Real
economic progress for working-class people has
been held back by a series of dysfunctional
economic theories on unemployment.
Phillips curve. The "Phillips
curve" purports to show that the annual percentage
rate of inflation consistently increases whenever
the percentage rate of unemployment decreases. The
observation originated in 1958
when A W Phillips documented a relationship
between unemployment rates and changes in wage
rates in the United Kingdom, again before
globalization. Other economists liked the
idea, but not the details, and replaced wages with
prices, predicting that the unemployment rate
would be negatively correlated with the annual
inflation rate, being that inflation is defined as
primarily wage-pushed. This reinvented
relationship was confirmed by US economic data for
the 1950s and '60s, but was contradicted by US
data for later years.
The US economy
achieved combinations of growth and inflation in
recent years that many economists thought were no
longer attainable. With the unemployment rate
below most estimates of the NAIRU
(non-accelerating inflation rate of unemployment)
and falling for the few years before 2000, many
Phillips curve-based forecasts predicted that
inflation should be rising. However, inflation has
generally remained stable or even declined because
of globalization (cheap imports). Many observers
have attributed this anomalous behavior to special
factors, such as large declines in import prices
associated with the 1997 Asian financial crisis
and the appreciation of the US dollar by default.
Important among those imports was crude
oil, whose price fell from roughly US$23 per
barrel in the fourth quarter of 1996 to just over
$10 at the end of 1998. Oil is now more than $60
and most analysts anticipate it will stay above
that level for the foreseeable future.
Since energy prices are a component of
many Phillips-curve models - the principal tool
used by economists to explain inflation - answers
to these questions could be read directly from
model estimates. However, the Phillips curve
literature has largely ignored a substantial and
growing body of evidence that oil prices have
asymmetric and non-linear effects on real
activity, as well as that structural instabilities
exist in those relationships. Since around 1980,
oil-price changes have seemed to affect inflation
mostly through their direct share in a price
index, with little or no pass-through into core
measures. By contrast, before 1980 oil shocks
contributed substantially to core inflation. The
econometric evidence for this result is highly
significant and is robust to different economic
activities, oil price, and inflation measures,
changes in sample coverage, and lag specification.
There are several reasons that the relationships
between oil prices and macroeconomic variables
might be difficult to identify. One is the
time-series behavior of oil prices themselves.
Okun's Law. In his original 1962
research "Potential GNP: Its Measurement and
Significance", economist Arthur M Okun (1928-80),
chairman of the Council of Economic Advisers under
US president Lyndon Johson, found that a 1%
decline in the unemployment rate was, on average,
associated with additional output growth of about
3%. Okun's Law is now widely accepted as stating
that a 1% decrease in the unemployment rate is
associated with additional output growth of about
2%.
But since data from the period
validating the law fell only within the range of
unemployment rates from 3% to 7.5%, Okun's Law is
interpreted as not applicable to zero
unemployment. In 1993, Okun's Law would have had
GDP (gross domestic product) growth increasing
substantially in the United States, whereas it in
fact fell relative to 1992. The reverse occurred
in 1996: GDP growth was higher than in the prior
year, despite the decline predicted by Okun's Law.
Of course Okun's Law did not take into account the
impact of globalization on growth and
unemployment.
Okun believed that wealth
transfers by taxation from the relatively rich to
the relatively poor are an appropriate policy for
government. By recognizing the loss of efficiency
inherent in the redistribution process, he set
limits on the benefits of redistribution. But the
solution is not to take from the rich, but to
prevent more from flowing unfairly to the rich.
Granger causality. The stock market
is the score-keeping arena of capitalism. The
procedure for testing statistical causality
between stock prices and the economy is the direct
"Granger causality" test proposed by C J Granger
in 1969. Granger causality may have more to do
with precedence, or prediction, than with
causation in the usual sense. It suggests that
while the past can cause/predict the future, the
future cannot cause/predict the past.
According to Granger, X is said to cause Y
if the past values of X can be used to predict Y
more accurately than simply using the past values
of Y alone. In other words, if past values of X
statistically improve the prediction of Y, then we
can conclude that X "Granger-causes" Y. Given the
controversy surrounding the Granger causality
method, empirical results and conclusions drawn
from them should be considered suggestive rather
than absolute. This is especially important in
light of the recurring "false signals" that the
stock market has generated in the past. The stock
market has traditionally been viewed as an
indicator or "predictor" of the economy. Many
believe large decreases in stock prices are
reflective of a future recession, whereas large
increases in stock prices suggest future economic
growth. But everyone knows stock prices do not
always reflect market fundamentals, only market
participant sentiments, which is the stuff of
technical analysis. Such sentiment includes herd
instinct and panic. There is also the dynamics of
overshoots and overcorrections. Yet in the age of
finance capitalism, finance dictates the fate of
the real economy.
Granger causality has
been used to compare stock market prices with
changes in GDP, allowing phase correlations
between the two to predict future GDP based on
prior stock-market trends. It is thus primarily a
creature of econometric models. An absurd example
of statistical causality would be: John drives to
work on the highway around 8am every morning,
Monday to Friday, but not Saturday or Sunday. On
exactly the same days, a torrent of traffic hits
the highway about 15 minutes after he drives on
it, but not on the days that he doesn't. Therefore
there is statistical causality in that John causes
the tide of traffic to follow him 15 minutes after
his passage. That's the kind of nonsense that
Granger causality can get you into. Economists use
it with great caution, as it has many hidden
traps, such as the quality of input data and
ignorance or oversight of other external causal
variables.
The traditional valuation model
of stock prices suggests that stock prices reflect
expectations about the future economy, and can
therefore predict the economy with self-fulfilling
dependability. The "wealth effect", former US
Federal Reserve chairman Alan Greenspan's frequent
term, contends that stock prices lead economic
activity by actually causing activities in the
economy, thus is regarded as support for the stock
market's predictive ability. Critics, however,
point to a number of reasons not to trust the
stock market as an indicator of future economic
activity. They argue that the stock market has
previously and repeatedly generated "false
signals" about the economy and therefore should
not be relied on as an economic indicator. The
1987 stock-market crash is one example in which
stock prices falsely predicted the direction of
the economy before and after the crash. Instead of
reflecting continuing growth, the market hit a
brick wall and the US economy entered a recession
that many expected to last a few years, though
with the Fed liquidity cure, the economy quickly
recovered and continued to grow until the early
1990s.
Even when stock prices do precede
economic activity, a question that arises is how
much lead or lag time the market should be
allowed. For example, do decreases in stock prices
today signal a recession in six months, one year,
two years, or will a recession even occur? An
examination of historical data yields mixed
results with respect to the stock market's
predictive ability. From 1956-83, stock prices
generally started to decline two to four quarters
before recessions began. Stock prices also began
to rise in all cases before the beginning of an
economic expansion, usually about midway through
the contraction. Other studies have found evidence
that does not support the stock market as a
leading economic indicator. A study indicates that
between 1955 and 1986, out of 11 cases in which
the Standard and Poor's Composite Index of 500
stocks declined by more than 7% (the smallest
pre-recession decline in the S&P 500), only
six were followed by recessions. Furthermore,
another study found that stock-price collapses
predicted three recessions for the years 1963,
1967 and 1978 that did not occur.
Now, the
question is: Can unemployment be eliminated
through growth? The answer seems clearly no, if
unemployment is viewed in macroeconomics as a
flexible but necessary component to keep inflation
low for growth. The Phillips Curve seems to
suggest that unemployment is necessary for growth.
In truth, the only cure for unemployment is to
make unemployment unacceptable, like a pandemic
disease. Policymakers need to set full employment
as a goal even if it means a lower growth rate, or
to assign a heavier penalty for unemployment in
the measurement of growth. In other words, there
can be no growth registered if there is
unemployment.
Zero unemployment must be
the sine quo non of registering growth. By
definition, 1% unemployment must be registered as
2% negative growth, rising on a geometric rate,
with 2% unemployment registered as 4% negative
growth. Then policymakers would not be toasting
themselves with champagne for their amazing growth
rates while ten of millions are still out of work.
A global cartel for labor could act as an
institutional lobby for changing anti-labor
economic concepts and formulas.
The
idea of a general glut Classical and
neo-classical theories are mostly based on the
simplistic, even tautological, assertion of supply
creating its own demand. Classical economists were
aware of the existence of widespread systemic
unemployment, which was later called structural
unemployment by monetarists, and that markets
could and regularly did fail if unregulated. But
in their quest for universal truth at the expense
of pragmatic reality, they concluded that these
were due to excess supplies and demands of
particular commodities and not excess supplies (or
gluts) of commodities on a macro scale; in other
words, problems of sub-optimization caused by
market inefficiency.
But markets exist
only because of sub-optimization inefficiency;
otherwise, if everyone produces only what he needs
or what his neighbors would readily absorb, there
will be no surplus to trade. British classical
economist David Ricardo was supported by James
Mill (1773-1836), father of John Stuart Mill
(1806-73) of On Liberty fame. A partisan of
the Banking School, James Mill also participated
in the Bullionist Controversies of the time,
arguing against gold parity (see Banking Bunkum Part 1: Monetary
theology, November 6, 2002). He wrote an essay
that reviewed the history of the Corn Laws,
calling for the removal of all export bounties and
import duties on grains and criticizing British
economist Thomas Robert Malthus for defending
them.
Mill opposed the views of William
Cobbett (1763-1835), who championed traditional
rural England against the changes wrought by the
Industrial Revolution, and Thomas Spence
(1750-1814), who was strongly influenced by Tom
Paine and argued that all land should be
nationalized. Cobbett argued that land (rather
than industry) was the source of wealth, that
there were losses to foreign trade between
nations; that the public debt was not a burden;
that taxes were productive; and that crises were
caused by a general glut of goods. A general glut
is the equivalent of overcapacity in today's
global economy.
Mill's Commerce
Defended (1808) attacked all of these
arguments, dismantling them point by point.
Ricardo extended this proposition to savings and
investment. If one produces more than one
consumes, then the surplus is saved and by
definition traded or invested. No one would
produce in excess of consumption needs if one did
not have a desire either to exchange the products
or invest its profits. Supply, therefore, creates
demand. Virtually all classical economists held
this to be an irrefutable truth. James Mill's
Elements of Political Economy (1821)
quickly became the leading textbook exposition of
doctrinaire Ricardian economics.
But in a
truly efficient market, only a fool will produce
more than he can consume through exchange. Markets
are the composite of well-meaning fools thinking
they act in their self-interest but in fact act in
their own self-disadvantage, which they then seek
to recover through the market. Thus a general glut
is unavoidable through aggregate sub-optimization.
It is by extending this mentality that Ben
Bernanke, the new chairman of the US Federal
Reserve, concludes that free trade has produced a
global glut of savings, by denying that in this
post-industrial age of finance capitalism, it is
demand that creates it own supply, not the other
way around. And rising demand comes only from full
employment at rising wages for a growing
population. Inadequate demand creates gluts. Thus
demand management is the challenge of the
post-industrial finance economy. To meet this
challenge, a global cartel for labor is necessary.
Ricardo also suggested the impossibility
of a "general glut" (an excess supply of all
goods), as overproduction in one sector results
necessarily in underproduction in other sectors,
so that an aggregate general glut cannot emerge.
While this assertion is theoretically promising,
it has since been invalidated by events in recent
decades when overcapacity has become the curse of
the global economy, albeit that the overcapacity
in manufacturing is actually the result of
undercapacity of social services.
Rent
must be spent on worker
benefits Ironically, Malthus and the French
economist J C L Simonde de Simondi, in their
belief in the inevitability of a general glut,
became exceptions to the classical economist's
faith in perfect markets. They argued that income
comes as wages to workers, as profit to
entrepreneurs and as rent to landowners. Classical
economics ordains that wages are consumed and
profits reinvested, but makes no stipulation as to
what happens to the rent received by landowners
who presumably may choose to consume or not to
consume it. As long as profits are positive and
worker income is mathematically less than output,
a general glut of goods will result even if the
investment-savings equivalence holds, if
landowners fail to consume their rent in peace or
waste it on war.
Under feudalism, before
the ascendance of the bourgeoisie, rent went
mostly to building of palaces and elaborate manor
estates and patronage of art and architecture to
prevent the emergence of a general glut. Malthus
made the famous argument that landlord consumption
functionally increased to "fill" the general glut,
an argument that framed itself as a scientific
apology for feudalism in which the aristocracy
owned the land by birthright and consumed
conspicuously, leaving behind in posterity a
network of tourist attractions in the form of
grand palaces and heroic monuments. Since
landlords did not produce anything, nothing was
added to output by their conspicuous consumption,
but their very unproductiveness was functionally
necessary since it maintained demand for goods and
services, particularly those not affordable by the
poor, while at the same time reducing investment
that might lead to a general glut, not to mention
bringing art and culture into civilization. But if
landlords should hold back consumption in
peacetime, a general glut would be unavoidable
that would inevitably lead to war.
In
post-monarchal societies, the state has replaced
the landowning aristocracy, and the state must
spent its rent income in the form of social
services, such as heath care, education,
retirement benefits, environmental protection and
cultural subsidies, the soft monuments of
civilization, to prevent a general glut. Instead
of palaces, the state must build universities and
research centers, and physical and social
infrastructure. This is the strongest economic
argument for a welfare state, not humanitarianism.
To the extent wages are raised to high levels, and
rent reduced, the threat of a general glut will be
reduced. Thus only high wages with full employment
can remove the regressive need for
welfare-statehood, not volunteerism in charity. A
global cartel for labor, then, is the best way to
do away with the humanitarian need for a welfare
state and to allow the state to refocus on its
economic role of spending rent on education,
physical and social infrastructure, and
environmental preservation.
Malthus'
identification of the landlord class as
functionally necessary and beneficial stands in
stark contrast to Ricardo's view of its members as
parasites. It had been the fundamental question
behind the class struggle between the land-owning
aristocracy and the rising bourgeoisie that gave
rise to the French Revolution that had influenced
the views of both Ricardo and Malthus. The
post-Revolution French bourgeoisie gained economic
dominance by manipulating the hungry masses
against the aristocrats, yet politically failed to
achieve full control of the state apparatus. The
power struggle after the French Revolution and
during the Age of Napoleon between the landowning
bourgeoisie and the rising factory-owning
industrialists had no class content, only an
intra-class rivalry, as reflected in the British
Corn Law controversy (see Big money and the Corn
Law, May 1, 2002), until the
industrialists won and produced a social structure
of mobile capital investing in labor productivity
that led to the Revolutions of 1848, in which the
first modern class struggle ended in failed
democratic revolutions.
The original Corn
Laws in 1360 were a set of regulations restricting
the export or import of grain to keep English
grain prices low, in defiance of the Law of One
Price. The purpose of the laws was to assure a
stable and sufficient supply of grain (or "corn"
in British English, not just maize, which the word
refers to in North America and Australia) from
domestic sources, yet allowing for import in time
of dearth. The Corn Law of 1815, in contrast, was
designed to maintain high farm prices, also in
defiance of the Law of One Price, much like
today's agricultural subsidies, and to prevent an
agricultural depression after the Napoleonic Wars.
Since its repeal in 1846, industrialism became the
governing force in England and worldwide free
trade its policy which consolidated British
control of the sea and the spread of official
British imperialism and its network of colonies
that constituted the British Empire. The Opium War
in China took place in 1840.
This
development accelerated the growing consolidation
of industrial capitalism with colonialism under
government protection. National income for the
imperialist countries grew, but a relatively small
portion of it went to domestic workers beyond
subsistence. National wealth grew independent of
domestic wages through the exploitation of
colonies. National income between the home country
and its colonies also polarized, as between those
nations with empires and those without, setting
off a race to acquire colonies even among minor
European states such as the Netherlands and
Belgium. The national wealth of Britain
skyrocketed, with modern factories, palatial
country estates and financial institution stocked
with gold alongside slums of the working poor. The
new industrial empires were built on low wages
both domestically and overseas.
The
accumulation of capital led to a need for a regime
for the export of capital in the overseas quest
for low-cost raw material and labor, as a way of
keeping domestic wages low even as general living
standards rose. Workers were then told by the
Manchester School intellectuals that the income of
workers is set by ineluctable laws of economic
science, that it is best and necessary to keep
wages low and that the way to a better life is to
leave the working class and to ape the employer,
or eventually become a Labor Lord through
unionism. This advice was given notwithstanding
that British society at that time provided not the
slightest social mobility, because of its rigid
class structure institutionalized by an education
system based on exclusionary social manners and
elocution. Elaborate labor-price theories were
concocted with circular data justifying the
theories, explaining circularly those very same
data as scientific truth, eventually leading to
NAIRU, a theory that argues circularly that
structural unemployment is necessary to curb
inflation and that uncurbed inflation only creates
more unemployment.
The concept of a
labor market The concept of a labor market
was promoted by market liberalism as a reigning
doctrine to reinstitute a new form of slavery for
the industrial age.
The institution of
slavery is predicated on the legal treatment of
humans as property to be bought and sold. In a
fundamental sense, slavery is dependent on the
rule of law in the protection of property over
morality and humanity. The growing wealth of Rome
and the protection of property by Roman law led to
a sharp increase in both domestic and
estate/plantation slaves whose land-owning masters
had absolute power over them. Manumission was
mostly a financial transaction. Spartacus led a
slave revolt against Rome in 73 BC. He was killed
in battle and the slave revolt was suppressed
within a year. Pompey, back from the conquest of
Spain, annihilated the movement, crucifying 6,000
captured slaves along the Capua-Rome highway as a
warning for future generations. Nevertheless, the
revolt served as warning to landowners against
excessive mistreatment of slaves.
At the
end of World War I, Karl Liebknecht and Rosa
Luxemburg led a group of radical German socialists
to form the Spartacus Party to typify the modern
wage slave in revolt like the Roman Spartacus.
Spartacists demanded the dictatorship of the
proletariat by mass action and officially
transformed themselves into the German Communist
Party. On January 5, 1919, a massive workers'
demonstration was brutally suppressed and
Liebnecht and Luxemburg were arrested a few days
later and murdered while in custody.
Both
Christianity and Islam accepted slavery. The
manorial economy of feudalism transformed slaves
into the serfs or villeins. The Black Death (1347)
depleted the supply of labor and opened a window
of freedom for European serfs by giving them more
market power. In China, Marxist historians viewed
the struggle of the emerging landlord class to
replace the slave-owning society that began in the
Zhou Dynasty (1027-221 BC) part of a revolutionary
dialectic.
In the industrial age,
emancipated slaves became free agents but labor
remained a commodity, sold by the laborer and
bought by the employer in a fantasized free
market, the ideal of which would be totally free
labor - at zero net cost to the employer beyond
the cost of keeping the worker alive. Thus the
English language is insightful that "free" means
both the ability to choose and a state of no cost
for something not quite worthless in a price
regime. Yet the value of capital is fundamentally
different.
The rent for money is interest,
while the intrinsic value of money is its
purchasing power. With labor, the rent of labor is
wages, while there is no intrinsic value for labor
without employment and the capitalized value of
labor is the discounted value of a worker's
lifetime aggregate wage potential. Thus humanity
is denied capital value by neo-classic economics.
Yet the mobility of capital is not matched by
mobility for labor, which remains fixed in
location by exclusionary immigration laws. The US
was unusual in having a welcoming immigration
policy, albeit openly racist until recently, which
contributed significantly to the rapid rise of US
national wealth.
The hourly wage serves
the employer better than no-wage slavery served
slave-owners. The employer is not even obliged to
pay living wages, passing much of the cost of a
decent life on to state-financed social-welfare
programs, while the slave owner had to bear the
fixed cost of keeping slaves alive and healthy for
productive work. The labor market is described as
being governed by the laws of supply and demand.
Employers can lay off workers in response to
business cycles caused mostly by overinvestment.
Low wages are tolerated as the neutral result of
impersonal market forces, not immorality on the
part of unprincipled management or misguided
government policies. And surplus labor supply,
like goods that are stored in warehouses, are to
be warehoused by poor relief to prevent social
unrest. The economic concept of a free market for
labor is that it is a mechanism to realize the
lowest price for the buyer rather than the highest
price for the seller, as in a cartel, which in
modern industrial enterprises is called a union
shop. The New Poor Law of 1834 in Britain
safeguarded the labor market for employers by
making unemployment relief more unpleasant than
below-living-wage employment, supported with
stern, self-righteous precepts of the dismal
science as set out by Ricardo and Malthus.
Karl Marx's critique of Malthus started
from a position of agreement. Marx's idea of
capitalist production, however, is characterized
by his concentration on the division of labor and
his observation that goods are produced for sale
for money in a market economy and not for
consumption or barter for other goods. In other
words, goods are produced simply for the intention
of transforming output into money as capital to
purchase other commodities for more investment.
Thus advertising becomes the means with which to
persuade the public to buy goods they otherwise do
not need or want. The possibility of a lack of
effective demand therefore is held only in the
possibility that there might be a time lag between
the sale of a product (the acquisition of money)
and the purchase of another commodity (its
disbursement) to add value by labor. This
possibility, also originally crafted by Simondi in
1819, endorsed the idea that the circularity of
transactions was not always, and in fact seldom if
ever, complete and immediate. If money is held,
Marx contended, even if for a little while, there
is a breakdown in the exchange process and a
general glut can occur. Moreover, in finance
capitalism, which arrived after Marx's lifetime,
money does get held speculatively to produce a
general glut as an opportunity to buy cheaply for
future profit.
Marx, like Malthus, also
accepted the savings-investment identification
link but reached a different conclusion. Since
investment is part of aggregate demand,
circulation does continue in time even if money is
held. The drive for accumulation, Marx concluded,
will continue unhindered and thus a general glut
crisis of the sort Malthus described can never
happen, or if it did, it would be practically
inconsequential. What can happen, as Ricardo
originally claimed, is that a single good may be
oversupplied, causing a very temporary and small
adjustment of proportions that might seem to be a
general glut but in fact is not. Thus all
classical economists except Malthus and Simondi
were generally in agreement over the validity of
Say's Law, at least in the long run and under
conditions of full employment. They all also
agreed on the linked identification of savings and
investment, as well as the possibility of
separating output and price theory. Thus when
supply-siders promote supply-pushed economic
stimulation while they accept unemployment as
structurally necessary for combating inflation,
they are walking on only one leg of Say's
two-legged law. This shortcoming is significant
because as long as unemployment is viewed as
necessary for sound money, overcapacity will
plague the economy.
In 1815, Ricardo
published his ground-breaking "Essay on Profits",
in which he introduced the differential theory of
rent and the law of diminishing returns to land
cultivation. With wages stuck at their natural
level, Ricardo argued that rates of profit and
rents were determined residually in the
agricultural sector. He then used the concept of
arbitrage to claim that agricultural profit and
wage rates would be equal to their counterparts in
industrial sectors, showing that a rise in wages
did not lead to higher prices, but merely lowered
profits. In his formidable 1817 treatise
Principles of Political Economy and Taxation,
Ricardo articulated and integrated a theory of
value into his theory of distribution. For
Ricardo, the appropriate theory was the
"labor-embodied theory of value" (LETV), ie, the
argument that the relative "natural" prices of
commodities are determined by the relative hours
of labor expended in their production at the
natural price of labor.
With prices pinned
down by the LETV, Ricardo restated his original
theory of distribution. Dividing the economy into
landowners (who spend their rental income on
luxuries or wars), workers (who spend their wage
income on subsistence necessities) and capitalists
(who save most of their profit income and reinvest
it), Ricardo argued how the size of profits is
determined residually by the extent of cultivation
on land and the historically given real wage. He
then added on a theory of growth. Specifically,
with profits determined by the gap of market price
over natural price, the amount of capitalist
saving, accumulation and labor demand, growth
could also be deduced. This, in turn, would
increase population and thus bring more land of
less and less quality into cultivation and use,
such as the founding of colonies overseas or
desert cities such as Los Angles and Las Vegas.
Moreover, mechanization and innovation improve the
yield from land and release labor from the
agriculture sector into the industrial sector,
which pays higher wages, generating more demand
and economic growth.
Ricardo did not
anticipate the emergence of finance capitalism, in
which labor from industry would be released into
service sectors, and growth can be driven by
financial engineering. Still, wealth cannot be
detached from human capital. If the value of labor
expressed as wages is kept low, growth can only
come as financial bubbles. For this reason, a
global cartel for labor is the solution to the
current debt bubble in the global economy.
Tomorrow: Toward living wages
in the modern era
Henry C K Liu is
chairman of a New York-based private investment
group. His website is at
http://www.henryckliu.com.
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2006 Asia Times Online Ltd. All rights reserved.
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