Monday, 28 July 2014

Competitiveness, unit labour costs, and the class struggle

It's hard to spend much time reading about the Eurozone crisis without coming across the term "unit labour costs" (ULC).  There's a common narrative (see this post) that says that the Eurozone peripheral countries let their ULCs get out of control before the crisis, losing competitiveness, and now they have to get those costs back down.  For instance, here's Mario Draghi earlier this year:
...most of the stressed euro area countries have made remarkable progress in gaining competitiveness. Over the past five years, the cumulative unit labour cost differential vis-à-vis the euro area have fallen by more than 20 percentage points in Ireland, around 15 percentage points in Greece and Spain, and almost 10 percentage points in Portugal. This was accompanied by substantial improvements in the export dynamics of these countries.
This narrative is illustrated with charts like this one:

However, there's somewhat more to this than meets the eye. Unit labour costs are a unitless ratio--the share of labour compensation (including non-wage costs) in total value added in the economy, also known as GDP.  What's compared on this chart is actually something known as nominal unit labour costs (NULC; all this is explained in this paper, which I wasn't sure I believed at first, but I've checked against the official definition from Eurostat, confirmed that the calculation is done as I describe below, and that the numbers the ECB reports as unit labour costs are these same ones) that are meant to have a monetary significance.  Here's the formula for calculating nominal unit labour costs, with some algebra done
NULC = (labour compensation/GDP) * price index * correction for self-employment 
For simplicity's sake, let's ignore the last term, and call the first term "labour's portion," meaning the portion of value-added that goes to labour, rather than profits. So the formula becomes
NULC = labour's portion * price index
In the presence of inflation, all a rising NULC means labour's portion is not falling as fast as inflation is rising.  It does not necessarily mean that wage gains are outstripping inflation, productivity, or anything like that.  The chart below is based on exactly the same underlying data as the first chart (including the same correction for self-employment), but without the effects of inflation.
Source; I assumed no change from 1999-2000 in Greece due to missing data.
Note how different this chart looks from the previous one! In the run-up to the crisis, there was absolutely no general redistribution to employees in the PIIGS. As of 2007, in fact, in all of them save Ireland, employees were getting a smaller portion of value-added than in 2000. Wage restriction in Spain was almost identical to that in Germany.  (The spike in Ireland in 2008-2009 is largely due to the rapid fall in GDP, with compensation growth falling more slowly; I take it that GDP is generally a weird number for Ireland due to domiciling issues, so that might have something to do with it as well.)

So, the differences in NULC reflect to some extent slower redistribution of value-added away from employees in Portugal, Italy, Ireland, and Greece than in Germany, but mostly national differences in inflation. And at a first glance, it's hard to make the case that these national differences in inflation themselves stem from excessive worker bargaining power outside of Germany. I'm still a neophyte in working with these figures, but this seems to me to be a problem for the position often taken by political scientists that NULC outcomes reflect institutional differences across the Eurozone.  For instance, Peter Hall claims that "industrial relations institutions promote the co-ordinated wage bargaining that can be used to hold down labour costs."  

In any event, the NULC these days has become the de facto operationalisation of "competitiveness" for the ECB and dominant elite Eurozone opinion. On this definition, "become more competitive" translates into "labour should be receiving a smaller portion of value-added." Promotion of competitiveness has become class struggle (or distributional struggle, if you prefer) by another name. Promotion of competitiveness so defined is also identical to suppression of domestic demand, worsening the problem of the Eurozone's missing demand model

Thursday, 24 July 2014

Europe's missing demand model

I. Keynes - the very quick version

Keynes had lots of important insights, but I think the most crucial one is underplayed in my field of comparative political economy. The crucial insight is this: in a capitalist economy, workers can't afford to buy everything they make. Since to be profitable, the price of a good must equal its cost plus a mark-up, and wages are costs, aggregate wages must be less than the aggregate price of goods offered for sale. Thus, the only way for everything to be bought would be if the people drawing profits spent all of them (in addition to wage-earners spending all their wages). But they don't. Let's call this the "underconsumption problem."

The rest of his theory can be viewed as an answer to the question of how, then, can everything be bought? How can the underconsumption problem be solved? Keynes emphasised (a quick version of his key points is here) above all that some people draw wages for investment projects that do not lead to immediate sales, which they can then use to purchase consumer goods (or services). Thus, how easy it is to keep people employed to make stuff for immediate sale depends on how much investment is going on.

Investment depends on the mood of investors, which, Keynes convincingly argued, can vary wildly for no particularly good reason. If investment is too low to keep people employed, we should do something about it. Central banks, for instance, can lower interest rates, making borrowing cheaper and hopefully prompting more investment. However, interest rates are subject to the "zero lower bound"--central banks can't pay people to borrow money. When even interest-free lending doesn't prompt enough investment to keep people employed, monetary policy is "pushing on a string."

If investment isn't doing the job, then to buy up all the consumer goods on offer and keep people employed there needs to be some other source of spending, or demand, in particular spending in excess of income (spending just your income means you buy only as much as you sell, and thus you can't help make up for the fact that people in general don't want to buy everything they sell). This is why Keynesians advocate government "deficit spending" as a form of "demand stimulus." But consumers, not just government, can spend in excess of income via borrowing. Colin Crouch made a seminal contribution by coining the term "privatized Keynesianism" to refer to a systematic effort to get consumers to play this role.

For the individual country, another option is (net) exports. However, it's not possible for every country to export more than it imports.

II. Does the Eurozone have a demand model?

Different nation-states have found very different solutions to the underconsumption problem, or what you might call different demand models. Demand models seem to be quite enduring (see Monica Prasad's recent book and this article from Fred Block; also Peter Hall and David Soskice who have supplemented their initially exclusively supply-side Varieties of Capitalism approach with more attention to demand-side factors.)

However, Germany is promoting its famously (or notoriously) export-focused demand model for the Eurozone as a whole. I've made the following excellent chart to help us consider how that's working out.  (Data from here; I'm using the term investment slightly imprecisely to refer to gross capital formation.) Below the line we can see elements of the GDP--which are just the Keynesian sources of demand described above.

Some conclusions:

  • Five years from the onset of the crisis, the Eurozone has recovered only a bit more than half its lost GDP.
  • This is despite a staggering tripling in the trade surplus.
  • Export growth slowed dramatically in 2013.
  • There is no sign that export growth is feeding through to investment or household consumption.

So the answer is no--Europe does not have a sustainable demand model. All the sources of demand other than exports are stagnant or falling, and exports cannot be relied upon to replace them.

Weidmann's deceit on Spanish export growth

Bundesbank Chief Jens Weidmann gave a speech in Madrid on Monday.  He followed Draghi in putting lipstick on the PIIGS, or the S anyway:
Thanks to improved competitiveness, Spanish exports have risen by 8 % over the past 12 months. Since the cyclical trough in 2009, exports have even risen by more than 50 %, with intermediate goods showing particularly strong growth.
Hmm.  When I look at ECB stats here, I get only a 36.1% rise in Spanish exports since 2009.  I presume heads are already rolling in Weidmann's office.

But the stats do show 8.1% growth in exports over the past 12 months. So maybe I was wrong about slowing Spanish export growth?  No, actually Weidmann's doing a spectacular job of lying with statistics.  Look at this chart:

As you can see, the 8.1% figure stems from a big drop-off in Q1 2013. There's no acceleration against the recent trend--if anything the opposite.  Weidmann's cherry-picking to make his case look good. Even with this help, the case that there's a significant "competitiveness" component to export growth is hard to make:
  • Export growth was much faster in 2009-2010, before the competitiveness improvements Weidmann's touting--presumably because Spanish companies had rapidly to find ways to export things Spaniards couldn't afford any more.
  • If the economy were becoming generally more competitive, imports should be capturing a smaller share of domestic demand. In fact, their share has risen continuously since 2009 and reached what was at least a 10-year high in 2013. 

Why are figures about export growth so important that Weidmann and Draghi feel compelled to be deceptive about them?  The reason is that they want to make the case that their preferred policy of austerity plus structural reform (which involves holding down wages) is a reasonable model of growth. For this to be so, exports must be able to drive growth. Consider what their policies do to the other sources of demand:
  • Government final consumption - restricted by austerity 
  • Household final consumption - restricted by austerity and structural reform
  • Investment (Gross capital formation) - so far held down by anaemic growth prospects 

This leaves just the trade surplus as a possible source of growth. For this reason, if advocates of austerity and structural reform want to be optimistic about the future, they have to trumpet--and sometimes exaggerate--export performance.  Stay tuned for another post about the weaknesses of this demand model.

PS: The Spanish export growth numbers are a bit different than in my previous post, presumably due to some combination of the facts that these are real rather than nominal figures and quarterly rather than annual ones, but that doesn't change the big picture.

Thursday, 10 July 2014

Why Draghi put lipstick on the PIIGS

In London yesterday, Draghi made a speech in which he advocated more centralised control over "structural reform" (liberalizing labour and other markets) for members of the Eurozone.  

In making the case that structural reform would be a good idea, Draghi implicitly relied on the badly misguided idea that it's feasible to generalise the German model of wage suppression and export-led growth. And to make this case, he said something demonstrably misleading:
[W]e have seen the improvement that has taken place when governments implemented reform. The change in current account positions in stressed countries ranges from an almost 11 percentage point correction of GDP in Spain to a 16 percentage point improvement in GDP in Greece [clearly since 2008-DW], only part of which is explained by lower imports in the context of a recession.
So, "current account positions" is exports minus imports (trade balance) plus some other stuff not very important for these countries. Draghi is claiming that trade balance in the "stressed countries" (presumably the PIIGS minus Italy) is improving not just because imports are sinking because people are too poor to afford them, but also because exports are increasing. This is supposed to substantiate the idea that export-led growth is a reasonable model.

It's not, and a closer look at the two countries Draghi cited proves it.  (Data for the claims below come from here and you can find my calculations here.)

For Greece, Draghi's claim is not even true. Greek exports are still below what they were in 2008, even in nominal terms.  Greece's trade balance in 2008 was -14.5% of GDP; if there had been no fall-off in imports it would been -20% of GDP instead of the -2.6% it actually was in 2013. (It's a tiny bit less misleading if you were to start in 2009 instead of 2008, but even over this period the rise in exports was less than a third of the fall in imports).

For Spain, what Draghi said was true. The rise in Spanish exports over this period was more than double the fall in imports. But the idea that this is a promising sign of a shift to a new sustainable model is laughable.
  • Over the last five years, increased exports have replaced only 40% of Spain's loss of domestic demand
  • Since 2008, Spain's exports have increased in nominal value at 4.91% per year. At this rate, even assuming domestic demand stops falling, Spain can expect to have replaced its lost domestic demand half way through 2020. 
  • Most of the gains in Spanish exports were actually in 2010-2011. More recently exports have been growing at 4% a year -- fast enough to replace lost domestic demand in the first quarter of 2022.  
Even in the better case for him, Draghi is touting as vindication trends that amount to a recipe for not just a lost decade, but a lost 12-14 years (even in nominal terms).  Impressive.

Friday, 4 July 2014

Commons, Hale, Polanyi, and, naturally, Piketty

I. Commons and Hale: Capitalism is a bargaining power economy in which coercion is omnipresent

The great institutional economist John R. Commons specified (see pages 65-69) that to understand any apparently bilateral transaction one must actually look at five parties:
  1. the buyer
  2. the seller 
  3. the buyer's next best option
  4. the seller's next best option
  5. the state, which shapes what the parties are allowed to do, what they are allowed to agree to, and whether and how agreements will be enforced.  
This is the minimal information one needs to understand bargaining power in the individual transaction, and thus the determinants of prices and wages.

One consequence of this, especially clearly set out by Robert Hale, is that it's not useful to think about market economies as eliminating coercion by enabling people to engage in voluntary transactions. As soon as you realise parties to transactions have to choose between available options what counts as "voluntary" becomes entirely a matter of taste.  "Your money or your life," "Accept my wage offer or starve," "Accept my wage offer or live on the dole," "Accept my wage offer or the one 10% lower at an easier job," "Buy this candy bar for £1.10 or walk to the next shop and buy an identical one for £1.05" are all choices. I've arranged them in rough order of how much subjective sense of coercion we might feel, from most to least, but there's no point at which you can draw a line and say: here's where the coercion starts. 

II. Polanyi: The meaninglessness of self-sufficiency in the net of bargained prices

Now, dear, patient reader, please consider the following passage from the sacred writ Polanyi's The Great Transformation:
Liberal economy gave a false direction to our ideals. It seemed to approximate the fulfillment of intrinsically utopian expectations. No society is possible in which power and compulsion are absent, nor a world in which force has no function. It was an illusion to assume a society shaped by man’s will and wish alone. Yet this was the result of a market view of society which equated economics with contractual relationships, and contractual relations with freedom. ... Vision was limited by the market which “fragmentated” life into the producers’ sector that ended when his product reached the market, and the sector of the consumer for whom all goods sprang from the market. The one derived his income “freely” from the market, the other spent it “freely” there. Society as a whole remained invisible. The power of the state was of no account, since the less its power, the smoother the market mechanism would function. Neither voters, nor owners, neither producers, nor consumers could be held responsible for such brutal restrictions of freedom as were involved in the occurrence of unemployment and destitution. Any decent individual could imagine himself free from all responsibility for acts of compulsion on the part of a state which he, personally, rejected; or for economic suffering in society from which he, personally, had not benefited. He was “paying his way,” was “in nobody’s debt,” and was unentangled in the evil of power and economic value. His lack of responsibility for them seemed so evident that he denied their reality in the name of his freedom.  
But power and economic value are a paradigm of social reality. They do not spring from human volition; noncooperation is impossible in regard to them.

(2001 ed., p. 266-267)
How are we to make sense of Polanyi's implication, that "every decent individual" is entangled in power and economic value? The idea of capitalism as a bargaining power economy helps quite a bit.  In such an economy, each bargain struck or contemplated involves a balancing of threats and opportunities that are part of a vast interconnected net of bargaining contexts. For example:

  • A consumer who has paid a low price for one good may be better able to pay a higher price for another, allowing that seller to capture a higher share of the consumer surplus.  
  • An employer paying high wages may be able to bargain harder with suppliers, by making them aware of the tight margins these wages imply. 

To buy, to sell, to consume, to produce is necessarily to introduce ripples into this interconnected net, expanding the choices of some, narrowing those of others, redistributing, minutely or massively, coercive capacities.  One pulls at the net's strings as soon as one chooses one purchase over another, helping to establish the current and prospective economic value of both.  Unemployment and destitution, as prospects or realities, shape wage and price bargains, sending out their own ripples. Any state with a remotely serious claim to a monopoly of legitimate violence is in the net as well, often constituting the resources bargained over (such as money and property), employing physical coercion against some to defend the property rights of others, everywhere affecting bargaining power.

Polanyi's suggesting that the language of self-reliance, "paying your way," being "in nobody's debt,"
obscures the "reality of society," the reality of the net--obscures how every individual in a market economy is causally implicated in all sorts of coercion that seem quite distant from her at first glance. Going a bit further, to ascribe moral status to paying your way is to implicitly to ascribe legitimacy to the price system that shapes your income and spending. If you thriftily make all your purchases at Wal-Mart so you can spend less than you earn, you're "paying your way," but you're doing so by taking advantage of, and contributing to, the company's enormous bargaining power in its dealings with suppliers and workers.

By the same reasoning, recognition of the net of bargaining power makes it extremely hard to give a sensible definition of a "meritocratic" income distribution. Some people believe that in a well-functioning market economy people are paid according to their marginal product and that this is what they deserve (although the second is not a logical implication of the first). But marginal product is defined as the addition to firm revenue achieved by hiring the person in question, and so again fundamentally depends on the price system. A moral defence of meritocracy along these lines would have to begin with a defence of the legitimacy of the prices shaped by the net of bargaining power (as Hale pointed out nearly a century ago). As an outstanding example of such a defence let me cite... well, actually, let me know if you ever see one; I haven't. Without such a defence, advocacy of meritocracy obscures the omnipresence of bargaining power just as the language of self-reliance does.

III. Piketty, meritocracy, and bargaining power

One of the most interesting criticisms of Piketty, to my mind, is that he ignores the processes that give rise to profits and the rate of return on capital. Here's an influential take from Deborah Boucoyannis, building on her outstanding reading of Adam Smith:
Where Smith emerges as more “radical” [than Piketty], ironically, is in his insistence that if we see high profits (a high r) it is sophistry, deception, and power that are to blame, not technology and trade increasing demand for capital. He may have said, faced with Piketty’s turn to taxation to fight inequality, that this treats the symptom, not the disease; that we should not be just treating inequality as pathological and inefficient, but high profits, too. As I argued also here, unless we start seeing high profits as a symptom of something wrong, any effort to limit them, either before or after taxes, will founder faced with the “insolent outrage of furious and disappointed monopolists.”
In other words, Smith is more radical than Piketty because he offers a critique of excessive bargaining power and an analysis of its origins. Galbraith also attacks at the same point, arguing for a reconfiguring of the bargaining power net:
If the heart of the problem is a rate of return on private assets that is too high, the better solution is to lower that rate of return. How? Raise minimum wages! That lowers the return on capital that relies on low-wage labor. Support unions! Tax corporate profits and personal capital gains, including dividends! Lower the interest rate actually required of businesses! Do this by creating new public and cooperative lenders to replace today’s zombie mega-banks. And if one is concerned about the monopoly rights granted by law and trade agreements to Big Pharma, Big Media, lawyers, doctors, and so forth, there is always the possibility (as Dean Baker reminds us) of introducing more competition.
What I'd like to suggest is that one reason Piketty ignores this issue is his ambivalent, but still real, affection for the meritocratic ideal. It's very easy to start making an argument about merit and immediately assuming the moral legitimacy of the price system that is merit's metric, and this is a trap into which Piketty falls.

The case is a little bit difficult to make, because Piketty really is very ambivalent. At some points Piketty comes off as an advocate of meritocracy who believes it crucial to democracy, and who fears that patterns of wealth accumulation will undermine it.
Our democratic societies rest on a meritocratic worldview, or at any rate a meritocratic hope, by which I mean a belief in a society in which inequality is based more on merit and effort than on kinship and rents. This belief and this hope play a very crucial role in modern society, for a simple reason: in a democracy, the professed equality of rights of all citizens contrasts sharply with the very real inequality of living conditions, and in order to overcome this contradiction it is vital to make sure that social inequalities derive from rational and universal principles rather than arbitrary contingencies. Inequalities must therefore be just and useful to all, at least in the realm of discourse and as far as possible in reality as well. (p. 422)
Piketty the engineer of meritocracy on rational and universal principles is on display in his proposal for a highly progressive income tax. On the basis of his own and others' research, Piketty concludes that there is an enormous gulf between what US top executives are paid and their contribution to productivity.  (He can be quite scathing on the misuse of "meritocratic extremism" as a mere cover story for vast divergences in pay unrelated to performance; p.417,487.) His diagnosis of the causes is that the top executives are winning this outrageous level of compensation from bargaining hard with "incestuous" corporate boards. And thus he proposes 80% marginal rates on high incomes, as this would reduce managers' incentive to push for high compensation, which would "drastically reduce remuneration [at the top] but without reducing the productivity of the US economy, so that pay would rise at lower levels."(p. 512).

I submit that the principle of meritocracy has really limited the scope of this argument. Piketty is only able to produce his critique of managerial pay in excess of productivity by accepting the field of prices that determines productivity. He finds such a disjuncture that he decides to look at what distorted meritocracy in this case and comes up with a bargaining situation that he hopes to re-engineer. But he never considers the possibility that the economy is bargaining situations all the way down, presumably because this would deprive him of a meaningful standard by which to measure productivity. That he assumes that pay denied managers would pass downwards, without offering any bargaining-power argument for this claim, is a striking illustration of the problem.

There's a second reason Piketty's proposals don't focus on tweaking the bargaining power net. Despite his analysis of excessive executive compensation, he doesn't seem to believe that such assessments are generally possible
[We need to] move beyond the futile debate about the moral hierarchy of wealth. Every fortune is partially justified yet potentially excessive. Outright theft is rare, as is absolute merit. (p.443) 
Broadly speaking, the central fact is that [wealth accumulation] often inextricably combines elements of true entrepreneurial labor (an absolutely indispensable force for economic development), pure luck (one happens at the right moment to buy a promising asset at a good price), and outright theft [not so rare, then?]. The arbitrariness of wealth accumulation is a much broader phenomenon than the arbitrariness of inheritance. (p. 446)
And this is why Piketty advocates his progressive global wealth tax. Forget about creating a fair economy; it can't be done. Just tax wealth, whatever its origins. Remarkably enough, both the attractions of meritocracy and its practical infeasibility turn out to give reasons to stay away from a restructuring of bargaining power--which is what a fairer capitalism would really need.

P.S. I've had Polanyi on the brain even more than usual thanks to a wonderful talk by and stimulating conversation with Peggy Somers this week--she and Fred Block have more on Polanyi's views on the "reality of society" in their great new book.