The Disquietude of Microeconomics - r02

Abstract

• We tend to conflate the terms economics and finance, which has broad implications. The student of economics is offered coursework in microeconomics unaware of this condition. There is no real economics in microeconomics. The term “microeconomics” is a misnomer.

How many times have you heard someone claim to do something for economic reasons? The intent is generally understood, but as is well known, people do things for financial reasons. Corporations, also, do things for financial reasons. Few, if any, can affect an economy with their actions. Our words betray us.

Suggesting one’s financial interest to be economic in nature may add a sense of resolve to the situation at hand but at what expense? Where does this misdirection matter? Consider how the discipline of economics is taught.
 
The student of economics may start with a desire to understand how economies work. Knowledge of this sort can be useful in many fields. To be taught at the undergraduate level, as mainstream economics holds, that markets are efficient, self-correcting, and lead toward a type of overall equilibrium that benefits all, sets the student of economics off onto a problem-solving exercise financial in nature. Imagining an economic solution is arrived at once the financial needs of markets are met, disempowers the student. The goal becomes one of market viability and not one of economic vitality. The presumption of market supremacy leads toward an intellectual vacuum. The full scope of economic mastery is neutered at inception.



Economic mastery involves managing economic performance at the level of aggregates. Aggregate supply and aggregate demand set the stage for good economic policy. A consideration of individual markets or even a consideration of markets as a whole is misleading. The discipline of economics operates outside of market activity.
 
For the student to be taught that markets are integral to economic policy has the student believe the market is also the intelligence of an economy, which it is not. Markets provide no intelligence to an economy. Markets are self-contained and work to establish price and quantity for a given commodity. Markets are to economies as pixels are to portraits.
 
Neither the interlaced networks of markets nor the economy itself provide intelligence necessary to sustain its participants. The intelligence of an economy must be super imposed. That was the contribution John Maynard Keynes made to the discipline in the 1930s with his doctrine of “effective demand”. A faltering economy cannot reestablish the incentive to invest short of the passage of time. Left to its own device an economy will operate at a level established by the more competitive actors leaving the needs of society in its wake. A million Irish gave their lives for this principle in the 19th Century. History is replete with such examples.
 
The discipline of economics, in part, suffers from a problem of its own making. Requiring the student to have a substantial background in calculus and higher math sends the wrong message. It puts the discipline at risk by enforcing a type of self-selection and predisposition toward a mathematical solution. Requiring a background in history, the humanities or philosophy would serve the discipline better. When the problem solver has only a mathematical hammer, every problem becomes a numerical nail.
 
Rarely is economics taught as a social science, in which it is. Usurping the authority of social interaction in terms of market forces is disquieting and sinister. Teaching economics from the business college by business professors suggests finding the right model for market forces is the only thing standing between what we have now and nirvana.
 
Mainstream economists like to talk about market failures. This notion is misguided. Economists should be concerned with policy failures. Failure to pull the plug on an overheated economy is one obvious example of policy failure. Failure to provide an adequate stimulus in times of reduced demand is another. Failure to recognize how current tax policy requires the wealthy to hoard their wealth for lack of a good investment is a policy failure. Market failures themselves are peripheral to sound economic policy.
 
Ludwig von Mises and Friedrich A. Hayek, both contemporaries of Keynes, seemed willing to consider the nature of markets by recognizing the importance of terminology. They agreed that the term “economics”, originating from the Greek word for household management, did not properly identify the true mission that markets embrace. They individually supported a derivative of the term “Catallaxy” first proposed by Richard Whately in his 1931 Introductory Lecture on Political Economy to properly identify the position markets enjoy. Derived from the Greek word “to describe the order brought about by the mutual adjustment of many individual economies in a market”, the word catallaxy better described what Hayek viewed as an “interlaced network of economies” (which might be better identified as an interlaced network of markets so as to not foul the very concept he is trying to clarify!). Mises anglicized the word to “catallactics” and adopted its meaning as “the science of exchange” or as the order brought about by the mutual adjustment of individual actors upon a market. Mises saw “catallactics” as the discipline of market behavior.
 
Unfortunately for us all, the term catallactics was not carried forward. Unfortunate in the sense that markets became irrefutably linked with the discipline of economics when the term “microeconomics” was born in the 1940s. From that point forward, markets and the law of supply and demand muddied the water for almost all subsequent economists up to the present time. An economy of markets became a market economy.

The field of study labeled as microeconomics does not represent the discipline of economics. The label is a misnomer, and its subject matter would better be identified within the disciplines of finance or market science where the investor or the business interest is the driving force. The label “microeconomics” is a mischievous and destructive term, and its use needs to be abandoned.

How Did Economists Allow Keynesianism to Become Trashed?

After rescuing the planet from a worldwide economic depression in the 1930s, and after providing the U. S. a stable economy with high growth, low unemployment and negligible inflation in the 1960s, standard economic folklore suggests that Keynesian economics is not viable. Mainstream economists attack the notion of effective demand that John Maynard Keynes put forward in his 1936 book, The General Theory of Employment, Interest and Money. Why is that? Where does the evidence point to Keynesianism as unworkable?

Some mainstream economists scoff at Keynes’ assertion an economy can be finely tuned such that at some point in the future it will be necessary to work only 15 hours per week. They forget Keynesian economics lasted only briefly in the 1930s and then again only briefly during the Kennedy administration. So, if we’re looking for blame why we’re not on track for the 15-hour work week, it should be fair to say it has little if anything to do with Keynesian economics.

Keynes is vilified as a disrupter of the economic system while outsourcing, tax havens and regulatory capture become standard operating procedure for many large corporations; while corporate greed ensures hourly wage earners no longer participate in productivity gains; while financialization replaces a bona fide investment as the go to strategy for profit seeking corporations; while the poor end up paying a higher percentage of their income to taxes than the wealthy. Have mainstream economists become ideologues? Why are they silent on issues of ethics and morality? Is it acceptable to ignore the plight of half the population?

This is not to say Keynes, who is credited with being the father of demand-side economics, had all the answers. He could have been more emphatic with the necessity of paying down the debt in times of prosperity. He could have alerted us to the likelihood the rich and powerful would skew the economic system to their favor and refuse to share with labor the fruits of increased productivity. He could have laid-out in stark terms the dangers of hording of wealth and how a sufficiently progressive tax code is necessary to keep the economic pump primed. He could have shown how a well-functioning society makes business activities even possible and how it’s incumbent upon us all to recognize the need for societal investments to keep the wheels of business turning. With all his faults, however, Keynes still must be credited with identifying inconsistencies buried within mainstream economic thinking and with offering an alternative approach that has proven in the past to be successful.

It must be stated at this point, a significant portion of the population feels the economy is performing well. Growth is high, unemployment is low, and there is little prospect of inflation according to official reports. The other 80% of the population, however, only know what they’re experiencing. Real wages for hourly wage earners have been stagnant or falling since the early 1970s. 90% of all new income goes to the top one-percent. Nearly half the population would have trouble handling an unexpected $500 expense. One of five children in this country live in a state of poverty. The middle class is shrinking, and globalization of business activities is fueling anger and resentment in rural America.

Keynes was able to show the economy was not self-correcting as neo-classical economists were happy to assume. He was able to show that there was no actor available to lift an economy out of a recession short of governmental intervention or vast stretches of time as prices and wages adjust. He was able to show that putting full employment at the center of economic policy and not price stability was critical to growth and that both monetary and fiscal policy are necessary to make that happen.

Simple truths can go unnoticed. Mainstream economists seem to not recognize consumption as the other half of the production equation. What doesn’t get consumed no longer has to be produced, and what doesn’t get produced inhibits growth. Without appropriate wages to support adequate levels of consumption (and more specifically without sufficient buying power), higher levels of production are less likely.

Demand for goods and services is the proverbial “goose that laid the golden egg”. Demand and not wealth accumulation is responsible for growth potential and ultimately higher profits. Demand for products and services will propel higher employment levels by requiring business to adjust. Putting more money into the hands of the wealthy with our currently regressive tax regime makes the wealthy only more-wealthy. Greater concentrations of wealth do not automatically create more jobs. The authors of the 2011 book, The Gardens of Democracy, put it this way: Companies don’t hire when they have an abundance of money. They hire when they have an abundance of demand.

Keynes was able to show that in the short-run there was no automatic stabilizer built into an economy. He was able to show good public policy that considers adequate levels of public and private spending as being critical to the prevention of prolonged downturns such as we experienced during the Great Recession. He showed judicious use of fiscal and monetary policies benefit not only most workers but society itself with better infrastructure and social services. The business community and their economists have fought these ideas even though full employment and a more activist use of fiscal policy would be in their long-term interest. We would all be better served if business trained economists took a more expansive view of their true mission of delivering public good and recognize the value labor and a fully functioning economic community provide.

Framework for Parity of Saving Strategy

An economy is like a pressure cooker. Allow too much pressure to escape and it becomes less effective. Excess saving is currently allowing pressure to escape from the U.S. economy at an unhealthy rate. A “Parity of Saving” strategy will help to limit the extraction of economy crushing resources. A summary of this strategy follows.

To start, income levels with high rates of saving are identified. This is done by dividing household income levels into deciles by number of households. With approximately 120 million households in the U.S. each decile is made up of approximately 12 million households. For each decile the average rate of saving is then determined based upon previous year's financial data. The average rate of saving for median income earners is then compared to rates of saving for higher income earners. Where the saving rate for these groups differ, adjustments to the tax rate is necessary.

For example, if it is found the average saving rate of decile six is at 10% of income and the saving rate of decile ten is 25%, the strategy is to lower the tax rate for the lower income groups and raise the tax rate for the higher income groups. Lowering tax rates on lower income groups puts more discretionary income into the hands of those with a high propensity to spend, thus spurring the economy. More discretionary income also will result in a slightly higher rate of saving for these groups. At the same time, by raising tax rates on higher income groups, less saving will result for these groups. The intent is to move those deciles above median income levels, deciles six through ten, toward an equality of saving over time. When a parity of saving has been achieved, excessive saving will have been squeezed out of the economy resulting in more money in circulation, more demand for products and services, and eventually more growth.

Teaching Supply-side and Demand-side Economics

Just as macroeconomics and microeconomics are taught separately at most universities, so too should demand-side economics and supply-side economics be taught separately.  Demand-side economics and supply-side economics are fundamentally distinct and require a program of coursework designed to explore each of these two approaches in full, absent conflicting arguments and theories.  Teaching the rudiments of each in one course is like teaching Spanish and French from the same textbook.  Without a suitable immersion into the efficacy of each approach, the student is left with a confusing array of theories and counter-theories.

Tax policy provides a good example for this concern.  Tax policies differ greatly depending on the policy objective.  There is little middle ground.

On the supply-side, tax strategies favor capital accumulation.  Lower taxes on wealthy corporations and high-income individuals they say will promote growth.  Reducing inefficiencies and distortions in the market are of paramount concern.  Ensuring business has a ready supply of investment capital is an objective.  For supply-side economics, the market is king, and a low tax rate for movers and shakers is the order of the day.

On the demand side, the consumer is king which suggests a more bottom-up approach.  Lower taxes for middle income earners they say will spur economic growth as business reacts to increased demand.  Demand siders maintain aggregate demand for products and services drives the economy, and when growth lags, governmental infusions into the marketplace are essential.  A sufficiently progressive tax code is a key component to demand-side policies.

Given these conflicting approaches to public policy, teaching them in one course does a disservice to the student.  The result of each strategy is unique and requires development in total.  Without a deep dive into the outcome of each approach, the student is left with a bewildering array of counter-factual theories.  Instructors need to flush this out by examining each of these competing theories in an untainted atmosphere of facts and hard data.  This can only be done by examining the finer points of each strategy in a stand-alone, end-to-end analysis of these two distinct approaches to economic growth and stability.

Blaming Capitalism

We tend to blame capitalism for our own faults.  Blaming capitalism for a culture of greed is like parents complaining they have lousy kids.  We elect representatives that permit a systemic rape of our national wealth.  Don’t blame capitalism for this shortcoming.

Capitalism is an amoral economic and political system.  It is neither good nor bad.  The manner in which it's interpreted is what matters.  In a democracy we have a choice in how we define and administer the tenets of capitalism.  Unfortunately, we have delegated that responsibility to those who favor the moneyed interests over and above all else.

“We the people” do not recognize the value of the society we help to create every day.  If there is a fault in capitalism, it is in its inability to offer an obvious path to greater prosperity for all.  The tenets of capitalism require a thoughtful and studied approach to a greater understanding of its variations, which is something most are unwilling or unable to do.

Saving Parity: The Road To a Sufficiently Progressive Tax Code

This is not about income inequality.  Income inequality poses no threat to our democracy, to us or to the economy.  This is about extreme income inequality.  Extreme income inequality is the threat.  Extreme income inequality adversely affects the fabric of our lives, as the authors of the 2010 book, The Spirit Level, point out.  Higher levels of drug abuse, incarceration, teenage pregnancies, obesity, cancer and heart disease, just to name a few, all correlate with high levels of income inequality.  If we are to create a well-functioning society where the needs of us all are placed above the needs of a few, we must find a way to reverse the trend toward excessive income inequality within this nation.

Part of the solution will be to bring about full and meaningful employment.  To do this we must overcome the notion rich people create jobs.  We must recognize business owners react to market conditions and that companies don't hire when they have an abundance of profits; they hire when they have an abundance of customers (Liu / Hanauer).  We must recognize the true job creator is the buying power of a financially strong middle class.  Our task, therefore, is to find a way to rebuild and sustain a strong middle class.

A pundit wrote recently that class warfare is alive and well in this country, and the tax code is the weapon of choice.   A few rich and powerful individuals are obsessed with the amount of money they pay in taxes, and they make their presence known in Congress and elsewhere.  Where money is no object, a lot of pressure can be brought to bear.  We end up with, as they say, 'the best government money can buy'.  For those who think we deserve better, the question becomes, "What can be done to turn this around?"

Consumer spending

Accounting for about 70% of the annual Gross Domestic Product (GDP), consumer spending drives the U.S. economy.  To turn things around, consumers need more discretionary income.  Given the top wage earners' high propensity to save, more discretionary income for median income earners means higher levels of consumer spending.

There are many tools available to put more money into the hands of those who would spend it.  The federal government could simply send a check to everyone, the so called "helicopter money", it could guarantee a job for anyone willing and able to work, as Roosevelt did in the 1930s or it could adjust the federal income tax code to make it more progressive, thereby lowering the tax rate on median income earners.  An adjustment to the federal income tax code will be the alternative favored here.

U.S. Tax Code

Enacted in 1915, the U.S. federal income tax code was designed to tax income according to one's ability to pay.  It's progressive, meaning the tax rate increases as the taxable amount increases.  This tax strategy is used in almost every industrialized country.  Few argue that the highest income earners should not pay a higher rate.  The question becomes, "How much higher?"  That is what will be examined here.

We, as a nation, have been all over the board in terms of federal income tax policy for these last one hundred years.  In the World War II era, income tax rates for high income earners topped out at 90 plus percent.  When Ronald Reagan was in office in the 1980s, the top rate had dropped to 28%.  Currently, the top rate is about 40%.  "What is the optimum rate of taxation?"  The optimum rate, argued here, is a moving target and should be set to one's level of saving.  Those with a higher propensity to save will pay a higher rate.  The idea is not to discourage the building of a nest egg but to limit excessive saving.

For most, excessive saving does not seem possible.  One never knows what calamity might arise.  In terms of those who cannot possibly spend a significant portion of their income, and particularly in terms of the economic health of the nation, more in savings, however, is harmful.  Economies, ultimately, are a result of money changing hands.  When money ceases to change hands on a broad scale, growth is compromised.  This is what happens when excessive savings is allowed to persist.  Growth is compromised when money is pulled out of an economy in the form of saving.  Our economy is bleeding in perpetuity with current high rates of saving.  We need to better understand specifically where the highest rates occur and how best to deal with it.

Saving Parity

An economy is like a pressure cooker.  Allow too much steam to escape, and it becomes less effective.  Excess saving is currently allowing pressure to escape from the U.S. economy at an unhealthy rate.  A parity of saving strategy will help to limit the storage of economy crushing wealth.  Let's take a look at how a strategy of this sort would work.

To start, we must identify income levels with high rates of saving.  This can be done by dividing household income into deciles (ten equal parts) by number of households.  Since there are approximately 120 million households in the U.S. each decile would be made up of approximately 12 million households.  For each decile the average rate of saving would then be determined based upon the previous year's financial data.  The average rate of saving for deciles five and six (the middlemost groups) are then compared to rates of saving for higher income groups.  Where the saving rate for the middlemost groups differ from the saving rate of the higher income groups, adjustments to the tax rate would be necessary.

For example, if it is found the saving rate of decile 5 is at 10% of income and the saving rate of the highest decile is 25%, the strategy would be to lower the tax rate for lower income groups and raise the tax rate for higher income groups.  By lowering the tax rate on middle income groups, these groups will have more discretionary income to spend thus spurring the economy.  More discretionary income will also result in a higher rate of saving for this group.  At the same time, by raising the tax rate on higher income groups, less saving will result for this group.  The intent, ultimately, is to have the top five decile groups achieve a type of saving parity (saving equality).  When saving parity has been achieved, excessive saving will have been squeezed out of the economy resulting in more money in circulation, more demand for products and services, and eventually more growth.

Conclusion

We have it within ourselves to create a more just society, but thoughtful action is required.  As Frederick Douglass once said, "Power concedes nothing without a demand."  To put an end to extreme income inequality we must demand a sufficiently progressive tax code be put in place and end the assault on the middle class.  A parity of saving strategy can help to take us there.

We must recognize an economy is a force of nature, and while we can influence it, we cannot change the way it works.  Keeping taxes artificially low for so called “job creators” is contrary to the way economies work.  For this economy to perform at a high level, consumption of goods and services must take place at that same high level.  Putting more money into the hands of the middle class consumer, the true job creator, will allow for this higher level of economic activity.

Creating a financially strong middle class is the recipe.  Squeezing out excessive saving is the secret sauce.