“Trade-offs between inequality, productivity, and employment”

by on August 1, 2012 at 2:01 am in Economics, Philosophy | Permalink

That is a new post from the excellent Interfluidity.  I read it as a version of Keynes’s chapter seventeen, where the demand to buy insurance (in various indirect forms) is the bottomless pit preventing full employment, rather than the demand to hold money.  One question I have is why the funds spent on insurance are not in some useful manner recycled.

Here is one provocative paragraph:

Why did World War II, one of the most destructive events in the history of world, engender an era of near-full employment and broad-based prosperity, both in the US where capital and infrastructure were mostly preserved, and in Europe where resources were obliterated? People have lots of explanations, and I’m sure there’s truth in many of them. But I think an underrated factor is the degree to which the war “reset” the inequalities that had developed over prior decades. Suddenly nearly everyone was poor in much of Europe. In the US, income inequality declined during the war. Military pay and the GI Bill and rationing and war bonds helped shore up the broad public’s balance sheet, reducing indebtedness and overall wealth dispersion. World War II was so large an event, organized and motivated by concerns so far from economic calculation, that squabbles between rich and poor, creditor and debtor, were put aside. The financial effect of the war, in terms of the distribution of claims in the US, was not very different from what would occur under Keen’s jubilee.

Interesting throughout, as they say.

Turing Test August 1, 2012 at 2:04 am

World War II did not “engender” prosperity — the end of WWII did

Silas Barta August 1, 2012 at 2:29 am

But holding money … *is* a species of insurance!

JW Mason August 1, 2012 at 2:34 am

I read it as a version of Keynes’s chapter seventeen, where the demand to buy insurance (in various indirect forms) is the bottomless pit preventing full employment, rather than the demand to hold money.

I think Chapter 17 of the GT is exactly the right comparison. But as Silas Barta says above, it’s not really a version of Keynes argument, it is the same argument, just explained differently. Buy insurance is not an alternative to holding money, it is the motivation for holding money.

This also explains why the “spending” on insurance is not recycled. The value of money as insurance is that it gives you a claim on anything that becomes scarce in the future, without you needing to know in advance what might become scarce. But precisely for that reason, it can’t be committed to the production of any particular good or service, and so does not create demand for labor or other factors.

James Hass August 1, 2012 at 5:45 am

I thought the standard story of war time repressed inflation and forced savings had a lot to do with the end of mass unemployment. Post war real returns to American industrial capacity was also high, due to the destruction of European competition. What am I missing? Don’t price cielings create shortages in Econ 10 anymore?

Rahul August 1, 2012 at 5:47 am

So is he saying equality catalyzes prosperity?

ChrisA August 1, 2012 at 6:22 am

I agree with Steve that the puzzle as to why the rich keep working is answered by wealth being a form of insurance even when they are fully satisfied in their material wants (I am in this place). One thing that keeps me working (and earning) is that when (if) a medical treatment comes along that cures old age, I want to be able to afford it as soon as I can. Hopefully the drug companies are aware of this need. So wealth building as a form of insurance is not actually zero sum , it is actually a very useful incentive for people to develop new technologies, initially for rich people, that eventually hugely benefit mankind. To stretch his libertarian Titanic analogy – the rich people on the ship provide wealthy consumers to fund potential improvements in the safety of the ship, which can help everyone on the ship. Making everyone equal in wealth on the ship means that the proposer of new safety improvements has a coordination problem – rather than just convincing one or two wealthy people he has to convince the entire ship, and many of the people on the ship may have different priorities.

On the point of the post war boom, like the pre-war depression, we have so many theories of the causes and contributions already and no way to prove any of them, do we really need another one?

Finally Steve is wrong that “one rarely sees the very poor reverting to low-tech, low productivity craft production of goods the wealthy can manufacture efficiently.” In fact in most poor countries I have lived in (In Africa and Asia) you can still see wooden hand looms, wooden oxen plows, handmade baskets, brooms s etc. Basically the poor in these countries are living in a parallel economy as they have nothing to trade with the rich developed world. Greg Clark has a discussion on this in India in a Farewell to Arms.

Orange14 August 1, 2012 at 8:59 am

The other obvious explanation is that with the destruction of industry in Europe (save Great Britain, though there was clearly damage there) and Japan, the US economy was not troubled by imported goods. We were also self-sufficient in energy. With what was essentially a captive market and a huge industrial machine that was cranking out planes, tanks, and other military equipment all that had to be done was to transition to consumer goods. Remember that most of the automobile industry was largely converted to military uses during the war (my dad was a project manager in the aircraft industry and part of his job was traveling around to other company plants to coordinate production schedules; antitrust laws were not a factor during the war!) . Pent up demand because of rationing translated to a lengthy consumer boom that started to slow down when imported goods became more available (and necessary in the case of oil).

Master of None August 1, 2012 at 9:14 am

“The remaining income of the erstwhile middle class was increasingly devoted to efficiently produced basic goods and away from the marginal, lower productivity services that enable full employment.”

Is this true? We lost most employment in low-productivity service sectors? I thought most of the losses were in construction and manufacturing?

Master of None August 1, 2012 at 9:27 am

This is (another) a beautifully written argument from Waldman. I hope that MR and Scott Sumner both respond to it in more depth.

I was afraid that he wasn’t going to tie in the connection with the “tools” at all, but it was brilliantly done.

Regarding the public choice elements of this debate, I think it’s important to note that the Fed is the only US institution that is politically insulated enough to effect the kind of re-distribution of wealth that Waldman is advocating.

Greg G August 1, 2012 at 9:59 am

Excellent post. This is the best explanation I have seen of why inequality lowers aggregate demand. And for those who hate macro, it is fully explained at the micro level.

As my wealthiest friend says, “You always still worry about the cushion.”

Rowz August 1, 2012 at 1:43 pm

“Fully explained at the micro level”? TC alludes to the fact that we have no reason to believe higher steady-state savings rates should prevent labor markets from clearing. There may be a cyclical story, but that’s not how this argument is couched. I’m going to chalk this up to inability or unwillingness to explicitly model a superficially plausible story.

derek August 1, 2012 at 10:53 am

10 comments and no counterfactuals? Let’s see, Zimbabwe. Soviet Union. There are quite a few situations in recent memory where ‘inequality’ was reduced by overthrow of an old regime. Very few instances meant anything from misery and poverty.

I would suggest that WW2 saw an unprecedented level of innovation in both the technologies and also the means of production. I lived near the aluminum plant in Arvida Quebec. There was a small plant and hydro electric facility pre-war, but 39-41 saw 40-50 thousand workers building a new and larger plant, a new hydro electric generation system, the railway, port system for transporting bauxite from Jamaica, along with everything required; a town for workers, etc. The production facilities were geared to produce aluminum for aircraft. This massive industrialization and increase in capacity was in many other places as well, and in similar scale. After the war, as the original article mentioned, everyone had savings. There was the means to mass produce at a good price all that these consumers would want. They paid cash or very limited borrowing; the collapse of the financial system in the 30′s had de-financialized the economy to a large extent. The opposite of the great stagnation, and opposite of the leverage fueled boom we have seen recently.

Master of None August 1, 2012 at 11:21 am

I don’t read Waldman as advocating revolutionary action as the solution. Rather, he correctly identifies it as a “last resort” tactic taken by the economic losers when political institutions fail to deliver the goods (via taxes/inflationary monetary policy).

No one is arguing that a violent overthrow is the silver bullet here…

Ian Lippert August 1, 2012 at 11:54 am

But this kind of misses dereks point. The technologies of WWII were able to harness a general increase in our technological capacity to create the plants that produced the instruments of war. This technological boom lasted until the end of the war when those plants were then retooled to produce consumer goods.

The counterfactual is to ask what would have happened if this technological boom had been funneled strictly into consumer goods had the US skipped the war. It might have nothing to do with the equality that came out of the destruction or it might, we’ll never know. Arguing about WWII is pretty pointless considering how many causal factors one can dig out of this extremely complex event.

Bill August 1, 2012 at 11:13 am

One ugly truth about WWII and the end of the depression is that the war served to ease unemployment by murdering much of the potential labor force.

derek August 1, 2012 at 11:19 am

Yes, and I find it bordering on distasteful to view that situation as a solution for anything. If we want to ignore nastiness, then I’d suggest from a jobs perspective Hitler would have been an extremely successful one term president. Went pretty sour in the second, and a disaster in the third.

JW Mason August 1, 2012 at 10:34 pm

Totally wrong. The vast increase in women’s labor force participation — and then a bit later in the birthrate — substantially increased the workforce, in the US certainly, and probably in a number of other belligerent countries as well.

Note that the capital stock increased much more rapidly during the war than before it, even in Germany. It is simply not the case that the war reduced productive capacity anywhere except the USSR.

ziel August 1, 2012 at 11:29 pm

After the war, though, the women were generally sent packing. But for the U.S,, total lost were less than half a million. Add in a couple hundred thousand too badly maimed to work, the casualty impact was probably around 750,000. Not really enough to have much of a material impact on the unemployment rate (less than 1 % point).

MPS August 1, 2012 at 11:28 am

In addition to insurance, wealth buys social status. You can think of the yacht as a piece of insurance, but in the event of a catastrophe, the yacht is worthless. As are many other luxury items (paintings, mansion, fancy cars, etc.). In the event of catastrophe, the only real currency is the things people really need. All these things, then, are better understood as status signals.

I say this because social status, like insurance, is something that must be vigilantly guarded, and it flows according to a zero-sum game as well. So it works equally well to explain why you can never have enough wealth. In the titanic analogy, one replaces the number of life-boats with the number of desirable romantic partners, or the number of chairs at the VIP table.

I think the rest of the analysis still follows. The status currency of wealth is not just the things you own — the yachts and paintings and mansions etc. — it’s the things you can buy at a moment’s notice. This is how you “guard” your status. And so you’re hesitant to spend too much; you must keep a lot in reserve. (I concede that at this point, my comments are sounding like the insurance argument. But the context is different, I think.)

JW Mason August 1, 2012 at 10:35 pm

You can think of the yacht as a piece of insurance, but in the event of a catastrophe

You’re missing Waldman’s point. The “insurance” he is talking about is specifically wealth held in financial form. Not yachts.

Stephen M August 2, 2012 at 12:48 pm

Prosperity? There was rationing of basic materials for crying out loud! Can someone point to another point in human history that prosperity occurred at the same time of nationwide rationing?

In order to believe that WW2 was prosperous, you would have to argue that it is prosperous to send your skilled labor force off to fight and die and see them replaced with a completely unskilled labor force who build bombs and bullets. All the while there is rationing of basic materials.

Please end the ‘WW2 was prosperous’ meme. It is a complete joke.

blastomere August 4, 2012 at 5:39 am

Easy to explain why the rich keep working. The rich tend to be bosses, and bossing people around is far more enjoyable than being bossed around.

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