INET grantee Vamsi Vakulabharanam describes his work to gather parallel social threads—such as class, caste, gender and religion—to better understand the mechanisms of inequality in India, and why this can lead to better outcomes around the world.
The conventional measures of economic well-being are dangerously limited, and we are seeing the resulting policy consequences play out daily.
Rob Johnson joins Background Briefing with Ian Masters to discuss public concern about inflation
University of Tennessee law professor Maurice Stucke, author of “Breaking Away: How to Regain Control Over Our Data, Privacy, and Autonomy” has been critical as tech firms have grown into giant “data-opolies” profiting from surveillance and manipulation. In a conversation with the Institute for New Economic Thinking, he warns that legislative inaction and wider government complicity in this surveillance are eroding fundamental rights to privacy along with the ability of federal agencies to regulate Big Tech.
Lynn Parramore: Concern over privacy is increasing right now, with people worrying about different aspects of the concept. Can you say a bit about what privacy means in a legal context? With the digital revolution, privacy obviously means something different than it did 50 years ago.
MS: Yes, privacy is not a single unitary concept. There are different strands. There’s bodily privacy and decisional privacy – the right to make important decisions about one’s life, like whether to have a child or not, without governmental interference. Within the bucket of decisional privacy would also be marriage, contraception, and things of that nature. There’s intellectual privacy (such as what one reads, watches, or thinks) and associational privacy (such as the freedom to choose with whom one associates). Informational privacy is another strand, where you can control your personal information, including the purpose for which it is used.
There used to be the idea that data protection and privacy are fundamental human rights.
Numerous supporters of privacy rights have argued that U.S. Constitution should protect an individual’s right to control his or her personal information. One of the earlier Supreme Court cases involving informational privacy tested that belief. New York passed a law requiring doctors to disclose to the government their patients’ name, age, and address when they were prescribed certain drugs. All of this information was collected in a database in New York. A group of patients and their prescribing doctors challenged the law, contending that it invaded their constitutionally-protected privacy interests. The case was decided in 1977 -- before the Internet and cloud computing. The Supreme Court, however, did not perceive any threat to privacy implicit in the accumulation of vast amounts of personal information in computerized data banks or other massive government files. The Court instead noted how the mainframe computer storing the data was isolated, not connected to anything else. Today, the data are not collected and maintained on some isolated mainframe. A torrent of data is being collected about us that we may not even have thought about. When you go to purchase gas at the local station, for example, you may not think of the privacy implications of that transaction. But there are powerful entities that collect vast reservoirs of first-party data from customers, and also sources that are reselling it, like the data brokers.
Congress, unlike the Supreme Court, recognized in the 1970s that the privacy of an individual is directly affected by the government’s collection, use, and dissemination of personal information and that the government’s increasing use of computers and sophisticated information technology has greatly magnified the harm to individual privacy. The preamble of the Privacy Act of 1974, enacted by Congress, states that privacy is a fundamental right protected by the Constitution. It was a landmark law in seeking to provide individuals greater control over their personal data in government files.
But the Supreme Court, on two occasions when it had the opportunity, declined to hold that the Constitution protects informational privacy as a personal and fundamental right. A majority of the justices just punted. They said that even if one assumed that such a right existed, it did not prevent the government from collecting the information it sought in both cases. Justices Scalia and Thomas were blunter in their concurring opinion: they simply argued that there is no constitutional right to informational privacy.
LP: What are some of the ways we are most vulnerable to government intrusion into our personal data right now?
MS: Well, the state can tap into the surveillance economy.
There are significant concerns about virtual assistants like Alexa. There was a case in Arkansas where someone was murdered in a hot tub, and the defendant had an Alexa device in his house. The government sought from Amazon any audio recordings and transcripts that were created as a result of interactions with the defendant’s Alexa device. The government wanted access to the data collected by Alexa to see if there was any incriminating evidence. Alexa records what information you ask it to find. That’s the data it’s supposed to store. But there have also been concerns that Alexa may record more data than it was intended to, such as communications between family members.
Geolocation data is another big concern. Consider the Supreme Court’s decision in Carpenter v. United States [the 2018 decision requiring a warrant for police to access cell site location data from a cell phone company]. The Court said there’s a privacy interest in one’s geolocation data under the Constitution’s Fourth Amendment. Our movements, the Court noted, provide an intimate window into our lives, revealing not only where we go, but through them our “familial, political, professional, religious, and sexual associations.” So, how then did the U.S. Department of Homeland Security obtain millions of Americans’ location data without any warrant? The Trump administration simply tapped into the surveillance economy. It purchased access to a commercially-available database that maps our movements every day through our phones and the apps on our phones. Unless you turn off your phone or leave it at home, your phone is tracking you and potentially letting the authorities know where you’re going, how long you stayed there, when you came home, etc.
LP: So our geolocation data can actually be purchased by government officials, bypassing the need for a search warrant?
MS: Exactly. Now the government can just buy it, and that’s even scarier. The current Supreme Court does not appear to view the right to privacy as a personal and fundamental right protected by the Constitution. This is where Europe differs -- its Charter of Fundamental Rights specifically recognizes privacy and data protection as fundamental human rights. Some U.S. states recognize privacy as a fundamental right as well, including California, but not all. That’s one of the concerns with the Court’s overturning Roe v. Wade -- it’s stripping away privacy rights that are inferred by multiple constitutional provisions. The Dobbs v. Jackson Women’s Health Organization decision really shows how a simple change in the composition of the Court can enable it to eliminate or chisel away what had been viewed as a fundamental privacy right. If the Court says you don’t have these rights, that these rights aren’t in the Constitution, you would have to then get a Constitutional amendment to change it. What are the chances of getting a constitutional amendment? I remember when growing up the challenges in getting the states to ratify the Equal Rights Amendment. No one even talks about amending the Constitution anymore.
So now you have the states and federal government tapping into the surveillance economy. The government can be complicit in it and even benefit from the private surveillance economy because now it’s easier to prosecute these cases without getting a warrant.
LP: So far, we’ve been talking about what we do online, but you’ve pointed out that it doesn’t stop there because the line between the online world and the offline world is blurry.
MS: That’s right. For example, Baltimore has a very high murder rate per capita and clears only 32 percent of its homicide cases. Even though Baltimore installed over 800 surveillance cameras and a network of license plate readers, the high crime rate persisted. So a private company offered three small airplanes equipped with surveillance cameras that can cover over 90% of the city at any moment. The pilot program tracked over 500,000 Baltimore residents during the daytime. Ultimately the program was struck down by the U.S. Court of Appeals for the Fourth Circuit as being an unreasonable search and seizure. [Leaders of a Beautiful Struggle v. Baltimore Police Dep't] But nothing stops this private company from going to other communities to institute the same surveillance program. Other courts might take the same view as the dissenting judges in the Baltimore case, namely, that people should not expect any privacy in their public movements, even if they are tracked for weeks or months. As a result, you might have extensive aerial surveillance, in addition to all the other surveillance tools being employed already.
The thing about the Baltimore case (and this is what the seven dissenting judges focused on) is that the company obscured the faces of the individuals, which were represented as “mere pixelated dots.” This was by choice. So what’s the invasion of privacy if the police can only see dots moving across the city? The majority opinion noted how the police could employ its other existing surveillance tools, such as on-the-ground surveillance cameras and license-plate readers, to identify those dots. Moreover, if you see a dot going into a house around 6 pm and emerging in the morning, you can assume that the person lives at that house. So the fact that the aerial surveillance depicts you as a dot is a red herring. The police could just cross-reference the dot with all the other technology that it is already using, like the license plate readers, the street surveillance cameras, and the facial recognition software, to identify who that dot is. That’s a key takeaway. You might think, oh, I can protect my privacy in one avenue, but then you have to think about all the other data that’s being collected about you.
Thus, we should take little comfort when Google says that it will delete entries from a person’s location history if it detects a visit to an abortion clinic. One need only piece together the other data that is currently being collected about individuals, to determine whether they obtained an abortion.
LP: You’ve noted that the Supreme Court is doing away with any notion that there’s a fundamental right to privacy. Is this a sign of creeping authoritarianism?
MS: It could be. You could end up with either an authoritarian state model or a commercial surveillance economy that the government co-ops for its purposes.
We are also running into another problem when you consider the Supreme Court’s recent West Virginia v. EPA decision. The Court cut back on the ability of the federal administrative agencies to regulate absent a clear congressional mandate. That potentially impacts a lot of areas, including privacy. For example, the federal agencies, under the Biden administration, could regulate apps and Big Tech firms, and tell them not to disclose health information to law enforcement. But those regulations could be challenged, using a new weapon with the Court’s EPA decision. The Court might very well strike down such regulations on the basis that privacy protection implicates major social and economic policy decisions, and decisions of such magnitude and consequence rest primarily with Congress, and not with the FTC or any other agency. And because Congress has been incapable of providing a comprehensive privacy framework, you are out of luck, unless your state offers some privacy protections.
LP: What would you like to see Biden doing regarding data protection? You’ve noted the importance of behavioral advertising to this discussion – advertising which allows advertisers and publishers to display highly-personalized ads and messages to users based on web-browsing behavior.
MS: Behavioral advertising is why these companies are tracking us all across the web. We need to address the fundamental problem of behavioral advertising and the collection of all this data. One issue is to what extent can the FTC use its authority under the Federal Trade Commission Act of 1914 to promote privacy and give individuals greater control over their data after the Court’s recent EPA decision.
The second issue is how to create a robust framework that actually protects our privacy. If you just say, well, companies can’t collect certain kinds of data, it’s not going to be effective. Facebook, for example, can make so many inferences about an individual just from their “likes.” It could discern their age, gender, sexual orientation, ethnicity, religious and political views, personality traits, intelligence, happiness, and use of addictive substances -- so much information by something seemingly innocuous. The more people “like” something, the more accurate the information is and the more personal it can become, such that Facebook can know more about an individual than that individual’s closest friends. If you prohibit behavioral advertising, you’re – hopefully – going to then lessen the company’s incentive to collect that data in order to profile you and manipulate your behavior.
Robust privacy protection means giving individuals greater control over what’s being collected, whether or not that data can be collected, and for what limited purposes it can be used.
LP: Can we really put the behavioral advertising genie back in the bottle now that it has become so pervasive, so key to the Big Tech business model?
MS: Absolutely. A business model can be changed. Most people are opposed to behavioral advertising, and that has bipartisan support. Senator Josh Hawley [R-MO], for example, offered the Do Not Track Act, which centered on data collected for behavioral advertising.
There’s also bipartisan support for anti-trust legislation to rein in these data-opolies. The House did a great report about the risks that these data-opolies pose to our economy and democracy, and there were several bipartisan bills on updating our antitrust laws for the digital economy. All the bills had bipartisan support and went through the committee. Unfortunately, they’re still being held up for a floor vote. There was even a recent John Oliver show about two of the proposed bills, and the legislation still hasn’t gotten through. This is the fault of Republican and Democratic leadership, including Schumer and Pelosi. Big Tech has spent millions of dollars lobbying against these measures and they’ve come up with these bogus commercials and bogus claims about how this legislation is going to harm our privacy.
In Europe, they’re getting this legislation through without these problems, but in the U.S., you’ve also got the Supreme Court and many lower courts chipping away at the right to privacy and the ability of the agencies to regulate in this area. The agencies can move faster than Congress in implementing privacy protections. But the status quo benefits these powerful companies because when there’s a legal void, these companies will exploit it to maximize profits at our expense.
Behavioral advertising is not about giving us more relevant ads. The data is not being used solely to profile us or predict our behavior. It’s being used to manipulate. That is what the Facebook Files [an investigative series from the Wall Street Journal based on leaked documents] brought to the fore. Facebook already tells advertisers how it can target individuals who have just had a recent breakup, for example, with advertising for certain products. They can maximize advertising profits by not just predicting what people might want but by manipulating them into emotional states in which they are more likely to make certain purchases. The Facebook Files showed that Facebook’s targeting actually causes teenage girls to develop eating disorders. It’s depressing when you think about it.
LP: People are increasingly thinking about how to protect themselves as individuals. What steps might be effective?
MS: There are some small steps. You can support a search engine that doesn’t track you, like DuckDuckGo. Cancel Amazon Prime. Avoid Facebook. But avoiding the surveillance economy is nearly impossible. If you don’t want to be tracked, don’t bring your phone with you. Of course, Carpenter v. United States is instructive on that point. The Court noted how “nearly three-quarters of smartphone users report being within five feet of their phones most of the time, with 12% admitting that they even use their phones in the shower.” Some people even bring them into the shower! It’s not realistic to force people to forgo their phones if they want their privacy. Realistically there are very few protections, and it’s very, very hard to opt out because even seemingly benign bits of information that you wouldn’t think would incriminate you can be very telling when they are combined with other data.
New York did a study about how much health information is being transmitted every day to Facebook, and it’s staggering. Facebook receives approximately one billion events per day from health apps alone on users, such as when someone opened the app, clicked, swiped, or viewed certain pages, and placed items into a checkout. All of these health-related apps are continually sending the data to Facebook, most likely without the individual’s knowledge. So, you might think you’re going to avoid Facebook, but if you’re on a popular app or using a smartwatch, it may very likely be sending detailed, highly sensitive information about you – including when you are menstruating or wanting to get pregnant – to Facebook and the other data-opolies.
We’re moving into a situation where our every movement can be tracked. Just look at China. We don’t have to imagine what the counterfactual is: China is actively investing in the surveillance of its citizens. There it’s mostly the government. Here in the U.S., you could say, well, the government is not doing that. But here the government doesn’t have to. These powerful firms are already doing it, and some of the government agencies are complicit in that surveillance economy.
LP: So we’re really not as different from China as we might like to think.
MS: Right. The companies that are surveilling us are largely unaccountable. Google and Facebook have committed numerous privacy violations. As the technology improves, the invasiveness will get even creepier. You’re going to have technologies that read a person’s thoughts and decipher their emotions -- and not even just decipher their emotions but predict and manipulate their emotions. To see what’s on the horizon, just look at the influx of patented technology. It’s scary.
After the initial reaction to the Supreme Court’s recent decisions has subsided, we need to consider the broader implications of these rulings. Hopefully, people will, even if they don’t agree philosophically or ideologically with the dissenting justices, be concerned with what the majority is doing. Will the Court make other personal decisions about myself and my family? What is to stop some states and this Court from deciding whom I can marry? What birth control can I use if any? To what extent are my rights, including the right to be left alone, protected? We’re seeing a steady erosion happening now. History teaches us that anything is possible. Germany was said to be the land of poets and thinkers – a nation that would never, ever accede to something like the Nazi Party. Totalitarianism was supposed to be beyond the realm of possibility.
Privacy legislation seems unlikely right now, and things are looking bad on so many levels. The economy has tanked. Inflation is eating away at our paychecks and savings. Gun violence. Global warming. Greater mistrust across political lines. Greater tribalism and rancor. No wonder most Americans believe that the country is heading in the wrong direction. It seems like we’re incapable of building or achieving anything. One wonders whether we are approaching the decline of civilization. But the thing about human events is that you could have remarkable change coming from unexpected places. Consider the Berlin Wall. It was for decades a fact of life: people thought their children and grandchildren would have to live in a city and country divided by this physical and ideological wall. Then all of a sudden, the wall was gone. It wasn’t the politicians that negotiated this to happen. It was the thousands of Germans who had enough of the Stasi, the surveillance state, and the repression of their freedoms. Meaningful privacy change requires people to say, I’m not going to tolerate what these companies are doing. I’m not going to tolerate the government engaging in surveillance.
I don’t want to seem defeatist. Just look at the California Consumer Privacy Act of 2018 and California Privacy Rights Act of 2020. There, a real estate developer spearheaded a revolution in privacy legislation. California was the last place one would expect this to occur -- the home of Google, Apple, and Facebook. But the developer spearheaded privacy reform by threatening a ballot. And when that 2018 legislation proved to be insufficient, that same real estate developer was able to get a ballot for amending and strengthening the law, and the majority of the Californians voted in favor of it. The 2020 statute is complex, over 50 pages long. There was a lot of lobbying by Big Tech against it, but the people got it.
We don’t have to accept the status quo. We can change things in small part through our behavior. If you don’t like Google, then don’t use it. If you switch to DuckDuckGo, it’s not going to be that great at first, but as more people switch to it, it’s going to get better through network effects. If you don’t like Facebook, then delete your account – but recognize that it’s not sufficient. You’ve still got to support privacy legislation. Congress can get it done. They were able to pass other legislation, like requiring federal judges to disclose conflicts, rather quickly. There’s no reason they shouldn’t be able to do this except for the lobbying and all the money that’s being thrown around. If the people push it, it can be done.
People can have an awakening that things are not all right. Young people could have an awakening about just how precarious our rights are and not take them for granted. Maybe they will see that our democracy is on not on cruise control and it’s not just operating on its own. It takes everybody getting involved on a local level and saying, I’m not going to take this any longer. Change can occur, but only if we demand it.
Few dispute that there can be no green transition without a greening of finance. Yet, the greening of finance drags on and on. In fact, estimates suggest that current practices in the financial sector have us headed for temperature increases two-fold larger in magnitude than those aimed for with the Paris agreement. In this predicament, might a way forward be to engage central banks in fostering the much-needed greening of finance?
Several monetary policy instruments can be tailored to affect incentives in the financial sector, in favor of low-carbon assets at the expense of carbon-intensive ones. This has been elaborately documented by the Network for Greening the Financial System (NGFS), the think-tank organization established by central banks themselves (NGFS 2021). And several initiatives appear to suggest that central banks are in fact beginning to engage proactively, such as the formal adoption of a green mandate by the Bank of England and the creation of a Climate Change Centre by the European Central Bank. But steps taken so far remain mainly symbolic and it's important to note that central bankers navigate in a political environment with strong countertendencies.
There is stout push-back from dominant players in the financial industry as well as from conservative politicians. While executives in the financial sector will express support for the objective of increasing funding for renewable energy, many fewer accept that lending to fossil fuel producers should be discontinued. For stakeholders with these views, the prospect of central banks deploying monetary policy tools to change relative incentives in the financial sector to promote the green transition appears almost atrocious. Yet, even within the financial industry and in the central bank establishment minority voices advocating that central banks should adopt a proactive approach are gathering momentum, not least as it becomes apparent that the hands-off, voluntary climate risk disclosure approach (advocated by Mark Carney and endorsed by the financial industry) is leading to little more than ever-escalating practices of “greenwashing.”
While green central banking is likely to continue to be a highly contested terrain in coming years, this does not absolve scholars of central banking and financial regulation from the duty of engaging with the issues. The aim of my new INET Working Paper is to contribute to preparing the ground analytically for green monetary policy-making. More specifically, the aim is to review a range of green monetary policy instruments in order to identify a policy mix likely to have a substantial climate change mitigation impact.
A Money View Perspective
Two things are needed if a proactive approach to green central banking is to gain traction. First, an intellectual armory is needed that can challenge the current conventional wisdom on central banking; and second; a policy strategy that is theoretically informed and feasible to implement. Revisiting the green central banking agenda from a Money View perspective provides both: a new theoretical foundation for thinking about monetary policy, as well as theory-based guidance on devising a policy strategy likely to be effective.
The Money View is an approach to monetary economics that combines the American institutionalist economics tradition of Young, Hansen, and Minsky with the British central banking tradition of Bagehot, Hawtrey, Hicks, and Goodhart. In Perry Mehrling’s own phrase, the Money View is “essentially a synthesis and restatement of the core ideas of these two traditions, reformulated for present institutional conditions” (Research Outreach, 2022). Conceptualizing banking as simultaneously a payments system and a market-making system, the Money View transcends the boundary between economics and finance and as such is particularly well-placed to reflect on central banking challenges in an era of market-based finance.
Addressing monetary policy issues from a money view perspective means taking a point of departure from the notion that all financial instruments from securities and bank deposits at one end to currency and gold at the other are constitutive elements of money hierarchies and subject to vertical convertibility, with gold as the most liquid asset and securities as the least liquid. Central bank haircuts are an integral element of money hierarchies; without them, securities would not be convertible into bank money through repos.
The convertibility of assets with different degrees of ‘moneyness’ in the hierarchy depends on intricate mechanisms of daily collateral valuation and margining. What this means is that collateral valuation is at the heart of modern systems of market-based finance. For climate change mitigation, the implication is that the policy instruments most directly influencing collateral values have to be at the core of any green central banking strategy hoping to be effective.
From a money view perspective, the interventions of central banks are seen as either providing elasticity or enforcing discipline on the monetary system. The distinction between elasticity and discipline can be expressed also in terms of expansion and contraction of market liquidity. When central banks provide elasticity to the system, market liquidity expands; when they provide discipline, market liquidity contracts. As the Working Paper details: “[A] reduction in the haircut of an asset unambiguously lowers its required return and can ease the funding constraints on all assets,” Ashcraft et al (2011: 143). In fact, each of the two main dimensions of collateral policy – haircuts and asset eligibility criteria – can be seen through a lens of elasticity and discipline; as instruments that can be tailored to engender either expansion or contraction, depending on financial market conditions and desired policy outcomes. Lower haircuts relax the settlement constraint for banks, while higher haircuts tighten it.
When collateral policy is approached from the perspective of Green Central Banking objectives, the question is not whether to aim for elasticity or discipline. We need elasticity for the low-carbon (green) assets that we wish to promote, and discipline for the carbon-intensive (brown) projects we oppose. But is this even possible? Can we achieve elasticity in one direction and discipline in another? Can we instigate a collateral expansion in green assets and a collateral contraction in brown assets?
The answer is affirmative. Just as money can be seen as a hierarchy of promises to pay, collateral too can be understood in hierarchical terms. We can understand collateral as a spectrum of assets that have different values when actors meet requirements to secure their borrowing with the central bank. The key question for the concerns here then becomes how we may reshape collateral hierarchies in a manner that favors green assets and disfavor brown assets. How can central banks shape collateral hierarchies such that green assets ascend while brown assets descend?
A core principle of the Money View is the notion of an inherent hierarchy of money and the observation that haircuts are crucial in enabling the convertibility of money in the hierarchy. This means that money hierarchies are predicated upon hierarchies of collateral, pledged in the repo operations that ensure the smooth functioning of the money and payment system. This implies, in turn, that there are no other, more profound effects on monetary and payment systems than those that stem from changes to the underlying collateral hierarchies.
Beyond this key principle of affording a central role to instruments that directly affect collateral hierarchies – such as haircuts and eligibility criteria – two further principles can be derived from the Money View perspective. First, measures that differentiate are preferable to those that exclude. For instance, tilted asset purchases are preferable to a negative screening of brown assets from asset purchase programs. A disciplinary mechanism that operates on a continuum is more effective in changing collateral hierarchies than a binary one (included vs excluded). In its most elementary form, a continuum requires two thresholds that jointly constitute a spectrum from green to grey to brown assets.
Second, targeting assets is preferable to targeting institutions. If counterparties are targeted, it will take the form of differential treatment based on the average level of low-carbon assets in the portfolio of those institutions or the collateral they pledge. This will inevitably be a blunt disciplinary modality since a counterparty could hold a high share of low-carbon assets, but also have a substantial amount of highly carbon-intensive assets and still get the preferential rate. Measures that target institutions should therefore be secondary and only considered in combination with measures that target assets.
Based on a Money View analysis, I identify a policy mix that meets the three-fold objective of (i) having a substantive mitigating effect on climate change, (ii) entailing no significant, negative impact on monetary policy effectiveness, and (iii) not causing a contraction of collateral space, with potential negative consequences for market liquidity.
The report by the NGFS reviewed nine monetary policy options in three overall categories and although it proclaims a desire not to “give recommendations,” it does nevertheless effectively provide a shortlist of monetary policy instruments suitable for a proactive agenda. Interestingly, the shortlist that results from this paper’s analysis, based on the Money View, turns matters upside down. Notably, adjusted collateral haircuts – disqualified by the NGFS as not of much significance or impact, indeed of “second order” – take center stage in the green monetary policy strategy informed by Money View principles.
More specifically, the core finding is that a promising policy strategy would be to combine i) an expansion of collateral eligibility through positive screening with ii) a widening of haircut spreads to change relative incentives in favor of green over brown assets, reshaping collateral hierarchies in the process, and iii) tilted asset purchases, to further reinforce that effect. This may be combined with differentiated lending rates for counterparties, according to the share of low-carbon assets in the collateral they pledge to access funding.
Given the key importance of differentiated haircuts for the reshaping of collateral hierarchies, I discuss several approaches. First, a sliding scale approach can be adopted, using industry emission averages as a benchmark around which haircuts are increased, for assets with higher-than-average carbon emissions; or decreased, for assets with lower-than-average emissions. Second, haircuts can be tilted according to the carbon intensity of the assets, as proposed by Dirk Schoenmaker (2021). And third, technical screening criteria for green and brown economic activities developed in the EU taxonomy could be used as an upper and lower threshold for differentiated haircuts. I advocate the latter option on the grounds that it would anchor green monetary policies in a comprehensive and ambitious classification of green economic activities – and thereby have the added benefit of potentially reining in widespread greenwashing practices in finance.
A persistent regime of low wages may determine very negative long-term consequences on the economy.
Stagnating real wages may have contributed to the slowdown of US productivity
In much of the advanced world, we have witnessed at least three decades of stagnating real wages and massive reductions in the labor share in income. Many analyses have documented these trends, reflecting on their causes and effects from very different standpoints. In the US economy, where the trend toward wage stagnation seems to be particularly strong, it goes together, according to Temin (2015), Storm (2017), and Taylor and Ömer (2020), with a ‘dualistic’ tendency of the economy, with growing polarization between a limited number of high-wage and high-productivity sectors and a growing mass of workers employed in low-productivity and low-wage sectors. Wage stagnation, Taylor and Ömer (2020) note, is also the basis of the growing inequality in personal and family incomes recorded in the USA as well as in many other societies.
The mainstream explanations of these trends generally rely on either globalization (Elsby et al, 2013) or technical progress, especially in the form of jobs-displacing automation (Autor and Salomons 2018, Acemoglu and Restrepo, 2017). Acemoglu and Restrepo (2020) also indicate automation as the main cause of growing intra-wage inequality, affecting especially low-qualified workers. The prevailing idea in the literature, it results, is that a combination of market mechanisms and exogenous shocks have made labor (and especially poorly qualified labor) superabundant with respect to other factors and the economy’s requirements.[1] Implicit or explicit, the message of the analyses that see the change in distribution as essentially the outcome of market forces is that there is little that policies can do, apart from somehow palliating the worst social consequences of the technological or commercial shocks.
Generally, however, these analyses fail to give an account entirely consistent with the data. As shown by Mishel and Bivens (2017), other waves of automation in the past did not result in a decrease in the wage share but rather went together with increased compensation and enhanced work conditions. Globalization and automation, note Stansbury and Summers (2020), cannot easily account for the concomitant extraordinary growth of profits unless other factors are also taken into account. Especially difficult to explain is the fact that the decline in the wage share and the stagnation of real wages have gone together in some periods (and most notably the 2010s) with a sustained growth of employment, also (and especially) of the low-wage variety, which testifies to a strong rather than weak demand for labor.
This leaves room for other, more ‘institutional’ explanations of the distributive shift. The latter may indeed be seen mainly as the product of social forces, i.e. changes in policies, institutions, and collective behavior that have produced a long-lasting loss of bargaining power for workers. It is not only a question of the increase in the oligopolistic power of employers, which enables them to reap as profits most of the productivity gains (Covarrubias et al 2019). Especially, as analyzed by Weil (2014), the diffusion of low-wage jobs in the US economy is related to the profound restructuring of the organization of business that has taken place in a variety of industries and firms since the 1990s, that included outsourcing activities and workers towards firms in which labor is comparatively less protected, and use of employment agencies. Weil especially focuses on the pressure of capital markets on big corporations to produce ‘value for investors’ and the role of information and communication technologies in enabling the coordination among workers of different firms. But policies have played an essential role in shaping the new institutions now prevailing on the labor market. As noted by Stansbury and Summers (2020) “changes in policy, norms, and institutions” have produced a “legal and political environment … in favor of shareholders and against workers.” The authors enumerate the laws “undermining unions’ ability to fund themselves and the increasing corporate use of union avoidance tactics, both legal and illegal.” The policy-induced loss of workers’ power over many decades can explain the comparatively prosperous periods as the 2010s have been characterized by wage stagnation.
This different conception of distribution as essentially shaped by social and institutional forces – which appears as supported by empirical evidence – has very different implications in terms of policy. Before coming to that, it is worth noting that, however divergent the diagnoses, not only is the decades-long trend itself towards wage stagnation little disputed in the literature, being evident in data, but there is also a certain consensus that something should be done. Many different analysts have advocated the need for measures that could at least in part check the tendency to wage losses, if only to avoid the worst effects of growing inequality in terms of social disintegration.
Against this background, it would be legitimate to expect that the recovery in nominal wages which has materialized in recent months in the USA should be saluted with relief and approval by economists of different persuasions, as a first sign of a changed situation and the beginning, perhaps, of an inversion of the long-term trend.
This is not so, as is well known. On the contrary, tight labor markets and rising wages, supposedly mainly brought about by excessively generous fiscal policy (especially in the USA), are now blamed, by more than one commentator, as the main source of unsustainable inflationary pressures. Among the most vocal advocates of the need to rein in wage growth, through a sustained increase in interest rates aimed at increasing unemployment, is the same Larry Summers who in Stansbury and Summers (2020) had shown how dramatic has been the loss of workers' power in the recent decades. It is very difficult to imagine that such persistent causes of weakness as analyzed there have suddenly evaporated, albeit under the impetus of the exceptional post-covid conditions, so as to result now in an excess of workers' power, with the inflationary consequences that this supposedly entails.
Though evoked as a threat to price stability, the occasional tightness of the labor market, which, as shown by Storm (2022), is in fact mainly the result of the enduring restrictions covid has imposed on labor supply – the continuing infection risks, the problems associated with childcare, the people kept away from actively seeking work by long-covid symptoms – is actually only a secondary cause of inflation and, especially, does not seem able to invert in any significant way the long-term trend towards real wage losses.
Actually, real wages have not risen in 2021 and are falling right now, both in the USA and in Europe, despite the historically low rates of unemployment. Moreover, the interest rates hikes currently taking place in the USA – and likely soon to be followed by similar rises in Europe – will in all probability be effective in raising unemployment, although this might occur through channels different from those traditionally indicated by textbooks (i.e., not through the disincentive to investment, but possibly through the impact on credit-financed consumption and the housing market). Combined with the economic consequences of the war in Ukraine and the current international instability, this is not unlikely to generate a recession. However ‘soft’ may be the landing, it will not increase labor’s strength. The trend towards compression of real wages and impoverishment of labor does not seem to be close to an end.
If wages are a problem, it follows, it is not the rise in nominal wages that should capture public attention, but rather the enduring weakness of real wage growth.
It is not only for reasons of fairness and social cohesion – which of course are of paramount importance because a social arrangement based on the increasing impoverishment of the largest part of the population obviously cannot be desirable – that wage stagnation should be regarded as a serious problem. It also produces economic effects that may have negative long-lasting consequences. In our new INET working paper, we focus on one of such possible effects and explore how stagnating real wages may have contributed in recent decades to the slowdown of US productivity.
In much literature, the relationship between wages and labor productivity is seen as unidirectional. If productivity growth may fail in some circumstances to be transmitted to wages, the possibility of reverse causation, whereby the dynamic of wages may be an important determinant of productivity growth, is generally little explored in the mainstream approach. This is due to the conception of distribution as endogenous to market forces (the relative scarcity of factors and their efficiency). Wages may be affected by productivity since slow productivity growth leaves less room for wage increases, but cannot generally exert an independent positive influence on productivity. Rather, if imperfections in the market mechanism or the interference of labor market institutions determining excessive workers’ power should cause wages to grow exogenously, this would imply increasing unit labor costs for the firms, loss of competitiveness, and loss of employment, with negative effects on growth. Productivity, in this theoretical framework, is typically seen as an indicator of technological efficiency, with its growth determined by technical progress or other supply-side factors as the accumulation of human capital.
In our paper, we start from a demand-led growth perspective, in which aggregate demand has a prominent role in determining both output growth and the growth of resources. Such an approach, we show, implies that productivity should be reconsidered, both in its definition and in its determinants. Far from being merely a measure of technological efficiency, observed output per unit of labor is also a reflection of the intensity of the use of resources, an intensity which is determined endogenously by the conditions in which the economy operates. The system is not endowed with mechanisms that continually ensure the tendency to produce close to the efficiency frontier, but the conditions of demand may well produce inefficiencies and waste of resources. It is within this flexible theoretical framework, in which productivity becomes a largely endogenous variable, that we explore the possible endogeneity of productivity growth to the dynamics of wages.
Our analysis takes inspiration from a conception of distribution – typical of the classical political economy of Smith, Ricardo, and Marx – as affected by social and institutional forces that are at least in part exogenous both to output growth and to productivity growth. This theoretical conception is perfectly compatible, it is hardly necessary to note, with the above-mentioned analyses that have documented the weight of political and institutional factors in shaping the trend of distribution in recent times.
In this theoretical context, wages may affect productivity not only indirectly, by expanding or depressing aggregate demand, but also directly. Following the analysis of Paolo Sylos Labini (1984, 1993), we analyze and distinguish in the paper two different direct effects of wages on productivity: one acting through induced technical progress – labor-saving innovations fostered by high wages – and a second one acting through the incentive that high wages represent towards a more efficient use of the labor input through reorganization of the production processes.
The first effect is triggered by an increase in the price of labor relative to the price of machines. Sylos especially underlines the role of competition, both in the domestic and in the international market, that forces firms, in a high-wage environment, to innovate in order to defend or increase their market shares. For its characteristics and its dynamic character, such an effect is very different from the neoclassical substitution mechanism based on the production function. The second effect is instead induced by an increase in wages relative to the price of output. This incentivizes firms towards a more efficient use of labor, through reorganizing production processes or work practices. Sylos labels this effect as the ‘organization’ effect. This effect is also conceived as acting dynamically since it entails a particular kind of innovation, i.e., ‘organizational’ innovations. Differently from the innovations entailing increased mechanization, these organizational innovations do not necessarily involve high investments in fixed capital and may thus take place more immediately (empirically, indeed, Sylos distinguishes the organization from the mechanization effect also for its faster action).
Our hypothesis is that these two effects of wages have each contributed to the productivity slowdown observed in the US economy. The dramatic distributional shift against wages has in our view reduced the incentive for technical innovation, at least in some sectors or sub-sectors of the economy. Moreover, it has constituted a strong incentive for firms in different sectors to build their business strategies by taking advantage of the mass availability of low-wage labor. Such strategies may involve using massively the labor input, often with the intermediation of other firms, which also implies the redistribution of employment, within the same sector, between firms with different work arrangements and different levels of productivity, thus entailing transformations along the various phases of the value-chains. To the workers, this may produce long and little-paid working hours, sometimes with the intermediation of types of contracts where the worker appears as self-employed or rather has multiple employers.
By analogy with farming techniques, we propose to label these strategies as based on ‘extensive’ vs ‘intensive’ use of labor in the production processes and the business organization. Extensive use of the labor input implies using cheap labor abundantly (in terms of heads or working time). Although such phenomenon has affected the various sectors with different intensity, we believe that the drift towards a more extensive use of the labor input is not limited to traditionally low-wage and low-productivity sectors, but may well have affected all those sectors which are susceptible to different forms of organizing production, including some important sectors in manufacturing, traditionally a high-productivity branch that has lately shown a slowing down of its productivity dynamics.
In the paper, we conduct two different exercises to test empirically our theoretical hypothesis on the US economy. In the first place, we propose a shift-share analysis of the dynamics of both productivity and wages in the USA in recent decades, to identify the main sectoral sources of change in the two variables. We also investigate the sectoral contributions to the cumulative growth of the wage-productivity gap. Through the shift-share analysis, we find that structural change may explain only a minor part of the weak dynamics of productivity, which is mainly due to factors acting within each sector. We also find that after a sharp change in distribution against wages, some historically high-productivity sectors switched towards slower productivity growth. This supports our hypothesis that the anemic growth of productivity may be partly due to the trend toward massive use of cheap labor. On the basis of this analysis, we advance the hypothesis that the disappointing growth in productivity is not only a structural phenomenon due to the growing weight of low-wage and low-productivity sectors but is also due to the recent trend towards the extensive use of labor even in traditionally high-productivity sectors. Indeed, after the 2008-09 crisis, a shift to a regime of low productivity growth seems to take place also in manufacturing.
Considering the central role of manufacturing in the US productivity slowdown, in the second place we focus our analysis on this sector, estimating the effects of wages on productivity through the productivity equation originally proposed by Paolo Sylos Labini. Our estimation of Sylos Labini’s productivity equation confirms the existence of two direct effects of wages, one acting through the incentive to mechanization and the other through the incentive to the reorganization of labor use. We also include two indicators that measure labor “weakness” in terms of duration and reasons for unemployment and we find that both stagnating wages and increasing labor insecurity do indeed contribute significantly to the decline of productivity.
This shows that the persistent deterioration in real wages and the wage share does not only raise social issues but may also produce permanent macroeconomic scars, in terms of long-term negative effects on the growth prospects of the economy.
The question is what could and should be done. As remarked above, if wage losses are regarded as the spontaneous outcome of market forces, they may be countered only in part, for example. by enhancing education and training programs for workers. By contrast, the idea that distribution is especially the product of social forces implies that society has the means, through the adoption of suitable policies and the reform of institutions, to change the course of events. As noted by Stansbury and Summers (2020), for example, “progressive institutionalists have long argued for pre-distribution alongside redistribution, strengthening worker power by changing the structure of labor market institutions…. Strengthening worker power can be an important countervailing force against firms’ dominance in product and labor markets… Overall, we believe that increasing worker power must be a central and urgent priority for policymakers concerned with inequality, low pay, and poor work conditions. If we do not shift the distribution of power toward workers, any other policy changes are likely to be short-term and insufficient.”
The problem of wages and work conditions is now crucial. Higher wages and safer and better jobs would not only re-orient firms towards higher productivity and more efficient organization. They would possibly also represent a serious incentive towards enhanced labor supply, thus easing one of the constraints currently concurring to inflation. The lasting wounds that the regime of low wages inflicts on the economy, in addition to what it entails for the greatest part of society, should be a matter of serious concern.
References
Acemoglu, D. and Restrepo, P. (2017), “Robots and jobs: evidence from US labor markets”, NBER Working Paper 23285.
Acemoglu, D. and Restrepo, P. (2020), “Unpacking skill bias: automation and new tasks”, NBER Working Paper 26681.
Autor, D, and Salomons A. (2018), “Is automation labor-displacing? Productivity growth, employment, and the labor share”, Brookings Papers on Economic Activity, Spring, 1-63.
Covarrubias,M., Gutiérrez, G. and Philippon, T. (2019), “From Good to Bad Concentration? U.S. Industries over the past 30 years”, NBER Working Paper 25983.
Elsby M.W.L., Hobijn B. and Şahin A. (2013), “The Decline of the U.S. Labor Share”, Brookings Papers on Economic Activity, 1-52.
Lawrence, R.Z. (2015), Recent declines in labor’s share in US income: a preliminary neoclassical account, NBER Working Paper 21296
Stansbury, A.M. and Summers, L.H. (2020), “The declining worker power hypothesis: an explanation for the recent evolution of the American economy”, NBER Working Paper 27193
Storm, S. (2017). The New Normal: Demand, Secular Stagnation and the Vanishing Middle-Class. Institute for New Economic Thinking, Working Paper 55; https://www.ineteconomics.org/...
Storm, S. (2022). Inflation in the Time of Corona and War, Institute for New Economic Thinking, Working Paper 185; https://www.ineteconomics.org/research/research-papers/inflation-in-the-time-of-corona-and-war
Sylos-Labini, P. (1984), Le forze dello sviluppo e del declino, Editori Laterza, Bari.
Sylos-Labini, P. (1993), Progresso tecnico e sviluppo ciclico, Editori Laterza, Bari.
Taylor, L. and Ömer, Ö. (2020); Macroeconomic Inequality from Reagan to Trump: Market Power, Wage Repression, Asset Price Inflation, and Industrial Decline, Cambridge University Press, Studies in New Economic Thinking.
Temin, Peter. 2015. The American Dual Economy: Race, Globalization, and the Politics of Exclusion, Institue for New Economic Thinking Working Paper No. 26; https://www.ineteconomics.org/...
Weil, D. (2014), The Fissured Workplace. Why Work Became So Bad for So Many and What Can Be Done to Improve It, Harvard University Press.
Endnote
[1] See also Lawrence (2015) who maintains that the analytical tools of standard neoclassical theory are more than sufficient to explain the persistent contraction of the labor share if one assumes a reduction in the elasticity of substitution between capital and labor and a labor-augmenting character of technical progress.
We are in the midst of another global transformation, but this time we might have the tools to get it right.
Ratner and Sim’s “Who Killed the Phillips Curve – A Murder Mystery”
“… the slope of the Phillips curve — a measure of the responsiveness of inflation to a decline in labor market slack — has diminished very significantly since the 1960s. In other words, the Phillips curve appears to have become quite flat.” Janet L. Yellen (2019)
A recent US Federal Reserve staff working paper written by David Ratner and Jae Sim (2022) has captured widespread attention, especially among economists, who, like ourselves, believe that a repeat of the anti-inflation policy scenario of the early 1980s of sharply rising central bank interest rates might prove inappropriate, if not catastrophic, as a solution to dealing with the current inflationary environment. While inflation hurts the poor disproportionally more because of their low incomes, steep across-the-board rate hikes may be a remedy that is worse than the disease, particularly since, as it has been well established (see, for instance, Storm 2022), we are not primarily facing with a demand-side inflation.
Indeed, not only might the inflation rate be quite insensitive to falling aggregate demand pressures, but sharp and persistent increases in interest rates could devastate many poor working households which would face the specter of increasing unemployment. This concern is amplified by the fact that, unlike the situation in the early 1980s, these poor households now tend also to be very heavily indebted as a proportion of their personal disposable incomes and may face even greater risk of insolvency from the combination of higher interest rates and increasing unemployment (see Costantini and Seccareccia, 2020).
The US Fed as well as many other central banks internationally seem now to be united in favor of a steep hike in the Fed’s policy rate, as we witnessed with the most recent 0.75 percent jump on June 15. We are told, moreover, that many more increases are required and likely to come since the Fed rate is, supposedly, still much below its “neutral” level. A particularly striking example is the recent paper by Bolhuis, Cramer and Summers (2022) in which they suggest that, to get the current inflation rate down to align with the US Fed’s 2 percent inflation target, it would now “require nearly the same amount of disinflation as achieved under Chairman Volcker.” (2022, p. 1).
Given the nature of the current supply shocks affecting our weak Covid-battered economies, the specter of another Volcker-style scenario is chilling. The recommendations, though, are at odds with the assessment quoted earlier of former US Fed Chair Janet Yellen in 2019 as well as with the research of the two US Fed economists, Ratner and Sim, who suggest that the slope of the Phillips Curve is actually relatively flat and it has remained so for decades, for reasons that have little to do directly with the Volcker shock of the early 1980s.
While this was long established outside of the mainstream (for a review, see Seccareccia and Kahn 2019), numerous researchers in established circles have been writing recently about the flat Phillips curve. For instance, Engemann (2020), Del Negro, Lenza, Primiceri, and Tambalotti, (2020), as well as Del Negro, Gleich, Goyal, Johnson, and Tambalotti (2022), all recognize what had actually been obvious to many of us for a long time. The important implication is that, as Yellen (2019) recognized, the flatness of the relation implies an immensely high sacrifice ratio if pursuing a Volcker-style strategy as recommended by (Stanbury and Summers 2020), since it would require excessively high unemployment to get the inflation rate down by even a very small increment.
Yet, the conventional wisdom nowadays ignores this empirical evidence. Instead it still relies on some variant of the so-called New Keynesian Phillips Curve resting on the crucial assumption that the inflation rate responds to aggregate demand pressures as reflected in an economy’s rate of capacity utilization and/or the unemployment rate. If that were true, then this would advise the adoption of some “automatic formula” such as a return to some Taylor rule equation, as some conservative policy analysts are recommending, that rests on an “inflation first” priority of central banking, which in the case of the United States would contravene the Fed’s dual mandate.
However, evidence-based economics would suggest that the well-worn relation between unemployment and inflation does not actually exist, at least not in the form traditionally depicted by the mainstream. Since the 1980s, particularly during the disinflation era of the Great Moderation associated with falling unemployment and, even more so, when the US unemployment rate did fall significantly (as immediately after the Global Financial Crisis (GFC), the inflation rate remained largely unresponsive. It stayed close to the 2 percent inflation target even though the US civilian unemployment rate fluctuated a great deal from a double-digit level of 10 percent towards the end of 2009 to a low point of 3.5 percent just before the pandemic at the end 2019 and early 2020.
Apparently, for the mainstream, as it is now observable from recent central bank decisions to steer economies towards higher interest rates, what we have witnessed over the last four decades since the Volcker shock was some strange aberration. The current low unemployment rates, such as the US 3.6 percent unemployment rate in May, arising as economies recover from the pandemic, are now considered “unsustainably” low rates, even though the same central bank authorities deemed similar unemployment rates relatively sustainable in 2019 and early 2020. Now these low unemployment and high vacancy rates suddenly call for high interest rates and necessitate growing unemployment to prevent the acceleration of inflation.[i]
It is as if we have been abruptly thrust back to what were the confused arguments of the 1970s when economists like Milton Friedman had described those low unemployment rates resulting from the 1960s’ Keynesian expansionary macroeconomic policies as the cause of the accelerating inflation that had resulted during the 1970s. We have reestablished a narrative with the same litany of arguments: governments have pumped too much money into the economy during the pandemic because of the massive deficit spending and because of the very loose monetary policy of quantitative easing and excessively low interest rates. These have now driven unemployment rates to unsustainably low levels that can only generate accelerating inflation. To prevent a galloping inflation, high interest rates have become an imperative.
In this climate, the Federal Reserve working paper on Kalecki’s economics, dated September 2021, but only recently published, is a breath of fresh air. Ratner and Sim (2022) claim that the Phillips curve in the United States and the United Kingdom has been almost flat since the 1980s because of the significant erosion of the bargaining power of workers. This began during the Reagan and Thatcher years, and which was especially reflected in declining union density rates over the last four decades. Thus, the supposed triumph over inflation for roughly four decades, until the surge during this last year of Covid-19, cannot be fully attributed to the conduct of monetary policy by the US Fed and the Bank of England. The Fed working paper, therefore, casts serious doubt on the mainstream narrative, which posits that the policy of the late Fed Chairman Paul Volcker of large hikes in interest rates was responsible for taming the 1980s inflation. If the Volcker shock was actually not what caused the long-term change in the dynamics of the inflation rate since the 1980s, and until the current Covid-19 crisis, then what was the culprit that flattened the Phillips curve?
The main takeaway of their paper is clear: interest rate hikes could have helped but it was rather the class conflict — particularly the offensive against the working class — that stood behind the inflation debacle of the Great Moderation, which had long-term consequences. Putting it that way, this could sound quite subversive to many mainstream economists. Indeed, as Nick Peterson (2022) writes in the Financial Times: “coming from deep inside the Fed this is near heresy. After all, central banks have naturally long been in thrall to theories that made them the heroes of the story.”
However, the authors recognize that the ideas are not new at all. In an unusual display of openness to heterodox ideas, Ratner and Sim give credit to post-Keynesian economics, and especially to the famous Polish economist Michał Kalecki (1943, 1971), who was a contemporary of John Maynard Keynes and co-discoverer of the principle of effective demand, apart from advancing several of Keynes’ contributions. Indeed, Kalecki, along with such less well-known writers as Henri Aujac (1950), was the founder of the view that inflation is primarily an expression and the outcome of class conflict (or conflicting claims) over national output by the way firms price their products vis-à-vis workers’ wage setting.
As a tribute, the authors replace the New Keynesian Phillips curve with a more general “Kaleckian” Phillips curve, as they call it, in which they include an exogenously-determined parameter impacting on its slope that reflects the degree of bargaining power between workers and firms.
We believe that their main contribution is the introduction of the “Kaleckian” Phillips curve to the canonical Two-Agents New Keynesian (TANK) model with monopolistic competition (in this case, the two agents are workers and firms). This tweak implies that, apart from the usual bargaining over wages, there would be bargaining over the product price (or monopoly rents). Workers through labor unions would try to keep the markup as low as possible so that wages and the labor share would be larger, whereas firms would try to do the opposite. The degree of bargaining power would determine the winners and losers in the distribution of monopoly rents. It follows that the “Kaleckian” Phillips curve explains why the inflation and unemployment rates have been relatively low since the 1990s — without considering the recurrent crises and the most recent inflationary episode — because the bargaining power of workers has been extremely limited.
Apart from that, the model has additional interesting aspects, of course, within the obvious constraints of the DSGE framework, which, to many of us, is problematic (see Storm 2021). For instance, the fight over the share of monopoly rents involves two different and opposed channels that impact the level of output and the NAIRU. When the degree of bargaining power is roughly balanced, small increments in the bargaining power of firms have a very positive impact on output and employment since the investment incentives are higher, whence the job creation channel dominates. In contrast, when the bargaining power of firms is particularly high, firms prefer to increase their profits by selecting the highest markup at the expense of output and job creation; thereby the markup channel dominates. But there is no reason why the degree of bargaining power would vary over time because it is an exogenous parameter. Thus, within the model, involving the standard DSGE assumptions of “rational expectations,” a steady decline in the bargaining power of workers is unexplained (and conceivably “irrational”) from the point of view of labor unions since this simply goes against workers’ interests.[ii]
On the other hand, the authors contrast the “Kaleckian” Phillips curve with respect to the New Keynesian Phillips curve in response to a positive demand shock. The results are different because, in the former, the slope of the curve changes with the degree of bargaining power between firms and workers whereas, in the latter, it remains constant regardless of the degree of bargaining power. That is because in both models there is bargaining over the wage but, in the “Kaleckian” case, there is also bargaining over the markup and product price. As a result, a positive demand shock in the “Kaleckian” model would amplify the impact on inflation and diminish it on employment.
Finally, the paper presents some time-series and cross-sectional evidence for the United States and the United Kingdom that leads to a significant positive relationship between the bargaining power of workers and the slope of the Phillips curve, which supports their model. Nevertheless, the econometric evidence does not discard the possibility that the respective monetary policies themselves did have a significant impact as well. In the authors’ own words: “The estimation results point to a possibility that both the post-1980s disinflation and the concurrent flattening of the Phillips curve owe as much to the labor market institutions of these two countries as to the monetary policies of these two countries” (Ratner and Sim 2022, p. 26).
We appreciate their research findings and find ourselves broadly in agreement with their conclusions about the flatness of the Phillips curve. This is a view, however, that is somewhat inconsistent with the current hawkish position of the US Fed that seems now to believe that the short-run Phillips curve is more hyperbolic rather than flat, otherwise its whole current strategy of wringing the inflation out of the US economy through strong doses of higher interest rates would be futile, since we are not experiencing primarily a demand-side inflation. We have already argued above and have also discussed elsewhere (see Seccareccia and Khan 2019, Lavoie and Seccareccia 2021, and Seccareccia 2022) that the Phillips curve is quite flat for a very large relevant range of the unemployment rate.
As shown in Figure 1 below, cost factors, such as international oil price shocks, can shift the whole curve upwards, but if we are in the broad flat range, the central bank cannot act on it to influence the current inflation unless it believes that the economy has reached the extremities of the curve (in this case at the extreme left). Indeed, as US Fed chair Jerome Powell has quite candidly admitted: “What [the Fed] can control is demand, we can’t really affect supply with our policies…so the question whether we can execute a soft landing or not, it may actually depend on factors that we don’t control.” (Jerome Powell (2022), cited in Shapiro (2022). Although the paper by Ratner and Sim does not look at very recent evidence during the pandemic, the burden of proof rests on central banks to show (rather than assume) that the current inflation is primarily a demand-side one, where the economy now finds itself within the extreme left in the upward-sloping section of the Phillips curve.[iii] If the economy is still in the relatively flat range, and that all that has happened recently is that supply-side shocks have shifted the whole flat range of the curve to a higher range as firms have been marking up these sustained cost changes, then these interest rate hikes will merely slow down the economy with minimal impact on the overall inflation rate. [iv]
Figure 1: Phillips Curve with a Significant Flat Range
While appreciating much of what Ratner and Sim analyze, we do, however, have some further concerns. Up to this point perhaps anyone with some knowledge of Kaleckian economics would notice that the Ratner and Sim model is far from representing the core ideas of the celebrated Polish economist. First, the model sticks to Say’s Law in the sense that it is saving that determines investment as in a pre-Keynesian loanable funds world. Kaleckian economics, on the contrary, sticks to the Keynesian principle of effective demand, whereby investment is autonomous, saving is endogenous, and the rate of interest depends on central bank policy (Kalecki 1943). Thus, profits are determined by consumption out of profits and investment, assuming workers spend all their income. This important theoretical departure from New Keynesian economics led to the famous Kaleckian aphorism (wrongly attributed to Kalecki): “capitalists earn what they spend, and workers spend what they earn.” (Lavoie 2022, p. 332).
Furthermore, the technology assumed by the authors’ model depicts constant returns to scale and diminishing returns to labor and capital, implying increasing marginal costs. By contrast, Kaleckian models assume constant marginal costs (up to full capacity) and so “higher real wages will not necessarily entail a reduction in production and employment” (Lavoie 2022, p. 314) such that the labor demand curve would be upward sloping. Ultimately, output is constrained by demand both in the short and long run. In contrast, the model of Ratner and Sim (2022) entails that steady-state output and employment is supply constrained by the level of saving, in turn determined by workers’ and firms’ preferences and a natural rate of interest that would pin down the value of the NAIRU.
Finally, we suspect that Kaleckians might be uncomfortable in calling the paper’s curve a “Kaleckian” Phillips curve. While it is true that the degree of bargaining power affects the Phillips curve in the authors’ model, the former is just a parameter exogenously determined, i.e., given the bargaining power of workers, the NAIRU and the natural rate of interest are pinned down and are unique, which is inconsistent with Kaleckian economics. Kaleckians, and more generally post-Keynesian economics, explicitly reject the existence of a NAIRU or a natural rate of interest. Therefore, a genuine Kaleckian Phillips curve would portray a horizontal segment that might depend on the bargaining power of workers, among other institutional factors but, as remarked by Kalecki (1943) in his “Political Aspects of Full Employment”, the bargaining power depends on the rate of employment and monetary policy, which is itself influenced by class conflict as well.
As we have already discussed above, the shape of a genuine Kaleckian/Post-Keynesian Phillips curve could depict a flat part but surrounded by downward-sloping segments or even an upward-sloping segment given by a hypothetical full-employment situation, as suggested by Seccareccia and Khan (2019). It is also very likely that the trends in the unemployment rate have affected the bargaining power of workers and the conflict over the distribution of income (Seccareccia and Matamoros Romero 2022). Last, partly as a result and since monetary policy is embedded in the class conflict, the Volcker shocks, and the subsequent high-interest rates policies — up to the financial crisis of 2008-09 — should be seen as part of the policies that eroded the bargaining power of workers and not as an independent phenomenon, as Ratner and Sim seem to posit. Central banks would themselves be taking sides in the class struggle.
But there is more going on than just conflict between workers and firms. As suggested by Seccareccia and Lavoie (2016) and Seccareccia and Matamoros Romero (2022), there are also the rentiers, much analyzed by Keynesian economists, who may have conflicting interests. Rentier interests have played an important role in what occurred historically. Owing to the growing importance of the financial sector, we have seen how the rentier perspective hijacked monetary policy through the adoption and framing of inflation-targeting monetary policy regimes since the last major inflation of the 1970s and 1980s. In fact, much of the current political pressure to revive the “inflation first” monetary policy commitment through some formal adoption of an official Taylor rule reaction function in the United States is part of this rentier revival in the macroeconomic policy agenda that waned after the financial crisis.[v] Ratner and Sim (2022) are completely silent on this matter of rentier interests, which has also been of great concern to many non-mainstream economists and which transcends the traditional two-class analysis discussed in their paper.
References
Aujac, H. (1950). Une hypothèse de travail : l’inflation, conséquence monétaire du comportement des groupes sociaux. Économie appliquée, 3(2) (avril/juin), 279-300.
Bolhuis, M. A., J. N. L. Cramer, and L. H. Summers (2022), Comparing Past and Present Inflation, National Bureau of Economic Research, Working Paper 30116 (June).
Costantini, O., and M. Seccareccia (2020), Income Distribution, Household Debt and Growth in Modern Financialized Economies, Journal of Economic Issues, 54(2), 440-49, DOI 10.1080/00213624.2020.1752537
Davidson, K. (2016), Yellen Objects to Proposed Rule for Rate Formula: Discussion of Legislation Opposed by the Fed Crops up during Wednesday’s Testimony, Wall Street Journal (February 10), https://www.wsj.com/articles/yellen-objects-to-proposed-rule-for-rate-formula-1455124921?mod=article_relatedinline
Del Negro, M. A. Gleich, S. Goyal, A. Johnson, and A. Tambalotti (2022), Disinflation Policies with a Flat Phillips Curve, Liberty Street Economics, Federal Reserve Bank of New Your (March 2), https://libertystreeteconomics.newyorkfed.org/2022/03/disinflation-policies-with-a-flat-phillips-curve/
Del Negro, M., M. Lenza, G.E. Primiceri, and A. Tambalotti, (2020), What’s Up with the Phillips Curve?, Brookings Papers on Economic Activity, (Spring), 301-357; https://www.brookings.edu/wp-content/uploads/2020/12/DelNegro-FINAL-WEB.pdfeven
Engemann, K.M. (2020), What Is the Phillips Curve (and Why Has It Flattened)?, Federal Reserve Bank of St. Louis, (January 14), https://www.stlouisfed.org/open-vault/2020/january/what-is-phillips-curve-why-flattened
Kalecki, M. (1943). Political Aspects of Full Employment. The Political Quarterly, 14(4), 322–330. https://doi.org/10.1111/j.1467...
Kalecki, M. (1971). Selected Essays on the Dynamics of the Capitalist Economy 1933-1970, Cambridge University Press.
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Lavoie, M., and M. Seccareccia (2021), Going Beyond the Inflation-Targeting Mantra: A Dual Mandate, Max Bell School for Public Policy, McGill University (April 23): 5–40, https://www.mcgill.ca/maxbells...
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[i] In fact, the model by Ratner and Sim (2022, p. 17) predicts that a low inflation-low unemployment environment would be consistent with high vacancy rates. This is because labor bargaining power would be particularly low, thereby firms would have much higher incentives to increase job postings. Hence, following the model, the current high vacancy rates in the United States would be in line with a low labor bargaining power, and the inflation surge would be unrelated to any supposed tightness in the labor market.
[ii] We are grateful to Servaas Storm for raising this point. Also, to be fair, Ratner and Sim (2022, p. 16) recognize that the degree of bargaining power is made exogenous for simplicity, but assert it could potentially be made endogenous in a more sophisticated DSGE model, despite being a challenging task. However, we have serious doubts that doing this in a DSGE framework would retain the Kaleckian insight that a long-run fall in the bargaining power of workers would be affected by monetary policies that are biased against workers’ interests.
[iii] A recent paper by Shapiro (2022) defending the Fed’s policy of raising rates suggests that perhaps about one third of the recent inflation arises purely from the demand side while the rest would be either “ambiguous” or of a supply-side nature, or to quote Shapiro (2022): “These results showing that factors other than demand account for about two-thirds of recent elevated inflation …” In our opinion, this methodology is somewhat flawed and highlights why understanding Kalecki’s model is important. Despite the complicated technique based on rolling regressions to generate predicted monthly values for quantity and price, his theoretical framework seems to rest on an elementary textbook division whereby, if the actual monthly values of price and quantity are both above or both below their predicted values, then it’s a “demand-driven” phenomenon, while if the values are of opposite signs, this would signal a “supply-driven” outcome, analogous to the elementary textbook demand/supply analysis. Unfortunately, this binary distinction can easily confound a cost-push inflation arising from increasing business markups with a pure demand-side inflation, as might be the case as the economy is recovering from the pandemic, where presumably price and output would be moving upward in tandem vis-à-vis their predicted values as well as the price markup! By contrast, Ratner and Sim (2022) allow for this Kaleckian markup effect in their specific model. Many recent studies suggest that rising markups are ubiquitous. See, for example, Storm (2022) or Konczal and Lusiani (2022).
[iv] This flat range is certainly well recognized at the US Fed, as Yellen (2019) points out about the importance of the “sacrifice ratio” along the flat range: “It’s important to point out, however, that a flat Phillips curve has a downside, which is that it raises the so-called “sacrifice ratio.” The sacrifice ratio measures the cost in terms of higher unemployment to lower inflation should it rise too high. With a flat Phillips curve, it’s necessary for monetary policy to create a good deal of slack in the labor market to return inflation to levels consistent with price stability. … Finally, even if the Phillips curve is quite flat over some range, it’s conceivable that it could become a lot steeper if unemployment is pushed to very low levels: that is, it may be nonlinear at very low unemployment. There is some evidence of such nonlinearity, so it’s a significant policy concern.”
We believe that this describes reasonably well what has been said for years by post-Keynesian economists. What at the US Fed may not be understood is that the flat anchor is not governed only by inflationary expectations impacting on wage growth, but also other supply-side/costs that can shift the whole curve as shown in Figure 1 above.
[v] This well-known Taylor rule is discussed, for instance, in Seccareccia and Kahn (2019), and was rejected by former chair Janet Yellen for possible adoption at the US Fed (see Davidson 2016). This pro-rentier “rule” rests on three elements: (1) a “natural rate” of interest that central banks would sustain over time, (2) a deviation between current inflation and the 2% inflation target, and (3) an output gap. Since the output gap is of concern to policy makers uniquely as a predictor of future inflation based on some standard Phillips Curve model, then monetary policy becomes focused solely on how to get the inflation rate back on target through interest rate policy, while preserving a stable positive real interest rate over time. As we have said, this pro-rentier Taylor rule policy framework would actually contravene the US Fed’s dual mandate since the so-called output gap in the equation is only of concern to policy makers for inflation-fighting purposes. Instead, the minimization of the unemployment rate towards a full employment level is not directly of any concern since it is not an independent policy objective within the Taylor rule framework unless one defines the NAIRU as full employment, which it is not.
