Middle Earth Economics

After so much gloom, I had to pass on this link as follows:

http://worthwhile.typepad.com/worthwhile_canadian_initi/2012/12/the-macroeco.html


Enjoy!

The Fiscal Cliff

It is hard to ignore the big news of the moment, which is the US fiscal cliff. For those who are not from the US, this is a summary from the Congressional Budget Office (CBO):

• A host of significant provisions of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (Public Law 111-312) are set to expire, including provisions that extended reductions in tax rates and expansions of tax credits and deductions originally enacted in 2001, 2003, or 2009. (Provisions designed to limit the reach of the alternative minimum tax, or AMT, expired on December 31, 2011.)
• Sharp reductions in Medicare’s payment rates for physicians’ services are scheduled to take effect.
• Automatic enforcement procedures established by the Budget Control Act of 2011 (P.L. 112-25) to restrain discretionary and mandatory spending are set to go into effect.
• Extensions of emergency unemployment benefits and a reduction of 2 percentage points in the payroll tax for Social Security are scheduled to expire. 

From the same article, this is the projection of the CBO:

CBO’s Baseline: Taking into account the policy changes listed above and others contained in current law, under CBO’s baseline projections:

• The deficit will shrink to an estimated $641 billion in fiscal year 2013 (or 4.0 percent of GDP), almost $500 billion less than the shortfall in 2012.
• Such fiscal tightening will lead to economic conditions in 2013 that will probably be considered a recession, with real GDP declining by 0.5 percent between the fourth quarter of 2012 and the fourth quarter of 2013 and the unemployment rate rising to about 9 percent in the second half of calendar year 2013.
• Because of the large amount of unused resources in the economy and other factors, the rate of inflation (as measured by the personal consumption expenditures, or PCE, price index) will remain low in 2013. In addition, interest rates on Treasury securities are expected to be very low next year.

 The current situation is summarised here (sorry, it's long):

WITH the clock ticking toward a New Year's time bomb of huge tax increases and spending cuts, US politicians are working to keep America from tumbling off the so-called fiscal cliff. 
 
The stakes in the game of holiday-interrupting brinkmanship are huge. Economists agree the $US500 billion ($A484 billion) in fiscal pain due to kick in as soon as the new year starts will stifle the gathering US economic recovery and send the United States back into recession, spelling bad news for the global economy as well.

Aides to leaders of the Democrat-controlled Senate worked behind closed doors on Saturday morning to fashion a deal palatable to both Republicans, who control the House of Representatives, and the Democrats.

A senior Republican aide said "discussions are under way". He added that details of any deal will not come out until leaders brief their caucuses on Sunday.

Both chambers would need to pass a deal by New Year's Eve. They thus have three days to get done what has eluded the White House and Congress for weeks, and will interrupt their year's end vacation in the process.

As negotiations proceeded, President Barack Obama urged Congress to protect the middle class from higher taxes and lay the groundwork for economic growth.

"We've got to do what it takes to protect the middle class, grow this economy, and move our country forward," Obama said in his weekly radio and internet address.

"Leaders in Congress are working on a way to prevent this tax hike on the middle class, and I believe we may be able to reach an agreement that can pass both houses in time," he added.

Obama met with top congressional leaders on Friday and said Senate Democrats and Republicans would work overtime this weekend to try to head off the fiscal cliff.

The president, sensing a mandate from his re-election last month, wants to raise taxes on the rich but exempt the middle class. Republicans want only to close tax loopholes to raise revenue and demand significant spending cuts in return.

But if nothing is done by the deadline, all taxpayers will see an increase.

The first point to note is the 'cliff' metaphor. It frames the spending cuts and tax increases in terms of something scary; falling off a cliff leads to harm. The use of this metaphor is of itself an argument, and and argument that says the tax increases and budget cuts are a bad thing. Framing the changes in this way also becomes an urgent call to action, and that is exactly what is taking place (albeit with no success so far). Another problem with the metaphor is that it is not actually a cliff:

For one thing, it isn't really a "cliff." The impact of the tax hikes and spending cuts will be felt gradually, over several months, so there will "be plenty of time beyond January 1, 2013 for things to get worked out."

In short, the term 'cliff' is a distortion of the actuality of the situation. The most worrying aspect of this distortion is that it is driving action, and driving hurried action. Although I am completely in favour of action to reduce the deficit, this is absolutely not the way to take action. Instead, what should be taking place is a more measured look at spending and taxation, and how the activity of government is prioritised and how it might be reformed. This is a question of what constitutes the core functions of government, and elimination of non-core functions. I do not give my view here on what those core functions are, as this is a political question, but it is a question that needs to be answered. Having answered the question of core functions, the functions thus identified have to be given priority, and hard decisions made on the allocation of finite resource to each core function, and how the underlying purpose of the function can be retained, whilst reducing the costs of the function (regular readers will have seen examples I have given for the UK where I have taken this approach, e.g. here). It is also about what share of the wealth of a country will be given over to the use of the government, and accepting that the government must operate from tax receipts and not use borrowing to dishonestly bribe the electorate with tax breaks now at future cost and provision of services funded with borrowed money at future cost.

The other point that needs measured examination is the US tax system, which is notoriously complex and unwieldy. Again, the US needs to go back to the core, and ask what taxation is really supposed to achieve. I have written on the UK tax system, but much of what I have written would certainly apply to the US. In particular, just as in the UK, the US tax system has become a political policy tool, rather than a system for collecting x amount of revenue. All taxation systems are in some respects political, but the politics should be limited to the distribution of the burden of taxation, rather than a political tool used for wider political goals. Although the arguments over the 'cliff' are focused on questions of distribution, the real problems of the current system's complexity and distortions are ignored.

Indeed, the entire debate over the 'cliff' is one of political grandstanding, rather than any serious attempt to address the real question that needs resolution; how can finite resource be best collected and used in order for government to achieve its core functions? The word 'cliff' is a problem, as it drives urgency that was never there, and plays to the desire for political grandstanding. I want to be clear here, that I believe that there is an absolute necessity to cut the deficit, but this is not the way to do it. It is urgent, but it is not 'fiscal cliff' urgent. All the term fiscal cliff has achieved is to drive out the mature debate that is necessary to enact real reform. This suits the politicians. Rather than take hard decisions, they can bury issues in messy compromises within the current system instead of facing the more fundamental and difficult questions.

Update: I nearly forgot. Thanks for the paypal donations from several readers, which I am guessing were inspired by Christmas. I would also like to wish all the readers a happy New Year!

False Assumption, Ponzi, and the Developed World

We are now heading towards 2013, and it very, very striking that the world is still mired in an economic crisis. It is very easy for people to be caught up in the 'events' that comprise the daily news stories in the media; the events appear as more real than the abstractions that are the explanations that sit under the events. The explanations of 'events' is 'events'. Thus we have an event such as a government announcement A, leading to event B. It is wonderfully tempting and seductive to take this view, as the correlations between events can be easily determined, easily seen, and easily explained. However, the event A does not take place in a vacuum, and the event B that follows likewise does not take place in a vacuum. Instead, what is really happening is the events sit in a messy context of broader drivers, the beliefs and perceptions of innumerable actors, contesting interests, and sometimes just plain irrationality.

For example, take the belief that seems to be common in the developed world that relatively high levels of wealth are a given, a natural state of affairs. Would anyone contest that this belief is firmly entrenched? Whilst some might argue about the distribution of the wealth, for example arguing that true wealth should see more even distribution, they would still proceed from an assumption that there is and will be a relatively high level of wealth for distribution. I have now been blogging for several years, and have been thinking about economics for longer, and have not found any examples which do not proceed from an assumption that the developed world should just somehow be more wealthy. Even when articles bemoan the rise of China, they do so on the basis that, somehow, it is a natural place/position/state of affairs that the developed country should, well...... just be more wealthy.

The articles that worry about the sliding position of the developed world are the most interesting. They have a sense that 'something must be done', and often they will offer their policy prescriptions to fix the problem. It does not matter whether the author is left or right leaning, the aim is to maintain the relatively high levels of wealth in the country under discussion. With the right tweak of policy here, tweak there, all will be fixed. They assume that the natural position of relative wealth might be maintained, if only we could just do x, y or z.

Most of the readers of this blog seem to be well informed about economics. As such, I ask you to think about the many articles you read, and the assumptions that underpin them. You will find an assumption that the developed world not only is naturally more wealthy than the rest of the world, but also should be more wealthy than the rest of the world. There are some exceptions, in particular on the left, that the developed world is somehow sinful for being wealthier, and that the developed world should actively redistribute its wealth to the poorer parts of the world. Even here, we see an assumption of natural wealth.

The problems with the assumption of natural wealth, and that the developed world should be more wealthy is that it is just that; an assumption. It is treated like a natural force, and a right that is dictated by some kind of natural law. The problems is that there is no natural law, and no right that can be supported or defended in any way whatsoever. When a less well developed country pulls itself up by its metaphorical boot straps, sees rapid economic development, and contests for a position in the top tier of wealthy countries, there is no natural force that might stop them, or reverse the ascent. Instead, there are the complexities of the trillions of individual purchase decisions, the choices of individuals in economic entities such as firms, regulators, and policy makers.These are the real forces at work in economics, rather than some unseen and non-existent forces and rights.

I too have been guilty of the assumption that the developed world should be more wealthy. Like many others, I have argued that the developed world should act to defend its position as 'wealthy', including offering my own solutions. In some respects it is wrong-headed. There is no real reason why any particular country should be more wealthy than its neighbours, if the people of each country are equally as hard working and innovative. It seems that, in this situation, there can be no justification for one country being wealthier than another. There are, of course, situations where a particular country is just blessed, as in the examples of the oil resources available to countries in the Middle East. Putting it crudely, they just do not have to work as hard as others. Resenting such good fortune is, of course, pointless and sometimes such blessings also turn out to be a curse.

However, the world is not so simple as I paint it here. It assumes a world of competition between economic entities, based upon hard work and innovation. However, there is another competition at work, and that is the competition of systems; systems of how society is ordered. At one extreme we have what might be described as a something like a fascist state; China. All ideas that are imported into the country are subject to 'sinification', so China's system is uniquely Chinese. I use the word fascist therefore in a very loose way as the nearest equivalent. It would then be tempting to say that, on the other side, we have liberal, democratic and free market countries of the developed world. It would be a neat narrative of black versus white, but it does not hold.

However, the latter categorization is nevertheless partially true. With differing degrees of dysfunction, the developed world is democratic, and to different degrees 'liberal'. I say dysfunctional, because democracy is not working well. The system is failing. There are certain types of dysfunction that I will put to one side here, such as the shocking amount of money that is necessary to compete for the US presidency (albeit that such problems also relate to my area of concern). My concern is rather with the dysfunction of the electorate.

A significant economic challenge has developed, and that challenge is very real. We have seen a significant shift in the economic structure of the world. It has been assumed that what we are witnessing is a game of 'catch-up', in which countries such as China are seeking to chase after the on-going growth of wealth in the developed world. The idea that 'surpass' might take place is only in aggregate, not at the level of individual wealth. However, the developed world is not growing in wealth, but seeing a diminishment of wealth. The developed world is on a down escalator, even whilst the developing world is on the up escalator. As I have pointed out recently, those on the up escalator now face their own problems, but to assume that they will not continue upwards and the developed world downwards would be complacent.

It is here that I return to the dysfunction of the electorate and the question of liberal democratic and free market. In the developed world, the electorate have been seduced by the idea of the natural right to wealth in their own country. They know that there are now challengers to their position of wealth. They cannot avoid seeing this reality. Even those with the most passing interest in economics will be aware that the world has changed. Faced with the challenges of a new economic structure, instead of facing the new competition, electorates have demanded that the world remains unchanged. However, demanding that the world remains unchanged does not make the world unchanged. All that has happened in response to this demand, is that the politicians have responded to the demand by developing a pretense that the world is unchanged. Happy days are just around the corner. But the corner continues to be elusive. So what is the pretense?

The pretense is that we still operate in a world of free markets and that the world has not changed. Of course, it has never been the case that markets have ever been truly free, so we are talking about degrees of freedom. The point is that, since the economic crisis came into view, the marketplace has come to be dominated not by market signals, but monetary and fiscal policy of governments. Governments have always had a role in the marketplace, but underlying market signals could still (mostly) be discerned from the noise created by government. This is no longer true. More pertinently, it is now being recognised, even in conservative organisations like the Boston Consulting Group, that current policy is simply impossible to sustain.  They are blunt; they call current policy in the developed world a 'ponzi scheme'. This is just one extract from the report, and the content will be no surprise to regular readers of this blog:

Intensifying International Competition and Rising Inequality. Globalization has brought the promise of economic prosperity to billions of people around the world. But it has also contributed to tougher international competition and the creation of new inequalities of wealth and income in the developed world. The growth in the global labor force continues to put pressure on labor costs in developed economies. At the same time, globalization is leading to increasing inequalities in income and wealth within countries, as some groups (such as investors) benefit more from increased globalization than others (such as manufacturing workers).

Income statistics highlight this development: between 1979 and 2007, the income of the average U.S. household grew by 62 percent. Over the same period, the income of the top 1 percent of households grew by an extraordinary 275 percent and the income of the rest of the top 20 percent grew by a slightly above-average 65 percent, while the income of the remaining U.S. households grew by less than 40 percent. The incomes of the lowest quintile grew by only 18 percent.

Inequality increases the risk of social unrest and declining support for capitalism and a free society. As University of Chicago economist and former IMF chief economist Raghuram Rajan points out, “Ultimately, a capitalist system that does not enjoy popular support loses any vestige of either democracy or free enterprise.”

In the last passage, they capture the problem of democracy, and why it is that the response of governments is to pander to demands. All of the new workers who have entered the global workforce are not going to go away. The advantage of capital over labour will not disappear for a long time. This is the reality and no amount of propping up of demand, printing of money or borrow and spend will make this reality disappear. Demanding a standard of living will not make it so.

When starting this blog, I was largely a lone voice. The economic crisis was called a financial crisis, with a suggestion that, with bailouts, and some largess from central banks, the problems would disappear. They have not. They have simply been magnified. I argued for the idea that the world had entered a world of 'hyper-competition' and that is still where we stand. I am no longer a lone voice in this, and the BCG report is just one of the more 'conventional' sources that has finally recognised the changes that have taken place. The problem was not, as I have always argued, some isolated financial crisis, but a shocking change to the world economy - to the very structure of the world economy. Globalization was more than a word, but was a description of an accelerating revolution. On my bookshelf, I have a long unopened book on globalization; even when I read it several years ago, it appeared fanciful and arrogant. It now seems positively quaint. So here we are now in a world of hyper-competition. I will highlight a quote from the BCG report:

Fortunately, there is still time to act. But leaders from all social sectors—government, business, organized labor, environmental and other stakeholder groups—need to act decisively and quickly in order to secure future economic prosperity, social cohesion, and political stability. It is in the nature of Ponzi schemes to collapse suddenly, without warning. No one knows what event may send the developed world and the global economy as a whole back into crisis.

They get what I did not get when I first started writing this blog. The absurdity of a ponzi scheme continues till it doesn't. The magic of a ponzi scheme is that they can sustain themselves for so long, before the weight of the fraud finally topples them. I thought that people would see through it much earlier because, in reality, it has always been in plain sight. People just had to choose to see it. And that is the problem. When confronted with reality, we (the electorates, the policy makers, the economists, the politicians) choose to look away. A while ago, I saw a film about the Madoff ponzi scheme (sorry, I forget the name), and the most striking point in the film was the stubborn refusal to see what was in plain sight. It is the same situation in the developed world economies. After all, it can run a little longer, and we will be ok, won't we?

Note: I did think about posting this after Christmas. It is not full of festive spirit, after all. However, when is the best time for bad news? I am not sure. So, I end here by wishing that you all enjoy Christmas, and only give thought to economics after enjoying Christmas with your families. On Christmas day, I will raise a glass of appreciation to all the regular readers of the blog, as it your interest that keeps me posting. Thank you, and have a great Christmas.

The RMB as a Reserve Currency: Breaking Habits of Thought

The economic power and influence of China continues to grow. In September, 2009, I wrote the following:

The last line of reasoning I considered appears to be the most probable. It is simply that China's wealth is indeed denominated in the $US, and they are just doing enough to hold the $US from free fall. The reason is that this allows them time to use the $US, which they are still accumulating in large quantities, to prepare themselves for the post-$US world. Returning to the speculative post in which I imagined what I might do if I were China, I suggested that they would also diversify their holdings into commodities (in particular gold), other currencies, and would continue and accelerate their purchase and control of commodity/resource companies.

Some quotes from a recent article from AFP:

Chinese firms have become more active in mergers and acquisitions since the global financial crisis that began in 2008, as economic distress has thrown up bargains around the world.

[and]

Between 2005 and 2011, the number of China's overseas acquisitions tripled to 177 and jumped five-fold by value to $63 billion, according to law firm Squire Sanders and intelligence service Mergermarket.

[and]

But academics said more was at work than commerce, as China seeks growing stature and competes with other countries for resources.

If you can cast your mind back to 2007, how did you think of China? The AFP reports on the unease being felt by China's growing influence. If jumping back in time to 2007, if somebody had suggested that China would be this influential, would you have taken them seriously? Whilst China was seen as important, the idea that China would be causing this kind of unease would have been dismissed as fanciful. Another point that I long ago made, at about the same time as discussing China's potential shopping spree, was that China would seek to displace the $US as a reserve currency, and develop the RMB as a potential replacement. This from April 2009:

I have a very curious sense at the moment of the world moving in slow motion. I had thought that the economic crisis would create dramatic moments, but in some respects it appears to be moving through a gradual shift.

One of the predictions that I have made, on two occasions, is the collapse of the $US and the end of the reserve status of the $US. However, it appears that the end of reserve status is being achieved with little drama, as it is apparent that the RMB is slowly but surely being positioned as a replacement of the $US as the reserve currency. We have this latest news from the China Daily:

Five major trading cities have got the nod from the central government to use the yuan in overseas trade settlement - seen as one more step in China's recent moves to expand the use of its currency globally.

From these modest beginnings, the process of moving the RMB to reserve status has continued, and I have occasionally given examples in my posts. This is recent development:

Cracks are beginning to appear; the latest sign is that China and South Korea have come to an agreement in which banks from either country are able to borrow funds from a swap line that makes loans available to companies for deals in local currencies. (Source: “China, South Korea to Boost use of Local Currencies in Trade,” Bloomberg, December 4, 2012.)

This is analysis from Reuters:

Fed up with what it sees as Washington's malign neglect of the dollar, China is busily promoting the cross-border use of its own currency, the yuan, also known as the renminbi, in trade and investment.
The aim is both narrowly commercial - to reduce transaction costs for Chinese exporters and importers - and sweepingly strategic.

Displacing the dollar, Beijing says, will reduce volatility in oil and commodity prices and belatedly erode the ‘exorbitant privilege' the United States enjoys as the issuer of the reserve currency at the heart of a post-war international financial architecture it now sees as hopelessly outmoded.

Zha Xiaogang, a researcher at the Shanghai Institutes for International Studies, said Beijing wants to see a better-balanced international monetary system consisting of at least the dollar, euro and yuan and perhaps other currencies such as the yen and the Indian rupee.

However, I would not want to give a false impression that everyone thinks that the RMB as a reserve currency is likely. For example, this rather curious article from Forbes gives a consideration of the many ways in which the RMB's status is accelerating before then oddly concluding:

Does all this mean China is about to overtake the dollar as the world’s reserve currency? Not anytime soon. A reserve currency, in our view, requires deep and credible government bond markets, an open capital account and critical mass in global financial systems. China’s central bank has laid out a 10-year plan for “internationalization” of its currency. China’s FX bands are widening, but in an incredibly cautious way. Dollar holders need not panic.

Indeed, most articles, including the Reuters one quoted earlier, give caveats, express doubts etc. It is all rather odd, as the expansion of the international role of the RMB is an actuality. Indeed, as long as I have been tracking this steady expansion, the same things are said with each new step, and always that reserve status is something for the distant future. There is a growing conflict between what is taking place, and the analysis of what is taking place. This is a habit of thought and I made the point in an article for Trade and Forfaiting Review in November 2009:

Imagine a world in which there was no international reserve currency, but that an organisation was proposing that the US dollar ought to be the future reserve currency. Would you take such a proposal seriously?

Your response might be that the US dollar sits atop mountains of debt, a shrinking economy and you would point out that the US monetary authorities are printing money to fund record government borrowing. You might actually laugh at such a prospect.

On the other hand, how would you view the Chinese renminbi? You might point out that China holds large reserves of other currencies, the renminbi rests on top of a massive current-account surplus, China’s economy is growing and that the prospects for future growth are all positive. Furthermore, China is a country of savers, with a small fiscal deficit and is an export machine selling goods around the world, ensuring an ongoing utility for the currency in trade.

I do not have a copy of the full article to hand, but recall that I argued something along the lines of the $US as a reserve currency was a habit of thought, rather than a rational assessment. Time has moved along since I wrote the TFR article, and time has supported my case, and still there is a sense that it just isn't possible, even though the step-by-step expansion of the RMB into a reserve currency progresses forwards.

However, at this stage, I am not so certain that the RMB will be the major reserve currency, but not for the reasons that are generally given (e.g. deep bond markets). As regular readers will be aware, I am increasingly cautious about the overall position of the Chinese economy. I am not entirely convinced that China can sustain its economic miracle and, as ever, see political risk in any major slowdown in the growth of the Chinese economy.

Nevertheless, if China does manage to continue its growth, then the indications are that it will continue to chip away at the reserve status of the $US. Returning to the start of the post, the influence of China continues to expand, as the Chinese state encourages firms to seek out and purchase access to resources, and also expand internationally. It is but one example of the astonishing growth in China's economic heft. That influence is being felt throughout the world, and the influence just further enhances China's credibility as a 'major player', and that, in turn, enhances the credibility of the RMB as a reserve currency. Set against this, the economic policy of the US can only continue to erode the influence of the $US. The following is a commentary on the $US and the challenge of the RMB:

Rome in its day held the reserve currency of the world, and how the mighty have fallen. Unless real changes are made, we might be witnessing the beginning of such a shift here. The rising U.S. debt levels are raising questions by many countries around the world as to the legitimacy and viability of the U.S. dollar as the reserve currency.

Politicians in Washington must wake up to the realization that the U.S. dollar’s status as a reserve currency is not written in stone. The financial markets are currently more dynamic and fluid than ever before. It takes only the click of a mouse to move money around the world.

Unless America gets its fiscal house in order, I believe we will see more agreements, such as this one with China and South Korea, which will avoid the U.S. dollar and increase the continuing questions about the viability of its reserve currency status.

The author has a point. After all, if the $US was not already the reserve currency, would you pick it out as a new reserve currency? I think that this unlikely, but perhaps you would disagree?

Krugman: The New Luddite

I know, I post too often on Krugman's musings in the New York Times. However, I could not resist the later missive from Krugman regarding automation (robots, and I presume he also means software that automates tasks currently performed by humans, but that is a guess):

If this is the wave of the future, it makes nonsense of just about all the conventional wisdom on reducing inequality. Better education won’t do much to reduce inequality if the big rewards simply go to those with the most assets. Creating an “opportunity society”, or whatever it is the likes of Paul Ryan etc. are selling this week, won’t do much if the most important asset you can have in life is, well, lots of assets inherited from your parents. And so on.

I think our eyes have been averted from the capital/labor dimension of inequality, for several reasons. It didn’t seem crucial back in the 1990s, and not enough people (me included!) have looked up to notice that things have changed. It has echoes of old-fashioned Marxism — which shouldn’t be a reason to ignore facts, but too often is. And it has really uncomfortable implications.

But I think we’d better start paying attention to those implications.

Welcome to the new Luddite approach to the improvement of the human condition. The robots will move wealth to the holders of capital from the workers.....and that is bad for us all. And what, might I ask, does he think happened in the industrial revolution? The hand loom weavers were put out of business due to automation. It was one of the heralds of the greatest changes in the history of mankind, and one from which we all now benefit. The industrial revolution was, in some respects, a painful process, but also served to create the potential for the huge benefits that we now enjoy.

In the modern and developed world, the adjustment to this new source of productivity should be less painful, albeit that the transition will not be easy either. However, unlike the industrial revolution, we are not transitioning from a system that was for many people barely above subsistence. Today, we are not barely above subsistence, but that is not to say that the transition will not be hard for some people. If you have spent years learning to do something like a search for legal precedents, the automation of this process will be a hard blow. However, for all of this pain, automation will have positive benefits alongside of these costs. In the case of legal services, access to the support of the law will be more affordable to those who would otherwise struggle to have access to the services, and that may matter a lot to many people. It is no different to the access to relatively cheap cloth that will have made new clothes more affordable to poorer people; at a cost to the hand loom weavers in the short term.
Just as the spinning jenny benefited the capitalists, the providers of automated legal searches will benefit the owners of law firms who adopt the technologies that are now available.

The examples of automation creating wider economic benefits are so many that it is difficult to know where to start. The end of canals in the face of the competition from more efficient trains (which created a boom and bust that left the UK with a railway system paid in full by the loss of the capital owners), the redundancy of the typing pool with the advent of the PC and so forth. In all these cases, automation has the result of getting more from less labour, and that means more 'stuff' per unit of employed labour, even in the case of the indirect effect of removing the typing pool. As fast as labour is being removed, more output is being created per worker, meaning that more 'stuff' is available per worker. With greater output of stuff per unit of labour, labour is freed to do new things. It is, just as happened in the industrial revolution, a situation in which new jobs arise to replace the old jobs, as people find new stuff to produce, as the emerging surplus of labour is absorbed in producing 'stuff' that was previously only afforded by the few. It is the process which generates greater wealth.

One wonders, when Krugman says that there are 'uncomfortable implications' and suggest that those implications 'need attention', what exactly he might mean? Does he mean that we should halt the current process of automation, perhaps smash the robots? I mean really, what does he mean? He leaves his article vague and open, hinting at ominous consequences. However, those consequences have precedents that (for once in economics) are clear. We see the result of the precedents all around us in the developed world; more than enough food, better health, heated and comfortable homes, our many forms of entertainments, our freedom to access information, and so the list goes on.

Think of the example of the impact of the PC on the typing pool. It saw what was a hard earned skill eventually made redundant (however, I taught myself touch typing, so not entirely redundant, but I do not need the level of skill of the typing pool where there is no 'backspace'). Should we have looked at the 'uncomfortable implications' of this shift? For a typist, it was undoubtedly not a good situation. However, would we turn back the clock, and stop this change if we could? We could certainly reverse the change, by making word processing software illegal, and blocking any web services that might offer a similar facility. In a few year time, with the magic of backspace button gone, we would have huge numbers employed in typing pools. Those same individuals will be drawn from the labour force, and will be an opportunity cost; the opportunity to do something else which is genuinely in more demand.

What we are discussing here is nothing more than a variant of the broken window fallacy; that breaking a window is a good thing as it creates employment. In breaking the window as a deliberate act, it creates employment, but employment with no real point. Better that the people employed in repairing the window are engaged in productive labour with a genuine demand, rather than an artificial 'created' demand. In the same way, better people are employed in new avenues than artificially supporting, or creating, employment through the rejection of more efficient means of engaging the same labour. It is a make-work scheme where there is no need for the work. Better that the labour is employed in creating real value.

If ever there were evidence that Krugman has nothing to offer, this rather odd article is the evidence. It is no wonder that he leaves the 'implications' and solutions unsaid. If he were to say clearly what his article implies, he would be ripped to pieces. It is, as the title of this post implies, nothing more than a disingenous revival of Luddism. Krugman hides in ambiguity, but the 'implications' are clear; break the machine to save the interest of labour. He cannot see that, painful as the adjustment might be, labour is also the recipient of the benefits of automation.

Further, Krugman writes from a US perspective, and the potential benefits to the US worker are obvious; the cost of labour differential is diminished through automation. Maybe the labour will no longer be the crude repetitive labour of yesteryear, but all those 'on-shored' factories that benefit from automation will nevertheless create new employment opportunities. There may, in other words, be losers from automation, but there will be many more winners; and the win will keep on delivering, just as the industrial revolution today reverberates to the benefit of all in our day-to-day lives. 

The UK Mid Year Budget Statement

The mid-year budget statement has prompted concerns about the UK economy. It is a classic case of 'incrementalism' and fiddling. For example, see here for benefits reform and the silliness of framing the limited reform with the discussion of 'Mummy Tax'.

This is gloomy pre-statement commentary from Alexander Heath in the Telegraph:

Psychologists call this cognitive dissonance; unkind folk would see it as plain cowardice. What is clear is that such self-deception has reached epidemic proportions when it comes to the economy, and has contaminated all major political parties as well as many professional forecasters.

In the absence of shock and awe supply-side and tax reforms, which are not on the cards, our long-term growth prospects are bleak. George Osborne’s greatest problem, as he prepares to deliver the Autumn Statement, is that the British economy is stuck in a rut.

He has grasped something of the reality. In the UK, we are now starting to see something of the negative spiral that follows in the wake of attempts to incrementally cut government borrowing growth in the face of an economy that is structured around servicing the growth in borrowing (sorry, for the convoluted sentence). However, this from the WSJ:

The U.K Treasury painted a grim economic picture, acknowledging that growth was weaker than the government expected and that a tough austerity plan would drag on longer than planned.

Treasury chief George Osborne, who presented his closely watched twice-yearly economic update Wednesday, delivered a triple whammy of bad news. He conceded the economic recovery was taking longer than expected; that he would likely fail to meet a key self-imposed debt goal; and that government cost cutting would continue until 2018, three years longer than initially planned. At that point, the U.K. will have experienced eight straight years of austerity.

Mr. Osborne and the Conservative-led coalition government is halfway through its five-year term. Having come to office promising to fix Britain's weak economy, Mr. Osborne is under immense pressure to demonstrate that his strategy is working ahead of the next general election, due 2015.

Except for the misuse of austerity, it is a reasonable summary. The pressure is no doubt building to get the money printing presses running again:

Sterling edged up from one-month lows against the euro on Wednesday after a gloomy UK budget statement which traders said was in line with expectations.

But forecasts from finance minister George Osborne that Britain would miss its debt-reduction and growth targets left the currency looking vulnerable.

Analysts said the poor UK economic outlook might revive prospects of more monetary easing by the Bank of England and increase the risk of a credit agency cutting the UK's top-notch rating, both of which would be negative for sterling.

 The OBR is taking a negative view, saying that:

The independent Office for Budget Responsibility predicted the UK economy would shrink slightly this year and grow less over the next four years than it had forecast in March. Robert Chote, chair of the watchdog, said: "What's striking is the weakness of the recovery over an extended period of time."

I hope that, for regular readers of this blog, that the 'weakness of the recovery' is in fact unsurprising, and that they already realised that the UK economy has only now just started an unavoidable process of shrinkage i.e. any economy which is structured around servicing debt growth cannot shrink the debt growth without negative consequence. Worryingly, the current state of affairs is leading to threats to the UK credit rating:

The chancellor's statement did nothing to dispel fears that the UK could be stripped of its triple A credit rating. Both Moody's and Fitch, two of the three major rating agencies, put negative outlooks on the UK's rating this year.

Whilst the ratings agencies are generally hopeless, they are still important. They make a major difference due to their role in banking regulation and their pronouncements have real impacts. I seem to recall that George Osborne placed the credit rating of the UK as one of the drivers for his policy, so any significant downgrade would certainly add to the pressure now being placed upon the government. This is Bloomberg's view on the mid-year budget statement:

In lieu of real change, he proposed a set of well-intentioned but ultimately insignificant policies, restricted by the need to make the package as a whole fiscally neutral. Osborne did not need to be this cautious.

The chancellor did act to redirect government money in a few ways likely to produce growth. He said he’d reduce the nominal rate of corporation taxes to 21 percent from 24 percent in 2014 (compared with 35 percent in the U.S.). He also increased by a factor of 10 the amount of capital investment that U.K. companies can make exempt from taxes each year, to £250,000 ($402,300) from £25,000.

Osborne scraped together £5 billion to spend on schools, transportation, and flood defenses. He also set up a body to eliminate the regulatory gridlock that’s blocking development of shale gas in the U.K. and promised tax breaks for exploration, ahead of a new policy aimed at increasing Britain’s production and use of natural gas. These are all intelligent ideas that may boost construction and employment in the near term, and growth in the longer term.

I am inclined to agree that there was no real change, but suspect that, if shale gas lives up to its promise, then this will have very significant impacts through the potential to lower energy costs; a factor in living standards but most importantly in the cost of manufacturing. However, this will not really have any major impact for several years, and before it will be a positive contributor to a more competitive economy and better living standards. In the short term, there may be a small impact through increased investment, with the activity that follows from this, but it will not be enough to significantly lift the economy. As such, although a positive, it does little to address the problems in the short term.

Nor will the rest of the measures. The problem that will now face the government will be the political pressure to reverse course. For example, I disagree with Bloomberg's view, which is inevitably echoing around the media, that the government should give a 'modest boost' to the economy by relaxing budget constraints. The one thing that the government should not do is relax on this issue.  
Regular readers will know my answer is to take more aggressive measures on government spending, at a cost of short term pain, in order to avoid a worse situation in the future. However, I accept that the real pressures mounting for the government to loosen will make this nearly impossible at this moment in time.

As a pragmatic compromise, instead, the government should follow what is (in some respects) sometimes good advice, but which is given as advice for the use of additional borrowing (i.e. the projects will increase borrowing). Rather than funding through additional borrowing, those projects which address genuine problems in infrastructure should be given as a priority but as a priority that displaces current levels of spending on consumption based services provided by the government. 
In other words, the government should cut spending to fund investment (and I mean investment in the sense before the distorted use of the word as a synonym for government spending). Where there is genuine need for certain types of infrastructure (and I here accept the current reality that government will fund this), it is a better way to use borrowed money than borrowing for consumption.This will require cuts in services, and the answers I give on how to cut remain the same.The answer is to ask which services are a priority, and then to make choices according to the priorities.

In my mind, this is best achieved by asking the question of whether service x or y is really the role of the government, and cutting anything which is not a core government function. It is a question of 'luxury' over 'necessity'. The economic question is 'what can the UK afford?' but the answers as to what is necessity and luxury are political questions. The other answer is the one that I have discussed previously in my sections on reform. Having established the priorities, how can they be delivered in a way that is cost effective, but also hold to the principles on which they were established? As an example, I have proposed reforming benefits, such that there is still a (generous) safety net for those who are confronted by bad luck / unexpected difficulties, but where the costs of the system are minimised.

As the situation stands, the UK is continuing down a road which does not address the fundamental problems of the UK, with reductions in borrowing growth that will not address the underlying economic problems, and without the kind of substantive reform necessary to lay a real foundation for economic recovery. I believe that I long ago expressed the concern that the UK government would try to resolve the UK's economic problems with incremental cuts and policy measures, and this is exactly the path being followed. The trouble with this approach is not just that overall debt continues to grow whilst the economy shrinks, but also the problem is that the inevitable contraction in the economy leaves the government open to pressure to reverse course mid-term. It is, in summary, self-defeating even when taking a political perspective.

I can never make up my mind what prevents the solutions that are possible to help resolve the problems of the UK economy; is it lack of courage, political consensus or lack of imagination, or the economists whispering 'easy' solutions in the ears of politicians. Perhaps it is all of them. I started the post with Alexander Heath's article, and who proposes cowardice; in light of the self-defeating nature of incrementalism, perhaps he is wrong? Perhaps it is just lack of imagination?