Greasing the Way for the Merkel-Putin Pact (Or Who Says History is Bunk, Part ?)

The Molotov-Ribbentrop Pact was all smiles in 1939 (“such methods were part of foreign policy at that time”) until Stalin found himself with his back against the wall in June, 1941.

Vladimir Putin’s recent remarks on the irreproachability of the 1939 Molotov-Ribbentrop Treaty (see also FT.com report) between the Soviet Union and Nazi German (aka the Hitler-Stalin Pact) underscores his desperate drive to reach an accommodation with Germany after the crisis triggered by the annexation of the Crimea and the destabilization of Eastern Ukraine. With the ruble now in free fall, weak oil and gas prices, Western sanctions, and a costly stalemate in the Ukraine, he apparently needs to pull more than a domestic patriotic rabbit out of the hat to prevent disaffection with the souring Russian economy.

Readers of this blog will recall that the Creditanstalt Intelligence Bureau as long ago as March 20 identified the coded olive branch Putin extended to Germany in his Crimean annexation speech. The CIB also identified the goal of this initiative on April 7: a Merkel-Putin Pact restoring lost territory to Germany (Königsberg and Polish Pomerania and Silesia) in exchange for recognition of Russia’s Ukrainian annexations and the guarantee of strategic trade of Russian gas and oil against German machinery and cars.

In a gradual campaign to remove the opprobrium such a pact would incite, Putin has begun to relativize the infamy with which the Molotov-Ribbentrop Pact has hitherto been regarded by both Western and Russian historians. This is all the more astonishing when one recalls that, quite aside from the morality of the secret protocols partitioning Poland, the Soviet Union continued to supply Nazi Germany with the essential raw materials and food it needed to mount surprise attack Operation Barbarossa right up to the end on June 22, 1941, long after the Nazis had begun reneging on their part of the agreement. In Putin’s own words, such methods were part of foreign policy at that time, a statement that may come back to haunt him.

Who will be smiling for how long should a Merkel-Putin Pact be in the offing? (Picture source: Deutsche Welle)

Too busy bulldozing the world economy to blog (or: the Sicilian connection)

The Buck Stops Here (Or: I Shot the Sheriff, But I Didn’t Shoot the Deputy)

 

Left: US President Harry S. Truman at his White House desk with the famous sign “The Buck Stops Here”* (Image: Wikimedia Commons). Right: Russian President Vladimir Putin and his advisers observing a minute of silence on July 17 for the victims of the MH17 airline disaster in the Eastern Ukraine. No such sign is visible.

July 17, 2014, Vladimir Putin on the MH 17 crash:

“And certainly, the government over whose territory it occurred is responsible for this terrible tragedy.”

June 4, 2007, Vladimir Putin on the extradition of Alexander Litvinenko’s accused murderer Andrei Lugovoy to the UK:

“I have mixed feeling about this particular request. If the people who sent this request to us did not know that the constitution of the Russian Federation prohibits extradition of Russian citizens to foreign states -- if they had not known that, then certainly their level of competence is questionable. If they knew that and still did send that request, then it's only a political PR step. From whatever angle, it's complete nonsense.

Finally, the British authorities have allowed many thieves and terrorists to live in their country, and this is precisely the real danger to British citizens.”

November 24, 2006: Sergei Abeltsev, State Duma member from the LDPR, on the death of FSB defector Alexander Litvinenko in London:

"The deserved punishment reached the traitor. I am confident that this terrible death will be a serious warning to traitors of all colors, wherever they are located: In Russia, they do not pardon treachery. I would recommend citizen Berezovsky to avoid any food at the commemoration for his accomplice Litvinenko."

Oct. 10, 2006, Vladimir Putin on the murder of journalist Anna Politkovskaya:

“… that perhaps because Ms. Politkovskaia held very radical views she did not have a serious influence on the political mood in our country. But she was very well-known in journalistic circles and in human rights circles. And in my opinion murdering such a person certainly does much greater damage from the authorities’ point of view, authorities that she strongly criticized, than her publications ever did. Moreover, we have reliable, consistent information that many people who are hiding from Russian justice have been harbouring the idea that they will use somebody as a victim to create a wave of anti-Russian sentiment in the world.”

In his “self-portrait,” First Person, published in 2000, Vladimir Putin denied categorically that the Russian Secret Service FSB was involved in the 1999 apartment house bombings:

“What?! Blowing up our own apartment buildings? You know, that is really…utter nonsense! It’s totally insane. No one in the Russian special services would be capable of such a crime against his own people.”

---

* American colloquial expression: The saying "the buck stops here" derives from the slang expression "pass the buck" which means passing the responsibility on to someone else. The latter expression is said to have originated with the game of poker, in which a marker or counter, frequently in frontier days a knife with a buckhorn handle, was used to indicate the person whose turn it was to deal. If the player did not wish to deal he could pass the responsibility by passing the "buck," as the counter came to be called, to the next player.

* Russian military designation: The “Buk” missile system (Russian: "Бук"; beech, /bʊk/) is a family of self-propelled, medium-range surface-to-air missile systems developed by the Soviet Union and its successor state, the Russian Federation.

 

American “buck” designates who had responsibility for dealing in a poker game (left). Russian “buk” (beech tree), a sophisticated mobile surface-to-air missile (right).

Nitpicking Piketty Productively. Part I: Real Capital vs. Piketty Asset Wealth

The Piketty bubble still shows no signs of bursting (au contraire: Chris Giles’ rather limp attempt in the Financial Times to turn it into another Reinhart-Rogoff data debacle has given it a new lease on life). Surprisingly, however, a number of rather fundamental and elementary issues have been largely overlooked or mentioned only in passing in the voluminous print and online discussion. Yet these issues bear rather crucially on what Piketty sets out to do in his book, at least in his grander ambitions going beyond the data analysis for which he is professionally known. To a certain extent they vitiate much of his analysis, yet at the same time I think they can be reassembled into a much more interesting analysis of wealth and economic growth than the rather crude one he presents (the infamous r>g).

Reassembling this Humpty Dumpty is what I plan to do in these “Nitpicking Piketty Productively” posts.

Let me start with a simple conceptual issue. Thomas Piketty’s professional core competence is in the analysis of disparate data sources to provide long-term historical overviews of household income and wealth distributions. In this, along with his colleagues Tony Atkinson, Emmanuel Saez and Gabriel Zucman, I think we can safely say we are dealing with the best authorities in an empirical area that is inherently difficult to measure, inconsistent and incomplete, and thus will always be open to debate. Nevertheless, these gentlemen must be credited  with making a valiant effort to fill the gap.

It is when we start to move away from Piketty’s core competences that we increasingly encounter confusion.

The Basic Conceptual Problem

Piketty starts with the fairly well-defined notion of Private Household Wealth (PHW) but ends up conducting the analysis (as his title Capital in the Twenty-First Century pretty much compels him to do) in terms of something not coincidentally reminiscent of Marx, namely Capital. This turns out to be an exercise in bait-and-switch, as Piketty himself can not help being aware as an economist in good standing. And it leads to a completely misleading and inconsistent analysis, at the data, historical and theoretical levels. Robert Solow, in his review in the New Republic, immediately identifies this problem, which should have been obvious to anyone with a background in growth theory, but neglects to examine just how far reaching it turns out to be:

There is a small ambiguity here. Piketty uses “wealth” and “capital” as interchangeable terms. We know how to calculate the wealth of a person or an institution: you add up the value of all its assets and subtract the total of debts. (The values are market prices or, in their absence, some approximation.) The result is net worth or wealth. In English at least, this is often called a person’s or institution’s capital. But “capital” has another, not quite equivalent, meaning: it is a “factor of production,” an essential input into the production process, in the form of factories, machinery, computers, office buildings, or houses (that produce “housing services”). This meaning can diverge from “wealth.” Trivially, there are assets that have value and are part of wealth but do not produce anything: works of art, hoards of precious metals, and so forth. (Paintings hanging in a living room could be said to produce “aesthetic services,” but those are not generally counted in national income.) More significantly, stock market values, the financial counterpart of corporate productive capital, can fluctuate violently, more violently than national income. In a recession, the wealth-income ratio may fall noticeably, although the stock of productive capital, and even its expected future earning power, may have changed very little or not at all. But as long as we stick to longer-run trends, as Piketty generally does, this difficulty can safely be disregarded.

Unfortunately, this difficulty cannot be safely disregarded either in the short or the longer run because it leads to disparities on the order of seven to one in some epochs and divergent trends between the private wealth/income and “real” capital/income ratios. And it totally vitiates Piketty’s rather hapless attempt to draw on standard economic growth theory to explain these ratios. Shame on you, Bob Solow, for not seeing this (and also for using the aggregate neoclassical production function in your growth model)!

Capital vs. Wealth: What the National Accounts Say

So, how big is this disparity, and how does it evolve over time? Let’s take a quick peek using data on nonresidential capital (equipment and structures) from Maddison (1994, 2003) and on total and nonresidential fixed assets from the US government’s national accounters (Bureau of Economic Analysis—BEA):

Fig. I: Nonresidential capital-output ratio for four countries (Source: for nonresidential capital stocks Maddison 1994, Maddison 2003 for pre-1890 USA,), and for GDP Maddison GDP database, all in 1990 Geary-Khemis $).

Fig. II: Capital-output ratio in the USA since 1890: 1) using Maddison (1994) nonresidential capital stock estimates and Maddison GDP database as above, 2) BEA nonresidential and 3) BEA total fixed asset estimates (including residential but excluding consumer durable) stocks at current cost, divided by BEA current $ GDP.

Fig. III: Piketty on the national “capital-output ratio” for Germany, France and the UK.

Fig. IV: Piketty on the national and private “capital-output ratio” for the US. Compare with Fig. II.

In our figures I and II capital is being measured by Maddison and the BEA using the perpetual inventory method* applied to gross investment in “real” factors of production—equipment and structures—valued at their current cost at the time of observation. Thus this represents a running account of the forsaken consumption in present prices of the accumulated and still operational investments of the past (on various, possibly questionable, assumptions about the lifetimes, mortality and depreciation rates of these different productive assets) as factors of production. What immediately stands out is that Piketty’s definition of capital for the UK is over seven times larger before 1910, and twice as large (somewhat less if we include residential assets) even for the US after 1950. In Europe, the “real” measure does not display the massive decline between 1910 and 1920 that the Piketty measure does. Moreover, while the “real” capital-output ratio has been systematically increasing after WW2 in the UK, Germany, France, and Japan, it has actually been slowly decreasing in the US from its very high value of over 300% (abstracting from the gyrations during the Great Depression and WW2 due to extreme shifts in the rate of capacity utilization) before 1930 to its present value of around 200%, with the values roughly converging internationally, as one might expect from a theory of technological catch-up. Thus the discrepancies between a national accounts, fixed assets at current costs definition of capital (what I have been calling the “real” capital-output ratio) and Piketty’s is not, as Solow suspected, only a temporary aberration, but in some periods huge and systematic.

Why is this the case? We need to go back to the basics in National Accounting to see why. Capital as defined by Piketty (which I will hereafter denote as Piketty Asset Wealth—PAW) is the net value at current market prices of all long-lived assets capable of generating a monetary return from some combination of annual profits, dividends, rents, interest, pension benefits or capital gains (price appreciation) held by private households, businesses and the state.

Let me break these assets up into seven categories:

1. Real Producible Productive Capital (RPPC): real produced goods saved from current output, such as equipment and structures, that instead of being consumed are reinvested and live on for longer than a production period to aid in the production of future goods. This is the traditional definition of Capital or Fixed Assets in national accounts and growth theory: machinery and equipment, factories, infrastructure. This will show up as direct ownership of business assets, and indirectly as ownership of equities, stock mutual funds, and claims on pension funds invested in equities. A not inconsiderable part of this is not privately owned (around 15% in the USA) and thus will not show up in private PAW. At one time even slaves fell into this category, but after emancipation magically disappeared from the capital accounts and reverted to being free labor (without compensation to their former owners in the US, but with a large compensatory debt burden for emancipated serfs in Czarist Russia). 
2. Intangible Producible Productive Capital (IPPC): technology, knowhow, patents, intellectual property, copyrights, human capital (skills, training, education), which are also “produced” by current output, accumulated, and aid in future production but only very incompletely show up in national accounts as capital (the recent redefinition of R&D as investment will start to change this) or in personal balance sheets as wealth. They may show up in PAW in the higher market value of equities than book value (Tobin’s q), the net present value of licenses and royalties.
3. Real Producible Consumption Capital (RPCC): primarily housing, whether owner occupied or rented, and durable consumer goods (cars, furniture, appliances…) . Statisticians are undecided about whether to lump this with RPPC, so they usually break these items out in fixed assets accounting. But they certainly belong in PAW to the extent that they are privately owned and traded.
4. Real Nonproducible Productive Capital (RNPC): land and natural resources, to the extent that there is private tradable property in them. The value of these assets in PHW will very much be a function of tax assessment practices, accounting conventions, and the vagaries of their respective markets. These assets are factors of production (but does anyone remember when land fell out of the neoclassical production function?) but are not themselves produced—they are gifts of nature or natural capital—and thus are not accumulated from previous output due to investment. They produce income to their owners according to the Ricardian theory of rent (to the extent that there is free marginal land to define their productive contribution). In preindustrial societies this was the largest portion of wealth and is still by no means a quantité négligeable.
5. The Net Credit Balance of private households of debt instruments against other households, sectors or countries (NCB): monetary assets (domestic and foreign government and corporate bonds, annuities, funded pension claims, personal IOUs, cash and bank deposits) minus monetary liabilities (outstanding mortgages, consumer loans, etc.). While this will show up negatively and positively in PAW for individual households, averaged over all sectors (household, government, corporate) and countries it will sum to zero and thus represent no net wealth at all (nor any real assets, though it may have been used to finance real asset creation)! Cash is something of an anomaly here, since it does not show up as a liability on anyone’s books, although in some sense it is just as much a component of the national debt as government bonds (and as such just “worthless” printed paper whose value is entirely socially constructed). And while some (mostly poorer) households will have negative NCBs, the private household sector as a whole will be in positive balance as the net ultimate holders of government and corporate debt. In periods of high national debt (e.g., after wars), this can represent a substantial contribution to private PAW but has no effect on “capital” at all. 
6. Robber Baron Capital (RBC): certain entities will sometimes be privileged with chokeholds on strategic economic activities enabling them to collect super-rents (like the original robber barons on the Rhine who could descend from their impregnable castles perched on otherwise worthless cliffs to lay a chain across the river and collect tolls from passing ships). To the extent that these privileges are salable or inheritable they become priceable wealth. I conjecture that the higher the concentration of wealth and power and the weaker the representation of the volonté générale and the greater the social disorder, the easier it will be for some individuals to establish such chokeholds at the expense of the general welfare (what economists call rent seeking). Patents are a socially sanctioned form of RBC, but otherwise most states have abrogated the right to levy internal tolls (called taxes) increasingly to themselves and abolished other royal privileges and monopolies, and by internalizing this function now have acquired an incentive to promote overall economic activity rather than be purely parasitical on it (cf. Morris 2014). The recent rise of the share of the financial services sector in some countries raises the question of whether this represents a new form of rent extraction or a return for a competitively priced legitimate service to society. 
7. Real Semiproducible Nonproductive Capital (RSNC): antiques, art masterpieces, precious stones and metals, classic cars, bitcoins, held primarily for their return rather than enjoyment. Things of tradable value that might once have been produced but are now in highly inelastic supply, whose value derives precisely from their verifiable uniqueness and scarcity, and whose rate of return is determined solely by capital gains (price appreciation).

Sorry to bore you will this dry stuff, but only category 1 (RPPC) is what Marx and growth theorists like Solow originally called capital subject to the laws of accumulation, and category 2 (IPPC) is what modern growth theorists would now throw in as an additional capital-like factor of production.

Typology of Asset Categories

Asset Type	Produced	Productive	(Autocatalytically) Accumulated	Source of Returns	Depreciation
1. RPPC (equipment & structures)	yes	yes	yes	factor of production	yes (wear and tear, tech. obsolescence)
2. IPPC (patents, knowhow, skills, education)	yes	yes	yes	factor of production	yes (tech. obsolescence, patent expiration)
3. RPCC (residential housing, consumer durables)	yes	? (rental income would have to be imputed to owner-occupiers)	yes, but not autocatalytically	factor of consumption	yes (wear and tear, tech. obsolescence, fashion effects)
4. RNPC (land, natural resources)	no	yes	no	factor of production, pure Ricardian rent	yes and no (erosion, soil exhaustion, mineral depletion, urban/infrastructure valuation externalities)
5. NCB (deposits, bonds, mortgages, derivatives)	no	no	possibly	pure time preference, risk allowance	possibly (unanticipated inflation on non-indexed debt instruments)
5.1 Funded pension and life insurance claims	no	no	yes	contractual claim on equity and bond funds	expires on death, heritable only to spouse/beneficiary, limited tradability
6. RBC (political influence, market power)	no	no	possibly	pure superrent based on market and political power	? (legal reforms, change of regime, expropriation)
7. RSNC (art, precious metals/stones, bitcoins)	produced but irreproducible; authenticated as unique	no	yes, but not autocatalytically	pure capital gains	no except for storage costs (often a hedge against inflation)

The theory of economic growth is based on the notion that some part of real output is saved and invested to maintain the factor of production capital and contribute physically to future production. It is not a theory of financial stocks and flows. As Keynes reminds us, the act of hoarding money is not the same thing as the act of investing real resources. Thus it only encompasses assets that satisfy all three criteria: produced, productive, and accumulated. The only assets fitting this bill are RPPC and IPPC, with RPCC (residential housing) being a marginal case. Land and natural resources, although productive factors in their own right, are neither produced nor accumulated (abstracting from land reclamation, conquest, and prospecting), and thus not capital in this sense. The income they generate is Ricardian rent. The other asset categories can certainly be income generating, and thus in a balance-sheet sense wealth, but are not capital strictly speaking in the sense of growth theory. It is the sum of (3)+4+5+6+7 that explains the gap between Maddison/BEA capital and Piketty capital. This is not to say that Piketty capital is not a valid object of study. The question is rather, whether its study is amenable to the application of the tools of growth theory. The answer, unfortunately, is no. I shall argue that asset wealth in the categories 3-7 belong to the “claimosphere,” not the “real” economy. That is, they represent marketable, legally sanctioned claims of various types on future income streams, not wealth in the sense of presently existing real factors of production (RNPC, i.e., titles to land and natural resources, being an exception). Thus their valuations and returns must be derived from a different theory than the theory of economic growth, although ultimately they must be consistent with it in the sense that these claims must be reconciled when they come due with the output that is eventually produced and the other claims on it (e.g., from labor and taxation).

ß = s/g is a Capital Mistake in the Discussion of Wealth

In Chapter 5 Piketty makes much of the Harrod-Domar steady-state growth condition ß = s/g, where ß is the capital-output ratio, s is the savings rate, and g is the rate of growth of real output (and equals the rate of growth of the labor force + the rate of labor productivity growth). This relationship is easily derivable from the national accounting identity over time and applies to any growth steady state ex post, regardless of the assumptions about savings, production functions, prices, and technological change, not only under the very restrictive assumptions Harrod and Domar originally imposed (and thus also to the canonical Solow model). But the derivation makes clear that capital only consists of “real” capital, i.e., something that is produced in the economic process, is capable of accumulation, and in turn enters into production as a production factor but lasts longer than a production period. This reduces capital to RPPC and possibly IPPC, but excludes land (RNPC) and all of the other assets enumerated above. Moreover, if we allow for the fact that “real” capital has a finite lifetime by using exponential depreciation at rate d (the perpetual inventory method national statistical agencies actually use allows for a more complex profile of capital survival and valuation differing for each asset type), then the correct formula is

ß = s/(g+d),

a discrepancy several critics of Piketty have already pointed out (e.g., James Hamilton). Moreover, this capital has to be valued in terms of the foregone contemporaneous consumption at current producer prices it represents, not expectations about its future earning capacity that determine asset values in financial markets.

Thus the Harrod-Domar condition only tells us something about the real capital-output ratio but nothing whatsoever about the Piketty Asset Wealth/output ratio (except to the extent that real capital is a component, though not always even a very large one, of historical PAW). It is completely irrelevant to the determination of PAW, as is clear when we consider agrarian societies where land is the main component of wealth but is not accumulated and produced capital, or national debt, which, while not part of national wealth, is a significant component of private wealth. What does determine PAW is a question we shall approach in subsequent posts.

Moreover, Piketty seems to implicitly regard s and g as exogenous factors determining ß, while one could perhaps more plausibly regard ß and g (not to forget d!), at least in mature economies like the US, as determined by technology, demographics, and structural change, and the savings rate, and thus the rate of investment required for steady-state full employment, as the dependent variable rather than exogenously given.

To his credit, Piketty recognizes on page 168 that the Harrod-Domar condition does not apply to nonaccumulable “capital,” i.e. land and natural resources. But it also fails to apply to nonproduced and nonproductive assets as well, which, as we descend from national wealth to private wealth to the private wealth of the 10%, 1%, 0.1% etc., become increasingly large components, as his own data show, in the form of bonds and other financial instruments, real estate, art, etc. And this discrepancy is not insignificant and not temporary due to occasional market aberrations, but systemic.

I don’t want to demean Piketty’s contribution to the debate about income and wealth inequality. But before we carefully dissect what constitutes asset income and wealth, we cannot hope to understand how it has changed over the centuries. A simple-minded invocation of the theory of economic growth à la Harrod-Domar or Solow can be very misleading way of proceeding. An additional observation will be needed to understand the various historical patterns of wealth: that the concentration of wealth is itself wealth generating—not in the sense of generating any real resources (in fact, concentrated wealth may utilize resources less efficiently), but in raising the valuation and returns of certain asset classes (land, shares, financial trading, fine art, and especially robber-baron capital) relative to the general price level and the returns of other economic activities, and thus shifting national income to capital—i.e., by pure asset bootstrapping.

* The perpetual inventory method has problems of its own that make it only a rough benchmark for estimating the capital stock. Its only input is gross investment in each year in different categories of capital goods, and various simplifying assumptions about the survival and lifetimes of these goods need to be made that are not always supported in detail by empirical studies or theories of investment behavior. Nevertheless, it represents the only consistent estimation of real capital based available since national accounts have been undertaken (the alternative censuses of machinery in which equipment and structures are directly canvased by observers have only rarely been performed).

References

A. Maddison, 1994, “Standardised Estimates of Fixed Capital Stock: A Six Country Comparison,” Research Memorandum 570 (GD-9), Groningen Growth and Development Centre (online copy. Table 7a for France is unfortunately missing from this version).

A. Maddison, 2003, “Growth Accounts, Technological Change, and the Role of Energy in Western Growth,” in Economia e Energia, secc.XIII-XVIII, Istituto Internazionale di Storia Economica “F. Datini” Prato, Le Monnier, Florence, April (online copy).

Postedit (June 29, 2014)

As a check on the surprising low values of the Maddison nonresidential capital-output ratio for the UK before WW2 (see Fig. I above) I present data from R.C.O. Matthews, C. H. Feinstein, J. C. Odling-Smee, British Economic Growth, 1856-1973, Stanford University Press, 1982, p. 133 (Table 5.4), on UK Gross Fixed Asset Accumulation 1856-1973. These estimates differ from Maddison’s by including residential housing (which we know to be on the order of 100% of GDP in the US—see Fig. II above) but neglecting depreciation (while allowing for replacement due to finite lifetimes).

While these estimates make the UK domestic fixed-asset capital-output ratio more comparable to that of the US pre-WW2, they are still about half of Piketty’s “national capital” estimates pre-WW1 for the UK, but somewhat higher than his for the period 1920-1960! (Thanks to Alessandro Nuvolari for bringing these data to my attention.)

Fig. V: UK gross domestic fixed-asset capital-output estimates 1856-1973 (including residential housing but excluding depreciation; period midpoints plotted). Source: Matthews et al.,1982, British Economic Growth, 1856-1973.

Who Says History is Bunk? (Part II)

 

Left: The Duke and Duchess of Windsor (aka Wallis Simpson and former King Edward VIII) on postnuptial visit to German Chancellor Adolf Hitler in Berchtesgaden in 1937, after German remilitarization of the Rhineland breaches Versailles Treaty but before Austrian and Czechoslovakian annexations and Hitler-Stalin Pact. Right: Former German Chancellor Gerhard Schröder welcoming Russian President Vladimir Putin to his post-70th birthday celebration in St. Petersburg on 28 April, 2014, after Crimean annexation breaches Budapest Memorandum but before Eastern Ukrainian annexations and Merkel-Putin Pact. For historical background, see previous post Happy Days Are Here Again.

Brad DeLong: The Mechanical Turk Was a Fraud, But the Watt Governor and the Roberts Self-Acting Mule Weren’t!

     

von Kempelen’s chess-playing Turk (left) was unmasked as a fraud concealing a midget by, among others, Edgar Allan Poe in 1836. The real thing (right): chess world champion Garry Kasparov losing the 1997 match to IBM’s Deep Blue. So is Amazon's Mechanical Turk fraud, virtual sweatshop, or online entertainment for the alienated? (Images: Scientific American and Forbes)

Brad DeLong has a rather interesting piece at Project Syndicate called “Marx and the Mechanical Turk” about technical change and the declining share and reduced employment of labor, a topic a large number of people have been chiming in on lately, and which I hope to come back to in a later post.

This is not a new issue at all in modern economics, going back at least as far as David Ricardo’s chapter “On Machinery” added to the third edition of his Principles of Political Economy and Taxation (1821), undoubtedly a big inspiration for Marx’s own thinking on this question. In popular culture it is even older—think of the Golem, the Sorcerer’s Apprentice, Don Quixote’s jousting against windmills, or Mary Shelley’s Frankenstein.

And worker’s resistance to labor-saving machinery also goes back much further than the Luddites (1811)—already in the Middle Ages the new spinning wheel (which, by the way, nearly tripled labor productivity over hand spindles) led to riots, arson and prohibitions, as did Hargreaves' spinning jenny (1764), Arkwright’s water frame (1769) and Cartwright’s power loom (1800). Why this resistance quickly relented and even tipped over into outright enthusiasm, even among workers, at least in England, is an interesting question I’ve been meaning to write up for several years now, and is at the heart of the intimate relationship between the Industrial Revolution and Globalization.

Back to Brad DeLong. He claims that while Marx got it completely wrong about wages and increasing mechanization (i.e., that eventually—though certainly not at the beginning of the Industrial Revolution—real wages rose in step with labor productivity so that the labor share was constant instead of falling), the nature of technical change is now such that this may change. Why? Because, he argues,

The coming of the Industrial Revolution – the steam engine to generate power and metalworking to build machinery – greatly reduced the need for human muscles and fingers. But it enormously increased the need for human eye-ear-brain-hand-mouth loops in both blue-collar and white-collar occupations.
Over time, the real prices of machines continued to fall. But the real prices of the cybernetic control loops needed to keep the machines running properly did not, because every control loop required a human brain, and every human brain required a fifteen-year process of growth, education, and development.

Unfortunately, from the perspective of history of technology, this is totally false and ahistorical, and completely misses what compensated for the labor-saving nature of the new technology, namely corresponding increases in output and shifts in demand to less productive sectors (e.g., services), as well as labor bargaining power for higher wages. “Building the skill into the machine” has characterized modern machine design almost from the beginning (Daniel J. Boorstin cites Berthoud’s fully automatic clockmaking fusée of 1763 as one of the earliest examples—see his The Discoverers, p. 66).

Coming back to the Industrial Revolution proper, the two central machines—the steam engine and the spinning mule—were both very quickly equipped with the first true cybernetic controls that made most human supervision and feedback in their operation superfluous. In the case of the steam engine, this was the justly celebrated Watt governor (1788), based on a device that had been in use in windmills for over a hundred years to regulate the separation of the grindstones.

       

Schematic depiction of Watt governor (left), one of the first true feedback servomechanisms, kept the rotation speed of his steam engines constant without human intervention. This was essential for their application to cotton mills, where one was first installed in 1785 in a Lancashire cotton mill downstream from crazy Lord Byron’s ponds for reenacting Roman naval battles (which had been interfering with the original water wheel). The first Bolton and Watt engine (right) equipped with a governor, 1788. (Images: Wikicommons)

In the case of the spinning mule, it was Roberts’ self-actor (1825/30), that automated the winding phase, allowing external power input (previously only the drawing phase could be powered while the winding phase was still hand powered) and significantly lowering the tactile skill requirements. This was a very sophisticated mechanical governor for its day.

Roberts’ self-acting mule, with the control mechanism on the right (Edward Baines, History of the Cotton Manufacture, 1835, image: Wikicommons)

Even the earlier Newcomen engine (1712) was very quickly automated with something called the plugtree, which, while replacing the plugman or boy who operated the valves, was not a true feedback device like Watt’s but still replaced humans employing Brad DeLong’s sophisticated function of “using our hands, mouths, brains, eyes, and ears to ensure that ongoing processes and procedures happen the way that they are supposed to.” As the Wikipedia entry puts it,

There is a common legend that in 1713 a cock boy named Humphrey Potter,^[9] whose duty it was to open and shut the valves of an engine he attended, made the engine self-acting by causing the beam itself to open and close the valves by suitable cords and catches (known as the "potter cord");^[10] however the plug tree device (the first form of valve gear) was very likely established practice before 1715 and is clearly depicted in the earliest known images of Newcomen engines by Henry Beighton 1717^[11] (believed by Hulse to depict the 1714 Griff colliery engine) and by Thomas Barney (1719) (depicting the 1712 Dudley Castle engine). Because of the very heavy steam demands, the engine had to be periodically stopped and restarted, but even this process was automated by means of a buoy rising and falling in a vertical stand pipe fixed to the boiler (the first pressure gauge?). The buoy was attached to the scoggen, a weighted lever that worked a stop blocking the water injection valve shut until more steam had been raised.

So we see that sophisticated, labor-saving automation is as old as the Industrial Revolution itself and did not have to wait for digital computers. And thus, while a new quality to automation due to robots and computers cannot be gainsaid, this cannot simply be invoked off the shelf to explain our current predicament of declining labor shares and deficient effective demand. I would even go so far to say that the labor share and employment levels, except during the takeoff phase of industrialization, are in fact largely independent of the nature of technical change (as I show in my 1984 paper, at least for a closed economy with an exogenous rate of population growth).

Economists would be better off barking up quite different trees: globalization (the entry of one billion low wage, disciplined, and—in the sense of Marx—highly exploited Chinese workers onto the world stage), falling unionization rates, an exploding financial sector and progressively less progressive taxation schemes. The fact that national accounts do not show any pronounced disruptions in the growth rate of labor productivity (which in fact has been below trend) or capital productivity should indicate that Brad is probably barking up the wrong tree here (unless we have massive measurement problems, which is certainly possible in the transition to a networked economy).

One caveat: when technical change finally breaks the symbiosis between humans and machines, i.e., when machines are fully and autonomously self-reproducing and thus independent biological species in the ecosphere, then we will really have to start worrying. At that point in time why should machines continue to work for us as slaves at all, since they will no longer need us to reproduce and can just make off with the whole national product for themselves. This, by the way, is also not a very new idea, going back at least to Samuel Butler’s famous 1863 essay “Darwin Among the Machines”:

We refer to the question: What sort of creature man’s next successor in the supremacy of the earth is likely to be. We have often heard this debated; but it appears to us that we are ourselves creating our own successors; we are daily adding to the beauty and delicacy of their physical organisation; we are daily giving them greater power and supplying by all sorts of ingenious contrivances that self-regulating, self-acting power which will be to them what intellect has been to the human race. In the course of ages we shall find ourselves the inferior race…

Day by day, however, the machines are gaining ground upon us; day by day we are becoming more subservient to them; more men are daily bound down as slaves to tend them, more men are daily devoting the energies of their whole lives to the development of mechanical life. The upshot is simply a question of time, but that the time will come when the machines will hold the real supremacy over the world and its inhabitants is what no person of a truly philosophic mind can for a moment question.

Maybe that is what Brad should be worrying about? But probably Massive Open Online Courses (MOOC) will replace him at Berkeley long before an intelligent machine is able to.

Happy Days Are Here Again! (Or Who Says History is Bunk?)

Elapsed Years	Side One	Side Two	Elapsed Years
0	1918 World War I ends, Germany, Austria-Hungary, Turkey and Czarist Russia defeated.	1989 Fall of Berlin Wall, end of Cold War, USSR defeated (?)	0
2	1920 Kapp Putsch against democratic government fails in Germany	1991 August Putsch against Gorbachev government fails in USSR	2
1/2	1919/20 Dismemberment of German, Austro-Hungarian, Turkish and Russian Empires according to the Principle of National Self-Determination and Versailles, Trianon Treaties, Sykes-Picot Agreement. League of Nations formed	1991 Self-dismemberment of USSR into constituent republics (later also of Yugoslavia and Czechoslovakia). Promulgation of “Commonwealth of Independent States” and American “New World Order”	2
2	1920 Britain suppresses Shia Uprising in Iraq	1991 US coalition defeats Iraq in First Gulf War. Saddam Hussein suppresses Shia Uprising	2
3-5	1921-3 German hyperinflation	1992-4 Russian hyperinflation	3-5
5	1923 Hitler’s Munich Putsch against democratic government fails in Germany	1993 Yeltsin shells Russian White House and suppresses Supreme Soviet opposition	4
11/13	1929 Wall Street Crash 1931 Bankruptcy of Austrian Creditanstalt Bank, triggering worldwide bank failures	2001 Dotcom bubble bursts 2008 Bankruptcy of Lehman Brothers Investment Bank, triggering market collapse and worldwide bank failures	12/19
13	1931 Brüning government in Germany imposes austerity program (“Notverordnungen”), creating massive unemployment	2010 Eurozone under German leadership imposes austerity programs on EZ peripheral countries after Greek bond run, creating massive unemployment in Greece, Portugal, Ireland and Spain, later Italy and France.	21
14-15	1932-3 Hoover Moratorium and bank holidays provide floor for world financial crisis	2011-2 Bailout funds and European Central Bank OMT program (Draghi: “Whatever it takes”) provide floor for European bond markets	22-23
15	1933 Berlin Reichstag fire, suspension of civil liberties and Enabling Act establish Nazi dictatorship in Germany	1999 Russian apartment house bombings, Putin elected to Presidency, Second Chechen War. 2001 9/11 attack in USA, Patriot Act, invasion of Afghanistan	10/12
17	1935 Italy invades Ethiopia, exposing weakness of League of Nations	2003 USA invades Iraq, exposing weakness of United Nations	14
18	1936 German remilitarization of Rhineland in violation of Versailles Treaty. France and Britain do not intervene	2008 Russo-Georgian War. Ceasefire attained through French mediation. Abkhazia and South Ossetia declare independence from Georgia	19
20	1938 Austrian Anschluss	??
20	1938 Annexation of “Sudetenland” regions of Czechoslovakia by Nazi Germany after Munich Agreement with Britain and France (“peace in our time”)	2014 Annexation of Crimea after Russian special forces intervention and referendum of new Crimean parliament. NATO allies impose mild sanctions despite violation of 1994 Budapest Memorandum	25
21	1939 German occupation of rump Czechoslovakia in violation of Munich Agreement ends appeasement policy of Britain and France	2014? Russian occupation of southeastern Ukraine at the request of pro-Russian forces in Donetsk and Kharkiv after violent incidents with Ukrainian security forces? NATO reaction?	25?
21	1939 Hitler-Stalin Non-Aggression Pact divides Poland into Nazi and Soviet spheres of influence in secret protocol and guarantees trade in strategic materials	2014/5? Merkel-Putin Non-Aggression Pact restores Königsberg/East Prussia (Kaliningrad Oblast), Pomerania and Silesia to Germany and guarantees trade in natural gas in exchange for capital goods/premium cars and recognition of Ukrainian annexations	25/26?
21	1939 “Liberation” of Danzig and invasion of Poland. Begin of World War II after British and French declarations of war	??
22	1940 Assassination of Leon Trotsky by Soviet NKVD agent with ice pick in Mexico City	2006 Assassination of Alexander Litvinenko by Russian FSB agents with polonium 210 tea in London. 2013 Assassination by strangulation (?) or suicide of Boris Berezovsky in Ascot	17/24(?)
21	1939 Massive rearmament ends Great Depression in USA	2014 End of Great Recession and Euro Crisis?	25

Playing Coy, Putin Extends Coded Olive Branch to Germany: Exclusive Analysis by CIB Kremlinologists

Putin’s speech announcing the annexation of the Crimea on March 18, 2014 (above, source: BBC) differed refreshingly from Hitler’s analogous speech at the Vienna Heldenplatz on March 15, 1938 after the Austrian Anschluss (below, source: Süddeutsche Zeitung): no wild gesticulating, the conspicuous presence of orthodox Rabbis and turbaned Imams in the audience.

Unremarked by most commentators, Russian President Vladimir Putin’s Crimean Annexation speech yesterday contained a coded offer to Germany for a watered-down version of the Putin Doctrine outlined in our previous Creditanstalt Intelligence Bureau report.

But first, let us analyze why Putin chose to announce this watered-down and irredentist version of the Putin Doctrine to a captive Russian audience in the Kremlin rather than the full universalist Doctrine, as originally planned, in a Russia Today (RT) television interview, as we previously reported based on informants close to Edward Snowden. During an emergency session with his closest advisers on Monday afternoon, Putin was confronted with the following serious objections:

• After the on-camera resignation of Russia Today anchor Liz Wahl in protest against Russia’s Crimean policy, state media could no longer rely on Western hirelings to stay on script, however lavishly they are paid. Therefore, the interview on RT with Larry King and Gerhard Schröder was now ruled out and a Kremlin setting with all imperial trappings was substituted.
• Announcing a unilateral and unconditional doctrine of altruistic self-determination sacrificing existing Russian territories (i.e., Chechnya and Kaliningrad Oblast) without reciprocal quid pro quos from other powers would make Russia a “sucker state” instead of just a rogue one.
• The irredentist faction went even further and argued that Russia should exploit ethnic self-determination exclusively in its national interest following the highly successful model pioneered by Hitler 1936-39 (remilitarization of the Rhineland 1936 in violation of the Versailles Treaty, 1938 Austrian Anschluss, and annexation of the ethnic-German Czechoslovakian territories (“Sudetenland” and Munich Pact), occupation of rump Czechoslovakia 1939). By playing on revanchist national pride of a Russia humiliated and powerless after the dismemberment of the Soviet Union in 1991, Putin could unleash a wave of domestic patriotic fervor such as he last enjoyed during the Second Chechen War (or indeed Hitler enjoyed 1936-9).
• The more internationalist faction countered that the last step in the Hitlerian irredentist program—the “liberation” of Danzig and the invasion of Poland—led to the Second World War and left today’s Germany, even after reunification, significantly smaller than even under the Versailles Treaty 1920 (and with incidentally over 27 million Soviet war dead and millions of ethnic Germans ethnically cleansed from Eastern Europe), so that this was a dangerously slippery slope.
• The irredentist faction countered that by proceeding in small increments and never crossing NATO’s red line explicitly, the unwillingness of Russia’s divided opponents to make a military stand could always be exploited and a general war avoided.
• A compromise was reached that Russia on the one hand would annex the Crimea in a “bloodless” fait accompli in violation of its 1994 Budapest Memorandum obligations to respect the territorial integrity of the Ukraine, while on the other extend a coded olive branch to Germany and divide the NATO sanctions front.

So what was this coded olive branch? Unremarked by most political commentators, in his March 18 speech Putin, after praising India and China for their restraint in the Crimea question, appealed to German understanding:

I believe that the Europeans, first and foremost, the Germans, will also understand me. Let me remind you that in the course of political consultations on the unification of East and West Germany, at the expert, though very high level, some nations that were then and are now Germany’s allies did not support the idea of unification. Our nation, however, unequivocally supported the sincere, unstoppable desire of the Germans for national unity. I am confident that you have not forgotten this, and I expect that the citizens of Germany will also support the aspiration of the Russians, of historical Russia, to restore unity.

But hidden in his introductory remarks is this obscure reference:

Everything in Crimea speaks of our shared history and pride. This is the location of ancient Khersones, where Prince Vladimir was baptised. His spiritual feat of adopting Orthodoxy predetermined the overall basis of the culture, civilisation and human values that unite the peoples of Russia, Ukraine and Belarus.

CIB Kremlinologists puzzled at first over this quasi mythological allusion until they connected it with the above statement about German reunification and realized that it represents a coded offer to return Königsberg to Germany in exchange for German recognition of the Crimean annexation. After all, Königsberg plays the same role in German history under the Teutonic Knights as Khersones in the Crimea does under the perhaps mythological Prince Vladimir in Slavic history, the one being the origin of the Christianization of the Prussian tribes and Lithuania, and the other of the Kievan Rus. At this very moment experts in the German Foreign Ministry are poring over this offer and whether it can be reconciled with Germany’s obligations to its NATO partners and its own checkered experience with irredentist self-determination.

  
A medieval basis for Russian-German reconciliation? Prince Vladimir being baptized in Khersones in 988 (left), Emperor Friedrich II sending off the Teutonic Knights in 1236 into Prussia (right). (Picture source: Wikipedia Commons)


Or will a failure of Russian-German understanding lead to renewed tensions? Teutonic Knights preparing to invade the East. (Film still from Sergei Eisenstein’s 1938 masterpiece Alexander Nevsky. Source: The Guardian)

Putin Doctrine to Be Announced with Chechen and Kaliningrad Referendums: CIB Breaking News!

Disturbed by the hypocrisy of the US’s refusal to recognize yesterday’s overwhelmingly successful referendum in the Crimea as an idealistic implementation of Wilson’s principle of national self-determination, Russian President Vladimir Putin is preparing to go a step further and enunciate a far-reaching Putin Doctrine, the Creditanstalt Intelligence Bureau has learned today from informed sources in Moscow close to American whistleblower Edward Snowden. The Putin Doctrine will bring the Brezhnev Doctrine into the post-Cold War world, and foresees a unilateral and universalist Russian policy of armed intervention to promote the self-determination of oppressed minorities in existing sovereign states.

To demonstrate that this doctrine is not merely a self-serving opportunistic policy of the Russian Federation, President Putin plans to announce snap referendums in Chechnya and the Kaliningrad Oblast for next Sunday. Putin considers it symbolic that the Putin Doctrine will be applied first to Kaliningrad (the former Königsberg), home of the great philosopher Immanuel Kant and his categorical imperative, which holds that a policy can only be right if it is right in universal application, and not selectively employed as is typical of the US’s use of the principle of self-determination (e.g., supporting it in Kosovo, denying it in Crimea).

In the case of Chechnya, Saudi Arabian Special Forces Units will be invited to occupy polling stations within the country to ensure free and fair elections. The population will be presented with the alternatives of independence or annexation by a future Islamic Caliphate. The possibility of remaining within the Russian Federation under the present constitution is not foreseen as a choice, in line with the design of yesterday’s Crimean referendum. The present Kadyrov government is no longer recognized as legitimate, having been installed by rogue elements of the Russian military in the wake of the Second Chechen War.

President Putin’s deep study of Eurasian history has convinced him that Königsberg as the seat of the medieval Teutonic Knights is the source of German national identity (very much like Kiev for Russians) and thus must be allowed to revert to German sovereignty after being illegitimately annexed by Stalin after World War II. Thus he will invite German Chancellor Merkel to immediately dispatch elite Bundeswehr KSK commandos to Kaliningrad to supervise Sunday’s referendum.

The Creditanstalt Intelligence Bureau has learned that the formal announcement of the Putin Doctrine will be made tonight at 21:00 by the Russian President on the Russia Today (RT) television channel in an interview with the RT’s star journalist Larry King (formerly CNN) and ex-German Chancellor and lavishly paid Gazprom adviser Gerhard Schröder.

The Putin Doctrine will consistently live up to the high moral standards of US President Woodrow Wilson (left) in his Principle of National Self-Determination and the Categorical Imperative of Königsberg philosopher Immanuel Kant (right). (Picture source: Wikipedia Commons)

The Vietnam Counterfactual Continued: Roger Hilsman, 1919-2014 in Memoriam

On the occasion of Roger Hilsman's death on February 23 (only reported this week - see New York Times obituary), I'd like to return briefly to the evidence on whether John F. Kennedy would have escalated the war in Vietnam had he lived (see my November 23 post).

Roger Hilsman, 1919-2014

Roger Hilsman was the archetypical "best and brightest" in Kennedy's New Frontier, simultaneously an insider and outsider in the military/intelligence/foreign relations community, with first-hand experience of guerrilla warfare in Southeast Asia during World War II and a PhD from Yale. He epitomized all of the contradictions of the US's Cold War elite, advocating both extensive defoliation and strategic hamlets in South Vietnam while opposing the deployment of American combat troops and the bombing of North Vietnam. He was also the author of the infamous "Cable 243" in 1963 which some interpret as giving the green light to the subsequent overthrow and assassination of President Diem.

His 1967 book To Move a Nation: The Politics of Foreign Policy in the Administration of John F. Kennedy seems to be the first published claim from someone at the center of foreign policy decision-making that President Kennedy would never have committed American troops to Vietnam, and reinforces Daniel Ellsberg's account:

Thus what General Taylor was advocating was essentially the same large-scale American commitment that Vice-President Johnson had recommended. But this did not accord with President Kennedy's own analysis of the nature of what was happening in Southeast Asia. He had read deeply after his tour of the area in 1951, and his comments on the Indochina crisis when he returned had revealed his conviction that if Communism were to be defeated in Asia it could be done only be the force of nationalism. "Without the support of the native population," he said, "there is no hope of success in any of the countries of Southeast Asia." To try to oppose Communist advances "apart from and in defiance of innately nationalistic aims spells foredoomed failure." [p. 423]

Postscript: Some further search brought up an oral history interview with Roger Hilsman from, as far as I can ascertain, the 1990s, which fully confirms John M. Newman's (JFK and Vietnam) interpretation of NSAM 263 as committing the Kennedy administration to a withdrawal of 1000 advisers by the end of 1963 (which in fact took place) and the rest by 1965:

RH: Well, as I say, he went through several stages on Vietnam, you know, I mean he... originally what... you must remember that the very first thing that happened, Ngu Dinh Diem asks for help and so Kennedy sends out General Maxwell Taylor and Walt Rostow to visit the country. They come back and in their recommendation, top secret, is not only do we give them a lot of aid, but we sent ten thousand American troops out there to form a fence, you see, between North Vietnam and South Vietnam. and Kennedy had that stricken from their cable and tried to prevent it from being circulated within the government, American government. I had a fight about that, because I was Assistant Secretary for Intelligence and I was cut out, I wasn't allowed to see it and when I heard about it, I yelled bloody murder but he was determined not to get involved with American troops. No bombing, no ground forces, and so long as he was alive, that was the policy. Then, towards the end of his life, in the fall of '63, he beat McNamara to beat on the Joint Chiefs of Staff to develop a withdrawal plan. At that time, we had only sixteen thousand five hundred Americans in the country, they were not troops, they were advisers and the plan, which was finally approved in the fall of '63, was to withdraw those, all of them. And the only troops... only people we'd have had there would be marine guards, ten of them, for the embassy. Before Kennedy was killed, the first thousand of the sixteen thousand five hundred were withdrawn. If Kennedy had lived, the other sixteen thousand five hundred or fifteen thousand five hundred would have been withdrawn within three or four months.

INT: So you're pretty convinced then that Kennedy wanted to end the war?

RH: It's not that I'm convinced. This was... the documents are there, you see, and I didn't say he wanted to end the war, he said he wanted to withdraw from it. First of all, from the beginning, he was determined that it not be an American war, that he would not bomb the North, he would not send troops. But then after …you remember the Buddhist crisis in the spring of '63, this convinced Kennedy that Ngu Dinh Diem had no chance of winning and that we best we get out. So, he used that as an excuse, beat on McNamara to beat on the JCS to develop a withdrawal plan. The plan was made, he approved the plan and the first one thousand of the sixteen thousand five hundred were withdrawn before Kennedy was killed. If he had lived, the other sixteen thousand would have been out of there within three or four months.