Rogoff on Wolf. Some comments or: empowering households made all the difference

Update: Summary: in times of balance sheet recessions and secular stagnation Keynesian policies should not just aim at the level of aggregate demand and income but also at the composition of aggregate demand and income.

In a very readable and insightful review of the new Martin Wolf book (which I haven’t read yet) Kenneth Rogoff plays the revolutionary card:’Let’s get rid of these debts, we’ve got nothing to lose than a deflationary chain of events’. This puts him, in a Eurozone perspective, in the radical left corner of politics (and it’s kind of ironic that he accuses text-book economists like Krugman of being ´hard-left´…). Quote:

Without question the best and most effective approach to the problem would have been to bail out the subprime homeowners directly, forcing banks to take losses but keeping them manageable. For an investment of perhaps a few hundred billion dollars, the US Treasury could have saved itself from a financial crisis whose cumulative cost, counting lost output, already runs into many, many trillions of dollars. Instead of “saving Wall Street,” a subprime bailout would have been targeted, almost by definition, at lower income households. But unfortunately, this approach too would have been politically impossible prior to the crisis.

I agree with almost the whole piece. I can however add some specifics which al point to towards the same conclusion: European austerity is not just about curtailing governments but very much also about disempowering households. For instance the UK recovery can largely be explained because this disempowerment happened to a much lesser extent in the UK, at least when we look at disposable income.

(A) Rogoff states that the German economy is arguably somewhat overheated. It arguably isn’t.

(1) Unemployment in North- and East Germany is still medium or high. Industrial output has been flat (favourable reading) for quite some time and production is still not above the 2007 level.

(2)Price increases are declining and ever more prices (except for a moderate increase in wages) show downward tendencies. In the second quarter economic activity actually diminished and

(3′ the rate of investment is low (though increasing a little, thanks to construction).

(4′ Yes, economic ‘slack’ is diminishing: the employment rate up, official ‘U-3’ unemployment is down and broad unemployment is going down, too (albeit slowly, at the moment). This is to quite some extent however caused by events which diminish potential supply, like de facto work sharing. It’s hard to call such a situation an ‘overheated’ economy.

(5) Rogoff rightly downplays the influence of  ‘flexible’ German wages (´flexible´ in this context  meaning: upward sticky) but this argument can be extended. Wages in German manufacturing are unlike the situation in 1990 not the highest of Europe anymore but still among the highest (see the graph in this blogpost – and since 2009 German wages only went up, relatively). The real wage declines took place in the government sector, especially education.

(6) The point is that keeping wages sticky while investments declined and declined (and declined again) caused a huge domestic demand gap and high and tenacious unemployment. The output gap was, eventually, filled with a combination of self-financed exports and ‘crappy domestic jobs’, a process which took over twenty years to complete. Which did not have to be. A devaluation in 1992 would have spared Germany two decades of wage deflation and while I do agree that investments have to be aimed at useful projects there does not seem to be a lack of such projects in Germany: improving hundred year old bridges and changing loads of buildings into of good, energy producing homes stuffed with e-domotica to accommodate a rapidly aging population at locations and environments which enable people to waste less time in their cars and self-driving scootmobiles is surely useful.

The German economy is not overheated and can surely use a healthy dose of well- directed investment (either financed and directed by the government, by households or by companies)

(B) Rogoff shides Larry Summers, who stated, in 2012 and about the UK:

I have for the past several years suggested that if the British economy — with its major attempts at fiscal consolidation — were to enjoy a rapid recovery, it would force me to substantially revise my views about fiscal policy and the macroeconomic

Summers has to revise his view. And we all have, as many events in the UK are without precedent. I’m not too sure about the true extent of UK government austerity but the seven year decline of real wages does not have a historical precedent in the modern (i.e. post 1850) era. A strong increase in employment which was until recently led by and for a time almost solely caused by self employed 65+ (who simply stayed self-employed) is without precedent (aside – the very strong increase in the number of self-employed after october 2014 is due to the privatization of Royal Mail). A 5% sustained decline in productivity in a country which already had relatively low productivity compared with all its neighbours except Canada (i.e. France, Germany, Belgium, Ireland, US of A, the Netherlands, Denmark, Norway, Sweden) is without precedent. A strong economic recovery in a situation when goods exports dwindle with 12% (except for Malta the largest decrease of the EU) is special.

What happened?

(1) First, average productivity can decline even when productivity of all different economic sectors increases but when the sectors with the highest productivity (oil, finance) decline in importance. To an extent, this happened in the UK, though, as productivity of oil and finance did (for very different reasons) not increase but even decreased, this effect was enhanced!
(2) Contrary to the situation in Greece and Ireland, total nominal wage income did not decline in the UK. At the same time domestic and international demand (oil: domestic supply) shifted from high wage sectors (finance, oil) to low wage tourism which means that one pound of demand led to an increased number of jobs.

(3) As a larger part of total wage income was flowed to low wage sectors and as the propensity to consume of low wage earners is higher than the propensity of high wage earners this led, in combination with some lending increases, to a relatively fast increase of consumer demand. Look also here.
(4) Before 2009, the financial sector increasingly managed to sell loans and debt based products by tempting people to use part of the loan to pay not just to pay incomes in the financial sector but also to increase their own income as well as to pay huge bonuses to others or to increase consumption (leveraged buy-outs were one way to do this). These debt based bonuses and incomes are counted as income and therewith as production in the national accounts and skewed the estimates of the productivity of the financial sector: pumping prime income.  To quite some extent, this mechanism broke down. See also the link at B (1)

Summarizing: the British recovery is based upon increased household income and less income inequality (less bonuses!), not on austerity (and tourism does very well, too). European austerity is not so much about curtailing governments, it´s about disempowering households.

(C) Contrary to the claims of Rogoff, Spain did complete the transition from ’emerging market’ to an advanced economy. Looking at the dwindled number of self-employed ‘small farmers’ or people exploiting ‘mom and pop’ retail stores, the share of agriculture in total production or the labour force participation rate of women it shows modern characteristics. The number of patents per million inhabitants is low – but rapidly rising and much higher than in Portugal or Eastern Europe, while the UK also boasts a pretty low number. The same for exports of high-tech products, which is low but (contrary to the situation in Portugal, Italy and Greece (which saw these exports dwindle…) rapidly increasing. Productivity in Spain is, when corrected for the building boom, rising rapidly, compared with english productivity.

Taken together, this all means that we have to stop disempowering households (and bailing out heavily indebted households which already suffered large declines in wealth and, especially in Spain, are often even evicted, indeed is a very good way to start).