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The Slow Death of Neoliberalism: Part 3 The Phillips Curve and Critical Theory

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Part 1.
Part 2.

I described attacks on the Phillips Curve in Part 2. This part discusses the history of the Phillips Curve in detail, and concludes with a discussion of the problems revealed by the failure. The Observations are the fun part if this is too long.

History of the Phillips Curve

This section is based on parts 1-3 of The History of the Phillips Curve: Consensus and Bifurcation by Robert Gordon, an economist at Northwestern, published in the 2008 in the journal Economica at p. 10 et seq. (behind paywall, but available online through your local library). In 1958, William Phillips published a paper which as Gordon puts it,

… replaced discontinuous and qualitative descriptions by a quantitative hypothesis based on an unusually long history of evidence. Since 1861 there had been a regular negative relationship in Britain between the unemployment rate and the growth rate of the nominal wage rate. P. 12.

Phillips fitted a curve to data from the period 1861-1913, and plotted data for the remaining periods, through 1957 against that curve to find disagreements. Phillips found that his curve was close across the entire time except for a couple of years that he explains away. Here’s the curve Phillips fitted to his data:

1) wt = -.90 + 9.64U-1.39

Gordon says “… the inflation rate would be expected to equal the growth rate of wages minus the long-term growth rate of productivity.” P. 12.

1a) p = w – k

For some reason p is inflation and k is productivity. Upper case letters are levels and lower case letters are rates of change. So equation 1 can be written

2) p = -.90 + 9.64U-1.39 – k.

Paul Samuelson and Robert Solow discussed the Phillips results in the US context in a 1960 article. They found no similar data for the US, but they did some estimates and suggested that the PC doesn’t fit their data for several periods, and that it can shift up and down. Phillips estimated that an unemployment rate of about 2.5% was consistent with zero-inflation, while Samuelson and Solow think it might have been 3% pre-World War II and was about 5-6% in the early 60s.

With this seal of approval, the idea was incorporated into econometric models in two equations. In one, the PC was embodied and other variables were added, including demand, unemployment, the rate of change of unemployment, taxes, expected inflation and others in different combinations. This result was fed into an equation that calculates inflation based on wage levels, price levels and trend productivity. Gordon explains that

The reduced form of this approach implied that the inflation rate depended on the level and rate of change of unemployment, perhaps other measures of demand, and lagged inflation.

This is followed by a long discussion of the views of the Chicago School, which Gordon dismisses as utter failures. Moving along to 1975, Gordon turns to efforts to modify the Phillips Curve by adding supply and demand shocks. The price of oil shot up in 1973 because of OPEC. The demand for oil doesn’t decrease quickly in the short run, so people spend more on oil and less on other things. The Phillips Curve didn’t predict the results. Gordon says

The required condition for continued full employment is the opening of a gap between the growth rate of nominal GDP and the growth rate of the nominal wage to make room for the increased nominal spending on oil. P. 21, cite omitted.

That means wages must fall, Gordon says, or we have to add money to the economy, but the latter would lead to inflation. What we actually did, he says, was wage rigidity, increased unemployment, and some nominal (meaning not adjusted for inflation) GDP growth. Gordon then developed and published this version of the Phillips Curve:

3. pt = Ept + b(Ut – UtN) + zt + et

The second U term is the “natural” rate of unemployment, which I’m not going to take up. The z term represents cost-push pressure from unions and supply monopolies. The e term is apparently a constant but it seems odd that it might vary over time. Gordon explains that this version incorporates inertia, the idea that if there’s inflation in one period, there will be inflation in the next. It also reflects supply and demand issues, like wage and price rigidity.

Gordon then mentions in passing that the wage equation (Equation 1a) is only valid if labor’s share of the GDP is fixed, but it isn’t. Here’s a chart from FRED

That problem, says Gordon, is “fruitfully ignored”. We don’t need to consider wages, we just look at prices. With these changes, we can understand the past by explaining away variations with negative or “beneficial supply shocks” and other variables. Gordon says that Equation 3 is foundation of the mainstream model. There is a related model, the New Keynesian Phillips Curve which is similar except that it incorporates future expectations of inflation, and makes no specific provision for supply and demand shocks. I assume these in some combination are the models used by the Fed, and heavily criticized as discussed in Part 2.

Observations

The concept is replaced by the formula, the cause by rules and
probability. Dialectic of Enlightenment, Horkheimer and Adorno,p. 3.

1. Phillips was working off empirical data when he fitted his curve, data about inflation and the rate of growth of wages. There are some theoretical issues in the preparation of that data. But the only abstract theory he adds to his data is Equation 1a, which Gordon says has a solid base in intuition. At the time he was writing, Phillips would only have seen data supporting that theory. We have new information:

As it happens, and perhaps not surprisingly, Phillips’ Equation 1 doesn’t work on US data. Gordon himself and others start adding things to make the Philips Curve work. They are convinced that there is a link between unemployment and inflation, and that they just need to add the relevant variables from their theoretical arsenal to get it to come out. Some focus on expectations, others on supply and demand shocks, and others add taxes or something else. Once they get those pesky variables set up, it’s just a matter of solving for constants. The point is to fit a curve to the actual data, not to use the actual data to see what’s happening. The concept connected to the real world is gone, replaced by the formula. The cause is replaced by the rules of economics.

2. If we set inflation at 0 in Equation 1a, the rate of wage growth is equal to the rate of productivity growth. As the above chart shows, this relationship broke about 50 years ago. If all the gains from productivity are not going to labor, they are going to capital. Of course, capital takes several forms, for example, housing, agricultural land and other domestic capital. See, Piketty, Capital in the Twenty-First Century, Figure 4.6. When you think about it, it seems almost impossible that some of the gains from productivity weren’t going to capital all along. But in the current economy, it’s obvious that companies like Facebook can provide vastly more services with disproportionally fewer additional employees, few of whom are well paid, so that most of the gains from increased sales go to capital. Or, suppose that manufacturing is outsourced, reducing labor costs. Some of the gains might go to cutting prices but surely some go to capital. Let’s rewrite Equation 1a to reflect this, using γ for the growth rate capital.

1b) p = w + γ – k.

Using Equation 1b instead of 1a, we would have this instead of Equation 2:

4) p = -.90 + 9.64U-1.39 + γ – k.

This equation focuses attention on the changes in the return to capital. That issue never seems to trouble most economists, but the rate of return to capital is the central focus of Piketty’s Capital In The Twenty-First Century. This chart from the Center on Budget and Political Priorities shows that top wealth started on its climb at the same time wages diverged from productivity, which supports the idea that gains from productivity are going to capital:

It also calls attention to the fact that nowhere in Gordon’s paper is there a mention of power, market power, political power, or social power, all of which Piketty talks about. Actually, hidden away in Gordon’s article is a backhanded reference to power. Equation 3 (Equation 7 in Gordon’s paper) includes a term “…zt to represent ‘cost-push pressure by unions, oil sheiks, or bauxite barons’”. P. 22. Obviously Gordon understands that the power to control the price of goods and services could create a negative supply shock, and the loss of control could produce a beneficial supply shock. P. 25. However, this is not explicit, and it certainly doesn’t deal with our current economy, in which almost all goods and services are dominated by a small number of gigantic companies exercising a significant degree of price control.

The tweaking Gordon describes might work for a while, but as the degree of price control through monopoly and oligopoly power increases, and γ becomes a bigger factor, the tweaks quit working.

3. Let’s put this in a larger context. For many economists, the Phillips Curve is structural. But why would you think so? It seems more likely that the relationship holds in a certain set of social conditions, including legislation and regulation, power conditions, and people’s attitudes. A logical use of the data is to work out the conditions that must exist to make it so. That’s how Piketty approaches his inequality data.

It’s a mistake to use a coincidence to predict the future. It seems to be a particular problem in economics. Even people who seem to know better continue to believe in the Phillips Curve. Here’s the President of the Boston Fed, Eric Rosengren:

A number of papers at the conference highlighted that some of the economic relationships that are frequently assumed to be stable over time have proven to be not so stable as we have come out of the financial crisis. These structural changes mean that if you tried to have a model that was fairly invariant to these changes, or a process that was invariant to these changes, there would start being big misses in monetary policy.

He goes on to explain that we have to raise interest rates because maybe not the Phillips Curve, but when employment goes up, inflation goes up. Rosengren knows there’s a problem, but he doesn’t have any idea of how to cope, so he keeps doing what he thinks he knows is right. It’s another example of Horkheimer and Adorno’s statement in action.

Updated to define γ more exactly.

The Dialectical Imagination by Martin Jay: Conclusion On Labor Day

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This series has been wonky, even for me. The Dialectical Imagination by Martin Jay is an eye-opening description of the creation of Critical Theory, a way of approaching the social sciences that is still important today, although the forces of formulaic empiricism are gathered against it. The insights of the scholars of the Frankfurt School were remarkably prescient, and are crucial today. They give a nice description of Homo Economicus in Dialectic of Enlightenment, p. 175, long before Friedman and Hayek began their push to create the new human. They were also right about the culture industry and the effect of mass culture. Michael Moore tells a version of this story in his movie Columbine.

But for me, the most important insight is the form that reason took during the Enlightenment. This is from an interview of Michel Foucault in 1978.

… I think that the Frankfurt School set problems that are still being worked on. Among others, the effects of power that are connected to a rationality that has been historically and geographically defined in the West, starting from the sixteenth century on. The West could never have attained the economic and cultural effects that are unique to it without the exercise of that specific form of rationality. Now, how are we to separate this rationality from the mechanisms, procedures, techniques, and effects of power that determine it, which we no longer accept and which we point to as the form of oppression typical of capitalist societies, and perhaps of socialist societies too? Couldn’t it be concluded that the promise of Aufklärung (Enlightenment], of attaining freedom through the exercise of reason, has been, on the contrary, overturned within the domain of Reason itself, that it is taking more and more space away from freedom?

The rationality Foucault is talking about here is the same one the Frankfurt School aimed at: the systematic logic of science and technology, focused by a drive for dominance over nature and over human beings. Our society is controlled by system of mechanisms, procedures, techniques and effects of power that focus that logic and allow it to dominate us. That project is far from complete, but we can see its outlines. The political system supports only one kind of life, a life focused on work. The solution to every problem is “Get a Job”. Schools are focused on jobs training, almost from the outset. Those without jobs are scorned and openly vilified, at least if they aren’t rich.

Businesses are focused on achieving dominance. The goal is monopoly and monopsony power, or at least oligopoly and oligopsony. They lobby for laws that free them from responsibility and give them the widest possible scope to control the lives of workers, and the freedom to screw the worker as it suits managers. They pay off courts and legislators to get their way. They demand trade conditions that permit them freedom at the expense of the rest of us. Those who best succeed at dominance get all the money, and corporations fight efforts to limit their income, even by disclosure.

Dominance entails a related submission. People readily allow the growth of dominance. We tell ourselves that our work is fulfilling, and that we are making a contribution, but just ask yourself how much of your work day is filled with mindless and stupid crap that shouldn’t be done at all. Most of us work for entities which are working towards dominance, and our own work is measured by how much we contribute to achieving dominance for the employer. Those not directly involved in establishing dominance are outsourced. That has led to a two-tier economy, in which people who can directly support the drive to dominance are made actual employees and rewarded, and those who don’t are pushed out into dead-end temp, contractor, adjunct or gig jobs.

A people who once fought and died for a fair share of the productive pie now accept flat wages, grotesque inequality of wealth and income, and slowly decaying prospects for our children. We carelessly threw away the protections our parents and grandparents won for us, 40 hour work weeks, paid vacations, fair taxation, and all those communal benefits from fairly priced colleges and tech training to decent mass transportation.

We all understand the reason for these losses. We just can’t afford this stuff. We can’t pay for essentially free college and technical training. If businesses have to pay fair wages, some foreign company will under-price them and put them out of business. If we tax the filthy rich, they’ll leave for the Cayman Islands and take their jobs with them. If we don’t put in 65 hour weeks, someone else will. We don’t have money for mass transit, so we sit on the road in heavy traffic. We give up our hours to traffic, our money for schooling, and our lives for a company that will dump us when it can.

All this is guided by the formal logic of capitalism, so we understand it. That’s the rationality Foucault and the Frankfurt School are talking about.

Each of these losses makes us less free. Every surrender to the formal logic of capitalism makes us less free. Every bit of information that Amazon and Facebook and Apple and Google and all the rest glom onto makes us less free, easier to manipulate. That’s the rationality of capitalism. That’s what comes of formal logic divorced from understanding and recognition of the wide variety of possible purposes. That’s what happens when the only thing that matters is dominance. That’s what happens when we submit to economic dominance.

The promise of the Enlightenment was that we could achieve freedom through reason. Seventy years ago the creators of Critical Theory told us that was wrong. Today we are learning how right they were.

The Dialectical Imagination by Martin Jay: The Enlightenment

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Chapter 8 of The Dialectical Imagination by Martin Jay discusses Dialectic of The Enlightenment, written during WWII by Max Horkheimer and Theodore Adorno and published in 1947. I haven’t read the book, though thanks to commenter Neighbor6 I have a copy, so this discussion is all based on Jay’s description. Dialectic of The Enlightenment (my copy is titled Dialectic of Enlightenment, but I will use Jay’s) opens with this:

Enlightenment, understood in the widest sense as the advance of thought, has always aimed at liberating human beings from fear and installing them as masters. Yet the wholly enlightened earth is radiant with triumphant calamity. Enlightenment’s program was the disenchantment of the world.* It wanted to dispel myths, to overthrow fantasy with knowledge.

The footnote references Max Weber’s quote, which I found here:

The fate of our times is characterized by rationalization and intellectualization and, above all, by the disenchantment of the world. Precisely the ultimate and most sublime values have retreated from public life either into the transcendental realm of mystic life or into the brotherliness of direct and personal human relations. It is not accidental that our greatest art is intimate and not monumental.

I think that’s how most of us would characterize the Enlightenment, as closing the door on superstition and opening the door to scientific inquiry. The obvious dark side of this apparently good thing is that nature becomes an object for study and manipulation; and human beings who are part of nature become objects for study and manipulation as well. The point of scientific inquiry moved quickly from an effort to understand to an effort to dominate. Science was primarily directed at supporting the production of goods and services and war machines. Adorno wrote that if Marx had his way, the whole world would become a “giant workshop” P. 259. Philosophy also became an element of the support system for a society based on industrial production. Kant’s effort to generate a morality from first principles failed, but for decades, it provided a basis for the morality that supported the capitalist system. Then the full potential of the power to dominate became clear as Hitler and Stalin achieved total domination and pushed the world into a nightmarish war.

A second problem, beyond domination, is the reductionism of science. As Horkheimer put it, “the formula supplants the image;”. P. 270. All that does not serve the capitalist system, about humans, animals, resources, the atmosphere and the planet itself, all of that is meaningless and is ignored. That includes all those spiritual and communal feelings that hold people together in groups of all sizes. It also includes our fellow feelings with other creatures, our feelings of oneness with the natural world, our gratitude for the bounty of the world, our respect for the beauty and power of the world, all useless and meaningless.

Jay begins Chapter 8 with a quote from Max Horkheirmer

If by enlightenment and intellectual progress we mean the freeing of man from superstitious belief in evil forces, in demons and fairies, in blind fate—in short, the emancipation from fear—then denunciation of what is currently called reason is the greatest service reason can render. P. 253.

Given the results of the 20th Century, Horkheimer can easily be excused for taking this pessimistic view. In any event, the idea of domination of nature became the focal point of the work of the Frankfurt School after WWII as the scholars worked to understand its ramifications. In a way, that work replaced the goal of unifying theory and practice, a central goal at the beginning of the Institute for Social Research, as it became obvious that this was not feasible. It was the last break with Marxism.

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Jay doesn’t explain why the Frankfurt School’s effort to combine theory and praxis failed, and why the scholars of the Institute concluded that philosophy and what they called speculative thought cannot provide a way towards social revolution and the betterment of society, so I’ll take a shot. One of the things I see in Jay’s book is that the scholars of the Frankfurt School believed deeply in the openness of the future. Jay writes:

In fact, the Enlightenment, for all its claims to have surpassed mythopoeic confusion by the introduction of rational analysis, had itself fallen a victim to a new myth. This was one of the major themes of the Dialectic [of The Enlightenment]. At the root of the Enlightenment’s program of domination, Horkheimer and Adorno charged, was a secularized version of the religious belief that God controlled the world. As a result, the human subject confronted the natural object as an inferior, external other. At least primitive animism, for all its lack of self-consciousness, had expressed an awareness of the interpenetration of the two spheres. This was totally lost in Enlightenment thought, where the world was seen as composed of lifeless, fungible atoms: “Animism had spiritualized objects; industrialism objectified spirits.” P. 260.

The scholars of the Institute completely rejected the idea that the world is closed; they saw it as infinitely open, and driven by human action. The world is not a collection of mindless fungible lifeless atoms, operating under simple laws or under the control of God. Instead, its future is open, radically open, open in ways we can’t imagine. Any social theory that could predict the future would have at its root the assertion that the social world, the world we humans create, operates under a set of definitive and permanent rules, like a clock or a computer. If there is no God, if there are no computer program, then how is it possible to create a theory that would lead to a praxis that would lead to a better society?

On the other hand, once we imagine ourselves, us humans, as part of a boundless and terrible and beautiful universe, we open up a vast panorama for action. The goals of that action are set by humans, hopefully through a decent political process, hopefully guided by our best thinking and our best judgment. That process continues even as Republican thugs carry on their war on the entire world. And it’s worth noting that nature, far from being dominated by humans, is quite able to overwhelm us.