Book IV. Presentations for the General Public

Presentations for the general public

In March / April 1996 I put two presentations for the general public in the Economics Working Papers archive at the Washington University at St. Louis. In August 1998 there was a third paper. These papers are directed to a general audience, and to teachers and students. Since this current book basically addresses economists and uses quantitative methods, I doubted whether I should include these texts here, also since there is some overlap that can be distracting. There however are two good arguments to include them with little adaptation: (i) Once a fellow economist is starting to grow convinced of the value of my analysis, then he or she will face the same problem of explaining it to others. These texts then can be of use. (ii) The historical date of these texts underlines the co-ordination problem. Even when a good summary was available, and even when the moral imperative facing Western nations was clearly formulated, our failing systems of economic policy making limped along, and caused misery upon misery for many of its citizens.

15. Unemployment solved !

A breakthrough in economic theory

Since the early 1970s Western economies have been plagued by mass unemployment and the threat of inflation. Over the years since then various economists have proposed various possible solutions, but never quite convincing ones. Now there is a novel analysis that means a breakthrough in economic theory. The present author is quite certain that the “missing link in the model” has been found. If true, this analysis offers guidelines for full employment under price stability, just as Western economies enjoyed in the 1950s. The main point is: don’t tax lowly productive labour. Why ? To keep it competitive so that more productive labour will not demand inflationary pay rises. Though this new analysis is only in the stage of presentation and introduction at the scientific fora, there is no reason to withhold the present rough sketch for a general public.

It is well-recognised these years that Western economies have a problem with jobs with a low level of productivity and thus a low level of market-earned income. The United States tolerate more poverty - the working poor - while Europe sets its minimum wage much higher so that Europa has more unemployment.

This problem with low productivity jobs finds various explanations, notably those of technology, globalisation, and inflexibility - the latter ornate for “welfare state sclerosis”. Policies based on these latter explanations have been enacted for some time now. For quite some time, in fact; while little is being achieved. It is proper that we pose the question: why is it that we don’t achieve much ?

Unemployment obviously has a much longer history than the current problem. Also, the Western track record on unemployment can only be understood when the record on inflation is taken into account too. Economic science has much to say on the complex relationship between inflation and unemployment. Now, we are forced to be brief here. We will concentrate on what is new and on why it is new.

We set out with the empirical evidence since 1950. This track record can be divided in meaningful decades:

· The 1950s had low unemployment and low inflation.

· The 1960s had the threat of unemployment, and governments accommodating inflation in order to actually prevent it.

· The 1970s nevertheless had mass unemployment bursting into the open, and governments accommodating high and accelerating inflation to battle it.

· The 1980s-till-now had governments come down hard on inflation, and accepting high levels of unemployment as the price for stability.

One sees a certain “trade-off” between unemployment and inflation. From the 1950s till the end of the 1980s the common view among economists and policy makers was that the unemployment in the trade-off was “general” unemployment. Nowadays we tend to link unemployment to lowly productive labour. For us it may be obvious, but compared to the earlier view it is revolutionary that the once-thought-to-be “general” unemployment now turns up as a rather specific type. To make the revolution specific: we will hold that the unemployment in the trade-off has always been related to the distribution of productivity across labour.

The crucial insight is that the people who can demand pay rises need not be the people who run the risk of unemployment thereof. High productivity workers run less risk of unemployment and can more easily demand pay rises, while low productivity workers run the larger risk of unemployment. High productivity workers are more versatile and are able to shift the risk of unemployment to the lower income groups. When jobs are scarce, the high productivity workers even crowd out others from the labour market.

Now obviously, when this is new, then it has not been recognised before, and then it has likely been missing in policy. And policy that was based on a wrong analysis, is likely to have been the cause of the very problem that it wanted to solve.

Let us see how it went wrong. Regard the legal minimum wage and note that people are not allowed to work below that minimum. Note too that there hence will be no earnings that can be taxed in that range. We can call this range the “tax void” or “tax vacuum”. However, tax statutes are defined in that range anyhow. Tax statutes in that void are actually used to define the gross minimum wage. In Europe, the high gross wage will cause unemployment and its related benefit burden. In the US, the void is reduced a bit by accepting poverty. In common economic terms: tax policy and social-economic policy are badly co-ordinated.

How this has come about is a story of a more technical nature. First note that OECD countries adjust their taxes for inflation. Tax exemption in 1996 will often be close to the inflation-adjusted real value of 1950. On the other hand, research in social psychology shows that subsistence tends to rise with the general level of income, the growth of which consists of inflation and real growth. So there is “differential indexation”. In the 1950s exemption was pretty close to subsistence, so that there was no void to speak of. Since then, exemption has lagged behind the standard of living. The inflation-adjusted subsistence of 1950 may be only a third of 1996 subsistence. When tax exemption lags behind net subsistence, then there is a multiplier effect on gross subsistence, with a fast increase of the tax void.

The alternative and new policy would be to scratch taxes in that void and to allow people to earn their own - decent and untaxed - living. This alternative policy reminds of an old rule. The Dutch economist Cohen Stuart proposed in 1889 to put tax exemption at the level of subsistence. To drive the point home he drafted the following analogy: “A bridge must carry its own weight before it can carry a load.” In 1996 there is the additional argument that abolishing void taxes will not cost anything, and that nations will save benefit payments due to more employment.

More employment.... Does that not fuel inflation ? The pieces of the puzzle fall into their places when the tax void is related to the unemployment & inflation problem. The steady rise of the void explains the track record of unemployment and inflation. The 1950s have been characterized by relatively low taxes on low income earners, and this allowed for full employment and low inflation. From the 1960s onwards the lagging tax exemption started causing problems with unemployment. The tax policy since at least 1965 enhanced the imbalance of the internal bargaining positions of labour instead of counter-balancing it. Hence inflation was persistent, and high levels of unemployment were required to achieve price stability.

How governments reacted depended upon the view of the day. Since the proper solution was not known, the problem did not go away. The differential indexation of tax exemption and the social minimum did not draw attention to itself. Each year adds only a slight gap which is hard to see. But over the years the gap has accumulated, and with huge consequences. And the problem will remain with us in the future unless policy changes.

Current policy is based upon other explanations. Notably those of technology, globalisation and flexibility. The ineffectiveness of current policy can be explained by the fact that these views are not entirely logical. The arguments of technology, globalisation and flexibility run up against contradictions. Technology is a source of wealth, and it boosts the productivity of the lowly productive jobs, making the problem of poverty and unemployment less serious than it would otherwise have been. “Globalisation” is a scare word for “trade”. Trade however is another source of wealth, and it too has been with us for ages. Rising wealth in distant countries means rising wages over there, and trade itself thus puts limits to foreign competition. Japan over the last 40 years is a prime example of this phenomenon, but every rich nation has had the same experience. Finally the “flexibility” or “welfare state sclerosis” argument can only explain that the US has poverty and Europe unemployment, but it does not explain that there is a problem with low productivity jobs in the first place.

The present situation bears another surprise. We diagnose current unemployment as inefficient. Be sure that you see what inefficiency means: it means that there is a solution that is beneficial to some and that does not hurt others. Having a bright idea always means a “win-win” situation or a free lunch. In this case it is the move to full employment under price stability. The present unemployed will find jobs. The higher productivity group will have a theoretically larger risk of unemployment, but in practice this risk will be modest as in the 1950s. Their real gain will come from the services that will be provided by the jobs of the present unemployed.

Policy makers will be hesitant about an overhaul of the tax system. Note, then, that the tax system defines our notion of a subsidy. A wrongly levied tax, in this case the tax void, can be compensated for by a wage cost subsidy. Abolishing the tax void is more sensible in the long run, but when this can only be done gradually, then some general subsidy directed at lowly productive jobs would speed up short term adjustment. If only those subsidies are reduced when tax exemption rises towards subsistence.

This was it, in a nutshell. Now I beg your understanding. My analysis is more complex than can be stated in these few lines. Both tax policy and social policy are quite complex themselves, and this certainly holds for their interaction with inflation and unemployment. For example, you may ask why I haven’t discussed income redistribution effects. Actually, this is because the alternative policy could be neutral to the income distribution. The reason for this is that the analysis focusses only on the link between wage costs and productivity. But you might want to hear more about this. Also, you might ask whether above explanation covers all possible cases of unemployment and inflation. Of course it doesn’t. The analysis does help to clarify that other types of unemployment need other types of policy, such as education and so on. But you might want to hear more on that too. These are just examples of issues, and there are many more issues that need to be dealt with. Which space forbids. However, given that my model amends existing economic models, much of the required explaining is ‘common economics’.

There remains one major point. That tax exemption is low, is defended by OECD governments with the argument that it keeps marginal rates down. And the attractiveness of low marginal rates is that they spur economic activity. My finding however is that the latter claim is only true when the marginal rate has been defined properly. Thus I agree with the claim, but it must concern the proper marginal tax rate. There is a difference between the proper rate, which is dynamic, and the rate used by OECD governments, which is the static and statutory rate. Dynamic analysis shows that the proper marginal rate will be close to the average rate. This part of my analysis is important for economic growth. Having less unemployment will mean lower average taxes, and thus lower proper marginal rates, and thus more incentives for sustainable growth. For many of my fellow economists it is this part of my analysis that will come as the greatest surprise of all. However, this is not an issue that can be settled in this review, and here I definitively have to refer to my extensive analysis.

This novel explanation is in the tradition of Keynes and Tinbergen while it fits in with mainstream economics. When my fellow economist check and confirm these findings, our economies are likely to enter into a new high growth path with full employment and low inflation.

Allow me to add the personal note that I am overjoyed by these findings.

(March 1996)

16. Enable Russia to help itself

World developments in the 1990s show a worrysome parallel to the 1930s with the Great Depression. Present-day Russia reminds of the pre-war Weimar republic, where a devastated economy and weak democracy allowed Hitler to take power. Western nations in the 1990s hinder trade with Russia and the Eastern nations for fear of unemployment at home, as they did in the 1930s with Germany. If trade were stimulated instead of hindered, Russia could regain economic and political stability by itself. The moral problem is not external and does not concern whether Russia would need financial aid. The moral problem is internal, and concerns whether Western political leaders are willing to face their own errors that cause the present mass unemployment at home.

Russia is shrouded in a veil of doom. A nation once proud about its achievements, is now, as so many feel, humiliated in the face of history. A loss of empire, a collapse of economic security, some coup attempts in both Kremlin and Duma, a rising reign of violence by a mafia in the main cities and by full-blown fighting at the geographical fringes, and a political arena that smells more of fear than of confidence. Like the Weimar republic in pre-war Germany, Russia has been subjected to the rules of chaos, and yet again the odds are risky - and risky for the world at large.

Something needs to be done. Something smart, something humane, something effective and efficient, and something courageous. Therefor, something which is not likely to happen quickly. However, there is one single possibility that is very much worth of our attention. It is something what we actually could do. And what - given the risks of this moment - we should do

It is trade that will help Russia and the Eastern nations to recapture economic security and thereby regain political stability. And, since it is our fear of unemployment that motivates us to block that trade, Western nations should tackle unemployment at home directly.

Parallel

Our comparison of present-day Russia with pre-war Germany is no coincidence. World developments in the 1990s show a worrysome parallel to the 1930s. The 1930s suffered from the Great Depression. In the 1990s the world is again plagued by mass unemployment. Again there is a major region that is economically devastated and that desperately needs access to the world market, and yet again the other wealthier nations hinder that entry, while concentrating shortsightedly on their own problems at home, and neglecting the consequences of neglect. The West might want to reduce the risk of a Russian disaster, but not at the cost of jobs at home. Trade barriers are there to keep cheap Eastern products from “flooding” its home market. Europe throws in huge subsidies for its agricultural exports. Western tariffs or quality requirements are pitted against Eastern exchange rates, in a war on trade whatever its consequences on economic and political stability.

The West is dugging in and seems to repress the recognition that history is repeating itself. Again the world finds itself in a deadlock, and yet again chaos feeds on it.

But we should remember the trade war of the 1930s and the rise to power of Adolf Hitler ! In the 1930s the same mechanism of trade, unemployment and political instability applied. In this period it was Germany that was the weak nation. The Versailles Treaty of 1919 that ended World War I put Germany under a huge reparations bill. The world forgot that the war had been started by an autocratic Kaiser and that Germany now had a new, fidging democracy. To pay that bill, this weak democracy was obliged to cut imports and to spur exports. The reparations bill worked like a foreign tariff that took away funds that could have been invested otherwise. By the end of the 1920s Germany defaulted on its international debt - and thereby indirectly caused the Wall Street Crash of 1929. Thereafter, all nations scrambled for the life-boats. Nations feared for their home markets and employment, and defended themselves by exchange rates and tariffs. In their fear they made things only worse. The German economy collapsed, and on the teutonic waves of resentment its weak democracy toppled and Hitler took power.

Let us now compare: Is the Russian democracy anything other than new and fidging ? Have its generals not tried to seize power ? Have its tanks not roared against its very own Parliament building ? Has its economy not dropped by a third? Or conversely, have all its nuclear weapons and uranium stores been savely secured ? Have the Western nations done their utmost in opening their markets ?

Risk not chance

Of course, there is a glimmer of hope. The Russian capacity for suffering is impressive. Few nations could sustain this suffering and national disgrace without lapsing into resentment, cruelty and violence on a much larger scale than we actually see in Russia. The West has provided some funds and done something more. The world is not at war and may not be at war for some time. The probability that things go right is large, and there is only a small chance that things go wrong.

But please consider: If the only glimmer of hope is that the world is not at war, then the situation is quite depressing. Hope is not the point, and neither likelihood nor expectation. The point is risk. Risk comes from the arithmetic of loss multiplied by chance. Thus: risk = loss * chance. If things go wrong in Russia then the consequences will be huge, and a small chance times a huge loss gives a risk too large.

Internal not external

The West should open its eyes and see the economic logic. Eastern nations need to take part in the international economy and thus need modern Western equipment. To buy the latter goods they need the proper currency. Either someone gives them that foreign currency, the dollars, yen or marks, or they have to earn it themselves by exporting. To simply give them credit, on the scale required, is absurd. Therefor it is access to Western markets that is essential for those nations and for political stability. Indeed, if they had access, and if the flow of trade were to start, then the World Bank and IMF could extend credits and thereby fuel the process towards stability.

At the same time, economic science tells us that it is not trade that has caused present Western unemployment. Marking trade down as the culprit, and using trade barriers to solve a situation that trade has not caused, only makes things worse.

The moral problem is internal and not external. The cause of present-day unemployment in Western economies is internal management and not external trade. There is a failure within the internal co-ordination of macro-economic policy, a failure by our very own governments. Western nations could tackle their unemployment problem at home - if only our political leaders were willing to take a hard look at their own internal policies.

The historic parallel also concerns the current lack of attention for the internal question. Policy makers that concentrate on an external trade war neglect the internal opportunities. There is the following sobering story about the economist John Maynard Keynes. From the early 1930s Keynes advanced his solutions to the Great Depression, and this culminated in his 1936 book that changed macro-economics. Policymakers could have reacted already in the early 1930s, ... but only did so after World War II had already begun.

Conclusion

We might ask: Do we care about the peoples of Russia and the Eastern nations ? And should we act with economic sense ? However, those questions are imprecise. The real question is whether our leaders care so much that they will reschedule their busy agenda’s and really look into a problem that they cause themselves.

There is every reason to believe that political leaders are quite deaf on this. So pray that there will not be a new world war. So shout to your political leaders: Stop that trade war !

Do something about external trade tariffs and internal unemployment. Enable Russia to help itself.

(March 1996)

17. Will the West repeat Versailles ?

Asia and the Eastern European nations are in a state of economic turmoil. An important element for improvement is that Western nations open their markets to more trade. This is in fact what the West could have done after the fall of the Berlin Wall. But petty shortsightedness of the governing elites in the West blocks this kind of solution. The situation reminds one of the Versailles peace conference after World War I that fostered a lot of resentment and helped cause World War II. The basis conclusion is that sound economic advice is not listened to. The best advice on how to steer out of the current world macro-economic mess is that every parliament installs a committee to enquire into the process of economic advice. They could study the books by Paul Krugman, and possibly also my analysis on unemployment and my suggestion for an Economic Supreme Court.

Western nations show an inadequate reaction towards the Eastern nations since the fall of the Berlin Wall, and this inadequate reaction is repeated with respect to the current economic throes of Asia. The West displays disinterest in the hardship and actual physical pain inflicted on millions of our fellow human beings, and a neglect of the long run effects of this egotistic behaviour. Part of this inadequate reaction however is also caused by wrong applications of economic theory, so that true compassion that is out there doesn’t get the chance to show itself. One lesson is that Western nations are advised to restructure their policy making process so that governments are better served with proper economic advice.

The negligent way that the Western nations treat the other nations reminds one of the Versailles peace conference after World War I. Historians agree about the sad Western attitude at the Versailles conference. The Western Allies humilated Germany and subjected that country to decennia of economic hardship, purposely crippling its economy. These events caused a huge resentment in Germany, and this fostered the rise of Adolf Hitler. Also, Germany’s defaults on its financial obligations were a major cause for the 1929 Crash and the subsequent Great Depression. This episode is another example that two wrongs don’t necessarily make a right, and it also shows how wrongs can backlash at the wrong-do-er.

The lesson of Versailles is that opponents can often best be allowed to grow into a relationship of companionship and economic competition and co-operation for the betterment of all. Rather than subdue them or take advantage of temporary weaknesses, they could be helped so that they could help us. This lesson should now be applied to the current situations of Asia and Russia.

It is useful to recall that Western nations were not without proper advice at the time of Versailles. They were warned, and by nobody less than J.M. Keynes. As Paul Krugman recently stated about Keynes: “After that war he became famous as the author of The Economic Consequences of the Peace, an eloquent condemnation of the vindictive terms imposed on the defeated Germans; his concern was vindicated by the rise of Adolf Hitler, and the memory of his warnings helped convince a victorious America to aid, not punish, its prostrate enemies after World War II.”

Indeed, after World War II the Allies helped Germany and Japan to reorganise their countries and to prosper again. While the average citizen may be deluded by sentiments of nationalism, religion or ideology, it normally is a governing elite that abuses those sentiments for purposes of its own grandeur - and once a decent government is in place, there often appears little reason to blame that average citizen for the errors of its country. In the same way post-communist Russia deserves our sympathy, and the same holds for Asia with its different history.

But why has the West forgotten this valuable lesson ? Why do Western governments neglect Nobel Prize winner Jan Tinbergen’s work on the Optimal Economic Order, and why do we again have a show of petty egotism and shortsightedness ?

The reason is that the West is not immune to the same ‘governing elite’ processes that can be at the detriment of common welfare. The governing elites and bureacracies in the West have agenda’s of their own, and though they are restrained by democratic rules, these rules are not as strong as they could be. Our systems of checks and balances are a product of history, and not necessarily of the quality required. Politicians and bureaucrats often still can lie and get away with it. The United States e.g. had David Stockman on the budget deficit, and it took too long before that matter was settled. In general, sound economic advice still is obstructed by political processes, and policies and the electorate itself then grow misguided in their choices.

To better understand the failure of Western democracies on the issue of economic advice, one can best start by reading Paul Krugman’s books “The Age of Diminished Expectations” (1990), “Peddling prosperity” (1994), “Pop Internationalism” (1996), and “The accidental theorist” (1997). For example, when Krugman discusses US majority leader Armey’s book “The Freedom Revolution”, he states: “Armey is no fool. He cannot be unaware that he is fudging his numbers. Possibly he regards a small fib as justifiable in the service of a higher truth. Or possibly he has managed to achieve a state of doublethink, in which the distinction between what is politically convenient to believe and the objective facts no longer exists . The end result is the same: His book is an effort to obscure the stark realities (…)” (1997:60). Similarly, one can read in the American Economic Review that the US Council of Economic Advisers is rather proud of its achievements in the last decades, but we should be aware that this council is a bureaucratic body, and it hasn’t the independent position that could have protected the US economy from the events and errors as are related by Krugman in his “Peddling prosperty” saga or shown by the record of mass unemployment.

Let us now regard what the West could have done with regards to Russia after the fall of the Berlin Wall and the first free elections there - and what could be done now also with respect to Asia. I take my own 1996 paper “Enable Russia to help itself”, and quote from its summary: “Western nations in the 1990s hinder trade with Russia and the Eastern nations for fear of unemployment at home, as they did in the 1930s with Germany. If trade were stimulated instead of hindered, Russia could regain economic and political stability by itself. The moral problem is not external and does not concern whether Russia would need financial aid. The moral problem is internal, and concerns whether Western political leaders are willing to face their own errors that cause the present mass unemployment at home.”

Clearly, with this being the state of affairs, one can imagine the strength of the forces that prevent a proper discussion of these issues. Western companies embrace tariff barriers to cheap imports - and raise their own prices. Bureaucrats embrace barriers since these give a sense of control, and these also justify the very existence of this bureaucracy. Labour unions will fight unemployment at home with whatever misguided argument it takes. Governments embrace economic tales about ‘globalisation’ and ‘competition from cheap labour countries’ since these distract attention from home grown errors, and these goverments neglect economists who tell them that ‘globalisation’ and ‘competition from cheap labour countries’ are rather like fairy tales indeed. Krugman again uses the term ‘globaloney’ - and have you heard your President or Prime Minister adopting that critical attitude too ?

The best economic advice for the current situation is as follows - and I urge upon my fellow economists to adopt and spread that advice too: Every parliament could install a committee that will enquire into the process of economic advice. This committee could study Krugman’s books and my suggestions for a solution of mass unemployment and for an Economic Surpreme Court amendment to the national constitution(s). Nothing less will do. Note, by the way, that when countries start installing these committees, the markets will be quick to anticipate the directions of their conclusions, and economic recovery would already set in.

We all know Lincoln’s words: “You can fool all of the people some of the time, and you can fool some of the people all of the time, but you cannot fool all of the people all of the time.” Let us act upon it, or show Lincoln wrong. (August 1998)

Notes in 1999: (1) A 1999 UNDP report describes the Eastern European situation as disastrous, and calls for a quick joining up to the EU (De Volkskrant October 16 1999). It is courageous that an international body speaks up like this - and it indicates the seriousness of the situation. (2) The journalist Peter Michielsen in NRC-Handelsblad October 30 1999 rightly calls attention to the original borders between the empires of Rome and Byzantium. The Eastern European countries that are doing relatively well belong to the Roman area, the others to Byzantium. He mentions that this cultural distinction has also been noted by Andreas Oplatka of the Neue Zürcher Zeitung 1994, who again refers to George Kennan in 1945. I was a bit surprised by this, hadn’t thought about it in this way. (3) These points however nicely fit what I have been argueing for ten years now. Enabling people to help themselves starts with taking account of the local conditions; and overall the barriers to trade should go.