"ZMP" stands for "Zero Marginal Product". It should really stand for "Zero Value Marginal Product". Can an additional worker produce no additional goods of any value? Is that why they are unemployed? Yes, but.
There are three types of ZMP. Two of them are based on two different types of coordination failure. The disagreement between macroeconomists is on what type of coordination failure is causing the ZMP of unemployed workers.
ZMP1. No coordination failure.
It is possible that some potential workers, perhaps because of severe disabilities, simply cannot produce anything useful, even in a perfectly functioning economy. Even the mythical central planner, who could allocate resources perfectly, wouldn't be able to think of anything useful they could work at, and would leave them idle. They have a Zero Value Marginal Product. There's no coordination failure. The problem simply can't be solved, given existing technology, tastes, and resources.
Nobody (I think) is talking about ZMP1.
ZMP2. Coordination failure 1. (Patterns of Sustainable Specialisation and Trade). (Thanks David and Wonks Anonymous).
The unemployed plumber wants his house re-wired. The unemployed electrician wants his pipes replaced. But the plumber doesn't know that there's an electrician in town; and the electrician doesn't know that there's a plumber in town. Given the current state of knowledge, both workers have Zero Value Marginal Product. Nobody is willing to pay for their labour. They would be willing to pay, if they knew of each other's existence, but they don't. The mythical central planner, who knows everything that anybody knows, would sort this one out immediately. All he has to do is introduce the plumber and the electrician, and both jobs are done.
Arnold Kling, I think (I'm not sure if I am representing his view correctly), is talking about ZMP2. (Of course, I have drastically oversimplified the coordination problem, just so we can understand it simply. In the real world it is much more complicated, and a real world entrepreneur might have to bring together many more people to interact in complex ways to resolve the coordination problem.)
There's an excess supply of plumbers' and electricians' services, and an excess demand for plumbers' and electricians' services, all at the same time. Both want to sell more of their own labour, and buy more of the other's labour.
ZMP3. Coordination failure 2. (Monetary Disequilibrium).
The unemployed hairdresser wants her nails done. The unemployed manicurist wants a massage. The unemployed masseuse wants a haircut. The hairdresser knows where the manicurist can be found. The manicurist knows where the masseuse can be found. The masseuse knows where the hairdresser can be found. But all three women are short of money, and won't spend any until after she earns some. Given the unwillingness of each to spend money, each of the three has a Zero Value Marginal Product. Nobody is willing to pay for their labour.
This one's a bit trickier for the mythical central planner to solve. Introductions alone won't do the trick. Each woman already knows where to find the service she wants. That's not the problem.
The central planner could simply order them all to provide the desired service, for no cash. That would make all three women better off. But if the central planner is mythical, and can only give mythical orders, that won't work.
He could try to get all three women together, and try for a three-way barter deal. But it's hard to cut someone's hair while your customer is giving a massage and you are having a manicure. Who's going to go first, and how will she know the other two won't break the chain?
The easiest solution is for the central planner to print more money and give each of the three women enough so they buy what they want.
ZMP3 is what the rest of us Monetarists and Keynesians (quasi or otherwise) are talking about.
There's an excess supply of each woman's labour. Each one wants to sell her labour and can't. In one sense (in Robert Clower's sense) there's also an excess notional demand for each woman's labour, because each woman would like to buy labour from one of the others. But she would only actually buy it if she could sell her own labour, and she can't. So there's no excess constrained or effective demand for labour.
Worthwhile Canadian Initiative 
Nice post! ZMP2 and 3 differ in two ways: three people instead of two, and services that can’t be rendered simultaneously. The first difference suggests a need for a medium of exchange; the second a store of value. Did you mean to invoke both of these properties of money or just one?
Thanks K! I hadn’t thought about the store of value angle. I was concentrating on the medium of exchange. And I wanted to explain why a three-way barter deal couldn’t happen.
In practice, almost any medium of exchange has to always be a store of value to some extent. Because there’s almost always a time gap between selling something and buying something else, however short.
I think Arnold’s is more entrepreneurial/technological. The electrician and plumber would like a new gizmo, but it doesn’t exist and there is nothing else they want. Wannabe gizmo producer wants both electrician and plumber services, but has to create his gizmo first before he has anything to trade. Half of his unemployment is voluntary.
Lord: that wasn’t how I interpreted Arnold. I interpret him as saying that it might be a new good. Or it might just be a re-arrangement of the way in which we produce existing goods.
I expect we will have to wait until Arnold responds, if he does. The big difficulty with capturing his vision though, is that we want a simple story so we can understand it, but if it really were that simple, a real-world entrepreneur would figure it out immediately.
(I wish I could remember what “PSST” stands for. Patterns of Sustainable something and Trade?)
Specialization
Courtesy of my friend SD, a description of how to solve the ZMP3 problem.
It is a slow day in a damp little Irish town.
The rain is beating down and the streets are deserted. Times are tough,
everybody is in debt, and everybody lives on credit. On this particular day
a rich German tourist is driving through the town, stops at the local hotel
and lays a EUR100 note on the desk, telling the hotel owner he wants to
inspect the rooms upstairs in order to pick one to spend the night. The
owner gives him some keys and, as soon as the visitor has walked upstairs,
the hotelier grabs the EUR100 note and runs next door to pay his debt to the
butcher. The butcher takes the EUR100 note and runs down the street to repay
his debt to the pig farmer. The pig farmer takes the EUR100 note and heads
off to pay his bill at the supplier of feed and fuel. The guy at the
Farmers’ Co-op takes the EUR100 note and runs to pay his drinks bill at the
pub. The publican slips the money along to the local prostitute drinking at
the bar, who has also been facing hard times and has had to offer him
“services” on credit. The hooker then rushes to the hotel and pays off her
room bill to the hotel owner with the EUR100 note. The hotel proprietor then
places the EUR100 note back on the counter so the rich traveller will not
suspect anything. At that moment the traveller comes down the stairs, picks
up the EUR100 note, states that the rooms are not satisfactory, pockets the
money, and leaves town. No one produced anything. No one earned anything.
However, the whole town is now out of debt and looking to the future with a
lot more optimism.
And that,
Ladies and Gentlemen, is how the bailout package works
And now back to the research report that I’m supposed to have a draft of by Friday…
“patterns of sustainable specialization and trade”
I personally think Kling is engaging in evidence-free bloviating inspired by bitterness about the economics profession. If he wants to dethrone Friedman’s (or even Rothbard’s!) take on the Great Depression he’ll need more than simply announcing his desire that people adopt his paradigm.
Specialization and Trade. It could be a new meal/dining experience which might take less time to create but more to perfect and become known and popular. And in his it is the affluent/educated that are jaded and the poor/uneducated that have nothing to offer, and the affluent are waiting on each other to create these for each other and the many are idle unless and until one of these opportunities arrive. Apparently the affluent/educated don’t see many opportunities or they would be busy creating them rather than taking leisure (which is a bit of a misnomer since American leisure is generally quite costly.)
Thanks David and Wonks! Post updated, and link added.
Frances: that is a lovely story, and illustrates the monetary disequilibrium view perfectly. It’s been doing the rounds, told about various countries. I think I first heard it from Michael Francis. It was set in Australia when I first heard it. It works very well for this post. It’s a variant of ZMP3, except: in your story, the trades have already taken place, based on trade credit. So there’s debt, but no unemployment. In my story there’s unemployment, but no debt.
Trade credit/debt sometimes has the same Wicksellian(? Damn, is that right?) triangle that the story of lack of coincidence of wants has for monetary exchange.
“The easiest solution is for the central planner to print more money and give each of the three women enough so they buy what they want.”
Yes. But central banks do not print money and give it away. They print money and sell it for cash-equivalents, at market prices. Therefore apart from changing the market prices between cash and cash-equivalents, central banks are unable to fix this problem.
Fiscal policy is when you “give money away”.
And it’s the giving away part that is key.
Fiscal policy is what changes net-worth, whereas portfolio shifts do not change directly change net-worth. They can only hope to change net-worth indirectly, by encouraging more people to borrow and spend at the (lower) rates, resulting in an increase in the net-worth of those who sell to them. But if everyone wants to be the saver and no one wants to be the dissaver, then these enticements stop working. And that’s the only tool in the monetarist’s toolbox.
“ZMP3 is what the rest of us Monetarists and Keynesians (quasi or otherwise) are talking about.”
No, it is not.
I wish you were talking about giving money away — about fiscal policy.
But you are instead arguing against the effectiveness of giving money away, and for the effectiveness of selling cash, at market prices, for cash equivalents.
And frankly, this blurring of the non-financial sector with the financial sector, the blurring of monetary policy with fiscal policy, and the blurring of currency with reserves, is frustrating.
From a bird’s eye view, we are all in agreement with the problem, but when it comes to policy implementation, and the hordes come begging for more money to increase their net-worth, you don’t supply it.
You only sell them the money for cash-equivalents, whereas what they want is to sell their labor for money, not their money for money. And not seeing the distinction means that when push comes to shove, the monetarists and quasi-monetarists oppose any helpful solution to the problem.
Isn’t there something missing here in this account. Imagine that a process requires input from two different specialists, and I have 1 of type A but not one of type B. Then the marginal product of type A is zero.
Reason: would that not constitute structural, rather than cyclical unemployment? That is really a kind of ZMP1 – the sort that “nobody is talking about.”
RSJ: what you said.
Nick: Arnold would include the case that person ‘A’ doesn’t know if he should be a plumber or electrician. The uncertainty of what the market will bear means his risk premium isn’t meet, and thus he neither becomes a plumber or a electrician but rather is waiting to figure it out.
Why is person ‘A’ not doing what he used to do? That information is ‘known’. Demand in that particular industry has collapsed.
RSJ: In my ZMP3 example here, the money is given away. It’s both fiscal and monetary policy. There’s a trasnsfer payment (negative tax) so it’s fiscal policy. And the money supply increases, so it’s monetary policy. (Yes, I know that MMTers define monetary and fiscal policy differently, and that according to their definition, helicopter money is fiscal policy only, but most economists don’t use the MMT definitions. And no, let’s not argue that point here.) Now, some monetarists and some keynesians argue about the relative effectiveness of fiscal vs monetary policy. But since this post is not about monetarism vs keynesianism, but about AD vs PSST theories, my example works well because it uses a policy that is both fiscal and monetary.
reason: the joint production, fixed coefficients case. Y=min{L,N), where the derivative is discontinuous. No worries. We combine the inputs into teams, and instead talk about the joint marginal product of the team. I see that as an example that would fit better with ZMP2 and the PSST type of coordination failure. Each worker has ZMP as an individual, but when the entrepreneur introduces them and joins them together into a team, their joint MP is now positive.
Off topic, but I can’t resist.
In certain complex design situations (software development being the big one) it is possible to have team members with negative productivity. They make so many mistakes that cost the others on the team time to fix that the team would be better off without them. Management with good clues about software production are scarce, so there are more of these situations than one might expect. In particular, this is very likely to happen in software bubbles. I suspect that it happens in other bubbles as well, but in simpler situations the management can tell what is happening and can fix it quickly.
Return to topic.
You’re forgiven Jim. That was interesting. And only slightly off-topic. Hmmm. In fact, your point here is just an extreme example of a more general problem. The people who hire others don’t know what their MP is in the job. But they must expect it’s positive, otherwise they wouldn’t hire them. But they could easily be wrong. Wherever I say “ZMP”, replaced it with “expected ZMP”?
Frances:
Your story is nice, but since the hotel keeper stole the money and then gave it back, the books won’t add up in the end. With fiscal policy the books will add up because a businessman will have unquestioned and legitimate entries in both sides of her ledger. The ledger won’t add up with the Hot Euro Note Solution.
Unless you regard taxation as theft. In which case this is a political argument, not an economic one.
Nick:
Your ZMP3 ladies seem to have created their own Prisoner’s Dilemma. A store of value isn’t a complete solution here because nobody can decide who will get paid first. So there is still a problem.
Though to be fair ZMP3 feels very much like the problem we are having now. I remember when a Trent Prof, Torben Drewes presented a graph of the broad money supply to a community group, attempting to explain the recession (then at an early stage). Everything was fine and consistent until the crisis when all the monetary measures, particularly M2 and above went haywire. I thought then that nothing good could come of that.
I’m not sure about the books not adding up, the the Hot 100 Euro isn’t making anyone any richer, just doing the usual facilitation. Everyone in the chain paid a 100$ debt and lost a 100$ asset as the debt to them was repaid. No-one is working any more or earning anything extra.
You could be saying that adding money to the system would help clear up an imbalance between “want/time/ability to work” (assets) and “lack of work” (debts). If so it seems like the key point is putting the money in, letting it do its magic and taking the money back out again. Which is a different solution than just adding it.
“The easiest solution is for the central planner to print more money and give each of the three women enough so they buy what they want.”
At what cost, and to whom? Unless you believe in free lunches…
Determinant: In Frances’ problem, each person has an equal asset and liability. But they can’t be canceled out in any sequence of pairwise cancelings. Just as there are no pairwise trades that my three women can do. That’s why you need a medium of exchange, to solve the coordination problem. It is a (variant on) prisoners’ dilemma. But it’s not a store of value that solves the problem; it’s a medium of exchange. Something that’s generally acceptable to all as payment.
Doug: if you take the money out next period, then the original problem re-appears. You have to put the money in, and leave it in (unless something else changes).
Dave: the cost is paper and ink. I always like what Arthur Laffer said about free lunches. “Of course there are free lunches; and it’s our job as economists to find them and eat them!” In other words, if you believe the economy is not working efficiently, and a change in policy can improve it, we should do that. It creates a free lunch. (Well, normally it’s just the benefits exceed the costs, but in this case the cost of paper and ink is trivial. That does not of course mean that printing money will solve all problems. And you can print too much.
Frances problem is that nobody actually gained 100 Euros. You can’t solve economic problems with the theft that occurred in this scenario, mostly because we can’t steal like that in the real world. Unless you actually want to commit fraud and/or theft.
The theft creates a mathematical and accounting inconsistency, which affects behaviour because you’ll act that you have to give it back. Nice story, but not a theory.
I’m all for printing money. We have this post every month or so it seems. The problem is always the same: the inflationistas will scream like it’s 1979. Now I’m all for screaming inflationistas and I think they really, really need to recognize that we have come full-circle on inflation and interest rates but they’ll trot out the same old arguments that Keynes was an idiot and Hayek a genius and Friedman will arise from his grave and kick the Fed in the rear end and the surest way to bring a capitalist economy is to debase its currency according to the Thrice-Accursed Lenin.
Can’t we have something new?
Determinant: a central clearing house does exactly the same thing that the 100 Euro note does in Frances’ story. It looks for circles of debits/credits, and cancels them out, leaving just the remainder. I read it as a parable. Money is just a decentralised version of a central clearing house.
On the inflationistas: sometimes I think it’s a generational thing. We have the memories of our formative years, and they stay with us till we die, and a new generation replaces us, with it’s own salient memories. Like generals always fighting the last war, except we go in circles.
I’ve been saying that about the inflationistas for a while now. Good to see that I’ve brought you on board.
Determinant: I might indeed have gotten the idea from you. My memory is too hazy to say.
Determinant: the tourist willingly laid down the cash, presumably as a security or deposit while he had the keys. He essentially paid the hotel owner to carry the risk (of theft) for giving him the keys to the room; the price was use of that 100 Euro for a short period of time, whether to make change or do a magic trick or whatever.
So if that 100 Euro note was utilized by the hotel keeper while it was legally in his possession, then immediately produced when the customer demanded it… isn’t that just an extreme case of fractional reserve loaning on deposits? (A reserve rate of 0%, and unlimited power to delay/time withdrawls.) Then, per Nick’s comment, the only thing you need to add is knowledge of all existent loans in the town: a central clearing house, or a well-connected hotel owner, or maybe the entire town posts its books at the town hall and lets firms figure out their own multi-party cancellations.
It might have been theft if the hotel owner did not know that the bill would circulate back to him in time to produce it; reading the whole story as a parable, this would be a bank defaulting on its depositors. Surely no such bank would last long in real life, but you have to cut a parable some slack for expediency.
It’s not all nice and neat. How did the commerce which incurred those debts occur in the first place? The story seems to assume a previous willingness to extend credit. So maybe it’s the sort of emergent order that could develop under ZMP3 if no central bank was around to print money: faced with permanent stalling of commerce, actors create a universal credit system, temporarily obviating the need for either a central planner or a helicopter dropping bags of money.
I wonder if the monetarists or -Keynesians would be happier to let such problems be solved via credit instead of currency?
Phil Koop,
yes but it is not what is normally thought of as structural employment – i.e. a sectoral imbalance, and the best remedy would seem to be selective immigration.
P.S. But you are right in another way – the same logic applies where one of the specialists is specialist investment goods.
The Unbeliever: Yep. Isn’t this roughly what happens with “re-hypothecation” of T-bills?
The trouble with trade credit is that the whole system can fall apart if one person in the circle defaults. Or if it is even suspected he might default. That’s why we need money, or the central clearing house, to do the multi-party cancellations.
“I wonder if the monetarists or -Keynesians would be happier to let such problems be solved via credit instead of currency?”
I would be happy to let such problems be resolved with credit, if that’s what it takes, if there were provision for multi-party cancellations. But if it did have such provision, I would say that the system is currency (or at least a medium of exchange) with the trivial difference of not using little bits of paper that pass hand-to-hand to keep tally of who is in how much net credit. Instead it’s recorded in a book, or computer somewhere.
Determinant,
he didn’t STEAL it, he borrowed it! (I admit without permission.) But the same story would work if the money was borrowed from the Central Bank, which is the whole point of the story.
Thanks, Nick. That was helpful.
Nick,
I think you represent my views reasonably well in context (i.e., consciously oversimplifying. A couple of points.
1. I don’t really think that the Z should be “zero.” It just has to be low enough to offset the overhead cost of hiring workers (including keeping new workers from disrupting the productivity of existing workers) and the opportunity cost of the worker’s time.
2. My simplified story is the barbershop quartet metaphor.
http://econlog.econlib.org/archives/2010/12/a_barbershop_qu.html
Thanks Nick, That clarified what was a very confusing topic for me. Would it be correct to say “unwilling to spend money because they don’t have enough” and “unable to sell labor because nominal wages are sticky” are two ways of thinking about ZMP3, or are they two different types of ZMP? I.e. do they lead to different policy implications for the central bank?
If only our ( U.S.) debt problem was like that of the damp little Irish town.
In our little towns , all of the debt is owed to Citibank , and Citibank is owned by a few rich folks who spend their money everywhere BUT in our little towns ( OK , maybe the hooker gets some action ). The townspeople can’t spend because of their debt , and because they don’t spend , they have no source of incomes to pay off their debts , and besides that , their incomes were meager even when people were spending , which is what necessitated the debt in the first place.
Money can’t perform a clearing-house function unless it is directly targeted to the townspeople , allowing paydown of debts , and even then the fix would only be temporary , since they’d be forced to go into debt again. However , there are a couple ways we could make the fix more permanent :
1)The townspeople could sleep on the streets and scavenge at the dump , thereby staying out of debt.
or
2)We could fix the income distribution.
Option (2) is anathema to most of the political right.
I favour it highly but I’m a lefty.
Arnold: thanks. Glad I didn’t misrepresent you. I agree with both your points. It’s hard coming up with an example to illustrate the sort of coordination failure you are talking about. Examples should always be simple. And yet if is is simple, it fails to do justice to the difficulty a real-world entrepreneur would have in solving it, and so looks implausible. And yep, “zero” doesn’t have to mean precisely zero. Just too low to make employment worthwhile.
Scott: those two things are essentially the same. It’s the real quantity of money that is too low, relative to the desired stock. “Real” could mean M/W, or it could mean M/P. In my example, W=P, so it doesn’t really matter. Which is my view of the world. I don’t think there’s any important distinction between M/W and M/P.
You can say M is too low, or W (or P) is too high. Or you can say that Md/W is too high. It’s all the same thing. But M is the variable that’s easiest to change. (This is my reading of Keynes’ GT, by the way).
Goldilocks and Determinant: There’s this meme floating around that says that debt is caused by an unequal distribution of income. And you have both just floated it above. The poor are forced by their poverty to go into debt to the rich. Bollocks! It is total rubbish.
Let me give you just one data point, but one very big data point, to show why it’s wrong. China is poor and the US is rich. And the US is in debt to China.
Theory does not say that an unequal distribution of income causes the poor to go into debt to the rich. (Though theory does say that those with low transitory income will go into debt to those with high transitory income.)
Theory says, on the contrary, that those who are improvident will go into debt to those who are provident. And theory also says that those who are improvident will, over time, become relatively poor; and that those who are provident will, over time, become relatively rich.
It is not an unequal distribution of income that causes debt. It is an unequal distribution of providence that causes debt. (And also causes the distribution of income to become more unequal over time).
“Whose theory?”, I hear you demand. “What sort of right-wing bastard would put forward such a theory??!!”
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Paul Krugman (with Gautti Eggertsson).
China is in debt to the US because it refuses to allow the convertibility of the yuan and the consequent capital imports to complete the cycle of trade between China and the US. The US has a massive capital surplus with respect to China. That money should be returned to China to relieve China’s capital deficit. China won’t let this happen. It should happen if the market signals weren’t smothered by regulation and the yuan peg.
China has chosen to have imbalanced trade with the US to keep its workers employed and therefore its regime in power. Beijing has quite literally chosen to buy peace from its citizenry. The cost is a massive pileup of US bonds or put another way, China is financing US consumption by loaning it the money to do so. It’s a massive form of Keynesian stimulus if you consider that the quirk in this instance is that the loans to finance consumption are cycled offshore instead of the whole transaction being conducted domestically.
Which begs the question of why China considers it better to loan money to Americans to finance consumption than to loan money to Chinese citizens to finance the same consumption.
There is also the real (pun intended) question of which country is actually provident. You can’t eat a US Bond. China hasn’t converted its forex reserves to real goods. Why? Why leave those promises on the table instead of purchasing real goods, that is real wealth?
Nick, on the basis of your argument do you then favour heavy economic sanctions against China to allow yuan convertibility and a balance of the capital/current accounts of the US and China with respect to each other?
“Theory does not say that an unequal distribution of income causes the poor to go into debt to the rich.”
Some theory says exactly that , including that of IMF economists , where the “Washington Consensus” no longer seems to be quite so consensual :
http://www.imf.org/external/pubs/ft/fandd/2010/12/Kumhof.htm
Are “memes” what economists call theories backed by DSGE modeling ? I’d use the term “myths” myself , based on what those models typically yield. Just the same , here’s a paper that uses them to study the inequality/debt connection :
Click to access wp629.pdf
“This paper has constructed and simulated a heterogeneous agents model that mimics
the distribution of income in the United States in the period 1963–2003. Such a model
can explain remarkably well the endogenous dynamics of household debt. The rise in
income inequality of the 1980s and the 1990s can, at the same time, account for the
increase in household debt, the large widening of wealth inequality, and the relative
stability of consumption inequality.”
Meme , myth , or something else ? I don’t think it’s something you can simply dismiss as “bollocks” with your facile China example. Are there conflicting models and theories ? Sure. My tendency is to look away from the theories that got us into this mess , and take a look at those that suggest ways to get out of it.
“…those who are improvident will go into debt to those who are provident”
The ‘Theory of Providence’? Ha! That’s a new one for me. It makes Blankfein’s claim that he was “doing God’s work” even more jarring when you think about all the improvidential behavior he facilitated.
Goldilocks: “The ‘Theory of Providence’? Ha! That’s a new one for me.”
That proves to me that you either didn’t read or didn’t understand the second paper you linked to, and used to argue against me. Because if you had read it and understood it then the ‘Theory of Providence’ would not be a new one for you.
It took me literally 1 minute reading that second paper by Matteo Iacoviello to see that it confirmed exactly what I was talking about:
“The economy consists of a large number of in finitely-lived agents who are distinguished by the scale of their income, by their discount rates, and by their access to the credit market.”
See that “discount rates”? That’s fancy economist talk for “improvidence”. It’s saying that some agents are more improvident than others. That’s what’s driving the model. Exactly what I was saying.
Do I need to read the first one too?
“Discount Rates = Improvidence”
Nick, care to explain why China borrows at higher rates than the United States, then?
The PBC base rate is 5.8%, the Fed’s is 0.25%.
No no no, the large US borrowings are a result of Chinese policy and an inoperative capital account exchange to balance off the current account difference.
China will feel robbed if the US is forced to inflate it way out of its debt problems instead of the better course of China voluntarily repatriating its US reserves by purchasing capital goods from the United States.
Determinant: you can’t directly compare US and chinese rates. China’s growth is driven principally by their relative underdevelopment and to a smaller degree by exchange rate manipulation. That’s the main story of rates. Additionally, Americans are currently feeling extremely “provident,” thus the low rates. “Demand shortfall” seems like the definition of provident. You are right though, that manipulation is preventing the low rates from causing a collapse of the dollar.
Reason:”he didn’t STEAL it, he borrowed it!”
But there was no certainty he’d be able to pay it back, unless all the debts were known to be risk free. But in that case they wouldn’t have had any problem in the first place. But, nobody would have felt any poorer if they owned risk free debt and they would have been able to use that debt itself as currency. The fundamental problem is real credit risk. Everybody discounts their assets but can’t discount their liabilities so they all feel poor. The answer is to increase the money supply, but a five minute loan wont do. It should be convincingly long term (like a helicopter drop) and it should be spread around (like a helicopter drop) rather than given to the German tourist (banks) who would never, in reality, lend it for free to the inn keeper.
Nick: speaking from personal experience… It takes a lot more “providence” to stay out of debt when your income is low than when your income is high. So of course “providence” is a factor but to pretend that it is just providence rather than providence conditional on income that is the principal determinant of debt is in fact also “bollocks” 🙂 . The indebted poor are less provident on average than the rest of the poor. But you simply cannot compare their intrinsic “providence” to the rich. Not that you did, but it rubs me the wrong way not to make it explicit.
“Discount Rates = Improvidence”
Sure. One problem is that any difference in discount rates will result in increased income inequality. Another is that the starving peasant necessarily has a higher discount rate than the billionaire with his yacht. Is this improvidence, or inequality of opportunity? Indeed, once income inequality is established, we expect the vicious cycle to continue, and barring intervention, the situation to only get worse. Or should we criticize the middle class for not living in shacks on beans and rice. The problem is not the inequality of income per se, it is the instability of the system.
Consider the system at the outset, with everyone at equal income. Clearly, those with lowest discount will gain advantage. So the greatest scrooge, who lives the meanest life and consumes the least, will come out on top. So everyone is motivated to minimize consumption. But, who will be willing to produce, what no one is willing to buy? So from everyone seeking to be the “most provident,” that is from a pursuit of virtue, everyone is poor. An interesting morality tale.
The discount problem is like the producer-consumer problem: No matter how much money the consumer starts with, the producer ends up with all the money, and then the system collapses. Only when the producer gives the money back to the consumer, does the system persist. Just lending the money doesn’t do it, as we see.
Only by continuously redistributing the money, can the system remain viable. Since those with money are now refusing to do this, (and making a moral issue of it,) they are managing the collapse of the system that has brought them their wealth.
Just some terminology on “discount rates = improvidence”.
There are subjective “discount rates”, aka rates of time preference, which are a close kin of “improvidence”. We need to disambiguate those subjective discount rates from the objective discount rates that, for example, central banks set on colateralised loans.
Improvidence is perhaps just a little bit different from having a high subjective discount rate. Improvidence/providence perhaps means not just caring about the future (pure time preference), but also has a suggestion of taking precautions for the risk of a rainy day?
K: I’m not sure. Pure theory of intertemporal utility maximisation says there should be no relationship between the scale of income and the savings rate. Everything just scales up. Unless you assume non-homothetic preferences, but that can make the relationship between savings and income go either way.
Pure theory says that those having temporarily low income will dissave and borrow from those who have temporarily high income.
And that those with high subjective discount rates will dissave and borrow from those who have low subjective discount rates.
Is theory right? I can see that when you are on the verge of starvation, so you will die anyway, there’s no point in saving for the future. But we left the Malthusian world 200 years ago.
People in the past were much poorer than us. But they saved, and invested. And it’s because they saved and invested that we are as rich as we are now. Has there been any secular rise in savings rates and/or fall in real interest rates over the last (say) 200 years in advanced countries?
And is it even true now that it’s all the poor dissaving and going into debt? Some people become poor due to dissaving, of course, but that’s not the point. And I read a lot of anecdotal evidence of people coming into wads of cash and blowing the lot. And people dissaving and going into debt to buy luxuries.
There is just something wrong with this meme that, just because you are poor, you can’t help yourself from consuming too much. There’s something intellectually and morally lazy about this way of thinking. And it bugs me. The poor aren’t per se idiots, and improvident. (Though idiots and improvident do tend to end up poor, which is different). “Soft bigotry of low expectations” maybe?
Sure it’s hard to live withing your means. But many poor people do it, and many rich people fail miserably. And we should stop making excuses. “They can’t help it; they are poor”.
This topic is striking a deep ancestral note in me. The old baptist and methodist side of my heritage is coming out. And it’s the self-discipline those old Non-Conformist (using that word in the UK sense) distilled in our parents and grandparents that gave us the massive wealth and opportunities we have today. If our ancestors had listened to this “the poor can’t help it” meme, we would all be starving in caves still.
Greg: “Only by continuously redistributing the money, can the system remain viable. Since those with money are now refusing to do this, (and making a moral issue of it,) they are managing the collapse of the system that has brought them their wealth.”
And my grandparents reply: “Sure, reward improvidence, and we might as well all be improvident. And Greg and Nick will be on the verge of starvation like our great grandparents were. No!”
I ought to blog this. “Get it off my chest”. Right now I’m collecting my thoughts. I will re-read over Determinant, Goldilocks, K, and Greg.
And thanks for the comments, by the way, despite my “bollocksing”. This is helping get my head straight on why I’m so opposed to this “inequality causes debt” meme.
Elizabeth Warren makes the point that, in the US at least, families are (or where) going into debt mainly through their mortgages and mainly because they where buying schools, since schools in rich areas (with expensive houses) tend to be much better than schools in poor areas. So at least in this one case, inequality is causing debt and it’s driven by (attempted) providence – investing in their children’s human capital.
I can’t find the link right now (it was a YouTube video), but she also debunks the idea that households are going into debt by consuming too much stuff (iPhones, XBoxes, flat screen TVs etc). When you compare what people spent 30 years ago, adjusted for inflation consumer ‘stuff’ is just sooo much cheaper today that it more than makes-up the difference (which it what you’d expect given technological progress).
The ‘h’ gremlin keeps messing-up my were’s and where’s !!!
Need another cup of coffee.
I lean more towards the Minsky tale of long periods of stability causing an underpricing of risk, overpricing of assets, growth in debt, and increase in inequality that a crash reverses. More effect than cause although there are political channels that can reinforce and accelerate these trends once they become large.
Nick:
OK. But “providence” and the presence of poverty is closely related to the cost of living. A one-bedroom apartment in Ottawa will cost you $1000 with utilities at least. Transportation is also relatively fixed. Food for one person is also less variable than income. The variance in these prices is less than the variance in the amount of income a person earns. This is the fundamental reason why we have a progressive income tax system. How else to rich people have more disposable income than poor people?
Likewise you’ll barely survive on an income of $25,000. If you have family that’s just not enough income. You need a second income.
When the income opportunities available to you are not enough to cover your needs for shelter, food, transportation and basic sundries, you are involuntarily improvident. It happens a lot, primarily because the cost of housing is so high and inelastic relative to income. It also happens because job searching takes time and money.
Nick wrote:
“This topic is striking a deep ancestral note in me. The old baptist and methodist side of my heritage is coming out. And it’s the self-discipline those old Non-Conformist (using that word in the UK sense) distilled in our parents and grandparents that gave us the massive wealth and opportunities we have today. If our ancestors had listened to this “the poor can’t help it” meme, we would all be starving in caves still.”
Hear that? That’s the sound of me ripping something.
Nick, that theology is 80 years out of date. But it’s timely we should revisit the reasons it wound up in the dumpster.
First, if you’re going to debate Methodist theology with me, you’re going to lose. I am the son of two United Church of Canada ministers and I’m two degrees removed from two others in my family. My other grandparents sat on the Session and Official Board for decades. I currently sit on my congregation’s Official Board and I’m heading over to the Session next month. I live and breathe this stuff.
The United Church and the Baptist Church both would have agreed with the assertion that improvident people are undisciplined and profligate until the 1930’s. The Great Depression changed everything. The Social Gospel was big in Canada. The United Church has many, many churches on the Prairies and we had to watch good farmers with families who never misspent a dime get thrown into the most dire poverty because they couldn’t sell enough grain. In Ontario we had to watch good men line up outside factories and still wind up with nothing. In economist’s terms we had to sit by and watch a coordination problem play out where everybody did everything right and still lose.
It’s not an individual’s fault when the market stays broken longer than they can stay solvent. It happens a lot.
Why do you think the United Church and the NDP are so closely related? Every wonder why our clergy seem so socialist? Nobody remembers the 1930’s with fondness. We come full circle 80 years later and have another depression and I see no reason whatsoever to challenge that conclusion. Get with the program Nick!
In 2, the plumber puts an add in the paper, electrican wanted. The electrician puts an ad in the paper. plumber wanted.
There are two job vacancies. The plumber puts an ad in the paper. Need your pipes fixed?
The electrician puts an add in the paper. Need your house rewired.
We have to people searching for employment.
Vacancies match the unemployed. It takes time to make the match. Output and income are zero until they make the match.
I think this is called “frictional unemployment.”
I don’t think this is zero marginal product of labor.
As I have argued many times, Kling also needs a no scarcity argument. The plumber wants his house rewired, but doesn’t know there is an electrician. So he buys more bread instead. If none of the bakers needs plumbing at all, then there he has a zero marginal product of labor in plumbing, and needs to bake bread. If, as is more likely, they can use plumbing, and it is simply that the electrician wants it more, then the plumbers marginal value product is lower because the electrician doesn’t know about him.
The same with the electrician. He needs plumbing, but doesn’t know about that, and instead buys bread. Now, if none of the bakers want rewiring, then his marginal value product is zero. He needs to bake bread. More realistically, they do want rewiring, and his lack of knowlege of the plumber means that the marginal value product is less.
Of course, the plumber can see the electrician trading with the bakers. And the electrician can see the bakers trading with the plumber. So, there is no problem!
Now, suppose everyone bakes their own bread. And they are just resting with their spare time. And so, you have the electrician and plumber as you said. They don’t know about each other. There is, of course, output and income. The bread. But people just enjoy leisure because no one wants any more bread. The electrican won’t sell rewiring for bread because he already has all the bread he wants. The plumber won’t sell new pipes for bread because he doesn’t want more bread. And so, you have the frictional unemployment–the matching adds in the paper.
I believe in frictional and structural unemployment. But they have to do with change, not this no scarcity scenarios.
I think the jaded rich notion of Lord is what is going on.
Nick:
Mike Moffatt thinks I’m a lefty and I’m fine with that. I like to think my politics and my religion are compatible. When I read economics I know that I’ll come across stuff I find politically or morally objectionable. Or really enticing on the surface but brutal in reality, like Hayek. The thing is when I say that I’m in favour of social welfare programs I know I’m saying that for me politics/morality/religion trumps economics. I’m OK with that.
Perhaps too when you minister to people in a small open economy whose income is critically dependent on decisions taken in markets and boardrooms thousands of miles away to whom you are just a price point it is hypocritical in the extreme to preach that saving is a virtue and improvidence is a sin and a sign of your lack of grace. That point has been reinforced again and again and again over the years.
I’m curious that while many would jump on me for overriding economics with morality, you seem to want to justify your economics with appeals to morality and religion. What behind every economist there is a dead theologian now?