Thursday, April 27, 2017

El super clasico: trade and technology duke it out at CUNY

Graduate Center CUNY organized yesterday (April 26) a star-studded discussion of the effects of trade on US jobs and wages. The participants were David Autor and Ann Harrison, both authors of seminal economic papers on the effects of China’s imports on US employment and wages (and professors at respectively MIT and Wharton), Brad DeLong, a polymath and former high Treasury official in Clinton’s administration (and professor at Berkeley), and Paul Krugman, Nobel Prize winner, professor at the Graduate Center CUNY, and probably one of the three most influential economists in the world.

The discussion was started by David Autor who pointed out that although US manufacturing employment was on a downward trend since 1943 (when it accounted for almost 40% of the labor force), what happened in the early 2000s with China’s accession to the WTO was a sharp (“off-the-cliff”) decrease in the number of manufacturing jobs. Between the late 1990s and today some 5 million manufacturing jobs were lost. While Autor thought that technological change was indeed a big factor explaining longer term trends the most recent drop cannot be dissociated from trade (import penetration from China).

Next, in the opening statements, Ann Harrison, referring to two very important papers which she coauthored, argued that the effects of trade are visible when one follows workers by occupation much more than when one looks simply at a given industry. Thus, people displaced by trade, even if they ultimately get reemployed, lose some 25% of their wage. The second paper of Ann Harrison carries a possibly slightly different message: many jobs were lost because capital goods became cheaper, and machines thus substituted for labor. It is a technology story with a twist: technological change responded to the change in relative prices. Harrison said that her position on the technology-trade (TT) debate is probably closer to the presumed position that Brad DeLong (the next speaker) would take than David Autor’s.  

Indeed, in his opening statement DeLong supported the technology explanation although, since he made this point after a long detour through his family history, it was not too clear to me whether it still applied to the current situation and China in particular.

Paul Krugman (the statements were made in alphabetical order), referred to the similar TT discussions in the 1990s where the consensus was that some 2/3 or more of the job and wage effects were due to technology. But, Krugman said, economists might have been right on trade’s limited role then; yet keeping the same opinions now was wrong since the boost in trade that has occurred in the past 20 years was much greater than what the US witnessed in the 1990s. He thought that trade today has a massive impact but that it is one-off event, linked to China, and unlikely to be replicated.

If soccer-like I were to summarize the positions, I would say that Autor and Krugman were of the opinion that “trade matters” while Harrison and DeLong tended to favor technological explanation. But that classification is too rough. Autor’s own work, of which he briefly spoke later, shows huge importance of technology, especially in displacing routine labor. (My favorite paper of Autor, Dorn and Hanson is the one which pits the trade vs. technology stories against each other and finds that both…matter.) Similarly, as I mentioned, Harrison does find incontrovertible impact of trade too.

There were at least three areas where the panelists seemed to agree.

(1) Withdrawing from globalization would be extremely costly for the US and the world. DeLong pointed out to the asymmetric effects of NAFTA. While he argued that NAFTA (trade with Mexico) had a miniscule impact on US job loss, withdrawing from NAFTA today would have an enormous negative impact because of the number and density of trade links that have been established in the past two decades. Everybody agreed that it was madness to withdraw from globalization and to go back to protectionism.

(2) Everybody agreed that economists underestimated the impact of trade. As Autor put it, the benefits of trade (cheaper goods) are diffuse, but the costs are concentrated (aka you lose your job). Krugman thought that this was because economists, enamored by the “jewel in the crown of economics”, theory of comparative advantage, tend to look at average effects, not at the heterogeneity of effects. He thought that this was changing now.

On a more philosophical note, Autor added that workers are people (yes) and that even if the compensating mechanisms for job loss were effective (Ann Harrison said they were not), people desire to have meaningful jobs and high wages rather than to subsist on  handouts.

(3) The China effect will not reoccur. As I mentioned, the point was made by Krugman in the opening statement, but was expanded on by both DeLong and Autor. DeLong thought that China will be the last example of export-driven development, made possible by the willingness of the US to be open to Asian imports (Japan and Korea before) and by the eagerness of the rest of the world to cover US deficits by squirreling the money in the United States. DeLong thus touched upon the global political economy issues which paradoxically made the richest economy in the world be capital importer rather than exporter. (Yet another example, in my opinion, of how with globalization many of the nostrums of the mid-century neoclassical economics got overturned.)   But the one-off effect of China (no Indias, Ethiopias, Burmas waiting in the wings) means that the current trade effects on US labor are not going to be repeated.

It was a great evening. The top economists in perhaps the hottest area of economic policy dispute today duked it out in a very fair way,  and came out to a fairly consensual position. We are back to 1817 where trade and technology (the famous Chapter XXXI) played such a great role in Ricardo’s “Principles”.  

Saturday, April 22, 2017

A theory of the rise and fall of economic leadership: review of Bas van Bavel’s “The Invisible Hand?”

The recently published “The invisible hand?: How market economies have emerged and declined since AD 500” (Oxford University Press, 2016, 330 pages) by Bas van Bavel has, like all important books, a relatively simple core theory which Van Bavel, a well-known economic historian teaching at the University of Utrecht, illustrates on five historical examples:  Iraq between 500 and 1100, Central and Northern Italy 1000-1500, the Low Countries 1100-1800, England 1800-1900, and the United States 1800-today. (The first three cases are discussed in detailed separate chapters, each running  to 50-60 pages, while the last two, to which Western Europe may be appended, are discussed in a single chapter called “Epilogue”).

Van Bavel’s key idea is as follows.  In societies where non-market constraints are dominant (say, in feudal societies), liberating factor markets is a truly revolutionary change. Ability of peasants to own some land or to lease it, of workers to work for wages rather than to be subjected to various types of corvées, or of the merchants to borrow at a more or less competitive market  rather than to depend on usurious rates, is liberating at an individual level (gives person much greater freedom), secures property, and unleashes the forces of economic growth. The pace of activity quickens, growth accelerates (true, historically, from close to zero to some small number like 1% per year) and even inequality, economic and above all social, decreases. This is the period so well recognized and analyzed by Adam Smith. Van Bavel, in a nod to Braudel, shows that very similar “essors”  have existed in the pre-medieval Iraq (then the most developed part of the world), medieval Central and Northern Italy (Florence, Venice, Milan, Genoa..) and on the cusp between the late medieval Europe and early modern period in the Low Countries.

But the process, Bavel argues, contains the seeds of its destruction. Gradually factor markets cover more and more of the population: Bavel is excellent in providing numerical estimates on, for example, the percentage of wage-earners in Lombardy in the 14th century or showing that in Low Countries wage labor was, because of guilds, less prevalent in urban than in rural areas.  One factor market, though, that of capital and finance, gradually begins to dominate. Private and public debt become most attractive investments, big fortunes are made in finance, and those who originally asked for the level playing field and removal of feudal-like constraints, now use their wealth to conquer the political power and impose a serrata, thus making the rules destined to keep them forever on the top. What started as an exercise in political and economic freedom begins to look like an exercise in cementing the acquired power, politically and economically. The economic essor is gone, the economy begins to stagnate and, as happened to Iraq, Northern Italy and Low Countries, is overtaken by the competitors.*

As this short sketch shows, Bavel’s theory has many links, or can be juxtaposed, to several contemporary views of economic history. Bavel is dismissive of a unilinear view that regards the ever widening role of factor markets, including the financial, as leading to ever higher incomes and greater political freedom. His view, although not fully cyclical (on which I will say a bit  more at the very end of the review) is “endogenously curvilinear”: things which were good originally, when they hypertrophy, become a hindrance to further growth. It is thus a story of the rise and fall where, like in Greek tragedies, the very same factors that brought the protagonists grandeur, eventually hurl them into the abyss.

Bavel’s view is at variance with recent theories proposed by Acemoglu and Robinson as well as by Landes, or even by McCloskey (although I write this based on the reviews and a couple of short articles; I have not read her “Bourgeois Virtues”). Unilineal theories are, according to Bavel, ahistorical and unduly Euro-centric. They ignore very similar developments in other parts of the world and, while he does not discuss it in the book, Bavel mentions, Roman Empire, Song China and Byzantium. By focusing on Europe only, and its increase in real income which parallels the growing marketization of the economy from the 18th century to today, such theories fail to acknowledge the elements of economic decadence.

This brings me to a point where, in my opinion, Bavel’s approach could have been made more effective. In the introduction and in the very detailed discussion of the three cases, Bavel speaks of a real-income rise and decline, that is of the economies that have become rich and then declined and got impoverished. This is especially evident for Iraq and Northern Italy, and slightly less so for the Low Countries. But when he discusses even the Low Countries at the end of their “Golden Age” and all the later cases, the decline is a relative one, that is compared to other competitors. Thus, the Low Countries were overtaken by England, the latter is overtaken by the United States, and (we are led to extrapolate) the United States will be overtaken by China. Thus, in my reading of the book, Bavel discusses the rise and fall of economic powers which would be a more effective way to present his central thesis and to solve a facile (and in my opinion wrong, but to some perhaps  fatal) objection that the Netherlands or England can hardly be said to have declined if their today’s real incomes are twenty or more times greater than what they were at their (relative) “peaks”.

It is not only the plausibility of the mechanism of decline that gives strength to Bavel’s thesis; it is also that he lists the manifestation of the decline, observable in all six cases. Financial investments yield much more than investments in the real sector, the economy begins to resemble a casino, the political power of the financiers becomes enormous. The richest among the financiers either directly or indirectly enter politics, they become patrons of arts,  sponsors of sports and education,  and we witness simultaneously (1) oligarchic politics, (2) slower growth and lower level of real investments, (3) higher inequality, (4) domination of finance and (5) artistic efflorescence.  What the ancient writers describe as “decadence” clearly sets it, but, as Bavel is at pains to note, it is not caused by moral defects of the ruling class but by the type of economy that is being created.  Extravagant bidding for assets whose quantity is fixed (land and art) is a further manifestation of such an economy: the bidding for fixed assets reflects lack of alternative profitable investments as well as the expectation that, as inequality increases, there would be some even crazier and richer investors who would pay even more for a work of art, thus enabling the realization of a capital gain.

The readers will not be remiss in seeing clear analogies to today’s West.

Let me end with the point about the cycles. Bavel’s theory is not fully cyclical, in the way that (say) Plato‘s was where each political system led to another one, in an endless cycle. In Bavel, after the relative fall, the economies do not seem to recover, although it is possible to imagine that, if the shackles of finance and inequality were broken, a Phoenix-like recovery should not be excluded (leading perhaps in its turn to another decadence). So not everything is yet lost!

In my own notes, I summarized the book thus: prerequisite for growth is more or less equal distribution of assets coupled with factor markets. But factor markets generate inequality.

* Strictly speaking, Van Bavel distinguishes three stages: market economy (output markets and security of property), accumulation (wage labor, capital accumulation, and growth), capitalism (dominance of the financial sector, use of the state by capitalists, monopolization).

Sunday, March 26, 2017

The welfare state in the age of globalization

In my previous post that looked at policies to reduce inequality in the 21st century, I mentioned that I will next discuss the welfare state. Here it is.

It has become a truism to say that the welfare state is under stress from the effects of globalization and migration. It will help to understand the origin of this stress if we go back to the origins of the welfare state.
As Avner Offer has recently reminded us in his excellent book (co-authored with Daniel Söderberg), the origin of social democracy and the welfare state is in the realization (and financial ability to deal with it) that all people in their lives go through periods where they are not earning anything, but have to consume: this applies to the young (hence children’s benefits), to the sick (health care and sick pay), to those who had a misfortune to get injured at work (worker’s accident insurance), to mothers when they give birth (parental leave), to people who lose jobs (unemployment benefits), and to the elderly (pensions).  The welfare state was created to provide these benefits, delivered in the form of insurance, for either unavoidable or very common conditions. It was built on the assumed commonality of behavior or, differently put, cultural and often ethnic homogeneity. It is no accident that the prototypical welfare state born in Sweden in the 1930s, had many elements of (not used here in a pejorative sense) national socialism.

In addition to commonality of behavior and experiences, the welfare state, in order to be sustainable, required mass participation. Social insurance cannot work over small parts of the workforce because it then naturally leads to adverse selection, a point well illustrated by the endless wrangles over US health care. The rich, or those who are unlikely to be unemployed, or the healthy ones, do not want to subsidize the “others” and opt out.  The system that would rely only on the “others” is unsustainable because of huge premiums it would require. Thus  the welfare state can work only when it covers all, or almost all, labor force, i.e. when it is (1) massive and (2) includes people with similar conditions.

Globalization erodes both requirements. Trade globalization has led to the well-documented decline in the share of the middle class in most western countries and income polarization. With income polarization the rich realize that they are better off creating their own private systems because sharing the systems with those who are substantially poorer implies sizeable income transfers. This leads to “social separatism” of the rich, reflected in the growing importance of private health plans, private pensions, and private education. The bottom line is that a very unequal, or polarized, society cannot maintain an extensive welfare state.

Economic migration to which most of the rich societies have been newly exposed in the past fifty years (especially so in Europe) also undercuts the support for the welfare state. This happens through inclusion of people with actual or perceived differences in social norms or lifecycle experiences.  It is the same phenomenon as dubbed by Peter Lindert lack of “affinity” between the white majority and African Americans in the US which rendered the US welfare state historically smaller than its European counterparts.  The same process is now taking place in Europe where large pockets of immigrants have not been assimilated and where the native population believes that the migrants are  getting an unfair share of the benefits. Lack of affinity need  not be construed as some sinister discrimination. Sometimes it could be indeed that, but more often it may be grounded in correct thinking that one is unlikely experience the lifecycle events of the same nature or frequency as the others, and is hence unwilling to contribute to such an insurance. In the US, the underlying fact that African Americans are more likely to be unemployed probably led to less generous unemployment benefits; similarly, the underlying fact that migrants are likely to have more children than the natives might lead to the curtailment of children’s benefits. In any case, the difference in expected lifetime experiences undermines the homogeneity necessary for a sustainable welfare state.

In addition, in the era of globalization more developed welfare states might experience a perverse effect of attracting less skilled or less ambitious migrants. Under “everything being the same” conditions, a decision of a migrant where to emigrate will depend on the expected income in one country vs. another. In principle, that would favor richer countries. But we have also to include migrant’s expectation regarding where in the income distribution of the recipient country she expects to end up. If she expects to be in the low income deciles, then a more egalitarian country with a larger welfare state will be more attractive. An opposite calculation will be made by the migrants who expect to end up in the higher ends of recipient countries’ income distributions.  If the former migrants are either less skilled or less ambitious than the latter (which is reasonable to assume), then the less skilled will tend to choose countries with more developed welfare states. Hence the adverse selection.

In very abstract terms, the countries that would be exposed to the sharpest adverse selection will be those with large welfare states and low income mobility. Migrants going to such countries cannot expect, even in the next generation, to have children who would climb up the income ladder. In a destructive feedback, such countries will attract the least skilled or the least ambitious migrants and once they create an underclass, the upward mobility of their children will be limited. The system then works like a self-fulfilling prophecy: it attracts ever more unskilled migrants who fail to assimilate. The natives tend to see migrants as generally lacking in skills and ambition (which may be true because these are the kinds of people their country attracts) and hence as “different”. At the same time,  failure to be accepted will be seen by the migrants as confirmation of natives’ anti-migrant prejudices, or, even worse, as religious or ethnic discrimination.

There is no easy solution to the vicious circle faced by developed welfare states in the era of globalization. This is why I argued in my previous blog for (1) policies that would lead toward equalization of endowments so that eventually taxation of current income can be reduced and the size of the welfare state be brought down, and (2) that the nature of migration be changed so that it be much more akin to temporary labor without automatic access to citizenship and the entire gamut of welfare benefits. This last point in discussed in Chapter 3 of my “Global inequality” as well as here and here.

Sunday, March 12, 2017

Why 20th century tools cannot be used to address 21st century income inequality?

The remarkable  period of reduced income and wealth inequality in the rich countries, roughly from the end of the Second World War to the early 1980s, relied on four pillars: strong trade unions, mass education, high taxes, large government transfers. Since the increase of inequality twenty or more years ago, the failed attempts to stem its further rise have relied on trying, or at least advocating, the expansion of all or some of the four pillars. But neither of them will do the job in the 21st century.

            Why? Consider trade unions first. The decline of trade union density, present in all rich countries and especially strong in the private sector, is not the product of more inimical government policies   only. They might have contributed to the decline but are not the main cause of it.  The underlying organization of labor changed. The shift from manufacturing to services and from enforced presence on factory floors or offices to remote work implied a multiplication of relatively small work units, often not located physically in the same place. Organizing dispersed workforce is much more difficult than organizing workers who work in a single huge plant and share a single interest. In addition, the declining role of the unions is a reflection of diminished power of labor vis-à-vis capital which  is due  to the massive expansion of wage labor (that is, labor working under capitalist system) since the end of the Cold War and China’s re-integration into the world economy. While the latter was a one-off shock, its effects will persist for at least several decades, and may be reinforced by future high population growth rates in  Africa, thus keeping the relative abundance of labor undiminished.

            Mass education was a tool for reduction of inequality in the West in the period when the average number of years of schooling went up from 4 or 6 in the 1950s to 13 or more today. This led to a reduction in the skill premium, the gap between college educated and those with only high or elementary school, so much so that the famous Dutch economist Jan Tinbergen believed in the mid-1970s that by the turn of the century the skill premium will be zero. But mass expansion of education is impossible when a country has reached 13 or 14 years of education on average simply because the maximum level of education is bounded from above. Thus we cannot expect small increases in the average education levels to provide the equalizing effect on wages that the mass education once did.

            High taxation of current income and high social transfers were crucial to reduce income inequality. But their further increases are politically difficult. The main reason may be a much more skeptical view of the role of government and of tax-and-transfer policies that is now shared by the middle classes in many countries compared to their predecessors half a century ago. This is not saying that people just want lower taxation or are unaware that without high taxes the systems of social security, free education, modern infrastructure etc. would  collapse. But it is saying that the electorate is more skeptical about the gains to be achieved from additional increases in taxes imposed on current income and that such increases are unlikely to be voted in.

            So if the high underlying inequality is a threat to social homogeneity and democracy, what tools should be used to fight it? It is where I think we need to think not only out of the box in purely instrumental fashion, but to set ourselves a new objective: an egalitarian capitalism based on approximately equal endowments of both capital and skills across the population. Such capitalism generates egalitarian outcomes even without a large redistributionist state. To put it in simple terms:  If the rich have only twice as many units of capital and twice as many units of skill than the poor, and if the returns per unit of capital and skill are approximately equal, then overall inequality cannot be more than 2 to 1.

            How can endowments be equalized? As far as capital is concerned, by deconcentration of ownership of assets. As far as labor is concerned, mostly through equalization of returns to the approximately same skill levels. In one case, it passes through equalization of the stock of endowments, in the other through equalization of the returns to the stocks (of education).

            Let us start with capital. It is a remarkable fact, to which little attention has been paid, that the concentration of wealth and income from property has remained at the incredibly high level of about 90 Gini points or more since the 1970s in all rich countries. This is to a large extent the key reason why the change in the relative power of capital over labor and the increase in the capital share in net output was directly translated into a higher inter-personal inequality. This obvious fact was overlooked simply because it is so…obvious. We are used to thinking that as the capital share goes up, so must income inequality. Yes, this is true—but it is true because capital is extremely concentrated and thus an increase in a very unequal source of income must push overall inequality up.

            But if capital ownership becomes less concentrated then an increase in the share of capital that may be (let’s suppose) inevitable because of international forces such as Chinese move to capitalism, does not need to lead to higher inequality within individual rich countries.   

            The methods to reduce capital concentration are not new or unknown. They were just never used seriously and consistently. We can divide them into three groups. First, favorable tax policies (including a guaranteed minimum rate of return) to make equity ownership more attractive  to small and medium shareholders (and less attractive to big shareholders, that is, a policy exactly the opposite of what exists today in the United States). Second, increased worker ownership through  Employee Stock Ownership Plans or other company-level incentives. Third, use of inheritance or wealth tax as a means to even out access to capital by using the tax proceeds to give every young adult a capital grant (as  recently proposed by Tony Atkinson).

            What to do with labor? There, in a rich and well-educated society, the issue is not just to make education more accessible to those who did not have a chance to study (although that too is obviously important) but to equalize the returns to education between equally educated people.  Significant source of wage inequality is not any longer the difference in the years of schooling (as it was in the past), but the difference in wages (for the same number of years of education) based either on the perceived or actual difference in school qualities.  The way to reduce this inequality is to equalize the quality of schools. This, in the US, and increasingly in Europe as well, implies improvement in the quality of public schools (a point argued by Bernie Sanders in the recent US election). This can be achieved only by large investments in improved public education and by withdrawals of numerous advantages (including tax-free status) enjoyed by private universities that command huge financial endowments. Without the leveling of the playing field between private and public schools, a mere increase in the number of years of schooling or the ability of a rare child of lower middle class status to attend elite colleges (that increasingly serve only the rich), will not reduce inequality in labor incomes.

            In my next post I will address the issue of the welfare state in the era of globalization and migration.