Why Is There an Economy?

From Paul Krugman’s blog:

There’s now a lot of talk about the fact that U.S. corporations are sitting on a lot of cash, but not spending it. I don’t find that particularly puzzling: with huge excess capacity, why invest in building even more capacity. But almost everyone seems to agree that if we could somehow get businesses to spend some of that cash, it would create jobs.

Which then raises the question: how can you believe that, and not also believe that if the U.S. government were to borrow some of the cash corporations aren’t spending, and spend it on, say, public works, this would also create jobs? (Brad DeLong has tried to make this argument repeatedly).

I didn’t know that U.S. corporations were sitting on a lot of cash, but this sort of ties in to something Yves Smith and Rob Parenteau wrote for the New York Times a couple of days ago, “Are Profits Hurting Capitalism?” In a nutshell, Smith and Parentau argue that over the past decade and a half corporations have been saving more and investing less in their own businesses. Smith and Parenteau continue,

The reason for all this saving in the United States is that public companies have become obsessed with quarterly earnings. To show short-term profits, they avoid investing in future growth. To develop new products, buy new equipment or expand geographically, an enterprise has to spend money — on marketing research, product design, prototype development, legal expenses associated with patents, lining up contractors and so on.

Rather than incur such expenses, companies increasingly prefer to pay their executives exorbitant bonuses, or issue special dividends to shareholders, or engage in purely financial speculation. But this means they also short-circuit a major driver of economic growth.

Krugman says that the corporations need an incentive to stop sitting on all that idle cash. Krugman discusses the famous exchange between President Lincoln and General McClellan, in which Lincoln asked McClellan if he could borrow his army, since McClellan wasn’t using it. Krugman continues,

We don’t literally have to borrow from the corporations; they’re parking their funds in the money market, and the feds would borrow from that market. But the end result would be to put some of that idle cash to work — and, ultimately, to give the corporations a reason to start investing, too, so that the deficit spending would crowd investment in, not out.

To which Brad DeLong adds,

After all, simply rename the United States government something like: “United States Joint-Stock Corporation” and then if it borrows and spends, or even spends more rapidly, employment goes up. The argument for the ineffectiveness of fiscal policy in all of its forms requires a rigid (or, at least, a completely interest-inelastic) velocity of money and money multiplier. And that means that increases in private desires to spend also have no effect save to raise interest rates–the full Say’s Law.

I had never heard of Say’s Law, so I looked it up. Apparently there are a lot of different “Say’s Laws,” including one that seems to support supply-side economics, but I don’t think that’s what Brad DeLong is talking about here. From what I glean from Wikipedia, Says (18th-19th century economist and businessman) said that what really drives an economy is the exchange of commodities, and that money is just a facilitator. That works for me.

I have long thought that we lose sight of what an economic system is for, which is to enable people to trade with each other for goods and services they need and want without having to do face-to-face negotiation for every little thing. So raw materials and finished goods all move to where they need to be without, say, the shoemaker having to barter directly with the tanner, and what if the tanner already has enough shoes?

Further, as I understand it, Say’s Law says the process of producing and exchanging goods and services will drive an increase in real income to purchase goods and services. That’s the part that gets picked up by supply-siders, but the flaw in supply-side theory is that just cutting taxes on businesses doesn’t necessarily translate into investment into more production of goods and services. As we see from the real world, it’s just as likely to create a class of hyper-rich corporate executives who sit on their money.

I think what Brad DeLong is pointing to here is that a desire for goods and services by itself will not grow an economy. It also suggests that when an economy becomes more about acquiring and hoarding money rather than producing goods and services, it will stagnate.

I thought this was all particularly interesting given the discussion that followed the last post. The righties who joined in continue to believe the private sector can save itself. In theory, I suppose it could. But the private sector is sitting on its hands, and there is no “market based” incentive in sight that might persuade it to do otherwise.

23 thoughts on “Why Is There an Economy?

  1. …that money is just a facilitator.

    Yes, yes, yes!

    When someone says “It’s MY money!”, try asking them to pull out a dollar and show you where their name is on it. Nowhere, of course, or it would be trading lower than Monopoly money. It does say (some form of) “U.S.” on it about a half dozen times. Because it actually does belong to the United States – that’s why it has value. You just get to use it for awhile.

  2. “But the private sector is sitting on its hands…”
    How is it that these Galt’s aren’t endlessly trying to make more and more money? And who knew the Gods of Mammon would sit on their hands?

  3. Hmm, so was money just a facilitator prior to fiat currency? I mean on some level yes, you can’t eat silver coins but capitalism functions on human greed and for a lot of people money is an end in itself. Frankly I think it’s that capitalism is a victim of its own success. Sure you had the Gilded Age rulers who were wealthier relatively speaking than anyone is now, but you also had an age more more dependent on actual construction of things rather than low cost virtual/electronic abstractions. So this might be a product of an age that actually requires little investment in concrete things to generate massive profits.

    Anyhow apparently DeLong despises “Shock Doctrine” so he remains puzzled as to why his suggestions are simply ignored.

    • Hmm, so was money just a facilitator prior to fiat currency?

      Ultimately, any form of currency has value only because of what it can buy. Even pure gold has no intrinsic monetary value except what human civilization somehow agrees to give it. Ultimately, the purpose of any financial system is to facilitate the exchange of goods and services, but people lose sight of that easily and get fixated on money as if it had intrinsic value. And when everybody thinks it has intrinsic value, it has value. It’s sort of like a mass hallucination, but if everyone in the system buys into it, that’s how it is.

  4. “There’s now a lot of talk about the fact that U.S. corporations are sitting on a lot of cash, but not spending it”

    My personal experience would say sure they are. I work for a large multi-national diversified manuf. auto, truck parts, high end industrial and commercial electrical equipment. We have not been hiring for 2 years (except my dept.) and we have also had our company match for our 401K taken away, all of the staff (salaried engineers, management, professional types) have had to take 4 weeks of mandatory unpaid leave per year since July 2008, no raises since July 2008, etc. I don’t complain too much, I know many have it a lot worse, My point is my company is flush with cash, we have to be our sales have been consistent (thanks to the stim we got quite a bit of work) but management is still not hiring, we still have travel restrictions and all the austerity measures are still in place. My opinion is the leaders of corporate America (the chamber of commerce crowd, business roundtable) want the Dems out of control from at least one of the legislative bodies. Having the Dems in control makes them nervous and they know the republicant’s are too god dam stupid to get elected on merit so if the economy falters some more then all those brain dead “independents” will vote the losers back in? That plus the fact that we still have 600 trillion dollars worth of synthetic derivative investments floating around, 600 trillion that’s 10 times the entire worlds GDP, that could be a problem?

  5. I just presented a workshop in the US Social Forum on mindful economics and system change. One of the questions for contemplation was ‘is fiat currency a private commodity, a public service or something more?’

    Also do we take time to ponder the little note in our dollar bill which says “this is a legal tender for all public and private DEBT?” Who is left out in this picture?

    • Also do we take time to ponder the little note in our dollar bill which says “this is a legal tender for all public and private DEBT?” Who is left out in this picture?

      I’m puzzled as to why you think there’s something significant about that wording. All it means is that the currency is recognized by law as a valid form of payment to anyone to whom you owe money.

  6. My company hasn’t been laying people off; their cutbacks have been rather silly in nature (cheap flimsy office supplies as opposed to quality that lasts longer, for instance). A few months ago they announced the purchase of three adjacent office buildings, to own a full-block square where they’ll build a spanking new HQ. No sign as to when construction will start, but to me it means they have (or had) a small mountain of capital growing for some time. Maybe now is a better time to start building than, say, 2007 was? I don’t know; I just ponder.

    • Regarding cheap companies — years ago I worked for a publishing division of Paramount, and as employees we were forever being told business was bad so they had to freeze our salaries and raise our medical benefits deductible, so sorry. But as shareholders (through the company 401K plan) we’d get messages about how great everything was. Once while we were going through a wage freeze the company announced it had too much cash sitting around not being used, so it bought a bunch of amusement parks. I realize that was a different division, but still … Another time the company had a hit film, and the CEO bought new $100,000 cars for the stars of the film. Shortly after that some wit with access to a fax in company headquarters sent all Paramount offices a fax saying that because we were appreciated so much, this same CEO would be buying us us all plastic replica hood ornaments.

  7. It appears that St. ronnies trickle down economy is not working. The rich and big corporations have made a lot of money, but they are not letting any money trickle down. They are sitting on it, Waiting for what?

  8. The righties who joined in continue to believe the private sector can save itself.

    Oh, it can save itself, all right.

    It just isn’t going to lift a finger to help the rest of us.

  9. Non-democratic concentrations of power suck because of the way those power games are played and who they reward.

    Such a simple concept, yet such a difficult one for tribalistic wingnuts to grasp. The best I ever got from any conservative was that all education must include strict morality and lessons about principles. Yet even that guy had real trouble picking out and condemning the obviously gamey and sociopathic “leaders” from amongst the conservative fold.

  10. In my college days I used to have a poster on my bedroom wall: “Is Your Washroom Breeding Bolsheviks?” Maybe you’ve seen it… a vintage paper-products ad depicting a snarling man as he wipes his hands on harsh, brown paper towels. Soft white paper towels are the answer to worker dissatisfaction!

  11. It depends on the economic system, maha. Capitalism is a system based on accruing capital, as much as possible, as close to the ‘poison’ line as possible. And it is also true that capitalism ‘runs’ on making things. The former is, according to capitalists, practiced in this country. It is the latter which has been disappearing for years.

    Even to the level of the absurd. For years, large corporations (which can afford to) have been buying new and innovative technology not to put it to use but to bury it. Why so, a sane person might ask. Because to put the new technology to use would mean actually investing in your corporation? Possibly. Because to make sure that the inventor of the technology doesn’t market it, i.e. compete with you for that market? Probably. Either way, the practices are a potential death blow to capitalism.

  12. In 20 years, the history books will call this the 2nd depression. We are in a liquidity trap, according to Paul Krugman. That’s central.

    “The term liquidity trap is used in Keynesian economics to refer to a situation where monetary policy is unable to stimulate an economy, either through lowering interest rates or increasing the money supply.”

    Modest inflation in our economy is normal and healthy. Inflation means that – relative to goods – your money will be worth LESS tomorrow than it is today. To a capitalist, there’s incentive to MOVE money because hoarded money is shrinkng money. Normally – not now.

    We are in a deflationay mode – the opposite condition. Money hoarded today will buy MORE widgets tomorrow than they did today. Even at 0% your money is growing, while the *stuff* you could invest in might be worth less in the future.

    The overall economy is shrinking. Business has cut back and laid off, so fewer people have money, which causes sales to slump, which causes businesses to lay off and pull back even more. Which feeds a downward spiral.

    Which brings us back to the ‘liquidity trap’. In a normal economy, the Fed uses the twin controls of interest rates and money supply to hype the economy, but those controls are flat against the peg. Money that would ordinarily be spent or invested is being hoarded almost as fast as it can be put in circulation.

    How do we get out? In economic terms, it’s obvious. You put large amounts of money in the hands of people who will spend it all – namely the unemployed and the poor. You increase consumption. You’re baiting capitalists into increasing production (and hiring). Second, you penalize businesses and individuals for ‘hoarding’ large amounds of capital, and provide economic incentives (tax breaks) for investing in funds that will ‘work’ that capital – and create jobs.

    The problem is that most people prefer a root canal without anesthesia to thinking about economics. What needs to be done would be spun by the GOP as open socialism despite the fact it’s intent & result would be to preserve the free market system and restore a healthy economy quickly. But I see no way to ‘sell’ the solution to an electorate who won’t think.

  13. Well, the ranks of the unemployed just went down:
    Lebron James signed with Miami! Yeah! The rest of the country can now rest easy…
    Me? I could give a flying whoop-de-damn-do.

    Doug, maybe if Lebron, and Michael Jordan were to explain how having a good point guard who distributes the ball means points for everyone, which means the team wins, whereas having one who hogs the ball for himself keeps the score low, and the team loses.

  14. Doug Hughes – great post. So simple, so clear, so logical, so matter-of-fact – and all those ‘so’s’, of course mean that the majority of economists would never dare admit to its efficacy. (They pride themselves on the high level of obfuscation contained by their theories all in the hopes that we’ll think economics is a science.)

    Deflation is far more lethal to an economy than inflation. You wrote of incentives and decentives, any ideas on how to make the “poor and unemployed” consume when they know that if they wait a while the prices of what they consume will drop?

  15. “any ideas on how to make the “poor and unemployed” consume when they know that if they wait a while the prices of what they consume will drop?”

    Yes – put money in their hands. They aren’t comparison shopping like the middle class. They have to eat so they buy food. If they are sleeping on the floor, they want a mattess and frame so they don’t have to share the floor with the roaches. They will buy clothes and all the consumable items that keep the economy moving. They might buy a TV and/or DVD player eventually, but the people I am thinking about are not in the market for a 54 inch plasma TV.

  16. The Says Law which I believe Brad Delong was referring to was the one which Keynes was reputed to have refuted, namely the idea that supply creates its own demand. This was associated with the classic theory of interest, which held that interest was the price paid for saving and investment, and penny saved was a penny invested which translated directly into jobs, employment and consumption. Classic economics before Keynes had held that any economic system was self-regulating and self-correcting, a belief which in the Great Depression was manifestly untrue to everyone but the economists and Herbert Hoover who scolded that “prosperity was just around the corner”. Keynes explained why that was not true and why equilibrium could be achieved at many levels not corresponding to full employment. Say’s law was logically untrue.

    On Paul Krugman: I’m reading his “Return to Depression Economics” and I realize he believes a lot of the crises in the past thirty years have been liquidity crises, but I got the sense lately that he believes the financial meltdown and the collapse of housing prices are not a liquidity crises but something else. I know Atrios says that and has been quite critical of government bailout efforts to prop up the banks without doing anything for the mortgagors. I understood he and Krugman were in agreement on this. Maybe I’m mistaken.

  17. David Sirota has an interesting piece in Salon, making the case that our low tax rates are the root cause of our tanking economy. 

    “Brazil has the highest tax-to-GDP rate in the Western hemisphere,” she pointed out. “And guess what? It’s growing like crazy. The rich are getting richer, but they are pulling people out of poverty.”

    This makes perfect sense. Though the Reagan zeitgeist created the illusion that taxes stunt economic growth, the numbers prove that higher marginal tax rates generate more resources for the job-creating, wage-generating public investments (roads, bridges, broadband, etc.) that sustain an economy. They also create economic incentives for economy-sustaining capital investment. Indeed, the easiest way wealthy business owners can avoid high-bracket tax rates is by plowing their profits back into their businesses and taking the corresponding write-off rather than simply pocketing the excess cash and paying an IRS levy.

    He states that the US economy boomed in the 1960’s when the highest marginal rate was over 90%.

    The whole thing is worth a read.

  18. That makes sense to me, Dave, because without some mechanism to force rich people to invest in the economy, they won’t or they’ll speculate with the unused funds. People forget that high tax rates usually have compensating deductions for worthwhile ( but sometimes wasteful) investments.

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