Thursday, November 23, 2017

Sources of Income 1929-2016


Stacked FRED Graph showing Relative Shares of Income since 1929
Top to bottom: Interest income
Dividends
Rental Income
Proprietor's income
Transfers
Compensation of Employees

Source: FRED Table 2.1. Personal Income and Its Disposition: Annual

Wednesday, November 22, 2017

Hey Tom


Remember when I said

I predict a boom of "golden age" vigor, beginning in 2016 and lasting eight to ten years. It has already begun. In two years everyone will be predicting it.

Tom, you said

Art goes out on the limb.

Remember? That was 19, almost 20 months ago. Have you noticed that the mood is more upbeat now? Rather than predicting recession, people seem to think we can get 3% growth.

We'll beat 3%.

Tuesday, November 21, 2017

Six years ago at Asymptosis...


Concise, clear, and correct:
Ultimately, of course, private debt and interest charges on that debt needs to be paid off from real-economy income. Asset prices can’t rise forever.

Economists will tell you that gross debt levels don’t matter because one person’s debt is another’s holdings. (Net: zero.) They ignore it.

But if the gross private debt is too large, the real assets in the real economy can’t generate enough income to pay it off. Not really complicated, conceptually.

Monday, November 20, 2017

The return and maintenance of economic vigor


I started predicting vigor in March of 2016. Then in July 2016 I showed a graph of Household Debt Service Payments at a low point and ready to rise:
I called vigor because financial costs are down:
Graph #4: The Fall and Rise of Household Debt Service Payments
Financial costs have fallen from 13% to 10% of Disposable Personal Income. And now consumers have 3% of DPI to play with. Look at the extreme right end of the blue line on the graph: The line is starting to go up again. Already.

In March I said "We are at the bottom now, ready to go up." Four months later I showed it going up. Debt service is starting to go up again already, I said.

But then, a year after my original prediction of vigor, commenting in March 2017 on the graph shown above, I said

The uptick at the end of Graph #4 seems to have fizzled out. The link shows TDSP thru the end of 2016: https://fred.stlouisfed.org/graph/?g=db7Y

Unfortunately, I wasn't clever enough to capture the graph as an image, and TDSP has since changed. The link in my comment doesn't show what I was looking at in March of 2017, which was something like the red line here:

Graph #1: Household Debt Service as of March 2016 (blue) and March 2017 (red)
The tiny uptick at the right end of the blue line was gone (or perhaps just slightly lower, now that I see this comparison!) and the newer data was flat. But I was still confident. "Vigor will come," I said.


When I looked just now at the graph linked in my March comment, it was the current version. The data had been revised, and the flat end was gone. Debt service is rising again. It is struggling to rise (as you might expect following a debt crisis, while people remain cautious) but it is rising. I marked up an interesting similarity:

Graph #2: Household Debt Service as of October 6 2017
Two very brief, very tiny maximums in the data, one after each major decline.

I expect what happens after the second tiny maximum will look a lot like what happened after the first: uptrend, a sign of economic vigor. And since the more recent major decline is much bigger, I expect the uptrend will also be bigger this time. We will see economic vigor again, for perhaps a decade.

All that remains is for us to take advantage of the good years: Use the time to prevent another decade of bad years. All we need to do is limit debt growth to something sustainable. Better yet, we should seek the debt-to-GDP ratio that's most conducive to growth. We want to be like a surfer riding a wave of debt, where the wave carries us forward at speed but does not grow to the size of a mountain.

It can be done. To have a vigorous economy, we need lots of borrowing (and that day is coming). But lots of borrowing creates lots of debt. The obvious solution is to pay down debt: to pay down debt faster than we have done in the past. We need policy to make that happen.

Accelerating the repayment of debt may slow the economy some. But so does raising interest rates. We can use accelerated repayment of debt as an anti-inflation policy, along with the interest rate hikes that policymakers already rely on. If accelerated repayment is used, rate hikes will be needed less. And debt will be lower.

But there is something else: Raising interest rates affects all new borrowing, and that curtails economic growth. That's not the best outcome. Accelerated repayment of debt, on the other hand, affects people who have already borrowed. It only slows the economy for those people. People planning to borrow are not hindered by this new approach to inflation control, so economic growth is less severely reduced.

The new policy has to allow for the fact that we're starting with a high level of debt. It must reduce debt gradually, so that people are not thrown into crisis by it. That may seem to defeat the purpose, but it does not. As long as debt is going down, we're on the right track. And almost immediately after the level of debt begins to fall, the economy will begin to improve.

We never had policy that accelerates the repayment of debt. That's the reason private debt got so big. We have lots of policies that encourage the use of credit, and none to encourage repayment. To make policy more balanced, more sensible, we need policies that accelerate the repayment of debt. This way we can keep policies that encourage credit use (and enjoy the growth that results from those policies) but avoid having debt grow to an unsustainable level.

We still do have a mountain of debt to deal with. Some people might worry that "accelerated repayment" would make life difficult for debtors. But there is no reason the policy should be punitive. At the start, the new policy must help us reduce our debt: It must not be punitive. Once debt falls back to a level that is compatible with a vigorous economy (and stabilizes there) the policy can be made neutral. It need never be punitive.

Sunday, November 19, 2017

Financial Cost (4): F over N


Table 1.14 shows "Gross value added of corporate business" along with a list of the component parts of GVA. The table also shows GVA of "financial corporate business" and of "nonfinancial corporate business". There's no list of components for financial corporate, but there is one for nonfinancial corporate.

Add financial and nonfinancial GVA together on a graph, and they completely cover over the "corporate business" GVA. It's a near perfect match. So I'm thinking I can take the "corporate business" component list and subtract the "nonfinancial corporate" component values, and this will give me the "financial" components. Then I can compare the financial and nonfinancial corporate data.

I'll remind you that what they call "nonfinancial" I call "productive" business, and that what they call "financial" I call "nonproductive". For some reason, they put financial ahead of nonfinancial in Table 1.14. I'd put them the other way around, and use my labels. I guess it depends what you think is more important.


Here's financial-relative-to-nonfinancial GVA (red) nicely centered on corporate-minus-nonfinancial-relative-to-nonfinancial GVA (blue):

Graph #1: Financial GVA relative to Nonfinancial GVA
Since using "corporate less nonfinancial" gives me a perfect "financial", I'll just call it "financial" when I do the "corporate minus nonfinancial" calculation. Less messy. And then, to make sense of the descriptions of what the graphs show, I want to use abbreviations. I'll use a prefix letter, either F for financial or N for nonfinancial. And to describe the data, I'll follow the prefix with one of these:

 CE  Compensation of Employees 
 OS  Operating Surplus 
 GVA  Gross Value Added 

So, for example, the above graph is abbreviated as FGVA/NGVA, the ratio of financial to nonfinancial Gross Value Added.


For Compensation of Employees, financial gained on nonfinancial from 1945 to 1980, and then gained on it even faster:

Graph #2: Compensation of Employees, Financial relative to Nonfinancial: FCE/NCE
The graph starts at 1929, so there is not much to go on regarding the run-up to the Great Depression. But it looks as if FCE was high and gaining on NCE before and during the Great Depression, fell during the "correction", then rose again to the crisis. Looks like a high level of finance (F relative to N) is a sign of trouble. This reminds me of my Debt-per-Dollar graph.


In part (3) of this series of posts I had in mind to subtract net interest from corporate profits, but I found out that net interest is not included in corporate profits, so I threw that idea away. For the graph below, I went the other way: I used Operating Surplus, which is profits plus net interest plus some other thing.

Graph #3: Operating Surplus, Financial relative to Nonfinancial: FOS/NOS
For Operating Surplus, financial gained on nonfinancial consistently, with an interruption every 20 years or so. Some kind of cycle, maybe? It looks like the interruptions are getting longer and longer. I wonder if that's a good thing or a bad thing. Maybe it depends on how high the line is getting. Maybe low and short and good go together; and then high and long and bad go together. That could be useful policy guidance (if true).

I noticed that coming out of WWII, compensation of employees (Graph #2) increases from 0.04 to something over 12 by the end of the graph. But the operating surplus (Graph #3) increases to maybe 25 by the end. I got the impression that the operating surplus (net interest and profit) is increasing quite a bit faster than employee compensation.

Is it? Look at the CE ratio relative to the OS ratio, Graph #2 divided by Graph #3:

Graph #4: Compensation of Employees F/N Ratio relative to Operating Surplus F/N Ratio
(FCE/NCE)/(FOS/NOS)
Looks pretty flat to me, bottoming repeatedly at the 0.5 level. So I have to think the employee compensation and operating surplus F-to-N ratios are increasing at about the same rate. The one big anomaly occurs at the Great Recession. And, possibly, there are cyclical highs where Graph #3 shows cyclical lows. But there is no reliable up- or down-trend that I can see. So it looks to me that the operating surplus is neither gaining ground nor losing it relative to employee compensation. At least not in the financial relative to nonfinancial corporate data.

So I'm left thinking that the problem, if one is visible in this data, the problem is not found in the increase of profit and interest relative to employee compensation. Rather, the problem would have to be in the growth of corporate finance in general, relative to nonfinancial corporate business. That problem is clearly visible in Graph #1.


// The Excel file

Saturday, November 18, 2017

Financial Cost (3), aborted


I want to take "net interest" out of corporate profits, and compare what's left to "gross" interest paid.

If you look at National income: Domestic business: Corporate business: Compensation of employees at FRED, down near the bottom of the page they show RELEASE TABLES. Clicking the link for Table 1.14 brings up a page that identifies the hierarchy of components of "Gross Value Added of Domestic Corporate Business in Current Dollars".

The table shows that net interest is not counted in corporate profits. So then, I don't have to subtract it out.

Friday, November 17, 2017

Financial Cost (2): Inspection


I want to use GVA (gross value added) as the context for profits and interest expense. Better than GDP in this case, I think, because the GVA I'm using is "Gross value added of corporate business". The Financial Times lexicon says

GDP is commonly estimated using one of three theoretical approaches: production, income or expenditure. When using production or income approaches, the contribution to an economy of a particular industry or sector is measured using GVA.

So the GVA number I'm using measures the part of GDP produced by corporate business. I think that's a good context number for corporate profits and corporate interest expense.

The data I downloaded for mine of the 12th (the data I'm using here) includes GDP and RGDP. (From these I can get price deflator values if needed.) Also: interest paid and compensation of employees for "domestic corporate business"; GVA for "corporate business"; and "corporate" profits. I'm pretty sure these data series (except GDP and RGDP) are all numbers for "domestic corporate business", but I don't know for sure. If you know something I don't, let me know.


First graph shows employee compensation, monetary interest paid, and corporate profit, each as a percent of corporate GVA:

Graph #1:
I should say right away that "monetary interest paid" is not a component of corporate GVA. It is a measure of all the interest expense of corporations, or gross interest. Only "net" interest is included in GVA. The reason for this, no doubt, is to avoid "double counting" of income. But cost is cost, so I'm looking at the bigger number. More on this later.

Employee compensation (blue) as a share of corporate GVA runs pretty stable (more stable than Labor Share, which seems to show decline since 1960), running above 60% until the year 2000, when it starts to drop.

Corporate profits (green) decline from about 25% of corporate GVA to just over 10%. They run low in the Reagan years (interesting!) but pick up a bit in the latter 1990s, then start rising just as labor share starts to drop. Profits are now running above 20% again.

Total corporate Interest paid (red) is shown as a percent of GVA for purposes of comparison. Interest starts out low, less than 2.5% of corporate GVA, but rises to 10% by 1970. It peaks at 27.4% of GVA in 1982, runs high while corporate profits run low (the Reagan years), and peaks at 28.5% in 1989. Thereafter, the trend is slowly downward, but with increasing volatility.

It appears that interest gained at the expense of profits in the 1980s, and that after 2000 profits gained on employee compensation ("labor"). For what that's worth.


To see the relative changes in the three series on the first graph, I divided each series by its 1947 value so all three series start with the value 1.0:

Graph #2:
Indexing the values that way really magnifies the "interest paid" numbers, because that data starts at such a low level. And because employee compensation was so high on the first graph and shows relatively little change, the variation in that series is reduced to almost nothing; here, the blue line is almost straight. The green line, not so high on the first graph and varying more than the blue, still shows some variation on the second graph.

The first graph emphasized the different sizes of the three data series. The second emphasizes the changes in size. The red line really stands out here, but the extreme flatness of the blue is equally noteworthy.


I took profits and employee compensation from Graph #1, and subtracted them from total corporate GVA to see how much of GVA remains for other corporate spending. That's the blue line here:

Graph #3:
I put the red line from Graph #1 on this graph for comparison. It starts significantly lower than the blue line, but catches up by around 1980, and doesn't drop off much after that.

"Interest paid" is a big number. Big, and mostly unnecessary.

Thursday, November 16, 2017

Financial Cost (1): Overview of the data


This graph shows "percent change" rates for the data downloaded for my post of 12 November. Annual data, so the graph shows "percent change from prior year".


The first tall spike we come to, above 40%, between 1948 and 1952, that yucky blue line shows corporate profits. Corporate profits are pretty volatile: The line peaks repeatedly, both upward and downward, and this behavior is consistent for the whole 1948-2016 period shown on the graph.

That volatility is the reason I'm doing this follow-up to mine of the 12th. In that post I looked at corporate data for 1955 through 1958, a brief period during which the growth of profits began by increasing 26% over the previous year, and ended by falling 12% below the previous year.

Those growth rates suggest that corporate profits were well above trend in '55 and well below trend in '58. I wasn't thinking about that when I wrote the post. I was working with those years because those were the years Samuelson and Solow considered in particular in their 1960 paper.

The differences from trend no doubt exaggerated the movements of my "interest cost relative to profits" ratio, giving me the ten-point increase in interest cost (from 15% to 25%) relative to profits. So I'm thinking my numbers exaggerated the situation, perhaps significantly. That's why I'm taking another look.

After the yucky blue line, the red line stands out as also highly volatile. That's the interest cost. This one shows more variation than do profits, across the whole 1948-2016 period. The red line is pretty tame before the mid-1960s, staying generally between 10% and 20%. Then from the mid-1960s to the early 1980s the red peaks grow increasingly higher, and the down-pointing peaks increasingly lower. The growing volatility in this period likely reflects the inflation of the time. Finally, since the mid-1980s the red line seems to show some increase over time, but I'd say the main feature is that the movements here are very much bigger than those before the mid-1960s. They are about equal in size to movements during the 1970s and early '80s, but run lower: During the Great Inflation the red line didn't want to go below zero; since the mid-80s it has been centered on the zero level.

The next  line that catches my eye is the gold one, Corporate Gross Value Added (GVA). This line shows little volatility, little vertical motion. It's chief function on this graph seems to be to hide the other lines that display little volatility: nominal GDP (purple) and Employee Compensation (dark blue).

The one line so far omitted from my review of the graph is the greenish line, which shows the growth of GDP with inflation removed from the numbers. This line is mostly hidden by the gold line, except during the years from the mid-1960s to the early 1980s. Again, this is the time of the so-called Great Inflation so we should expect to see the green line run low in these years. And the fact that it does run low supports the view that the growing volatility of the red line in those years "reflects the inflation of the time.

Notice that the gold line and the lines that it hides show a hint of uptrend during the years of inflation. This isn't news. But I want to mention it now so that maybe I won't be fooled by it when I'm lost in the details of my analysis of the numbers.

Sunday, November 12, 2017

Comparative advantage, economies of scale, and the cost of finance


Paul Krugman has an old paper titled How I Work which might be worth your time to read. I want to repeat a fragment of it here, for my own purposes. Krugman writes of his early days as an economist:

What had I found? The point of my trade models was not particularly startling once one thought about it: economies of scale could be an independent cause of international trade, even in the absence of comparative advantage. This was a new insight to me ...

"... within a few days," Krugman says, "I realized that I had hold of something that would form the core of my professional life." It was important to him, this little fragment which said not only comparative advantage, but also economies of scale drive international trade. It was important to him for personal reasons.

It is important to me because I read it this way:

not only comparative advantage, but other things also drive international trade.

It is important to me because it opens a door, the other things also door. And I know what I must bring through that door: the cost of finance.

That shouldn't surprise you. I always look at things in terms of the cost of finance.

Conservatives always gripe about the cost of labor. Liberals always grumble about profits. To my mind you need both wages and profits, if you are to have an economy. And, certainly, you also need finance.

But how much finance do you need? These days, we need a lot. Or, as I see it, we don't really need a lot of finance, but we sure do have a lot. And because we have a lot of finance, the cost of finance is high.

No, not just the rate of interest. Rather, the rate of interest applied to every dollar of debt. If there is not much debt, the cost of finance is low. If there is a lot of debt the cost of finance can be high, even when interest rates are low.

On the consumption side, the cost of finance reduces aggregate demand. On the production side, the cost of finance reduces profits and increases prices. A high cost of finance reduces demand and profits, both, and creates an economy in decline, the kind of decline we have endured now for decades. The cost of finance is a crucial consideration. That's why I talk about it all the time. But set all that aside.

In addition to reducing demand and reducing profits, the cost of finance also adds to the cost of products. It contributes to the increase of prices. (And this does not consider the effect finance has on the quantity of money, and the "inflation is always a monetary phenomenon" thing. But set that phenomenon aside.)

When the cost of finance is rising, it increases costs. It makes output more costly.


In Krugman's "How I Work" paper he says he doesn't worry that his assumptions might be unrealistic. He worries about not knowing what his assumptions are. There are some problems with that approach, but I'll go with it for now. I'll assume that the level of finance was at its best around 1955. You might think 1955 is an unrealistic date. I think it's not far off. But if it makes the reading easier, you can assume I picked a more reasonable date -- still decades ago, but not so many decades ago. That would make the latter 1950s a premonition of what was to come. I can live with that.

By "the level of finance was at its best" I mean that when finance was less, it hindered economic growth more, and that when finance was more it also hindered growth more. I imagine something like a "Laffer curve" for the optimum size of finance. If my Laffer curve comparison doesn't make sense to you, don't worry about it.

In 1960, looking back at the latter 1950s, Samuelson and Solow wrote:
... just by the time that cost-push was becoming discredited as a theory of inflation, we ran into the rather puzzling phenomenon of the 1955-58 upward creep of prices, which seemed to take place in the last part of the period despite growing overcapacity, slack labor markets, slow real growth, and no apparent great buoyancy in over-all demand.

In the end, Samuelson and Solow could not reject the cost-push explanation:
We have concluded that it is not possible on the basis of a priori reasoning to reject either the demand-pull or cost-push hypothesis ...

Ten years later, Federal Reserve Chairman Arthur Burns was pointing to the increases in employee compensation as the driver of inflation. Robert Hetzel quotes from the Board of Governors Minutes for November 1970, that Burns thought in terms of "cost-push inflation generated by union demands."

Perhaps by 1970 union demands were driving inflation. But in the latter 1950s? In the latter 1950s, the rising cost of finance was squeezing profits.

Growing financial cost got the inflation ball rolling. Union demands took the hit for it later, and perhaps rightly so. But union demands did not create the initial problem. The rising cost of finance got inflation going, and kept it going until a wage-price spiral emerged.

For domestic corporate business, financial cost increased faster than the compensation of employees:

Graph #1: Interest Costs Increased Faster Than Compensation of Employees
Consider the 1955-1958 period, the years that concerned Samuelson and Solow. For every dollar corporations paid out as employee compensation in 1955, they paid out five cents for interest costs. By 1958 that number was seven cents. For every dollar of employee compensation they paid out, corporate business spent two cents more on interest in 1958 than in 1955. Financial costs gained on labor costs.

Financial costs also gained on profits:

Graph #2: Interest Costs Increased Faster Than Corporate Profits
For domestic corporate business, financial costs increased faster than profits. Between 1955 and 1958, corporate interest costs rose from 15 cents to 25 cents per dollar of corporate profits: a ten-cent increase in interest costs, ten cents for every dollar of profit.


If financial costs had grown more slowly, if they had grown at the same rate as profits, say, how would the world have been different?

In 1955, corporate business interest paid totaled $7.3 billion, something less that 15% of profits. In 1958, interest paid came to $11.4 billion, something more than 25% of profits. Other things unchanged, if interest paid in 1958 remained at the 1955 percentage, the cost of interest would have been about $6.4 billion. This is $5 billion less than the actual 1958 cost of interest.

If this $5 billion expenditure had not happened, other things unchanged, corporate profits would have been $5 billion higher.

But I can't add that $5 billion to corporate profit, because it changes my interest-to-profit ratio. It throws the calculation off. In order to work thru the calculation cleanly, we cannot add the $5 billion of interest savings to corporate profits, nor to any corporate spending category. The only way to dispose of the $5 billion is to reduce gross corporate revenue by reducing the price of the corporate product.

In 1958, the gross value added (GVA) to the economy by corporate business amounted to $256.9 billion. If we reduce the price of GVA by $5 billion, the reduced number is $251.9 billion. The reduced GVA number is 98% of the actual number. So, to make the calculation work we have to reduce the price of corporate output by 2%.

If corporate interest costs in 1958 remained in the same proportions as 1955, corporations could have reduced their prices by 2% without reducing their profits and without reducing the wages and benefits paid to their employees. Without reducing any of their spending, other than interest.

This is an exercise in "other things unchanged". Ceteris paribus. The assumption is not realistic. But the numbers tell an honest tale: The cost of interest increased faster than other corporate business costs, fast enough to push prices up 2% between 1955 and 1958.

This suggests a different conclusion for the Samuelson-Solow paper: identification of cost-push as the cause of the 1955-1958 inflation.


How did the rising cost of finance affect the economy?

In 1962, President Kennedy was "jawboning" the steel companies, trying to talk them out of raising prices. They raised prices anyway. In response then,

Kennedy launched investigations by the FTC and Justice Department into collusion and price rigging by the steel companies [and] threatened to break Pentagon contracts with U.S. Steel.

The steel companies acquiesced, rolling back the price hike. But they raised prices anyway the following year. This cannot have been simply

a tiny handful of steel executives whose pursuit of private power and profit exceeds their sense of public responsibility

as Kennedy claimed. The price increase was driven by financial cost pressures that Kennedy could not see. "Operating cost" pressures, according to encyclopedia.com:

Profits were being squeezed between rising operating costs and relatively stable prices, and in April 1962 U.S. Steel unexpectedly announced an across-the-board price increase ...

Kennedy was looking for a wage-price spiral. The steel price hike was not part of a wage-price spiral. In March of 1962 the Steelworkers accepted a contract that gave them no wage increase. In April, the price of steel increased 3.5%. The source of the cost pressure was not labor, but finance.


In 1965, on the last day of the year, in its renowned We Are All Keynesians Now article, Time magazine wrote:

First the U.S. economists embraced Keynesianism, then the public accepted its tenets. Now even businessmen, traditionally hostile to Government's role in the economy, have been won over—not only because Keynesianism works but because Lyndon Johnson knows how to make it palatable. They have begun to take for granted that the Government will intervene to head off recession or choke off inflation, no longer think that deficit spending is immoral. Nor, in perhaps the greatest change of all, do they believe that Government will ever fully pay off its debt, any more than General Motors or IBM find it advisable to pay off their long-term obligations; instead of demanding payment, creditors would rather continue collecting interest.

The "greatest change of all" was acceptance of the view that government would act more like business, rolling debt over rather than paying it off.

That change didn't last. Already in 1964, Ronald Reagan had spoken on behalf of Presidential candidate Barry Goldwater. Reagan:

Today, 37 cents of every dollar earned in this country is the tax collector's share, and yet our government continues to spend $17 million a day more than the government takes in. We haven't balanced our budget 28 out of the last 34 years. We have raised our debt limit three times in the last twelve months ...

In 1980, Reagan himself was elected President in a landslide. "We don’t have a trillion-dollar debt because we haven’t taxed enough," he said; "we have a trillion-dollar debt because we spend too much." By 1980, the greatest change of all was that people had come to believe the Federal debt must be reduced. So much for being all Keynesian.

But notice what was not a change in 1965: businesses did not "find it advisable to pay off their long-term obligations". Accumulating debt was standard practice. For the longest time, people thought it was okay if private debt increased. I guess that did finally change, about ten years back. But here's the thing: Corporate interest costs ran neck-and-neck with profits in 2003-2005. Other than that, interest costs were higher than corporate profits from 1980 to the crisis.

Corporate business interest costs were only 15% as much as profits in 1955. By 1980, interest costs were more than profits. The growth of financial cost, a trend visible in the late 1950s, continued to 1980 and continued on to the crisis.


By 1970 one could easily see that wage hikes were driving inflation, because employee compensation is a far larger number than the cost of interest. And by 1970, everyone was trying to catch up with everyone else. Inflation had become self-sustaining. But how, in the latter 1950s, with "no apparent great buoyancy in over-all demand", how is "the 1955-58 upward creep of prices" to be explained? And then in the early 1960s, the price of steel? These were not stories of demand-pull inflation. They were cost-push stories. But the driving force was not compensation of employees or union demands or wages. The driving force was rising financial cost.

"Comparative advantage" makes some domestic products an international bargain, and this, as Paul Krugman writes, is a "cause of international trade". But the point of Krugman's trade models was to show that economies of scale can also make some products a bargain in foreign markets. The lesson we learn from Paul Krugman is that costs affect trade: Low costs increase trade. High costs reduce it.

In the US we rely on credit. Credit has a cost. The use of credit in the productive sector raises the prices of US products. If we rely more on credit than other nations, our financial costs will be higher than theirs. Those costs are reflected in the higher prices of our products. High prices make our products less competitive in international markets.

Increasing financial costs, by raising prices, may be to blame for a significant share of US trade deficits going all the way back to the 1970s.

The point of this essay is not particularly startling once one thinks about it: Despite the best comparative advantage and the greatest economies of scale, high financial costs can be an impediment to the export trade.

// The Excel file

Saturday, November 11, 2017

What was it that got the wage-price spiral started?


It had to be something other than the wage-price spiral.

What was the initial shock that started the Great Inflation? In Ronald Reagan and the Politics of Freedom, Andrew E. Busch says what everybody thinks -- it started with a wage-price spiral:


I disagree. There had to be some other "push" that got things started.


Wikipedia:

In macroeconomics, the price/wage spiral (also called the wage/price spiral or wage-price spiral) represents a vicious circle process in which wage increases cause price increases which in turn cause wage increases, possibly with no answer to which came first.

This is totally unsatisfactory!


From InvestingAnswers:

The general idea behind a wage-price spiral is a simple one of supply and demand. People can do only two things with money: save it or spend it. If they have more money on hand, they likely will spend at least some of that money. Accordingly, putting more money in people's hands creates more demand for goods and services. Thus, something like a wage increase across the board (think, for example, of a rise in the minimum wage) creates more demand for goods and services and drives up the prices of those goods and services.

So the Minimum Wage caused the Great Inflation? No.


From Chron:

When an economy is operating at near full employment and people have money to spend, demand for goods and services increases. To meet the demand, companies expand their businesses and hire more workers. However, at near full employment, most workers already have jobs. So companies have to lure workers with higher wages, which, of course, increases the companies' costs, explains the website Biz/ed. The workers then push for higher wages to meet the higher prices and expected price hikes, which increases company costs again. Theoretically, this continues in an inflationary spiral until a loaf of bread costs the proverbial wheelbarrow full of cash.

Full employment creates a wage-price spiral? That sounds reasonable...


So they're saying the 1965-1971 spike in employee compensation (relative to GDP) is what got the wage-price spiral going. But most of that spike occurred after the Great Inflation was already under way! And the other spikes, did they also cause wage-price spirals that led to Great Inflations?

And what about the 1960-65 decline in employee compensation? Prices were going up then, too. "Full employment" may be a plausible story of the Great Inflation, but it doesn't seem to explain how the wage-price spiral got started.

Thursday, November 9, 2017

David "Dirtbag" Ricardo


Wikipedia on David Ricardo:

He made the bulk of his fortune as a result of speculation on the outcome of the Battle of Waterloo. Prior to the battle, Ricardo posted an observer to convey early results of the outcome. He then deliberately created the mistaken impression the French had won by initially openly selling British securities. A market panic ensued. Following this panic he moved to buy British securities at a steep discount. The Sunday Times reported in Ricardo’s obituary, published on 14 September 1823, that during the Battle of Waterloo Ricardo "netted upwards of a million sterling", a huge sum at the time. He immediately retired, his position on the floor no longer tenable ...

In August 1818 he bought Lord Portarlington’s seat in Parliament for £4,000 ...

Wednesday, November 8, 2017

Slowly, people are recognizing that the economy is improving


30 Aug 2017: Trump's hope for 3% growth no longer looks so far-fetched at CNBC:

When President Donald Trump predicted that his policies would spur growth of 3 percent or more, a lot of economists didn't take him seriously. They may now.
...
"It's not just the GDP report. We've had a really steady stream lately, whether it's GDP or ADP or [jobless] claims or retail sales or confidence measures," said Jim Paulsen, chief investment strategist at the Leuthold Group.


8 Sept 2017: Two signs the US economy really is getting better, from World Economic Forum:

Forget the soaring stock market. Here's the real evidence the U.S. economy is getting better: Food stamp usage is down, and spending on entertainment — everything from Netflix to Disney World trips — is up.


27 October 2017: US economy on solid growth path from dw.com:

The world's largest economy has seen its total output expand by a rate that the US President had expected to see because of his tax and investment policy. But for all of 2017, the rate will be hard to maintain.
...
For all of 2017, forecasters believe the economy will grow at an annual rate of around 2.2 percent, rising to 2.4 percent next year.

Tuesday, November 7, 2017

The world is not digital


In a digital world, economic growth would look something like this:


But our world is not digital. Economic growth looks like this:


In our world it is difficult to tell what will happen next. In a digital world, it is true, the bottom could drop out at any time. But until it did, at least you would know whether your economy was "good" or not. Those would be the only choices in a digital world: It's good, or it's not good.

A digital world might offer a high level of confidence about the future. Our world offers only a low level of confidence about the future. Nevertheless, I confidently predict a good decade for the US economy. Where does my confidence come from, and why isn't everyone making similar predictions?


There are a couple different ways of looking at the economy. One way is to grab the most current data announcements you can find, because the most current announcements are nearest to what we want to know about: the future.

It's not a perfect method, because it doesn't really give you the future. But it does give you the closest thing.

The trouble with this method is that the world is not digital. The most current data announcements are up today and down tomorrow. Current data is all over the place. So you have to filter the facts, or prioritize the information, or assign weights to the data to determine what you think the future will look like.

The other way to look at the economy is to focus on everything but the most current data. Don't worry about the last ten minutes or (in this case) the last ten years. Focus instead on a lifetime of years before that. Look for patterns in that data. Give some weight to existing knowledge, and give almost as much weight to "heterodox" views, but always put the most emphasis on what you can see for yourself.


In Current GDP Growth Isn't Anything Special, Justin Fox is trying to see the future. He relies on the most current data announcements:

Real gross domestic product has now grown at an estimated annual rate of 3 percent or more in the U.S. for two quarters in a row (3 percent in the third quarter, 3.1 percent in the second).

"... but two quarters don't tell us much," he says. Fox reminds us that quarterly data is volatile and noisy. He considers looking at the 12-month change rather than one or two 3-month changes. That smooths things out a bit. And the longer wait provides more solid evidence. But when things finally do start getting better, you have to wait a year to get your evidence! And as Justin Fox says, "looking back four quarters is, well, backward-looking." It tells you about the past, not the future.

Fox has another thought: Look at different data, something less volatile than GDP. He references a 2015 study that uses "real final sales to private domestic purchasers". He looks at the most recent data for this series, and he writes:

By that metric, economic growth in the third quarter was just OK, at 2.2 percent... But there's really no sign from the GDP data yet that the slow-growth era is ending.

There might be a sign that the slow-growth era is ending. Those two most recent quarters of GDP growth might be a sign. We won't know for sure until the evidence is solid. But by the time the evidence is solid the improvement won't be news anymore. People want to know now. And if you have reasons for thinking that the economy is improving now, you want to talk about it now, not a year from now.

This goes back to the question that got me writing today: How can we know before it happens that the economy is improving?

Not by tracking the most recent data. You know it by studying the past until you think you understand how the economy behaves. After that, you start watching the recent data, looking for patterns that mimic patterns you've seen in the past. When you find those patterns, you make your prediction about the economy. Then you wait and see.

Recently I've been pointing out the most recent data myself: better productivity here, improved growth here and here. Upbeat data like that is not evidence; not yet. It will be, when there is enough of it. I point out such data to remind you of my prediction that our economy will soon be "good" for about a decade. Because in the context of my prediction, that data is evidence.

Hey, I could be wrong about the economy improving. But here's the thing. If I'm not wrong, then maybe the patterns I've found in the old data are significant. Maybe those patterns describe an area of study that economists ought to include in their work: Accumulated debt relative to the quantity of circulating money. Private debt relative to public debt. Debt service relative to income. Things like that. Today, economists nibble around the edges of such concepts, or miss them entirely.

That's why I so often bring up my prediction of a decade of vigor.


How do you predict the future? You want to look at what is sometimes called "fundamentals". Nobody ever defines fundamentals, of course. They only say the fundamentals are sound when they're telling us not to worry about some worrisome thing. But I'll tell you what "fundamentals" is, what my idea of it is: it is the cost of finance in comparison to the cost of labor and profit. And I'll tell you how it works: If the cost of finance is low, the economy can grow, and if the cost of finance is rising, the economy is growing. But if the cost of finance is high, there can be no vigor.

Monday, November 6, 2017

A psalm of balance


The use of credit gives the economy a boost, but also creates debt which eventually undermines the "boost" effect.

Policymakers are well aware that the use of credit boosts the economy. They create all sorts of policies to encourage the use of credit: deductible interest expense, financial deregulation, low interest rates and quantitative easing, for example.

Except in times of crisis, these policies cause the use of credit to grow at an accelerated rate. Therefore, debt ordinarily grows at an accelerated rate.

We have no policy designed to accelerate the repayment of debt. Therefore, debt grows at an accelerated rate until it accumulates enough to create a crisis.

If we insist on having policies that encourage the use of credit, then we must also have policies that accelerate the repayment of private debt.

Sunday, November 5, 2017

Shitting on the Cato guy


From Cato: Labor’s Share of GDP: Wrong Answers to a Wrong Question by Alan Reynolds.

The opening paragraph:
A recent paper by David Autor of MIT, Lawrence Katz of Harvard and others, “The Fall of the Labor Share and the Rise of Superstar Firms,” begins by posing a mystery: “The fall of labor’s share of GDP in the United States and many other countries in recent decades is well documented but its causes remain uncertain.”  They construct a model to blame it on U.S. businesses that are too successful with consumers.

"They construct a model to blame it on U.S. businesses that are too successful with consumers." The writing reeks of attitude. Attitude often makes for a good read, but it seldom makes for a good argument.

I'm interested because I have trouble understanding what "labor share" represents. I mean, at FRED, Labor Share for the business sector, and also for the nonfarm business sector, are shown as indexes, not as percent of GDP. I can guess that the indexes show changes in labor share as a percent of GDP over time, yes, but I can't tell what the percent values actually are.

There is a "Share of Labour Compensation in GDP" series with "ratio" units. It's a simple thing to get "percent" values from that one. And the overall trend of this series is like the others: downhill. But at a slightly closer glance it doesn't really match either of the "labor share" series. So I'm left hanging. I thought maybe the Cato article would help.

Heh.

Second paragraph:
Five broad industries, they found, became more dominated by fewer firms between 1982 and 2012: retailing, finance, wholesaling, manufacturing and services. But those aren’t industries at all, much less relevant markets: they’re gigantic, diverse sectors. Is all manufacturing becoming monopolized? Really? Census data ignores imports, but why ruin this bad story with good facts.

So the guy is complaining that Autor and Katz left out the word sectors? Because they said "industries" instead of "industrial sectors"? Really?

And again, attitude: Five gigantic, diverse sectors became more dominated by fewer firms, "but why ruin this bad story with good facts."

At last, in the third paragraph, a possibly useful observation:
Jason Furman and Peter Orszag found “the decline in the labor share of income is not due to an increase in the share of income going to productive capital—which has largely been stable—but instead is due to the increased share of income going to housing capital.”

The useful observation is Orszag and Furman's, not Cato's, but at least the Cato guy provides a link.

In paragraph four, Cato guy is complaining about "industries" versus "industrial sectors" again:
President Obama’s Council of Economic Advisers, under Jason Furman, nonetheless worried that the 50 [!] largest firms in just 10 “industries” (if you can imagine retailing and real estate to be industries) had a larger share of sales in 2012 than in 1997 ...

But yeah, I can imagine retailing and real estate as industries. Cato guy is being ridiculous. Finally, in the rest of paragraph four, he moves on to a different complaint:

They concluded that, “many industries may be becoming more concentrated.” Noah Smith, Paul Krugman and many others have suggested that this nebulous “concentration” allowed monopoly profits to rise at the expense of the working class, supposedly explaining labor’s falling share of GDP during the high-tech boom. A quixotic search for even one actual example of monopoly soon morphed into advice about using unconstrained antitrust to constrain Amazon, which is apparently feared to have monopoly profits invisible to the rest of us.

Now he cannot see the boom in corporate consolidation, and cannot figure out why monopoly might be a problem. And look what he does there at the end: "Invisible to the rest of us," he says. Cato guy takes us, his readers, and imagines we stand with him, blind to the monopoly profits that may or may not exist in the one particular place where my wife does all her shopping: Prime.

But forget that Cato crap about "invisible" profits which are "apparently feared" by some unidentified but obviously stupid bunch of people. Forget that. I'll tell you what really bothers me about Amazon. And it's not the so-called "free" shipping. What bothers me is that Amazon is doing to the rest of the economy what supermarkets and big-box did to Mom and Pop. Nobody even knows anymore what a mom-and-pop is. Amazon is doing the same to everyone else: Putting them out of business.

Paragraph five:
Research that starts with such a meaningless question as “labor’s share of GDP” was never likely to lead us to any profound answers. Workers do not receive shares of GDP – they receive shares of personal or household income.

I thought Cato guy might be on to something with that. Hey, you know? I always figure after a guy has two or three stupid ideas in a row he's bound to come up with a good one, just by dumb luck.

Nah. "Workers do not receive shares of GDP" he says, emphatically. But GDP is a measure of income. And workers do receive income. So it is okay to talk about “labor’s share of GDP”. Sure, to appease Cato guy, you could use GDI instead of GDP. But those two are really supposed to be equal, so Cato guy is complaining about nothing. Again.

That's enough. This Cato guy is not worth reading.


No, I can't let it go. I have to point out one more thing. Cato guy says

Workers do not receive shares of GDP – they receive shares of personal or household income.

Cato guy takes "labor share" and turns it into "worker's share". He takes the relevant macroeconomic concept (the split between labor and capital) and tosses it aside. In its place he puts you and your weekly paycheck. He brings it down to a personal level, and (bad as the argument is) we like him for it. Then he says that our weekly paychecks don't get counted in GDP. That part is just not true.

Cato guy turns "labor share" into a story of "the individual and his paycheck". And he tells us our weekly paychecks don't count in GDP. He mixes up ideas, and he lies.

Saturday, November 4, 2017

Excerpts


From mine of 7 April 2016:

I predict a boom of "golden age" vigor, beginning in 2016 and lasting eight to ten years. It has already begun. In two years everyone will be predicting it.


From mine of 3 March 2016:

This is not going to be your typical anemic recovery. This is going to be the full tilt, rapid output growth, rapid productivity growth, high performance boom.


From NEWS RELEASE: PRODUCTIVITY AND COSTS, Third Quarter 2017, Preliminary (PDF)

Nonfarm business sector labor productivity increased 3.0 percent during the third quarter of 2017... From the third quarter of 2016 to the third quarter of 2017, productivity increased 1.5 percent...

Friday, November 3, 2017

John Kay and Mary Bonsu on UBI


Paying everyone a basic income is not a realistic or fairer way to tackle poverty by John Kay at johnkay.com.

Frankly I prefer what Yves said. It is brief. It is clear. It presents specific objections that sound right to me. But John Kay tells an interesting tale. Here is part of it:
What goes around comes around, and Atkinson and Meade were themselves reprising a debate which had occurred 30 years before. At that earlier time, the two sides were represented by Lady Juliet Rhys Williams, the architect of social dividend, and Sir William Beveridge. Each had devised their schemes in reaction to the injustices of the 1930s

The Beveridge view was encapsulated in what he called social insurance. The idea was to eliminate poverty by eliminating the causes of poverty. The state should organise insurance against the contingencies of misfortune, such as disability, unemployment, sickness and old age. Beveridge envisaged that these benefits would be supplemented by minimal social support for the few people who fell through the cracks

In the Rhys Williams vision ... poverty was the result of low incomes, and would be eliminated by ensuring that nobody had low incomes.

Beveridge was an economist, and had some idea how the economy works. Rhys Williams was concerned for people's welfare but obviously had no idea how the economy works.

I'm making assumptions here. I don't know anything about either Rhys Williams or Beveridge. But I see how people are, these days. There are a lot of people these days who are concerned for people's welfare but have no idea how the economy works. They seem to think they don't need to know how the economy works because you can just pass a law and that's the end of it. But it doesn't work like that.

Take a familiar example: raising the minimum wage. I can't say I'm against it because I would certainly like to see less disparity between rich and poor than we have today. And because I'm not altogether heartless. And no better solution is ever presented. But I can say raising the minimum wage does not solve the problem.

Raising the minimum wage may temporarily relieve some of the stress that low income creates, but it does not solve the problem that creates low income. See the difference?

Thursday, November 2, 2017

"solid growth"


In an article titled US economy on solid growth path (27 October 2017) we read:

For all of 2017, forecasters believe the economy will grow at an annual rate of around 2.2 percent, rising to 2.4 percent next year. That would be an improvement from the meager 1.5 percent in 2016, but would still fall below the expectations of the Trump administration.

2017: 2.2
2018: 2.4
2019: 2.6
2020: 2.8
2021: 3.0
2022: 3.2
2023: 3.4
2024: 3.6
2025: 3.8
2026: 4.0
2.2 percent? Whoop-de-doo. And 2.4% next year. This is "solid growth"? Let's see, at this rate, a zero-point-two percent per year increase, we could reach 3% annual growth by 2021, and 4% growth in the middle of Trump's third term!

A solid growth path, my ass.

Actually, the numbers are better than indicated. The forecasters are undershooting. The article tells us

The US economy grew at a steady annual rate of 3 percent in the third quarter, marking the first time in three years that economic expansion hit at least 3 percent for two consecutive quarters

Graph #1: Real GDP Growth

They also note that

Consumer spending slowed to 2.4 percent growth in the third quarter. But that was offset by a strong 8.6-percent gain in business investment in equipment.

The investment number sounds good, but it sure could be better:

Graph #2: Real Business Investment in Equipment
You would have to ignore a lot of data to say we have a rising trend. But don't forget, we're also ignoring future data: data we don't have yet. I expect further improvement.

Actually, I wouldn't be surprised to see a spike in investment, similar to what happened after the 1982 recession. Back then, everyone was excited about the possibilities that came with President Reagan. As Graph #2 shows, investment growth fizzled out quickly, back then; but expectations did create a big, brief burst.

There's a lot of covert excitement these days, what with all the economic changes promised by President Trump. That excitement will become less bashful as the economy improves. The more visible excitement will amplify expectations. Thus I expect an investment spike, a Trump spike comparable to the Reagan spike.

Combine the expectations effect (as in the 1980s) with the effect created by a reduced accumulation of debt (as in the 1990s) and you should get a decade or so of impressive economic growth: maybe 4% in Trump's first term.

As I've been saying. But don't make the mistake of giving President Trump all the credit for the economic improvement. Trump gets credit only for the shock to expectations. The longer-term improvement is due to the drop in debt growth since the crisis, and the greater quantity of circulating money.

Wednesday, November 1, 2017

Three classes of incentives


Dietrich Vollrath says "The core of economics is that people respond to incentives."

I like that. I was thinking about different sources of incentives:

1. Policy creates incentives (including disincentives). That's why policy is useful. It moves the economy. Now, if only we could find the right policy...

2. Promises sometimes create incentives. Think of FDR or Reagan or (maybe) Donald Trump (we'll see) coming to office with a story that excites people and brings hope of economic improvement. Or, no that's not it: Every politician tries to bring hope of economic improvement. Instead, say coming to office at the right time, so that the new leader's "impending prosperity" story actually pans out.

3. Actual economic conditions offer the best incentives of all. Coming to office at the right time, and all that.

Tuesday, October 31, 2017

Yves on UBI


From Ilargi: Is Capitalism Dead or Merely Dying? at Naked Capitalism:
Yves here...

As readers know, we also are not fans of a universal basic income. First, if it were high enough to provide even for a subsistence living, it would be massively inflationary. That means it would at best be a stipend that would wind up subsidizing businesses, since it would allow them to pay lower wages. It would also be used to cut/end existing targeted programs, which are often far more generous to populations with specific needs. Second, it would reduce recipients to being mere consumers, held in contempt by supposedly more productive people. That also means, like the Speenhamland system, it would be at risk of being ended abruptly and displacing people who had long been largely or entirely out of the workforce and would not be able to find sufficient employment.

Monday, October 30, 2017

"Steady economic growth continues"


At Econbrowser: Steady economic growth continues, by James Hamilton. The title says it all.

Well, the title says most of it. There is also this:

U.S. real GDP grew at a 3.0% annual rate in the third quarter. That is close to the long-term historical average of 3.1%, and better than the 2.1% we’ve seen on average since the Great Recession ended in 2009.

And this:

The U.S. remains clearly in the expansion phase of the business cycle.

So that's all good.

No doubt Hamilton's blog-buddy Menzie Chinn has also noticed the improvement in GDP growth. I wonder if Chinn remembers his old Making American Growth Great (by Spaceology*) from January of this year:

From the Trump-Pence website:
DONALD J. TRUMP’S VISION

Boost growth to 3.5 percent per year on average, with the potential to reach a 4 percent growth rate.

Menzie said growth in the 3.5-4% range was "unlikely". I wonder what he'd say today.

Sunday, October 29, 2017

Looking at John Taylor's stuff


I found a link in my URL dropdown to John Taylor's Take Off the Muzzle and the Economy Will Roar. Great title! It's a little creepy to read, what with references to "Lucy and Susan" and The Lion, the Witch and the Wardrobe. But Taylor can write a powerful sentence, and he makes good graphs. So.

Take off the Muzzle links to Taylor's Slow economic growth as a phase in a policy performance cycle (PDF, 7 pages, here referenced as Policy). Another great title. There is a little sleight-of-hand, too: In a list of economists offering "evidence that the poor performance of the economy during the past decade—the Great Recession and the Not-So-Great Recovery—is largely due to poor economic policies", Taylor lists himself twice! He gets away with it because of that wonderful "Great Recession and Not-So-Great Recovery" line, and because he's not listing economists but rather references to their works. Still, in the writing, Taylor says:

While debate over the question is raging among economists, many, including [list] have offered evidence ...

His sentence calls for a list of economists. He provides a list of references.

When someone has the ability to write really well, you have to look askance at the writing. You have to overlook the good writing and concentrate on the discussion of economic forces. I've said that before, about Krugman. It applies to John Taylor as well.

Muzzle also links to Can We Restart the Recovery All Over Again? (PDF, 4 pages, here called Restart). This one I looked at before. That accounts for Muzzle showing up on my URL dropdown list.

"Economics and history," Taylor says, "tell us that changes in economic policy lead to changes in economic performance." Ayep. The trick is reading the tea leaves. Taylor's own read of those leaves is not in doubt. In Muzzle, for example, he says

To turn the economy around we need to take the muzzle off, and that means regulatory reform, tax reform, budget reform, and monetary reform.

John Taylor calls for reform, reform, reform, and reform. It's a complete list that tells us nothing. Reminds me of a glug I heard on MSNBC the other day: Trump has been telling his people to "talk about tax cuts, not tax reform." Whatever. Taylor offers a more informative version of his list of reforms in Restart, where he says

In my view, economics and history also tell us which policies produce good performance: tax reform to lower tax rates on people and businesses and thus reduce disincentives to work and invest; regulatory reforms to scale back and prevent regulations that fail cost-benefit tests; free trade agreements to open markets, entitlement reforms to prevent a debt explosion and improve incentives, and monetary reform to restore predictability and create output stability along with price stability.

Now that is a complete list! But of course when John Taylor writes of "preventing a debt explosion" he is talking about government debt, not private debt. Private debt didn't make his list. It's almost like there was no financial crisis.

And whyingodsname do people insist on thinking that the only way to "reform" taxes is by lowering the tax rate? I've said over and over that we need to create incentives to pay off private debt faster, as a way to reduce the imbalance created by existing incentives that encourage the use of credit. My plan has nothing to do with raising or lowering tax rates. You could use reduced rates as an incentive to pay off debt; that would be a good way to do it. But the important thing is to reverse the existing incentives that encourage the accumulation of private debt.

What affects people personally is tax rates. I get that. But what damages the economy as a whole is having policy that encourages credit use, without also having policy that encourages repayment of debt. We need to prevent the excessive accumulation of debt that occurs when the use of credit increases.

Good grief! There is so much more to consider than just tax rates.

Friday, October 27, 2017

Fair coin, foul outcome


From the Mathematics of Inequality article I quoted yesterday:

This is essentially a coin toss, and you might think that in the end both sides would end up with the same amount of wealth. But it turns out those who have more keep getting more. Even if both agents have the same wealth to begin with, one will eventually begin to dominate the other, even though the coin is fair.

Yeah okay, but I wanted a better explanation. I Googled yard sale model. The first hit was The Growth of Oligarchy in a Yard-Sale Model of Asset Exchange: A Logistic Equation for Wealth Condensation (PDF, 15 pages) by Bruce Boghosian, same guy. The idea quoted above is restated in his PDF:
In the absence of any kind of wealth redistribution, Boghosian et al. proved that all of the wealth in the system is eventually held by a single agent. This is due to a subtle but inexorable bias in favor of the wealthy in the rules of the YSM: Because a fraction of the poorer agent’s wealth is traded, the wealthy do not stake as large a fraction of their wealth in any given transaction, and therefore can lose more frequently without risking their status. This is ultimately due to the multiplicative nature of the transactions on the agents’ wealth, as pointed out by Moukarzel.

So: In any exchange of two equal values, the wealthier party puts a smaller percentage of his wealth at risk than the other guy. The worst outcome for the rich guy is not as bad as the worst outcome for the poor guy. Now, play this game over and over again. Even if the odds are even, the rich guy stands to do better.

Into a spreadsheet, so I can see if I believe this story.


Something else in the article has me confused. What is this "transfer of wealth" that occurs independent of the exchange of equal values? How much is it? Again, from the article:

A simplified version [of the Yard Sale Model] goes something like this: Two people enter into a series of transactions, and both have the same probability of winning some amount of wealth from the other, just as in a free-market transaction.

What is this "small amount of wealth" -- slop in the connection? A dollar's worth of money exchanged for a dollar's worth give or take of stuff? And the better or luckier or wealthier dealmaker (or all of these in one) ends up with the difference?

Maybe that's it. The article quotes economist Michael Ash, who refers to "mutually acceptable, apparently equal exchanges" (emphasis added). Apparently equal, but there's a little slop. Okay, that's good enough for now.

For my spreadsheet I figure there is a poor guy who starts out with wealth equal to 100 and a rich guy who starts with ten times as much. I figure a transaction equal to 10% of the poor guy's wealth, and a wealth transfer equal to 10% of the transaction amount. I don't pretend these numbers are realistic. I just want to see how they work out. Does the wealthy guy always get the slop? I want to see this for myself.

I set up different scenarios. First, the rich guy always wins the wealth transfer:

Graph #1: The Rich Guy Always Wins
The blue line shows the rich guy, who begins with 1000 units of wealth. His wealth climbs to 1100 as the poor guy's wealth drops from 100 to zero. By eye, that transfer of wealth is complete after about 400 transactions. (The numbers on the horizontal axis indicate the number of transactions.)

On this graph, with each transaction, one percent of the poor guy's remaining wealth is subtracted from his total and added to the rich guy's total. The rich guy wins every time.

On the next graph, the guy we call the "poor guy" always wins the wealth transfer:

Graph #2: The "Poor Guy" (the one who starts out poor) Always Wins
The guy we call the poor guy starts out poor, but ends up with more wealth than the guy we call the rich guy. This time the so-called poor guy's wealth grows from 100 to 1100, while the so-called rich guy's wealth falls from 1000 to zero.

By eye, on this graph the transfer of wealth is complete after less than 250 transactions. The transfer happens faster on this graph than on Graph #1. Why? Because the transfer is one percent of the wealth of the guy we call the poor guy, but that guy doesn't stay poor. As the transfer of wealth continues, the amount lost by the so-called rich guy becomes bigger and bigger. So the "rich" guy's wealth evaporates quickly.

I finessed the calculation, and made another graph. On the next graph, one percent of the wealth of whichever guy is wealthier gets transferred to whichever guy is less wealthy:

Graph #3: The Actually Poorer Guy (whichever one is poorer) Wins
The transfers of wealth bring the rich guy's number down and the poor guy's number up until they meet. After that, the transfers take from the guy with a little more, and give to the guy with a little less. This causes the red and blue lines to stabilize around the 550 level.

Finally, the next graph shows the "fair coin" example that the article is about. It shows what happens when the rich guy and poor guy take turns receiving the transfer. The blue line shows a relentless increase in the rich guy's wealth. The red line shows an equally relentless decline in the poor guy's wealth:

Graph #4: Alternating Winners (rich guy, poor guy, rich guy, poor guy ...)
The blue wealth begins at 1000 (low side of the left end of the blue line) and rises to just below 1005 (low side of the right end of the blue line; find the value on the left-hand scale).

The red wealth begins at 100 (high side of the left end of the red line; find the value on the right-hand scale). It falls to just over 95 (high side of the right end of the red line, again on the right-hand scale).

After a thousand transactions the wealthy guy's wealth increases by approximately five wealth-units, while the poor guy's wealth decreases by the same amount. Remember, the wealthy guy receives the wealth transfer for the first, third, fifth, and all the odd-numbered transactions. And the poor guy receives the transfer for the second, fourth, sixth, and all the even-numbered transactions.

Okay, I accept the claim made by the article, that even using a fair coin, "without redistribution, wealth becomes increasingly more concentrated, and inequality grows until almost all assets are held by an extremely small percent of people." In this model, at least.

But why (you may ask) why are those lines so thick? I didn't know, either. So I cropped off the left and right sides of the graph, just keeping the middle section where the lines cross. I zoomed-in on it to get a better look:

Graph #5: A Closer Look at the Thick Lines for the Alternating Winners
You can see here that the "thick" red and blue lines are actually made up of thin lines that zig-zag rapidly up and down. We can say each "zig" is a transaction where the wealthy guy receives the transfer. And each "zag" is a transaction where the poor guy receives the transfer.

The "top edge" of the "thick" blue line is really the sequence of values that trace out the wealth position of the wealthy guy after he receives the transfers. The "bottom edge" represents the wealth position of the wealthy guy after the poor guy receives the transfers. (The thick red line represents comparable values for the poor guy.)

If you look at the position of a thin "zig" line relative to the one just before, the later line is just a very little higher (or a very little lower) than the earlier line. That tiny difference is the "slop" that causes wealth to concentrate.

The thin lines show that after each consecutive pair of transactions, there is almost no change in either guy's wealth. But transactions occur all the time. And the overall result of very many very tiny transfers of wealth, given enough time, turns out to be a very large transfer of wealth. Reminds me of Richard Prior in the Superman movie, turning rounding-errors into huge amounts of money.

But it's not just one guy doing it. It's everybody involved in transactions, and all the transactions. And it turns out that those who have more keep getting more. And without redistribution, wealth becomes increasingly more concentrated, and inequality grows until almost all assets are held by an extremely small percent of people.

The Mathematics of Inequality It's an interesting concept.


Woke up early again. I get it now.

Consider a two-transaction sequence. On average in a two-transaction sequence, because the coin is fair, the rich guy and the poor guy should each win one of the wealth transfers. There are two ways this can happen:

1. The rich guy wins the first transfer, and the poor guy wins the second. Or
2. The poor guy wins the first transfer, and the rich guy wins the second.

If the rich guy wins first, the first transfer reduces the poor guy's wealth. So the second wealth transfer is smaller. The poor guy loses the larger transfer and wins the smaller one. Therefore, his wealth is reduced.

If the poor guy wins first, the first wealth transfer increases the poor guy's wealth. So the second wealth transfer is larger than the first. The poor guy loses this larger transfer. Therefore, his wealth is reduced.

Either way, the poor guy loses.

Poor guy!

// The Excel file