Catherine Rampell had an interesting column dealing with the question of when prices will “come back down?” Rampell correctly answered “never,” but I am not convinced this is the real question people are posing.
Rampell deals with the question as being one about the overall Consumer Price Index (CPI). She is explicitly not talking about the price of the everyday items, like food and gas, that people purchase regularly.
This distinction is my reason for skepticism. First, the price of many food items has come back down. Overall food prices have not, but it actually is plausible that we will see further declines in the food basket.
The prices of most commodities, like wheat and corn, are pretty much back to their pre-pandemic level. Shipping costs have also fallen back to roughly pre-pandemic levels. And, corporations are complaining that they are losing some of the pricing power that they had during the pandemic.
All of this translates into a picture where the rate of inflation in food prices may drop further (the annual rate was 1.6 percent over the last three months) and could possibly turn negative. I doubt that food prices will fall back to pre-pandemic levels, but we may see the overall index decline for a period of time.
We see a different picture with gas prices. Production cutbacks by Saudi Arabia (was there a “perfect phone call” from Donald Trump?) have sent crude oil prices from $70 a barrel to $90 a barrel, raising gas prices back to almost $3.90 a gallon as a nationwide average.
However, it is plausible that these prices will fall again. For better or worse (obviously worse from a climate perspective), U.S. oil production is at a record high. Exploding growth in the EV market, especially in China and Europe, will reduce demand. Maybe Saudi Arabia will respond with further cuts (I don’t have a crystal ball), but it is not absurd to think that gas prices will come back down.
Anyhow, the point here is that the prices that are most directly in people’s faces can come back down. When we move beyond these prices to items like rent, owners’ equivalent rent (the rent you would pay yourself for living in a home you own), and new car purchases, I’m not sure that these fit well into most people’s conceptions of inflation.
Owners’ equivalent rent accounts for over a quarter of the CPI, do the two-thirds of households who own their home actively think about how much it would cost them to rent the place? Most people rarely buy a new car, and even used car purchases are not frequent (used car prices have been falling over the last year).
I also doubt that many people other than economists and people who write on economics have a clear vision of the overall CPI or the price index of their choosing. For this reason, I’m not sure that many people really expect prices to come back down. Average hourly wages have risen by almost 20 percent since the start of the pandemic, do people really expect that they will pay the same for stuff as they did in 2019?
It is also worth noting that prices never came back down in the 1980s. Ronald Reagan was singing about “Morning in America” in his 1984 re-election campaign when inflation was still over 4.0 percent.
My guess here is that the concern for prices coming back down is being fueled by the Fox News gang and their allied politicians. This is a theme they endlessly tout. I know this because Elon Musk has decided that I have to see the tweets of every right-wing politician and pundit in the country in my Twitter feed. (I have blocked most of them, but I still see plenty.)
As is often the case, Fox can have a huge impact on the national political agenda. We see this all the time, most obviously with the absurdity around Biden’s impeachment. Months of extensive investigation have produced absolutely nothing in terms of serious evidence and shot down most of the right-wing theories of President Biden’s corruption. Yet, the House is prepared to move forward, and close to half the country actually says they think there is a plausible basis for impeachment.
Anyhow, we know that Fox and its friends endlessly harp on out-of-control inflation. This may not correspond to reality, but that is not a big factor for many people. In short, I don’t think the issue is whether inflation will flip over to deflation, the question Rampell addresses, I think the issue is when, if ever, the right stops whining about inflation.
The Myths of Deflation
As long as we’re on the topic, I want to beat up on one of the myths about the problem of deflation. Rampell repeats the widely circulated story that when we see deflation, like what Japan had in the 1990s and 2000s, consumers will delay their purchases, leading to less demand and a weak economy.
I’m afraid this story does not make much sense. Deflation peaked in Japan at around a 1.0 percent annual rate, but it usually was a smaller decline. Would people really delay buying a $40 shirt or pair of pants because it might cost 20 cents less in six months? Even with a big-ticket item like a $30,000 car, would it make sense to delay the purchase six months to save $150?
Also, focusing on the overall index misses the fact that when inflation is close to zero the prices of many items are already falling. In fact, car prices often fell here in the decades before the pandemic, even as the overall inflation rate was positive. If the inflation rate falls from a rate of positive 1.0 percent to negative 1.0 percent, it just means that the balance of items with falling prices has increased.
There is a plausible story that falling prices hurt investment. If an auto manufacturer is looking to build a new factory, it is asking about how much it can expect to sell its cars for over the next ten or twenty years. If it believes that prices will be lower five or ten years out, then it will be less likely to build the factory.
For this reason, we can certainly tell the story that deflation would be bad news for the economy, but it is bad news in the same way that 1.0 percent inflation is worse than 2.0 percent inflation, crossing the zero mark means nothing. (We could tell a story of a deflationary spiral, but Japan never saw anything like that, nor has almost anyone else since the start of the Great Depression.) In short, deflation can be bad, but only in the same way, that very low inflation can be bad. Zero is not the problem.
Catherine Rampell had an interesting column dealing with the question of when prices will “come back down?” Rampell correctly answered “never,” but I am not convinced this is the real question people are posing.
Rampell deals with the question as being one about the overall Consumer Price Index (CPI). She is explicitly not talking about the price of the everyday items, like food and gas, that people purchase regularly.
This distinction is my reason for skepticism. First, the price of many food items has come back down. Overall food prices have not, but it actually is plausible that we will see further declines in the food basket.
The prices of most commodities, like wheat and corn, are pretty much back to their pre-pandemic level. Shipping costs have also fallen back to roughly pre-pandemic levels. And, corporations are complaining that they are losing some of the pricing power that they had during the pandemic.
All of this translates into a picture where the rate of inflation in food prices may drop further (the annual rate was 1.6 percent over the last three months) and could possibly turn negative. I doubt that food prices will fall back to pre-pandemic levels, but we may see the overall index decline for a period of time.
We see a different picture with gas prices. Production cutbacks by Saudi Arabia (was there a “perfect phone call” from Donald Trump?) have sent crude oil prices from $70 a barrel to $90 a barrel, raising gas prices back to almost $3.90 a gallon as a nationwide average.
However, it is plausible that these prices will fall again. For better or worse (obviously worse from a climate perspective), U.S. oil production is at a record high. Exploding growth in the EV market, especially in China and Europe, will reduce demand. Maybe Saudi Arabia will respond with further cuts (I don’t have a crystal ball), but it is not absurd to think that gas prices will come back down.
Anyhow, the point here is that the prices that are most directly in people’s faces can come back down. When we move beyond these prices to items like rent, owners’ equivalent rent (the rent you would pay yourself for living in a home you own), and new car purchases, I’m not sure that these fit well into most people’s conceptions of inflation.
Owners’ equivalent rent accounts for over a quarter of the CPI, do the two-thirds of households who own their home actively think about how much it would cost them to rent the place? Most people rarely buy a new car, and even used car purchases are not frequent (used car prices have been falling over the last year).
I also doubt that many people other than economists and people who write on economics have a clear vision of the overall CPI or the price index of their choosing. For this reason, I’m not sure that many people really expect prices to come back down. Average hourly wages have risen by almost 20 percent since the start of the pandemic, do people really expect that they will pay the same for stuff as they did in 2019?
It is also worth noting that prices never came back down in the 1980s. Ronald Reagan was singing about “Morning in America” in his 1984 re-election campaign when inflation was still over 4.0 percent.
My guess here is that the concern for prices coming back down is being fueled by the Fox News gang and their allied politicians. This is a theme they endlessly tout. I know this because Elon Musk has decided that I have to see the tweets of every right-wing politician and pundit in the country in my Twitter feed. (I have blocked most of them, but I still see plenty.)
As is often the case, Fox can have a huge impact on the national political agenda. We see this all the time, most obviously with the absurdity around Biden’s impeachment. Months of extensive investigation have produced absolutely nothing in terms of serious evidence and shot down most of the right-wing theories of President Biden’s corruption. Yet, the House is prepared to move forward, and close to half the country actually says they think there is a plausible basis for impeachment.
Anyhow, we know that Fox and its friends endlessly harp on out-of-control inflation. This may not correspond to reality, but that is not a big factor for many people. In short, I don’t think the issue is whether inflation will flip over to deflation, the question Rampell addresses, I think the issue is when, if ever, the right stops whining about inflation.
The Myths of Deflation
As long as we’re on the topic, I want to beat up on one of the myths about the problem of deflation. Rampell repeats the widely circulated story that when we see deflation, like what Japan had in the 1990s and 2000s, consumers will delay their purchases, leading to less demand and a weak economy.
I’m afraid this story does not make much sense. Deflation peaked in Japan at around a 1.0 percent annual rate, but it usually was a smaller decline. Would people really delay buying a $40 shirt or pair of pants because it might cost 20 cents less in six months? Even with a big-ticket item like a $30,000 car, would it make sense to delay the purchase six months to save $150?
Also, focusing on the overall index misses the fact that when inflation is close to zero the prices of many items are already falling. In fact, car prices often fell here in the decades before the pandemic, even as the overall inflation rate was positive. If the inflation rate falls from a rate of positive 1.0 percent to negative 1.0 percent, it just means that the balance of items with falling prices has increased.
There is a plausible story that falling prices hurt investment. If an auto manufacturer is looking to build a new factory, it is asking about how much it can expect to sell its cars for over the next ten or twenty years. If it believes that prices will be lower five or ten years out, then it will be less likely to build the factory.
For this reason, we can certainly tell the story that deflation would be bad news for the economy, but it is bad news in the same way that 1.0 percent inflation is worse than 2.0 percent inflation, crossing the zero mark means nothing. (We could tell a story of a deflationary spiral, but Japan never saw anything like that, nor has almost anyone else since the start of the Great Depression.) In short, deflation can be bad, but only in the same way, that very low inflation can be bad. Zero is not the problem.
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The media have been giving considerable attention to the national debt in the last year or so. They have some cause, it has been rising rapidly, and more importantly, the interest burden of the debt has increased sharply since the Fed began raising rates last year. But, if we want to be serious, rather than just write scary headlines, we have to ask why the debt is a problem.
The first concern to dispel is the idea that the country somehow has to pay off its debt. Our national debt is in dollars, which the government prints. Unless something truly bizarre happens, we will always be able to print the dollars needed to pay interest and principal on government bonds.
We could have some story that if our economy collapses people could lose confidence in our debt. That is true, but a bit nuts. If our economy collapses, we should be worried about our economy collapsing, the debt is really beside the point.
The more serious issue is that rising interest payments will be a burden. This is a real issue, but there are several important qualifications. First, in spite of the large debt, even relative to the size of the economy, interest payments relative to GDP are not especially high. Currently, interest payments relative to GDP were just hitting 2.8 percent last quarter. They are still below the 4.4 percent share reached in the early 1990s. And, for history fans, this burden did not prevent the 1990s from being a period of general prosperity.
Military Spending
The second point is that we do need to put this burden in a bit of perspective since it is often treated as a generational issue. Suppose the interest burden does rise to three or four percent of GDP, or even higher. Is that an unbearable burden?
Back in my younger days, we used to spend a much larger share of the budget on the military. In the 1950s and 1960s military spending was generally over 8.0 percent of GDP. At the peak of the Vietnam War, it exceeded 10.0 percent of GDP. It dropped in the 1970s, but the Cold War buildup under Reagan again pushed it above 6.0 percent of GDP.
Military spending is currently under 3.0 percent of GDP. Suppose a magician came down and eliminated the national debt so we no longer had to pay any interest, but forced us to increase spending on the military to 6.0 percent of GDP. Are we now better off? Can we tell our children that they should be happy?
What we should care about with military spending is that we are secure as a country. If that can be accomplished by spending less than 3.0 percent of GDP on the military, then we are much better off than in a world where we are spending 6.0 percent of GDP on the military.
The amount of spending it takes to make us secure, and what that means, are obviously debatable points, but the basic logic is not. From the standpoint of maintaining and improving our living standards, spending on the military is the same thing as throwing money down the toilet.
This is an important point that needs to be yelled loudly at the people anxious to have a New Cold War with China. They also need to recognize that the Soviet economy peaked at around 60 percent of the size of the U.S. economy. The Chinese economy is already more than 20 percent larger using a purchasing power parity measure of GDP. This means that Cold War-type competition with China is likely to be incredibly expensive, even assuming we never get into an actual hot war.
Global Warming: Will We Celebrate Containing the Debt if the Planet Burns?
The third point on this generational issue is that we need to look around at the country and the world. Global warming is having a large and devastating effect on the environment. We are seeing an unprecedented wave of extreme weather events, including droughts, dangerous heat waves, hurricanes, and flooding. This will only get worse through time.
It is great that Biden put the country on a path toward clean energy with the Inflation Reduction Act, but we will need to do much more. Thankfully, the rest of the world, and especially China, is far ahead of us. The idea that somehow the debt is an overriding generational issue, when we are facing the destruction of the planet, is something that can only be taken seriously by our policy elites. Our success in limiting global warming will have infinitely more relevance to the quality of the lives seen by our children and grandchildren than anything that happens with the national debt.
Why Spend Money When We Can Just Issue Patent Monopolies?
The fourth point is that direct spending is only one way the government pays for things. The government supports a huge amount of innovation and creative work by awarding patent and copyright monopolies. While these monopolies are one way to provide incentives, they also carry an enormous cost. In the case of prescription drugs alone, they likely cost the country more than $400 billion a year (more than $3,000 per family, each year) in higher drug prices. We will spend over $570 billion this year for drugs that would likely cost us less than $100 billion if they were sold in a free market without patent monopolies or related protections.
If we look at the impact of these government-granted monopolies in other industries, like medical equipment, computers, software, video games, and movies, they almost certainly add more than $1 trillion a year to what households pay for goods and services. For some reason, the people screaming about the debt literally never say a word about the costs the government imposes on us by issuing patent and copyright monopolies.
And, these costs are interchangeable. For example, we can spend more money on government-funded research in developing prescription drugs and require that drugs developed as a result are available as generics sold in a free market. In the standard deficit accounting, we would only pick up the extra cost from the government-funded research. We would not see the savings from cheaper drugs, except insofar as the government paid less for buying drugs.
We could also go the other way. We could give out patent or copyright monopolies as a way to fund various government services. For example, we could give the Social Security trust fund a patent monopoly on ice that lasts for 1000 years. It could finance benefits by charging licensing fees for using ice. That would save the government around $1 trillion a year in Social Security spending. That should make the deficit hawks very happy.
Yeah, that would be absurdly inefficient and be a license for all sorts of corruption. But so is our current patent system, which does things like encourage drug companies to push opioids and lie about the effectiveness of their drugs. But, we know the deficit hawks, and many in the media who push their handouts, don’t care about efficiency, they just want lower debt. So, the patent monopoly on ice should be good with them.
Debt and Stock Prices
Okay, but I promised to say how a higher debt can be bad news like higher stock prices. This requires a little bit of Econ 101. The serious story of how higher debt is bad is that it can lead to higher interest payments.
The “can” here is important. The debt-to-GDP ratio rose considerably in the Great Recession and the years immediately following, but the ratio of interest payments to GDP fell. This was because we had very low-interest rates in these years. The Fed deliberately kept rates near zero because it was combatting weak growth and high unemployment, as we faced a period of secular stagnation.
We don’t know yet whether the economy will return to something like secular stagnation as the impact of the pandemic fades into the distance. Some of the factors that led to this stagnation, most notably slower population and labor force growth, and an upward skewed distribution of income, are still present. However, we have seen some reversal of the upward redistribution of income, as wage growth has been strongest for those at the bottom of the wage ladder. But, we don’t know how far this trend will go. We also don’t know if the full increase in profit shares will be reversed.
The impact of new technologies, most notably AI, is still very much unclear. If they do have a substantial impact on productivity growth, then we may again see rising unemployment and a need for the Fed to push rates lower. Also, as we switch to clean technologies, there will be less demand for fossil fuels and many of the associated services. Of course, these technologies may also be associated with an investment boom that will increase demand for labor.
There are reasonable arguments on both sides of the secular stagnation issue, but let’s assume that the Fed does not return to its zero-interest policy, but rather we get an interest rate structure that looks something like what we saw just before the pandemic. In that context, we will see higher interest payments as a share of GDP.
It is worth thinking for a moment why this would be bad. As the Modern Monetary Theory people remind us, the problem of a government deficit is not the financing – we can always print the money – the problem is that it can be inflationary since it can lead to too much demand in the economy.
Interest payments on the debt don’t directly create demand in the economy. They create demand only when people spend the interest payments. Insofar as the payments are made to high-income people with low propensities to consume, they will have a relatively limited impact on spending and demand. But not all interest payments go to rich people, and even rich people will spend some fraction of their interest.
So, the problem of higher interest payments on the debt is increased consumption demand, which can create inflationary pressures in the economy. This gets us to the problem of a rising stock market.
While some people think of the stock market as a way to raise money for investment, most firms rarely raise money through this channel. In fact, companies typically go public as a way for the initial investors to cash out their gains. The main economic impact of a rising stock market is not on investment but rather on consumption.
There is a well-known, stock wealth effect that is usually estimated at between 3 to 4 percent. This means that an additional dollar of stock wealth leads to an increase in annual consumption of 3 to 4 cents. Households currently hold around $30 trillion in stock wealth. If the stock market rises by 20 percent, that would create another $6 trillion in stock wealth.
Assuming that people spend 3-4 percent of this new wealth, we would see an increase in annual consumption of between $180 billion and $240 billion. If we are concerned about excess demand creating inflationary pressures in the economy, then we should be worried about the impact of this rise in stock wealth.
In that sense, a rising stock market is bad news for the economy in the same way as increased interest payments on government debt. If we assume that 70 percent of interest payments are spent, then a 20 percent rise in the stock market will create roughly the same inflationary pressure as $300 billion in additional interest payments.
So, if we are worried that interest on the debt will lead to inflation, we should also be reporting the bad news on inflation every time we see a big run-up in stock prices. In short, interest on the debt can be a problem, but it gets far more attention than items that are much bigger problems in any realistic assessment of the situation.
The media have been giving considerable attention to the national debt in the last year or so. They have some cause, it has been rising rapidly, and more importantly, the interest burden of the debt has increased sharply since the Fed began raising rates last year. But, if we want to be serious, rather than just write scary headlines, we have to ask why the debt is a problem.
The first concern to dispel is the idea that the country somehow has to pay off its debt. Our national debt is in dollars, which the government prints. Unless something truly bizarre happens, we will always be able to print the dollars needed to pay interest and principal on government bonds.
We could have some story that if our economy collapses people could lose confidence in our debt. That is true, but a bit nuts. If our economy collapses, we should be worried about our economy collapsing, the debt is really beside the point.
The more serious issue is that rising interest payments will be a burden. This is a real issue, but there are several important qualifications. First, in spite of the large debt, even relative to the size of the economy, interest payments relative to GDP are not especially high. Currently, interest payments relative to GDP were just hitting 2.8 percent last quarter. They are still below the 4.4 percent share reached in the early 1990s. And, for history fans, this burden did not prevent the 1990s from being a period of general prosperity.
Military Spending
The second point is that we do need to put this burden in a bit of perspective since it is often treated as a generational issue. Suppose the interest burden does rise to three or four percent of GDP, or even higher. Is that an unbearable burden?
Back in my younger days, we used to spend a much larger share of the budget on the military. In the 1950s and 1960s military spending was generally over 8.0 percent of GDP. At the peak of the Vietnam War, it exceeded 10.0 percent of GDP. It dropped in the 1970s, but the Cold War buildup under Reagan again pushed it above 6.0 percent of GDP.
Military spending is currently under 3.0 percent of GDP. Suppose a magician came down and eliminated the national debt so we no longer had to pay any interest, but forced us to increase spending on the military to 6.0 percent of GDP. Are we now better off? Can we tell our children that they should be happy?
What we should care about with military spending is that we are secure as a country. If that can be accomplished by spending less than 3.0 percent of GDP on the military, then we are much better off than in a world where we are spending 6.0 percent of GDP on the military.
The amount of spending it takes to make us secure, and what that means, are obviously debatable points, but the basic logic is not. From the standpoint of maintaining and improving our living standards, spending on the military is the same thing as throwing money down the toilet.
This is an important point that needs to be yelled loudly at the people anxious to have a New Cold War with China. They also need to recognize that the Soviet economy peaked at around 60 percent of the size of the U.S. economy. The Chinese economy is already more than 20 percent larger using a purchasing power parity measure of GDP. This means that Cold War-type competition with China is likely to be incredibly expensive, even assuming we never get into an actual hot war.
Global Warming: Will We Celebrate Containing the Debt if the Planet Burns?
The third point on this generational issue is that we need to look around at the country and the world. Global warming is having a large and devastating effect on the environment. We are seeing an unprecedented wave of extreme weather events, including droughts, dangerous heat waves, hurricanes, and flooding. This will only get worse through time.
It is great that Biden put the country on a path toward clean energy with the Inflation Reduction Act, but we will need to do much more. Thankfully, the rest of the world, and especially China, is far ahead of us. The idea that somehow the debt is an overriding generational issue, when we are facing the destruction of the planet, is something that can only be taken seriously by our policy elites. Our success in limiting global warming will have infinitely more relevance to the quality of the lives seen by our children and grandchildren than anything that happens with the national debt.
Why Spend Money When We Can Just Issue Patent Monopolies?
The fourth point is that direct spending is only one way the government pays for things. The government supports a huge amount of innovation and creative work by awarding patent and copyright monopolies. While these monopolies are one way to provide incentives, they also carry an enormous cost. In the case of prescription drugs alone, they likely cost the country more than $400 billion a year (more than $3,000 per family, each year) in higher drug prices. We will spend over $570 billion this year for drugs that would likely cost us less than $100 billion if they were sold in a free market without patent monopolies or related protections.
If we look at the impact of these government-granted monopolies in other industries, like medical equipment, computers, software, video games, and movies, they almost certainly add more than $1 trillion a year to what households pay for goods and services. For some reason, the people screaming about the debt literally never say a word about the costs the government imposes on us by issuing patent and copyright monopolies.
And, these costs are interchangeable. For example, we can spend more money on government-funded research in developing prescription drugs and require that drugs developed as a result are available as generics sold in a free market. In the standard deficit accounting, we would only pick up the extra cost from the government-funded research. We would not see the savings from cheaper drugs, except insofar as the government paid less for buying drugs.
We could also go the other way. We could give out patent or copyright monopolies as a way to fund various government services. For example, we could give the Social Security trust fund a patent monopoly on ice that lasts for 1000 years. It could finance benefits by charging licensing fees for using ice. That would save the government around $1 trillion a year in Social Security spending. That should make the deficit hawks very happy.
Yeah, that would be absurdly inefficient and be a license for all sorts of corruption. But so is our current patent system, which does things like encourage drug companies to push opioids and lie about the effectiveness of their drugs. But, we know the deficit hawks, and many in the media who push their handouts, don’t care about efficiency, they just want lower debt. So, the patent monopoly on ice should be good with them.
Debt and Stock Prices
Okay, but I promised to say how a higher debt can be bad news like higher stock prices. This requires a little bit of Econ 101. The serious story of how higher debt is bad is that it can lead to higher interest payments.
The “can” here is important. The debt-to-GDP ratio rose considerably in the Great Recession and the years immediately following, but the ratio of interest payments to GDP fell. This was because we had very low-interest rates in these years. The Fed deliberately kept rates near zero because it was combatting weak growth and high unemployment, as we faced a period of secular stagnation.
We don’t know yet whether the economy will return to something like secular stagnation as the impact of the pandemic fades into the distance. Some of the factors that led to this stagnation, most notably slower population and labor force growth, and an upward skewed distribution of income, are still present. However, we have seen some reversal of the upward redistribution of income, as wage growth has been strongest for those at the bottom of the wage ladder. But, we don’t know how far this trend will go. We also don’t know if the full increase in profit shares will be reversed.
The impact of new technologies, most notably AI, is still very much unclear. If they do have a substantial impact on productivity growth, then we may again see rising unemployment and a need for the Fed to push rates lower. Also, as we switch to clean technologies, there will be less demand for fossil fuels and many of the associated services. Of course, these technologies may also be associated with an investment boom that will increase demand for labor.
There are reasonable arguments on both sides of the secular stagnation issue, but let’s assume that the Fed does not return to its zero-interest policy, but rather we get an interest rate structure that looks something like what we saw just before the pandemic. In that context, we will see higher interest payments as a share of GDP.
It is worth thinking for a moment why this would be bad. As the Modern Monetary Theory people remind us, the problem of a government deficit is not the financing – we can always print the money – the problem is that it can be inflationary since it can lead to too much demand in the economy.
Interest payments on the debt don’t directly create demand in the economy. They create demand only when people spend the interest payments. Insofar as the payments are made to high-income people with low propensities to consume, they will have a relatively limited impact on spending and demand. But not all interest payments go to rich people, and even rich people will spend some fraction of their interest.
So, the problem of higher interest payments on the debt is increased consumption demand, which can create inflationary pressures in the economy. This gets us to the problem of a rising stock market.
While some people think of the stock market as a way to raise money for investment, most firms rarely raise money through this channel. In fact, companies typically go public as a way for the initial investors to cash out their gains. The main economic impact of a rising stock market is not on investment but rather on consumption.
There is a well-known, stock wealth effect that is usually estimated at between 3 to 4 percent. This means that an additional dollar of stock wealth leads to an increase in annual consumption of 3 to 4 cents. Households currently hold around $30 trillion in stock wealth. If the stock market rises by 20 percent, that would create another $6 trillion in stock wealth.
Assuming that people spend 3-4 percent of this new wealth, we would see an increase in annual consumption of between $180 billion and $240 billion. If we are concerned about excess demand creating inflationary pressures in the economy, then we should be worried about the impact of this rise in stock wealth.
In that sense, a rising stock market is bad news for the economy in the same way as increased interest payments on government debt. If we assume that 70 percent of interest payments are spent, then a 20 percent rise in the stock market will create roughly the same inflationary pressure as $300 billion in additional interest payments.
So, if we are worried that interest on the debt will lead to inflation, we should also be reporting the bad news on inflation every time we see a big run-up in stock prices. In short, interest on the debt can be a problem, but it gets far more attention than items that are much bigger problems in any realistic assessment of the situation.
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• UnionsSindicatoUnited StatesEE. UU.Wage InequalityWorkersSector del trabajo
The strike of the UAW against the Big Three automakers raises many important issues that go well beyond the auto industry. It is worth taking a closer look at some of them. As I go through these, I should be clear that I have no inside knowledge about the negotiations, I just know what has been reported in the media.
Low Pay of Autoworkers
The first thing that is striking is how much the pay of many unionized autoworkers has fallen relative to economywide productivity. Going back forty years, a UAW job in the auto industry would have been a real prize for a worker without a college degree. The pay of an autoworker was sufficient to raise a family on a single income and send kids to college. It also covered health care and provided for a comfortable pension in retirement.
To be clear, there is nothing golden about a single-earner family. It is great that there are increased opportunities for women so that most are in the paid labor force. But, we would expect to see a two-earner household have a considerable income dividend over a one-earner household. This is often not the case.
According to reports in the media, many of the “temporary” workers in the industry are getting just $18 an hour. From 1938 to its peak purchasing power in 1968, the minimum wage rose not just in step with prices but also with productivity growth. This meant that minimum wage workers got their share of a growing economy.
After 1968, the minimum wage failed to keep pace with prices, with workers falling behind inflation. If the minimum wage had continued to keep pace with rising productivity, it would be over $25 an hour today. This means that many UAW workers are now being paid less than a minimum wage worker would have received in 2023 if Congress had kept raising the minimum wage in step with productivity, as it had done from 1938 to 1968.
Higher Productivity Can Mean Less Work, Not Fewer Workers
When the media are not hyperventilating about declining populations leading to a labor shortage, they are hyperventilating about how AI and robots will lead to mass unemployment. (Yes, those are complete opposites.) In fact, AI and robots are just newer versions of our old friend, productivity growth.
Productivity growth is the reason why most people do not have to work on farms growing our food. Productivity in agriculture has exploded over the last two centuries so that we can feed our population and even export food, with less than 2.0 percent of our workforce working in agriculture.
There are similar stories in other sectors. Productivity growth has radically reduced the need for workers in most sectors. It is why manufacturing now employs just over 8.3 percent of the workforce. (Yes, the trade deficit also reduces manufacturing employment, but even if we increase the figure by 20 percent, assuming something close to balanced trade, that still only gets us to 10.0 percent.)
Anyhow, we should not think of the technologies coming on the horizon as alien creatures. They are like the steam engine, electricity, the computer — new technologies that allow us to produce more with fewer labor hours.
Productivity growth has provided the basis for higher wages and living standards over time. It also can provide the basis for more leisure in the form of shorter workweeks, more vacations, and longer retirements. In the United States in the last four decades, we have taken the benefits of productivity growth (insofar as workers have seen them) primarily in the form of higher pay. In other countries, a much larger share of the benefits has been in the form of more leisure.
This has meant not only longer vacations (five or six weeks of paid vacation a year is now standard in Europe), but also paid family leave and paid sick days. Also, most other wealthy countries have lower ages at which workers qualify for Social Security benefits.
The UAW has put a 32-hour workweek on the table as one possible response to improvements in technology in the auto industry, specifically the shift to electric cars, which will require less labor. This is a great way of keeping workers employed as productivity improvements going forward allow us to produce more with less labor. If we can apply this formula more generally, then we can ensure that the benefits of adopting AI and the more widespread use of robots are widely shared.
In this context, it is worth debunking a foolish myth that enjoys great currency in elite circles. It is not technology that shifted income upward in the last half-century. It was our rules on technology that shifted income upward, most notably government-granted patent and copyright monopolies. There are alternative mechanisms for supporting innovation and creative work that would not lead to so much inequality.
CEO Pay is a Rip-off
The UAW has highlighted the issue of exploding CEO pay, pointing out that it has risen 40 percent over the last decade, with the CEO of GM now getting $27 million a year. This is a huge deal, and not just in a moral sense that we should be outraged about the inequality of CEOs getting paid 200 or 300 times as much as ordinary workers.
Unlike the case with ordinary workers, there is no real check on CEO pay. Ostensibly, corporate boards of directors are supposed to limit CEO pay to ensure that they are not ripping off the companies they work for. However, most directors don’t even see it as their job to limit CEO pay. Directors say that they see their job as serving top management. In that context, it is unsurprising that CEOs have seen their pay explode, going from 20 to 30 times the pay of ordinary workers to 200 to 300 times the pay of ordinary workers.
And, the issue is not just outlandish pay for the CEO. If the CEO is getting $27 million, the other top executives are likely getting $10 to $15 million, and third-tier executives are likely pocketing $2 million to $3 million. This also affects many structures outside the corporate sector. It is now common for presidents of universities and major foundations or charities to earn $2 to $3 million a year. Their second tier of management can pocket close to $1 million.
Imagine a world where CEOs still earn 20 to 30 times the compensation of ordinary employees, $2 million to $3 million a year. These pay structures would look very different. And, with less going to the top, there is more for everyone else. Suppose that in a world where the CEO of GM got $3 million and the pay of other top management was adjusted downward accordingly. This might free up around $200 million a year for ordinary workers. That would come to $4,000 annually for each of GM’s 50,000 UAW members. That doesn’t completely reverse forty years of stagnating wages, but it’s a good start.
Also, if the point is not obvious, there is nothing intrinsic to the market or capitalism that says CEO pay has to go through the roof. CEO pay has gone through the roof because of how we have structured the rules of corporate governance. Rules that gave shareholders (or anyone) better ability to contain CEO pay would result in a much different pay structure both at the top and in the economy as a whole.
Auto Industry Profits Provide Some Room for Higher Pay
It has been widely reported that GM made over $20 billion last year, with much of this being paid out to shareholders in the form of share buybacks or dividends. (For reasons I don’t understand, people get more upset about money paid out to shareholders as buybacks than dividends. I will add that Biden’s buyback tax is great news.) They jump from this number to saying that GM, and the other two auto giants, have plenty of money to pay their workers more.
Some important qualifications must be considered before giving workers all of GM’s profits. (That’s a joke, no one is proposing this.) First, GM’s net income, which is after-tax, was reported as $10.1 billion last year. Furthermore, this is a considerable jump from pre-pandemic levels when it was less than $7 billion a year.
In principle, it is net income that GM has available to finance its new investment. I said “in principle” because GM’s accountants tell us what GM’s net income is. There is reason to believe that it is fudged considerably, but the fact that the money they have left, after paying taxes and other expenses, is considerably less than gross profits is not disputable.
Anyhow, it seems that the profit figure reported for 2022 may have been somewhat inflated due to GM taking advantage of pandemic-related supply chain issues to raise margins. We may expect profits to return to something like pre-pandemic levels as supply conditions in the industry normalize.
The other fact that is not disputable is that GM does have to worry about its stock price. This is not because it matters much for its ongoing operations, whether it goes up or down by 10 percent or 20 percent, but an extraordinarily low stock price can leave the company vulnerable to a takeover. Paying out money to shareholders, as buybacks or dividends, helps to maintain the stock price.
Currently, GM’s market capitalization is $46.7 billion. Ford’s market cap is $50.5 billion. That means Elon Musk could buy both companies and still have half his fortune left to buy more social media companies and send people to Mars.
I couldn’t care less about the shareholders of these companies. But, if their stock prices fell sharply from current levels, these companies would be very vulnerable to takeovers. Union contracts stick in the event of a takeover, but contracts do expire. It would not be good for the UAW if some PE company committed to smashing the union were to take over GM and Ford. (We have seen this story many times.) For this reason, the UAW does have an interest in ensuring that these companies continue to maintain reasonable levels of profitability.
Just for some simple arithmetic, if GM raised pay for its 50,000 UAW members by an average of $10k each, that comes to $500 million a year. GM can surely afford that. An increase of $20k a year comes to $1 billion. Given that some of this will be passed on in higher prices, that still looks affordable. Getting much beyond that, I don’t know.
Inflated Stock Prices for Tesla and Other Wall Street Favorites Have a Cost
The flip side of the relatively low stock price for GM and Ford is the crazy price for Tesla. It now has a market cap close to $860 billion, almost 80 times its annual earnings. (GM’s price-to-earnings ratio is less than five.) This means that Elon Musk can raise capital at almost no cost by selling stock. That makes it difficult for other automakers to compete.
I haven’t tried to analyze Tesla’s stock price but I will say it looks high. (Brad DeLong did analyze it and came to this conclusion.) Anyhow, if the high price is just a case of irrational exuberance, the workers at the traditional car companies will pay a price.
We have seen this story many times in the past. My favorite example is when Time Warner, then the largest media company in the world, sold itself to AOL for AOL stock. AOL stock quickly plummeted, which means that the largest media company in the world essentially sold itself for nothing.
That made Steve Case and other big AOL shareholders incredibly rich but did nothing useful for the economy or Time Warner shareholders. These people now can enjoy lavish lifestyles – putting pressure on inflation – having essentially just pulled off an elaborate con. Anyhow, we do pay a price for irrational exuberance.
It Is Not an Issue of Electric vs. Gas-Powered Cars
Much of the media discussion has implied that UAW members stand to lose jobs from the Big Three’s conversion to electric cars. This is not true in any plausible universe. The Big Three currently have around 40 percent of the U.S. vehicle market, meaning the rest of the industry has around 60 percent.
The other manufacturers are rapidly adopting electric cars. The price of these cars is falling rapidly. Their ranges are improving and charging networks are being established nationwide. If the Big Three don’t also move rapidly to producing electric cars and compete in this market, their share of the total market is virtually certain to plummet.
Suppose the UAW were to block the Big Three’s shift to electric cars. If we can then envision a future ten or fifteen years out where their market share is down to 20 or 25 percent, is there any plausible story where that means more jobs, even if these are all gas-powered, than if their market share stays at 40 percent and half or more are electric? That seems a pretty hard story to tell.
In short, the Big Three have no choice but to move aggressively into producing electric vehicles. The UAW needs to fight to preserve as many jobs as possible, but blocking this shift is not a route that will do it.
The UAW and Big Three Are Still a Really Big Deal
The UAW contracts with the Big Three set a pattern for much of corporate America in the decades immediately following World War II. The auto industry is a much smaller part of the economy today than it was seventy-five years ago, and the Big Three have a much smaller share of the auto market. Nonetheless, the UAW’s negotiations are still drawing considerable attention. The outcome will likely have a major impact on the extent to which ordinary workers can share in the gains from productivity growth in the decades ahead.
The strike of the UAW against the Big Three automakers raises many important issues that go well beyond the auto industry. It is worth taking a closer look at some of them. As I go through these, I should be clear that I have no inside knowledge about the negotiations, I just know what has been reported in the media.
Low Pay of Autoworkers
The first thing that is striking is how much the pay of many unionized autoworkers has fallen relative to economywide productivity. Going back forty years, a UAW job in the auto industry would have been a real prize for a worker without a college degree. The pay of an autoworker was sufficient to raise a family on a single income and send kids to college. It also covered health care and provided for a comfortable pension in retirement.
To be clear, there is nothing golden about a single-earner family. It is great that there are increased opportunities for women so that most are in the paid labor force. But, we would expect to see a two-earner household have a considerable income dividend over a one-earner household. This is often not the case.
According to reports in the media, many of the “temporary” workers in the industry are getting just $18 an hour. From 1938 to its peak purchasing power in 1968, the minimum wage rose not just in step with prices but also with productivity growth. This meant that minimum wage workers got their share of a growing economy.
After 1968, the minimum wage failed to keep pace with prices, with workers falling behind inflation. If the minimum wage had continued to keep pace with rising productivity, it would be over $25 an hour today. This means that many UAW workers are now being paid less than a minimum wage worker would have received in 2023 if Congress had kept raising the minimum wage in step with productivity, as it had done from 1938 to 1968.
Higher Productivity Can Mean Less Work, Not Fewer Workers
When the media are not hyperventilating about declining populations leading to a labor shortage, they are hyperventilating about how AI and robots will lead to mass unemployment. (Yes, those are complete opposites.) In fact, AI and robots are just newer versions of our old friend, productivity growth.
Productivity growth is the reason why most people do not have to work on farms growing our food. Productivity in agriculture has exploded over the last two centuries so that we can feed our population and even export food, with less than 2.0 percent of our workforce working in agriculture.
There are similar stories in other sectors. Productivity growth has radically reduced the need for workers in most sectors. It is why manufacturing now employs just over 8.3 percent of the workforce. (Yes, the trade deficit also reduces manufacturing employment, but even if we increase the figure by 20 percent, assuming something close to balanced trade, that still only gets us to 10.0 percent.)
Anyhow, we should not think of the technologies coming on the horizon as alien creatures. They are like the steam engine, electricity, the computer — new technologies that allow us to produce more with fewer labor hours.
Productivity growth has provided the basis for higher wages and living standards over time. It also can provide the basis for more leisure in the form of shorter workweeks, more vacations, and longer retirements. In the United States in the last four decades, we have taken the benefits of productivity growth (insofar as workers have seen them) primarily in the form of higher pay. In other countries, a much larger share of the benefits has been in the form of more leisure.
This has meant not only longer vacations (five or six weeks of paid vacation a year is now standard in Europe), but also paid family leave and paid sick days. Also, most other wealthy countries have lower ages at which workers qualify for Social Security benefits.
The UAW has put a 32-hour workweek on the table as one possible response to improvements in technology in the auto industry, specifically the shift to electric cars, which will require less labor. This is a great way of keeping workers employed as productivity improvements going forward allow us to produce more with less labor. If we can apply this formula more generally, then we can ensure that the benefits of adopting AI and the more widespread use of robots are widely shared.
In this context, it is worth debunking a foolish myth that enjoys great currency in elite circles. It is not technology that shifted income upward in the last half-century. It was our rules on technology that shifted income upward, most notably government-granted patent and copyright monopolies. There are alternative mechanisms for supporting innovation and creative work that would not lead to so much inequality.
CEO Pay is a Rip-off
The UAW has highlighted the issue of exploding CEO pay, pointing out that it has risen 40 percent over the last decade, with the CEO of GM now getting $27 million a year. This is a huge deal, and not just in a moral sense that we should be outraged about the inequality of CEOs getting paid 200 or 300 times as much as ordinary workers.
Unlike the case with ordinary workers, there is no real check on CEO pay. Ostensibly, corporate boards of directors are supposed to limit CEO pay to ensure that they are not ripping off the companies they work for. However, most directors don’t even see it as their job to limit CEO pay. Directors say that they see their job as serving top management. In that context, it is unsurprising that CEOs have seen their pay explode, going from 20 to 30 times the pay of ordinary workers to 200 to 300 times the pay of ordinary workers.
And, the issue is not just outlandish pay for the CEO. If the CEO is getting $27 million, the other top executives are likely getting $10 to $15 million, and third-tier executives are likely pocketing $2 million to $3 million. This also affects many structures outside the corporate sector. It is now common for presidents of universities and major foundations or charities to earn $2 to $3 million a year. Their second tier of management can pocket close to $1 million.
Imagine a world where CEOs still earn 20 to 30 times the compensation of ordinary employees, $2 million to $3 million a year. These pay structures would look very different. And, with less going to the top, there is more for everyone else. Suppose that in a world where the CEO of GM got $3 million and the pay of other top management was adjusted downward accordingly. This might free up around $200 million a year for ordinary workers. That would come to $4,000 annually for each of GM’s 50,000 UAW members. That doesn’t completely reverse forty years of stagnating wages, but it’s a good start.
Also, if the point is not obvious, there is nothing intrinsic to the market or capitalism that says CEO pay has to go through the roof. CEO pay has gone through the roof because of how we have structured the rules of corporate governance. Rules that gave shareholders (or anyone) better ability to contain CEO pay would result in a much different pay structure both at the top and in the economy as a whole.
Auto Industry Profits Provide Some Room for Higher Pay
It has been widely reported that GM made over $20 billion last year, with much of this being paid out to shareholders in the form of share buybacks or dividends. (For reasons I don’t understand, people get more upset about money paid out to shareholders as buybacks than dividends. I will add that Biden’s buyback tax is great news.) They jump from this number to saying that GM, and the other two auto giants, have plenty of money to pay their workers more.
Some important qualifications must be considered before giving workers all of GM’s profits. (That’s a joke, no one is proposing this.) First, GM’s net income, which is after-tax, was reported as $10.1 billion last year. Furthermore, this is a considerable jump from pre-pandemic levels when it was less than $7 billion a year.
In principle, it is net income that GM has available to finance its new investment. I said “in principle” because GM’s accountants tell us what GM’s net income is. There is reason to believe that it is fudged considerably, but the fact that the money they have left, after paying taxes and other expenses, is considerably less than gross profits is not disputable.
Anyhow, it seems that the profit figure reported for 2022 may have been somewhat inflated due to GM taking advantage of pandemic-related supply chain issues to raise margins. We may expect profits to return to something like pre-pandemic levels as supply conditions in the industry normalize.
The other fact that is not disputable is that GM does have to worry about its stock price. This is not because it matters much for its ongoing operations, whether it goes up or down by 10 percent or 20 percent, but an extraordinarily low stock price can leave the company vulnerable to a takeover. Paying out money to shareholders, as buybacks or dividends, helps to maintain the stock price.
Currently, GM’s market capitalization is $46.7 billion. Ford’s market cap is $50.5 billion. That means Elon Musk could buy both companies and still have half his fortune left to buy more social media companies and send people to Mars.
I couldn’t care less about the shareholders of these companies. But, if their stock prices fell sharply from current levels, these companies would be very vulnerable to takeovers. Union contracts stick in the event of a takeover, but contracts do expire. It would not be good for the UAW if some PE company committed to smashing the union were to take over GM and Ford. (We have seen this story many times.) For this reason, the UAW does have an interest in ensuring that these companies continue to maintain reasonable levels of profitability.
Just for some simple arithmetic, if GM raised pay for its 50,000 UAW members by an average of $10k each, that comes to $500 million a year. GM can surely afford that. An increase of $20k a year comes to $1 billion. Given that some of this will be passed on in higher prices, that still looks affordable. Getting much beyond that, I don’t know.
Inflated Stock Prices for Tesla and Other Wall Street Favorites Have a Cost
The flip side of the relatively low stock price for GM and Ford is the crazy price for Tesla. It now has a market cap close to $860 billion, almost 80 times its annual earnings. (GM’s price-to-earnings ratio is less than five.) This means that Elon Musk can raise capital at almost no cost by selling stock. That makes it difficult for other automakers to compete.
I haven’t tried to analyze Tesla’s stock price but I will say it looks high. (Brad DeLong did analyze it and came to this conclusion.) Anyhow, if the high price is just a case of irrational exuberance, the workers at the traditional car companies will pay a price.
We have seen this story many times in the past. My favorite example is when Time Warner, then the largest media company in the world, sold itself to AOL for AOL stock. AOL stock quickly plummeted, which means that the largest media company in the world essentially sold itself for nothing.
That made Steve Case and other big AOL shareholders incredibly rich but did nothing useful for the economy or Time Warner shareholders. These people now can enjoy lavish lifestyles – putting pressure on inflation – having essentially just pulled off an elaborate con. Anyhow, we do pay a price for irrational exuberance.
It Is Not an Issue of Electric vs. Gas-Powered Cars
Much of the media discussion has implied that UAW members stand to lose jobs from the Big Three’s conversion to electric cars. This is not true in any plausible universe. The Big Three currently have around 40 percent of the U.S. vehicle market, meaning the rest of the industry has around 60 percent.
The other manufacturers are rapidly adopting electric cars. The price of these cars is falling rapidly. Their ranges are improving and charging networks are being established nationwide. If the Big Three don’t also move rapidly to producing electric cars and compete in this market, their share of the total market is virtually certain to plummet.
Suppose the UAW were to block the Big Three’s shift to electric cars. If we can then envision a future ten or fifteen years out where their market share is down to 20 or 25 percent, is there any plausible story where that means more jobs, even if these are all gas-powered, than if their market share stays at 40 percent and half or more are electric? That seems a pretty hard story to tell.
In short, the Big Three have no choice but to move aggressively into producing electric vehicles. The UAW needs to fight to preserve as many jobs as possible, but blocking this shift is not a route that will do it.
The UAW and Big Three Are Still a Really Big Deal
The UAW contracts with the Big Three set a pattern for much of corporate America in the decades immediately following World War II. The auto industry is a much smaller part of the economy today than it was seventy-five years ago, and the Big Three have a much smaller share of the auto market. Nonetheless, the UAW’s negotiations are still drawing considerable attention. The outcome will likely have a major impact on the extent to which ordinary workers can share in the gains from productivity growth in the decades ahead.
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Peter Coy had an interesting column last week on saving money on health care. The piece focused on an interview with James and Robert Rebitzer and discussed ways to reduce the cost of treating patients, especially the cost of prescription drugs.
At the end of the discussion, the piece mentions the idea of buying out patents and then placing them in the public domain so that they can be sold as cheap generics. While this would solve the problem of high drug prices, there is a step further that could be taken.
The government doesn’t have to give out the patent monopoly in the first place. Instead of paying companies to innovate by giving them patent monopolies, it can just pay for the research upfront as it did when it paid Moderna to develop a COVID-19 vaccine. (Unfortunately, it also then gave Moderna control over the vaccine, creating at least five Moderna billionaires. Ever wonder why we have so much inequality?)
The government already spends more than $50 billion a year funding biomedical research through the National Institutes of Health and other government agencies. It can triple this sum, thereby replacing patent monopoly-supported research. As a condition of getting the funding, researchers would be required to post all findings on the web as soon as practical and all patents would be placed in the public domain, so that everything could be produced as a cheap generic as soon as it was approved.
This would mean new drugs would be cheap and eliminate the enormous incentive for corruption created by government-granted patent monopolies. But, it would create fewer billionaires, so apparently it is not on anyone’s agenda.
Peter Coy had an interesting column last week on saving money on health care. The piece focused on an interview with James and Robert Rebitzer and discussed ways to reduce the cost of treating patients, especially the cost of prescription drugs.
At the end of the discussion, the piece mentions the idea of buying out patents and then placing them in the public domain so that they can be sold as cheap generics. While this would solve the problem of high drug prices, there is a step further that could be taken.
The government doesn’t have to give out the patent monopoly in the first place. Instead of paying companies to innovate by giving them patent monopolies, it can just pay for the research upfront as it did when it paid Moderna to develop a COVID-19 vaccine. (Unfortunately, it also then gave Moderna control over the vaccine, creating at least five Moderna billionaires. Ever wonder why we have so much inequality?)
The government already spends more than $50 billion a year funding biomedical research through the National Institutes of Health and other government agencies. It can triple this sum, thereby replacing patent monopoly-supported research. As a condition of getting the funding, researchers would be required to post all findings on the web as soon as practical and all patents would be placed in the public domain, so that everything could be produced as a cheap generic as soon as it was approved.
This would mean new drugs would be cheap and eliminate the enormous incentive for corruption created by government-granted patent monopolies. But, it would create fewer billionaires, so apparently it is not on anyone’s agenda.
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There is considerable handwringing over the fact that Elon Musk now controls Twitter and is making ad hoc decisions, based on his unusual political views, as to what posts get amplified and what gets banned. (I was briefly banned last fall, for no obvious reason.)
While many people may not like Musk’s calls on these issues, the real issue is not Musk, the issue is why anyone is allowed to get so much power. Musk’s erratic behavior and fondness for far-right propagandists has chased many people off Twitter (or “X” as he now calls it), but it still has a reach that dwarfs that of even the largest traditional media outlets. This should have caused serious concerns even before Elon Musk took it over.
Unfortunately, people who care about things like rich oligarchs dominating our media tend to be more interested in handwringing than thinking about things that can be done to change the situation. Several years ago, I suggested that repealing the protections given to Internet platforms by Section 230 might be a good route for downsizing Internet giants like Twitter and Facebook. The takeover of Twitter by a right-wing jerk makes me more convinced than ever that this is a worthwhile proposal.
What Section 230 Does
The content of Section 230 of the 1996 Communications Decency Act is straightforward. It says:
“No provider or user of an interactive computer service shall be treated as the publisher or speaker of any information provided by another information content provider.”
This distinguishes a web platform from a newspaper or broadcast outlet, which are treated as publishers and held responsible for third-party content. For example, if a newspaper or television station allows a commentator to write a column or speak on air on a topic, and what they say is defamatory, the newspaper or television station can be sued, not just the commentator.
The same applies to paid ads. If someone takes out an ad in a newspaper or a TV station and makes some outlandish accusation against a politician or a business, the newspaper or TV station is liable for damages, not just the person taking out the ad. In fact, the famous New York Times v. Sullivan case, which set out the higher standards for proving defamation of a public figure, was over an ad run in the Times, not its own content.
The laws on defamation mean that print and broadcast outlets have to vet third-party material or risk being sued. This is a big deal. In fact, the case where Dominion sued Fox, and won $787 million in damages, was based largely on third-party content. Fox repeatedly hosted people who made absurd claims about Dominion’s voting machines.
The logic of holding print and broadcast outlets responsible for third-party content is that they are wholesaling allegations that otherwise might have almost no audience. Sidney Powell standing on a street corner yelling about Dominion voting machines is an irrelevant joke. Sidney Powell speaking to millions of viewers on Fox News about how Dominion stole the election from Donald Trump is a very big deal to both Dominion’s reputation and the country.
It’s also worth mentioning that print and broadcast outlets can profit from carrying defamatory material. If hosting outlandish charges from third-party sources increases circulation or viewership, that means more revenue from advertisers. With a defamatory ad, the benefit for the outlet is even more direct.
Since print and broadcast outlets both make third-party generated defamatory material much more harmful by carrying it, and profit by carrying it, it is reasonable to hold them responsible for the potential damage it causes. However, Section 230 means that this same degree of culpability does not apply to Internet platforms.
Section 230 means that the producers of content can in principle be held responsible for defamatory material, but the Internet platform is not responsible. I am saying “in principle” because many comments on platforms like Twitter are posted anonymously.
It would be difficult for someone who was defamed to even know who the originator of the content was. (A prominent right-wing Twitter commentator, and friend of Elon Musk, posts under the name “Catturd.” If this person defamed someone, they would have to first uncover the identity of Catturd before even initiating a lawsuit.) It is also worth mentioning that platforms’ liability is not affected even if their algorithms work to amplify defamatory content.
The same story applies to third-party ads. If some person, even anonymously, paid Elon Musk or Mark Zuckerberg millions of dollars for a large-scale advertising campaign defaming an individual or company, Section 230 means they just get to pocket the cash, but face no legal risk.
What Section 230 Does Not Do
There is a huge amount of confusion about Section 230. For years, and maybe still, many on the right seemed to think that Section 230 makes it possible for Internet platforms to remove posts for being racist, sexist, homophobic, or other modes of expression of far-right bigots. For this reason, they complained that Section 230 limited their free speech. That is pretty much 180 degrees at odds with reality.
Section 230 simply says that Internet platforms are not liable for defamatory content posted by third parties. Internet platforms have the right to remove offensive right-wing tripe because of the First Amendment, not Section 230. If anything, Section 230 makes it less likely they will remove loony rants from the right.
For example, without Section 230 protection, if some crazy person tweets that George Soros is funding a pedophile ring, Soros could sue Twitter for defamation. However, Section 230 protection means that Soros has no case against Twitter, just the loon who posted the Tweet.
This means that if Section 230 did not exist, Internet platforms like Twitter and Facebook, would have to comb through third-party posts and remove potentially defamatory statements, or risk being sued. For this reason, Section 230 almost certainly made it less likely that right-wing content would be removed.
Applying Defamation Law to Internet Platforms
Many of the people who get hysterical about the idea of repealing Section 230 insist that it would not be possible for Internet platforms to comb through the hundreds of millions of user-generated comments that they post every day. If the argument is that they have to avoid posting them in the first place, they might have a case, but we can restructure the law to accommodate web platforms, just as the law was reshaped to accommodate broadcast outlets.
We can require that, in order to avoid potential liability for defamatory material, platforms promptly remove material after being given notice by the person or entity claiming defamation. There is a model for this already. The Digital Millennial Copyright Act (DMCA) requires that Internet hosts remove infringing material promptly after being given notice in order to avoid being sued for copyright infringement.
The DMCA is problematic, there are many instances where material is removed wrongly by hosts who do not want to risk being sued. Nonetheless, the DMCA does provide a model that shows Internet platforms can in fact manage to cope with take-down requests, in spite of the vast amount of content they host.
Copyright law also provides a special inducement to sue, since it provides for statutory damages in addition to actual damages, which in the vast majority of cases would be trivial. Since the law on defamation does not provide for statutory damages, frivolous removal notices would pose less risk of actually leading to trials and meaningful damages.
There is no doubt that making Internet platforms liable for defamatory statements by third parties will raise their costs, even if they do have the option of protecting themselves by removing material in response to a takedown notice. They would have to hire staff to deal with notices and set up rules for when material would be removed.
They could just go the route of blanket removal of material any time they get a notice. This might be the cheapest route, since it can probably be done largely mechanistically, requiring no review from staff or lawyers. However, this would almost certainly antagonize users, since people using Twitter, Facebook, or other sites would be seriously annoyed if they routinely had their posts removed.
The alternative would be to have some process of review. If challenging material as defamatory became a common practice, this could become costly. Presumably, there would be some staff, with minimal legal training, who could make a preliminary decision on whether something should be removed. In many cases, the alleged defamation would likely be sufficiently trivial or absurd that the complaint could be safely ignored.
However, there could be a substantial number of cases that would require serious review for possibly defamatory material. In these cases, platforms would likely err on the side of removal rather than expose themselves to legal liability. That would be unfortunate, but it is not obvious that it is better than the alternative where someone who is defamed has no recourse against the site that wholesaled the defamatory material.
This is the logic that is applied to print and broadcast outlets. There is not an obvious reason that we should be willing to say that Elon Musk can wholesale defamatory material and profit from it with impunity, but CNN and the NYT cannot.
Exceptions for Sites that Don’t Make Money from Ads or Selling Personal Information
Taking away Section 230 protection would be a big challenge for the Internet giants like Facebook and Twitter, but they could probably deal with the additional costs. For smaller sites, the costs could matter more. As I have argued in the past, we could structure a repeal to give smaller sites an out, we can exempt sites that do not sell ads or personal information.
Millions of smaller Internet hosts would then still enjoy Section 230 protection, for them nothing would change. If they supported themselves through subscriptions or donations, they could continue to operate just as they do now. This would apply even to some large sites. For example, Mastodon, a major competitor with Twitter, with millions of users, supports itself through donations. It would continue to enjoy Section 230 protection.
For many other sites, there would be some adjustments required. Would a site like Glassdoor be able to operate by subscription? How about Yelp or Airbnb?
There are two possibilities here. Many sites would probably have difficulty surviving by marketing themselves as a subscription service. I don’t know how many people would subscribe to a site like Yelp or Glassdoor, and the marketing costs would likely be expensive relative to potential subscription revenue.
However, it is plausible that aggregators could bundle a set of sites, as cable services do now with television channels. This would not require Internet users to take advantage of, or even know about, every site included in a bundle. Presumably, they would choose from aggregators in the same way that they choose now among cable services, selecting ones that included the sites they cared about most.
People will dislike paying for something they used to get free, but this has happened with television. Fifty years ago, almost all television was free. At its peak in 2016, almost 100 million households were paying for cable services. There is no basis for assuming that people would be unwilling to pay a monthly fee for access to Internet sites that they value.
The other route is that sites could assume the liability, but require some sort of waiver from users as a condition of service. For example, Airbnb hosts may be asked to sign a waiver of their right to sue for defamatory postings, subject to some sort of screening procedure by Airbnb. (I am not sure what their current policy is, but I assume they will not allow a racist, sexist, or otherwise offensive comment to stay on their site.)
Some sites may also stop hosting comments to avoid the problem altogether. For example, newspapers may opt not to let readers comment on pieces posted on the web.
There certainly is no guarantee that every site that now survives based on ad revenue or selling personal information would make enough through a subscription service to survive, however if our criterion for a good policy is that it never results in anyone going out of business, we would not be implementing very many policies. The question is whether we would be better off in a world where Internet platforms have similar liability for circulating defamatory material to print and broadcast outlets, or the current one where they can profit from this material with impunity.
Reducing the Power of the Internet Giants
It is hard not to be disgusted by the idea that elected officials have to beg people like Elon Musk or Mark Zuckerberg to act responsibly in removing lies and disinformation from their platforms. At the end of the day, these are private platforms and the rich people who control them can do what they want.
This has always been the case with newspapers and television stations, many of which often pushed pernicious material to advance their political agenda or simply to make money. But, this mattered much less when it was one of many television stations or newspapers. It would be wrong to glorify a golden age of a vigorous freedom-loving media, that never existed. But even the decisions of the largest newspaper or television network did not have as much weight as the decisions on content made by today’s Internet giants. If we can restructure Section 230 in a way that leads to their downsizing and promotes a wide variety of competitors, it will be an enormous victory for democracy.
A repeal of Section 230 can be sliced and diced in a thousand different ways, and the route suggested here may well not be the best. But it is worth having a debate on this topic. Anyone who thinks the current situation is fine, where Elon Musk and Mark Zuckerberg unilaterally decide what tens of millions of people see every day, does not have much understanding of democracy.
I realize handwringing on this topic is much more marketable in major media outlets than proposed solutions, but we should be looking for some nonetheless. We know that intellectuals have a hard time dealing with new ideas, but this is a situation where we desperately need some.
There is considerable handwringing over the fact that Elon Musk now controls Twitter and is making ad hoc decisions, based on his unusual political views, as to what posts get amplified and what gets banned. (I was briefly banned last fall, for no obvious reason.)
While many people may not like Musk’s calls on these issues, the real issue is not Musk, the issue is why anyone is allowed to get so much power. Musk’s erratic behavior and fondness for far-right propagandists has chased many people off Twitter (or “X” as he now calls it), but it still has a reach that dwarfs that of even the largest traditional media outlets. This should have caused serious concerns even before Elon Musk took it over.
Unfortunately, people who care about things like rich oligarchs dominating our media tend to be more interested in handwringing than thinking about things that can be done to change the situation. Several years ago, I suggested that repealing the protections given to Internet platforms by Section 230 might be a good route for downsizing Internet giants like Twitter and Facebook. The takeover of Twitter by a right-wing jerk makes me more convinced than ever that this is a worthwhile proposal.
What Section 230 Does
The content of Section 230 of the 1996 Communications Decency Act is straightforward. It says:
“No provider or user of an interactive computer service shall be treated as the publisher or speaker of any information provided by another information content provider.”
This distinguishes a web platform from a newspaper or broadcast outlet, which are treated as publishers and held responsible for third-party content. For example, if a newspaper or television station allows a commentator to write a column or speak on air on a topic, and what they say is defamatory, the newspaper or television station can be sued, not just the commentator.
The same applies to paid ads. If someone takes out an ad in a newspaper or a TV station and makes some outlandish accusation against a politician or a business, the newspaper or TV station is liable for damages, not just the person taking out the ad. In fact, the famous New York Times v. Sullivan case, which set out the higher standards for proving defamation of a public figure, was over an ad run in the Times, not its own content.
The laws on defamation mean that print and broadcast outlets have to vet third-party material or risk being sued. This is a big deal. In fact, the case where Dominion sued Fox, and won $787 million in damages, was based largely on third-party content. Fox repeatedly hosted people who made absurd claims about Dominion’s voting machines.
The logic of holding print and broadcast outlets responsible for third-party content is that they are wholesaling allegations that otherwise might have almost no audience. Sidney Powell standing on a street corner yelling about Dominion voting machines is an irrelevant joke. Sidney Powell speaking to millions of viewers on Fox News about how Dominion stole the election from Donald Trump is a very big deal to both Dominion’s reputation and the country.
It’s also worth mentioning that print and broadcast outlets can profit from carrying defamatory material. If hosting outlandish charges from third-party sources increases circulation or viewership, that means more revenue from advertisers. With a defamatory ad, the benefit for the outlet is even more direct.
Since print and broadcast outlets both make third-party generated defamatory material much more harmful by carrying it, and profit by carrying it, it is reasonable to hold them responsible for the potential damage it causes. However, Section 230 means that this same degree of culpability does not apply to Internet platforms.
Section 230 means that the producers of content can in principle be held responsible for defamatory material, but the Internet platform is not responsible. I am saying “in principle” because many comments on platforms like Twitter are posted anonymously.
It would be difficult for someone who was defamed to even know who the originator of the content was. (A prominent right-wing Twitter commentator, and friend of Elon Musk, posts under the name “Catturd.” If this person defamed someone, they would have to first uncover the identity of Catturd before even initiating a lawsuit.) It is also worth mentioning that platforms’ liability is not affected even if their algorithms work to amplify defamatory content.
The same story applies to third-party ads. If some person, even anonymously, paid Elon Musk or Mark Zuckerberg millions of dollars for a large-scale advertising campaign defaming an individual or company, Section 230 means they just get to pocket the cash, but face no legal risk.
What Section 230 Does Not Do
There is a huge amount of confusion about Section 230. For years, and maybe still, many on the right seemed to think that Section 230 makes it possible for Internet platforms to remove posts for being racist, sexist, homophobic, or other modes of expression of far-right bigots. For this reason, they complained that Section 230 limited their free speech. That is pretty much 180 degrees at odds with reality.
Section 230 simply says that Internet platforms are not liable for defamatory content posted by third parties. Internet platforms have the right to remove offensive right-wing tripe because of the First Amendment, not Section 230. If anything, Section 230 makes it less likely they will remove loony rants from the right.
For example, without Section 230 protection, if some crazy person tweets that George Soros is funding a pedophile ring, Soros could sue Twitter for defamation. However, Section 230 protection means that Soros has no case against Twitter, just the loon who posted the Tweet.
This means that if Section 230 did not exist, Internet platforms like Twitter and Facebook, would have to comb through third-party posts and remove potentially defamatory statements, or risk being sued. For this reason, Section 230 almost certainly made it less likely that right-wing content would be removed.
Applying Defamation Law to Internet Platforms
Many of the people who get hysterical about the idea of repealing Section 230 insist that it would not be possible for Internet platforms to comb through the hundreds of millions of user-generated comments that they post every day. If the argument is that they have to avoid posting them in the first place, they might have a case, but we can restructure the law to accommodate web platforms, just as the law was reshaped to accommodate broadcast outlets.
We can require that, in order to avoid potential liability for defamatory material, platforms promptly remove material after being given notice by the person or entity claiming defamation. There is a model for this already. The Digital Millennial Copyright Act (DMCA) requires that Internet hosts remove infringing material promptly after being given notice in order to avoid being sued for copyright infringement.
The DMCA is problematic, there are many instances where material is removed wrongly by hosts who do not want to risk being sued. Nonetheless, the DMCA does provide a model that shows Internet platforms can in fact manage to cope with take-down requests, in spite of the vast amount of content they host.
Copyright law also provides a special inducement to sue, since it provides for statutory damages in addition to actual damages, which in the vast majority of cases would be trivial. Since the law on defamation does not provide for statutory damages, frivolous removal notices would pose less risk of actually leading to trials and meaningful damages.
There is no doubt that making Internet platforms liable for defamatory statements by third parties will raise their costs, even if they do have the option of protecting themselves by removing material in response to a takedown notice. They would have to hire staff to deal with notices and set up rules for when material would be removed.
They could just go the route of blanket removal of material any time they get a notice. This might be the cheapest route, since it can probably be done largely mechanistically, requiring no review from staff or lawyers. However, this would almost certainly antagonize users, since people using Twitter, Facebook, or other sites would be seriously annoyed if they routinely had their posts removed.
The alternative would be to have some process of review. If challenging material as defamatory became a common practice, this could become costly. Presumably, there would be some staff, with minimal legal training, who could make a preliminary decision on whether something should be removed. In many cases, the alleged defamation would likely be sufficiently trivial or absurd that the complaint could be safely ignored.
However, there could be a substantial number of cases that would require serious review for possibly defamatory material. In these cases, platforms would likely err on the side of removal rather than expose themselves to legal liability. That would be unfortunate, but it is not obvious that it is better than the alternative where someone who is defamed has no recourse against the site that wholesaled the defamatory material.
This is the logic that is applied to print and broadcast outlets. There is not an obvious reason that we should be willing to say that Elon Musk can wholesale defamatory material and profit from it with impunity, but CNN and the NYT cannot.
Exceptions for Sites that Don’t Make Money from Ads or Selling Personal Information
Taking away Section 230 protection would be a big challenge for the Internet giants like Facebook and Twitter, but they could probably deal with the additional costs. For smaller sites, the costs could matter more. As I have argued in the past, we could structure a repeal to give smaller sites an out, we can exempt sites that do not sell ads or personal information.
Millions of smaller Internet hosts would then still enjoy Section 230 protection, for them nothing would change. If they supported themselves through subscriptions or donations, they could continue to operate just as they do now. This would apply even to some large sites. For example, Mastodon, a major competitor with Twitter, with millions of users, supports itself through donations. It would continue to enjoy Section 230 protection.
For many other sites, there would be some adjustments required. Would a site like Glassdoor be able to operate by subscription? How about Yelp or Airbnb?
There are two possibilities here. Many sites would probably have difficulty surviving by marketing themselves as a subscription service. I don’t know how many people would subscribe to a site like Yelp or Glassdoor, and the marketing costs would likely be expensive relative to potential subscription revenue.
However, it is plausible that aggregators could bundle a set of sites, as cable services do now with television channels. This would not require Internet users to take advantage of, or even know about, every site included in a bundle. Presumably, they would choose from aggregators in the same way that they choose now among cable services, selecting ones that included the sites they cared about most.
People will dislike paying for something they used to get free, but this has happened with television. Fifty years ago, almost all television was free. At its peak in 2016, almost 100 million households were paying for cable services. There is no basis for assuming that people would be unwilling to pay a monthly fee for access to Internet sites that they value.
The other route is that sites could assume the liability, but require some sort of waiver from users as a condition of service. For example, Airbnb hosts may be asked to sign a waiver of their right to sue for defamatory postings, subject to some sort of screening procedure by Airbnb. (I am not sure what their current policy is, but I assume they will not allow a racist, sexist, or otherwise offensive comment to stay on their site.)
Some sites may also stop hosting comments to avoid the problem altogether. For example, newspapers may opt not to let readers comment on pieces posted on the web.
There certainly is no guarantee that every site that now survives based on ad revenue or selling personal information would make enough through a subscription service to survive, however if our criterion for a good policy is that it never results in anyone going out of business, we would not be implementing very many policies. The question is whether we would be better off in a world where Internet platforms have similar liability for circulating defamatory material to print and broadcast outlets, or the current one where they can profit from this material with impunity.
Reducing the Power of the Internet Giants
It is hard not to be disgusted by the idea that elected officials have to beg people like Elon Musk or Mark Zuckerberg to act responsibly in removing lies and disinformation from their platforms. At the end of the day, these are private platforms and the rich people who control them can do what they want.
This has always been the case with newspapers and television stations, many of which often pushed pernicious material to advance their political agenda or simply to make money. But, this mattered much less when it was one of many television stations or newspapers. It would be wrong to glorify a golden age of a vigorous freedom-loving media, that never existed. But even the decisions of the largest newspaper or television network did not have as much weight as the decisions on content made by today’s Internet giants. If we can restructure Section 230 in a way that leads to their downsizing and promotes a wide variety of competitors, it will be an enormous victory for democracy.
A repeal of Section 230 can be sliced and diced in a thousand different ways, and the route suggested here may well not be the best. But it is worth having a debate on this topic. Anyone who thinks the current situation is fine, where Elon Musk and Mark Zuckerberg unilaterally decide what tens of millions of people see every day, does not have much understanding of democracy.
I realize handwringing on this topic is much more marketable in major media outlets than proposed solutions, but we should be looking for some nonetheless. We know that intellectuals have a hard time dealing with new ideas, but this is a situation where we desperately need some.
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Bret Stephens had to be creative to push the “Why are Americans so down on Biden” story in his New York Times column this week. He starts his piece by pointing to a number of positive developments. But then we get the big warning:
“But there’s another explanation: The news isn’t all that good. Americans are unsettled by things that are not always visible in headlines or statistics but are easy enough to see.”
Okay, statistics never capture everything, but what does Stephens have to show us?
“Easy to see is the average price of a dozen eggs: up 38 percent between January 2022 and May of this year.”
Well, that looks like a statistic, but a somewhat dated one. If Stephens had bothered to look at the most recent data from July he would see that egg prices have fallen by 9.3 percent in the last two months, putting egg inflation since the pandemic only slightly higher than nominal wage growth over this period.
He then points to the price increases in chicken, bread, and gas. Only the latter has substantially outpaced wage growth under Biden, largely a result of the recession-depressed gas prices of 2020.
Incredibly, Stephens then tells readers:
“Yet none of these increases make it into what economists call the core rate of inflation, which excludes food and energy. The inflation ordinary people experience in everyday life is not the one the government prefers to highlight.”
This is wrong to the point of being virtually an outright lie. In discussing the impact of inflation on living standards, literally every economist in the country uses a measure of inflation that includes food and energy prices. The core index, which excludes these volatile components, is a useful analytic tool, but no economist would try to say that it is an accurate measure of the inflation people see.
Stephens then turns to crime and general upheaval, at one point saying:
“And news reports of brazen car thefts, which have skyrocketed this year.”
Sounds pretty bad, but the headline of the article to which Stephens linked is “Most violent crime is declining in the US after COVID-19 surge, while car thefts soar.” So, I guess in Stephens’ view people don’t care about the drop in violent crime, they’re just upset about the rise in car thefts.
It’s an interesting view. Oh yeah, and when did violent crime soar? That was in 2020, when Donald Trump was in office.
Anyhow, the NYT is the country’s leading newspaper. If this is the base case one of their conservative columnists can make against Biden, I guess he is doing pretty good.
Bret Stephens had to be creative to push the “Why are Americans so down on Biden” story in his New York Times column this week. He starts his piece by pointing to a number of positive developments. But then we get the big warning:
“But there’s another explanation: The news isn’t all that good. Americans are unsettled by things that are not always visible in headlines or statistics but are easy enough to see.”
Okay, statistics never capture everything, but what does Stephens have to show us?
“Easy to see is the average price of a dozen eggs: up 38 percent between January 2022 and May of this year.”
Well, that looks like a statistic, but a somewhat dated one. If Stephens had bothered to look at the most recent data from July he would see that egg prices have fallen by 9.3 percent in the last two months, putting egg inflation since the pandemic only slightly higher than nominal wage growth over this period.
He then points to the price increases in chicken, bread, and gas. Only the latter has substantially outpaced wage growth under Biden, largely a result of the recession-depressed gas prices of 2020.
Incredibly, Stephens then tells readers:
“Yet none of these increases make it into what economists call the core rate of inflation, which excludes food and energy. The inflation ordinary people experience in everyday life is not the one the government prefers to highlight.”
This is wrong to the point of being virtually an outright lie. In discussing the impact of inflation on living standards, literally every economist in the country uses a measure of inflation that includes food and energy prices. The core index, which excludes these volatile components, is a useful analytic tool, but no economist would try to say that it is an accurate measure of the inflation people see.
Stephens then turns to crime and general upheaval, at one point saying:
“And news reports of brazen car thefts, which have skyrocketed this year.”
Sounds pretty bad, but the headline of the article to which Stephens linked is “Most violent crime is declining in the US after COVID-19 surge, while car thefts soar.” So, I guess in Stephens’ view people don’t care about the drop in violent crime, they’re just upset about the rise in car thefts.
It’s an interesting view. Oh yeah, and when did violent crime soar? That was in 2020, when Donald Trump was in office.
Anyhow, the NYT is the country’s leading newspaper. If this is the base case one of their conservative columnists can make against Biden, I guess he is doing pretty good.
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As everyone learns in Econ 101, and immediately forgets, the purpose of the financial sector is to facilitate transactions and allocate capital. This seems like a simple and obvious point, but you would never know it in most discussions of the financial sector.
The point here is that we need finance for these purposes. We don’t need finance to develop elaborate betting games and complex financial instruments. Financial instruments are only useful when they serve the purpose of better facilitating transactions or improving the allocation of capital.
In this context, an efficient financial sector is a small financial sector. We want to use as few resources as possible to serve its function, just as we want to use as few resources as possible in the trucking industry.
Like finance, transporting goods is hugely important to the economy. But if the number of people and the amount of capital involved in the trucking industry doubled relative to the size of the economy, it would look like we had a very inefficient trucking industry, unless there was some obvious benefit, like radically reduced waste.
For some reason, finance is never talked about this way. That comes to mind in reading this NYT piece on the $700 million spent on legal fees in the bankruptcy cases of major crypto companies. Of course, $700 million is not huge relative to the size of the economy, but it is a lot of money to most of us. It’s equivalent to more than 320,000 food stamp person years, to take something people like to complain about.
Anyhow, when we see this $700 million figure for legal fees, it is worth asking exactly how crypto is helping to facilitate transactions or better allocate capital. Are we more quickly able to pay our monthly bills if we use crypto rather than a credit card with automatic withdrawals from our bank account?
Is crypto better allocating capital? Are there innovative startups that are getting capital with Bitcoin that could not raise money through the traditional financial system?
I’ve heard that the FTX folks did lots of drugs before its collapse wiped out their fortunes. It would probably take a lot of drugs for someone to answer “yes” to these questions. The money that went to the crypto gang has been a huge drain on the rest of the economy.
The $700 million in legal fees is just a tiny tip of the iceberg. The fortunes that many have accrued, in effect peddling nothing, is like counterfeit money that they will use to drive up the price of housing, travel, and anything else that is in limited supply in the economy.
This indictment can be directed at the financial sector more generally, which has exploded relative to the rest of the economy over the last half-century. To be fair, some innovations are real. Direct deposit of paychecks and direct payments of bills provide substantial savings in time. But these have been around for four decades.
The proliferation of derivative instruments and complex trading strategies has made some people very rich, but it does nothing to facilitate transactions or improve the allocation of capital. We waste hundreds of billions of dollars (several thousand dollars per family) supporting our bloated financial system.
A small financial transactions tax, similar to the sales tax most of us pay when we buy food, clothes, and most other items, would do wonders for improving the efficiency of the financial system and raise well over a hundred billion dollars annually. And, it would go far towards reducing inequality by eliminating many of the great fortunes made in finance.
But, there is little interest in this point in major media outlets. We can speculate on the reason, but as I said, the purpose of the financial sector is something that is forgotten immediately after leaving Econ 101.
As everyone learns in Econ 101, and immediately forgets, the purpose of the financial sector is to facilitate transactions and allocate capital. This seems like a simple and obvious point, but you would never know it in most discussions of the financial sector.
The point here is that we need finance for these purposes. We don’t need finance to develop elaborate betting games and complex financial instruments. Financial instruments are only useful when they serve the purpose of better facilitating transactions or improving the allocation of capital.
In this context, an efficient financial sector is a small financial sector. We want to use as few resources as possible to serve its function, just as we want to use as few resources as possible in the trucking industry.
Like finance, transporting goods is hugely important to the economy. But if the number of people and the amount of capital involved in the trucking industry doubled relative to the size of the economy, it would look like we had a very inefficient trucking industry, unless there was some obvious benefit, like radically reduced waste.
For some reason, finance is never talked about this way. That comes to mind in reading this NYT piece on the $700 million spent on legal fees in the bankruptcy cases of major crypto companies. Of course, $700 million is not huge relative to the size of the economy, but it is a lot of money to most of us. It’s equivalent to more than 320,000 food stamp person years, to take something people like to complain about.
Anyhow, when we see this $700 million figure for legal fees, it is worth asking exactly how crypto is helping to facilitate transactions or better allocate capital. Are we more quickly able to pay our monthly bills if we use crypto rather than a credit card with automatic withdrawals from our bank account?
Is crypto better allocating capital? Are there innovative startups that are getting capital with Bitcoin that could not raise money through the traditional financial system?
I’ve heard that the FTX folks did lots of drugs before its collapse wiped out their fortunes. It would probably take a lot of drugs for someone to answer “yes” to these questions. The money that went to the crypto gang has been a huge drain on the rest of the economy.
The $700 million in legal fees is just a tiny tip of the iceberg. The fortunes that many have accrued, in effect peddling nothing, is like counterfeit money that they will use to drive up the price of housing, travel, and anything else that is in limited supply in the economy.
This indictment can be directed at the financial sector more generally, which has exploded relative to the rest of the economy over the last half-century. To be fair, some innovations are real. Direct deposit of paychecks and direct payments of bills provide substantial savings in time. But these have been around for four decades.
The proliferation of derivative instruments and complex trading strategies has made some people very rich, but it does nothing to facilitate transactions or improve the allocation of capital. We waste hundreds of billions of dollars (several thousand dollars per family) supporting our bloated financial system.
A small financial transactions tax, similar to the sales tax most of us pay when we buy food, clothes, and most other items, would do wonders for improving the efficiency of the financial system and raise well over a hundred billion dollars annually. And, it would go far towards reducing inequality by eliminating many of the great fortunes made in finance.
But, there is little interest in this point in major media outlets. We can speculate on the reason, but as I said, the purpose of the financial sector is something that is forgotten immediately after leaving Econ 101.
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We constantly see reports in the media that people are unhappy about the economy and they blame President Biden. I, along with many liberal/left colleagues, have been telling people to shut up and enjoy the good times.
Okay, that is not quite what we have been saying, but we have been saying that the economy looks pretty good by most measures. Given the hit from the pandemic and the disruptions created by the war in Ukraine, it is probably about as good as we have a right to expect.
Anyhow, I want to dig a little deeper into that one since I know many people are quite rightly not satisfied with the economy. They are absolutely right not to be satisfied, but I will share a bit of my thinking.
It’s 1935, Is the Economy Good?
I am not picking 1935 randomly. It was the third year of the first Roosevelt administration, the most transformative presidency since the Civil War. If we were discussing the state of the economy in September of 1935, would we be saying the economy was good?
That’s not easy to say. The unemployment rate was around 20.0 percent at that point. That’s hardly something to celebrate, but it was down from peaks of over 25.0 percent in 1933. The economy was growing at a rate of around 9.0 percent, but GDP was still more than 10 percent below its 1929 level. Millions of people were going hungry and homeless.
The best you could really say was that things were going in the right direction. Roosevelt had started the Civilian Conservation Corps at the beginning of his administration, which gave millions of workers jobs on construction projects in National Parks and other public lands. More recently, he had begun the Works Progress Administration, which undertook an even larger set of public works projects. But these were still only employing a fraction of the people looking for work.
Roosevelt had moved aggressively to stabilize the financial system, ordering a weeklong bank holiday immediately after taking office, during which weak banks were closed. He then arranged for the Federal Reserve to provide effective deposit insurance until the Federal Deposit Insurance Corporation existed the following year. He also established the Securities and Exchange Commission to police Wall Street and prevent many abuses that led to the 1929 stock market crash.
These important policies secured the financial system for many decades, but they didn’t get back the money people had lost due to earlier bank failures. And, at the time, people could not possibly know how well they would succeed.
The Wagner Act, which set up the rules that govern most labor-management relations, had just been signed into law in the summer. While this would provide the basis for a massive unionization drive later in the decade, in 1935, it was too early to fully appreciate its importance.
Congress had also approved the Social Security Act in the summer of 1935. This established the Social Security System that now supports tens of millions of workers and their dependents in retirement and provides insurance in the event of disability or early death. But it would be several years before anyone would receive any benefits. Other key measures — like the Fair Labor Standards Act, which established the federal minimum wage and the 40-hour workweek — would have to wait until Roosevelt’s second term.
Of course, the full menu of New Deal programs is considerably longer, but the point is that people could still find plenty to complain about halfway through the third year of the Roosevelt administration. The country was still in the grips of the Great Depression, and as much as Roosevelt’s policies were turning things around and providing more stability for both the system and individual workers, most people were not likely seeing the benefits yet.
The best that could be said was that they saw a president acting aggressively to do things that were in the interest of ordinary workers. Apparently, that view was widely held, as Roosevelt won re-election in 1936 with more than 60 percent of the vote, carrying all but two small states in the Electoral College.
Joe Biden Is Not Franklin Roosevelt
We all know that, or at least we should know that. Roosevelt was an extraordinarily gifted politician who took over the presidency during a crisis. He also had more than 300 Democratic seats in the House after the 1932 election, as well as 59 seats in a 96-seat Senate. His majorities in both houses actually grew in the 1934 elections, with a nine-seat Senate pick-up giving the Democrats 69 seats in a 96-seat Senate.
That world is different from the Congress President Biden had to deal with. He had literally the barest of majorities in the Senate, with the vote of the vice-president needed on any important piece of legislation passing without Republican support. This meant that his agenda was entirely at the mercy of two center-right Democrats, Joe Manchin and Kyrsten Sinema.
The situation in the House was not much better, with Democrats holding just a four-seat majority. Here also, conservative members were acting as a brake on virtually everything Biden put on the table. And, he lost even this slim majority in the 2022 election, although an additional Senate seat gave him a small amount of extra wiggle room.
But we know that most people don’t follow politics closely. They want to see their lives getting better, and they don’t care that some jerk in the House or Senate is blocking a key piece of legislation.
So, let’s just look at what Biden has delivered. The first and most important item in people’s immediate experience was the American Rescue Plan (ARP), which provided a $1.9 trillion boost to the economy. This guaranteed that we would have a quick recovery, in contrast to the slow painful road back to full employment following the Great Recession.
The unemployment rate, which stood at 6.3 percent when Biden took office, had fallen to 3.9 percent by the end of 2021, and has not gone over 4.0 percent since. This is the longest period where the unemployment rate has been below 4.0 percent in more than half a century.
The specific spending also did much to protect people from the impact of the pandemic. It included $300 a week supplements to people getting unemployment insurance. It enhanced the subsidies in the Affordable Care Act, allowing millions more to get health care insurance. It provided subsidies for child care, and extended a moratorium on evictions, ensuring that people could stay in their home. It also provided substantial funds for health care issues directly related to the pandemic, such as improving ventilation in schools.
In short, the ARP was a really big deal. And it passed with no votes to spare in the Senate and a four-vote margin in the House.
As a result of the ARP, the United States is the only major economy that is largely back to its pre-pandemic growth path. The US also now has the lowest inflation rate of any of the G-7 economies.
In spite of the inflation of 2021 and 2022, real wages for the average worker are higher than they were before the pandemic. And, there have been larger gains for those at the bottom, reversing roughly a quarter of the rise in wage inequality we saw over the last four decades.
People have seen other benefits from the recovery under Biden. There was a massive reshuffling in the labor market in 2021 and 2022 as tens of millions of workers quit jobs they disliked or didn’t pay them enough. As a result, the Conference Board reports that workplace satisfaction is at the highest level in the almost forty years they have conducted their survey.
Tens of millions of people are now working from home, either entirely or partially, saving themselves hundreds of hours a year in commuting time, and thousands of dollars on work-related expenses. These savings in time and money do not show up in our data on real wages.
Roughly 15 million homeowners could refinance their homes, taking advantage of the low mortgage rates we saw before the Fed started raising rates last March. This saved them an average of more than $2,000 a year on interest payments. Homeownership rates also rose under Biden, with larger than average increases for Black, Hispanic, young and moderate-income households.
These are all extraordinarily positive developments for large segments of the population. There is no period since the late 1990s that could even come close to the progress made in the first two and a half years of the Biden administration.
Again, there are plenty of grounds for people being upset about the state of the economy. Tens of millions are still struggling at the edge of poverty. Many pandemic programs under ARP have ended, most notably the childcare subsidies, which will be eliminated this fall. Also, the jump in mortgage rates over the last year and a half has put homeownership out of reach for first-time buyers.
But on the whole, it is pretty hard not to see the overall picture as being overwhelmingly positive, especially considering that Biden had to deal with the disruptions created by multiple waves of COVID-19, as well as Russia’s invasion of Ukraine.
Just as people had plenty of grounds to be unhappy about their circumstances in September of 1935, they have grounds today. But, as in 1935, things are headed in the right direction. And, just as Roosevelt had a longer-term agenda that yielded benefits for many decades to come, Biden also does.
Biden’s Longer-Term Agenda
In addition to the ARP, Biden got three major pieces of legislation through Congress. The first was an infrastructure bill that he managed to pass with a large bi-partisan majority. Apparently, a large number of Republicans couldn’t resist the opportunity to show up at the groundbreakings for roads and bridges, as well as dishing out contracts to campaign contributors in their states and districts. This bill will help to address long-neglected infrastructure needs across the country. It also includes substantial funds that will support a green transition, notably by modernizing the country’s power grid and setting up a system of charging stations for electric cars.
The second piece of legislation Biden got through Congress was the CHIPS Act, which appropriated $280 billion over the next five years (approximately 1.0 percent of the federal budget) for research and support for manufacturing of advanced semiconductors in the United States. A large bi-partisan majority also supported this bill. Part of the story was again Republican politicians wanting to get in on the gravy, but also some jingoistic Cold War sentiment.
The latter has to be grounds for concern for progressives. It probably makes sense in any world to ensure that key components for the economy will be accessible in the event of a conflict with China, and given that Taiwan is our major supplier, this is a real concern. However, insofar as this is part of a process of escalating tensions with China, which could lead to a Cold War-type military buildup, it is definitely bad news. The cost of another Cold War will almost certainly be sacrificing any progressive social agenda, as well as slowing a green transition to a speed that could make it irrelevant.
The money spent on researching advanced chips is almost certainly a positive story from an economic standpoint, although we should be asking more about ownership of this research than seems to be the case now. I’ll get back to this issue in the next section.
While the infrastructure bill and CHIPS Act passed with large bipartisan majorities the Inflation Reduction Act (IRA), passed on a strictly partisan basis. Biden somehow managed to get the support of Joe Manchin on a bill that is jump-starting a green transition.
The IRA includes large subsidies for clean energy and electric cars. As a result, in the relatively short time since its passage, we have seen an explosion in plans for factories producing electric cars and batteries, as well as wind and solar power. While there are many issues with implementation, most notably environmental reviews that create lengthy delays for power plants and transmission lines, we at last seem to be making good progress towards a green transition.
Given the amount of money that industry now has on the line, it is difficult to envision how the transition can be turned back. We are now seeing conservative Republicans stand up for solar energy or electric cars because they mean jobs and tax revenue in their states and districts. The explosion in factory construction related to the green transition is impossible to miss in the GDP data.
The revenue parts of the IRA are also important. The main way it raises revenue is through increased funding of IRS enforcement. For many people, especially rich people, paying taxes has become voluntary. The government is losing hundreds of billions every year because rich people don’t pay the taxes they owe. The increased enforcement capacity created by the IRA will substantially reduce the money lost to tax evasion.
The other revenue raiser in the IRA is a 1.0 percent tax on money paid out to shareholders through share buybacks. As I have written many times, I don’t think buybacks are the horror story that many progressives imagine. It makes little difference whether money is paid out to shareholders as buybacks or dividends. We might prefer they invest the money or raise workers’ wages, but if we completely outlawed buybacks tomorrow, the vast majority of the money would just be paid out as dividends instead. That hardly seems like a great victory.
But there is a reason the buyback tax is a big deal. The corporate income tax is an extremely difficult one for the IRS to collect. The reason is that corporate profits are difficult to monitor. There are all sorts of accounting rules on issues like the treatment of inventories and depreciation, that determine taxable profits. We can’t see corporate profits directly; corporate accountants tell us what corporate profits are. This leaves enormous room for gaming the tax code, which corporations naturally exploit to the fullest extent possible.
However, there is an alternative. We can make returns to shareholders (the money companies pay out in dividends, plus capital gains from the increase in value of their stock price), the basis for the income tax. This has the great advantage that returns to shareholders are completely transparent. We can get this information off any financial website.
It would be possible to calculate the tax liability of all publicly traded companies on a single spreadsheet. Just put up their dividend payouts, the increase in their market capitalization over the course of the year, then plug in the tax rate, and we’ve got it. No muss, no fuss. It’s cheap for the IRS and we can put the whole tax gaming industry out of business.
While I doubt this was the motivation behind the buyback tax, it actually is an important step in this direction. The buyback tax is likely to go down as the most administratively efficient tax ever. We will be able to raise billions of dollars of tax revenue each year, just by monitoring what companies announce they are spending on buybacks. And, we don’t have to worry they will cheat. What will they do, lie to their shareholders?
And, if a tax is cheap to collect, it stands to reason, we would want to increase it at the expense of taxes that are harder to collect, like the current corporate income tax. In short, the buyback tax can be a huge foot in the door towards shifting the basis of the corporate income tax to returns to shareholders.
It’s a long way from a 1.0 percent tax on the portion of profits used to buy back shares, to replacing the corporate income tax, which currently averages around 13 percent of all profits, but this is an incredibly important first step. It will be important to pay attention to the efficiency of the buyback tax which has not so far received much attention.
Administrative Agencies
Before completing the list of Biden administration accomplishments, it is important to mention the impact of the people he has appointed to administrative agencies, most notably the Federal Trade Commission (FTC) and the National Labor Relations Board (NLRB). Starting with the former, Biden appointed Lina Khan, a legal scholar who believes in anti-trust law, to head the commission. Since taking office, Khan has challenged a number of mergers that likely would have gone through without question under prior administrations of both parties.
It is important to realize that the importance of an approach that takes competition seriously cannot be measured simply by Khan’s won-loss record in challenging mergers. (Microsoft won the FTC’s biggest action under Khan, an effort to block its merger with the video game company Activision.) When companies know that there is a competition cop on the beat, they may not even try some mergers that they think might have sailed through under prior administrations. And, they may structure mergers to pose less of a threat to industry competition in order to pass muster under the new regime, as happened to some extent with Microsoft and Activision. With a growing body of evidence showing that a lack of competition has been important in raising profits at the expense of wages, this is a big deal.
The other notable area where Biden’s administrative appointees have made a visible difference is at the NLRB. Biden’s appointees are committed to respecting workers’ rights to have a union, if they want one. They have been markedly more pro-union in their rulings since the current chair, Lauren McFarren took over, but they made a qualitative break with the past boards in a ruling two weeks ago.
The workers at the Cemex building materials company had been involved in an organizing drive. They had already submitted cards, signed by a majority of workers, to get an NLRB supervised election. As is standard practice, Cemex engaged in a number of actions designed to delay the election and intimidate pro-union workers. The union complained that these were unfair practices and violated the National Labor Relations Act.
Past NLRBs have generally responded to such violations with what amounted to a slap on the wrist. They would tell the company to stop doing them. And, if they kept violating the law, the NLRB would tell them again to stop, rinse and repeat. Biden’s NLRB told Cemex that it has a union.
One way that workers can organize is by having a majority of workers sign cards requesting recognition, as happened at Cemex. If the company voluntarily accepts recognition, then the workers have a union. If it doesn’t, then the NLRB holds an election. Biden’s NLRB effectively said that by violating the law, Cemex has now accepted that it has a union.
This is potentially a huge deal, since it will remove one of the major roadblocks to workers seeking to organize. There still is a long way to go on this one. Cemex will contest this in the courts, and who knows where the Republican Supreme Court will end up. There is also a second major roadblock in getting first contracts. Companies routinely treat the legal requirement to negotiate in good faith as a forced weekly meeting to talk about the weather and Superbowl prospects. But this NLRB ruling is a big step forward.
Does Biden Have a Vision?
It’s possible to point to the things that Biden has done as both offering immediate benefits and much more important changes done the road, but does he have a clear vision of a better society down the road? I guess my answer is that I don’t know, and I don’t especially care.
Does Biden see that his share buyback tax can lay the basis for switching the basis for the corporate income tax from profits to returns to shareholders? My guess is that he doesn’t, but when we have clear evidence of the much greater efficiency of this sort of tax, we will be able to move quickly down that road. The Republicans, and many Democrats, will do everything they can to prevent corporations from paying more tax, but when we have them defending pure waste, we are fighting them on favorable turf.
I do worry that the administration does not seem to be attentive to who owns the benefits from government-subsidized research. This issue comes up with both the CHIPS Act and the IRA.
This is a huge deal. While it is standard practice in policy circles to attribute the upward redistribution of the last four decades to technology, that is a lie. It was government policy on technology, in the form of longer and stronger patent and copyright protections, that allowed a relatively small group of capitalists and well-placed workers to get a grossly disproportionate share of the benefits from the technologies developed over this period. As I like to point out, if the government did not threaten to arrest people who made copies of Microsoft software without his permission, Bill Gates would likely still be working for a living. (Yes, I’m talking my book, Rigged [it’s free], see also here and here.)
To take a more recent example, we created at least five Moderna billionaires by paying the company to develop a COVID vaccine and then letting it keep control of its distribution. We should worry about how many more billionaires we will create if the government pays for research on semiconductor technology and various types of green technologies and then hands out patent monopolies to private actors. It will need some huge efforts on the tax and transfer side with the left hand to offset the inequality we are directly creating with the right hand.
While I see little appreciation of this problem in the Biden administration, on the plus side here, he is moving to negotiate drug prices in Medicare. This is hitting one end of the problem. Absurdly, the Biden administration’s efforts to restrain prices is being discussed as an interference with the free market. This is absurd because the big interference with the free market was when the government-granted monopolies or related protections in the first place. It was the government that made drug prices high, Biden is just attempting to limit the damage.
Anyhow, we need to have a more critical view of rules on intellectual products. Biden has not expounded one, but his actions do open the door.
And, this has to be seen as the bigger picture on other issues as well. Progressives were endlessly frustrated with Roosevelt as well. He didn’t openly embrace many of the issues that progressives felt were hugely important. However, he did create a framework that allowed for enormous progress in a wide range of areas.
I would say the same about Biden, but he is doing it in a context where he enjoys a far more tentative majority than Roosevelt faced. And he clearly is not the same sort of charismatic figure as Roosevelt. But all in all, he is doing a damn good job.
We constantly see reports in the media that people are unhappy about the economy and they blame President Biden. I, along with many liberal/left colleagues, have been telling people to shut up and enjoy the good times.
Okay, that is not quite what we have been saying, but we have been saying that the economy looks pretty good by most measures. Given the hit from the pandemic and the disruptions created by the war in Ukraine, it is probably about as good as we have a right to expect.
Anyhow, I want to dig a little deeper into that one since I know many people are quite rightly not satisfied with the economy. They are absolutely right not to be satisfied, but I will share a bit of my thinking.
It’s 1935, Is the Economy Good?
I am not picking 1935 randomly. It was the third year of the first Roosevelt administration, the most transformative presidency since the Civil War. If we were discussing the state of the economy in September of 1935, would we be saying the economy was good?
That’s not easy to say. The unemployment rate was around 20.0 percent at that point. That’s hardly something to celebrate, but it was down from peaks of over 25.0 percent in 1933. The economy was growing at a rate of around 9.0 percent, but GDP was still more than 10 percent below its 1929 level. Millions of people were going hungry and homeless.
The best you could really say was that things were going in the right direction. Roosevelt had started the Civilian Conservation Corps at the beginning of his administration, which gave millions of workers jobs on construction projects in National Parks and other public lands. More recently, he had begun the Works Progress Administration, which undertook an even larger set of public works projects. But these were still only employing a fraction of the people looking for work.
Roosevelt had moved aggressively to stabilize the financial system, ordering a weeklong bank holiday immediately after taking office, during which weak banks were closed. He then arranged for the Federal Reserve to provide effective deposit insurance until the Federal Deposit Insurance Corporation existed the following year. He also established the Securities and Exchange Commission to police Wall Street and prevent many abuses that led to the 1929 stock market crash.
These important policies secured the financial system for many decades, but they didn’t get back the money people had lost due to earlier bank failures. And, at the time, people could not possibly know how well they would succeed.
The Wagner Act, which set up the rules that govern most labor-management relations, had just been signed into law in the summer. While this would provide the basis for a massive unionization drive later in the decade, in 1935, it was too early to fully appreciate its importance.
Congress had also approved the Social Security Act in the summer of 1935. This established the Social Security System that now supports tens of millions of workers and their dependents in retirement and provides insurance in the event of disability or early death. But it would be several years before anyone would receive any benefits. Other key measures — like the Fair Labor Standards Act, which established the federal minimum wage and the 40-hour workweek — would have to wait until Roosevelt’s second term.
Of course, the full menu of New Deal programs is considerably longer, but the point is that people could still find plenty to complain about halfway through the third year of the Roosevelt administration. The country was still in the grips of the Great Depression, and as much as Roosevelt’s policies were turning things around and providing more stability for both the system and individual workers, most people were not likely seeing the benefits yet.
The best that could be said was that they saw a president acting aggressively to do things that were in the interest of ordinary workers. Apparently, that view was widely held, as Roosevelt won re-election in 1936 with more than 60 percent of the vote, carrying all but two small states in the Electoral College.
Joe Biden Is Not Franklin Roosevelt
We all know that, or at least we should know that. Roosevelt was an extraordinarily gifted politician who took over the presidency during a crisis. He also had more than 300 Democratic seats in the House after the 1932 election, as well as 59 seats in a 96-seat Senate. His majorities in both houses actually grew in the 1934 elections, with a nine-seat Senate pick-up giving the Democrats 69 seats in a 96-seat Senate.
That world is different from the Congress President Biden had to deal with. He had literally the barest of majorities in the Senate, with the vote of the vice-president needed on any important piece of legislation passing without Republican support. This meant that his agenda was entirely at the mercy of two center-right Democrats, Joe Manchin and Kyrsten Sinema.
The situation in the House was not much better, with Democrats holding just a four-seat majority. Here also, conservative members were acting as a brake on virtually everything Biden put on the table. And, he lost even this slim majority in the 2022 election, although an additional Senate seat gave him a small amount of extra wiggle room.
But we know that most people don’t follow politics closely. They want to see their lives getting better, and they don’t care that some jerk in the House or Senate is blocking a key piece of legislation.
So, let’s just look at what Biden has delivered. The first and most important item in people’s immediate experience was the American Rescue Plan (ARP), which provided a $1.9 trillion boost to the economy. This guaranteed that we would have a quick recovery, in contrast to the slow painful road back to full employment following the Great Recession.
The unemployment rate, which stood at 6.3 percent when Biden took office, had fallen to 3.9 percent by the end of 2021, and has not gone over 4.0 percent since. This is the longest period where the unemployment rate has been below 4.0 percent in more than half a century.
The specific spending also did much to protect people from the impact of the pandemic. It included $300 a week supplements to people getting unemployment insurance. It enhanced the subsidies in the Affordable Care Act, allowing millions more to get health care insurance. It provided subsidies for child care, and extended a moratorium on evictions, ensuring that people could stay in their home. It also provided substantial funds for health care issues directly related to the pandemic, such as improving ventilation in schools.
In short, the ARP was a really big deal. And it passed with no votes to spare in the Senate and a four-vote margin in the House.
As a result of the ARP, the United States is the only major economy that is largely back to its pre-pandemic growth path. The US also now has the lowest inflation rate of any of the G-7 economies.
In spite of the inflation of 2021 and 2022, real wages for the average worker are higher than they were before the pandemic. And, there have been larger gains for those at the bottom, reversing roughly a quarter of the rise in wage inequality we saw over the last four decades.
People have seen other benefits from the recovery under Biden. There was a massive reshuffling in the labor market in 2021 and 2022 as tens of millions of workers quit jobs they disliked or didn’t pay them enough. As a result, the Conference Board reports that workplace satisfaction is at the highest level in the almost forty years they have conducted their survey.
Tens of millions of people are now working from home, either entirely or partially, saving themselves hundreds of hours a year in commuting time, and thousands of dollars on work-related expenses. These savings in time and money do not show up in our data on real wages.
Roughly 15 million homeowners could refinance their homes, taking advantage of the low mortgage rates we saw before the Fed started raising rates last March. This saved them an average of more than $2,000 a year on interest payments. Homeownership rates also rose under Biden, with larger than average increases for Black, Hispanic, young and moderate-income households.
These are all extraordinarily positive developments for large segments of the population. There is no period since the late 1990s that could even come close to the progress made in the first two and a half years of the Biden administration.
Again, there are plenty of grounds for people being upset about the state of the economy. Tens of millions are still struggling at the edge of poverty. Many pandemic programs under ARP have ended, most notably the childcare subsidies, which will be eliminated this fall. Also, the jump in mortgage rates over the last year and a half has put homeownership out of reach for first-time buyers.
But on the whole, it is pretty hard not to see the overall picture as being overwhelmingly positive, especially considering that Biden had to deal with the disruptions created by multiple waves of COVID-19, as well as Russia’s invasion of Ukraine.
Just as people had plenty of grounds to be unhappy about their circumstances in September of 1935, they have grounds today. But, as in 1935, things are headed in the right direction. And, just as Roosevelt had a longer-term agenda that yielded benefits for many decades to come, Biden also does.
Biden’s Longer-Term Agenda
In addition to the ARP, Biden got three major pieces of legislation through Congress. The first was an infrastructure bill that he managed to pass with a large bi-partisan majority. Apparently, a large number of Republicans couldn’t resist the opportunity to show up at the groundbreakings for roads and bridges, as well as dishing out contracts to campaign contributors in their states and districts. This bill will help to address long-neglected infrastructure needs across the country. It also includes substantial funds that will support a green transition, notably by modernizing the country’s power grid and setting up a system of charging stations for electric cars.
The second piece of legislation Biden got through Congress was the CHIPS Act, which appropriated $280 billion over the next five years (approximately 1.0 percent of the federal budget) for research and support for manufacturing of advanced semiconductors in the United States. A large bi-partisan majority also supported this bill. Part of the story was again Republican politicians wanting to get in on the gravy, but also some jingoistic Cold War sentiment.
The latter has to be grounds for concern for progressives. It probably makes sense in any world to ensure that key components for the economy will be accessible in the event of a conflict with China, and given that Taiwan is our major supplier, this is a real concern. However, insofar as this is part of a process of escalating tensions with China, which could lead to a Cold War-type military buildup, it is definitely bad news. The cost of another Cold War will almost certainly be sacrificing any progressive social agenda, as well as slowing a green transition to a speed that could make it irrelevant.
The money spent on researching advanced chips is almost certainly a positive story from an economic standpoint, although we should be asking more about ownership of this research than seems to be the case now. I’ll get back to this issue in the next section.
While the infrastructure bill and CHIPS Act passed with large bipartisan majorities the Inflation Reduction Act (IRA), passed on a strictly partisan basis. Biden somehow managed to get the support of Joe Manchin on a bill that is jump-starting a green transition.
The IRA includes large subsidies for clean energy and electric cars. As a result, in the relatively short time since its passage, we have seen an explosion in plans for factories producing electric cars and batteries, as well as wind and solar power. While there are many issues with implementation, most notably environmental reviews that create lengthy delays for power plants and transmission lines, we at last seem to be making good progress towards a green transition.
Given the amount of money that industry now has on the line, it is difficult to envision how the transition can be turned back. We are now seeing conservative Republicans stand up for solar energy or electric cars because they mean jobs and tax revenue in their states and districts. The explosion in factory construction related to the green transition is impossible to miss in the GDP data.
The revenue parts of the IRA are also important. The main way it raises revenue is through increased funding of IRS enforcement. For many people, especially rich people, paying taxes has become voluntary. The government is losing hundreds of billions every year because rich people don’t pay the taxes they owe. The increased enforcement capacity created by the IRA will substantially reduce the money lost to tax evasion.
The other revenue raiser in the IRA is a 1.0 percent tax on money paid out to shareholders through share buybacks. As I have written many times, I don’t think buybacks are the horror story that many progressives imagine. It makes little difference whether money is paid out to shareholders as buybacks or dividends. We might prefer they invest the money or raise workers’ wages, but if we completely outlawed buybacks tomorrow, the vast majority of the money would just be paid out as dividends instead. That hardly seems like a great victory.
But there is a reason the buyback tax is a big deal. The corporate income tax is an extremely difficult one for the IRS to collect. The reason is that corporate profits are difficult to monitor. There are all sorts of accounting rules on issues like the treatment of inventories and depreciation, that determine taxable profits. We can’t see corporate profits directly; corporate accountants tell us what corporate profits are. This leaves enormous room for gaming the tax code, which corporations naturally exploit to the fullest extent possible.
However, there is an alternative. We can make returns to shareholders (the money companies pay out in dividends, plus capital gains from the increase in value of their stock price), the basis for the income tax. This has the great advantage that returns to shareholders are completely transparent. We can get this information off any financial website.
It would be possible to calculate the tax liability of all publicly traded companies on a single spreadsheet. Just put up their dividend payouts, the increase in their market capitalization over the course of the year, then plug in the tax rate, and we’ve got it. No muss, no fuss. It’s cheap for the IRS and we can put the whole tax gaming industry out of business.
While I doubt this was the motivation behind the buyback tax, it actually is an important step in this direction. The buyback tax is likely to go down as the most administratively efficient tax ever. We will be able to raise billions of dollars of tax revenue each year, just by monitoring what companies announce they are spending on buybacks. And, we don’t have to worry they will cheat. What will they do, lie to their shareholders?
And, if a tax is cheap to collect, it stands to reason, we would want to increase it at the expense of taxes that are harder to collect, like the current corporate income tax. In short, the buyback tax can be a huge foot in the door towards shifting the basis of the corporate income tax to returns to shareholders.
It’s a long way from a 1.0 percent tax on the portion of profits used to buy back shares, to replacing the corporate income tax, which currently averages around 13 percent of all profits, but this is an incredibly important first step. It will be important to pay attention to the efficiency of the buyback tax which has not so far received much attention.
Administrative Agencies
Before completing the list of Biden administration accomplishments, it is important to mention the impact of the people he has appointed to administrative agencies, most notably the Federal Trade Commission (FTC) and the National Labor Relations Board (NLRB). Starting with the former, Biden appointed Lina Khan, a legal scholar who believes in anti-trust law, to head the commission. Since taking office, Khan has challenged a number of mergers that likely would have gone through without question under prior administrations of both parties.
It is important to realize that the importance of an approach that takes competition seriously cannot be measured simply by Khan’s won-loss record in challenging mergers. (Microsoft won the FTC’s biggest action under Khan, an effort to block its merger with the video game company Activision.) When companies know that there is a competition cop on the beat, they may not even try some mergers that they think might have sailed through under prior administrations. And, they may structure mergers to pose less of a threat to industry competition in order to pass muster under the new regime, as happened to some extent with Microsoft and Activision. With a growing body of evidence showing that a lack of competition has been important in raising profits at the expense of wages, this is a big deal.
The other notable area where Biden’s administrative appointees have made a visible difference is at the NLRB. Biden’s appointees are committed to respecting workers’ rights to have a union, if they want one. They have been markedly more pro-union in their rulings since the current chair, Lauren McFarren took over, but they made a qualitative break with the past boards in a ruling two weeks ago.
The workers at the Cemex building materials company had been involved in an organizing drive. They had already submitted cards, signed by a majority of workers, to get an NLRB supervised election. As is standard practice, Cemex engaged in a number of actions designed to delay the election and intimidate pro-union workers. The union complained that these were unfair practices and violated the National Labor Relations Act.
Past NLRBs have generally responded to such violations with what amounted to a slap on the wrist. They would tell the company to stop doing them. And, if they kept violating the law, the NLRB would tell them again to stop, rinse and repeat. Biden’s NLRB told Cemex that it has a union.
One way that workers can organize is by having a majority of workers sign cards requesting recognition, as happened at Cemex. If the company voluntarily accepts recognition, then the workers have a union. If it doesn’t, then the NLRB holds an election. Biden’s NLRB effectively said that by violating the law, Cemex has now accepted that it has a union.
This is potentially a huge deal, since it will remove one of the major roadblocks to workers seeking to organize. There still is a long way to go on this one. Cemex will contest this in the courts, and who knows where the Republican Supreme Court will end up. There is also a second major roadblock in getting first contracts. Companies routinely treat the legal requirement to negotiate in good faith as a forced weekly meeting to talk about the weather and Superbowl prospects. But this NLRB ruling is a big step forward.
Does Biden Have a Vision?
It’s possible to point to the things that Biden has done as both offering immediate benefits and much more important changes done the road, but does he have a clear vision of a better society down the road? I guess my answer is that I don’t know, and I don’t especially care.
Does Biden see that his share buyback tax can lay the basis for switching the basis for the corporate income tax from profits to returns to shareholders? My guess is that he doesn’t, but when we have clear evidence of the much greater efficiency of this sort of tax, we will be able to move quickly down that road. The Republicans, and many Democrats, will do everything they can to prevent corporations from paying more tax, but when we have them defending pure waste, we are fighting them on favorable turf.
I do worry that the administration does not seem to be attentive to who owns the benefits from government-subsidized research. This issue comes up with both the CHIPS Act and the IRA.
This is a huge deal. While it is standard practice in policy circles to attribute the upward redistribution of the last four decades to technology, that is a lie. It was government policy on technology, in the form of longer and stronger patent and copyright protections, that allowed a relatively small group of capitalists and well-placed workers to get a grossly disproportionate share of the benefits from the technologies developed over this period. As I like to point out, if the government did not threaten to arrest people who made copies of Microsoft software without his permission, Bill Gates would likely still be working for a living. (Yes, I’m talking my book, Rigged [it’s free], see also here and here.)
To take a more recent example, we created at least five Moderna billionaires by paying the company to develop a COVID vaccine and then letting it keep control of its distribution. We should worry about how many more billionaires we will create if the government pays for research on semiconductor technology and various types of green technologies and then hands out patent monopolies to private actors. It will need some huge efforts on the tax and transfer side with the left hand to offset the inequality we are directly creating with the right hand.
While I see little appreciation of this problem in the Biden administration, on the plus side here, he is moving to negotiate drug prices in Medicare. This is hitting one end of the problem. Absurdly, the Biden administration’s efforts to restrain prices is being discussed as an interference with the free market. This is absurd because the big interference with the free market was when the government-granted monopolies or related protections in the first place. It was the government that made drug prices high, Biden is just attempting to limit the damage.
Anyhow, we need to have a more critical view of rules on intellectual products. Biden has not expounded one, but his actions do open the door.
And, this has to be seen as the bigger picture on other issues as well. Progressives were endlessly frustrated with Roosevelt as well. He didn’t openly embrace many of the issues that progressives felt were hugely important. However, he did create a framework that allowed for enormous progress in a wide range of areas.
I would say the same about Biden, but he is doing it in a context where he enjoys a far more tentative majority than Roosevelt faced. And he clearly is not the same sort of charismatic figure as Roosevelt. But all in all, he is doing a damn good job.
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The August jobs numbers were mostly good with one big exception, a 0.3 percentage point rise in the unemployment rate to 3.8 percent. This is still a relatively low rate. Coming out of the Great Recession, many economists argued that the unemployment rate could not get below 5.0 percent without triggering spiraling inflation, so an unemployment rate below 4.0 percent looks pretty good by comparison. In fact, this is our 19th consecutive month with unemployment below 4.0 percent, a record unmatched since the end of the 1960s.
While it’s hard to get too upset about the level of unemployment, a 0.3 pp jump in a single month is disconcerting. However, on closer look, the story may not be that bad. The jump in unemployment was due to a big jump in people in the labor force, not a spike in layoffs.
The labor force reportedly grew by 736,000 in August, which would come to 8.8 million at an annual rate. Needless to say, this did not really happen. There was no event in the world that would have plausibly led to this sort of leap in labor force participation, so we have to recognize that the differences in the household survey data between July and August were largely driven by errors in the data.
If we ignore the July to August change and just compare August levels with prior months, there does not look to be much cause for concern. There were 2,914,000 workers who reported being unemployed in August as a result of losing a job. That is up by almost 300,000 from the July level, but only 14,000 from the June level. In fact, it is actually 46,000 below the May level. Clearly, there is no evidence of a surge in layoffs driving the unemployment rate higher.
The main reason why unemployment is higher than earlier in the year is that more people report being unemployed who are reentrants to the workforce or new entrants. The number of unemployed reentrants in August was 150k above the average for the first seven months of the year, while the number of unemployed new entrants was 80k higher. Insofar as there is a story of higher unemployment in August it is one where the economy is not generating enough jobs to employ all the people entering the workforce.
But, other data don’t square with that story. Most notably, the establishment survey showed the economy generating 187,000 jobs in August. The numbers from the prior two months were revised down, so that the three-month average stood at just 150k, but even this figure implies a considerably faster pace than most projections of potential labor force growth.
The Congressional Budget Office (CBO) puts the potential growth in the labor force at less than 1 million a year over the next three years, which implies a rate of employment growth of less than 90,000 a month. So, if CBO is anywhere close to the mark, 150k jobs a month should be more than enough to keep the unemployment rate from rising. It’s also worth noting that the household survey showed employment rising by 220k in August.
The weekly data on new and continuing unemployment claims are also inconsistent with any appreciable rise in unemployment. The four-week moving average for new unemployment claims stood at 231k for the most recent week, which is lower than its been for most of the last five months. The number of continuing claims stood at 1,692k, the lowest level since the start of February. There is no evidence here of any uptick in the number of people having difficulty finding jobs.
Wage Growth, Productivity, and Inflation
The other big issue of concern with this month’s jobs report was whether there was evidence of faster wage growth, which could trigger a reacceleration of inflation. The news was clearly good on this front. Wage growth slowed modestly, with the three-month annual rate dropping from 4.9 percent in the three months ending in July to 4.5 percent in the three months ending in August.
This is probably still somewhat faster than would be consistent with the Fed’s 2.0 percent inflation target, but not by much. There were several periods in 2018-19 when the rate of wage growth approached 4.0 percent. There also is still some room for the profit share to shrink back to its pre-pandemic level, which means that we could have more rapid wage growth, without seeing it passed on in prices. And, we have even further to go with profit shares if we target the pre-Great Recession shares.
The only serious basis for Fed concern would be if wage growth seemed to accelerating. That is clearly not the case with the data in the Average Hourly Earnings series in the jobs report. Since this was the only wage series that had shown any evidence of acceleration, the Fed should be reasonably comfortable that accelerating wage growth will not reignite inflation.
The other piece of good news on the inflation front is that it seems that the strong productivity growth number we saw in the second quarter will be repeated in the current quarter. The index of aggregate weekly hours rose 0.4 percent in August, but that was after dropping 0.2 percent in July. It is on course to show a gain of 0.3-0.4 percent for the quarter, translating into an annualized rate of 1.2 to 1.6 percent.
GDP to date has come in very strong with the GDPNow model putting growth for the quarter at over 5.0 percent, as of August 31. That will surely come down with data from August and September, but if the quarter’s growth ends up over 3.0 percent, it will translate into another very good productivity number.
These data are erratic and subject to large revisions, but it is always good to have another quarter where productivity goes in the right direction. In any case, it is one more item arguing that the Fed can hold tight on any further rate hikes. All the data suggest that inflation is continuing to slow, with a drop in rental inflation, the biggest single component in the index, a virtual certainty given the slowdown of inflation in marketed units. Inflation may still be above the Fed’s 2.0 percent target by the end of the year, but it should be close enough that the Fed can declare victory.
Recession Fears?
There were many predictions of recession earlier in the year, given the Fed’s extraordinary pace of tightening. While it was certainly reasonable to worry about the impact of these hikes, it was difficult to see the path through which they would cause a recession.
The main channels through which rate hikes led to recessions in the past were a slowing of construction, especially residential construction, and a drop in net exports due to a rise in the value of the dollar. We have seen relatively little impact on either channel to date.
The rise in interest rates has reduced housing starts, which peaked at an annual rate of more than 1.8 million last April, and then fell to less than 1.4 million this spring. However, due to the huge backlog of unfinished homes created by supply chain problems, the number of units under construction is still larger than it was back in March of 2022 when the Fed started its rate hikes.
There is a similar story with non-residential construction. There had already been a big falloff in office and retail construction at the start of the pandemic, so these sectors had little room to fall further. On the other hand, the CHIPS Act and the Inflation Reduction Act provided a huge boost to factory construction. As a result, non-residential construction has been rising rapidly this year. In August, construction added 22,000 jobs.
Rate hikes have also not had the normal effect on the dollar for two reasons. First, the dollar had already risen considerably against other major currencies following the passage of the American Rescue Plan at the start of the Biden administration and then again following the Russian invasion of Ukraine. This meant that the dollar did not have as much room to rise further as would ordinarily be the case.
The other factor was the rise in interest rates by other major central banks. Since all rates were going up more or less together, the higher rates in the U.S. did not have much impact.
Without a rise in the dollar, there was no reason to expect the sort of fall in net exports that might ordinarily follow a sharp rise in interest rates by the Fed. Since there has been no major drop in net exports, there has not been a fall in manufacturing output and employment. The number of jobs in the sector rose by 16,000 in August.
With construction and manufacturing, the two most cyclical sectors in the economy, still adding jobs, it is difficult to see how we can get a recession. This doesn’t mean the Fed’s rate hikes have had no impact on the economy. They brought an end to the refinancing boom that had taken place in 2020-21. This directly had an impact on jobs by reducing employment in the financial sector. Jobs in credit intermediation and related activities are down by almost 70,000 from where it was in March of 2022.
The loss of this source of credit also likely had some impact on slowing consumption, as many people did cash-out refinancing, where they borrowed against their home equity to undertake a major purchase, such as buying a car or remodeling their house. In addition, some of the money people saved from lower interest payments would have gone into consumption.
However, this impact has been fairly limited, as consumption has continued to grow at a healthy pace based on real wage growth. In any case, it’s hard to see a recession in the cards.
Probably the biggest cause for concern would be further problems in the financial sector due to losses that banks have on their books from government bonds and other long-term loans. Write-downs on loans to commercial real estate will also be a problem.
For this reason, it would be great if the Fed could signal that it is at the end of its round of rate hikes. They obviously are concerned about declaring a premature victory in their battle against inflation, after being slow to recognize the problem, but they don’t somehow even the score by making a mistake in the opposite direction.
At the very least, Chair Powell should more explicitly acknowledge the progress made to date, as other FOMC members have done, most notably Raphael Bostic. Anything that can produce a modest reduction in long-term rates will reduce the risk of a financial meltdown that could pose a series problem for the economy next year.
The August jobs numbers were mostly good with one big exception, a 0.3 percentage point rise in the unemployment rate to 3.8 percent. This is still a relatively low rate. Coming out of the Great Recession, many economists argued that the unemployment rate could not get below 5.0 percent without triggering spiraling inflation, so an unemployment rate below 4.0 percent looks pretty good by comparison. In fact, this is our 19th consecutive month with unemployment below 4.0 percent, a record unmatched since the end of the 1960s.
While it’s hard to get too upset about the level of unemployment, a 0.3 pp jump in a single month is disconcerting. However, on closer look, the story may not be that bad. The jump in unemployment was due to a big jump in people in the labor force, not a spike in layoffs.
The labor force reportedly grew by 736,000 in August, which would come to 8.8 million at an annual rate. Needless to say, this did not really happen. There was no event in the world that would have plausibly led to this sort of leap in labor force participation, so we have to recognize that the differences in the household survey data between July and August were largely driven by errors in the data.
If we ignore the July to August change and just compare August levels with prior months, there does not look to be much cause for concern. There were 2,914,000 workers who reported being unemployed in August as a result of losing a job. That is up by almost 300,000 from the July level, but only 14,000 from the June level. In fact, it is actually 46,000 below the May level. Clearly, there is no evidence of a surge in layoffs driving the unemployment rate higher.
The main reason why unemployment is higher than earlier in the year is that more people report being unemployed who are reentrants to the workforce or new entrants. The number of unemployed reentrants in August was 150k above the average for the first seven months of the year, while the number of unemployed new entrants was 80k higher. Insofar as there is a story of higher unemployment in August it is one where the economy is not generating enough jobs to employ all the people entering the workforce.
But, other data don’t square with that story. Most notably, the establishment survey showed the economy generating 187,000 jobs in August. The numbers from the prior two months were revised down, so that the three-month average stood at just 150k, but even this figure implies a considerably faster pace than most projections of potential labor force growth.
The Congressional Budget Office (CBO) puts the potential growth in the labor force at less than 1 million a year over the next three years, which implies a rate of employment growth of less than 90,000 a month. So, if CBO is anywhere close to the mark, 150k jobs a month should be more than enough to keep the unemployment rate from rising. It’s also worth noting that the household survey showed employment rising by 220k in August.
The weekly data on new and continuing unemployment claims are also inconsistent with any appreciable rise in unemployment. The four-week moving average for new unemployment claims stood at 231k for the most recent week, which is lower than its been for most of the last five months. The number of continuing claims stood at 1,692k, the lowest level since the start of February. There is no evidence here of any uptick in the number of people having difficulty finding jobs.
Wage Growth, Productivity, and Inflation
The other big issue of concern with this month’s jobs report was whether there was evidence of faster wage growth, which could trigger a reacceleration of inflation. The news was clearly good on this front. Wage growth slowed modestly, with the three-month annual rate dropping from 4.9 percent in the three months ending in July to 4.5 percent in the three months ending in August.
This is probably still somewhat faster than would be consistent with the Fed’s 2.0 percent inflation target, but not by much. There were several periods in 2018-19 when the rate of wage growth approached 4.0 percent. There also is still some room for the profit share to shrink back to its pre-pandemic level, which means that we could have more rapid wage growth, without seeing it passed on in prices. And, we have even further to go with profit shares if we target the pre-Great Recession shares.
The only serious basis for Fed concern would be if wage growth seemed to accelerating. That is clearly not the case with the data in the Average Hourly Earnings series in the jobs report. Since this was the only wage series that had shown any evidence of acceleration, the Fed should be reasonably comfortable that accelerating wage growth will not reignite inflation.
The other piece of good news on the inflation front is that it seems that the strong productivity growth number we saw in the second quarter will be repeated in the current quarter. The index of aggregate weekly hours rose 0.4 percent in August, but that was after dropping 0.2 percent in July. It is on course to show a gain of 0.3-0.4 percent for the quarter, translating into an annualized rate of 1.2 to 1.6 percent.
GDP to date has come in very strong with the GDPNow model putting growth for the quarter at over 5.0 percent, as of August 31. That will surely come down with data from August and September, but if the quarter’s growth ends up over 3.0 percent, it will translate into another very good productivity number.
These data are erratic and subject to large revisions, but it is always good to have another quarter where productivity goes in the right direction. In any case, it is one more item arguing that the Fed can hold tight on any further rate hikes. All the data suggest that inflation is continuing to slow, with a drop in rental inflation, the biggest single component in the index, a virtual certainty given the slowdown of inflation in marketed units. Inflation may still be above the Fed’s 2.0 percent target by the end of the year, but it should be close enough that the Fed can declare victory.
Recession Fears?
There were many predictions of recession earlier in the year, given the Fed’s extraordinary pace of tightening. While it was certainly reasonable to worry about the impact of these hikes, it was difficult to see the path through which they would cause a recession.
The main channels through which rate hikes led to recessions in the past were a slowing of construction, especially residential construction, and a drop in net exports due to a rise in the value of the dollar. We have seen relatively little impact on either channel to date.
The rise in interest rates has reduced housing starts, which peaked at an annual rate of more than 1.8 million last April, and then fell to less than 1.4 million this spring. However, due to the huge backlog of unfinished homes created by supply chain problems, the number of units under construction is still larger than it was back in March of 2022 when the Fed started its rate hikes.
There is a similar story with non-residential construction. There had already been a big falloff in office and retail construction at the start of the pandemic, so these sectors had little room to fall further. On the other hand, the CHIPS Act and the Inflation Reduction Act provided a huge boost to factory construction. As a result, non-residential construction has been rising rapidly this year. In August, construction added 22,000 jobs.
Rate hikes have also not had the normal effect on the dollar for two reasons. First, the dollar had already risen considerably against other major currencies following the passage of the American Rescue Plan at the start of the Biden administration and then again following the Russian invasion of Ukraine. This meant that the dollar did not have as much room to rise further as would ordinarily be the case.
The other factor was the rise in interest rates by other major central banks. Since all rates were going up more or less together, the higher rates in the U.S. did not have much impact.
Without a rise in the dollar, there was no reason to expect the sort of fall in net exports that might ordinarily follow a sharp rise in interest rates by the Fed. Since there has been no major drop in net exports, there has not been a fall in manufacturing output and employment. The number of jobs in the sector rose by 16,000 in August.
With construction and manufacturing, the two most cyclical sectors in the economy, still adding jobs, it is difficult to see how we can get a recession. This doesn’t mean the Fed’s rate hikes have had no impact on the economy. They brought an end to the refinancing boom that had taken place in 2020-21. This directly had an impact on jobs by reducing employment in the financial sector. Jobs in credit intermediation and related activities are down by almost 70,000 from where it was in March of 2022.
The loss of this source of credit also likely had some impact on slowing consumption, as many people did cash-out refinancing, where they borrowed against their home equity to undertake a major purchase, such as buying a car or remodeling their house. In addition, some of the money people saved from lower interest payments would have gone into consumption.
However, this impact has been fairly limited, as consumption has continued to grow at a healthy pace based on real wage growth. In any case, it’s hard to see a recession in the cards.
Probably the biggest cause for concern would be further problems in the financial sector due to losses that banks have on their books from government bonds and other long-term loans. Write-downs on loans to commercial real estate will also be a problem.
For this reason, it would be great if the Fed could signal that it is at the end of its round of rate hikes. They obviously are concerned about declaring a premature victory in their battle against inflation, after being slow to recognize the problem, but they don’t somehow even the score by making a mistake in the opposite direction.
At the very least, Chair Powell should more explicitly acknowledge the progress made to date, as other FOMC members have done, most notably Raphael Bostic. Anything that can produce a modest reduction in long-term rates will reduce the risk of a financial meltdown that could pose a series problem for the economy next year.
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