Saturday, March 30, 2013

Austerity Is Good for the Soul

A. C. Grayling, proprietor of the New College for the Humanities, may be a bit of a charlatan. But I suspect that in this piece for the FT, he's a good guide to the next turn of the zeitgeist.

Is austerity a bad thing? Not always. The austerity years of the second world war and its aftermath were surprisingly good for people; calorie restriction meant flat tummies and robust health, at least for those not smoking the lethal cigarettes of the day. That was a physical benefit; the psychological benefit was perhaps greater. Being in the same boat promoted a sense of common purpose and comradeship. ...
Lent, the 40 days before Easter, is supposed to involve an elective form of austerity; we are to give something up, engage in self-denial as a discipline. Different stories are told about the reason for it... But the real reason for Lent is that the late winter and early spring was always a time of dearth. ... The experience of Lent, when it really was a time of belt-tightening and hard work to get the next tranche of resources on its way, was doubtless salutary in keeping people (as we now say) real. Keeping real means being mindful of how tenuously we own our comforts. 
... the realities of austerity in hard economic times mean giving up the car, going out less often, cutting not just amenities but necessities, or what we think are necessities. The people who take the hardest hit are the poor and vulnerable, who already do without what others regard as necessary. 
But there is the glimmer of opportunity that austerity offers. Most of the things that are intrinsically most valuable in human life do not cost money, though by the application of money to them we think we embellish them. ... Epictetus, the Stoic philosopher of antiquity, said that the truly rich person is he who is satisfied with what he has. Think that saying through. How rich one is, if content with a sufficiency; how poor, with millions in the bank, if dissatisfied and still lusting for more. Enforced austerity, as in a major economic downturn, might teach what is sufficient, and how one might be grateful not to be burdened with more than is sufficient. ...
So long as people measure their worth by how much they earn or own, they will think that having less is austerity, that living more simply is austerity, that getting to know their own locale rather than rushing to distant beaches is austerity. Yet perhaps “austerity” actually means “the opportunity to live more richly”. Then, of course, it would be austerity no more.
It's insidious because it contains an element of truth. Still:
Among the highly placed,
It is considered low to talk about food.
The fact is: they have
Already eaten.

Thursday, March 28, 2013

Where Do the Rich Get Their Money, Again?

This was an early topic at the Slack Wire, but worth revisiting.

There's this widespread idea that the rich today are no different from us. We no longer have the pseudo-aristocratic rentiers of Fitzgerald or Henry James, but hard-working (if perhaps overcompensated) superstars of the labor market. When a highbrow webzine does an "interview with a rich person," it turns out to be a successful graphic designer earning $140,000 a year.

Sorry, that is not a rich person.

The 1 percent cutoff for household income is around $350,000. The 0.1 percent, around $2 million. The 0.01 percent, around $10 million. Those are rich people, and they're not graphic designers, or even lawyers or bankers. They're owners.

From the IRS Statistics of Income for 2010:

Wages and Salaries Pensions, Social Security, UI Interests, Dividends, Inheritance Business Income Capital Gains Total Capital Income

Total 64.5% 18.5% 6.1% 7.2% 3.8% 17.1%

Median Household 72.7% 21.5% 2.4% 2.4% 0.0% 4.8%

The 0.01% 14.6% 0.7% 23.1% 19.0% 40.6% 82.7%

As we can see, for households at the very top of the distribution, income overwhelmingly comes from property ownership. Total property income at the far right, the sum of preceding three columns. (The numbers don't add to quite 100% because I've left out a few small, hard-to-classify categories like alimony and gambling winnings.) The top 0.01 percent's 15 percent of labor income is not much more than the same stratum got from wages and salaries in 1929. No doubt many of these people spend time at an office of some kind, but the idea of "the working rich" is a myth.

Here's the same breakdown across the income distribution. The X-axis is adjusted gross income.

So across a broad part of the income distribution, wages make up a stable 70-75 percent of income, with public and private social insurance providing most of the rest. Capital income catches up with labor income around $500,000, making the one percent line a good qualitative as well as quantitative cutoff. It's interesting to see how business income peaks in the $1 to $2 million range, the signature of the old middle class or petite bourgeoisie. And at the top, again, capital income is absolutely dominant.

It's an interesting question why this isn't more widely recognized. Mainstream discussions of rising inequality take it for granted that “those at the top were more likely to earn than inherit their riches," with the clear understanding that "earn" means a paycheck. Even very smart Marxists like Gerard Dumenil and Dominique Levy concede that "a large fraction of the income of the wealthiest segments of the population is made of wages," giving a figure of 48.8 percent for the wage share of the top 0.1 percent. Yet the IRS figures show that the wage share for this stratum is not nearly half, but less than a third. What gives?

I think at least some of the confusion is the fault of Piketty and Saez. Their income distribution work is state of the art, they've done as much as anyone to bring the concentration of income at the top into public discussion; I'd be a fool to criticize their work on the substance. They do, however, make a somewhat peculiar choice about presentation. In the headline numbers in much of their work, they give not the top 0.01, 0.1, 1, etc. percent by income, but rather the top percentiles by income excluding capital gains. [*] This is clearly stated in their papers but it is almost never noted, as far as I can tell, by people who cite them.

There are various good reasons, in principle, for distinguishing capital gains from other income. But in an era when capital gains are the largest single source of income at the top, defining top income fractiles  excluding capital gains seriously distorts your picture of the very top. For instance, you may miss people like this guy: In both 2010 and 2011, the majority of Mitt Romney's income took the form of capital gains.

"They have taken untold millions that they never toiled to earn," or if you prefer, "Save your money -- same like yesterday."

[*] The fractiles are defined this way even when capital gains income is reported. You have to dig around a bit in their data to find the composition of income by raw income fractiles, equivalent to my table above.

Tuesday, March 12, 2013

"Recession Is a Time of Harvest"

Noah and Seth say pretty much everything that needs to be said about this latest #Slatepitch provocation from Matt Yglesias.  [1] So, traa dy lioaur, I am going to say something that does not need to be said, but is possibly interesting.

Yglesias claims that "the left" is wrong to focus on efforts to increase workers' money incomes, because higher wages just mean higher prices. Real improvements in workers' living standards -- he says -- come from the same source as improvements for rich people, namely technological innovation. What matters is rising productivity, and a rise in productivity necessarily means a fall in (someone's) nominal income. So we need to forget about raising the incomes of particular people and trust the technological tide to lift all boats.

As Noah and Seth say, the logic here is broken in several places. Rising productivity in a particular sector can raise incomes in that sector as easily as reduce them. Changes in wages aren't always passed through to prices, they can also reflect changes in the distribution between wages and other income.

I agree, it's definitely wrong as a matter of principle to say that there's no link, or a negative link, between changes in nominal wages and changes in the real standard of living. But what kind of link is there, actually? What did our forebears think?

Keynes notoriously took the Yglesias line in the General Theory, arguing that real and nominal wages normally moved in opposite directions. He later retracted this view, the only major error he conceded in the GT (which makes it a bit unfortunate that it's also the book's first substantive claim.) Schumpeter made a similar argument in Business Cycles, suggesting that the most rapid "progress in the standard of life of the working classes" came in periods of deflation, like 1873-1897. Marx on the other hand generally assumed that the wage was set in real terms, so as a first approximation we should expect higher productivity in wage-good industries to lead to lower money wages, and leave workers' real standard of living unchanged. Productivity in this framework (and in post-GT Keynes) does set a ceiling on wages, but actual wages are almost well below this, with their level set by social norms and the relative power of workers and employers.

But back to Schumpeter and the earlier Keynes. It's worth taking a moment to think through why they thought there would be a negative relationship between nominal and real wages, to get a better understanding of when we might expect such a relationship.

For Keynes, the logic is simple. Wages are equal to marginal product. Output is produced in conditions of declining marginal returns. (Both of assumptions are wrong, as he conceded in the 1939 article.) So when employment is high, the real wage must be low. Nominal wages and prices generally move proportionately, however, rising in booms and falling in slumps. (This part is right.) So we should expect a move toward higher employment to be associated with rising nominal wages, even though real wages must fall. You still hear this exact argument from people like David Glasner.

Schumpeter's argument is more interesting. His starting point is that new investment is not generally financed out of savings, but by purchasing power newly created by banks. Innovations are almost never carried out by incumbent producers simply adopting the new process in place of the existing one, but rather by some new entrant -- the famous entrepreneur-- operating with borrowed funds. This means that the entrepreneur must bid away labor and other inputs from their current uses (importantly, Schumpeter assumes full employment) pushing up costs and prices. Furthermore, there will be some extended period of demand from the new entrants for labor and intermediate goods while the incumbents have not yet reduced theirs -- the initial period of investment in the new process (and various ancillary processes -- Schumpeter is thinking especially of major innovations like railroads, which will increase demand in a whole range of related industries), and later periods where the new entrants are producing but don't yet have a decisive cost advantage, and a further period where the incumbents are operating at a loss before they finally exit. So major innovations tend to involve extended periods of rising prices. It's only once the new producers have thoroughly displaced the old ones that demand and prices fall back to their old level. But it's also only then that the gains from the innovation are fully realized. As he puts it (page 148):
Times of innovation are times of effort and sacrifice, of work for the future, while the harvest comes after... ; and that the harvest is gathered under recessive symptoms and with more anxiety than rejoicing ... does not alter the principle. Recession [is] a time of harvesting the results of preceding innovation...
I don't think Schumpeter was wrong when he wrote. There is probably some truth to idea that falling prices and real wages went together in 19th century. (Maybe by 1939, he was wrong.)

I'm interested in Schumpeter's story, though, as more than just intellectual history, fascinating tho that is. Todays consensus says that technology determines the long-term path of the economy, aggregate demand determines cyclical deviations from that path, and never the twain shall meet. But that's not the only possibility. We talked the other day about demand dynamics not as -- as in conventional theory -- deviations from the growth path in response to exogenous shocks, but as an endogenous process that may, or may not, occasionally converge to a long-term growth trajectory, which it also affects.

In those Harrod-type models, investment is simply required for higher output -- there's no innovation or autonomous investment booms. Those are where Schumpeter comes in. What I like about his vision is it makes it clear that periods of major innovation, major shifts from one production process to another, are associated with higher demand -- the major new plant and equipment they require, the reorganization of the spatial and social organization of production they entail ("new plant, new firms, new men," as he says) make large additional claims on society's resources. This is the opposite of the "great recalculation" claim we were hearing a couple years ago, about how high unemployment was a necessary accompaniment to major geographic or sectoral shifts in output; and also of the more sophisticated version of the recalculation argument that Joe Stiglitz has been developing. [2] Schumpeter is right, I think, when he explicitly says that if we really were dealing with "recalculation" by a socialist planner, then yes, we might see labor and resources withdrawn from the old industries first, and only then deployed to the new ones. But under capitalism things don't work like that  (page 110-111):
Since the central authority of the socialist state controls all existing means of production, all it has to do in case it decides to set up new production functions is simply to issue orders to those in charge of the productive functions to withdraw part of them from the employments in which they are engaged, and to apply the quantities so withdrawn to the new purposes envisaged. We may think of a kind of Gosplan as an illustration. In capitalist society the means of production required must also be ... [redirected] but, being privately owned, they must be bought in their respective markets. The issue to the entrepreneurs of new means of payments created ad hoc [by banks] is ... what corresponds in capitalist society to the order issued by the central bureau in the socialist state. 
In both cases, the carrying into effect of an innovation involves, not primarily an increase in existing factors of production, but the shifting of existing factors from old to new uses. There is, however, this difference between the two methods of shifting the factors : in the case of the socialist community the new order to those in charge of the factors cancels the old one. If innovation were financed by savings, the capitalist method would be analogous... But if innovation is financed by credit creation, the shifting of the factors is effected not by the withdrawal of funds—"canceling the old order"—from the old firms, but by ... newly created funds put at the disposal of entrepreneurs : the new "order to the factors" comes, as it were, on top of the old one, which is not thereby canceled.
This vision of banks as capitalist Gosplan, but with the limitation that they can only give orders for new production on top of existing production, seems right to me. It might have been written precisely as a rebuttal to the "recalculation" arguments, which explicitly imagined capitalist investment as being guided by a central planner. It's also a corrective to the story implied in the Slate piece, where one day there are people driving taxis and the next day there's a fleet of automated cars. [3] Before that can happen, there's a long period of research, investment, development -- engineers are getting paid, the technology is getting designed and tested and marketed, plants are being built and equipment installed -- before the first taxi driver loses a dollar of income. And even once the driverless cars come on line, many of the new companies will fail, and many of the old drivers will hold on for as long as their credit lasts. Both sets of loss-making enterprises have high expenditure relative to their income, which by definition boosts aggregate demand. In short, a period of major innovations must be a period of rising nominal incomes -- as we most recently saw, on a moderate scale, in the late 1990s.

Now for Schumpeter, this was symmetrical: High demand and rising prices in the boom were balanced by falling prices in the recession -- the "harvest" of the fruits of innovation. And it was in the recession that real wages rose. This was related to his assumption that the excess demand from the entrepreneurs mainly bid up the price of the fixed stock of factors of production, rather than activating un- or underused factors. Today, of course, deflation is extremely rare (and catastrophic), and output and employment vary more over the cycle than wages and prices do. And there is a basic asymmetry between the boom and the bust. New capital can be added very rapidly in growing enterprises, in principle; but gross investment in the declining incumbents cannot fall below zero. So aggregate investment will always be highest when there are large shifts taking place between sectors or processes. Add to this that new industries will take time to develop the corespective market structure that protects firms in capital-intensive industries from cutthroat competition, so they are more likely to see "excess" investment. And in a Keynesian world, the incomes from innovation-driven investment will also boost consumption, and investment in other sectors. So major innovations are likely to be associated with booms, with rising prices and real wages.

So, but: Why do we care what Schumpeter thought 75 years ago, especially if we think half of it no longer holds? Well, it's always interesting to see how much today's debates rehash the classics. More importantly, Schumpeter is one of the few economists to have focused on the relation of innovation, finance and aggregate demand (even if, like a good Wicksellian, he thought the latter was important only for the price level); so working through his arguments is a useful exercise if we want to think more systematically about this stuff ourselves. I realize that as a response to Matt Y.'s silly piece, this post is both too much and poorly aimed. But as I say, Seth and Noah have done what's needed there. I'm more interested in what relationship we think does hold, between innovation and growth, the price level, and wages.

As an economist, my objection to the Yglesias column (and to stuff like the Stiglitz paper, which it's a kind of bowdlerization of) is that the intuition that connects rising real incomes to falling nominal incomes is just wrong, for the reasons sketched out above. But shouldn't we also say something on behalf of "the left" about the substantive issue? OK, then: It's about distribution. You might say that the functional distribution is more or less stable in practice. But if that's true at all, it's only over the very long run, it certainly isn't in the short or medium run -- as Seth points out, the share of wages in the US is distinctly lower than it was 25 years ago. And even to the extent it is true, it's only because workers (and, yes, the left) insist that nominal wages rise. Yglesias here sounds a bit like the anti-environmentalists who argue that the fact that rivers are cleaner now than when the Clean Water Act was passed, shows it was never needed. More fundamentally, as a leftist, I don't agree with Yglesias that the only important thing about income is the basket of stuff it procures. There's overwhelming reason -- both first-principle and empirical -- to believe that in advanced countries, relative income, and the power, status and security it conveys, is vastly more important than absolute income. "Don't worry about conflicting interests or who wins or loses, just let the experts make things better for everyone": It's an uncharitable reading of the spirit behind this post, but is it an entirely wrong one?

UPDATE: On the other hand. In his essay on machine-breaking, Eric Hobsbawm observes that in 18th century England,
miners' riots were still directed against high food prices, and the profiteers believed to be responsible for them.
And of course more generally, there have been plenty of working-class protests and left political programs aimed at reducing the cost of living, as well as raising wages. Food riots are a major form of popular protest historically, subsidies for food and other necessities are a staple policy of newly independent states in the third world (and, I suspect, also disapproved by the gentlemen of Slate), and food prices are a preoccupation of plenty of smart people on the left. (Not to mention people like this guy.) So Yglesias's notion that "the left" ignores this stuff is stupid. But if we get past the polemics, there is an interesting question here, which is why mass politics based around people's common interests as workers is so much more widespread and effective than this kind of politics around the cost of living. Or, maybe better, why one kind of conflict is salient in some times and places and the other kind of conflict in others; and of course in some, both.

[1] Seth's piece in particular is a really masterful bit of polemic. He apologizes for responding to trollery, which, yeah, the Yglesias post arguably is. But if you must feed trolls, this is how it's done. I'm not sure if the metaphor requires filet mignon and black caviar, or dogshit garnished with cigarette butts, or fresh human babies, but whatever it is you should ideally feed a troll, Seth serves it up.

[2] It appears that Stiglitz's coauthor Bruce Greenwald came up with this first, and it was adopted by right-wing libertarians like Arnold Kling afterwards.

[3] I admit I'm rather skeptical about the prospects for driverless cars. Partly it's that the point is they can operate with much smaller error tolerances than existing cars -- "bumper to bumper at highway speeds" is the line you always hear -- but no matter how inherently reliable the technology, these things are going to be owned maintained by millions of individual nonprofessionals. Imagine a train where the passengers in each car were responsible for making sure it was securely coupled to the next one. Yeah, no. But I think there's an even more profound reason, connected to the kinds of risk we will and will not tolerate. I was talking to my friend E. about this a while back, and she said something interesting: "People will never accept it, because no one is responsible for an accident. Right now, if  there's a bad accident you can deal with it by figuring out who's at fault. But if there were no one you could blame, no one you could punish, if it were just something that happened -- no one would put up with that." I think that's right. I think that's one reason we're much more tolerant of car accidents than plane accidents, there's a sense that in a car accident at least one of the people involved must be morally responsible. Totally unrelated to this post, but it's a topic I'd like to return to at some point -- that what moral agency really means, is a social convention that we treat causal chains as being broken at certain points -- that in some contexts we treat people's actions as absolutely indeterminate. That there are some kinds of in principle predictable actions by other people that we act -- that we are morally obliged to act -- as if we cannot predict.

Tuesday, March 5, 2013

Deleveraging by Default

The new Household Credit and Debt Report came out last week from the New York Fed. Fun!

The stuff about student debt got the scary headlines, and with reason -- especially once you notice that the 17 percent delinquency rate on student debt, bad enough, understates the problem, since that figure includes debt on which no payment is due:
when we remove the estimated 44 percent of all borrowers for whom no payment is due or the payment is too small to offset the accrued interest, the delinquency rate rises to over 30 percent.
Student debt is not really my beat, though, so I want to call attention to something which has gotten less attention: how much household "deleveraging" is really about defaults, rather than reduced borrowing.

The Credit and Debt Report is based on the New York Fed's Consumer Credit Panel, with the underlying data from the credit bureau Equifax. It's unique, as far as I know, in its comprehensive coverage of the various flows that make up changes in household liabilities. The Flow of Funds, by contrast, sees household debt only from the creditors' side, and doesn't directly observe flows, only changes in stocks of debt. So with this data we can see much more clearly what's actually driving the fall in household debt-to-income ratios. [1] And here's what we find:

The heavy lines are the year-end ratios of mortgage and total household debt, respectively, to disposable personal income. The dotted lines are the path these ratios would have followed if defaults were held fixed at their pre 2007 levels. So we see that total household debt peaked at 119 percent of income at the end of 2007, and has since fallen to 100 percent, a substantial decline. But when we break out the various factors accounting for changes in debt -- new borrowing, repayment, and default -- we find that the fall is entirely the result of higher defaults. If households had continued defaulting on debt at the same rate after 2007 as before, household debt would not have fallen at all. (It is true that since 2009, there has been some deleveraging even net of defaults, but even over those two years two-thirds of the fall in debt-income ratios is due to elevated default rates.) Mortgage debt follows the same pattern: If default rates had continued at their 2003-2006 level, mortgage debt would have been greater, relative to income, at the end of 2011 than at the end of 2007.

It's interesting to compare the debt writeoffs reported by households with the writeoffs reported by commercial banks. The biggest difference between the two series is that banks report their net losses, i.e. after recoveries. But both show the same dramatic rise in the Great Recession.

As we can see, the two series move more or less together. It's noteworthy, though, that before the crisis the amount of debt discharged by default was consistently about five times greater than banks' default losses; after 2007, this ratio dropped to more like like two to one. This represents some mix of lower recovery rates -- underwater homes are worth less than their mortgages -- and a worse default performance among mortgages owned by entities other than commercial banks.

So why does all this matter? Well, the obvious reason is that we want to get the story of the recent past right. The usual debate about falling debt is how much it's due to banks' unwillingness to lend, and how much to households' unwillingness to borrow. If it's really due largely to higher default rates, our stories of the financial crisis and its aftermath should reflect that. But they seldom do. Richard Koo, just to pick one example at random, treats changes in household liabilities as simply a measure of household borrowing.

A couple other reasons to care. For one, the role of defaults is further evidence against the idea that demand is being constrained by a lack of access to credit. 

More broadly, it's evident that the relationship between defaults and changes in income is nonlinear. Over a normal business cycle, household defaults are stable and fairly low. (This is not true of business and especially commercial real-estate defaults.) It takes an exceptionally deep fall in income to produce a noticeable rise in household defaults. The macroeconomic significance of this is that defaults, like Koo-style deleveraging, weaken the link between current income and current expenditure; in both cases, a higher share of changes in income show up as changes in the flow of payments to creditors, rather than changes in spending on currently produced goods and services. This dampening of the income-expenditure link helps put a floor under demand fluctuations, as discussed in the previous post (provided that defaults don't limit other units' access to credit -- this is an important difference  between the recent crisis and 1929-1933.) But by the same token it also weakens demand dynamics in the recovery; if a major margin on which households adjust to changes in incomes is changes in payments to creditors, rising incomes will do less to raise demand for current output.

The central importance of defaults in the deleveraging process to date also is a reminder of the importance of the terms on which debt can be discharged. Laws and norms that make default relatively easy can evidently serve as an escape valve that helps prevent the debt deflation process from taking hold.

Looking forward, this is further evidence of how difficult it is to reduce leverage just through lower expenditure. It's noteworthy here that since 2007, the household sector has had large primary surpluses (i.e. new borrowing is less than interest payments), but in the current environment of slow growth, relatively high real interest rates, and low inflation, this has not been sufficient on its own to produce any fall in leverage. So if lower debt-income ratios are a precondition for sustained growth, more systematic debt writedowns may be necessary. From the conclusion of Arjun's and my paper:
A recent IMF staff report (Gottschalk et al., 2010) notes that for public sector debt, defaults are most likely to lead a long-term improvement in the fiscal position (and have generally occurred historically) in countries with small primary deficits, or primary surpluses. In such cases unsustainable debt growth is driven by the interaction of high effective interest rates with a large existing debt stock; a one-time reduction in the debt stock can change an unsustainable path to a sustainable one, even if the interest rates on new borrowing rise as a result. A similar logic might apply to private sector debt. If so, some form of systematic debt forgiveness may be the logical, and eventually unavoidable, solution to the problem of excessive household leverage.
Finally, the importance of defaults over the past five years is a reminder that a crisis is precisely a situation when inconsistent expectations cannot be ignored. By definition, in a crisis not all contractual commitments can be fulfilled, and it's always ultimately a political question which are honored and which are not.

[1] The published report doesn't include writeoffs, only the fraction of debt that is currently delinquent. To get annual household debt writeoffs, we have to combine the report with the numbers reported by the New York Fed in its Liberty Street blog.