Results for “department why not”

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There has been some pushback on my recent China consumption post, so let me review my initial points:

There exists a view, found most commonly in Michael Pettit (and also Matthew Klein), that suggests economies can have structural shortfalls of consumption in the long run and outside of liquidity traps.

My argument was that this view makes no sense, it is some mix of wrong and “not even wrong,” and it is not supported by a coherent model.  If need be, relative prices will adjust to restore an equilibrium.  If relative prices are prevented from adjusting, the actual problem is not best understood as a shortfall of consumption, and will not be fixed by a mere expansion of consumption.

Note that people who promote this view love the word “absorb,” and generally they are reluctant to talk much about relative price adjustments, or even why those price adjustments might not take place.

You will note Pettis claims Germany suffers from a similar problem, America too though of course the inverse version of it.  So whatever observations you might make about China, the question remains whether this model makes sense more generally.  (And Australia, which ran durable trade deficits from the 1970s to 2017, while putting in a strong performance, is a less popular topic.)

Pettis even has claimed that “US business investment is constrained by weak demand rather than costly capital”, and that is from April 4, 2023 (!).

It would take me a different blog post to explain how someone might arrive at such a point, with historic stops at Hobson, Foster, and Catchings along the way, but for now just realize we’re dealing with a very weird (and incorrect) theory here.  I will note in passing that the afore-cited Pettis thread has other major problems, not to mention a vagueness about monetary policy responses, and that rather simply the main argument for current industrial policy is straightforward externalities, not convoluted claims about how foreign and domestic investment interact.

Pettis also implicates labor exploitation as a (the?) major factor behind trade surpluses, and furthermore he considers this to be a form of “protectionism.”  Now you can play around with scholar.google.com, or ChatGPT, all you want, and you just won’t find this to be the dominant theory of trade surpluses or even close to that.  As a claim, it is far stronger than what a complex literature will support, noting there is a general agreement that lower real wages (ceteris paribus) are one factor — among many — that can help exports.  This point isn’t wrong as a matter of theory, it is simply a considerable overreach on empirical grounds.  Of course, if Pettis has a piece showing statistically that a) there is a meaningful definition of labor exploitation here, and b) it is a much larger determinant of trade surpluses than the rest of the profession seems to think…I would gladly read and review it.  Be very suspicious if you do not see such a link appear!

Another claim from Pettis that would not generate widespread agreement is: “…in an efficient, well-managed, and open trading system, large, persistent trade imbalances are rare and occur in only a very limited number of circumstances.” (see the above link)  That is harder to test because arguably the initial conditions never are satisfied, but it does not represent the general point of view, which among other things, considers persistent differences in time preferences and productivities across nations.

Now, it does not save all of this mess to make a series of good, commonsense observations about China, as Patrick Chovanec has done (Say’s Law does hold in the medium-term, however).  And as Brad Setser has done.

In fact, those threads (and their citation) make me all the more worried.  There is not a general realization that the underlying theory does not make sense, and that the main claim about the determinants of trade surpluses is wrong, and that it requires a funny and under-argued tracing of virtually all trade imbalances to pathology.  And to be clear, this is a theory that only a small minority of economists is putting forward.  I am not the dissident here, rather I am the one delivering the bad news.

So the theory is wrong, and don’t let commonsense, correct observations about China throw you off the scent here.

That is the theme of my latest Bloomberg column, here is one excerpt:

It is possible, contrary to the predictions of most economists, that the US will get through this disinflationary period and make the proverbial “soft landing.” This should prompt a more general reconsideration of macroeconomic forecasts.

The lesson is that they have a disturbing tendency to go wrong. It is striking that Larry Summers was right two years ago to warn about pending inflationary pressures in the US economy, when most of his colleagues were wrong. Yet Summers may yet prove to be wrong about his current warning about the looming threat of a recession. The point is that both his inflation and recession predictions stem from the same underlying aggregate demand model.

You will note that yesterday’s gdp report came in at 2.9%, hardly a poor performance.  And more:

It is understandable when a model is wrong because of some big and unexpected shock, such as the war in Ukraine. But that is not the case here. The US might sidestep a recession for mysterious reasons specific to the aggregate demand model. The Federal Reserve’s monetary policy has indeed been tighter, and disinflations usually bring high economic costs.

It gets more curious yet. Maybe Summers will turn out to be right about a recession. When recessions arrive, it is often quite suddenly. Consulting every possible macroeconomic theory may be of no help.

Or consider the 1990s. President Bill Clinton believed that federal deficits were too high and were crowding out private investment. The Treasury Department worked with a Republican Congress on a package of fiscal consolidation. Real interest rates fell, and the economy boomed — but that is only the observed correlation. The true causal story remains murky.

Two of the economists behind the Clinton package, Summers and Bradford DeLong, later argued against fiscal consolidation, even during the years of full employment under President Donald Trump [and much higher national debt]. The new worry instead was secular stagnation based on insufficient demand, even though the latter years of the Trump presidency saw debt and deficits well beyond Clinton-era levels.

The point here is not to criticize Summers and DeLong as inconsistent. Rather, it is to note they might have been right both times.

And what about that idea of secular stagnation — the notion that the world is headed for a period of little to no economic growth? The theory was based in part on the premise that global savings were high relative to investment opportunities. Have all those savings gone away? In most places, measured savings rose during the pandemic. Yet the problem of insufficient demand has vanished, and so secular stagnation theories no longer seem to apply.

To be clear, the theory of secular stagnation might have been true pre-pandemic. And it may yet return as a valid concern if inflation and interest rates return to pre-pandemic levels. The simple answer is that no one knows.

Note that Olivier Blanchard just wrote a piece “Secular Stagnation is Not Over,” well-argued as usual.  Summers, however, has opined: “we’ll not return to the era of secular stagnation.”  I was not present, but I can assume this too was well-argued as usual!