Wealth and Recession

by Brian on October 21, 2011

Nate Silver had “a tweet”:http://twitter.com/#!/fivethirtyeight/status/127352379866742784 this morning that’s relevant to a debate that went on here a month or so ago.

bq. The median American’s non-household wealth declined by 14% between 2001 and 2007. So when household wealth evaporated, guess what happened?

I’m not sure of the source of this, so take some of this with a grain of salt. But if it’s true, it is relevant to something Daniel Davies “claimed”:https://crookedtimber.org/2011/09/22/but-whos-the-real-criminal-its-me-isnt-it/ and Brad DeLong “rejected”:http://delong.typepad.com/sdj/2011/09/over-at-crooked-timber-daniel-davies-turns-into-an-internet-troll.html, namely (to quote Daniel) “we are in a recession basically because of the disppearance of a huge amount of household sector wealth”.

I basically think Daniel is right on this, and Brad wrong, for reasons I’ll go into below the fold. And I take it Nate is endorsing Daniel’s line, namely that the recession was brought about by a huge collapse in household wealth.

Brad offers, I think, two arguments against the wealth effect explanation of the recession. One is that “wealth had disappeared before–remember Black Monday on the stock market in 1987, or the collapse of the dot-com boom?–without it triggering a Lesser Depression.” But both of those collapses led to a huge loss of wealth among people with substantial stock holdings, i.e., among people with the lowest marginal propensity to consume in the economy. That’s very different to a general fall in the value of houses; that tends to affect people who have a very high marginal propensity to consume, and hence lead to recession.

The other argument is a timing argument. Brad says that new construction fell well before the recession hit. And it’s true, it did. And that would be a good argument against the claim that the recession was caused by job losses to construction workers. But it’s not a good argument against the claim that of household wealth caused the recession. Let’s look at when house prices started to fall (at least in the US).

Case Shiller 10 City Average

That looks like like house prices collapsed just before the recession hit. So the timing works.

It’s true that house prices start falling in 2007, and there’s no recession until into 2008. But I think (a) you’d expect a wealth effect to percolate slowly through the economy, and (b) people didn’t *think* house prices had collapsed in late 2007, early 2008. It’s true by then that people knew that house prices in Phoenix and inland California were on their way down. But you don’t see much rapid movement downwards in the prices in non-bubbly areas until much further into 2008. If you like you can look through “the data”:http://www.standardandpoors.com/indices/sp-case-shiller-home-price-indices/en/us/?indexId=spusa-cashpidff–p-us—- to see that. Or you can just remember what that time was like. Certainly around New York, the prevailing wisdom was that a bubble in desert properties had quite properly popped, but that was no reason to doubt that New York properties would be affected. And lots of building went on in 2008 on that basis.

So the timeline works out for the theory that loss of household wealth is what did it. On the other hand, I don’t understand Brad’s positive theory of the recession. Here’s what he says.

bq. It was because people recognized that banks that were supposed to have originated-and-distributed mortgage-backed securities had held on to them instead, that as a result a large chunk of the $500 billion in subprime losses had eaten up the capital base of highly leveraged financial institutions, and that you were running grave risks if you lent to a bank. The run on the shadow banking system that followed was the source of the crash as financing for exports and for equipment investment vanished, and then the whole thing snowballed.

But if banks had followed the originate and distribute model, and we found out that all the MBS’s were lousy, you would have had risks on lending to anyone in the financial system anywhere. That would seem to generate an even bigger run on the shadow banking system. Frankly, a pure originate-and-retain model, followed by the bankruptcy of a few dedicated mortgage brokers, would probably have been less complicated to unwind than the mess we have. Certainly it seems that the fact that so much of the market was orginate-and-distribute is causing big problems for doing mortgage adjustments. (I think that “SemiEcon”:http://delong.typepad.com/sdj/2011/09/over-at-crooked-timber-daniel-davies-turns-into-an-internet-troll.html#comment-6a00e551f080038834015435ab527c970c makes basically this point in Brad’s thread.)

The dispute between Brad and Daniel is caught up in a bigger dispute about whether the banks are to blame for the crash. I wonder whether this is going to be too hard to figure out without doing some tedious work on defining just what we mean by “the crash”. Here’s one rough take on the Bush era economy. It basically was awful; a long recession in the style of 1920s England. This fact was disguised because house prices kept going up, and people were able to turn rising prices into consumption via HELOCs and the like. In turn, the easy availability of just this financing helped keep house prices rising. But this couldn’t last forever, and when it stopped, there was a crash.

That suggests that bad, or at least odd, behaviour by the banks contributed to the crash. But it also suggests that a more responsible banking sector would have left us so badly off all through the 2000s, that the economy would have been just as bad by the end of Bush’s term. (Assuming, in the relevant counterfactual world, that Bush even won in 2004; without the housing bubble, he might not have.) If that’s right, the banks aren’t to blame for the crisis; Bush is. And the solution to the crisis isn’t to fix the banking sector, either through regulatory reform or continuing to bail out the banks, it’s to stop Bush-era economic policies.



Omega Centauri 10.21.11 at 10:10 pm

I’m more a bit of the bit of both kinda guy. The house price collapse, that reduced apparent consumer net worth so much, and forced a change in consumer debt behavior, from running up more debt, to rebuilding balance sheets, also severely impacted any financial instruments that depeneded ultimately upon mortgages. So we had a combination of a banking crises and a consumer wealth destruction crisis at the same time. Either one would have been bad by itself, the combination is worse (additive at least).

Had banks not been playing games with risk, the bubble wouldn’t have floated as high as it did. The question then becomes, is a higher bubble popping, worse than if the bubble had never gotten so high in the first place? I.e. are there nonlinear effects that create additional damage? I think the answer is yes. You see abandoned projects on which real physical economy goods were spent, that are just sitting around decaying (such as roads, with house foundations and utility hookups that sit rotting in the fields), i.e. some of the excess investment, resulted in wasted physical resources, not just paper ones.


Billikin 10.21.11 at 10:20 pm

If there was a housing bubble, then what was destroyed was not wealth, but the illusion of wealth. Not that that would not have economic consequences, but it is not the same thing.


Omega Centauri 10.21.11 at 10:27 pm

Billikin. True, but false illusions can lead people into making economically damaging decisions. Such as taking out a HELOC inorder to install garnite-countertops, only to later mail the keys to the bank, because the mortages are too far underwater. Those are a form on nonlinear destructive effect (of a bubble), I refer to. Plus things often overshoot, on the way down as well as up, and that creates destructive effects as well.


michael e sullivan 10.21.11 at 10:31 pm

My guess as to what Brad meant when he says that “banks that were supposed to have originated-and-distributed mortgage-backed securities had held on to them instead” refers to the *risk* of those mortgages, and the effective short housing put. They distributed the mortgages, and that was supposed to get rid of the risks.

But then, they bought a bunch of that risk back in the form of securities with big “AAA-SUPER-SAFE” labels on them, which turned out to carry massive tail risk in the event that there was a big housing crash. A tail risk that, modeled appropriately, would have made them borderline investment grade well before the housing top, and junk by the middle of 2006.


michael e sullivan 10.21.11 at 10:41 pm

Where you seem to be going with this is the idea that all the problems were structural. But it’s plain as day that there is no good reason to think this. Plenty of people and capital were gainfully employed in 2007 doing things other than housing and finance related work that are now idle, and have remained so for years now. You are right that policy is responsible for this, but it is central bank and fiscal policy beginning in 2008 that is responsible. You could argue that policy of 2001-2007 is responsible for the bubble which needed to burst, but the terrible macroeconomic stabilization policy of 2007-2011 is the reason we have continuing 9% unemployment, instead of a short spurt of high unemployment mostly in finance and construction working it’s way out of the system and back to near full employment over the last 3-4 years. That would have required accepting some inflation as the penalty for recognizing the weak economy, but that too would have worked it’s way out and given way to real growth again as the economy healed itself. Instead we’ve been starving the patient with fiscal contraction and tight money.


Henri Vieuxtemps 10.21.11 at 11:38 pm

This fact was disguised because house prices kept going up, and people were able to turn rising prices into consumption via HELOCs and the like.

Does this mean that the housing bubble was essentially an equivalent of a Keynesian stimulus? And if so, does the 2008 crash indicate that Keynesianism fails, in the long term. (No, not that long so we are all dead)


Peter K. 10.22.11 at 1:05 am

Great, thought-provoking post! I’ve been wrestling with this also (as you’ll see).

I think it’s a mistake to try to blame it all on “Bush-era polices.” My guess is that his tax cuts were bubbly but otherwise what’s the mechanism? He just continued the deregulatory-privatizing trend of things since the Reagan revolution through the Clinton years.

Greenspan could have popped the housing bubble early on, but didn’t. There was obviously a failure to regulate lending standards and the rating agencies failed, etc. The banks went wild. (go see the film “Margin Call.”)

I agree with #1 and #5 that it was a bit of both. The wealth effect did add demand which replaced the demand missing from the fact that workers wages weren’t rising with productivity gains.

As Davies pointed out, you also had a bubble in Spain which had plain old vanilla mortgages. I think this had to do with the Global Savings Glut which lowered interest rates in general. China and oil producing countries’ savings were causing interest rates to drop which helped cause the housing boom which morphed into a bubble and took on a life of its own. So the wealth effect wasn’t merely lower lending standards or the Fed being too loose with its monetary policy.

I think DeLong is correct about the financial system’s implosion causing the recession. This has happened before in history. The financial system imploded because of the popping of the bubble and the loss of the wealth effect helped it snowball. Compared with the Internet bubble, maybe this time the financial system was more leveraged up and you had the shadow banking system freezing. No one trusted anyone’s books, panic ensued and credit markets froze. I think the panic did real damage to the economy. Credit markets unfroze but lending standards are tighter now. The demand we had before the bubble popped hasn’t been replaced even though the economy is growing again.

I agree with #5 that if in 2008-2010 we had better fiscal and monetary policy we would be back up to full employment even without the wealth effect. There’s also the trade deficit, but that can be financed with foreign capital coming in to the U.S.’s safe haven, no? At least for the moment.


Brian Weatherson 10.22.11 at 1:10 am

Does this mean that the housing bubble was essentially an equivalent of a Keynesian stimulus? And if so, does the 2008 crash indicate that Keynesianism fails, in the long term.

A very poorly designed and distributed stimulus, but yes it was a stimulus. And when you need to keep the stimulus going as long as we needed to under Bush, the repayment issue will become pressing. Stimulus, even under orthodox Keynesian views, should be short and sharp. Years of HELOCs isn’t the way to do it.


Major Alfonso 10.22.11 at 1:19 am

My immediate reaction to this is simply to refer to Dean Baker. It’s about employment and wealth creation. Employment and wealth creation in the US were fundamentally misdirected into housing as a store of wealth [and here in Ireland the same happened exponentially] leveraging a workforce’s future earnings. There is no recovery until employment recovers and starts sustaining the type of wealth creation that can buy a house, a pension, a child’s college education or insurance against a vampire health system. The legacy of “irrational exuberance” is a curse undreamt of by gypsy curses, a structural dry rot of debt: housing, sovereign, personal, corporate.


Brian 10.22.11 at 1:19 am

I think it’s a mistake to try to blame it all on “Bush-era polices.” My guess is that his tax cuts were bubbly but otherwise what’s the mechanism?

He also ran two very expensive wars, and didn’t come up with anything like a mechanism to pay for them. I think this hurt a lot. In other words, it might be that the tax cuts really did a lot of the damage. But you’re right; a causal story would be better here than a vague accusation.

As Davies pointed out, you also had a bubble in Spain which had plain old vanilla mortgages.

Good point; I should have talked about this. I’m a bit confused about what to make of this. Strikingly, there wasn’t a housing bubble in Texas, and the best explanation of that I think is the stricter mortgage regulation there. So I think explaining why there was a bubble in Arizona and Spain, and not one in Texas, is very hard.

My very uninformed guess is that there really wasn’t a bubble in Spain. The introduction of the Euro, and the continued economic advances, made Spain a much better place to live, work and invest. So naturally, house prices rose.

But I’d like to know more about what experts make of the Arizona/Spain/Texas contrasts. I’ve mostly read people making interstate comparisons (e.g., Arizona/Texas), or international comparisons (e.g., Spain/US), but parts of Europe to parts of US comparisons. (Probably I don’t read widely enough.)


Brian 10.22.11 at 1:24 am

@Michael (#5)

You could argue that policy of 2001-2007 is responsible for the bubble which needed to burst, but the terrible macroeconomic stabilization policy of 2007-2011 is the reason we have continuing 9% unemployment, instead of a short spurt of high unemployment mostly in finance and construction working it’s way out of the system and back to near full employment over the last 3-4 years.

I actually agree with almost all of that. A better stimulus plan at the end of the Bush years (even just more of the $600 checks for lots of people plan), and a bigger and better stimulus from Obama would have made a big difference to the effects of the recession. That $100bn in state aid they cut to get the Maine Senators support would have made a huge difference, as would have adding another few hundred billion in state aid support.

But I think we might be talking a bit at cross purposes. I think the cause of the recession was that people suddenly found out they had less money than they thought they had. You say that the effects were worse than they needed to be because the policy response was weak. I say that’s right – we should have addressed the cause directly by giving people more money. Daniel’s explanation of the cause of the recession makes it seem like helicopter drops of money could have made a very big difference.


Matt McIrvin 10.22.11 at 1:54 am

Reading about the timing is strange to me, because I remember the scary process of selling my house in the summer and fall of 2006, and I know the market in the Boston area was in free fall then. But I also remember that the bubble popped very early in Massachusetts and real-estate markets were still strong elsewhere, so I think you’re right.


Brian 10.22.11 at 2:56 am

Case Shiller has the peak in Boston being April 2005-January 2006. By that Fall it doesn’t look great. But at that point Vegas is still holding steady, heading towards the cliff it is going to reach in early summer of 2007.


Brian 10.22.11 at 3:00 am

Actually, it’s a bit messier than that. I’ve been going back and forth between looking at seasonally adjusted and not seasonally adjusted prices. The not seasonally adjusted prices have Vegas peaking in August-September 2006. But you could easily convince yourself that the tick downwards in the months after that was the usual boil going off the market after summer. It was when nothing came back in spring/summer 2007 that it was clearly time to watch out below.


shah8 10.22.11 at 3:19 am


It’s just your standard label pernicious debt crisis with stagflation in things people must have. The crisis is a function of lots of money flowing into the economy but not a lot of people getting access to it (other than in ways that impair other people’s need), such that housing, education, and medicine are stumbling blocks to greater economic activity. Not just because these are expensive, but also because the value inherent in houses, education, and medicine has become so illiquid. It’s hard to move to opportunities. It’s hard to profitably study in an expanding field. It’s hard to strike out on your own when you see something others haven’t, quite yet.

I would go with Brad Delong in this case. The problems are fundamentally political in origin, in the sense that we have too big an upper middle class and we have too many rentiers with too much control over the state. If the economy was being properly managed, the housing price crisis would be a blip. The decline in the value of houses are symptoms of other financial distress in real America. That implies to me that Delong’s story about shadow bank runs is a truer one. There just isn’t a deep supply of invest-worthy projects in the aggregate in the US (or elsewheres), mostly because of politics. There isn’t a supply because huge parts of the populace can’t fully participate in the marketplace for various reasons, mostly to do with politics. No customers. No reasons for business expansion, and thus no source of growth to eat up toxic assets over time. Damn straight you wouldn’t want most big banks as counterparties.


Peter K. 10.22.11 at 3:43 am


“My very uninformed guess is that there really wasn’t a bubble in Spain. The introduction of the Euro, and the continued economic advances, made Spain a much better place to live, work and invest. So naturally, house prices rose.”

Yes, I thought about this some more and remembered reading about capital flows and current account deficits in the periphery of Europe. Basically cheap capital flowed in to Spain, caused a boom, and flowed out causing a downturn. The Spanish didn’t have much of a budget deficit until the downturn.


MQ 10.22.11 at 4:03 am

Saying “it’s the Bush economy and not the banking sector” is just a false dichotomy. You can’t separate the Bush economy (or even the later Clinton economy) from finance-led growth. The housing bubble and the intermediation of all the cheap lending through the banking (and shadow) banking system involved a fundamental misallocation of capital and talent. The later stages of the internet bubble probably involved the same thing (which is why we needed such a big effective stimulus from 2000 on after it popped). Losing the manufacturing sector to China was happpening throughout this period and also contributed to big misallocations (the so-called ‘global imbalance’).


MQ 10.22.11 at 4:07 am

….not to mention the balance sheet consequences of debt-driven growth, which is a huge factor in where we are today. I’m not sure I really understand this post, actually. This stuff seems obvious.


Michael E Sullivan 10.22.11 at 4:19 am

Brian @12: perhaps I’ve been reading too much right wing rhetoric. And talking to too many economically clueless liberals who think that we are just going to have to live with declining standards of living full stop.

I think you are right that the decline in housing wealth among the middle class was the primary driver of the crisis, but I also believe the proximate cause was a combination of bank mistakes and central bank mistakes.

I’m inclined toward the market monetarist view that the recession could have been made *much* milder by an alert expected NGDP targeting central bank in the summer of 2008. This is the point where the data starts to show that pressures on household wealth and bank liquidity from housing continuing to drop have caused a plummet in monetary velocity. From the market monetarist viewpoint this should be viewed as an exogenous shock to the money supply, which needs to be countered by central bank action — and the data was there to see what was going on before the worst of the crisis hit in September and October.

If the Fed comes out with a statement in August 2008 to the rough effect of “The combination of subprime concerns and falls in real estate prices over the last year have led to a nearly unprecedented drop in monetary velocity. We are prepared to use our authority to do everything necessary to keep nominal demand on a sustainable growth path and will tolerate moderate inflation if necessary. We believe this will greatly speed the recovery from our current recession. To that end, we are lowering our overnight loan rate peg by a full 1% (or some step larger than anyone was pricing in), and will continue to adjust our stance as necessary to maintain an expected NGDP growth path of 5%/year.”

I’m not sure at that point that there is any major financial crisis, or that the recession is any worse than that of 2001. Also, even with the suicidal tendencies of the ECB, without a massive global recession in 2008-2009, it’s not clear we ever see the kind of problems with the euro that we’ve had for the last year.


Sebastian 10.22.11 at 5:30 am

“My very uninformed guess is that there really wasn’t a bubble in Spain. The introduction of the Euro, and the continued economic advances, made Spain a much better place to live, work and invest. So naturally, house prices rose.”

If it really is just (or largely) the Bush disaster plus the US-only housing bubble, why is so much of the EU suffering? This depression isn’t US-only. Ifthe EU doesn’t get its act together, it is going to be an EU banking crisis that throws it all back down the tubes. And weren’t there ginormous bank bailouts? Why would those have been necessary if it was just a housing bubble? And last I looked most of the problem credit default swaps that almost brought AIG down weren’t even very closely linked to housing. Why did they explode so spectacularly if the banks were doing their jobs?

It seems there are a lot of bank-related problems going on for this not to be a bank-related problem.


john c. halasz 10.22.11 at 6:04 am

Why do philosophy majors get to comment on economic affairs?


Chris Bertram 10.22.11 at 7:04 am

_This depression isn’t US-only. Ifthe EU doesn’t get its act together, it is …._

Aside from the offensive “getting its act together” cliché this comment from Sebastian ignores the fact that one of the reasons European sovereigns are in trouble is because they stepped in to save European banks after the US-triggered crisis in 2008. But focusing on the “getting its act together” part – now a staple bit of carping from the US political class and their commentariat – this is (a) a bit rich after the debt ceiling debacle and (b) completely underestimates the scale of the political problem. Suppose that, within the context of NAFTA, Obama had to persuade US taxpayers that they needed to bail out Mexico to the tune of trillions of dollars, how much success would he have? Less than Merkel has had with the Germans I’m guessing.


roger 10.22.11 at 8:13 am

The important thing, here, is to recognize that the 2000s were a disguised recession. The housing bubble, far from being an accident, was a necessity – that is, if we were to pursue the remedies to the solution to the recession of 2000-2001 suggested by Bush, and that are being recycled, in a more pernicious form, by both Obama and the Republicans in this round. The tax cuts – the most important of which may well have been the cut to capital gains taxes – and the deficit financial policy that was enacted via war spending, an enormous increase in Medicare due to the new drug supplement package, have to be combined with the Fed policy (which became obsessed with trying to maintain stock market values, as we saw in 2007, when the Fed’s bizarre behavior seemed to be dictated solely by an attempt to keep the stock market from sliding) were all responses to the long range crisis, which was one of wealth inequality. That is at the very basis of these crises, and that will continue to be at the basis of the crises as the Reps and the Dems do everything they can to ignore it. Unfortunately, this inequality crisis can only be solved politically – and no political player on the horizon even sees it.
To understand the recession of 2008, you have to understand the effects of the solution to the recession of 2001. I don’t think the name for the sum of those solutions is “Bush” – the Democrats made no attempt to make inequality an issue, because they had neutered themselves on that front in the 90s. Let’s call it, instead, neo-liberalism. The neo-liberal model is always going to lead, is structurally dedicated to, increasing wealth inequality – for which it uses the government as a backstop, as we saw in the Treasury-Fed program of feeding trillions of dollars to Wall Street in the form of 1 percent or below loans, and as a dispensor of band-aids, as we saw with the marginal increases in EITC.
French political scientists around Foucault liked to talk about l’etat providence – the welfare state, if you like. Neoliberalism does not, as its proponents like to say, break with l’etat providence – they simply change its focus. The state now operates as a Wallfare state – redistributing upwards.


Tim Worstall 10.22.11 at 9:55 am

“My immediate reaction to this is simply to refer to Dean Baker.”

Indeed: as he says, if $7 trillion of housing wealth evaporates you’re going to have a recession whatever the banking system has been doing or will do.

What happens to the banking system might well make it worse, but there will be a recession no matter what.


Avattoir 10.22.11 at 10:50 am

Referring to the Nate Silver tweet & your comment “I’m not sure of the source of this”, I’m pretty sure this is Silver’s source:


Having rendered this community service, I’ll take a stab at another: that this Levy Institute study is worthy of it’s own thread here.

Now I close this by climbing above my raising with two brief impressions:

1. If anyone seriously doubted G.W. Bush’s qualifications for ‘worst POTUS evuh’, this study should resolve that: apparently 2002-4 is the only expansionary period is U.S. history that showed a recessionary effect on median household wealth. (It’s like a special talent revealed or something.).

2. If I’m reading this correctly (My economics cred is limited to 3 university undergrad intro courses & otherwise regular dollops of Krugman, Higgins here & Delong when he doesn’t lose me.), the stage was set for that singular accomplishment by policy & regulatory changes going back to 1998, implying Bill Clinton’s sins went beyond the carnal, even beyond signing off on the repeal of Glass-Steagall, as well as bringing more nuance to enduring influence of the Rubin set. Also, to the extent this gets around widely enough, it’ll damage Bill’s claim as the ‘first black POTUS’.


Avattoir 10.22.11 at 10:56 am

Ach, insomniac typo & ADDo : “in U.S.”, not “is U.S.”, and “Quiggin” not “Higgins”.


Peter K. 10.22.11 at 3:02 pm


“Suppose that, within the context of NAFTA, Obama had to persuade US taxpayers that they needed to bail out Mexico to the tune of trillions of dollars, how much success would he have? Less than Merkel has had with the Germans I’m guessing.”

DeLong’s buddies Summers and Rubin did in fact bail out Mexico with success.


And in the last go around the US bailed out French and German financial institutions. Bernanke and the Fed bailed out all sorts of weird foreign companies. As I understand it many if not most of these were backdoor bailouts of US firms, just like the bailout of Mexico was also a bailout of US banks.


Chris Bertram 10.22.11 at 4:16 pm

_DeLong’s buddies Summers and Rubin did in fact bail out Mexico with success._

Maybe so. But my point was that Obama could not do this now. US politics today are a little different to how they were in 1994.


leederick 10.22.11 at 4:29 pm

How does the disappearance of household wealth make any difference? It’s essentially non-productive and doesn’t have any cashflow implications. If you’re paying X/month on a mortagage and the value of the house drops from Y to Z it doesn’t effect your payments. If the suggestion is that there was a widespread funding of consumption by withdrawing capital gains on housing wealth, how does this fit in with a housing bubble? I can’t see how houses can have a bubble (i.e. loads of money deployed on housing forcing up prices) and there be the widespread use of equity to fund consumption too (i.e loads of money extracted from housing and spent on other things). Surely it must net out one way or the other.


Ed 10.22.11 at 4:55 pm

one of the reasons European sovereigns are in trouble is because they stepped in to save European banks after the US-triggered crisis in 2008.

Really? I think that’s only true of Ireland. Not of Greece, or Spain, or Portugal, or Italy.


Chris W 10.22.11 at 5:12 pm

Brian, #10:

“My very uninformed guess is that there really wasn’t a bubble in Spain. The introduction of the Euro, and the continued economic advances, made Spain a much better place to live, work and invest. So naturally, house prices rose.”

This doesn’t sound right to me. What about the role of deliberate policy choices in Spain, speculative investment and influx of (or the massive attempt to attract) foreign home owners from places like the UK?

Now I may be quite wrong on this, as my understanding of economy is woefully incomplete. This is why I usually prefer to be a reader rather than a commenter here. But it would be good to get those of you who are knowledgeable to analyse, say, the narrative laid out in the (beautifully made and wildly) popular Españistán video (http://www.youtube.com/watch?v=xWrbAmtZuGc).


Michael E Sullivan 10.22.11 at 5:56 pm

Leederick@29: “If the suggestion is that there was a widespread funding of consumption by withdrawing capital gains on housing wealth, how does this fit in with a housing bubble?”

The household wealth effect is real and doesn’t depend on withdrawing capital gains on housing wealth to fund consumption.

It’s easy to imagine this having an effect on your consumption without ever actually withdrawing housing wealth. Consider two scenarios for a middle class family with a home.

Situation one, house is worth 300k and rising, mortgage of 180k. You have a normally comfortable amount of retirement savings in tax protected accounts (on track to retire when you want to), and a prudent amount of emergency savings (3-6 mos expenses), and an income. We’ll consider all these to be constant from scenario 1 to 2. Your home equity is significant. If need be, some of that equity would be available for low interest loans. In the case of job loss, the house could be sold, and you would clear a significant amount of money. If you need to move to change jobs, there is plenty of equity in your house for a solid new down payment on a similar size house even after selling and buying expenses. Other than keeping your retirement kitty funded, and emergency fund up to date, the only saving you really need to do is for specific future purchases. And if something comes up that’s too good to wait for, you have equity to draw on so that you can do the saving up afterwards. Under normal circumstances you will not do this, but the mere fact that it is an option acts as a cushion.

Now, situation 2 is exactly the same except now the housing market has tanked and your house is only worth 175k instead of 300k. It probably doesn’t make sense to walk away from your house since you don’t really gain enough to cover moving expenses and hassle, and you can still afford your mortgage payments just fine. On the other hand, if you needed to move to keep a good job, now you don’t have a down payment, and it could be very stressful and eat through much of your emergency savings should that situation arise. Big medical payment or other catastrophe happens, now you can’t cover it with a home equity loan, and it may eat all your emergency savings and more.

In that situation, maybe you won’t, but I would be much more worried about savings beyond a standard retirement path. I would cutting back on consumption and increasing the size of my emergency fund and investments outside tax-deferred plans, relative to the first situation.

In fact, situation 2 is not so far from where I am right now, compared to situation 1, where I might have expected to be if the housing market had continued on its upward pace and gained 20% in the 5 years since I bought it instead of losing 20%, we are talking about my actual reactions.

The closer to the line you are, the more true this is.


Bruce Wilder 10.22.11 at 5:56 pm

Michael E Sullivan @ 19

Scott Sumner is a highly articulate nutcase, the key term being, “nutcase”.

Also, whenever anyone attributes causality to the “velocity of money”, run from the room. Economics as pseudo-physics is taking over dead minds and turning them into zombies. (The velocity of money is neither a strategic variable or an independent causal agent; the economy is what people are doing, in response to information and in accord with their own plans and constraints.)

Bernanke knew what was coming in 2007, although like most libertarian true-believers he had an exaggerated sense of the foresight and prudence of our Galtian Overlords and the Magic Market. Bernanke’s Fed in late 2007 and early 2008 was flooding the world with dollar liquidity, and what happened? There were price spikes in commodities. Do you remember the price spikes? Record prices for rice and wheat. Spot market oil soaring over $100/barrel. Copper and silver, whoosh! “Targeting nGDP” looks easy on graph paper; in the real world, it can entail rice riots in Mumbai.

The commodity price spike drove the inflation rate up in U.S. dollars, and accelerated the recession, as economic activity declined: people drove less and spent less, in response to the spike in gas prices. What goes up, must come down. And, the sharp spike up, entailed a sharp decline, which meant a deflation.

Scott Sumner’s mumbling about “targeting nGDP” is equivalent to the claim that the deflation of late 2008 could have been avoided by adroit Central Bank interventions. But, Central Bank interventions had already triggered the commodity price spike. Was the CB supposed to keep commodities at a price plateau? How would that work? Once the provision of excessive liquidity had triggered the commodity price spike, a deflation, however brief, was inevitable. Deflation is a monetary catastrophe for a highly leveraged economy; it is equivalent to lighting a match in a barn full of dry hay, after soaking the hay with gasoline. Deflation will trigger a collapse of all the carry trades, initiate general de-leveraging and accelerate an inventory cycle, which, in turn, can shut down virtually all trade on a wholesale level, all of which it did.

It is fashionable among macroeconomists, who deal in abstractions so arcane that they would embarass a scholastic specializing in angels on pins, to speak arrogantly about the need for “microfoundations”. They are excusing their own abject ignorance, but regardless of the abuse of language and abstraction, the economy remains a concrete system, the artifacts of what we do in our material world.

Widespread control fraud drove the housing bubble. Not a strange psychological mania. Cheating. Con-games.

I know this will come as a shock, but cheating is not economically productive. I will leave it to the scholastics to figure out if cheating is pareto-efficient. I cannot pretend that I understand the reluctance of so many economists to studiously avoid the pervasive reality of fraud and what Minsky called ponzi-finance. Galbraith reported a while back that he attended a conference looking back at 2008 where the subject was never mentioned, and he raised it in a public question, and was greeted with silence.

Central banks are generally given considerable control over banking regulation, for what I would think are obvious reasons, although those reasons are clearly not obvious to academic macroeconomists, who rarely consider the role of banking regulation in monetary policy. Banks create money and credit, and the central bank cannot manage the money, unless it controls the banks. At the most basic level, a national Central Bank is managing the marketable national debt, which becomes a bedrock “zero-risk” reference point and source of hedging for all the deals, financial intermediaries do. In this sense, the national debt is a financial equivalent of a public utility. Economists speak of interest rate policy, but, in practice, the central bank uses the yield curve to induce recessions.

The U.S. Federal Reserve lost control of the U.S. marketable national debt in the late 1990s and early 2000s. Private players realized that China’s insatiable demand for U.S. sovereign debt at a time when the U.S. debt was actually shrinking, was creating a kind of arbitrage opportunity, to supply pseudo-sovereign-debt in the form of mortgage-backed securities. That became the foundation of all else.

Economics, especially macroeconomics, seems to me to be largely an exercise in obfuscation through abstraction. Even the “good guys” — people like Krugman, or DeLong or Mark Thoma, with whom I share general political sentiments — often seem determined to obscure more than they really explain, or understand.

Keynes was a very smart guy, but his Frankenstein is macroeconomics, a discipline which supplies poorly defined disembodied policy abstractions (fiscal stimulus — is it spending? taxes? purchases? transfers? is it a deficit?) where the national polity should be considering more basic economic questions, like how does the country develop and become wealthier and happier and manage a world of limited resources, etc.?

The U.S. has been on a macroeconomic course, which entails disinvestment, for a decade, maybe 30 years. That’s a seriously self-destructive path. But, macroeconomics doesn’t help us talk sensibly about it. At best, we can resurrect some slogans about rentiers from a century ago, to draw some attention to what matters. I would think it obvious in our era of peak oil and global warming and middle east wars, that oil matters a lot, and global resource contraints should figure in macroeconomic policy considerations, but you won’t often find Krugman admitting anything of the sort, when he confidently asserts that all we lack is aggregate demand (and the universal understanding of Keynesian ideas, as interpreted by Krugman). Autistic economics has a serious disassociation problem, and it conjoins with a poor sense of mechanism and an amoral unconcern with institutional probity, to create some major behavioral issues.


roger 10.22.11 at 6:53 pm

@29 – this is an interesting comment: “How does the disappearance of household wealth make any difference?”
This question is pretty simple to answer. If non-household wealth, income, is going down, and you have a certain lifestyle to maintain, it is very convenient that you can actually mine your house – that is, you can very well realize the nominal value of the supposed increase in the price of your house without going on the market. You simply take out a second mortgage. As most commentators noticed, during the downturn of 2000-2001, consumption did not disappear – as it has now. Why? Gross Home equity extraction was definitely one of the powerful mechanisms for smoothing over the drop or freeze in income. Here’s the Greenspan Kennedy graph of the market, showing the drop in 2005: http://www.wikinvest.com/image/Gross_and_net_mortgage_equity_extraction_graph.png. Notice that at its peak, it is close to a trillion dollars.
Thus, as housing prices fell, people were in effect not only losing money on the house, but having to pay for the lifestyle they had borrowed for from 200-2005. That this double whammy is overlooked by Delong is astonishing.


Bruce Wilder 10.22.11 at 7:11 pm


might be worth reading on the general subject of “cashing out”. The Home ATM was only one instance of a general pattern.


jack strocchi 10.22.11 at 8:48 pm

So the timeline works out for the theory that loss of household wealth is what did it. On the other hand, I don’t understand Brad’s positive theory of the recession

This debate is solvency (stocks) versus liquidity (flows). That is wealth effect versus liquidity flows credit squeeze argument. But both can be right, but solvency crisis has ultimate causal primacy even though it is a liquidity crisis that is the proximate cause. Thats because

By 2006 US housing asset prices were far in excess of plausible rental income earnings, mainly due to the fact that the owners or renters lacked the human capital to service the underlying debts – remember NINJA loans? The solvency crisis became latent when the underlying stock of US housing assets were not worth the liabilities undertaken to finance them. It borrowed or drew on the pool of global and national savings to build or buy accommodation at prices which were not justified by subsequent returns (either rental or occupational).

The solvency crisis became manifest when the inflow of occupational/rental revenue from these assets dried up and was insufficient to service the outflow of interest expenditure. Owner-occupiers and land-lords then reneged on their debts. The banks that were left holding the toxic bad debts then became untouchable, which led to the liquidity crisis credit squeeze.

Ultimately solvency trumps liquidity. A short=term bridging finance, from the FRB or IMF can overcome temporary liquidity crisis when the underlying value of the asset is sound. But US housing assets have poor underlying assets because the life-time earning potential of US householders, particularly the sub-prime sector, is very low.

Basically the GFC exposed the fact that most US householders (the 99%) have been living on the never-never for a decade or more. And finally the repo man chickens came home to roost.


john c. halasz 10.22.11 at 10:43 pm

It might be worth chiming in here that the “wealth effect” would actually be better termed the “domestic household dis-savings effect”, since high (inflated) asset prices encourage an increase in consumption expenditure without an increase in realized income, which is thus a lower savings rate. (In some quarters the household savings rate during the last cycle was 0 or even slightly negative and in the end it was annually averaging about 1%). But, of course, the U.S. has been running on the theory of an “asset-based economy” for quite some time now, with elaborated macro-economic theories forming its supporting techno-structure. It was clear to me from the get-go that the first-order effect of cutting taxes on the highest incomes and on unearned income from financial assets would be simply to bid up the prices of the extant stock of financial assets and would not necessarily incentivize increased real productive investment and productive efficiency, since there is a difference between money-capital and real capital and they don’t automatically and continuously convert into each other, while, after all, high financial asset prices are inversely proportional to their yield, which would have ambiguous effects on the level and composition of investment, given the price-signaling function financial assets are supposed to perform with respect to returns from real productive investment, as well as various contradictory effects on the level and composition of consumption demand. At any rate, a quasi-monetarist policy regime of regulating and stabilizing the macro-economy through central bank interest rate policy aimed at low inflation brought about steady dis-inflation, which at least implicitly amounted to a policy of regulating READ by propping up financial asset prices, while ignoring both rising over-all debt loads and rising and persistent CA deficits. (Those connections are just one “causal” pathway or channel by which I think that the Krugman/Quiggin thesis that a full employment economy could be achieved with a high degree of wealth and income equality based on producing luxury goods for the upper crust, “provided the upper crust would continue to consume sufficiently”, denying the thesis that the distribution of income between capital and labor, wages and profits, effects both the level and composition of READ, is misguided, since that amounts basically to consumption out of capital income rather than such income going for real re-investment, which implies lower real investment levels and higher domestic and external debt-loads. The factoid that U.S. GDP is 70% PCE is simply an artifact of of a decline of the investment component as a % of GDP during the last cycle in the noughties, when corps. net saved 1.5% of GDP, as opposed to net dis-savings averaging 1.7% of GDP during the previous 40 years, as per Yves Smith). So we’ve reached the end of a long cycle, in which dis-inflation threatens to turn into debt-deflation, and we get in the main the contradictory policy response of attempting to restore the status quo ante, through reflating asset prices with extraordinary monetary policy, while imposing fiscal austerity.

I think I’ve mentioned this before on CT, but a commenter at Mark Thoma’s site, kharris, who is apparently an econ pro, once compared what has happened to the U.S. to the “Dutch disease”, to which I responded, yes, but natural resources are a real and valuable productive factor, whereas the implied land-rents of housing lots are not.


Omega Centauri 10.22.11 at 10:58 pm

6,8 A bubble can have stimulative effects like an unplanned Keynesian stimulus. It is unsustainable, because it is a bubble, i.e. the law a gravity will eventually reassert itself. It is worse of course if it runs debt up to levels that will eventually force people to retrench and rebuild their balance sheets. In terms of the sustainability of longterm Keynesian stimulus: For a short term stimulus, it isn’t an issue, and you can do as Krugman pointed out “pay people to dig holes and fill them back up”. If stimulus must be continued for a long period of time, then the debt buildup can cause problems. I’m of the opinion that stimulus can be continued indefinitely, but only if it is treated as investment whose future earnings must cover the debt service incurred. That implies we should be doing deficit spending applied towards investments, which are designed to create future government revenues (which is not what we are doing).

Roger, @23. Very good point. The real economy has been underperforming for over a decade now, and we’ve been trying to paper that over by blowing various sorts of bubbles, and accumulating public debt. That is clearly an unsustainable process.
Worse, it was not just the pernicious effects of increasing inequality. We had/have the long term decline of manufacturing. And oil production plateaued in roughly 2005. Since then high prices have been transferring significant sums from consuming nations to exporting nations. Those are a lot of headwinds to overcome with financial smoke and mirrors. And we still have those headwinds today. Limits to growth, in the form of pricey commodities will probably be with us for essentially forever, so I claim reversion to previous economic growth trendlines isn’t physically in the cards. Yet the economics profession (and especially the political profession), doesn’t want to come to grips with this nasty new constraint.


mpowell 10.23.11 at 2:12 am

You know, I think you are more right than Brad on this issue, but I’m not going to give any credit to Dsquared. Because the problem with the banks was not that they encouraged the issuance of a bunch of fraudulent mortgages and then rebundled them in a bunch of fraudulently risk-assessed securities (although the fact that they did this was wrong). It’s because the banks have eaten up all the growth in the economy over the last decade. As a whole, the US economy grew more productive/capita from 2000-2008. But excluding the bankers, we all got poorer. Our vulnerability to this recession was driven by the reduction in median earner wages that was caused by the banker (and also CEO) class successfully increasing their level of rent-seeking. So I do fault the banks for this recession, just not for Brad’s reason. Dsquared seems to be currently in denial of this fact. Probably because he is a banker and is friends with them and the idea that his industry needs to be downsized is unpalatable to him. It’s a normal human reaction.

That being said, I completely disagree with Wilder’s take on the macroeconomics. His timing on the commodities price spike and monetary easing is misleading at best. My personal view is that with the US at full employment and Europe doing only slightly better, oil will have to be priced at ~$150/barrel because there is simply not enough supply. The US economy can easily survive that price as long as the fed does not interpret that price spike as ‘inflation’. The reduction in quality of living it would imply would be small compared to reduction we’ve seen from 2007 to today (for the median american). The whole intellectual project relating inflation to monetary policy does not properly deal with extremely important commodities that experience a hard supply limit which we have with oil.


john c. halasz 10.23.11 at 3:47 am


This ignores the way that commodity prices across the board evinced simultaneous rises and declines. Prima facie evidence of a speculative financial speculation component, which doesn’t contradict, but rather rides on and supplements a supply-and-demand explanation.


Henri Vieuxtemps 10.23.11 at 8:43 am

@Omega Centauri, 38. See, this is all very confusing to me. You read good economists, and there it’s all about stimulus – we need more stimulus, not enough stimulus – as opposed to bad economists, where it’s all about tax cuts and deregulation. Yes, we had tax cuts and deregulation – and it all crashed and burned. But we also had a tremendous stimulus, in the form of housing bubble, and it all crashed and burned.

I’m getting the impression that, under the circumstances, stimulus is just as much bullshit as tax cuts and deregulation. That there are severe structural problems, to such an extent that agitating for stimulus is silly. Chicken soup helps against the cold, but when what you have is gangrene, treating you with chicken soup is going to kill you; what you need is to have your damn leg amputated. Of course I’m not an economist, so this is just my intuition.


Walt 10.23.11 at 9:08 am

Henri, “structural reform” is just a code-word for “advance my policy agenda”. You may, in fact, have a perfectly awesome policy agenda, but it doesn’t have much to do with the problem of the current recession, which is a shortfall of aggregate demand.

To stick with the medical metaphors, your argument is essentially we shouldn’t treat an HIV patient for a secondary infection because the underlying problem is HIV. Instead we should wait for a cure for HIV. Unfortunately, thanks to the secondary infection by then the patient will be dead.


Henri Vieuxtemps 10.23.11 at 9:26 am

I disagree about the agenda. I don’t need any specific agenda to see that the place is FUBAR, and to suspect that stimulus is not going to fix it, any more than deregulation.

So, assuming for the sake of argument that my intuition here is correct, you want to put this thing on life support, to postpone the final collapse. Fair enough. It’s just a bit surprising to see so much passion and enthusiasm for a big stimulus. It’s as if they feel it’s a panacea.


Tim Wilkinson 10.23.11 at 3:28 pm

HV – no doubt structural change is needed as well as getting some money to those who will spend it. But the difference between ‘quantitative easing’ and a housing bubble is surely that the latter is a totally uncontrolled process which only creates spending power on the back of false expectations and is thus bound to crash and burn at some point, while the former involves some plan about how and when the money that’s been created will (if necessary) be taken back out of the system in a controlled way.

The really big problem with the stimulus was (wasn’t it?) that it went to the banks rather than into government projects or transfers to those on low incomes, etc. And the banks hung onto to it for their own reasons (one of those presumably being that they were a touch more insolvent than they ought to be), instead of lending it out as someone somewhere must have hoped they would. Not that more lending by an unreformed banking system would be entirely unproblematic anyway.

And wishing to see a final collapse is compatible with hoping that it can be managed somewhat gracefully – i.e. minimising death and misery as far as possible.


Bruce Wilder 10.23.11 at 5:57 pm

mpowell @ 39: “I completely disagree with Wilder’s take on the macroeconomics.”

That’s unfortunate, for your thesis as well as mine. Your thesis: . . . the problem with the banks[:] . . . the banks have eaten up all the growth in the economy over the last decade. deserves some kind of underlying analysis of mechanisms. Otherwise, what’s to be done? My macroeconomics (not original with me, of course) says that the foundation of financialization lies in the recycling of petrodollars: using exports of U.S. debt (instead of U.S. manufactured goods) to pay for oil, with an important metastasis in response to the coincidence of Clinton’s balancing of the budget, “strong dollar” policy, and financial reforms . . . and, oh yeah, the 1997 Asian financial crisis. Some U.S. banks and financial institutions took over the job of supplying debt to the Chinese currency peg, extending the export of debt to pay for oil to the export of debt to pay for manufactured consumer goods. That financial tilt made investment in Chinese manufacturing virtually risk-free and, hence, wildly profitbable, while making U.S. manufacturing into a victim of disinvestment; Manhatten boomed, while Michigan and Ohio became rustbowls — manufacturing wages fell beneath the average U.S. wage. Making and exporting mortagage-backed financial securities became a growth industry, that drove the housing bubble.

Your objection to my connecting the commodity price explosion with Bernanke’s policy of providing prophylactic liquidity seems like it could be only a minor quibble, due in part, perhaps, to my failing to sufficiently emphasize that the world had to be pretty close to its global resource ceiling, for the hazard of easy money to take this particular dramatic form.

I think the U.S., as a matter of policy ought to price oil at around $150/barrel, adding carbon taxes as needed to maintain a high price, because I think the U.S. policy of exporting financial securities to oil sultans, who accumulate sovereign wealth funds, which bid up asset prices, is a self-destructive course, made even more obviously self-destructive in light of the prospects for climate change due to fossil fuel consumption. If the price of carbon fuels was sustained at high level, the U.S. would move away from fossil fuel dependence.


Bruce Wilder 10.23.11 at 6:07 pm

jch@40 also the commodity price spike happened after the recession had begun. The yield curve inversion to trigger recession was in early 2007, as I recall, and everyone but Brad DeLong was aware that the recession was beginning by late 2007.


Bruce Wilder 10.23.11 at 6:49 pm


Bernanke can “print money”*; he cannot print oil, he cannot print any actual good. This can become a problem, when debt creation is not matched by investment in a corresponding capacity to derive income from the increased production of goods. In this respect, “quantitative easing” can become just as untethered and uncontrolled as a housing bubble.

The “really big problem” with the stimulus is that it was not aimed at changing any of the structural problems in the economy: the most obvious and natural target, (even in the absence of some definitive, consensus diagnosis of our macroeconomic problems) would seem to be the increasingly decrepit state of public infrastructure. But, all sorts of excuses immediately surfaced for not doing much infrastructure investment.

I would say that one of the most remarkable aspects of U.S. macroeconomic policy is how obscurantist it is.

The thing about “quantitative easing” is no one can explain, easily and exactly, what it is.

Macroeconomics, as an intellectual project, is designed to be obscurantist, in that it is designed to abstract away from the particular and the structural. There might be situations in which that would be politically useful, in that, maybe, people could agree on, say, “a stimulus”, which was all things to all people. To some extent, I think Obama tries to take political advantage of such ambiguities, and did so, with the content of his 2009 stimuls plan. But, in our politics, it just adds to the pathology, as an elite can direct an economic policy, without effective or meaningful criticism. A Larry Summers might be following his own lights, or those of his paymasters on Wall Street; we’d never know, because the language to explain his actual purposes and constraints is not part of the vocabulary of Econ 101, let alone the popular political discouse.

Did Summers limit the size of the stimulus and devalue infrastructure spending out of sheer incompetence or was he trying to avoid bumping up against the global resource ceiling? It is possible that the elite consensus is that growth and employment in the U.S. should be sacrificed to keep the more profitable party going in the BRIC (Brazil, Russia, India, China), but conveniently, that truth — if it is the truth — can only be communicated to the 99% through de-legitimized channels. It cannot be communicated in the authoritative voice of mainstream macro, because mainstream macro doesn’t take such concrete, structural factors into explicit consideration. “Structural” in orthodox, mainstream macroeconomics is code for “not our responsibility, not our department, nothing we can do, nothing we should do”. When the structural does manifest, macroeconomists treat it as mysterious or a shocking surprise, like the residents of Flatland encountering the third dimension. Bernanke, when he could no longer completely ignore the enormous imbalances in financial and trade balances driven by the Chinese currency peg, gave speeches waxing philosophic over the mysteries of the “global savings glut”; when the collapse of Lehman finally seemed to trigger financial panic, Bernanke was Chicken Little, but Chicken Little, demanding unlimited authority and resisting all accountability.

The collective ignorance and stupidity, which is mainstream macroeconomics, is not politically healthy. It doesn’t help us to hold politicians accountable. It doesn’t help us define alternatives or differences of interest, or arrive at collective choices. It doesn’t help us solve problems. It doesn’t help us understand what we’re doing or what is happening. It has gone from being a dirty window, to a blanket thrown over every window.


Alex 10.23.11 at 7:10 pm

It basically was awful; a long recession in the style of 1920s England. This fact was disguised because house prices kept going up,


Further, on the “when did the recession begin” issue, the financial crisis began in the summer of 2007 when the asset-backed commercial paper market froze up, various investment funds were shut down, and the first bank (DKB Deutsche Industriebank) hit the wall. Just blogging, I was aware of the crisis when I went on holiday that summer. I recall that a Barclays trader decided to quit over his summer break and there was a wave of rumours that they were in deep trouble. It later turned out that it was all the other banks, not Barclays, but still…and of course the Rock blew up within weeks.

If you look at the Case Shiller plot, the national-level housing crash gets going just before the financial crisis (although Irvine Housing Blog, Calrisk et al were covering it live in the winter of 2006).

The oil price, for its part, was hurtling upwards in early 2008 even though demand for oil was falling. IMHO that was the last bubble of the great bubble bath.


Anders 10.23.11 at 7:38 pm

Henri Vieuxtemps: it’s misleading to refer to the housing bubble as a Keynesian ‘stimulus’. A stimulus actually improves the balance sheet of the non-govt sector (thus ‘worsening’ the balance sheet of the govt sector), and so contrasts with a credit bubble which initially appears to improve private sector balance sheets but ultimately leaves household balance sheets worse than they started.

Quantitative Easing does not effect balance sheet repair, but merely exchanges one quite liquid asset for a slightly more liquid one (which yields lower interest).

By MMT, dsquared’s thesis looks a slam dunk. I know most people here are pretty hostile to MMT, but isn’t it now uncontroversial that Sector Financial Balances provides a healthy sense-check when analysing any macroeconomic scenario?


john c. halasz 10.23.11 at 8:04 pm

B.W. @46:

Here’s the oil price chart, to refresh memories:


Oil had actually come down quite sharply at the beginning of 2007, then began a steady rise across the year, only to sky-rocket in the beginning of 2008, when, yes, it was already apparent that the expected recession had begun, since the GFC broke out explicitly in Aug. 2007 and Bush passed a tax cut stimulus in early 2008, eh? I find it hard to reconcile the shape of that chart with claims that it was only about global supply-and-demand. And, of course, everyone who wasn’t a shill had to realize that, if nothing else, that sky-high oil price would be the knock-out blow, tipping the economy into recession.

Just in case anyone is interested, here is a revealing write-up about the actual commodity trading firms, which serve a market making function, most of which are privately held, including Koch Industries:



Sebastian 10.23.11 at 8:04 pm

“that one of the reasons European sovereigns are in trouble is because they stepped in to save European banks after the US-triggered crisis in 2008.”

You’re working that “one of the reasons” thing really hard. And of course it was in fact the US bank and AIG bailout which saved the European banks if you want to bother being accurate. And saying that if the EU doesn’t get its act together on Greece or else they will push the whole world’s economy right back down isn’t letting US stupidity off the hook, nor is it blame transfer, it is a simple statement of fact. You don’t need to get all whiney about it.

It is a fact that the Greek problem was not caused by the US. It is a fact that the European banks which were most exposed in the US housing crisis were exposed because they were complicit in it and the other shady crap going on around it. It is a fact that their asses were saved by the US bailouts, especially of AIG. It is a fact that they are deeply involved in the garbage surrounding Greece, and Ireland, and Italy, and that none of that is the fault of the US either. (Except insofar as Goldman’s is involved, which I will grant you a full measure of).

This isn’t a US vs. Europe thing anyway. This is the bankers have been fucking us and continue to fuck us issue. That is the very thing that Daniel and apparently Brian wish to deny. And it is ridiculous. There are way too many bank-related disasters here for us not to realize that lots of it is deeply bank-related.


Henri Vieuxtemps 10.23.11 at 8:55 pm

@49, MMT – I don’t know, but from the traditional POV, whether demand was pumped up by your borrowing against your fictional house value, or by the government borrowing and sending you checks – what’s the difference? In the end, you still have to pay the debt. In theory, it’ll be easy to pay off, as the economy will miraculously recover and start booming without any stimulus. But the point is, in this case the stimulus, Keynesian or not, didn’t produce a self-sustained economy. Well, why didn’t it?


Anders 10.23.11 at 9:09 pm

@52 Henri – well yes, except the govt doesn’t need to pay off debt.

Paying off govt debt in nominal terms is probably ill-advised. The US govt has only actually reduced the federal debt on 7 or so occasions since c. 1820, all promptly followed by sharp GDP downturns (which may or may not be correctly interpreted as the govt forcing the private sector to rely more heavily on its own credit creation for growth than the low-level fiscal stimulus which is provided during most years).

Govt debt can keep on increasing, as long as debt/GDP isn’t taking an asymptotic trend – but this proviso is more about managing the interest rate down below the NGDP growth rate than anything else.


Dirk 10.23.11 at 10:19 pm

@52 Henri – I think ‘stimulus’ is not the right phrase to use. Technically, we have an asset market where assets have been trading at ‘wrong’ prices for many years, probably due to government interference in the secondary market (among other things, I’d say). After people changed their mind about house prices, they also modified their expectations and starting paying off debt. This is the typical aftermath of a financial bubble. Government need not have a hand in it (see: Tulipmania).

And if you do want Keynes in this picture, I think he would more or less say something like this. When a boom turns to bust, spending collapses because animal spirits have left the investors. Everybody repays debt (saves), nobody invests. Idle resources are sitting around, and if government would have the courage to put them to use, then we would have a ‘sustainable’ economy after all, never mind the bubble. And if I, John Maynard Keynes, am not mistaken, you should cast your vote my way as the ‘Upper Class Twit of the Century’. (Right now, Schumpeter and von Hayek are in the lead.)


Bruce Wilder 10.24.11 at 2:40 am

Anders: “A stimulus actually improves the balance sheet of the non-govt sector ”
HV @52: “whether . . . borrowing against your fictional house value, or by the government borrowing and sending you checks – what’s the difference? In the end, you still have to pay the debt.”
Anders @ 53: “. . . the govt doesn’t need to pay off debt”
Dirk @ 54: “Everybody repays debt (saves), nobody invests.”

I don’t carry a brief for MMT, but there are a couple of things I have grown to appreciate about its operationalization of macroeconomic policy. Mainstream macro, with its representative agent models and DSGE, isn’t just abstract, it is deeply unrealistic and apparently unconcerned about the role of money and finance in the macro-economy. MMT, in contrast, seems to zero in on the role of bank-created credit, or inside money, in driving the business cycle.

Although we often talk as if spending money uses it up, in ordinary transactions, money, like physical energy or matter, is neither created nor destroyed. Many economists reason as if this were true in debt creation as well; ultimate investors borrow from ultimate savers, with the latter foregoing spending to enable the spending of the former; when debt is repaid, it is thought to have no “real” effects on anything except, perhaps, the distribution of wealth or income — whatever consumption debtors forego to repay their debts ought to be offset as creditor income increases.

The activities of financial intermediaries in borrowing short and lending long create credit. This sort of inside money leveraging creates not wealth, per se (imaginary or otherwise), but, in common sense meaning of the term, creates money. If I decide to quit my job, and launch myself as an independent consultant, I might go to a bank, mortgage my house for a loan, to finance the working capital of my new consultancy. There’s no ultimate borrower or ultimate investor involved — I am, in effect, both; but, there is more money, as the money the bank has loaned me is now a part of its deposit base, and its deposit base is a part of the money supply. Even if spend down my deposit balance a bit, the spending just becomes the income of some other business, which is keeping the circulating money deposited in the banking system.

I don’t know if this a genuine marker for MMT theorizing about the macroeconomy, but it seems as if their general presumption is that increasing inside-money debt expands the money supply and adds to aggregate demand. In that sense, there would seem to be exactly the kind of analogy HV posits, to fiscal stimulus accomodated by monetary policy, in that expanding inside money, financializing assets or real service streams, adds to aggregate demand. And, conversely, deleveraging inside money debt, subtracts from aggregate demand.


Bruce Wilder 10.24.11 at 3:11 am

The conventional macroeconomic view, as I understand it, is that banks (or financial intermediaries, in general) are conduits of funds from Savers to Investors, in which Interest rates, as a price, equilibrates supply and demand: the supply of funds by savers to the demand for funds by Investors, with opportunities to invest.

An alternative view, though, suggests itself, in the MMT framework: in MMT world, banks lend to every credible prospect, who wants to borrow, since banks can create credit, just by making entries on their books. There’s no real funding constraint on that credit creation, since their loans immediately become part of their deposit base, and the whole fractional reserve thing is kind of an empty formality in practice. The important thing is that the banks do not lend on projects with an expected negative present value. Each loan is a deal with the future, and the banks have to make sure that the future can pay.

When the banks fail in that responsibility, and the future does not pay, what then?


Henri Vieuxtemps 10.24.11 at 7:30 am

Dirk, the housing bubble injected what – $8 trillion into the system? People, the metaphor goes, were using their houses as an ATM. To buy stuff. If that’s not ‘stimulus’, then I don’t know what is. Plus two wars, to the extent of a couple of more trillion dollars.

Anders, forget debt for a second. It was going on for years, many years, before the crash. My problem is that this huge stimulus hadn’t produced a boom, self-sustained economy, full employment, anything like that. What gives?


Bruce Wilder 10.24.11 at 7:48 am

It did produce considerable redistribution of wealth and income upward, though.

(That’s another obscuring pretense of mainstream macroeconomics: that the distribution of income has no necessary or systematic relationship to level of activity or the achievment of full employment.)


Dirk 10.24.11 at 8:14 am

Henri, I think it is just a question of vocabulary. As an economist, stimulus for me means that the government expands spending. In a looser way, I might also include tax cuts (if you insist). These would generate injections of the money that you wrote about. I agree.

However, economic processes are self-sustaining and there is a lot of cumulative causation. You might call a Chinese real estate ‘bubble’ in 2012, built on high growth rates today and expectations of continuation of such rates. You then would explain the expansion of a stimulated system by stimulus. As I see it, it doesn’t add much in way of explaining the problem. You are mixing changes in regulation, fiscal and monetary policies together, but does this aggregate make sense? Maybe you could explain what is not a stimulus?

You wrote: “My problem is that this huge stimulus hadn’t produced a boom, self-sustained economy, full employment, anything like that. What gives?”

I am not aware of any economic theory that says a huge stimulus leads to all these things. Certainly, the dot-com crash did not do it, and there is the savings&loans crisis from not so long ago, which was the result of stimulus by deregulation. Economists, even neo-classical ones, accept the existance of business cycles. Abolishing them is the holy grail of a part of the discipline, but so far the only way mainstream economists have succeeded is through using models that assume they don’t exist (RBC, DSGE, …). The other part of the discipline is trying to abolish the slumps.


Anders 10.24.11 at 10:44 am

Henri – I’d rephrase your question as follows: there was a significant (albeit temporary) improvement in private sector balance sheets, so why wasn’t there a greater boom in employment and GDP.

The answer can only be that the ‘stimulus’ provided by the boom in consumer asset prices wasn’t actually big enough to offset the various headwinds. The first of these is a notably large RoW surplus (aka current account deficit) of 5-6% over 2003-8 for the US. The second headwind I can see is that firms have in aggregate been running a financial surplus (ie investing less than their profits) for most of the past two decades, which is extremely perverse: a healthy sector financial balances picture would see households making decent surpluses which should offset firms running decent deficits representing healthy investment. I would link the poor performance on employment to the lack of capital investment in the recent past.

You seem suspicious of stimulus in general – and I think it’s legitimate to challenge a defence of an apparently failed stimulus on the grounds that it was too small (as eg Krugman does), since this gambit could be used of any failed stimulus, and therefore looks ’empty’.

But the response should be as follows: when does a stimulus become too big? The answer is simply: when it boosts demand excessively, leading to a tight output gap and tight labour markets, risking a wage-price spiral. There is no other relevant test for a monetarily sovereign economy. Despite the inflation visible in certain countries (notably UK), labour markets in particular remain far from tight, which indicates that a larger fiscal stimulus would not exacerbate inflation.


Henri Vieuxtemps 10.24.11 at 11:30 am

You seem suspicious of stimulus in general

I’m sure stimulus is fine under some circumstances. But if, for example (hypothetically), 100% of the demand generated is satisfied by imports, stuff produced abroad, and the surplus abroad isn’t buying any domestic goods or services – how does it help?


VandalsStoleMyHandle 10.24.11 at 12:34 pm

Presented without comment, Krugman in 2002:

“The basic point is that the recession of 2001 wasn’t a typical postwar slump, brought on when an inflation-fighting Fed raises interest rates and easily ended by a snapback in housing and consumer spending when the Fed brings rates back down again. This was a prewar-style recession, a morning after brought on by irrational exuberance. To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.”


I’ve let this out of moderation, possibly a wrong judgement, given the spectacular dishonesty of presenting it as if it as advice to Greenspan, rather than a comment on the strategy Greenspan was pursuing, and which Krugman predicted at the time would fail. Since the commenter has provided the full link, it’s easy to check this, rather than reading into it what he things you should – JQ


Dirk 10.24.11 at 3:01 pm

@Anders: I get it now.

@Henri: It doesn’t do any good in the real economy in the US, under the (hypothetical and extreme) scenario you provided. It provides a 100% spillover for foreign demand. On the financial side, things will get even worse as more money flows into the capital market which has been plagued by low yields already. The ROW improves its balance sheet and might grow as well, given today’s global slump.


VandalsStoleMyHandle 10.24.11 at 4:47 pm

JQ, my intention is not to score points along ‘he said, she said’ lines; I don’t particularly care if this is Paul McCulley’s view, Paul Krugman’s view, Stephen Roach’s view or none of them. The whole ‘someone on the right/left blogosphere is wrong’ thing doesn’t interest me at all. What I was illustrating, clumsily, is that this was a view that was somewhat prevalent back then; however, in its more explicit forms, it has been somewhat airbrushed out.

Nonetheless, the Fed’s main policy instrument was, and continues to run along the lines of: let’s make people feel richer so they buy another shiny toy and thereby create a virtuous circle of spending and employment. This is clearly a rather double-edged way to run an economy.


Anders 10.24.11 at 4:52 pm

@Henri “if, for example (hypothetically), 100% of the demand generated is satisfied by imports, stuff produced abroad, and the surplus abroad isn’t buying any domestic goods or services – how does it help?”

First – if we have a continued current account deficit, this means that by definition the surplus abroad is not buying any of our goods or services.

To your main point, adding to Dirk’s comment, does an element of foreign leakage undermine the case for stimulus? Absolutely. But it’s a question of degree.

Imagine the starting flows balances are: govt deficit 8%, RoW surplus (ie current account deficit) 2%, and domestic private sector 6%. A 2% fiscal stimulus, taking the budget deficit to 10%, should rightly be evaluated on what it will do to the other two balances. If the new private sector surplus will still be 6% and the current account will worsen to 4%, there is much less case for stimulus.

Conversely, if someone is making the case (as I would) for a bigger rather than a smaller budget deficit, they need to maintain that the other difference between a bigger and a smaller deficit is not getting entirely (or mainly) offset by a movement in the current account (ie the foreign sector balance).

Looking at data for the UK, the 7% point swing between 2007 and now in the budget deficit has been offset by 6% points of private sector retrenchment and 1% point of current account worsening (the latter being mainly commodities driven).

Again, the only argument against fiscal stimulus per se should be that it is inflationary – because the govt is competing with private sector demand for goods and services.


Bruce Wilder 10.24.11 at 5:08 pm

Shouldn’t policy focus on, among other things, changing the current account deficit (and the related pattern of domestic disinvestment)? Why isn’t that part of “designing” an effective stimulus policy? What’s the strategy? Shouldn’t there be a strategy?


Anders 10.24.11 at 5:28 pm


If we regard stimulus as something which accommodates an increased domestic private sector propensity to run a surplus, then yes – policy ought to explore how far the current account can help accommodate this, complementing the govt sector (as opposed to partially offsetting the benefit of a fiscal stimulus).

The trouble with expecting too much from the current account is that it’s very difficult to manage. Broadly, over-valued currencies should expect to see current account deficits; given that most countries are trying competitive devaluation in order to improve their current accounts, it is difficult for any country to hope for a target of, say, a 2% improvement in the current account balance from a simple devaluation alone. So this leaves the only area for policy focus as the price elasticities of imports and exports. I’m not an economist but I would imagine that these would typically take decades to address.

The US of course has an additional current account constraint. Unless there is a considerable change to the international currency system, the USD will remain the reserve ccy for the forseeable future which means the US is likely to continue to be forced to run current account deficits.

I’m most amazed by how little focus you hear about the long-standing domestic disinvestment in most western countries. I’ve no idea why this doesn’t get more attention.


john c. halasz 10.24.11 at 5:57 pm

“I’m most amazed by how little focus you hear about the long-standing domestic disinvestment in most western countries. I’ve no idea why this doesn’t get more attention.”

Umm…because for certain dominant interests and their economic rationalizers it’s a feature, not a bug.


Anders 10.24.11 at 6:11 pm

@john c. halasz – I had assumed that the dominant interests you cite would actually be interested in nominal GDP growth. Sure, GDP growth lowers unemployment, which seems likely to reduce income inequality, which would be a bad thing for such interests; but the growth alone ought to be a good thing, and this class can always maintain myriad barriers to protect its privileged position.

But perhaps you are right: the evidence certainly suggests that economies are being run in such a way as to foster a persistent output gap rather than grow nominal GDP. In other words, the powers that be don’t seem to care about the interests of equity investors.


john c. halasz 10.24.11 at 10:31 pm

Anders @69:

I went into this a bit from a different angle @37 above. But here the point is that MNCs and Wall St. Hi-Fi “earn” enormous rents through the globalization of both production supply chains and financial asset flows, by arbitraging differential FX values and thus, with that, wages, taxes, regulations, etc., which, of course, flow into those returns to equity investors, (amongst which, of course, are top executives remunerated with stock grants), which, in turn, has been a major factor in growing “in country” income inequality in many countries, effecting domestic READ. As I conjectured above, the neo-liberal quasi-monetarist macro theory/policy, which has tended to ignore both CA deficits and growing domestic debt loads, while focusing on dis-inflation and thus implicitly on propping up financial asset prices to regulate the economy, has not been simply an ideology to disguise what was happening, but rather a techno-structure that co-evolved with the globalized “asset-based” economy. Even those who don’t buy into the policy ineffectiveness macro critique, based on fanciful artificial assumptions, have nonetheless tended to disparage the role of fiscal policy, in favor of monetary policy. Yet note that the increasing globalization of capital has abstracted and extracted it from national, domestic economies, and increased its capacity to play off governments, both national and local, against each other, to extract all sorts of accommodating concessions on its behalf, thereby diminishing the taxing powers and fiscal “space” of governments. Coincidence?

There is no such thing as pure, disinterested theory, but rather all forms of theory bear a reflexive relation to underlying social practices, whether their practitioners are relectively aware of that or not, (which is, after all, a good deal of the point of constructing theories). Likewise, economies are not somehow sheerly pre-given, automatically operating and self-regulating systems, independent of the agents and agencies bound by their constraints. Rather such theories are always intricated in a political economy from which they arise and to which they respond. So the question of cui bono is always there, even if it shouldn’t be asked in a too crudely reductive form.


Bruce Wilder 10.24.11 at 10:49 pm

Naked Capitalism points to quite a sharply critical article in the New York Times today, which exposes this pattern in microcosm:
(That is the perma-link)
Disinvestment can be highly remunerative for those in charge, even while it deeply damages even the soft capital of professions and related institutions.


William Timberman 10.24.11 at 10:53 pm

Yes. That giant sucking sound was never coming from Mexico. And cui bono is a lot clearer to a lot more people than it was then. Unfortunately, what still isn’t clear to most people — thanks to the giant fog machines in Washington and New York — is how much of what we’ve been stuck with was a matter of choice, and not the workings of an invisible hand.


Anders 10.25.11 at 8:11 am

@ john c. halasz – your account is intriguing but your exposition (here and elsewhere) is compressed. I gather you don’t write a blog yourself; can you direct me to a step-by-step analysis somewhere that sets out your thesis? I work in the FIRE sector and struggle to follow this.

In particular:
– surely an economic policy which fostered NGDP growth would boost the values of equity assets, and would lower default rates for debt assets – so why wouldn’t this sort of approach have evolved, instead of one which purely benefits fixed income investors
– “diminishing the taxing powers and fiscal “space” of governments” – I take your point about MNCs playing of govts internationally, but based on the classic Kaldorian equation, profit is boosted by budget deficits. Given a balanced budget, to make the same level of profit, capitalists need households to go into greater debt, which quickly becomes destabilising (ie 2000s). So I would have expected all govts to be pushed into running budget deficits
– “arbitraging differential FX values” doesn’t seem an intuitive explanation of rent capture

In general, an important disagreement of the age (and one which may well be the nub of the clash between MMT and sophisticated non-MMTers) is whether inflation can be managed by fiscal policy. If you can get comfortable with taxes keeping a lid on inflation, then you can get comfortable with any level of sovereign debt or deficits you like. (Interestingly, the US and UK may be heading towards the model of Japan, which means that like it or not there will be no monetary ‘space’ to manage inflation with interest rates any more, which will force people to start using fiscal policy again!) But I struggle to see how the mainstream preference for monetary policy over fiscal stems from political economy considerations, aka the FIRE sector or MNCs.


john c. halasz 10.26.11 at 3:41 am

Anders @73:

Sorry, no links, except to the calcified proteins picked out of my brain, which end up as somewhat tortuous and compressed syntax. To be clear, I have a rather U.S,-centric perspective, since that’s where I live and where I know the economic data drip and overall profile. Other than that your handle is a common Nordic name and that you work somewhere in the FIRE sector, I don’t know where or how you’re situated.

But I was addressing that political economy puzzle of why seemingly the worst policy options get adopted and better policy knowledge gets sidelined, which the likes of, e.g., Krugman is constantly beating his head against, without ever really directly addressing. To my way of thinking what’s happened nowadays is the end of a long cycle that goes back to the stagflation crisis of the 1970’s, which partly was a result of the demise of Bretton Woods, switching to an international system of floating FX rates, and represented a crisis in profitability of industrial capital. (The technical architect of the scuttling of Bretton Woods BTW was a U.S. Undersecretary Of the Treasury by the name of Paul Volcker). Which was also the period in which revisionist monetarist and then quasi-monetarist macro rose into ascendancy as offering a diagnosis and “solution”, accompanying the rise of globalized neo-liberalism starting with Thatcher and Reagan. The empirical connection there, as a matter of historical fact, at least, should be plain enough.

As to the likes of Kaldor, (who IIRC had already criticized and refuted Friedman’s monetarism before it had gained any currency, so to speak), and East Anglia Keynesianism and Post-Keynesianism, well, Keynes in effect was intent on saving capitalism from the capitalists, and my understanding is that, yes, a gov. deficit can result in increased profits than otherwise, both by providing for adequate READ and by providing for renewed opportunities for real capital investment via gov. contracting, infrastructure spending and the like, but a real full employment economy would tend to decrease the relative rate-of-profit as a share of GDP, even as it increases the absolute amount of profit. But the profit equation which you refer to, (which I take it is basically and roughly the Kalecki profit equation with gov. deficit added to the right-hand side), is an aggregate macro equation. However, there is no such thing as a capitalist-in-general, which would correspond to that aggregate, rather than different capitals in different firms, sectors, factions, with competing interests and only loose and rough coordination through markets and representative associations. Further, such a macro aggregate is directed toward national economies with discrete governments, i.e. to quasi-closed economies with policy autonomy. So there is a quasi-paradox here of just what is in the interest of capitalist profit. Add to that, if the government is to assume the role, faute de mieux, of capitalist-in-general, then it will become the target of capture by capitalist interests.

So then it wasn’t a matter of optimizing profit-in-general in the overall capitalist interest, but of which configuration of capitalist interests would come to prevail in the new changed global environment, without their being any overall master-plan or “conspiracy”, nor any perfect foresight, but rather a process that occurs in successive waves to an overall end-result. And gradually the new dispensation formed to restore the rate-of-profit, in the face of saturated markets, rising worker expectations and increased international competition between capitals, which has been dubbed “neo-liberalism”, a cocktail of deregulation, globalization and financialization, which now is at its “logical” end. (It’s important to emphasize the arbitrage of FX rates and differentials, because, even before wages-as-production-cost, “assets” in the form of foreign firms and banks can thus be bought up, especially in the wake of financial crises caused by rapid influxes of foreign financial flows and their sudden stop, resulting in IMF “structural adjustment”, in which privatization of public assets and opening up the domestic economy to foreign investment form key demands. But what used to be business as usual on the “periphery” has now struck at the “center”). It doesn’t seem to me quite a stretch to see how the development of a quasi-monetarist techno-structure, which at once props up financial asset prices through maintaining the provision of cheap credit and holds down wages through targeting dis-inflation, while compensating the loss of wage-based demand with consumer credit and cheap import prices, fits into such a globalized configuration. And it also doesn’t seem hard to figure how the inter-linkages between credit and equity markets conduce to the boosting of equity “values”, though at the expense of longer-run real investment through retained earnings.

But I suppose I don’t understand what you would mean by “rent capture”, as opposed to what Bruce Wilder means, which is a singular focus of his obsessions, and I don’t understand why you would think that constricting deficits and fiscal space would solely benefit “fixed income investors”, though I do understand how dis-inflationary policy would benefit current bond holders, in the mirror image of how stagflation had given them most of all net capital losses. Are the mega-banks such investors, rather than the creators of credit-money liquidity, which is a unique resource in creating rent captures, by leveraging not just productive businesses, but entire economies?

I’ll leave off with a fact, which I’ve cited several times before, here or elsewhere. In 2006, the official measure of the external debt attaching to the U.S. economy, the N.I.I.P, stood at just south of $2.6 trillion, which was surprising, since it had actually shrunk, even as the U.S. was reaching record CA deficits of 6% of GDP. Further, if one added up the U.S. CA deficits since 1990, $2.9 trillion was “missing” from the N.I.I.P. The basic explanation is that U.S.-based investment in foreign equities and FDI was booming in $ value, as compared to relatively lackluster domestic returns, which allowed a counter-balancing “equilibrium” to the basic disequilibrium represented by those CA deficits. That fact alone is a large empirical clue to what has been going on in terms of the global restructuring of corporate and financial rents. And their domestic distributional consequences and READ effects.


Bruce Wilder 10.26.11 at 4:50 pm

What’s READ?


john c. halasz 10.26.11 at 6:15 pm

Real effective aggregate demand?


Bruce Wilder 10.26.11 at 6:40 pm

What are the modifiers, “real” and “effective” meant to distinguish, separately and in combination?

Is “real” contra-distinct to nominal amounts — an attempt to filter out the effect of price changes? Do you think that’s appropriate in the context? And, how does that work with “effective”?


john c. halasz 10.26.11 at 6:49 pm

READ was the original Keynesian phrasing, and, yes, when people start talking up NGDP targeting, (when it’s real growth that matters and when historical evidence that somewhat elevated levels of inflation are all that damaging to real growth is scarce to non-existent), and when the top 10% takes in 50% of all income and accounts for 40% of all consumption, the real and effectiveness part of AD comes into question.


James Wimberley 10.26.11 at 9:56 pm

Spian: I’m not an expert but I do live there.
Thre was an undoubted housing and housing construction bubble. In the peak year (2007 I think) there were 700,000 housing unit starts in Spain, a country with no natural growth in population, more (I’ve read) than in Britain, France and Germany combined. This overbuild was all over the place, not just in the Costas where the expats like me go to moulder in the sun. The most reckless banks were the regional Caixas, treated as fiefs by regional politicians, who also failed to stop local mayors from making a corrupt bonfire of planning controls. (One of the Caixas most recently nationalised was in Galicia, a rainy place where no expats go.)
The weakness of governance wasn’t really one of national economic policy, which was fiscally conservative and prudent, but a tragedy of over-decentralisation. It will therefore be very hard to fix structurally, and I doubt if the PP when it takes power will want to change things.


Anders 10.27.11 at 8:24 am

@78 isn’t the “effective” part also intended to convey ‘ex post’ AD within a period as opposed to ‘ex ante’ AD?

JCH: the NIIP is very interesting, but I’m not sure your conclusions are warranted. In the UK in 2Q07, people complained that with an NIIP of -24% of GDP, ‘nearly a quarter of the country was foreign owned’ or some such; by 1Q09, this had fallen to -5%. The two important things to remember are that (1) NIIP is a net number and the gross assets and liabilities are considerably larger (each around 700% of GDP in the UK at least, imagine US has similar orders of magnitude), and (2) in a floating FX environment, it is ‘self-righting’ in the sense that once it gets ‘too big’ for the market, the currency will weaken, automatically reducing it.

Also: the phrase “global restructuring of corporate and financial rents” is simply not a phrase that most outside a Marxist/Marxian tradition will recognise. I think I follow it, but the difference between your ‘rent’, and profit (or super-normal profit), isn’t clear. But why do you look to NIIP to analyse this development – isn’t it enough to focus on the Gini index and measures showing reduced income decile mobility to make this point?

Re: fixed income vs equity investors, the former have one pivotal objective which is to avoid inflation; equity investors are much more relaxed about it. Equity investors therefore seem more likely to favour a fiscal stance which promotes higher employment levels even at the risk of a slightly elevated inflation (I agree with you that there is simply no evidence that say high single digit inflation reduces real GDP growth).


john c. halasz 10.27.11 at 7:55 pm

Anders @80:

Well, this is too large and complex a topic to be fully addressed in subaltern blog comments.

But I’m well aware that the “N.” stands for “net” and that gross flows are mind-bogglingly greater. Global GDP might be, say, $60 trillion with maybe a quarter of that involved in international trade, but FX markets notionally swap $1 quadrillion annually. I don’t know the exact U.K. profile, except that its economy is even more dominated by Hi-Fi as its “comparative advantage” than the U.S. and like the U.S. it has long been experiencing industrial dis-investment. That 20-25% depreciation of GBP is no doubt the cause of the swing in its N.I.I.P, but the depreciation was due to the financial crisis, whereas ordinarily FX effects are not the largest determinant of changes in external debt. And, sorry, counting on Mr. Market to “automatically” correct these matters is a bit of a stretch, (complicated in the U.S. case by reserve currency status), since the main theories of long-run FX equilibrium have no real predictive value, with short-run flows swamping any proposed equilibrium mechanism. I recall a discussion of an econ paper several years ago to the effect that the FX “carry trade” should not be possible because it would equally distribute profits and losses and unpredictably so, yet the carry trade seemed to be quasi-permanently profitable. The implication is that the carry trade “works” by driving FX values further off their “equilibrium” levels. Japan adopted ZIRP for domestic policy reasons, but the fact that it also instigated a Yen carry trade, which drove the Yen down, could not have been unwelcome to Japanese policy-makers, which is why they were often criticized as “selfish”. (Japan BTW has a net external surplus of $3 trillion, maybe 70% of GDP, which might help to explain the curious profile of that economy, with very high public debt and very low interest rates). At any rate, current accounts accumulate as external accounts and its a factor that receives little apparent comment or attention…until it’s too late. The 2008 U.S. N.I.I.P stood at $3.4 trillion and I can’t help but wonder when and if all those vapor-bucks might re-materialize, “when tears come down/ like falling rain”…

Defining economic rents, let alone operatively identifying them, is a tricky issue. For now, I would define them as profits that have been detached and displaced from underlying costs-of-production, such that those costs are borne elsewhere and by others. There are, of course, land and natural resource rents, a well known case. RE bubbles are due to an excess of credit provision inflating implied land rents, which is an endemic problem, since lending is secured by collateral and RE in generally the largest class of such collateral. It’s called the FIRE sector for good reason. But there are also productive rather than unproductive rents. Modern economies are dominated by large-scale, capital-intensive oligopolies, which tend to be price-makers, not price-takers, and enjoy large rents from market-dominant positions. But that’s an ambivalent phenomenon, since those rents are partly “justified” by a) the fact that the technical efficiency of large-scale capital-intensive production reduces unit output costs far more than any market competition between smaller firms ever could, and b) those rents serve to incentivize and compensate for the difficulties of managing high-cost, fixed, long-run capital investment under endemic uncertainty. (It takes at least 4 years to build an oil refinery, for example, and 20 years to amortize the cost). So such corporations follow investment strategies aimed at locking-in such long-term rents rather than just short-run optimization or maximalization of profits and production. (This is Bruce Wilder’s constant theme with variations in criticizing mainstream economics, and he’s no Marxist, but a left-liberal MBA with Keynesian leanings, speaking from practical experience in industry). To give an entirely domestic example, 30% of the U.S. cattle herd is owned by the meat-packing corps. themselves-, (there are now 4 dominant firms). That way, when cattle prices rise, they can cull from their own herds to drive them back down, and when cattle prices are low, they can re-stock their herds. Are the margins of ranchers and feed-lot operators being sorely squeezed? Judging by their complaints, you betcha. Are the lower prices being passed on to consumers, as the so-called consumers’ surplus.? I highly doubt it.

MNC production platforming of globalized supply chains, (Jack Welch’s “factory on a barge”), is a highly lucrative strategy for stove-piping such rents to the top. And, of course, the high financing costs for build-outs and acquisitions, as well as, the need for hedges to manage such complex, far-flung operations, means that MNCs are joined at the hip with Wall St. Hi-Fi. In the old “Fordist” era of domestic mass production oligopolies, semi-skilled mass production workers eventually managed to organize a gain a share in those oligopoly rents, which effected wages across the board in the domestic economy, with concomitant effects on sustaining READ. But a combination of technological developments and globalized “free trade” and most of all their synergy in the hands of corporate investment strategies has eliminated such concentrated mass employment and thus the capacity of labor to share in those rents and sustain a relatively high wage-structure as % of GDP. And the flattening of earned labor income, wages and salaries, and its decreasing share in GDP has effected domestic READ, since earned labor income is not just a production cost, but a prime source of READ. Nowadays the emblematic corporation would be Walmart, which paradoxically has built up a hugely dominant position in the highly competitive, low-margin retail sector. The solution to that puzzle is that it has converted its monopsony position to squeeze cost reductions out of it suppliers, and thus, though organizing its global supply chains in depth, amounts to an entriely virtual industrial oligopoly.

And then there are the rents accruing to Hi-Fi itself, through its crucial role in the (mis-)allocation of capital and credit. In the last cycle, FIRE accounted for 30% and at its peak 40% of all U.S. corporate profits. Let’s just say it’s highly doubtful that these are “productive” rents, and they draw into question the classic economic thesis that the equalization of the rate-of-profit across firms and sectors will optimally allocate capital and thereby optimize efficiency and output. A main goal or target of neo-liberalism is the privatization of public assets and infrastructure, (indeed, of the very public sphere itself). To give just one example, Obama’s proposed infrastructure bank, which ostensibly gets around tightly constrained public fiscal “space” by “partnering” with private financial investors, (who have clearly communicated to him, as his donor base, the availability and readiness of such funding), would only have the effect of raising the financing costs of infrastructure spending by 200-300 bps. as compared to financing through gov. bond issues. (I won’t even get into the hilarious Chicago parking-meter deal). Public investment in public goods is supposed to have a “loss-leader” effect in improving the overall productive efficiency of the economy, which investment can then be recouped through higher future tax revenues. By privatizing such infrastructure, a “toll booth” economy of financialized rent extractions is constructed, which impairs overall productive efficiency, not to mention leading to a dereliction of public functions, such as, e.g., optimizing the flow of traffic and transport.

I don’t focus here on Ginis, since, aside from the fact that its a very crude and variable measure, it’s part of the explanandum, not the explicans. The topic being addressed is why severely sub-optimal economic policy regimes are adopted or imposed, despite the apparently availability of much better policy knowledge, and what are the causal and behavioral factors and structural interests that lead to such outcomes. And I don’t understand still your point in dividing investors into just two slots, fixed income vs. equity, which strikes me as far too simple. Rather there is a broad diversity of investors, with different “portfolio preferences” in various “asset classes”, though its mostly only the wealthiest and largest such investors that proportionally count. And there are myriad interconnections between credit and equity markets. (“We” have discussed elsewhere the role of debt-financed stock buy-outs in boosting share prices, while increasing the “operating leverage” of companies, thereby diminishing the long-term investment horizons and capacities, another example of a financialized rent extraction by insiders, extracting existing “value” at the expense of the creation of increased future value). Besides which there are all sorts of devices, from managing portfolio duration to IR swaps, by which bond investors can deal with inflation and IR risks. The more interesting question is which investors get to be the stuffees, when Hi-Fi credit is created solely for the purpose of complicated schemes of short-term financial rent-extractions.


Tim Wilkinson 10.28.11 at 12:30 pm

Defining economic rents, let alone operatively identifying them, is a tricky issue.

Yes. I get the distinct impression that this fact is not widely appreciated even by those you’d expect to appreciate it. The basic neoclassical position is, isn’t it, that rent is reward over and above what is required to elicit a certain ‘contribution’ or behaviour? (The problem being that this is implicitly a counterfactual or hypothetical concept, and there are problems involved in properly formulating and evaluating the counterfactuals involved.)

I can informally see how that conception would fit with:

profits that have been detached and displaced from underlying costs-of-production, such that those costs are borne elsewhere and by others

But not so much with:

there are also productive rather than unproductive rents

and definitely not with:

those rents serve to incentivize and compensate

which on the canvassed understanding of ‘rent’ ought to be impossible.


john c. halasz 10.28.11 at 4:54 pm


Elsewhere and some years back, “we” discussed whether what I here termed “productive rents” shouldn’t rather be called “quasi-rents”. “Economic rents” are so called because the concept goes back to Ricardo’s analysis of land rents, which was a easy case, since it was obvious that incumbent landlords made no contribution to the costs-of-production. (Incidentally, if you put together Ricardo’s theory of rents with his theory of the inversely proportional distribution of the surplus product between profits and wages, you easily get his theory of comparative advantage. That theory has a sound conceptual logic, but it was also an advocacy of a specific class interest, that of industrial capitalists, in a specific historical conjuncture). Standard neo-classical theory recognizes the notion of “monopoly rents” and that of “imperfect competition”, though I don’t think they get many of the implications, nor the prevalences right, since they focus on a theory of nominal price formation through competitive markets rather than on the structure of production, which has constraints and dynamics of its own, not reducible to market exchanges. For example, for a number of reasons, oligopolies maintain excess capacity, and by far the largest component of their cost structure is fixed long-run capital investment, with labor and materials a much smaller share; hence the more that they produce and can sell, the lower their average unit cost, such that they would always like to sell more, if they could. Such firms tend to price-gouge,- (though not Walmart!),- but they will also price-discriminate, and higher profits and lower prices are not necessarily at odds. Which also works in reverse. If there is a sudden sharp drop-off in demand, average unit costs will sharply rise, so the response can’t be to cut prices, as neo-classical price/quantity equilibrium adjustment would suppose. That is why one of the first “spontaneous” responses to the Great Depression in Germany and America, under Bruening and Hoover, were attempts at cartelization.

But I think the example I offered of the U.S. beef industry was a clear enough illustration of detached and displaced costs-of-production. The point is there are myriad such strategies aimed at locking-in “productive” quasi-rents. But identifying them requires close attention to the details of business practices and technologies and to specific market and organizational structures and their interactions. However economic theory operates generally at such a level of abstraction the prevalence of these issues mostly flies under the radar. MNC global production platforming and its arbitrage of FX differentials, etc. is just a large and predominant set of such cases. (One third of international trade is actually infra-corporate transfers of MNCs; probably another large chunk is indirectly associated with their activities. But, of course, standard models of international trade don’t include MNCs in their modelling, just a DSGE models aimed at calibrating monetary policy don’t include banks).


Tim Wilkinson 10.28.11 at 7:46 pm

Hmm, so a quasi-rent is perhaps something that is only revealed to be a rent/windfall given the benefit of hindsight? If that makes sense.

Well it doesn’t really, put like that.

So: at the time, the expected value of the occurrence of R at a certain probability P was necessary to elicit whatever supply it is that was elicited, i.e. was merely-minimally-motivating, thus not a rent. But given that R becomes actual, and this thus no longer discounted by the vulgar fraction P, it resolves itself into a rent – because R-at-probability-1 is more-than-minimally-motivating, which is the key property of a rent.

But then why (in Platonic neoclassical economics world, at the very least) are there not also negative quasi-rents which arise when the probability of R resolves to 0, and which overall balance out the positive ones?

I conclude I’m probably on the wrong track altogether.


john c. halasz 10.28.11 at 10:30 pm


Obviously, “productive” quasi-rents can’t be commanded into existence in advance! Oligopolies evolve emergently through competitive shake-out, as firms that achieve sufficient scale drive out or buy up competitors. Historically, most all industrial markets developed oligopolistic structures, with 3-7 dominant firms enjoying 90% combined market share and 100 firms occupying niche positions in the “tail”. Once such market-dominant firms attain such positions, they will invest strategically to try and maintain their incumbency and their rents will permit them to attempt to do so.
So, yes, there is a bit of an after-the-fact aspect to the analysis and identification of such quasi-rents, But remember the conditions: high up-front fixed capital costs, fairly lengthy lead-times to build capacity and a long duration to fully recoup the investment, through many business cycles with varying READ conditions, and lots of contingencies with respect to changing technical conditions, markets, and socio-political events. Hence there is no simple probability calculation ex ante in the face of such endemic uncertainty, but rather a speculative dimension without perfect foresight in the face of such a high “hurdle rate”. Hence such investments will largely be made in strategic anticipation of possible quasi-rent lock-ins. Of course, investments can fail just as well as succeed, but what counts is that profits exceed losses in aggregate, and the enjoyment of “productive” quasi-rents renders such risks more tolerable. And, of course, such quasi-rents can erode over time: e.g. GM,- (but note that the various GM “brands” were once independent competitors). But declining oligopolies generally don’t give way to newly competitive markets, but rather to new oligopolies. And new oligopolies can spring up with technical change and the development of entirely new markets. (Consider the extreme rapidity, by historical standards, with which they have formed in the IT/telecom sector, due not to increasing returns to scale, but rather increasing returns due to the need for technical standards and interoperability, network effects, and IP protections).

But my argument here has not been about the existence of such quasi-rents, which I take to be realistically a pervasive fact structuring much of modern economic life, but rather about how such corporate quasi-rents have gradually come to be restructured in the post-Bretton Woods era, with its floating FX rates, free flows of global finance capital, increased competition and consolidation between formerly national or regional incumbents, and weakening of governmental policy and regulatory “autonomy”. And that to begin to address the political-economy conundrum of why, in this penultimate crisis of “neo-liberalism”, the worst, most- self-undermining policy regimes are being followed or imposed, despite much better possible policy alternatives, to the detriment of standard claims about optimal social welfare. Cui bono?


Bruce Wilder 10.28.11 at 11:16 pm

As JCH says above, the relation of economic rents to business strategy is my little obsession.

The term, “economic rent” and its relatives, have a long history as pejoratives, though the applications and connotations have shifted a bit over time. Ricardo’s analysis makes the unimproving landlord out to be something of a parasitic drone, a singularly subversive thought in an England ruled by a landed aristocracy. Henry George’s Single-Tax idea, more influential in its day than the WSJ’s Laffer Curve in our own, popularized the general intuition that rents could and should be heavily taxed. Keynes could attack the rentier, without much explanation, and Schumpeter buffed the heroism of his Entrepreneur, by emphasizing how he undermined rents.

In our own day, the pejorative quality of “rent” has shifted significantly, I think, under the influence of public choice theory. Theorists like Mancur Olson were relentless in their rhetorical onslaught against those flocking to the political capital, seeking favor, an activity they characterized as “rent-seeking”. For reactionary conservatives, it fit nicely with a background mythos of the virtues of the private, free-market capitalism, corrupted by the swelling leviathan of the regulatory, bureaucratic state. It has become the core, not of a real analysis, but of a powerful rhetorical framework, in which all the problems and shortcomings of the actual market economy can be blamed on the shortcomings of a regulatory state, captured by corrupting interests.

You can see the power of the rhetorical framework in the debates over the causes of the financial crisis. Liberals often naively think that reactionary and libertarian free-market types would be humbled by the manifest failures of efficient markets, but, no, the reactionaries quickly spin out stories where the villain is the government intervention gone awry — Fannie and Freddie, or “affordable housing programs,” among others.

I’m going to write a second comment, summarizing my functional analysis of “economic rent”, but I wanted to draw attention to the powerful role the concept has had as a pejorative, with moral implications.

The concept of economic rent always entails an implicit counterfactual comparison, and the moral weight of the term derives, in large part, from that implicit comparison. It is necessarily a counterfactual comparison, and as such, can be imaginative to the point of being fantastical. The ideal of the perfectly competitive market, where all rents are competed away, is such a fantastical standard of comparison, a never-never land where the fairies live, if we only clap loud enough, and no one ever has to grow up.


Bruce Wilder 10.29.11 at 5:58 am

TW @ 82 & 84

The significance of economic rent doesn’t emerge in platonic neoclassical world, because the neoclassical model is one of complete information and perfect rationality, tending toward stasis. There’s almost nothing that could be recognized as strategic behavior; there’s no genuine uncertainty, little point to insurance, and control of production processes is just assumed to be perfect.

In a world of genuine uncertainty, a factor earning a large economic rent can become a basis for organizing and structuring economic activity, and particularly the economic activity of controlling production processes. A large economic rent is a large margin or cushion against variation in results large enough to force re-allocation of the factor. As such, it becomes the focus for organizing the structure of the economy, and particularly for organizing loci of control, where the residual returns from control are income to the factor.

In the unconstrained world of the neoclassical model, the concept of “economic rent” does seem ambiguous and ill-defined. In a world of genuine uncertainty and unexpected results, though, the profit-maximization of the neoclassical model is also undefined. In a world of genuine uncertainty, there can never be unconstrained maximization of anything; all decision-making requires attenuation of information and strategic choice of constraints against which to “optimize”. In the presence of particular contraints, and genuine uncertainty, then, rent-seeking becomes a very good explanatory strategy for how people will organize their economic behavior. It says people will try to use the limited knowledge they have to control economic (production) processes, to economize on error and waste, and they will orient that control so that the residual returns to control flow to factors earning a large economic rent, as a source of risk-attenuation enhancing the stability of their arrangements.

In the neoclassical model, the firm is just proportioning input to output, because it is assumed that the production process is perfectly controlled: output is function of input. Output is not a function of input in an uncertain world, where mistakes are made, and the same set of inputs could result in any of a vast range of outputs, depending on how much waste occurred, due to poor technical control or management of process.

In an uncertain world, transactions are not simple exchanges, but imply contingent and/or incomplete contracts, in which credibility and the ability to absorb risk are critical. Control of large economic rents becomes a source of power to make committments, to absorb risk and maintain a structure and organization to production and distribution.

The use of bureaucracies by business corporations is dependent on the ability of the corporation to earn large rents. The contingent contract for employment, which at its core reads, “do as instructed or you’re fired”, only works if being fired is a genuine loss. The same is true, of economic regulatory models premised on licensing; the license has to be worth something — has to confer rent — if losing it is to be a penalty.


Bruce Wilder 10.29.11 at 6:17 am

To complete the thought, there’s no observed symmetry around zero rents, because only positive rents can be used to absorb risk and structure the economy. Fall to zero, and that structure ceases to be structure; the factor is re-allocated. (That said, people do take chances.)


Tim Wilkinson 10.29.11 at 1:06 pm

BW @86 – Yes, see #82: there are problems involved in properly formulating and evaluating the counterfactuals involved – these problems being centred around the q. what is to be held constant (suppose there are two bidders, Mervin and Pervez, each valuing my toenail clippings at $2000. Then if I sell them to Mervin, the two grand I take off the poor demented loon is not a rent, since I have foregone $2000 from Pervez, and this heavy opp’ty cost eats up all my surplus).

the general intuition that rents could and should be heavily taxed – the ‘could’ bit, at least, can of course be supported by the idea that in some sense, confiscating rents cannot cause any market distortion since rents are by definition motivationally inert. This corresponds to the ‘consequentialist’ side of justifications of Teh Market: optimising, invisible hand, incentives, all that. David Gauthier suggests rents may be taxed on this kind of ground, in his otherwise pretty anti-egalitarian Morals by Agreement.

Meanwhile, corresponding to the deontological, entitlement, side of market apologetics – is the idea that rents are not earned – where earning is a matter of sacrifice; of giving something up, whether effort or some other good in exchange. This is one area in which those counterfactuals come in, because it starts to look on this kind of view as though one never actually earns any improvement in one’s condition (an improvement is always a surplus) – and given that there is no obvious a priori baseline defining one’s ‘initial’, unimproved condition, it looks rather as though all entitlement is unearned and thus prima facie liable to be taxed.

Given that it doesn’t ‘belong’ to them as ‘earnings’ in such a way that redistributing it must be deemed to involve the dreaded Pareto-inferiority (actually, incommensurability; but anyway not P-superiority nor P-equivalence), taxing and redistributing it – possibly back to the person from whom it was taxed – dominates the strategy of not taxing it (not reserving the right of the rex publica to tax it).

This is in effect to take the neoclassical idea of perfect rent-eliminating competition, supposedly a noble wise and good standard, and to use it against those who normally tend to rely on it by first taking it to its logical conclusion – that realistically speaking, anything that is worth doing is worth doing because it provides a surplus, i.e. a rent, and then pressing hard on the two pronged point that there is no good reason not to hold all such rents to be liable to ‘redistribution’ – indeed, that since they’re unearned, their allocation to others is not, normatively speaking, a redistribution at all.

jch @85 – there is no simple probability calculation ex ante in the face of such endemic uncertainty – yup, understood – I was doing a bit of the old metaphorical modelling, neoclassical style.

I think the general point stands, though. Positive quasi-rents ought to tend to be balanced by negative ones – if the (purely notional) cost-benefit calcs are to turn out to have been done in the right way. I don’t consider the distinction between uncertainty and risk to be an obstacle – uncertainty not in the end being different in kind from risk – unless by risk we really do mean only calculations within situations, like games of chance, contrived so as to causally underwrite a particular application of the principle of indifference).

The general point, in this stylised sense, stands – I’m just not sure what conclusion to draw from it.

Perhaps the following update in response to Bruce will help…

BW @87 – All this sounds quite correct – the issue is I suppose that it doesn’t seem to provide a reason why these large rewards/surpluses/whatever should be called ‘rent’ at all. In essence I can envisage (not much of a one for syntactical math. symbolism – I want to ‘get it’ in a quasi-visual way) two ways of looking at the mechanism whereby the negative side of the canvassed symmetry is eliminated.

One is irrecoverability due to limited liability (and of course even fleshly persons can take on obligations which become impossible for them to satisfy), so that the payoffs resemble the crenellated profile of a sine wave with the lower half truncated. A kind of weak anthropic principle – if the payoff goes negative, there is no entity left to be bothered about it. This is presumably not very realistic in terms of actual peoples’ motivations – however the closely related ‘in the medium term we’ve all retired’ concept is. I digress.

The second way this lack of symmetry can be pictured is as the whole waveform (representing the future stream of payoffs subject to all the vicissitudes of time and chance, which as any fule no, happeneth to them all) being shifted upwards a bit so as to fall within an acceptable range. now the thing is the issue of what defines the axis about which such symettricality can be measured, or what fixes the frame of reference relative to which the wave is shifting.

If it is to do with rents, then – I boldly assert – it is to do with expectations and minimal motivation. But this leaves the initial problem, paradox, antinomy, what have you – of #82: that if the stream of fluctuating and somewhat, but of course not utterly, unpredictable outcomes that in fact eventuates does so only in bare satisfaction of the expectations which were barely sufficient to motivate the action that originated them (deep breath) then it is not right to call them rents at all – the peaks are merely fluctuations in an underlying trend of zero-surplus returns.

Conversely, since we don’t suppose that there is just a constant coincidence of things working out nicely, if the actual stream of outcomes does reflect something we can properly call a rent – i.e. an outcome that could have been partially occluded without altering behaviour – then it cannot be correct to claim that the rent is productive, or necessary, useful, functional, from a social welfare point of view (obviously it is good for various interests aligned more or less closely with those of ‘the firm’).


dictateursanguinaire 10.29.11 at 5:10 pm

How does the disappearance of household wealth make any difference? It’s essentially non-productive and doesn’t have any cashflow implications. If you’re paying X/month on a mortagage and the value of the house drops from Y to Z it doesn’t effect your payments. If the suggestion is that there was a widespread funding of consumption by withdrawing capital gains on housing wealth, how does this fit in with a housing bubble? I can’t see how houses can have a bubble (i.e. loads of money deployed on housing forcing up prices) and there be the widespread use of equity to fund consumption too (i.e loads of money extracted from housing and spent on other things). Surely it must net out one way or the other.

IANAE (yet) but this ^ is a little confusing to me. Sure, your mortgage doesn’t change but it seems like people were factoring the value of the house when they decided how big of a mortgage they could handle. On the topic of demand in general, people were basing their current and (what they thought would be) future consumption on wealth. That’s pretty normal behavior — I just think one of the problems was, AFAICT, that many people were misreading the housing market (N.b. one problem of many, one other of which was fraud.) To answer the capital gains question, I don’t think people who actually made sales and got capital gains were the problem — that does net out since someone bought it (sure, they probably overpaid but whatever, there is no ‘missing’ wealth.) That’s where all the ‘real’ bubble money went so that nets. The problem, I think, is when you get into situations where people were going into debt or taking out loans. A lot of people were hanging on to their houses, thinking the market would keep rising and making loans against it. Since they kept hanging on to their houses and didn’t try to sell them, they didn’t realize that some of the wealth they anticipated on receiving was actually fictitious. Basically, the collateral was not worth as much as anyone thought it was and so a lot of loans that just cannot be paid back were made, and that’s where the missing wealth goes since the banks acted under the assumption that those BS loans had real worth and so on, the whole domino chain thing.

People who have finished their econ degrees or who know more about this, feel free to correct.


Bruce Wilder 10.29.11 at 5:44 pm

TW @ 89

Perhaps I should tell a few stories, which might make the role of rents in motivation clearer, because, as I said, though in stasis with complete information and no strategic behavior, they are, as you note, not “motivating”, by contrast, in dynamics with incomplete information, rents are central to motivating strategic behavior: rents are a margin of (varying) income, they serve as a buffer against uncertainty; people orient their behavior around rents to reduce risk-aversion.

There isn’t a static balance of winners and losers, but there is an on-going dynamic balance of such — an on-going contest of established rentiers with a vested interest in preserving the past against innovative entrepreneurs seeking to undermine and divert those rents into new channels. That’s Schumpeter’s story.

What we see about us in the world is the outcome of a process of experimental selection. The lucky survivors are the ones, which managed to win a lottery for contested markets. In dynamic terms, they managed to mount the unicycle and get the wheel turning fast enough to create some semblance of stability for themselves. That’s the significance of most competitive “first mover” stories, and why so many major industries are dominated by firms with very long histories. The “first mover” is only rarely actually a founding or pioneer firm, but the winners write the history, so to speak, and the “first move” that counts is using your rents to mount that unicycle and get the stability of forward motion, in motion.

This is the story of the corporation in the second industrial revolution: seeking rents leads to investment in better controlling processes and thus to on-going dynamic exploitation of increasing returns. This is based in part on the virtuous cycle that develops between organizational power, and the associated ability to reduce required returns (cost of capital) associated with investment.

Rockefeller’s Standard Oil sought monopoly power for its immediate business advantages, but ended up controlling (in a cybernetic sense) oil distribution; the wild booms and busts of the oil patch were greatly dampened, and pretty soon, a vast, worldwide bureaucracy was marshalling geologists by the platoon to discover new fields, building pipelines and ships and vast refineries, marketing kerosene and oil and gasoline, with brands.

The original speadsheet, Visicalc, failed to give rise to a company that could keep up the pace of re-design. Lotus took over, but didn’t survive the transition to the GUI, and so we have Microsoft Excel dominant.

Ford Motor got an amazing start on perfecting the assembly line, but General Motors was adept earlier, at the task of the model changeover. Ford stumbled, trying to replace the Model T with the Model A, a herculean task, and nearly failed in the 1940s — probably would have, if the War hadn’t filled its coffers.

What you see in the economic landscape about you — the remarkable dominance of that landscape by large, bureaucratic corporations — is the outcome of a process of selection, in which some methods and technologies have come to dominate logically possible alternatives. This represents an advance of knowledge and its application to controlling production and distribution processes. This is where the distinction between uncertainty (what you don’t know that you don’t know) and risk (what you know that you don’t know) applies: to get an economically practical production process going, you have to bring that process “under control”. That requires, typically, sunk-cost investments in R&D and tools and plant and intangibles, like brand reputation, as well as maintaining a large fixed-overhead. It involves applying scientific knowledge and re-organizing the production process.

The cycle can be very, very long. Ford’s auto assembly methods have been advancing for over 100 years since their first application in 1903. The container shipping model has been making large efficiency gains, year after year, since 1960. Wal-Mart has been expanding on the basis of its superior logistics for decades.

The thing is that what we see in the world is not automatically optimal. It has nothing whatsoever to do with a competitive stasis in market price, and claims for its virtue, based on a theory of market price are misplaced, at best. But, there is something to Adam Smith’s insight that market competition can be partially self-defeating for the businessman, and, therefore, beneficial to the consumer. The thing about rent-seeking is that it has to be partially self-defeating to be beneficial; conflict has to be preserved, vested interests have to lose out in the end, for society to benefit.


john c. halasz 10.30.11 at 2:38 am

I’m still not sure exactly what T.W.’s complaint is, whether he is making a semantic quibble or a substantive criticism. Speaking for myself, of course, I’m not making any formal neo-classical analysis, but rather tend to think in classical terms of analyzing the sources of productive surpluses, rather than in the neo-classical terms of assuring “equilibrium” through an account of nominal price formation across markets, basically through an auction-like mechanism, (of which the maximizing of individual utility preference functions is the artifact, which is a philosophical, if not logical, howler, when it comes to “defining” a “social welfare optimum”). So the real distributable surplus product is the total product minus that part of it is used-up in the processes of its production, and the question becomes what determines its distribution.

I get the Analytic game T.W. is playing: for something to be adequately defined as a causal law, it must be sufficiently defined in terms of its hypothetical counter-factuals. And, indeed, the notion of an economic rent requires such counter-factual implications to be defined, let alone operatively identified. But let’s just say that IMHO neo-classical econ is severely confused about issues of causality and that social “science” concerns the structural constraints on agents generated by systems of social action (and communication), such that it doesn’t generate any such causal, invariant laws, properly speaking. (Perhaps the problematic of “agent causality” is relevant here, though it misses the role of rule-governed structuring in “constituting” agency, as opposed to the stark contrast between causal laws and the exercize of individual agency). But let’s just say that defining “rents” against the background of the logically inverted ideal of perfectly competitive markets is a mug’s game, even though some markets, such as agricultural produce, (if one ignores subsidies), or retail sales, (if one ignores Walmart), approximate such conditions.

But back to the main show, land or other natural resource rents are so identified because they are not man-made, not produced, but rather “natural” givens. However they would not “exist’ except as drawn into a more-or-less extensive system of prices from which they draw off their “value”. What was “natural” under feudalism became “scandalous” under the pressures of industrial capitalism. But what I don’t understand is why such rents should be regarded as “inert” and “minimally motivational”, except under artificial neo-classical premises. To the contrary, Ricardo attempted (and failed in his lifetime) to target and eliminate or diminish them. And, e.g., RE developers and financiers manipulate land-use regulations to instigate RE booms. (It’s a favorite point of econ libertarians that areas with large land availability and minimal land-use regs are largely immune to RE boom and bust cycles. Though that’s just to say that there are better and worse land-use regulations, not that there is unlimited availability of land, such that such regulations are superfluous, and that rent-seekers will try not to find a way to punch holes in any regulatory regime, for fun-and-profit).

So AFAICT the objection amounts to the notion that “rents” can not be produced. Well, they can’t be commanded into existence, but they can be significantly generated through processes of market competition and productive consolidation, due to various forms of “increasing returns”, which shake-out factually rather than counter-factually. The formulation of the counter-factual conditions for identifying them operationally is the tricky problem, for the semantically finicky ones, not their actual historical existence. Because that is where the issue of increased productive surpluses and their distributions come into play. The counter-factual conditions for identifying them need to be put into play with the changing factual conditions by which such “productive” quasi-rents might be generated. And, indeed, increasing returns generating market-dominant “rents” through technical efficiencies in technology and organization amount to a significant challenge to the theory of “competitive” market-based prices, as assuring GE (and optimal social welfare). Such technical efficiency tends to out-compete market-based “competitive” efficiency, until it doesn’t, because it lowers costs and prices far more than market competition could, thus increasing available productive surpluses and their potential distributions, which is why they are at once “productive” and “rent-like”. And thus are not simply pre-given and “motivationally inert”, but rather a roughly identifiable strategic target.

So why are there no “negative rents” balancing out positive ones? Well, the semantic quibble would be that they would not then be “rents”. But if the point is that “rents” involve displacement of costs within an overall growing aggregate productive surplus, then such rents can be accommodated within a fluctuating “wave-pattern” with a rising slope, until they can’t. The losses and gains are relative, until some limit is breached, returning aggregate losses.

So putting on my old Marxian thinking cap, a prized relict from those old fun-house days, there is that hoary old chestnut, “the tendential law of the falling rate-of-profit”, which was couched in “value” terms. Competitive market processes do indeed tend to drive down the rate-of-profit and also erode market-induced rents. But the concentration of capital with increasing returns-to-scale amounts to an escape mechanism from such a competitive tendency, even as the destruction of other capitals induces losses of the return to older capital stocks, and thus to the extant capital stock in aggregate, while the increased requirements of concentrated large-scale capital investment combined with the lowering of output prices induces a new different dilemma for maintaining the overall rate-of-profit. In effect, capital-intensive sectors, (not Marx’ terminology), are drawing “value” off of more labor-intensive sectors, even as it tends to shift more labor to those sectors, while diminishing wage-based demand. But then excess profits get shifted to those lagging sectors, wherever they might be found, since “competition breeds monopoly and monopoly breeds competition”, and a “global” restructuring of the economy through expanding opportunities for capital investment ensues. What then is produced and what is not? What is a “rent” and what is not? No simple answers.

So to return to my original query/speculative thesis,- (even if it is not the topic of the OP, though see @21),- what has happened such that “we” have arrived at the present global economic crisis and why are all the worst “remedies” being proposed and undertaken, despite putative better knowledge? Why are “we” stuck in that double-bind between what is “politically” possible and what is really possible? If either T.W. or B.W. would care to hazard a contribution toward discussing that question, I would be most grateful.

Of course, my commentary is merely “literary” and not properly formalized and “analytic”. But if economic systems are non-ergodic, path-dependent, and not timelessly self-regulating in accordance with pre-given equilibria as the neo-classicals imagine, then they are historical, hence susceptible to merely “literary” accounts. It’s worth remarking that the very notion of history involves a surplus of counter-factual possibilities over and above what actually and factually gets realized or enacted, else the notion of history is itself nonsensical. Even if such counter-factuals could never be arranged into any, but the most provisional, law-like generalities.


Bruce Wilder 10.30.11 at 6:53 pm

I don’t know about the “counterfactuals”, but history is certainly the record of a series of fully resolved, but originally contingent decisions.

A point that I tried, perhaps unsuccessfully, to make earlier in this thread, about the apparent vagueness in using counterfactuals to identify and define “rents”, is that that vagueness is a product of the neoclassical frame: first, the attempt to “objectify” rent is misguided (even if it is consistent with the pseudo-physics tradition of the marginal revolution), and second rent’s significance to incentives and choice derives from uncertainty and risk. In practice, “rent-seeking” is a good explanatory strategy for the strategic behavior of economic actors precisely because “rents”, from the particular point-of-view of a particularly situated actor, are not vague at all. Truly unconstrained choice involves not just threshold anxiety, but entails an impossible degree of computational complexity. (If JCH’s comments can be subaltern, mine can have existential import;) Economic actors focus on rents as part of hedging their bets and reducing the decision-choice set to something they can calculate on productively. It might be as simple as deciding to invest in a professional training and license, because you believe that a man with a trade can always find employment; that’s rent-seeking.

Economic rents, considered from the traditional, detached god’s eye perspective of an economist, and in the abstract, may seem vague or ill-defined. “The difference between this use and the “next-best use” — why is this “next-best”, again?” But, the particular decision-maker can figure out the particulars of his own situation; if he knows something about farming, and stands to inherit productive bottom land, he knows this. And, these concrete particulars stand in contrast to a myriad uncertainties. Strategic behavior is marrying uncertainty to knowledge, using knowledge to control processes, but using the margin afforded by implicit economic rents to hedge and insure.

Knowledge is power, we are told, but knowledge has its limits, and in its limits, insurance is power. Economic rents are the “real economy” foundation for insurance.

The neoclassical analysis of incentives tends to focus on aligning the marginal reward with the desired behavior, but looking at the central tendency misses the main action, which is the distribution of risk. The distribution of income is the distribution of risk, and the distribution of risk shapes the “incentives” and thus, the economic behavior of economic actors.

Leaping ahead along this path of thought, to address JCH’s question, “Why are ‘we’ stuck in that double-bind between what is ‘politically’ possible and what is really possible?”, I think the problem, at its core, is that enlightened views require the destruction of rents.

Rent-seeking, keep in mind, is a strategy for economizing on imaginative thought. It is very Whiggish, if you like, calculating the returns on the small increments of change, always hedging, always pragmatically preserving, admiring but suspicious of radical designs and architectures, wanting experiments and trial, but reluctant to commit to anything, which cannot be undone.

We are in a revolutionary moment, ill-suited to old Whigs. Anything sensible thing we do, will entail the massive destruction of old rents, old structures, of wealth.

There’s a lot of talk from the center-left about “inequality”, but for all the hand-wringing, I don’t sense much enthusiasm, or even willingness to acknowledge that doing anything effective will require destroying the wealth of a lot of wealthy people. The appeal of neoliberal opinion for a lot of people, apparently, is that remarkable combination of a modicum of “concern” about manifest problems, with a policy quiver filled with rubber-tipped arrows.

Globalization and deregulation have been pretty good for the top 20%, who run everything, and who command the rents the present institutional regime affords them. And, any sensible reforms will attack those rents. It is asking a lot of enlightened reason, to overcome those felt interests.

I think macroeconomic policy, in particular, is trapped at the top of a tall dune. Any change in policy will entail a trip downhill, and it might be a preciptous trip. And, even though Bernanke, Geithner et alia may sense that the dune on which they stand is only sand, subject to rapid erosion, they fear the descent too much to plan a trip to more solid ground. Pretty much everyone they know at Princeton or in the backalleys of Wall Street would be hurt tremendously by the descent, entailing as it would, the destruction of paper wealth and corrupt institutions. I’m tempted to call it near-sightedness, which it is, with regard to the general interest, but the destruction of wealth would be real enough, and that is seen, 20-20.

Good policy circa 2011 entails the destruction of existing institutions, and those institutions have been very good to the elites, who control them. The establishment is not enthusiastic about leading its self-destruction. And, it isn’t just corrupt self-interest acting. The available, legitimate modes of thought about policy are fitted and adapted to these structures. Better, more enlightened policy would require elevating thinking about institutions and economics and politics to an unusually high meta-level of critical thinking. As you know, I commented almost daily on Mark Thoma’s site for years and years. I don’t doubt Thoma’s personal integrity, and don’t think he thinks or acts out of any form of corrupt self-interest. And, he’s a tenured academic at a decent state university; his blogging fame has carried him to the first rank of international conferences and such, and no one seems embarrassed by his intellect. Yet, he doesn’t seem able to wrap his mind around the simple logical entailment that reform and preservation are antithetical.

I suppose that “we” got to this pass by some combination of private rent-seeking and a colletive embrace of a neoliberal constitutional design for economic and political institutions, which did anticipate the collective consequences of private rent-seeking within the constraints of the neoliberal architecture. It should not be shocking, I suppose, that the neoliberals and libertarians are no better at analysis post-crisis than they were ante-crisis, and interests of established elites remain embedded in the architecture of the neoliberal structure.

Jay Ackroyd had an interesting comment the other day, which he cross-posted to Atrios’ blog.



Tim Wilkinson 10.31.11 at 6:38 pm

BW – #93 – Globalization and deregulation have been pretty good for the top 20%, who run everything, and who command the rents the present institutional regime affords them. And, any sensible reforms will attack those rents. It is asking a lot of enlightened reason, to overcome those felt interests.

Yes, “that much at least is not really a mystery”.

Also, re: the eschaton blog link. It’s the supposedly ‘post-ideological’ end of history mythology that has, or had, been very effectively erected around the current consensus. So that in the strange argot of the soi-disant egalitarian ‘left’ (e.g. a certain ex-?CT poster) ‘Thatcherite’ becomes ‘technocrat’, and entirely respectable. This is perhaps not the case, or at least far less pronounced in the US, what with it’s having been fundamentally proprietarian/possessive-individualist roughly since the very first syphilis bacterium arrived on the continent.


Tim Wilkinson 10.31.11 at 7:11 pm

#91: What you see in the economic landscape about you—the remarkable dominance of that landscape by large, bureaucratic corporations—is the outcome of a process of selection, and What we see about us in the world is the outcome of a process of experimental selection. The lucky survivors are the ones, which managed to win a lottery for contested markets.

This does seem to resonate with the ‘weak anthropic principle’ explanation of productive rent (the w.a.p. being a selection based principle). So maybe that isn’t so far from the mark as I had suspected.

In general these stories explain or at least document the emergence of bureaucratic firms in receipt of ‘rent’, or something intuitively categorisable as substantial or ‘supernormal’ profit (though the latter concept is as laden with convoluted hypotheticals as that of rent).

My concern is really with what we are (or can coherently be) talking about when we talk of economic rents, and whether that is what we are actually describing here and if so how they work.

On a more general note I’m reminded of the almost complete disconnect between economics and business strategy literature, for example the literature on the ‘rule of three‘, or of three and four.

Henderson in the 2nd link says The underlying logic is straightforward. Cost is a function of market share as a result of the experience curve effect. If two competitors have nearly equal shares, the one who increases relative share gains both volume and cost differential. The potential gain is high compared to the cost. For the leader, the opportunity diminishes as the share difference widens. A price reduction costs more and the potential gain is less. The 2 to 1 limit is approximate, but it seems to fit.

BH’s own rather self-helpily ideosycratic-looking concept (in keeping with the superstitious guru-seeking nature of much management ‘theory’, with its high turnover of jargon), the ‘experience curve effect’ appears to mean increasing returns to scale. The explanation looks a bit like a rough attempt at an econ-style mathematical derivation of equilibrium but it notably doesn’t have much to say about efficiency or the tightly constrained options that economics tends to posit. Instead the talk is of discretion – who is willing to keep investing at higher rates for longer to win market share, etc.

Meanwhile Sheth & Sisodia say Ultimately, the Rule of Three is about the search for the highest level of operating efficiency in a competitive market. Industries with four or more major players, as well as those with two or fewer, tend to be less efficient than those with three major players. The role of the government is to ensure that free market conditions do indeed prevail, to allow industry rationalization and consolidation to occur naturally, and to step in when an industry seeks to consolidate too far, i.e., to a level where fewer than three players control the lion’s share.

Which means we’ve shifted from description to recommendation, on what basis I dunno.

But my point anyway was aimed primarily at trying to fathom the idea that oligopolists’ ‘rents’ are both rents and a good or useful thing in some sense, relative to some background assumptions (or faits accompli) concerning the system of economic organisation, anyway.

Henderson by contrast says, FWIW, The lowest possible price will occur if there is only one competitor, provided that monopoly achieves full cost potential even without competition and passes it on to the customer. – quite a proviso – and certainly the passing on to the customer seems unlikely absent democratic control of some kind.

Presumably the ‘full cost potential’ bit would be where Tim Worstall starts going on about ‘creative destruction’ – relevant to the idea of ‘rents’ as sustained by a selection process.

BUT – the thing about selection processes is that they = trial and error which is painfully slow and wasteful. So non-random ‘mutation’ mechanisms come to the fore, at which point we are talking about human creativity, ideas, intentional planning. Not ‘markets’ and ‘price signals’.


Tim Wilkinson 10.31.11 at 7:41 pm

jch – no, not semantic quibble or Analytic game, so far as I’m concerned, anyway. And while I wouldn’t claim they are ‘literary’ (It’s a long way to literary), my comments have been in words, and non-rigorous. So without wishing to be the slightest bit unfriendly about it I would suggest you give that faintly sniffy battle-of-the-fundamental-paradigms stuff a miss.

But anyway, I still am having trouble – not an ‘objection’ in the devising obscure counterexamples kind of style, just that I really don’t see what is being meant by ‘rent’, or if you prefer what rent is, and it seems that for it really does seem too slippery a concept to having so much weight rested on it.

A rent is a payment that doesn’t affect supply, isn’t it. That is what we are talking about. So one problem was, how can a rent be productive: what does it influence? Or are we actually talking about some radically different kind of thing when we talk about a rent? Which is the second more general problem, which is that I can’t actually get a firm grip on the standard n-c concept of a rent in any case.

I’ve tended to suppose that a rent is basically the same thing as a surplus (as in consumer or producer surplus). But this is not a simple matter of relationships between revenue and ‘cost’ – we keep coming up against the same kind of convoluted problems with opportunity costs, ‘supernormal’ profit, what have you.

FWIW Wikipedia has:

Classical factor rent

Classical factor rent is primarily concerned with the fee paid for the use of fixed (e.g. natural) resources. The classical definition is expressed as any excess payment above that required to induce or provide for production.

“A payment for the services of an economic resource which is not necessary as an incentive for its production”[7]
“Any payment that does not affect the supply of the input”[8]
“A payment to any factor in perfectly inelastic supply”[8]

Neoclassical Paretian rent

Neoclassical economics extends the concept of rent to include factors other than natural resource rents. But the labeling of this version of “rent” may be somewhat opportunistic or simply incorrect in that Vilfredo Pareto, the economist for whom this kind of rent was named, may or may not have proffered any conceptual formulation of rent.[9][10]

“The excess earnings over the amount necessary to keep the factor in its current occupation”[1]
“The difference between what a factor of production is paid and how much it would need to be paid to remain in its current use”[11]
“A return over and above opportunity costs, or the normal return necessary to keep a resource in its current use” [12]

And none of these seems capable of really grounding the conecopt in a way that makes me feel I’ve ‘got it’. But I’m probably getting a bit boring about this by now (if not some time ago).


john c. halasz 11.01.11 at 2:30 am

T.W. @96:

Which paradigm battle, Analytic vs. “continental” or classical vs. neo-classical? And I applied the epithet “literary” to my own comments, not yours, it being a standard put-down deployed by formal mathematical economists against interlopers or predecessors, (though I tend to think their formalizations often enough lose and let slip the concepts and their conditions or contexts of application that they are ostensibly supposed to encode).

But note that I didn’t disagree that the notion of “rents” entailed counter-factual hypothetical conditions by which they are to be defined and identified, and I said that is indeed a tricky question. B.W. might be a bit more dismissive of counter-factuals than I. (When he says,”history is certainly the record of a series of fully resolved, but originally contingent decisions”, he obviously has a different conception of “history” than I do). And I explicitly said the cases of “productive” quasi-rents were a highly ambivalent phenomenon, which were only partly “justified”, and in no wise suggested that they were conducive to a social welfare optimum, since I was explicitly offering something of a structural explanation of how the re-structuring of corporate and financial rents under a generation of neo-liberal globalization, coming to a head now with the GFC, was moving them ever further away from any social welfare optimum. (Though I also don’t think a social welfare optimum can be uniquely and formally defined, and its approximation is far more a political matter concerning the balance of power in social conflicts rather than something susceptible to a formal proof of the beneficent efficiency of Mr. Market).

AFAICT you have two objections: 1) explicitly, how can such an ill-defined and hard to operatively identify concept be accorded such a large explanatory “weight” and role; and 2) more implicitly or penumbrally, if such rents are as pervasive a factor as claimed, then how could “we” at all move to a different socio-economic structure and institutional order, much more in line with a putative equitable social welfare optimum. As to 1) I think both B.W. and I would answer, “eppur si muove”, that such rents are a large and pervasive factor in structuring economic activity and investment strategies, as a matter of fact, and that they stem from the structure of production far more than from market transactions. (Recall Marx’ discussion of reproduction schemas: in order for an economy to re-produce, let alone expand, inputs and intermediate goods need to be reproduced in a balanced, proportional way, which is a requirement imposed by production systems, whether or not they are market-mediated or vertically integrated, on market transactions, not vice versa. There is always a more-or-less long-lived installed capital stock/productive capacity, which can’t be switched on or off or rearranged at will, which is a heavy fact determining the course of an economy. Import-export penetration, for example, takes place over a number of years and can only be reversed over a number of years, which is why, e.g., rapid rather than gradual RMB appreciation would be disruptive and counterproductive.) As to 2). well, that’s what I’ve been addressing in an inverted, back-handed, “negative” and pessimistic way. Concentrated corporate and financial power can only be put in check by countervailing power, residing in the regulatory state, the public sphere to which it is accountable, and labor- and community-based organizations. But, of course, the regulatory state has been at once weakened and captured by corporate and financial power operating on a globalized basis, the public sphere manipulated and obfuscated by propaganda, infotainment and think tank “research”, and the solidarities of labor and communities have succumb to atomization and fragmented isolation. And that has much to do with how rents and quasi-rents have been increasingly stove-piped to the top, rather than being more broadly distributed. If you disagree with such an observation/explanation, pray tell, propose another.

So let’s go back to Ricardan rents, since that’s a clear-cut kind and often easily identifiable, (e.g., Saudi oil rents). Ricardo’s point was the the cost-price of food would be determined by how much marginal lower-quality land needed to be put into production to meet the total demand for food and that the difference in land quality would be “compensated’ for by rents, such that eliminating rents would not lower food prices, but merely transfer those rents to someone else, say, the farmer rather than the landlord. His worry was that, since the wage was largely determined by the cost of food, high prices would transfer the social surplus to landlords at the expense of capital formation for further industrial investment. So he proposed “free trade” to exchange industrial exports, with a broader market, for cheaper food imports, thereby reducing rents at the expense of landlords and in favor of industrialists. The vague moralistic imputation is that such rents are “unearned”, but that doesn’t interest me, since they are “inevitably” produced by an extensive system of production and prices, however they might be distributed. (And after all, one can just as well question whether profits are “earned”, since for Marx profits and rents were both just different forms of surplus-value. There are a number of functional “virtues” to a system of productive investment driven by profit, which go together with its endemic dysfunctions, and any alternative or successive system of production would have to devise at least functionally equivalent solutions to those “virtues”, if it is to be sufficiently efficient to be “competitive” in “evolutionary” terms, while eliminating or attenuating those dysfunctions to attain a markedly better outcome in terms of social equity and well-being. But what is a rent, what is a profit and what is a wage, “earned income”, is always in flux, since there can be and are rents attached to “labor”, but it’s less a matter of distortions in production than distortions in distribution). And I’m also not much interested in the moralistic imputation that rents are “excessive” profits, since they needn’t be large at all and profits are already a surplus over costs and will gravitate to where that surplus is largest willy-nilly over time, as ostensibly the measure which optimizes productive surpluses. Once production costs are fully accounted for there remains the overall surplus and its distribution, (though production costs can’t be accounted for within a system of prices, without first determining distributions, “the transformation problem”, and distributions will determine READ, with iterative follow-on effects through feed-back loops and cycles on further production and investments). So I defined a “rent” provisionally as profits or payments from the surplus displaced and detached from those required costs-of-production. Consider a “negative basis trade”, an example of a financial rent derived from regulatory arbitrage. It might yield only 15-20 bps. from just 10% of a structured security with a par value of $1 billion and an aggregate yield of, say, 800 bps. , which is just $150-200,000, small change in on the whole, but ostensibly “free money” and such chisellings with appropriate accounting trickery can add-up in aggregate to a whole lot of loot. I earlier offered an example from the U.S. beef industry which was fairly clear-cut, though my main aim here has been MNC production platforming and financialized FX arbitrage, as a large number of cases by which profits and wealth has been stove-piped to the top. (Stereotypically, those sneakers that cost $5 to produce and retail for $100). Anders said my usage was merely Marxian; no, not nearly and not exclusively. Rather what I said was that cases need to be distinguished “casuistically”, by examination of the details of cases, but those cases add and mount up to a large secular trend.

I don’t think that the baseline neo-classical model of perfectly competitive markets with constant returns-to-scale, whereby MP=MC, profit is reduced to the cost of capital = the rate of interest, and the ” law” of diminishing returns rules the roost, is of much use as a counter-factual in defining and identifying rents. Since it’s a logically idealized and inverted account that doesn’t have realistic application in identifying operative conditions. In fact, since firms that are persistently profitable do exist, the implication of such a model would be that they only exist by stabilizing or controlling one of more markets in the conjuncture at which they operate, to effectively exclude potential competition. Likewise, opportunity-costs are entirely hypothetical counter-factuals, unless there is factually a competing bid. But the idea that there is always and everywhere a competing bid available, just like the idea that there is always and everywhere a set of price/quantity adjustments that can ensure market-clearing equilibrium is just part of the neo-classical fantasy of logical idealization, rather than realistically examining the configuration of all those “second-best” conditions. How useful neo-classical analytic devices are and where, I wouldn’t have a global judgment upon, except that they seem to miss much that is relevant. But I do think a set of useful counter-factuals could be constructed on a case-by-case basis, starting from path-dependent economic history and examining data on differential returns,- (since, as one of those business gurus noted, market-share “leaders” tend to “enjoy” stock price premiums),- to analyze rents and quasi-rents and how they contribute to the stove-piping of wealth and income, granted that there will be both clear-cut and border-line cases.

BTW Wikipedia also has a page on “quasi-rents”:


I didn’t know that it was Alfred Marshall who first conceived/observed them, but it’s not too shabby of a pedigree.


Bruce Wilder 11.01.11 at 8:23 pm

@ TW

I am sympathetic with the difficulties you are having with the concept of “economic rent”. The concept of “economic rent” is entirely and strictly an analytic distinction; it does not refer to a measurable thing-in-the-world; there is nothing visible and objective, which you can adamically denote as an “economic rent”; you are only going to encounter it in counterfactuals. Contra JCH, I have no problem with counterfactual statements, which express implicit contingency, which is what “economic rent” is generally about. My problem is with people, who reify their personal point of view with assertions of the form, “the fact is if . . . “. Actual patterns of behavior are shaped by expectations, risk-aversion, etc., and economic reasoning offers important insights that can be applied to interpreting what we observe; “economic rent” is a concept carrying a lot of such insight.

I’d suggest you try setting yourself a few super simple “problem sets” involving the concept, and see what you can work out. Imagine two farms: one, situated on fertile, bottom land, and the other in the sandy soils of a highland. Standard neoclassical analysis says that there is no basis for terming the first, a rich farm and the latter, a poor farm. The “profitability” of either, in competitive markets for farm products, will tend toward zero, the higher productivity of the rich farm offset by the higher cost of the rich farm as a resource or asset. What matters most, supposedly, is the marginal. So, if both farms produce, say, potatoes, the marginal cost of the potatoes produced will be the same: equal to the price of potatoes.

Now, consider a classic political problem: building a road. Building a road to either farm may reduce the cost of transporting farm product. Try to work how a particular farmer might respond to such a proposal. Consider, for the sake of argument, that the farmer on the bottom land is already near a navigable river; how does he feel about a road into the highlands? How does either feel about financing the road construction with a toll? With property taxes?

Think about the nature of farm markets for a moment. Every decision to plant is a sunk-cost investment; farmers fear a bumper crop more than adverse weather. Back in the day, before Federal price stabilization and the zombie of the EMH, agricultural economists touted a cobweb model for some farm product markets. Are unstable farm markets “equally” disadvantageous to the rich farm and the poor farm? Are futures markets equally advantageous?

Finally, think about how the farmers might deal with scientific agricultural knowledge and the possibility of investing in capital equipment.

As far as business strategy is concerned, I have been roped into helping teach the business strategy course, which the culminating course for MBAs, on a couple of occasions. I’m familiar with the general outlines of the “Organization and Strategy” lit going back to before Henderson and the Experience Curve, as well as the closely related, but mostly now defunct Industrial Organization specialty in Economics, going back to Caves and Stigler. Much of the business strategy stuff is designed to stimulate and flatter bored and demoralized, but ambitious salesmen aspiring to be executives, and, therefore, is puddle-deep.

The alleged pattern, underlying the Rule of Three, and similar, is, of course, yet another example of the Power Law applied to a self-organizing, somewhat “random” phenomenon. Another way to think about it, would be to recognize that the “competition” among firms is strategic, and the structure of production matters.

Firms make sunk-cost investments in production systems, which in a few, but consequential, cases, exhibit increasing returns. The logic of Supply, though, is the opposite of Demand. Demand wants infinite customization; Supply, to achieve increasing returns, wants something like infinite standardization. Strategy consists of the art of compromising this conflict in making the sunk cost investment underlying the organizing of production, while still ensuring that a return can be “earned” on the sunk-cost investment.

There’s a basic paradox in the neoclassical analysis of a sunk-cost investment. A rational decision-maker should disregard sunk-costs. This is not a merely theoretical proposition; Wal-Mart may pressure a supplier into making an investment to reduce the supplier’s costs, but, as many suppliers have discovered to their grief, Wal-Mart will not want to pay a premium to ensure that the investment earns a return for the supplier. And, it is not just a matter of a powerful monopsonist at work. Coase made a brilliant argument showing how the classic monopolist supplying a durable good, would have a hard time maintaining a monopoly price in competition with himself.

Of course, a strategic decision-maker knows of the sunk-cost problem, and the search for viable business models consists largely in trying to find ways to structure a sunk-cost investment in ways that permit earning a return. That’s another way of saying, quasi-rents are important and pervasive.

The most common prescription of strategic competition is zag, to the other guy’s zig. It is not hard to see how Firm A’s zig in choosing a production system exhibiting scale economies might grab 40% of the market, while Firm Big’s zag takes the next biggest product niche available, allowing for a scale economy handicap, but a customization advantage. This strategic competition can continue over very long periods of time, as exploiting increasing returns to scale or networks requires “learning”. There’s a kind of random walk of many small choices behind an apparent Experience Curve or Power Law pattern. There are many classic examples in the Business School Case literature. Westinghouse chased General Electric in the turbine generator business for decades. General Motors and Ford have an interesting history of pursuing complementary strategies.

The general pattern suggests the possibility of a process that is almost ergodic, adapting predictably, by a process of discovery, to a fixed underlying reality of technology and demand, but there are also accidents, that suggest an arbitrary path-dependence. Some of the alleged accidents, and their significance — like the Qwerty keyboard — are hotly disputed.

I have to say I agree completely with JCH on the Big Picture paradigm issue. The neoclassical analysis is turned topsy-turvy by admission of uncertainty, and the idealism of 1st best economics is pathological.

Prescriptively, the pious endorsement of government as a fair referee, by the business strategy folks TW quotes, seems naive and ungrounded.

Strategic behavior is something that neoclassical analysis attempts to abstract away; that’s a good reason to ask neoliberals and libertarians, who rely on neoclassical analysis, to STFU, imho.

Institution-building has to be strategic, as well. Granting (small) rents to particular actors, or groups of actors, is one of the most effective things government can do, in devising stable and effective institutional contexts. The trick to avoiding “capture” is to create opposing private players, whose conflicted lobbying for privilege will leave politicians and regulators, as a group, strategically “free”.

As I see the Big Picture evolution of the last 30 years, much of the underlying pathology is traceable to the emergence of corporate executives as a unified class, and the related emergence of the corporate conglomerate, as a means of exercising executive power. In banking and finance, the univeral bank undermined the strategic opposition of various constituent parts of the sector, a development that had ramifications everywhere. Rating agencies and financial accountants and real estate appraisers, as well as regulators, lost their integrity along with a business model, where integrity earned an economic rent. Ditto, in Media, where corporate conglomeration has eliminated the strategic opposition among book publishers, newspapers, television stations, authors, tv producers and creative types, etc., not to mention the subversion of journalism as a profession.


Tim Wilkinson 11.02.11 at 11:11 am

jch – I was referring to the hyped-up anal-autistic v. incontinental divide. Distinctions between classical and neoclassical econ are, to avoid conceding too much modesty, not part of my mental furniture.

So, thanx for pointing me at the Wikipedia flat-pack intro to ‘quasi-rent’ – should have checked that before; v useful. Basically the temporally perspectival aspect I’d been musing about is borne out, but much simpler than I’d thought. The ‘quasi’ here really means business – this is really, really quasi, about as quasi as you can get without actually slipping into full-blown ‘non’:

a quasi-rent is only a Paretian Rent excluding the sunk cost investment. Viewed in an economic short term frame – after the sunk cost investment has been made – The income realized by a sunk cost investment constitutes a rent to the extent that it exceeds the amount that would be realized in the next best use of the sunk cost investment. Viewed in an economic long-term frame, which includes the decision to make the investment, the same income is not a rent, but instead might legitimately be called interest.

So pretty much a technicality, based on drastically reduced alternative opportunities, thus low opportunity costs of continuing on the current course, rather than high rewards coparing favourably with background opportunities. But as far as the decision to bring resources into one use rather than another, so far as mopre-than-minimal-motivation and its implications for non-distorting taxation, so far as producer surplus and any normative consequences in terms of ‘unearnedness’, quasi rent need have none of the core features of rent proper (I bracket problems with that for now).

I think this really suggests that we would be better off talking about profit – or ‘supernormal profit’, adjusted relatively simply by accounting for an interest and/or inflation rate (?), because the concept of quasi rent is entirely distinct from that (neither nec nor suff in anal-autistic-Aristotelian terms), and really just means irreversibly sunk costs. Quasi rent, it seems, has no necessary connection with the key concept of incentives (and windfalls; surplus), which is where the action is in argument over neoliberalism, markets, stock exchanges etc.

Getting rid of talk of ‘rent’ would be quite a good thing, in particular in view of the fact that the term ‘rent-seeking’ (⊂ profit maximising) has tended to be appropriated by the supposedly ‘free market’ types to indicate various horrific market distortions perpetrated by dastardly commies etc.

Talking instead of profits, and explicitly about incentives where they are relevant and tractable, would probably improve clarity, if that’s not too Anglophone an ambition.

And it’s probably a bit late to be opening a whole new can of fresh worms, but I would certainly be interested in trying to pin down those functional “virtues” to a system of productive investment driven by profit you mention. Because I’m sure we agree that quite a few of the commonly touted candidate ‘virtues’ (advantages over known alternatives?) are illusory. In particular (to refer back to another thread) what is it about stock markets that helps so much with long term planning/sizeable cost-sinking?

BW – yes I absolutely agree that econ. rent and especially (if that makes sense) so-called Paretian, or neoclassical, factor rent is an ineliminably counterfactual concept (actually I think I’m right in saying that is one thing the three of us have been agreed on from the start).

My specific puzzlement over quasi-rent has been assuaged as described above. I’ll have to mull over the significance of the exercises you supply, and also ponder this:

There’s a basic paradox in the neoclassical analysis of a sunk-cost investment. A rational decision-maker should disregard sunk-costs. This is not a merely theoretical proposition; Wal-Mart may pressure a supplier into making an investment to reduce the supplier’s costs, but, as many suppliers have discovered to their grief, Wal-Mart will not want to pay a premium to ensure that the investment earns a return for the supplier. And, it is not just a matter of a powerful monopsonist at work. Coase made a brilliant argument showing how the classic monopolist supplying a durable good, would have a hard time maintaining a monopoly price in competition with himself.

On Coase, I think marketing is very successful in encouraging early adopters, and of course inbuilt obsolescence and irreparable breakdown help. Also Pac man, apparently: http://en.wikipedia.org/wiki/Pacman_conjecture#Durable_Goods_Monopolists_and_the_Coase_Conjecture

There’s certainly a treadmill of computing power/software bloat. Old software ceases to be supported and conpatiblem – or like flash based internet stuff, is just replaced, while newer software requires increasingly powerful machines to run it (And new machines tend to have preinstalled OSs or are incompatible with older ones, and those tedn to be incompatible with older software… Take MS office – this continues to bloat while the ‘improvments’ – at least the ones that might conceivably require bloat – are largely cosmetic (and actually quite irritating) – all sorts of shading and fading and previews and re-rendering, none of which is actually very productive or useful.

I’m now complaining about MS Office. Time to stop.


john c. halasz 11.02.11 at 8:43 pm


Getting toward closing time. But, yes, it really is a matter of business as usual, which is what I think both B.W. and I have been saying all along, except that neo-classical econ doesn’t provide a particularly good description of business as usual. Wherein prices are determined by competitive markets, there are always competitive markets, at least notionally, and Pareto-optimality of transactions “defines” efficiency, while short-run market adjustments will always determine ‘equilibrium” and thus optimal output. I think what we’re really talking about is economic power and the balance of such power in determining how costs get displaced and extracted productive surpluses get distributed. Which is why I don’t get the notion that “rents” are supposed to be motivationally inert. Rather than very pervasive in determining much business investment strategy and economic behavior in general. Consider that incumbent oligopolies not only face large sunk-costs, but will work to defend and extend their incumbent positions incessantly. Oil majors will never become “green”, despite BP’s now exploded “branding” strategy, since virtually all there capital stock and technical expertise is bound up in the extraction, refining and distribution of oil and gas, and they would never work toward the devaluation of their capital and the erosion of their returns. Any investment is “green” projects is just PR or minor hedging.

It might be better to think in terms of general systems theory, in which systems are constituted by delimiting themselves from their environment and conduct their interaction with the environment through informational operations that “map” their environment, whether correctly or not. Firms would be such organizations and their environment would be markets and other firms. But the operations “internal” to the firm are not market transactions and reliable and above-normal returns to long-run investment serve as “insurance” for system-maintenance against contingent shocks that might occur in the environment, which could cause the collapse and dissolution of the system or force its re-differentiation and re-structuring. The basic motivation would be system-maintenance, “satisficing”, except of course that “environmental” pressures dictate a constant need for growth, prompting defensive/offensive strategies. But the basic point is that productive investment and inputs are not nearly as fungible and substitutable as the market-based opportunity-cost account would require. In the absence of readily available competing bids for “resources”, doubling down on controlling and displacing costs is not “minimally motivating”, which is why “we” think that attempting to analyze and operatively identify how “quasi-rents”, which might, in fact, be quite minimal and incremental, while summing up to a much larger “factor”, become embedded in cost-structures is a key, if too little credited, part of understanding how “business” actually works.

As a general rule or principle, I tend to think the emergently evolved systems have come into existence for some reason, which might not be a “good” or “sufficient” reason, but will indicate some degree of functionality. (Marginal analysis, for example, does often yield insights, which I wouldn’t disparage; it’s its systematization into a total economic model that’s the problem). As to those functional “virtues” of a profit-driven system of productive investment, they are fairly obvious, though by no means definitive or insuperable: allocation of investment in accordance with the tendency to equalize the rate-of-profit across firms and sectors to optimize output, payment for managerial services, reward for innovation and entrepreneurship, ready measure of relative productive surpluses, adjustment to fluctuations or basic changes in demand and responsiveness to consumption needs, differential incentives for discipline and further effort, and the like. My only point is that one needs to understand such basic functions to understand how they can become excessive, distorted and dysfunctional, and thus how they might be remedied or replaced. As you should have guessed by now, I’m no fan of capitalism as it has been or now is, and am not much prone to meliorist, incremental reformism, and am not offering any sort of normative defense. (The Virginia School/public choice analysis of political rent-seeking is not entirely wrong, but rather largely hypocritical. And one obvious counter to it is to point out how “rents”, if suitably identified, can constitute a private tax on the rest of the economy). But, on the other hand, given my “origins”, I also not keen on abstract normative elaborations, without regard for the functional “grid” in which they are intricated and to which they must respond. But, as for “known alternatives”, wouldn’t that be precisely an appeal to counterfactuals, to potentials, to other possibilities. (As an aside, I would regard philosophical desire as the desire to fully know the possible, which is an impossible desire, which is why, incontinently speaking, philosophy tends to repeatedly stumble over its own ruins, rather than achieving definitive progress). If you didn’t understand the point about how stock markets can assist in raising large-scale productive investment, nonetheless, it wasn’t a normative defense of stock markets as “necessary”, nor as they currently operate; rather I raised the debt vs. equity issue, since an entirely debt based system might be far worse, and pointed to the way in which current market were being leveraged and manipulated by “insider” debt/credit issuance. On the other hand, if you would want to get an idea of what a sheer, systematic functionalism is like, and how loopy and abysmally cynical it becomes in trying to derive or explain normative issues, I might recommend this:


At any rate, to get back to my original comment intervention here, I differentiated three kinds of “rents”, land/natural resource rents, “productive” quasi-rents, and financialized rents, offering particular discrete examples, and was addressing how the third type, interacting with the other two on a globalized basis, had increasingly and dysfunctionally stove-piped wealth and income to the top. Based on the implied premise that it is the structure of production that crucially determines the distribution of income, but that the distribution of income effects the further development of the structure of production. If you have a better alternative account, by all means resume it at some future comment opportunity.

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