to remember that this is the average rate of tax expressed as a share of income. For example, those in the top 1% are almost surely  paying the top marginal tax rate of about 40% on the top dollar earned. But when all the income taxed at a lower marginal rate is included, together with exemptions, deductions, and credits, this group pays an average of 20.1% of their income in individual income tax.

2) Average individual income taxes are negative for the bottom two quintiles. This arises because of \”refundable\” tax credits like the earned income tax credit and the child tax credit, which mean that many lower-income households not only owe zero in taxes, but receive an additional payment from the IRS.

3) In the calculations for effects of the corporation income tax, the underlying assumption is that high-income households end up paying much of the cost, because they are the ones who own most of the stock in these companies. In the calculations for excise taxes, the analysis is that low-income households pay a greater share of their income for these taxes, because they spend a greater share of their incomes on these products.

What if instead of looking at average tax rates, we look at the share of each of these taxes collected from the different groups? The table looks like this:

The top quintile pays 92.9% of all income taxes and 68.8% of all federal taxes. The top 1% pays 39% of all income taxes and 24.2% of all federal taxes.

How have federal tax rates changed over time for various income groups? It\’s true that average tax rates for the top 1% are down from the mid to late 1990s. It\’s also true that tax rates for the rest of the income distribution are lower in 2010 than back in the 1990s. From 2008 through 2010, the federal tax rate as a share of income was at its lowest level during this time period. Of course, this is due in part to people having less income and finding themselves in lower tax brackets, and in part to various tax cuts aimed at stimulating the economy.

Finally, how does the federal tax system alter the distribution of income in the United States? Here\’s a table from the report that I edited to focus on the 2010 data. You can see that in terms of before tax income, the lowest quintile had 5.1% of income before taxes, and 6.2% of income after taxes; the highest quintile had 51.9% of income before taxes, and 48.1% of income after taxes; and the top 1% had 14.9% of income before taxes, and 12.8% of all income after taxes. Because these figures are based on income, they don\’t take into account how spending programs that don\’t provide income directly to people like Medicare, Medicaid, or food stamps affect consumption levels.

I\’ll close by saying that in my experience, presenting these kinds of statistics doesn\’t really change anyone\’s mind about whether the tax system is fair or unfair, or how the tax system should be altered.  Back in 1938, Henry Simons of the University of Chicago wrote a book called Personal Income Taxation, in which he commented: \”The case for drastic progression in taxation must be rested on the case against inequality — on the ethical or aesthetic judgement that the prevailing distribution of wealth and income reveals a degree (and/or kind) of inequality which is distinctly evil or unlovely.\” Most people don\’t alter their \”ethical or aesthetic judgement\” about what is \”evil or unlovely\” based on statistical charts. But I live in hope that the presentation of facts, like water against stone, can at least erode the sharper edges of some of our political disputes.

Most of the commentary on the ultra-low interest rate policies that have been pursued over the last five years or so by the Federal Reserve and other central banks has focused on whether they were useful in limiting the length and depth of the Great Recession, and whether or how long they should be continued. In their recent discussion paper for the McKinsey Global Institute, Richard Dobbs, Susan Lund, Tim Koller, and Ari Shwayder acknowledge and accept the conventional wisdom that the ultra-low interest rate policies were useful and appropriate as part of the effort to stave off the Great Recession, but that there is some controversy over continuing the policies. But in \”QE and ultra-low interest rates: Distributional effects and risks,\” they then tackle a different if related question: Who has won and who has lost from the ultra-low interest rates? Although their analysis is international, I\’ll focus mainly on the U.S. results here.

Ultra-low interest rates will have two main sets of distributional effects: the first set involve interest payments made or received; the second set involve how interest rates affect the level of asset prices like homes and bonds. Here\’s a figure looking at how ultra-low interest rates have affected interest income and payments from 2007-2012.

Of course, lower interest rates help borrowers pay less, while those who are receiving interest payments get less. Thus, the big winner from ultra-low interest rates is the U.S. government, which over the 2007-2012 period could owe $900 billion less in interest payments. Indeed, the McKinsey report also notes that central banks like the Federal Reserve have been buying assets as part of the \”quantitative easing\” policies in recent years, and funds earned by the Fed over and above operating expenses go to the U.S. Treasury. They estimate that the quantitative easing policies gained the U.S. government another $145 billion or so during this time period. So overall, the ultra-low interest rate policies have been worth about $1 trillion to the U.S. government.

Nonfinancial U.S. corporations have interest-bearing debt in the form of bonds and bank loans, so the low interest rate policies have been worth $310 billion to them. U.S. banks have also seen a rise in their net interest income–that is, the amount by which the interest they received from borrowers exceeded the interest they paid to depositors. (In contrast, banks in Europe as a group have been worse off as a result of the ultra-low interest rate policies.)

On the other side, those who were depending on receiving interest payments are worse off. For example, insurance and pension funds that were relying on interest payments for part of their returns are down $270 billion from 2007-2012. As the report points out, many of these companies hold bonds that they purchased before interest rates fell, and so they have been somewhat protected from the fall in  interest rates. But as the period of ultra-low interest rates continues, insurance companies will either need to shift toward purchasing higher-risk products in search of higher returns, or they may become insolvent.

Household that were relying on interest payments also suffered.  However, because younger households tend to be borrowers, while older households are more likely to be relying on interest income, these losses fall heavily on older households. They also fall heavily on households that have high levels of wealth–in particular, on the 10% or so of US households that have 90% of the financial wealth.

Finally, the rest of the world holds large amounts of U.S. dollar debt: for example, think of China\’s $3.7 trillion in U.S. dollar reserves. The rest of the world has received about $480 billion less as a result of the ultra-low interest rate policies from the U.S. Federal Reserve during 2007-2012.

Now shift over to thinking about the effect of ultra-low interest rates on asset prices. The McKinsey report estimates that as a result of the ultra-low interest rates, U.S. housing prices are about 15% higher than they would otherwise have been (although this estimate is not intended to be precise!) and value of fixed-income bonds is about 37% higher. (If a bond was issued at some point in the past when interest rates were higher, and now interest rates fall, then the bond is worth more as a result.) The report argues that the effect of lower interest rates on stock prices is minimal. But the first two effects mean that household wealth is up about $5.6 trillion as result of ultra-low interest rates. Of course, these gains are experienced either by those who own a house or by those who own bonds–which again would be the 10% or so of all households that hold 90% of the financial wealth. It\’s a little tricky to think about these gains in asset values, because presumably at some point when interest rates return to more normal levels, these gains from ultra-low interest rates will fade away.

These distributional effects of ultra-low interest rates may well be less important than the macroeconomic issues of using the low rates to limit the economic carnage of the Great Recession. But the distributional effects are surely large enough to deserve notice. The big gainers are the U.S. government and nonfinancial corporations. The big losers are those trying to save for the future: older households, pension funds, life insurance companies. Other countries around the world have gotten hit in two ways:  not just much lower interest payments than they expected, and also potentially unstable inflows of U.S. investment dollars. When U.S. interest rates are rock-bottom, U.S. dollar investment funds flow into smaller economies around the world seeking higher returns; when it seems as if U.S. interest rates might rise, these U.S. dollar investment flows can easily flee back to the U.S. economy, destabilizing the capital markets and exchange rates of the smaller economies.

A standard line in economics, which I\’ve certainly emphasized often enough, is the remarkable ability of the social institution of markets to transmute self-interested behavior into social welfare. When firms are seeking a profit, they try to provide a combination of price and quality that appeals to customers. When people work at a job, they try to provide the combination of effort and skill that will result a certain mix of wages and work conditions. When customers shop for the best deal, they provide an incentive for firms and workers to act in these ways. The result of these interacting forces is a set of incentives that translate into improved standard of living. Of course, the narrow pursuit of self-interest can also lead to connivance, fraud, crime, violence, war, and politics. Jack Hirshleifer made this case in a memorable 1993 speech entitled \”The Dark Side of the Force,\” in which he argued that economists were too sunny in their view of self-interest, and needed to look more closely at both sides.

But as economists have quarreled over how society might best shape and direct the force of self-interest, they have opened themselves to an attack from the philosophers who argue that rather than assuming that people are motivated by narrow self-interest, why don\’t we seek a world in which people are motivated by virtuous behavior? Luigino Bruni and Robert Sugden seek to counter this critique in \”Reclaiming Virtue Ethics for Economics,\” which appears in the Fall 2013 issue of the Journal of Economic Perspectives. (Full disclosure: All articles in the JEP are freely available online courtesy of the American Economic Association. I\’ve been Managing Editor of the JEP since its inception in 1987.)

Bruni and Sugden point out that the critique that economic behavior is instrumental, rather than virtuous in itself, goes back a long way. For example, they quote Aristotle’s Nicomachean Ethics:
“The life of money-making is one undertaken under compulsion, and wealth is evidently not the good we are seeking; for it is merely useful and for the sake of something else.” They sketch the views of modern philosophers who also argue that economic behavior lacks virtue because it is not an end in itself, but instead is an activity that is in some sense socially compelled and performed for the sake of something else. As Bruni and Sugden note, responding to this argument by saying that markets raise the standard of living would miss the point.

Instead, Bruni and Sugden seek to confront this argument about virtue and market behavior head-on. They point out that virtue is typically defined in the context in which a person operates. Thus, even if a soldier or a doctor earns a paycheck, the virtues of their professions lie in courage or in healing. Of course, describing virtues in this way does not mean that all soldiers or all doctors are are virtuous!

Bruni and Sugden then argue that market behavior contains the possibility of intrinsic virtue as well, which lies in the action of participating in an activity in which mutual gains are realized. They write: \”But economic freedom is not the freedom of each person to get what he wants tout court; it is his freedom to use his own possessions and talents as he sees fit and to trade with whoever is willing
to trade with him. We suggest that the common core of these understandings of markets is that
markets facilitate mutually beneficial voluntary transactions.  … [A] market virtue in the sense of virtue ethics is an acquired character trait with two properties: possession of the trait makes an individual better able to play a part in the creation of mutual benefit through market transactions; and the trait expresses an intentional orientation towards and a respect for mutual benefit.\” With that perspective in mind, here is the list virtues that they see in market behavior:

Universality. \”If the market is to be viewed as an institution that promotes the widest possible
network of mutually beneficial transactions, universality has to be seen as a virtue. Its opposites—favoritism, familialism, patronage, protectionism—are all barriers to the extension of the market.\”

Enterprise and Alertness. \”[E]nterprise in seeking out mutual benefit must be a virtue. Discovering and anticipating what other people want and are willing to pay for is a crucial component of entrepreneurship. … The virtue of alertness to mutual benefit applies to both sides of the market: for mutual benefit to be created, the alertness of a seller has to engage with the alertness of a buyer. Thus, the inclination to shop around, to compare prices, and to experiment with new products and new suppliers must be a virtue for consumers.\”

Respect for the Tastes of One\’s Trading Partners. \”The spirit of this virtue is encapsulated in the business maxim that the customer is always right. This virtue is closely related to the idea that market transactions are made on terms of equality, and opposed to the paternalistic idea that the relationship of supplier to customer is that of guardian to ward.\”

Trust and Trustworthiness. Because the monitoring and enforcement of contracts is often difficult or costly, dispositions of trust and trustworthiness (qualified by due caution against being exploited by the untrustworthy) facilitate the achievement of mutual benefit in markets. If that is right, these dispositions must be market virtues.\”

Acceptance of Competition. \”[A] virtuous trader will not obstruct other parties from pursuing mutual benefit in transactions with one another, even if that trader would prefer to transact with one or another of them instead.\”

Self-Help. \”Thus, it is a market virtue to accept without complaint that others will be motivated to satisfy your wants, or to provide you with opportunities for self-realization, only if you offer something that they are willing to accept in return. … Seeing self-help as a virtue makes it easier to understand how people can find satisfaction in work that they would not choose to do if they were not paid for it.\”

Non-Rivalry. \”Thus, it must be a market virtue to see others as potential partners in mutually beneficial transactions rather than as rivals in a competition for shares of a fixed stock of wealth or status. A disposition to be grudging or envious of other people’s gains is a handicap to the discovery
and carrying through of mutually beneficial transactions. The corresponding virtue is that of being able to take pleasure in other people’s gains—particularly those that have been created in transactions from which you have gained too.\”

Stoicism about Reward. \”But an adequate account of market virtue cannot maintain that what a person earns from market transactions is a reward for the exercise of virtue, in the sense that a literary prize can be seen as a reward for artistic excellence. A person can expect to benefit from market transactions only to the extent that she provides benefits that trading partners value at the time they choose to pay for them. To expect more is to create barriers to the achievement of mutual benefit. Thus, market virtue is associated with not expecting to be rewarded according to one’s deserts, not resenting other people’s undeserved rewards, and (if one has been fortunate) recognizing that one’s own rewards may not have been deserved.\”

Again, just to be clear, Bruni and Sugden are certainly not claiming that everyone who participates in markets is virtuous in these ways. They are also certainly not claiming that those who are most virtuous in these ways will accumulate the highest riches.

What Bruni and Sugden are trying to do, it seems to me, is to point out the possibilities of virtue in the everyday lives that most of us lead. It\’s easy to talk about virtue in the context of those spend their lives working in a leper colony, or creating great art, or educating impoverished children. But some of the philosophers who criticize economic behavior for its inordinate focus on self-interest and lack of virtuous behavior seem to say fairly explicitly that the everyday life of, say, a bricklayer or a factory worker or a file clerk must necessarily lack even the opportunity for virtuous behavior, because their efforts to make a living are without a possibility of intrinsic merit. Indeed, the argument that economic behavior cannot be virtuous seems to shade into a claim that only those who don\’t need to work for a living can be virtuous. In contrast, Bruni and Sugden argue that market behavior of everyday life has its virtues worth defending, too.

For a contrasting argument that expresses concerns about how markets may infringe on other important social values, the same issue of JEP has an article by Michael J. Sandel called \”Market Reasoning as Moral Reasoning: Why Economists Should Re-engage with Political Philosophy.\” I posted on one aspect of Sandel\’s argument a couple of weeks ago in \”Is Altruism a Scarce Resource that Needs Conserving?\”

Jagdish Bhagwati gives his perspective on the state of the Doha Round of world trade talks in \”Dawn of a New System,\” which appears in the December 2013 issue of Finance & Development. It\’s useful reading as background for the Ninth Ministerial Conference conference of the World Trade Organization that starts tomorrow in Bali.

As Bhagwati looks back at the status of the Doha Round of trade talks that started back in 2001, he considers three options. One choice, which he calls Doha Heavy, represents the grand bargain in which nations all around the world make substantial movements toward reducing trade barriers and government subsidies. This choice isn\’t happening. But in 2011, a more modest trade liberaliztion deal was on the table that Bhagwati calls Doha Lite. In Bhagwati\’s telling, this deal was acceptable to developing countries around the world, as well as to David Cameron in the UK and Angela Merkel in Germany, but \”Obama was unwilling to confront the U.S. business lobbies, which held out for major new concessions by the bigger developing economies.\” 

So the choice that remains is what Bhagwati calls Doha Lite and Decaffeinated, which will be discussed starting tomorrow at the conference in Bali. Basically, this agreement would on the \”trade facilitation\” agenda, which according to an OECD study would emphasize issues like \”the availability of trade-related information, the simplification and harmonization of documents, the streamlining of procedures and the use of automated processes.\” Indeed, the OECD maintains a website of 16 trade facilitation indicators. The OECD writes: \”[C]omprehensive implementation of all measures currently being negotiated in the World Trade Organization’s Doha Development Round would reduce total trade costs by 10% in advanced economies and by 13-15.5% in developing countries. Reducing global trade costs by 1% would increase worldwide income by more than USD $40 billion, most of which would accrue in developing countries.\”

In the context of the world economy, these gains aren\’t very large–but they are still worth having. Also, as Bhagwati points out, even a Doha Light and Decaffeinated agreement would help support the other aspects of the multilateral trade agreement: setting rules on issues like antidumping and government subsidies, and the dispute settlement mechanism. Bhagwati has characteristically sharp observations to make about the Trans-Pacific Partnership and the Transatlantic Trade and Investment Partnerships that are also under negotiation. But like many trade economists, Bhagwati fears that a proliferation of regional trade agreements won\’t work well as global supply chains become ever-longer and emerging economies like China, Brazil, and India play an ever-larger role in the world economy.

Consider the editors who have worked on the Oxford English Dictionary. Lorien Kite tells some of the stories in \”The evolving role of the Oxford English Dictionary,\” which appeared in the Financial Times on November 15. For those not familiar with the OED, it not only aspires to include every word in the English language, whether in current use or archaic, but it also seeks to give examples of usage of words over time. The full article is worth reading, but here are a few snippets.

\”James Murray (1837-1915), the indefatigable editor who oversaw much of the first edition, was originally commissioned to produce a four-volume work within a decade; after five years, he had got as far as the word “ant”.\”

\”When work began on OED3 in the mid-1990s, it was meant to be complete by 2010. Today, they are roughly a third of the way through and Michael Proffitt, the new chief editor, estimates that the job won’t be finished for another 20 years.\”

\”The first edition, published in 10 instalments between 1884 and 1928, defined more than 400,000 words and phrases; by 1989, when two further supplements of 20th-century neologisms were combined with the original to create the second, this had risen to some 600,000, with a full word count of 59m. Once the monumental task of revising and updating that last (and possibly final) printed incarnation is complete, the third edition is expected to have doubled in overall length.\” 

\”The OED records 750,000 individual “sessions” each month, most of which come via institutions such as libraries, universities, NGOs and government departments. … The surprising thing, explains Judy Pearsall, editorial director for dictionaries in OUP’s global academic division, is that a quarter of these monthly visits are coming from outside what we think of as the English-speaking world.In September, the US accounted for the single biggest group of users, followed by the UK, Canada and Australia. At numbers five and six, however, are Germany and China. Readership from countries where English is not the first language is growing faster too …\”

Thanks to Larry Willmore at his \”Thought du Jour\” blog for pointing out the article. I\’m going to put it in \”Editor Hell\” file folder next to the example of Werner Stark, who edited the collected economic works of Jeremy Bentham. Here\’s my description of his task from an essay I wrote in 2009 called \”An Editor\’s Life at the Journal of Economic Perspectives.\” (If you are curious about my personal background and approach to editing, you might find it an interesting read.)

[C]onsider the problems posed in editing the papers of Jeremy Bentham, the utilitarian philosopher and occasional economist. Bentham wrote perhaps 15 pages in longhand almost every day ofhis adult life. His admirers gathered some of his work for publication, but much was simply stored in boxes, primarily at the library of University College, London. In 1941, an economist named Werner Stark was commissioned by the Royal Economic Society to prepare a comprehensive edition of Bentham’s economic writings, which in turn are just a portion of his overall writings. Inthe three-volume work that was published 11 years later (!), Stark (1952) wrote in the introduction: 

The work itself involved immense difficulties. Bentham’s handwriting is so bad that it is quite impossible to make anything of his scripts without first copying them out. I saw myself confronted with the necessity of copying no less than nine big boxes of papers comprising nearly 3,000 pages and a number of words that cannot be far from the seven-figure mark. But that was only the first step. The papers are in no kind of order: in fact it is hard to imagine how they ever became so utterly disordered. They resemble a pack of cards after it has been thoroughly shuffled. . . . The pages of some manuscripts, it is true, were numbered, but then they often carried a double and treble numeration so that confusion was worse confounded, and sometimes I wished there had been no pagination at all. In other manuscript collections the fact that sentences run uninterruptedly from one sheet onto another, is of material help in creating order out of chaos. I was denied even this assistance. It was one of Bentham’s idiosyncrasies never to begin a new page without beginning at the same time a new paragraph. But I cannot hope to give the reader an adequate idea of the problems that had to be overcome. 

Stark’s lamentations would chill the heart of any editor. “Bentham was most unprincipled with regard to the use of capitals.” “After careful consideration, it was found impossible to transfer the punctuation of Bentham’s manuscripts on to the printed page. When he has warmed to a subject and is writing quickly, he simply forgets to punctuate . . . ” And so on.

Of course, the task of editing can have some extraordinary payoffs. Making Bentham\’s thoughts available and accessible to readers is of great importance. One can imagine a future in which you will buy the OED as an app for your e-reader or your word-processor, and definitions and past uses will be only a click away. In a 2012 essay \”From the Desk of the Managing Editor,\” written for the 100th issue of the Journal of Economic Perspectives, I tried to describe some of what an editor can hope to accomplish:

Communication is hard. The connection between writer and reader is always tenuous. No article worth the reading will ever be a stroll down the promenade on a summer’s day. But most readers of academic articles are walking through swampy woods on a dark night, squelching through puddles and tripping over sticks, banging their shins into rocks, and struggling to see in dim light as thorny branches rake at their clothing. An editor can make the journey easier, so the reader need not dissipate time and attention overcoming unnecessary obstacles, but instead can focus on the intended pathway. 

Obstacles to understanding arise both in the form of content and argument and also in the nuts and bolts of writing. An editor needs a certain level of obsessiveness in confronting these issues, manuscript after manuscript, for the 1,000 pages that JEP publishes each year. Plotnick (1982, p. 1) writes in The Elements of Editing: “What kind of person makes a good editor? When hiring new staff, I look for such useful attributes as genius, charisma, adaptability, and disdain for high wages. I also look for signs of a neurotic trait called compulsiveness, which in one form is indispensable to editors, and in another, disabling.”

The ultimate goal of editing is to strengthen the connection between authors and readers. Barney Kilgore, who was editor of the Wall Street Journal during its time its circulation expanded dramatically in the 1950s and 1960s, used to post a motto in his office that would terrify any editor (as quoted in Crovitz 2009): “The easiest thing in the world for a reader to do is to stop reading.” An editor can help here, by serving as a proxy for future readers.