Key variable in model for Secular Stagnation is Labor Share
The search for a model to explain Secular Stagnation is happening behind the scenes at the moment. Larry Summers is presenting Secular Stagnation as an Inverse of Say’s Law… “Lack of demand over time creates lack of supply”. But getting the mathematical mechanisms of how lack of demand suppresses supply (output) seems to be missing.
I now refer to two models, first a new paper by Gauti Eggertsson and Neil Mehrotra, A Model of Secular Stagnation. Second my model that I presented here on Angry Bear on December 16, 2013, Fed Policy is Heading into Trouble.
First the EM paper is an effort to provide a model for Secular Stagnation. As the authors say in their introduction…
“Despite the prominence of Summers’ discussion of the secular stagnation hypothesis and a flurry of commentary that followed it (see e.g. Krugman (2013), Taylor (2014), Delong (2014) for a few examples), there has not, to the best of our knowledge, been any attempt to formally model this idea, i.e., to write down an explicit model in which unemployment is high for an indefinite amount of time due to a permanent drop in the natural rate of interest. The goal of this paper is to fill this gap.“
The paper reaches 3 stabilizing solutions to Secular Stagnation…
- higher inflation target
- more government spending
- redistribution of income
As such, Paul Krugman today mentioned the need for a higher inflation target and maybe permanent fiscal stimulus… Why doesn’t he include redistribution? Eventually he will…
- “while an inflation target, if believed, can bootstrap you out of secular stagnation, it has to be a sufficiently bold target. Announce your commitment to 2 percent inflation when the economy needs 4, and nothing happens.”
- “I need to work a lot more on the mechanics of this paper; I’m wondering in particular whether there is a possibility of sustaining the economy with permanent fiscal expansion.”
Apart from the solutions, the EM paper highlights the causes of Secular Stagnation. The implication is that if the causes are removed, Secular Stagnation will fade away.
“Perhaps a main takeaway from the analysis is not just that a permanent recession is possible, but instead that a liquidity trap can be of arbitrary duration and last as long as the particular dynamics that give rise to it (such as a deleveraging shock and/or rise in inequality and/or population growth slowdown).”
As you might notice, I highlighted a rise in inequality as a dynamic causing Secular Stagnation. Inequality will affect the ability to deleverage. So it is a fundamental cause of the Secular Stagnation that we see.
Back in December, 2013, I presented a video that gave a model to explain Secular Stagnation. My model focuses on inequality through the variable of labor share. I put the video again here.
In the video, I show how the Effective Demand limit pushes the natural level of real GDP lower as labor share shifts lower (in terms of the composite utilization level of capital and labor, Total Factor Utilization Rate, the x-axis in the video.) I see that the Fed and other economists are slow to recognize the significance of this shift. The result is that they are still thinking that the economy will return to the previous composite level. Thus, in order to return to the previous higher natural level of real GDP, a negative real interest rate would be necessary, but it is not a desirable path. The Fed’s forward guidance is taking us down a dangerous path.
In the video, I refer to Larry Summers and his idea of Secular Stagnation where the natural real interest rate will have to be negative for many years to bring us back to full employment (17:30 point). You will see a solid brown line sloping down from left to right. This line marks the natural real interest rate needed to maintain any given level of composite utilization of capital and labor in regards to the effective level of labor share. So, if the natural level of real GDP is actually lower than expected, and economists try to calculate the natural real interest rate at full employment real GDP, there is a good chance they will calculate a negative real interest rate.
As the EM paper above stated, inequality is a cause and redistribution is a cure for Secular Stagnation. I support that view with my model saying that labor share has to rise.
I agree with Mr. Krugman about the benefits of fiscal expansion. I agree with him on a higher inflation target. But there is a little detail which I would hope to contribute. Even if government spending and the inflation target were to increase, their effectiveness would be muted unless labor share also increased. Thus, the bottom line in any solution to Secular Stagnation involves an increase in labor share.
One final note, as Michael Pettis has laid out, the rise in labor share has to be coordinated globally among advanced nations. If one country raised its labor share, most likely the benefit would be experienced not by its own country’s labor force, but another’s. And we can ultimately conclude that the problem of a falling labor share is not particular to one or two countries… Low labor share is a problem throughout the advanced countries, including Japan by the way. Thus, Secular Stagnation is deepened by being a global phenomenon… and so raising the inflation target just in the US, or increasing government spending just in the US is most likely not going to solve the problem.
It seems to me that Krugman and Baker are saying that as the debt overhang is eliminated that demand will return. This will in turn result in better jobs and better jobs means higher labor share.
I have my doubts, but I am not sure why you insist that labor share will not rise. Where is the model for what drives labor share?
Hi Arne,
Labor share is driven by international forces & domestic forces. There are strong international forces that suppress labor share from rising from Europe, Japan and still from China.
Unemployment is still high which weakens bargaining for certain sectors of the labor market.
From my research, labor share has more flexibility to adjust during a recession, as opposed to being near full employment. Labor contracts and hiring can be re-done depending on the crisis level.
As I see it, the economy will have to contract some for labor share to rise. The economy may continue to contract depending on its sensitivity.
I expect profit reports to be weaker than expected this month because labor share was so low at the end of 2013, which helped boost profit reports before. Now I expect some of the income to flow back to labor in first quarter 2014 as a balance from keeping income away from labor to boost profits at the end of 2013.
There is a movement to raise labor share, but it may trigger a contraction earlier than expected. The economy is somewhat sensitive to forecasts of tightening.
Yet, all in all, will labor share rise as the economy nears full employment? It is not a done deal. We have to watch many factors going forward. I expect labor share to stay fairly stable throughout the year, otherwise you would see corporate profits taking a hit with its resulting effect on the markets.
Isn’t declining labor share a sign of progress in terms of greater efficiency of production?
If people’s loss of labour income can be replaced by an increasing share of the capital income then that will also be part of the solution. This can be achieved by mandating that a certain part of peoples wages go towards purchases of equity.
A higher inflation target wont be that effective under current monetary policy regime because policy is centered on lending and portfolio rebalancing which disproportionately benefits the wealthy capital owners anyway. If MP is designed to directly interact with the broad public this would be much more efficient in that all people would be treated equally (capital and labour providers).
Japan had/has a population growth slowdown, what other criteria were present at the start of their stagnation that are cited in this model (particularly, what did the labor share look like, the Gini was much lower in Japan in the 80s than it was here, but I think they are similar now).
Lambert
thank you. i hope people are listening, or figuring it out on their own, again.
but i wish you wouldn’t say “inequaltiy,” but “more inequality.” You are not going to see “equality”… ever, but just talking about it gives the bad guys motivation to fight against whatever you propose, and to scare other people to fight against you. i would also suspect that a more developed model would show that there is a point at which “too much equality” also slows growth.
i think we could manage pretty well by letting those who are motivated to get rich, give it a try. As long as they don’t do it by stealing from the workers or otherwise abusing the general welfare. And as long as they don’t get so rich that they start to own (control) the country… or even their local county.
Somewhat similarly
while I think I understand Dannyb2b’s point, I am not sure that forcing people to buy stocks is a great idea. For one thing you can’t control the abuses that would go on as the “smart” took advantage of the “not so smart.” For another, forcing people is hard enough asking them to pay taxes and stop at red lights. Even Social Security which is very, very good for most people and for the country as a whole, drives some people crazy exactly because it is “forced.”
Labor share is a consequence of public policy not some act of god or the marketplace. We have seen a systematic assault on labor law and regulation over the past forty plus years. ‘Globalization’ has run interference for this assault but it has been a smokescreen. It has always been about the balance of power. Shifting the balance of power or more accurately eroding the political power that labor had gained to claim a fair share of the spoils of productivity gains. This process is now nearly complete the victory of capital over labor nearly total and the result is a system so out of balance that in a consumer driven economy it is now almost assured to underperform for the foreseeable future.
“Isn’t declining labor share a sign of progress in terms of greater efficiency of production?”
I would think only if your government policies allow the efficiency gain to only go to capital. Which as we are seeing when that is the structure of the economy, capital ends up with no viable place to go as supply of what that expended capital’s resultant efficiency produced is greater than can be sold/used up. Contraction!
It would only be true naturally (non policy created) if said efficiency is created completely without the input of labor.
What seems to be forgotten in all of this is that greater efficiency/productivity results in more people being able to afford the supply which should drive ever greater need for supply. Unless you undo the relationship of productivity gain and wage growth. Which is what we have done. Thus ultimately over supply. Contraction.
As to Krugman, he can’t speak the words of redistribution via labor because as much as he is not considered Chicago School, he is Milton influenced in that Milton core was simply: mind the money and all else will follow as needed. Krugman is stuck in the fun house of monetary policy. It a powerful house of funny mirrors.
Also, I’m not convinced that one nation could not unilaterally raise it’s labor share to it’s advantage. This is pretty much what we had done and in doing became the world desired place to set up shop for selling your wares. We were not called the worlds market because of Wall St. And, China is not seeing it’s growth slow because we’re growing our consumption at a rate greater than the rate of substitution of our production of finished products for importation from the east. China et al needs the world consumers to consume at a rate greater than is the substitution of the consumers production for imports.
Theres a difference between liquid and illiquid labour share, and though I haven’t puzzled this out to be sure, I think that illiquid LS would be the way to go to prevent the capture or offshoring of it.
By illiquid LS I mean things like universal health care, good public transit and education, good child care services, parental leave, a reasonable safety net, and so on.
Liquidity tends to be skimmed, but how do you skim a rail system, public library, or public university?
The ceaseless preta-craving to privatize public services is nothing less, I think, than the desire to liquefy them and make them, and the people who depend on them, vulnerable.
Noni
Dannyb2b,
You make a good point about the inflation target. it would be a non-sequitor.
Coberly,
Yes, you are right. It would be better to say “more inequality”.
SW,
Ageed. Even though there are dynamics to bring down labor share, there is definite evidence of policy breaking down the power of labor.
Daniel Becker,
I wish it was not about Krugman. I hold out hope.
And it is good to question that idea about one country raising its labor share. Yet, as we were raising our labor share after WWII, other countries were doing it too in Europe and Japan. Productivity grew and labor shared in the productivity. And remember the days when wages kept up with productivity and inflation? Neither do I…
“Thus, Secular Stagnation is deepened by being a global phenomenon… and so raising the inflation target just in the US, or increasing government spending just in the US is most likely not going to solve the problem.”
From Ezra Klein’s Larry Summer interview on 14 Januar 2014:
http://www.washingtonpost.com/blogs/wonkblog/wp/2014/01/14/larry-summers-on-why-the-economy-is-broken-and-how-to-fix-it/
Larry Summers: “Secular stagnation refers to the idea that the normal, self-restorative properties of the economy might not be sufficient to allow sustained full employment along with financial stability without extraordinary expansionary policies.”
In my opinion, secular stagnation may be global but the cause varies by country.
The United States is THE net importer. We interrupt our own circular flows by bringing manufactured goods into the country instead of producing them here. In the process we leave American workers unemployed or underemployed. This is the cause of our secular stagnation. We can move closer to solving our problems by forcing renegotiations of our trade treaties to get much much narrower trade imbalances. Given that we are THE net importer, the benefits of such a move would accrue directly to us.
In contrast, Japan does the opposite. They produce manufactured goods and export them to more advanced economies. In the process they employ more Japanese workers. But they have faced growing competition for the U.S. import market. Thus Japan’s secular stagnation is not from the same cause as the United States version. Japan can not solve their problem directly, since they can not force the more advanced economies to import more goods or to buy more from them.
If our economy improves, then Japan’s economy will improve. But they also have the problem of competition from the other southeast Asian countries’ exports to the United States.
From: “The China Syndrome: Local Labor Market Effects of Import Competition in the United States” October 2013
http://economics.mit.edu/files/6613
“The value of annual US goods imports from China increased by a staggering 1,156 percent from 1991 to 2007, whereas US exports to China grew by much less. ”
Does anyone seriously believe that this problem has ceased? No the damage is continuing.
Dean Baker seems to understand this.
Sooner or later the American public will realize that they have been duped and that Global Free Trade has not been a “rising tide that lifted all boats”. The Chinese are not allowed to vote in our elections. These staggering trade imbalances will be dealt with by the Democrats or the Republicans or there will be a third political party to force the issue.
JimH,
Great comment…And I saw Dean’s post today. International trade is affected by labor shares too, because they determine national savings, and thus trade deficits. Michael Pettis has been writing about this.
Third Party, Folks.
I think you’re more likely to see civil unrest before you see a viable third party. The two party system is so entrenched, and now controlled by large corporate/ wealthy individuals, that the big money will marginalize any successful third party. It is going to take someone from within that elite structure to make the kinds of changes that will lessen inequality and get the middle class growing again. Unfortunately, most of what’s left of the middle class has a penchant for continually voting against their own self interests. It’s been happening since the Reagan “revolution.” (before then to be sure, but this was the beginning of the decline of middle class America in our generation’s lifetime.
Nanute:
Third Party, Folks, IS the one thing that will work as it DIVIDES the power structure of the corrupt two main parties, YET FEW will try it. Sometimes people LOVE their corruption, just like loving GITMO. Sure its immoral and wrong, criminal, but WE love it, thinking it keeps the bogyman away. The two parties gave US what WE have today. Yes, its awful for the poor and minorities among US, reverses the positive gains of the past and adds unbalanced POWER to the rich, STILL ???
I promote it mainly because the excuses intrigue me.
Third parties can not get traction over several election cycles and for a very good reason.
Because one or both of the major political parties steal the third party’s agenda.
But in a sense that is success.
Third Parties don’t get traction because no one joins them. FEAR of positive change, I suppose. OR love of the status quo, perhaps.