Influence Of Government Size On Income Distribution

I have been reading Philip A. Klein's Economics Confronts the Economy (Edward Elgar, 2006). He presents data in two tables that I thought, when combined, suggest relationships. So I drew the regression lines below. The data on income distribution is from 1998. Total government expenditures as a percentage of GDP is from 1999. Government expenditures include, for example state and local spending in the United States. The graphed data are for the United States, and, in order of decreasing percentage of government spending as a percentage of Gross Domestic Product, Sweden, Denmark, Belgium, Finland, France, Austria, Italy, Netherlands, Norway, Canada, Germany, New Zealand, the United Kingdom, Spain, Ireland, Australia, and Japan. Apparently, in advanced industrial democracies, as government spending directs a greater percentage of resources, the poorest have relatively more income and the richest have relatively less. One can see why the richest would like lackeys to fight the latter tendency.

Figure 1: Share of Income in Lowest 10% Among Developed Economies

Figure 2: Share of Income in Highest 10% Among Developed Economies

I haven't finished Klein's book, but I think I'll note two points I find of interest. He argues that when economists advocate for positive analysis of existing economies, they implicitly accept the status quo. This is a value judgement that could be contested. Secondly, when economists limit normative theory to Pareto-improving recommendations, they restrict themselves from commenting on such matters as income distribution and the quality of life of the vast population. (Moving along one of the regression lines probably makes some worse off.)

A Brouhaha

Some mainstream economics have been pointing out other well-known economists are simply incompetent. Among those doing the pointing are Paul Krugman and Brad DeLong. Robert Waldmann provides some background. (I'm not sure if this is Waldmann.) Mark Thoma comments. I think Uwe Reinhardt's post somehow fits in this grouping. Matthew Yglesias opts for believing the economists being pointed at are deliberately misleading, instead of merely stupid.

I was amused at the ignorance exhibited by a self identifed "UMN Econ Student" in the comments to Waldmann's post:

"The short of it, and this is coming from a Minnesota Econ PhD student, is that we try hard not to bullshit people by hiding our assumptions, no matter how ridiculous you may find them."

A canonical freshwater macroeconomic model is not merely a General Equilibrium model with perfect competition, perfect information, etc. It will also have a single representative agent and, in each period, a single homogeneous produced good that can be used either as a consumption good or as a capital good. What special-case assumptions on technology and preferences would one like to impose in a multi-good multi-agent model such that such a model behaves like a one agent, one good model? Economists have no answer.

The above posts are a selection. It is only in the comments that anybody points out that both saltwater and freshwater economists totally ignore Post Keynesians. I like this comment by A. Senderowicz.

Update: Somehow I missed Daniel's overview. Neil Sinhababu, at Ezra Klein's blog, has noticed this contretemps.

Samuelson Jests

I might as well document some jibes Kevin Quinn finds amusing. These are from two different articles from two different periods:

"I have dealt with Karl Marx the economist, not Marx the philosopher of history and revolution. A minor Post-Ricardian, Marx was an autodidact cut off in his lifetime from competent criticism and stimulus."-- Paul A. Samuelson (1957) "Wages and Interest: A Modern Dissection of Marxian Economic Models", American Economic Review, V. 47 (Dec.): pp. 884-912

"The 'transformation algorithm' is precisely of the following form: 'contemplate two alternative and discordant systems. Write down one. Now transform by taking an eraser and rubbing it out. Then fill in the other one. Voila! You have completed your transformation algorithm.'" -- Paul A. Samuelson (1971) "Understanding the Marxian Notion of Exploitation: A Summary of the So-Called Transformation Problem Between Marxian Values and Competitive Prices", Journal of Economic Literature, V. 9, N. 2 (June): pp. 399-431

"The truth has now been laid bare. Stripped of logical complication and confusion, anybody's method of solving the famous transformation problem is seen to involve returning from the unnecessary detour taken in Volume I's analysis of values. As I have cited in my mathematical paper, such a 'transformation' is precisely like that in which an eraser is used to rub out an earlier entry, after which we make a new start to end up with the properly calculated entry." -- Paul A. Samuelson (1971) "Understanding the Marxian Notion of Exploitation: A Summary of the So-Called Transformation Problem Between Marxian Values and Competitive Prices", Journal of Economic Literature, V. 9, N. 2 (June): pp. 399-431

Samuelson refers to:

• Paul A. Samuelson (1970) "The 'Transformation' from Marxian 'Values' to Competitive 'Prices': A Process of Rejection and Replacement", Proceedings of the National Academy of Sciences, 67(1) (Sept.): pp. 423-425.

As far as I know, no economist responded to Samuelson’s paper in the 1950s. He had reaction in the 1970s. The JEL published replies by Abba Lerner and Michio Morishima; an editorial comment by Mark Perlman; an analysis by Martin Brofenbrenner of submitted but unpublished reactions by Gordon Bjornson, Jean Cartelier, Bruno Jossa, David Laibman, Paul Massick, and Murray Wolfson; a paper on Marx by William Baumol; and responses by Samuelson, including an interchange with Joan Robinson. I suggest the difference in the number of reactions has something to do with events in non-academia. Perhaps the sixties had some impact on the algebra in which some economists were interested.

Krugman Correct

More than a decade ago, Paul Krugman characterized Austrian Business Cycle Theory (ABCT) as "The hangover theory":

"It is the idea that slumps are the price we pay for booms, that the suffering the economy experiences during a recession is a necessary punishment for the excesses of the previous expansion"

The other day, Steven Horwitz, one of the leading advocates of ABCT offered the following analogy for economics:

"the mistake is drinking too much and being hungover is the correction."

(Steven Horwitz is the secretary and webmaster for the Society of the Development of Austrian Economics and manages to get letters to the editor published in the Watertown Daily Times. Myself, I read the Lowville Journal & Republican if I want to know who is growing the largest pumpkin and who has been visited over the weekend by their children away at college.) I think my critique of ABCT goes more into the nuts and bolts of the theory.

Elsewhere, Krugman adopts a Post Keynesian point:

"I should also point out this, in [Robert] Barro’s article:

'John Maynard Keynes thought that the problem lay with wages and prices that were stuck at excessive levels. But this problem could be readily fixed by expansionary monetary policy, enough of which will mean that wages and prices do not have to fall.'

Is it too much to ask that someone criticizing Keynes actually, you know, read Keynes — at least enough to know that he devoted a whole chapter to explaining why a fall in wages would not expand employment?"

Hart and Zingales, Stupid or Dishonest?

On 3 December 2008, Oliver Hart and Luigi Zingales wrote on the funny pages of the Wall Street Journal:

"This year will be remembered not just for one of the worst financial crises in American history, but also as the moment when economists abandoned their principles. There used to be a consensus that selective intervention in the economy was bad."

What kind of principle of economics is this that tells us what policy should be?

It is obviously untrue that any such consensus existed. Corporations for which their owners have limited liability could not be founded without a selective government intervention in the economy. Any legal protection for Intellectual Property, such as any non-zero period for copyrights and patents, is a selective government intervention. The existence of the Federal Reserve is a selective government intervention. Furthermore, economists have had no consensus for decades on claims that monetary policy is ineffective or that the monetary authorities should conform to the Cassels/Friedman rule of growing the money supply at a constant rate. Bankruptcy law, including its recent tweaking against the interests of debtors, is a selective government intervention. Hart and Zingales demonstrate, with the balderdash in their first paragraph, that they have not given a serious moment's thought to the theory of the firm, industrial organization, or macroeconomics.

What has been demonstrated is, in general, orthodox economists are willing to serve as lackeys to the malefactors of great wealth. (I could pick many more examples.) What effect on elite opinion does this willingness of supposed academic experts to teach nonsense in the news organs of the affluent have, do you think?

A Theory of the Rate of Change in Exchange Rates

1.0 Introduction
I created this model by thinking about what would happen if no basic commodity existed, and yet no commodity could be produced with unassisted labor alone. That is, suppose (seed) corn can be used to produce corn, and rice can be used to produce rice. But corn does not enter either directly or indirectly into the production of rice. Nor does rice enter either directly or indirectly into the production of corn.

The mathematical problem posed by these thoughts can be set out in a model of two countries trading. I end up with an explanation of relative rates of currency appreciation across countries by the interaction of technology and the distribution of income - class struggle, if you will - in each country. I think this model illustrates that non-mainstream ways of thinking about economics can suggest new models and new insights.

I don't claim originality for this model. I was re-reading Samuelson (1957) to confirm my impression that that is where Samuelson describes Marx as "a minor Post-Ricardian". (I'm fairly sure Samuelson sets out his eraser algorithm in his 1971 JEL article.) I did not recall that Samuelson had set out a Marxist scheme of reproduction in his 1957 paper, albeit with a poor supply and demand interpretation. Anyways, I stopped at this passage:

"Without going into the social relations of the past or future, any economist... can evisage a case where Industry III [luxuries] alone, by virtue of having a₃ = 0 and b₃ < 1 will determine its own-rate of profit by itself, and he will realize that if this new r differs from that of (11) what must give is not bourgeois economic theory or the capitalistic institutional economy but rather the assumption of stationary relative prices." -- Paul A. Samuelson (1957)

This quote jostled my memory of a Joan Robinson review of Sraffa's book. I also dimly recall Keynes' 1923 analysis of arbitrage in forward trades in international currency markets and expected rates of inflation. I'd have to review whether one of the papers collected in Steedman (1979) sets out something like this model. I don't recall any conclusion as simple as the one I obtain, but I think there must be something like this in older Marxist models.

2.0 The Model
Consider two countries, each producing one of two commodities, corn and rice. The commodity produced in each country is a basic good in that country's economy. Assume no migration of labor is possible between the countries. Hence, wages can vary across economies. Assume, however, that no barriers to international flows of (financial) capital have been erected. Thus, a tendency exists for the same rate of profits to arise across countries, where financial outlays and revenues are calculated in some common abstract unit of account.

Without loss of generality, assume the price of corn is always one dollar per unit. The price of rice is one yen per unit. And the exchange rate at the start of the year is one yen per dollar.

These assumptions allow one to formulate equations for the prices of production in a common unit of account, for example, dollars. In the corn-producing country, prices of production satisfy the following equation:

a_c,c (1 + r) + a_0,c w_c = 1

where

• a_c,c is the amount of corn needed as input per unit corn produced
• a_0,c is the person-years labor needed as input per unit corn produced
• w_c is the wage in units corn in the corn-producing country
• r is the rate of profits

I here follow Sraffa's approach of regarding the wage as being paid at the end of the cycle of production. Given the assumptions, both sides of the above equation can be considered as being expressed in terms of dollars per unit corn produced. The rate of profits shows how many dollars are returned for each dollar invested.

The remaining equation specifying the model relates the revenues, in terms of dollars per unit rice produced, to costs in the rice-producing country. That equation is:

a_r,r (1 + r) + a_0,r w_r/p = 1/p

where

• a_r,r is the amount of rice needed as input per unit rice produced
• a_0,r is the person-years labor needed as input per unit rice produced
• w_r is the wage in units rice in the rice-producing country
• p is the exchange rate of yens per dollar at the end of the year

The above equations express the idea that the capitalists are indifferent between investing their dollars in producing corn in the corn-producing country or producing rice in the rice-producing country.

One can easily solve the above equations for the exchange rate at the end of the year:

p = [(1 - a_0,r w_r)/a_r,r]/[(1 - a_0,c w_c)/a_c,c]

The left-hand side of the above equation is ratio of the exchange rate at the end of the year to the exchange rate at the start of the year. The right-hand side is the quotient of two ratios, each ratio characterizing one of the two countries. These are the ratios of the net product remaining after compensating the workers for their labor power to the outlay needed to produce that surplus.

3.0 Conclusion
This model suggests that the smaller the rate of surplus value the capitalists are able to extract from the workers in a given country, the stronger their currency tends to become.

Update: I originally had the conclusion incorrect.

References

• John Maynard Keynes (1923) A Tract on Monetary Reform
• Paul A. Samuelson (1957) "Wages and Interest: A Modern Dissection of Marxian Economic Models", American Economic Review, V. 47, N. 6 (December): pp. 884-912
• Paul A. Samuelson (1971) "Understanding the Marxian Notion of Exploitation: A Summary of the So-Called 'Transformation Problem' Between Marxian Values and Competitive Prices", Journal of Economic Literature, V. 9, N. 2: pp. 399-431.
• Ian Steedman (editor) (1979) Fundamental Issues in Trade Theory, Macmillan

Samuelson on Hayek

Barkley Rosser, Jr., has published a piece by Samuelson on Hayek in the current issue of The Journal of Organization and Behavior, as well as an article, by Andrew Farrant and Edward McPhail, about a dispute between Hayek and Samuelson. I here record some thoughts by Samuelson in justifying his tone in an earlier article on Sraffa:

"If a scholar in his ninth decade is to record his considered opinions on an important topic, it had better be a matter not of when but of now... Dr. Samuel Johnson said that being hung in the morning greatly clarifies the mind. Nonsense. It is more likely to paralyze coherent thought. True though that as the days grow shorter, one does dispense with nice diplomancies and ancient jockeyings for victory." -- Paul A. Samuelson, "Sraffa's Hits and Misses", in Critical Essays on Piero Sraffa's Legacy in Economics (edited by Heinz D. Kurz), Cambridge University Press (2000)

Anyway, a number of bloggers have reacted. I noticed Tyler Cowen, Brad DeLong, Peter T. Leeson, Mark Thoma, and Barkley Rosser himself.

The comments sections for these posts is of varying length. I'm in the one on Rosser's co-blog. In discussing Hayek's contribution to the socialist calculation debate on Thoma's blog, Rosser brings up Jean-François Revel's The Totalitarian Temptation. I haven't read this book in decades. I'd have to reread it to see if Revel predicted the fall of the Soviet Union.

I also want to point out Chris Dillow's comments on Keynes' anti-semitism. I don't think much about Sraffa being of Jewish descent; Sraffa angered Mussolini directly anyways, what with his reporting on Italian banking in the December 1922 issue of the Guardian and Sraffa's support for Gramsci. I had known about Keynes' support of Sraffa, including intervention with the British government to obtain his release from internment. Dillow points to documentation of more broad-based support of Keynes for Jewish refugees. (I've previously linked to some other post on that month's discussion on that list.)

Economists Without Ethics

As I understand it, the American Economic Association (AEA) is almost unique among professional organizations. The AEA does not have a code of ethics.

School Rankings

I have been reading Philip A. Klein's Economics Confronts the Economy, which I purchased in the Strand, several weeks ago. This 2006 book is an institutionalist critique of mainstream economics. At one point, Klein wants to establish that mainstream economists at the best schools are, for the most part, no longer taught, for example, the history of economic thought. He provides the following list of schools:

1. University of Chicago
2. Harvard
3. MIT
4. Princeton
5. Stanford
6. Norwestern
7. Yale
8. University of Pennsylvania
9. University of California at Berkeley
10. University of California at Los Angeles
11. University of Wisconsin
12. Columbia
13. University of Rochester
14. Cornell
15. University of Minnesota
16. University of Michigan

I don't know the basis of Klein's ranking. If one were to ask me which schools in the U.S. are considered the most prestigious among mainstream economists, I might have named seven from this list. Maybe Northwestern is higher than I expect, and Columbia is lower. I suppose one could offer further quibbles

Does Depression, V. 2, Require Economists To Reconsider Theory?

Jeff Madrick reports little sign of the consideration of this question at the AEA/ASSA conference last week. Yves Smith comments on this question, and points us to a paper by Daron Acemoglu. I have yet to read Acemoglu's paper. Steve Keen makes a case for such reconsideration. (I wrote this post before reading this particular bit from Keen.) Peter Boettke asserts current events cannot challenge laissez faire economic policy because laissez faire has yet to be tried.

Hicks Invents Arrow-Debreu Model Of Intertemporal Equilibrium

"It is possible, at the other extreme, to conceive of an economy in which, for a considerable period ahead, everything was fixed up in advance. If all goods were bought and sold forward, not only would current demands and supplies be matched, but also planned demand and supplies. In such a 'Futures Economy' ... plans would be co-ordinated; and, for practical purposes, expectations would be co-ordinated too. (The price which would govern a firm's planned output for a particular future week would be the futures price, and not its own individual price-expectation.)" -- J. R. Hicks, Value and Capital: An Inquiry into Some Fundamental Principles of Economic Theory, Second edition, Oxford University Press, p. 136

Hat tip to Pierangelo Garegnani.

A Troll Is A Trail

"[Miss Ingram] entered into a discourse on botany with the gentle Mrs. Dent. It seemed Mrs. Dent had not studied that science: though, as she said, she liked flowers, 'especially wild ones;' Miss Ingram had, and she ran over its vocabulary with an air. I presently perceived she was (what is vernacularly termed) trailing Mrs. Dent; that is, playing on her ignorance--her trail might be clever, but it was decidedly not good-natured." -- Charlotte Bronte, Jane Eyre, Chapter 17

The Meaning Of A Word Is Its Use In The Language

The economy is never in equilibrium, or so many heterodox economists say. Being a Joan Robinson fan, I'm likely to agree. To understand the implications of the idea, and the use and abuse of equilibrium analysis, one must understand what economists mean by "equilibrium".

Tyler Cowen and Richard Fink provide an example of abuse, that is, a confusion about the implications of the economy not being in equilibrium. In the following passage, Cowen and Fink explicitly put aside income effects, false prices, strategic behavior, etc.:

"all that the Rothbard-Mises analysis implies is that there is a tendency towards equilibrium in a world with frozen data. Of course, this implies little or nothing about whether there is a tendency towards equilibrium in a world where the data are not frozen. All that [Evenly Rotating Economy] theorists are saying is that, if we freeze the disequilibrating forces, then the equilibrating forces will prevail. But on this basis we may likewise assert a tendency towards disequilibrium. By allowing the data to change just as it does in the real world, and 'freezing' all individual learning, we can demonstrate that the economy would degenerate into a series of successively less-coordinated states of disequilibrium. However, this would clearly be an illegitimate proof of a real world tendency towards disequilibrium..." -- Tyler Cowen and Richard Fink, "Inconsistent Equilibrium Constructs: The Evenly Rotating Economy of Mises and Rothbard", m V. 75, N. 4 (Sep. 1985): 866-869

(Hat tip to Matthew Mueller.) If there were a tendency, with frozen data, towards a ERE, the time path of the ERE corresponding to the data at each moment of time would show the tendency of the economy as a function of time. This is not the only point at which Cowen and Fink are confused.

What economists mean by equilibrium is not a simple question. Economists use the word "equilibrium" in many ways. The number of such ways has proliferated with the development of game theory. In this post, I compare and contrast only two uses of the word "equilibrium". And I think I don't fully explicate even these two uses.

The economy can be said to be in equilibrium when the following two conditions are met:

• The quantity supplied equals the quantity demanded of all commodities with positive prices
• The quantity supplied does not fall below the quantity demanded of all goods with zero prices.

This definition is specific to a particular neoclassical theory (or model).

Another definition comes out of the mathematical abstraction of a dynamical system. A dynamical system specifies how state variables change at any momement of time as a function of the location in state space. For example, a system of differential equations can define a dynamical system:

dx(t)/dt = f(x(t))

A limit point is a location, x, in the state space such that that location does not change with respect to time as function of the system dynamics. In other words, f(x) is zero at a limit point. Certain loci, other than the set of limit points, are of interest in dynamical systems. I am thinking specifically of limit cycles, strange attractors, and non-wandering sets. Consider a model of the economy as a dynamical system. The economy is in equilibrium, by a dynamical systems definition, when it is at a limit point.

The definition of equilibrium as equating supply and demand can be read as a special case of the definition of equilibrium as a limit point in a dynamical system. The tâtonnement process is a model of a type of dynamical system. Equilibrium, in the sense of a limit point in this system, is equilibrium in the sense of no excess demand for goods.

But Keynes can be read as suggesting the dynamical system definition of equilibrium need not equate supply and demand, particularly in the labor market. That is, Keynes' view of the possibility of the existence of an equilibrium with unemployment is more general and points to a non-neoclassical theory of prices.

Debauched By Economics

The following is a letter Sraffa sent to Robinson in 1936:

King's College, Cambridge
27.10.36

Dear Joan

Many thanks for your letter – it is a valuable addition to my museum and I shall hang it next to an extract from Sidgwick where, after lecturing Ricardo on how meaningless it is to talk of a quantity of labour, goes on cheerfully himself to talk of quantities of utility.

If one measures labour and land by heads or acres the result has a definite meaning, subject to a margin of error: the margin is wide, but it is a question of degree. On the other hand if you measure capital in tons the result is purely and simply nonsense. How many tons is, e.g., a railway tunnel?

If you are not convinced, try it on someone who has not been debauched by economics. Tell your gardener that a farmer employs 10 men – will he not have a pretty accurate idea of the quantities of land and labour? Now tell him that he employs 500 tons of capital, and he will think you are dotty – (not more so, however, than Sidgwick or Marshall).

Yours
P.S.

This Is Not A...

...mural by Diego Rivera. This mural, from which Figure 1 is a detail, replaced one by Diego Rivera. John D. Rockefeller, Jr., was displeased by the commie imagery in Rivera's mural.

Figure 1: Detail Of Jose Maria Sert's American Progress at Rockefeller Center

I also had a chance to see a cubist painting by Rivera, at the Musuem Of Modern Art. In general, I am not a fan of cubism.

Figure 2: Diego Rivera Painting at MOMA

I deliberately did not stay in New York City over new year's eve.