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…via Tyler Cowen:

The fact that the US is running a persistent trade deficit and experiencing significant net capital inflows seems like very strong evidence that we are not in a traditional Keynesian situation, where we have ‘excess saving.’

If we have excess saving, why are we having a capital inflow rather than a capital outflow?

If combined private and public demand were below the economy’s productive capacity, why are we running a trade deficit? Doesn’t the existence of a persistent trade deficit indicate that our demand is in excess of our supply?

Very much not our grandma’s recession.

There’s an important assumption here that Dennis should make explicit – that trade deficits are only a demand-side issue. But the marginal propensity to import is as critically decided by supply-side issues. For example, as American shale production booms, we will become a net exporter of oil.

But there’s an even more important distinction. Remember, back in Keynes’ time, gross national product was the preferred measure of economy. Indeed, only in 1991 did the United States switch to domestic product as the standard measure.

In this case I submit that the former is definitely a better framework for understanding demand. Foreign capital inflow finances development in America, and is definitely a good thing (of course, for a global reserve it is inevitable). But they are also a foreign claim on future domestic earnings. Assuming easy repatriation of profits, they will ultimately be used to increase consumption – hence demand – in some other country, moderated only by that country’s marginal propensity to import from America.

Investment is just deferred consumption. But that linearity is correct only for American residents. In fact, trade deficit by itself probably doesn’t tell us much about aggregate demand at all. He says “Doesn’t the existence of a persistent trade deficit indicate that our demand is in excess of our supply.” Conversely, I’d say the sovereign of the only big global reserve currency is bound to run trade deficits. (Think about it this way: there’s excess savings in the domestic currency – that’s infinitely more important).

Increased demand for oil creates a captive demand for American dollars, only exacerbated by a global safe-asset shortage. Therefore capital inflow is inevitable. I’d argue this is more structural than nominal, and hence not really pertinent to demand, per se. Actually, since the financial crash, the trade deficit has fallen. So if you follow Dennis’ syllogism, wherein a trade deficit implies more a check on excess saving, then we’re actually saving more. That is net capital inflow relative to GDP has fallen.

Since there’s been overall deleveraging in America. The logic does not add up at all. The only way to make it work is to use what is an inappropriate use of “we”. Remember, this is tautological, as the accounting identity goes: private financial deficit + public financial deficit + foreign financial deficit = 0.

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Matt Yglesias has this to say about the Left:

The way a given worker or class of workers improves his real wages is by persuading his boss to give him a nominal raise that outpaces the growth in the cost of living. But the way the economy as a whole works is that my income is your cost of living. If Slate doubled my salary, I’d be thrilled. But if everyone’s boss doubled everyone’s salary starting on Monday, we’d just have one-off inflation. As it happens, a little inflation would do the macroeconomy some good at the moment. But the point still holds that while “you get a raise” is the way to raise your living standards, “everyone gets a raise” is not the way to raise everyone‘s living standards.

This is partly true, but also hazy thinking, and less true than it has ever been. The math behind this is quite simple. If wages are n% of a firm’s cost of production, for the inflation to be “one off”, n would have to be 100.

However, many firms have to spend on licensing, capital investment, and all kinds of other things. This is to say that costs scale sublinearly by wages: if wages double, costs less than double. And costs themselves don’t scale perfectly with inflation. Consider this:Image

Since the ’70s, wage share of GDP has crashed, with a happy exception of the Clinton years, while relative profits have soared. This is tautological, when relative wages fall they are either replaced by capital income, which accrues in the hands of a few, or by greater profits. I agree with Matt that, by itself, this is a good thing. Technological efficiency is always good and we shouldn’t forsake science and capital improvement to avoid structural unemployment.

But this graph also proves two things, not only do costs scale sublinearly with wages, but this is increasingly the case. The idea that increases in nominal income will eventually result in real cuts due to price increases is false, and getting falser. There’s another point to be made with this graph. The latter-day cash hoarding, as indicated by the almost vertical red-line after the economy bottomed-out, means that even if wages increase, output will remain largely unchanged, and relative profits might decline.

Matt concludes that the real way to drive real income is with technology and increased capital output, together driving down relative prices and hence increasing real income. This is perfectly true, but misses an important point: the same reason increases in nominal wages are not fully undone by corresponding price increases, as per the standard neoclassical model, decreases in nominal wages will result in falling real income.

All this isn’t to say that the Left hasn’t made a “big mistake” regarding wages. The real problem among the Left is an aversion to capital and technology. Where Matt and I see lower prices, many liberals see structural unemployment. The real challenge of governance in this century will be the transition from wage-intensive income to capital-intensive income, as the above figure painfully demonstrates.

In the postwar era, America embraced the idea of a “property-owning democracy” through various schemes to promote homeownership. We need to embrace the idea of broad capital ownership. Some radical ideas might be a lump-sum provision of stock at the age of majority: at least then the median worker can take some pleasure as capital incomes rise.

In light of our most recent budget… my thoughts

Neither of India’s national political platforms can really support visionary thinking; the BJP falls prey to religious and social populism, while the National Congress does so to economic populism. However, urbanization will bring an end to the unfair grip rural India has on national politics. While neither leading candidate for premier, Rahul Gandhi or Narendra Modi, are likely to oversee the same level of liberalization as did the Narasimha Rao government, the defining moment of the next Union Cabinet will be the transition to an urban India. If it facilitates a strong city system, with independent mayors, competitive economic zones, and strong rule of law, the stage will be set for meaningful growth and reform.

Comments appreciated!

In 1989, Francis Fukuyama penned his now famous essay, The End of History? This is a topic I’ve written about several times over the past few years, usually in the context of current unemployment and the divorce between human dignity and economic models.

As someone very interested in technology, computer science and politics, the emergence of technology in political analysis fascinates me. XRDS, a CS magazine I frequently read, had an essay a few months ago describing how algorithmic social choice theories might solve vote manipulation. Technology really can be in the service of democracy.

This was the thesis of an essay I wrote to win a scholarship from the Telluride House at Cornell. During my interview (with an English major, computer science PhD, and urban planner) I was taken to task on my pretty assertive belief that technology is the ultimate equalizer. The Internet, after all, is the purest democracy.

Is there anything wrong with my opinion, I was asked? Well, I certainly couldn’t get away with the hubris that “my opinion is perfect”, and luckily I did have a few concerns in mind, namely the ability to exploit technology to one’s benefit lies in the hand of the few, i.e. The ability for a technocrat to reap disproportionate benefits.

However, in the past few months, I was wondering if there is a graver consequence of modern technology, intimately connected with Fukuyama’s concept of the end of history. Imagine yourself in a world where the political government is perfect – in perfect accordance with the classically liberal ideas of free-markets, exerting little more influence than an independent court system that enforces contracts between private parties.

The political government, that is. Running in tandem to this government is a black-box technocracy that models the world as a complex system, and with incredible computational power, brilliant algorithms, and intuitive heuristics, achieves a top-down organization of the economy. This black-box is entirely unbiased, and has the simple outcome of optimizing the economy based on a set of weights determined by the people (income, equity, mobility, satisfaction with work, etc.) This computer could have some flexibility to operate among different cultures (that is in a more family-oriented society could optimize for employment in family units perhaps at the cost of greater income, or the like).

Before I go on, let me clarify, I have no idea whether such an algorithm could even exist. This is just a thought experiment to make my greater point. Would it be sad, ahistoric, aclimactic to live in this world? The theoretical satisfaction of our society would be maximized, god knows poverty might be irradiated, but would this life be a happy alternative to the current world, very much in the mires of history and ideological struggle?

With caution and qualification, I say no – this society would be no better. The ownership of our destiny would be ultimately wrested from our convictions and beliefs to an algorithm. Even if life is perfect, and scarcity is scarce, what pleasure is there from living in a world that tells you precisely what to do next and how to do it. Other than the orgasmic reactions this would have from Marxist intellectuals, what real happiness is there? My sentiments to this society are perfectly captured by Fukuyama’s nostalgia at what he considered to be the end of history – dispassionate victory that brought down the Berlin Wall:

The end of history will be a very sad time. The struggle for recognition, the willingness to risk one’s life for a purely abstract goal, the worldwide ideological struggle that called forth daring, courage, imagination, and idealism, will be replaced by economic calculation, the endless solving of technical problems, environmental concerns, and the satisfaction of sophisticated consumer demands. In the post-historical period there will be neither art nor philosophy, just the perpetual caretaking of the museum of human history. I can feel in myself, and see in others around me, a powerful nostalgia for the time when history existed. Such nostalgia, in fact, will continue to fuel competition and conflict even in the post-historical world for some time to come. Even though I recognize its inevitability, I have the most ambivalent feelings for the civilization that has been created in Europe since 1945, with its north Atlantic and Asian offshoots. Perhaps this very prospect of centuries of boredom at the end of history will serve to get history started once again.

Yet, when reading Fukuyama’s gripping essay years ago, I had one big qualification, a fleeting hope for the end of history. Ideological struggle is romantic for those of us who sit in comfort and liberty. For the scholars who write in the dimmed halls of Harvard. For the precocious high schoolers who fawn on every dripping word from their history teacher.

But for the many who are in the throes of historical struggle, there is nothing poetic about history. For the Russians who were slave to the Gulag, the romanticism of Wilson’s To the Finland Station, is but a Western concoction of reality, beautifully written for the scholar.

Just as the post-Soviet world might feel anticlimactic to the likes of Fukuyama, in its end is very much an unabashed victory of liberalism (in his own words) that has lifted millions out of silence and poverty. Who am I to say that algorithmic perfection would be sad, after all, when I have fallen on the right side of inequality.

For the small actors in history, the girls murdered by Taliban and the dissidents silenced by Communists, the real victory would be a textbook of history blank after today.