Marginal Productivity? Think Again

May 13, 2014 3 comments

I am writing  a paper on inequality and the crisis,  for which I used Piketty and Saez ‘s World Top Income Database to try to understand whether the distributional effect changed over time. Unfortunately their data cover 2012 only for a handful of countries, among which are the United States; waiting for new data here is the evolution of income percentiles, including capital gains, from 2007 to 2009 (yellow bars), and from 2009 to 2012 (red bars):

US_Top_Incomes

The financial crisis of 2007-2008 mainly hit asset prices, thus having a major impact on the richest layers of the income distribution. In fact, the top 0.1% to 0.01% (a handful of people) lost more than 40% of their income in real terms, while average income of the bottom 90% dropped of around 10%. This was short-lasted, nevertheless, as the prolonged recession, and the jobless recovery that followed, quickly restored, and further deepened the distance between the rich on one side and the middle and lower classes on the other.  Since 2009 average income of the bottom 95% stagnated (for the bottom 90% it kept decreasing). Nothing really new, here. The iAGS 2014 report, to which I (marginally) contributed, reaches similar conclusions. But I thought it would be interesting to share it.

And while we are at it, here are the ratios of average income of those at the very top, with respect to income of the bottom 90% (from the same dataset):

US_Top_Incomes_Ratios

The top 0.1%-0.01%, the same handful of people as before, has an average income that is 120 times the average income of the bottom 90%. This is also barely breaking news…

Now, as we all know, the traditional view on income distribution states that  factors of production are paid according to their contribution to the production process (their “marginal productivity”). Within this traditional view, the recent steep increase of inequality would be explained by skill-biased technical progress and increased competition in the globalized labor market: the entrance in the global labor market of low-skilled workers from emerging and developing economies lowered the average marginal productivity of labor, thus reducing its share of national income. Increasing inequality would then be an ineluctable process that policy is not supposed to address, if not at the price of reduced efficiency and growth. Is this a caricature? Not so much. in his recent Project Syndicate comment on Piketty, Kenneth Rogoff proposes once again the old tradeoff between inequality and growth that the crisis seemed to have buried once and for all (just look at the widely cited IMF discussion paper  by Ostry et al). The traditional view is alive and kicking, and those who oppose it are dangerous liberal extremists! After all, Rogoff tells us, the tide raises all boats…

The bottom line is that if a top executive makes on average 120 times the wage of his or her employee, well, this means that he or she is 120 times more productive. Rent seeking and political capture play no role in explaining the difference in pay. Circulez, il n’y a rien à voir…

Nothing new under the sky, I guess. But it is important, from time to time, to send out reminders.

Wrong Debates

May 9, 2014 1 comment

Paul Krugman has a short post on the Eurozone, today (I’d like him to write more about us; he has been too America-centered lately), pointing out that the myth of fiscal profligacy is, well, just a myth. in fact, he argues, the only fiscally irresponsible country, in the years 2000 was Greece. It is maybe worth reposting here a figure that from an old piece of this blog, that since then made it into all my classes on the Euro crisis: Fig1PostMArch16
The figure shows the situation of public finances in 2007, against the Maastricht benchmark (3% deficit and 60% debt) before the crisis hit. As Krugman says, only one country of the so-called PIIGS  (the red dots) is clearly out of line, Greece. Portugal is virtually like France, and Spain and Ireland way better than most countries, including Germany. Italy has a stock of old debt, but its deficit in 2007 is under control.

So Krugman is right in reminding us that fiscal policy per se was not a problem before the crisis; And yet, what he calls fiscal myths, have shaped policies in the EMU, with a disproportionate emphasis on austerity. And even today, when economists overwhelmingly discuss unconventional measures available to the ECB to contrast deflation, fiscal policy is virtually absent from the debate and continued fiscal consolidation is taken for granted. I will write more on this in the next days, but it is striking how we aim at the wrong target.

Reforming Europe

May 6, 2014 2 comments

I just finished editing a collective volume, in English and in French, on possible ways to reform Europe. Here is the blog post that presents it:

What Reforms for Europe?

by Christophe BlotOlivier RozenbergFrancesco Saraceno  et Imola Streho 

From May 22 to May 25, Europeans will vote to elect the 751 Members of the European Parliament. These elections will take place in a context of strong mistrust for European institutions. While the crisis of confidence is not specifically European, in the Old Continent it is coupled with the hardest crisis since the Great Depression, and with a political crisis that shows the incapacity of European institutions to reach decisions. The issues at stake in the next European elections, therefore, have multiple dimensions that require a multidisciplinary approach. The latest issue of the Debates and Policies Revue de l’OFCE series (published in French and in English), gathers European affairs specialists – economists, law scholars, political scientists – who starting from the debate within their own discipline, share their vision on the reforms that are needed to give new life to the European project. Our goal is to feed the public debate through short policy briefs containing specific policy recommendations. Our target are obviously the candidates to the European elections, but also unions, entrepreneurs, civil society at large and, above all, citizens interested by European issues.

In the context of the current crisis, the debate leading to the next European elections seems to be hostage of two opposing views. On one side a sort of self-complacency that borders denial about the crisis that is still choking the Eurozone and Europe at large. According to this view, the survival of the euro should be reason enough to be satisfied with the policies followed so far, and the European institutions evolved in the right direction in order to better face future challenges.

At the opposite, the eurosceptic view puts forward the fundamental flaws of the single currency, arguing that the only way out of the crisis would be a return to national currencies. The different contributions of this volume aim at going beyond these polar views. The crisis highlighted the shortcomings of EU institutions, and the inadequacy of economic policies centered on fiscal discipline alone. True, some reforms have been implemented; but they are not enough, when they do not go in the wrong direction altogether. We refuse nevertheless to conclude that no meaningful reform can be implemented, and that the European project has no future.

The debate on Europe’s future and on a better and more democratic Union needs to be revived. We need to discuss ways to implement more efficient governance, and public policies adapted to the challenges we face. The reader nevertheless will not find, in this volume, a coherent project; rather, we offer eclectic and sometimes even contradictory views on the direction Europe should take. This diversity witnesses the necessity of a public debate that we wish to go beyond academic circles and involves policy makers and citizens. Our ambition is to provide keys to interpret the current stakes of the European debate, and to form an opinion on the direction that our common project should take.

The volume can be downloaded  in French and in English, and for free!!

 

ECB: One Size Fits None

March 31, 2014 18 comments

Eurostat just released its flash estimate for inflation in the Eurozone: 0.5% headline, and 0.8% core. We now await comments from ECB officials, ahead of next Thursday’s meeting, saying that everything is under control.

Just this morning, Wolfgang Münchau in the Financial Times rightly said that EU central bankers should talk less and act more. Münchau also argues that quantitative easing is the only option. A bold one, I would add in light of todays’ deflation inflation data. Just a few months ago, in September 2013, Bruegel estimated the ECB interest rate to be broadly in line with Eurozone average macroeconomic conditions (though, interestingly, they also highlighted that it was unfit to most countries taken individually).

In just a few months, things changed drastically. While unemployment remained more or less constant since last July, inflation kept decelerating until today’s very worrisome levels. I very quickly extended the Bruegel exercise to encompass the latest data (they stopped at July 2013). I computed the target rate as they do as

Target=1+1.5\pi_{core}-1(u-\overline{u}).

(if you don’t like the choice of parameters, go ask the Bruegel guys. I have no problem with these). The computation gives the following:

EMU_Taylor_March_2014

Using headline inflation, as the ECB often claims to be doing, would of course give even lower target rates. As official data on unemployment stop at January 2014, the two last points are computed with alternative hypotheses of unemployment: either at its January rate (12.6%) or at the average 2013 rate (12%). But these are just details…

So, in addition to being unfit for individual countries, the ECB stance is now unfit to the Eurozone as a whole. And of course, a negative target rate can only mean, as Münchau forcefully argues, that the ECB needs to get its act together and put together a credible and significant quantitative easing program.

Two more remarks:

  • A minor one (back of  the envelope) remark is that given a core inflation level of 0.8%, the current ECB rate of 0.25%, is compatible with an unemployment gap of 1.95%. Meaning that the current ECB rate would be appropriate if natural/structural unemployment was 10.65% (for the calculation above I took the value of 9.1% from the OECD), or if current unemployment was 11.5%.
  • The second, somewhat related but more important to my sense, is that it is hard to accept as “natural” an unemployment rate of 9-10%. If the target unemployment rate were at 6-7%, everything we read and discuss on the ECB excessively restrictive stance would be significantly more appropriate. And if the problem is too low potential growth, well then let’s find a way to increase it

Overheat to Raise Potential Growth?

March 19, 2014 4 comments

Update, March 20th: Speaking of ideological biases concerning inflation, Paul Krugman nails it, as usual.

On today’s Financial Times, Phillip Hildebrand gives yet another proof of unwarranted inflation terror. His argument is not new: In spite of the consensus on a weak recovery, the US economy may be close to its potential , so that further monetary stimulus would eventually be inflationary.

He then deflects (?) the objection that decreasing unemployment reflects decreasing labour force participation rather than new employment, by suggesting that it is hard to know how many of the 13 millions jobs missing are structural, i.e.not linked to the crisis. I think it is worth quoting him, because otherwise it would be hard to believe:

However, an increasingly vocal group of observers, including within the Fed, posits that more of the fall in the participation rate appears to have been structural than cyclical, and it was even predictable – the result of factors such as an ageing workforce and the effect of technology on jobs.

(the emphasis is mine). Now look at this figure, quickly produced from FRED data: Read more

Commission Forecasts Watch – March 2014 Edition

March 13, 2014 1 comment

Last week the Commission published its second flash estimates for 2013 GDP growth. This allows to update an earlier exercise I had made on forecast errors by the Commission (around this time last year). This is what I had noticed at the time:

The Commission tends to be overly optimistic, and forecasts turn out to be in general higher than actual values. It should not be like this. While I expect a government to inflate a bit the figures, a non-partisan, technocratic body should on average be correct.
Related, it is also surprising that in November of the same year the Commission is still consistently overoptimistic (yellow bar). Let me restate it. This means that in November 2012 the Commission made a mistake on GDP growth for 2012. November!

I had concluded that there was a likely political bias in the Commission’s forecasts, with excessive optimism used to deflect criticisms of austerity. I also ventured in a quick and dirty estimate of the range for GDP growth in 2013, based on the Commission’s past errors. Actual growth turned out to be -0.5%, i.e. at the lower bound of my range (and below the forecast of the time by the Commission, that was -0.3%). I must nevertheless confess that my range was rather wide…

But what about this year? Read more

Wanted: German Inflation

March 6, 2014 7 comments

The latest Eurostat release on inflation shows that the Eurozone, and the EU at large, keep flirting with deflation. This happens mostly because peripheral countries have near-zero inflation rates.  Strikingly, no EU country had, in January, annual inflation rates above the  2% ECB target (Finland and the UK stood at 1.9%). Deflation is a problem for debtors, who see the real value of their debt increase. It is a problem for macroeconomic policy (in particular monetary policy). But it is also a problem for rebalancing. The imbalances that built over the period 1999-2007 show up in diverging inflation rates and labour costs. Take the former, from Eurostat data: Read More