Monday, December 22, 2014

Adair Turner Provides His Big Picture Of The Economy

This video of Adair Turner's speech in London pulls several strands of the economy together into a comprehensible mosaic.  He links rising income and wealth inequality to some of its more obvious causes such as globalization and immigration which expands the labor supply and fosters wage competition, but he also shows how our new economy decreases demand for labor and physical capital.  That contributes in income and wealth inequality and it also contributes to slower economic growth.  Its easy to see that effect when one compares Facebook with the Ford Motor Company.  A relatively small number of software engineers and physical capital was required to bring Facebook public at a value of $170 billion.  Facebook can also add new customers at almost zero marginal cost.  It also becomes more valuable through network effects.  The more customers it attracts, the more valuable it is to every customer and to advertisers.  Henry Ford needed a large labor supply and a huge investment in physical capital to bring his cars to market.  We also had to build the roads and the infrastructure necessary to support auto transport.  A large sales and service network was also required.  Business investment spending and consumer spending expanded as the auto industry developed.  Facebook made a small number of people very rich but it does relatively little to increase business investment and consumer spending.

Turner also destroys some of the myths about our banking system that taught in econ 101.  Banks do act as intermediators between savers and businesses that require those savings for investment.  Only 15% of bank assets are loans to businesses.  65% of the savings are used to fund mortgages,  and a large share of real estate transactions are for the purchase of existing properties.  25% of bank lending is used to support household consumption. 

Given the large amount of savings that are used to fund mortgages it is not surprising to learn that most of our wealth is held in real estate.  Moreover, most of the asset appreciation is in the price of the land.  There is a fixed supply of highly desired real estate locations and a high elasticity of demand for those locations.  Investors have responded by purchasing choice locations to capture the asset appreciation.  Most of that appreciation will go to investors who have surplus income.  That contributes to wealth inequality and it does little to expand aggregate demand.

Turner argues that income inequality has led to the expansion of credit to support aggregate demand.  There has been almost no real wage growth for the bottom 75% of the income distribution in the US.  Consequently,  private credit has been used to fill the income gap. That is what the sub prime mortgage system was all about. The idea was to expand credit to households that would not otherwise have access to credit.  That is unsustainable over the long run.  Consumption spending slows down, the economy contracts, and government debt increases in response to declining tax revenue and increased spending on public welfare programs.  The rise in public debt leads to fiscal austerity, and a reliance on monetary policy to support fiscal austerity programs.

Turner is not a fan of quantitative easing.  He argues that low interest rates have driven up asset prices but they have done little to increase aggregate demand.  He favors policies that put more money into the hands of households that will spend it.  Progressive tax policies would be part of his agenda.

Turner does not have much regard for economists who claim that our basic problem is a skill gap.  It doesn't take much to destroy that argument.  A quick look at job growth projections by the US Bureau of Labor shows that there is very weak demand for computer and network technologists.  Moreover, wage growth in those areas has also been weak.  Most of the job growth is in the service sectors and many of those jobs do not require advanced training.

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