Marxism

[this is from about nine months ago]

Economics is descended directly from Marx. Marx (and himself directly influenced by the British political economists) wrote that as capital accumulates, returns diminish. So does demand as capital owners substitute capital for less efficient factors from the rest of the economy.
 
Thus capitalism is self-contradictory. It is made of the processes that will bring about its own demise. It slows to a halt. With all the greater need for inputs, it drives labourers to rebellion. (Marx assumed that when this point was reached, the workers would at least have a full set of physical capital to make progressive use of. This was a tragic overestimate.)

Macroeconomics is the science of the fall of capitalism. Its explicit aim is to devise an array of spanners in the works, to freeze the process Marx describes.

Keynes and Friedman were both solving the problem identified by Marx.

Savers are capital owners. The interest rate is the rate of return on capital. If there is a negative interest rate, it means that capital is being destroyed/sold off. The economy as it is presently constituted cannot accommodate so much capital. If the level of capital is kept the same, then the economy will eventually be squeezed to the point of revolution. (This is a business cycle effect - it can be a negative real rate, as long as inflation is greater than the nominal rate.) The negative rate winds back the clock on Marx's mechanism.

It is enough to make the capital more cheap. What matters is the return to capital. An investment which produces low yields may become viable if it costs less.

Here is a good piece by Izzy Kaminska, of how recent financial events fit into this scheme.

"The greatest trick the Fed ever played was convincing the world it did not taper."

Izzy Kaminska uses the (apt) analogy of Germans taking sun-loungers early in the morning. Reserved sun-loungers are then left unused for part of the day, even though people who weren't so fast could beenfit from them. If there are more sun-loungers the relative price of a sun-lounger falls. This would be capital destruction.

Repos/Reverse Repos are like when you buy clothes. You can get a refund if you bring the clothes back within a certain time. Quantitative Easing, and this new Fixed-rate-full-allotment-reverse-repo-facility, are the same for capital, except the Fed pays out the refund even if the clothes are damaged. Capital owners now get a refund if their capital gets destroyed through negative rates.

Of course, Kaminska has been arguing for a while that there will be a reduction in aggregate demand if capital holders lose confidence, and start to believe that their wealth will decline. This change to the quantitative easing mechanism has inspired her to change her mind - the crisis will finally end when we have destroyed (redistributed) enough capital.

(One of the complaints of Scott Sumner, right from the start, was that the Fed was still paying interest on reserves - like the new fixed-rate-repo facility - throughout 2008.)

Criticism of Pessoa and Van Reenen, "The UK Productivity and Jobs Puzzle: Does the Answer Lie in Labour Market Flexibility"

Here is the information from that LSE CEP paper. Pessoa and Van Reenen firstly give a very handy list of all of the explanations for the UK's productivity gap raised over the past few years: GDP mismeasurent, undercounting intangible capital, labour-hoarding, insufficient skills (workers who put off retirement may be less productive) and capital misallocation ('forbearance', when banks do not call in underperforming loans). But these effects are relatively small and/or inevitable shocks to total factor productivity.

(I would add difficulties with exports, although in the UK this has been a problem for over a century now. Overcoming distance and whatever other barriers is an investment lost if the firm is forced out of the market by low demand or inability to access domestic credit. Exporting firms must be more productive than foreign competitors, in order to cover these costs. The same credit and foreign demand constraints block entry into this group of exporting firms - there is less reason for the domestic firm to make the needed investments. Especially for heavy and technical manufacturing, these can be a big deal. The UK chemicals industry has done very badly, despite the precipitate drop in the real exchange rate.)

Pessoa and Van Reenen's main concern is capital shallowing - there is not enough aggregate capital per worker. Total factor productivity is how efficiently the capital is used (zombie jobs/companies). The raw capital level is treated separately.

The British labour market is elastic. Firms make more use of cheap and plentiful labour after an aggregate demand shock, rather than relatively more expensive capital investment. Between Q2 2008 and Q2 2012, the capital/worker ratio has fallen by 5% (using ONS figures for real net investment and the capital stock in 2009). The ratio between the product wage and the cost of capital is 6.1%.

The authors' calculation is that the fall in capital per worker is much more important than the fall in total factor productivity. (And that total factor productivity is stagnating in a faily similar way to the recession in the 1980s.)

    So next on the list is the capital market. The ONS data on investment is here. Total investment is c.15% of GDP. Business investment, 8% of GDP, buildings and land rights 5%. These ratios have not changed much over time - the government's share has increased since 2006, but from a low base (though presumably this does not count finance sector nationalisation). What is the supply side in the capital market? How much of investment is from businesses retaining profits and offering shares, how much from the savings of the population at large, how much foreign direct investment? Banks have built up 'capital' on their balance sheets after 2008. This will not be counted in the national accounts - is it capital that would have been put to tangible use before 2008, or just the accounting of fiat money moved from the Bank of England to the vaults of the financial sector?

And the other question. In the present the deficit is not money pulled from thin air. The government's deficit is resources that are purchased on the capital market. The building society either loans money to a business to buy new machines or it loans money to the government to spend. It is quite conceivable that the goverment spends the money on investment - spending on education, social work and healthcare is investment in human capital even though the national accounts lists separate general investment. Or it could be white elephants, like that glistening new hospital overlooking Birmingham Edgbaston. Still, the public sector has no monopoly on this. (The level of general government investment is less than spending on debt interest or transport, 2% of GDP, where the deficit is c.8%, total government spending c.47%.)

(The deficit is not from pulled from thin air. It should be. If there are idle resources in the economy, and the fiscal multiplier is greater than the private sector's multiplier, there is no reason to not use fiat money to increase aggregate demand. It is a public sector deficit only because it is public spending not financed by taxes. Quantitative Easing does this, sort of, recycled through the financial sector which keeps much of it for itself. As of 2012, the government has borrowed twice as much as the Bank of England has printed.)

The deficit increased from basically nil to 10% of GDP in the course of the '00s, the period of the fall in capital stock described by Passoa and Reenen. This is classical public sector crowding out, and monetary policy has not adequately accommodated it. Instead, monetary policymakers have been lulled by the cheap labour propping up the economy as the capital stock falls.

Or not.

As I have written before, the land market is under the strict control of the state; a house price boom our era's prevalent method of electoral patronage. Biting supply restrictions have massive political support.

Most of the fall in capital formation is from dwellings and capital gains (i.e. proceeds from the sale of non-produced capital) since 2007.
 
This is a fall in rents society pays to property owners. It only damages total output because the property owners spend according to their wealth, and fewer houses are built where there are (expensive) permits. 2006 is the peak, and the blue line includes government investment, which rises along with the deficit after 2006, perhaps from government crowding out.

Van Reenen and Passoa are convincing, on the back of an envelope. The capital/labour ratio may have fallen at the same time as output, but the type of capital is clearly significant. The location of a house or office does not affect productivity. If it does, the easiest way to resolve the problem is to declassify green belts, allow more skyscrapers in London and increase the feasible commute distance (with, say, high speed rail).


Update: It seems JP Morgan are making the same mistake.