Why it matters who is in office.

Some say it matters little whether Republicans or Democrats are in power. Both are equally bad (or good). Given the current concern about unemployment (as of November, 2009) I thought I would take a look at how unemployment fared during Republican and Democratic regimes. The results are stunningly consistent. Unemployment always goes up during Republican regimes and down during Democratic regimes. So when it comes to unemployment, the data suggest that it is always unwise to vote in Republican regimes (that is, assuming one considers unemployment a bad thing). It is always better to have a Democratic regime, unemployment-wise, no matter who that Democrat is. The chart below shows why.

Note that when the blue "regime" line is high (Democratic regime) unemployment always is lower at the end of the regime than at the start; when the "regime" line is low (Republican regime) unemployment is always higher at the end of the regime than at the start.I can't help but think that this has something to do with Republican versus Democratic policies, but, then, correlation doesn't imply causality; it could just be that Republicans have real bad luck.

Wealth and Closed-Loop Economics

Here's more follow-up on taxes and the rich.

I didn't understand economics either until rather recently. It turns out that economics is my specialty-- control theory applied to living systems -- writ large. Economics is very clear and obvious when looked at from a high enough (macroeconomic) level. It's just people collectively controlling, via specialized production, for the goods and services they want and need

As far as whether or not the rich (wealthy) create jobs or not, I think we first have to distinguish the rich (who have a lot of money) from producers (who do create jobs). Job producers are often rich; but Bill Gates (and the Google guys) were not rich when they first created the jobs. And the scions of the Mars family are rich but they are mainly clipping coupons now. Their candy company certainly creates jobs but most of the rich heirs of Mr Mars no longer do.

My point is that jobs are not created by people with excess capital but, rather, by people (management, who are sometimes rich, sometimes not) who are running companies producing goods and services using people (and capital equipment) in jobs. Management will increase or decrease the number of jobs depending on demand for those goods and services (there's the market at work). Demand depends on people (consumers, who are the same as the people occupying -- or not occupying -- jobs) having money that they can use to purchase what is being produced. If many people don't have jobs, there is less demand and, thus, no need for more jobs.

In a closed loop economy (as all economies are), it is the existence of jobs that creates and maintains jobs. It's not the wealth of the producer that "drives" job creation (and maintenance); it's the wealth of the consumers who have the jobs (and that includes the job of manager; in a closed loop economy producers and consumers are, to a first approximation, the same people) that creates and maintains the jobs; because without jobs there is no demand for what is being produced.

You are right about the "middle class" being an arbitrary concept. Where one draws the line for where the middle ends and the rich (and poor) starts is rather arbitrary. I think of these terms (middle class, poor, rich) as just a way of talking about the skew of the income distribution.

The data on wealth discrepancy (http://www.mindreadings.com/WealthDiscrepancy.jpg) shows that the income distribution is very positively skewed, which means that the main (middle) "bulge" of this distribution is way down toward the low end of possible income values. So the "middle" income bulge, representing probably 90% of the population, gets lower and lower as the upper .01% control more and more of the wealth. So when I say the middle class is disappearing I just mean that the middle income "bulge" is going lower and lower relative to the range of possible income values; wealth discrepancy is increasing.

There is a real problem for a closed loop economy when you get very high levels of wealth discrepancy. Wealth is just demand potential; as more wealth moves to the upper .01%, middle income consumers have less ability to consume. And the upper .01% has more than they can possibly use to consume; they are basically hording demand capability. The result is recession or depression. That's what the graph shows. Note the 2 dates when wealth discrepancy peaks: 1929 and 2007.

I think the economy didn't tank as quickly in 2007 as it did in 1929 because these days we have a cushion (like a capacitor) in the system that maintains demand and prevents (at least for a few months) a precipitous collapse (as happened in 1929); that cushion is credit. Nowadays, consumer demand is maintained, to some extent, because people have credit cards and can take equity out of homes. Of course, when that became impossible (the "credit crisis") then the economy tanked, just as I had predicted it would as soon as Bush was re-elected.

Conservatives just don't understand closed loop economics. Liberals don't either but their bias toward egalitarianism leads them to adopt policies that are typically better for the economy because they reduce wealth discrepancy. That's why the economy has always fared somewhat better under Democrats. But it's really just been a lucky side effect of their "liberal" social biases. There is no science of closed loop economics yet; until there is, all economic policies will basically be based on voodoo.

Taxes and the Rich

I'm afraid I am not very good at maintaining this blog. But here's a reply I sent to a friend in response to this article: http://www.creators.com/opinion/larry-elder/in-defense-of-the-rich.html. I'll just put my reply up here for the record.

The Larry Elder article makes two points with which I take issue. The first (which required the development of a spreadsheet) is that the rich (top 5%) pay 60% of taxes. Again, this is misleading because it does not take into account the proportion of taxable GDP that goes to the rich. If we assume that 50% of taxable GDP goes to the rich (a conservative estimate; I've seen estimates of over 90%) then my spreadsheet shows that the average effective tax rate for the upper 5% is 20%, which is about what both Bush (24%) and Cheney (20%) paid in taxes, according to Elder's figures. The bottom 95% pays an effective average of 14% in taxes, which is lower than that for the rich but we're hardly talking about rates that "soak the rich". In fact, this is very close to a flat tax, which is quite regressive.

Elder's second point, mentioned in an aside, is that the rich are "job creators". I know of no evidence that this is the case; the claim seems to be based on the _theory_ that the rich use their money to "build up" their industries, which creates jobs. But this theory ignores the fact that producers only expand production when there is demand for what will be produced. And demand requires consumers who have the money to buy what is produced. And consumers get their money from working jobs. When there is high unemployment there is low demand so the "rich" are not inclined to invest in expansion and hiring. If they were so inclined, that would fix things right up. But the data suggest that investment doesn't occur until _after_ there is growth in consumption.

The growth in consumption can happen simply because the economy bottoms out or because the government intervenes and produces consumers (by hiring people to do stuff that industry doesn't want to do, like improve infrastructure). The lesson is that it is _both_ the rich (through capital investment) and the middle class (by having jobs and, hence, money which maintains demand) who create jobs: it's a closed loop system. ... Read More

By the way, this is the problem with all contemporary economic models; they don't take into account the closed loop nature of an economy. The free-marketers think the economy is driven by producers; the socialists think it is driven by consumers. And control theorists like me just sit on the side lines and hollish;-)

Money and the Economy

Now we move to the role of money in the economy. Keep in mind that the essence of an economy, from my point of view, is control. Individuals are acting to produce products (goods and services) that are consumed as inputs. Each individual controls for consuming a reference amount of these products. To the extent that individuals are doing this successfully -- consuming the goods and services that they want -- they are in control. When there is specialization, the products that individuals in the group want to consume are, to some degree, produced by others. This means that all individuals in the group depend on each other, to some extent, to be able to control their own inputs.

What each individual depends on is having others -- farmers, hunters, child rearers, cooks, etc -- who specialize in producing certain products -- grain, meat, care, food preparation, etc -- provide the products they want to consume but that they don't produce themselves. The obvious way for individuals to obtain these products is to trade their own products for those produced by others. This exchange of products (goods and services) is, of course, a market.

As I noted in my earlier post, the market for exchange of products in small groups can be very informal; like the informal exchanges that go on in a family group ("if you make dinner I'll set the table") this wouldn't even look like a market. Some people in the group just agree to specialize in producing one product (perhaps a service such as child care) while others agree to produce another (a good such as food). The child rearers take care of the kids while the hunters are out producing food, which they bring back and share with the child rearers. Despite the specialization -- which (as Adam Smith noted) improves the ability to produce goods and services but makes individuals dependent on others for producing some of the products they want to consume -- everyone is able to control their inputs successfully because there is cooperation.

True markets, where there is what I would call quantitative exchange of the goods and services produced through specialization, probably emerged as both specialization and the size of the economic group increased. I imagine that the first quantitative exchange markets involved barter, which simply means that each person would exchange some amount of the specialized things they produce for the specialized things that others produce. So the potter trades a pot for some amount of grain from the farmer and some amount of childcare from the caregiver; the farmer trades some amount of grain for the a pot and some childcare; and the caregiver trades some childcare for grain and pots. The amount each trades for each is determined by a "bid-ask" control process; the bidder has some reference amount (of his own product) that he is willing to pay and the asker has some amount (of his product) he wants to get. This interactive control process will generally converge to a point where the bidder pays about what he's willing to pay and the asker gets close to what he wanted to get. This market process, then, determines what each product (of specialization) costs in terms of all the other products. It is quantitative in the sense that the cost of each good or service exchanged in the market can be measured in terms of the number of other goods and/or services needed to obtain it.

I imagine that the market process using barter would be somewhat cumbersome, especially when the goods and services to be traded are hard to subdivide. If a camel is worth 2 years of grain, 2 years of childcare or 10 ceramic pots, how do you use it to get the 6 mos of grain, 6 mos of childcare and 2 pots that are the products you actually want to consume. The answer is "money"; a common medium of exchange that would let you "divide" the camel into smaller purchasing parts (monetary units). So if the camel is worth 1000 units, then 6 mos of grain is 250 units, 6 mos of childcare is 250 units and 2 pots are 200 units. If you can sell the camel for 1000 units you can buy what you need and have 300 units left over to get other stuff.

Money itself is just a symbol for what things are worth in terms of what other things are worth. All that the money units themselves must be are relatively small (so it's easy to carry or store many of them), durable (so that they don't rot away) and hard to counterfeit (for obvious reasons). This is why gold is a good monetary medium; it has all these properties. It also has the property of being valued in itself This probably led to the belief that money itself must have value. But this is clearly not true as the success of paper money attests. It's not really value that is needed but agreement (a reference or goal shared by all individuals) that whatever is used as money will be accepted in exchange for the goods and services produced by the group.

So, for me, money is just a convenient quantitative symbol for how much of one good or service is needed in exchange of another. The exchange rate -- how may fractions of a camel are needed to but 6 mos of grain, for example -- is determined by the market. How this market works seems to have been the main interest of economists. As a non-economist, I'm content to accept that the markets work (trough the bid-ask control process mentioned earlier). The market works in the sense that the "exchange rate" for goods and services is fairly constant over time (ignoring inflation and deflation for the moment). The market provides a fairly stable solution to the assignment of monetary value to different goods and services.

What is interesting to me about money is not so much how it gets it's "value" (how the market works) but the fact that it is a way of dealing with specialization. Money facilities control of the products people want to consume as inputs but that they themselves have not necessarily produced. So money allows me to go to the market and buy the food I have not grown, take a ride in the airplane I have not built and fix the car that I can't fix. I do this by purchasing these products with the money that I am paid for the specialized goods and/or services that I produce. Again, an economy is, I believe, all about control; but it's about that special kind of control where many of the products each individual wants to consume are produced by others. Money is just a means of facilitating people's ability to control this consumption (input).

The story would end there except that money introduced some interesting new capabilities (and problems) that have to be considered when trying to model an economy. I think the most dramatic new capability introduced by money is "time binding", to use Korzybski's felicitous phrase. In this context it may be better to call this "anticipatory control". Unlike many of the goods and services that money can buy (such as food and paper plates), money doesn't spoil (well, it can spoil people but the money itself stays the same). So it can be stored (saved). This saved money can then be used to time bind by being loaned to purchase goods and services now with the promise of payback in the future. This capability led to the development of a banking and financial sector of the economy. Banking and finance involve individuals providing products (financial goods and services) that allows them to control present inputs using outputs that will occur in the future. I'll try to deal with this in the next episode.

What is an Economy?

My ideas about economics start with imagining the simplest possible economy; a single individual human. I view this individual as an economy of one. Being a purposeful agent, this individual acts to control his inputs, the most important being those that are necessary for survival: food, water, and oxygen, etc. These inputs are controlled relative to specifications that are set autonomously inside the controller himself. In order to control, say, water input, the controller must vary his actions appropriately (going to different locations to find filled streams, building a cistern to collect rain water, etc) to compensate for disturbances (dried up streams, drought periods, etc) and keep the water input at its specified level.

This control process embodies the main components of an economy: production and consumption. The controller is acting to produce products that it can consume as inputs. So the simplest economy is the controlling done by an individual. At the level of the individual, then, economics is the same as psychology; it is simply the science of control. Economics separates from psychology once many individual controllers are involved. But it's not just the number of controllers that matters; what matters is how these individuals organize themselves into societies of controllers. As Adam Smith points out, the most significant thing about a collection of humans that makes up an economy is specialization in terms of production. From a control theory perspective, specialization means that now individuals in a group no longer produce everything they consume; part of each person's controlling is done by others. The individual who used to control his food input by doing his own hunting, butchering and cooking now depends on others to do this, while he takes care of producing other things, perhaps services like child rearing, which help control inputs for others as well as, possibly, himself.

Once we have specialization we have people depending on each other for the control of their own inputs; cooperation is essential. This makes specialization somewhat risky; non-cooperation by those producing the food could mean loss of control of food input by those who are specializing in child care, for example. But apparently people are very good at cooperating, at least in their own tribal groups, so specialization probably got started very early in human evolution. Small bands of humans were, thus, the first multi-individual economies, with some people specializing in hunting, others in food preparation, others in child care, etc. At this point there was probably no need for bartering or money; with very little specialization it is probably easy to share the fruits of specialization; the food producer just shares food with the child raiser and doesn't worry about how much child rearing is needed to get a certain amount of food. Anthropology might help at this point; it would be interesting to know whether there are small groups of people where there is some degree of specialization (division of labor) that allows individuals in the group to control for what they need (survive) without the need for barter or money.

So the essence, for me, of a multi-individual economy -- the kind of economy studied by economists -- is specialization, where each individual's ability to control their inputs depends, to a certain extent, on what is produced by every other individual. An economy is interdependent or "collective" control by a group of individual control systems. The interdependence is required by specialization. The success of this kind of control depends on cooperation; sharing. If the people who makes the food won't share with the people who take care of the kids, for example, then specialization won't work;it is literally every man (and woman) for himself (controlling alone).

Dear Robert Reich

Here's a little note I sent to Robert Reich in my never ending attempt to find out why economists think taxes are recessionary. Apparently, Reich doesn't think they are, which is a nice surprise. So I wonder what he knows that all the other economists don't. I don't really expect a reply from Robert. I also wrote to Paul Krugman and he hasn't replied, even though we share birthdays.

This is an excellent article, Robert. But I have one question. You say, regarding the conclusion of the Bank of America Merrill Lynch report that Congress and the White House should be careful not to raise taxes on the top 10 percent, that "this logic is morally and economically indefensible". I agree that it is morally indefensible but I wonder why you say it is also economically indefensible. All economists, liberal and conservative, seem to agree that raising taxes is always recessionary. I had always assumed that this consensus was based on data. But I recently did an analysis where I looked a the relationship between annual growth rate (dGDP/dt), annual top marginal tax rate (TR) and annual unemployment rate (UR) for the years 1947 to the present and got these results:

dGDP/dt w/TR.....0.18
UR w/TR...........-0.23

These correlations go in the "wrong" direction: increasing the top marginal tax rate is associated with increased growth and _decreased_ unemployment rate. Did you know about these relationships when you said that the recommendation not to raise taxes on the top 10 percent was economically indefensible? Are you the only economist who knows this? Why are not more economists using this readily obtainable data to rebut the lie that increasing taxes on the wealthy is recessionary? Why in the world have so many economists assumed that taxes are recessionary in the first place?

Rick Marken

Government, Business and Freedom

Here's some thoughts from William T. Powers that were "inspired" by some of my discussion of taxes. I think they are worth making a Mental Note of:

A sudden thought inspired somehow by this thread. Maybe it was the back-and-forth between government spending and private spending. It suddenly struck me that what is meant by "private" is not the consumer or wage-earner, but the dictatorships that divide the United States into both large and small power centers: businesses.

Businesses are not democracies. They are owned; their policies are determined by their owners. The rules that govern the workers are not voted upon; they are announced. The division of income between workers and owners is whatever the owners find they can get away with and still have the business function; the owners almost always take a share vastly larger than any one worker's share. When economic conditions reduce the owners' income, workers are simply disposed of and left to fend for themselves. Workers who complain publicly about the business policies, or who reveal illegal or dishonest activities by the business, can be dismissed without trial or hearing. Businesses compete; they do not work together for the common good.

I'm sure that many other aspects of the business dictatorships could be spelled out. Other terms, of course, could be substituted, such as kingdom or duchy or fiefdom, as long as the meaning is "control of the many by and for the benefit of the few." I think that is the main underlying conflict in the United States and elsewhere.

I wonder what would happen if this view were more publicly discussed?