Comments on economics, mystery fiction, drama, and art.

Friday, February 21, 2014

Yet more things I read but don't understand how anyone could write

Another quotation from the ongoing thread on the history of thought listserv:

Several students also tend to ask me why not many economists, including our textbook authors, appear to be aware of the classical macroeconomic principles, including definitions of such terms as saving, capital, investment, and money, that I explain to them and they can clearly understand. 

I assume that the writer means "aren't aware of the classical definitions of saving, capital investment, and money."  While he might not like the definitions of these terms commonly used in introductory economics classes, they exist. But let's start with trying to get some understanding of the "classical" meanings of these terms.  For this, I'm using Mark Blaug's Economic Theory in Retrospect, 5th Edition (1996). 

"All of this is disguised by the fact that the classical economists almost never used the word "investment" and spoke of "saving" to denote, not the process, but rather the result of saving, that is, the actual resources saved:  with them "saving" already implies the conversion by way of investment into additional capital equipment.  This suggests that saving is actually identified with investment, but this cannot be what they had in mind..." (p. 157)
Let's break off here and ask what's going on.  Essentially, for classical economists, income earned by  workers ("wages") was all spent on consumption.  "Saving" came entirely from capital income, and, almost by definition, those who earned income from capital refrained from consumption spending in order to add to some stock of capital.  Thus, the conversion of resources from income to capital  occurs as saving.  Which leads us inevitably to the question of what the classical economists meant by capital.  Beginning with Ricardo (well, with Quesnay and the Physiocrats, actually), we find a distinction between "fixed capital" and "circulating capital." 

Based on Blaug's discussion (on pp. 26 and 27), fixed capital appears as "buildings, implements," and "permanent...improvements," while circulating capital seems to be payments for what we would now call "variable resources:"  wages, seed and fertilizer in an agricultural economy, purchased consumable inputs, and so forth.  So in money terms, we would take the classical definition of "capital" to be both what we would today consider to be capital plus what we would today consider to be variable costs.  So "investment" would be any addition to capital, "fixed" or "circulating"--that is, any use of income for continued operation of production.

Finally, money in classical economics.  Again, let's at least start with Ricardo.  Blaug tells us:

Ricardo is a "metallist" and naturally expounds a labour theory of the value of the monetary metal...Given unhampered  coinage and the possibility of melting coins, the quantity of money in the long run is indeed governed by the cost of producing gold... (p. 127)

But, as Blaug acknowledges in his discussion of the "bullionist" controversy, other classical economists would include paper currency and small non-precious metal (e.g., copper) coin that are convertible on demand into gold as money (in addition to gold and silver coin) (pp. 127-128).  (The argument for paper currency was the difficulty in providing "small" denomination coins.)  So let us say that classical economists regarded money as (a) gold and (possibly) silver coin and (b) convertible paper currency and "token" coins. 

So now we have at least a beginning of what classical economists might mean by saving, investment, capital, and money.

What will we find in most contemporary economics textbooks?  The definitions are not quite the same.

"Saving" is derived from the equations defining the uses of income and the categories of expenditures.  The expenditure equation is (in a closed economy, with neither exports nor imports):
Y = C + I + G
Where Y = the total value of production of goods and services for final use, C is consumption, I is Investment (to which we will return), and G is government purchases of goods and services (for final use).

The uses-of-income equation is

Y = C + S + T

Where S is saving and T is taxes.  Combining these two equations, we get: 

C + I + G = C + S + T , or
I + G = S + T, so
S = I + (G - T)
And, if governments do not run deficits, S = I.  But this looks very much like the classical conclusion.  In both cases, however, it is an ex post equality.  That is, it need not be the case, either in classical or in contemporary economic thinking, that planned S and planned I must be equal.  So, so far, this looks like correspondence. 

But an important difference today is that we do not think saving is confined to those who receive income from property, and we do not think that there is a more-of-less automatic transference of saving into capital.  Today, we regard saving as (mostly) the accumulation of financial assets that give savers a claim on resources or goods and services at an undefined time in the future.  Savings can consist of holdings of money, of deposits, of ownership of binds or shares of stock.  To a classical economist, however, holdings of money (however defined) were not saving--they thought of this as hoarding.  And hoarding was recognized as a problem in that it could reduce current spending on current production.

In addition, we currently think that saving is, to a large degree, undertaken by one group (households) and investment is undertaken by another (firms).  So there must be some process, and probably some set of institutions, that allows the savings of households to be channeled to firms to be spent on new capital goods.  (Yes, businesses also save.  But that does not solve the problem.  Apple saves, for example, and is sitting on a multibillion stash of financial assets.  So some of Apple's savings also have to be channeled to other firms.)  Hence the large role played by financial intermediaries in our economy.

Contemporary economic thought also has a very different conception of capital--it is very much more like the classical concept of fixed capital.  That is, capital is a resource that is re-usable in production and depreciates.  So there's a difference.

Finally, money.  We do not regard gold coin as money these days.  First of all, very few of us have any gold coin, much less use gold coin to make purchases.  Secondly, we do not define our paper currency (or our token coins) as bearing a fixed relation to gold.  Third, we now use bank deposits for many transactions, and regard the balances in those bank deposits as a medium of exchange. 

For the classical economists, money was defined more as a unit of account (e.g., in the U.S., $1 was defined as a fixed weight of gold or silver.  $1 meant 0.0484 ounces of gold (or, if you like, 1.369 grams of gold), or, in silver, 15 times as much (0.726 ounces or 20.537 grams of silver).  For us, $1 is $1, and has no fixed meaning--or value.

So it is possible, I suppose, to approach capital, saving, investment, and money as classical economists did.  And I suspect that most economists are at least aware of the differences in how we use these categories analytically today.  But it's not clear to me that using the conceptual categories as they were used by classical economists would improve our ability to analyze our economy.  We have different institutions and practices, for one thing.  We no longer think saving is confined to recipients of capital income.  We no longer regard only precious metals (or token coins and currency convertible into precious metals) as money.  So why would we want to teach or use those definitions?  How would it make understanding the contemporary economy easier for our students?

That's what baffles me.


Monday, February 17, 2014

Scary chart of the day (broadband edition)

(Click to enlarge.)

Which I found in Felix Salmon's very interesting discussion of the proposed Comcast acquisition of Time-Warner cable.

Monday, February 10, 2014

Labor Force Participation Rates for Men and Women, by Age, for Four Labor Force cohorts

This is something I've been thinking about for a while.  But I'm still not sure where it's going or what to say about it.  In any event, the following two charts show labor force participation rates by age groups, for men and women, for four age cohorts.  These are non-overlapping cohorts; the first (C48) consists of people who were just entering the labor force (ages 16-19) in 1948, and were, in 1998, 65-69.  The fourth (C63) is actually my labor force cohort, ages 16-19 in 1963, and now ages 65-69.

(Click to enlarge.)

What is happening is fairly clear.  I'm working on what it means.

Wednesday, February 05, 2014

Understanding theory

I occasionally read something so amazing that I am all but speechless:
 But to argue that you have understood classical theory when you don’t agree with a word of it makes me have to ask why you are so sure you have it right?

So the only people who can understand--and critique--a theory are those who believe--exactly how much of it do I have to believe before I can understand and critique it, again?  And, if the theory is wrong, how much of it do I have to believe before I can understand and critique it?