The depression in the 1930s gave us Keynes and stagflation in the 70's gave us Friedman and I am pretty sure there will be a new luminary to rise from the ashes of the current mess we are in. Frankly, neither of the "old schools" looks likely to predict the "first best solution" correctly.
Keynesians really struggle to find an elegant solution to the ending current cash hoarding and low private sector investment when their demand side policies would further raise public debt. Why would a company or an individual risk investing in new ventures in a country where sovereign debt is increasingly out of control and where there is a risk of default or very high interest rates in the future(particularly when most investors are not followers of Keynes)? The risk of slowly reducing asset value is always preferable the risk of a total loss investment. Followers of Keynes offer no insights into how this conundrum is resolved.
In the same way monetarist struggle to solve the problem of very low private sector investment when real interest rates have been and are likely to be negative for years to come. They argue for more public sector austerity, that would reduce demand and further endanger recovery. They also can’t resolve the problem that supply side solutions would further erode labour share (the % of national income earned by employees), which is one of the main reason for falling demand and productivity.
|Rogoff on the left and Krugman on the right - just for a change|
Someone will find an escape route from this vicious circle - and it will be someone new and this Messiah will sit in judgement on the failed thinking of the Keynes and Friedman!
The problem that needs unpicking has a number of dimensions.
1. We can find no interest rate equilibrium at negative real interest rates. The enduring shock of the financial crisis means investors (private and public) are still highly risk adverse - governments have stopped spending and corporations are sitting on their cash. The investment gap that needs to be bridged can’t be narrowed by governments, because they are already in too much debt. Whether these debts can be serviced or not is not the issue – the issue is that private sector investment will reduce relative to any increase public sector indebtedness and consequential risk of default.
2. This investment gap, means that companies tend to satisfy growth / demand by increasing unskilled head count rather than capital spending on new technology. This has triggered the on-shoring of jobs back to the developed world (off-shoring has not been that effective) This increases levls of employment but kills: productivity, growth, take home pay and demand. Our workers are becoming ever less productive, and weirdly firms are hiring them in ever increasing numbers. Whilst nominal wages have hardly grown over the last decade prices have risen much faster, leading to a steady erosion in real pay and this is the start of the vicious circle – low pay, low demand, low productivity, low levels of investment – no lasting recovery.
3. Supply side reforms to the labour market have had the unintended consequence of reducing productivity. As labour organisations have lost power and employment rules have been relaxed in favour of employers we have all become “un-sticky” workers. We can be hired and fired at very low cost, making us a cheap and low risk alternative to real investment in innovation and technology.
4. Finally since 1980 labour share has fallen dramatically, this means a much greater share of national income goes to owners of capital rather than employees (labour). This is consistent with the rise in cash hoarding by businesses and investors. See the recent research by Loukas Karabarbounis and Brent Neiman. This loss of labour share has created an easing in the substitution of capital for labour (low investment) and additionally, the loss of labour share also impacts demand as living standards drop and there is only so much a billionaire can spend!
These are all highly complex issues that cannot be fixed by increasing demand through public spending nor can they be fixed through supply side initiatives. The answer to today’s economic puzzle must be in technology and productivity and here are some measures that might make a short list of sensible initiatives.
1. Raise the returns on private investment through tax breaks on investments, introduce a savings tax (on large corporate cash balances) and use macro-prudential measures to direct credit availability to productive investments
2. Raise the value / cost of employees by raising minimum wages and extending mandatory ages for education and maybe even reducing retirement ages temporarily.
3. Encourage exchange rates to rise, forcing businesses to become more competitive – this should be achieved by an early but small increase in interest rates. Rising interest rates will also close Zombie businesses that are tying up capital (human and financial) that could be better deployed in our economy.
All in all we have to make a commitment to improved productivity, rising wages and a sensible value of our currency - this will drive investment in new technology and productive employment.