Palley\’s Economics

This really is quite wondrous. Thomas Palley, in explaining where we\’ve all been wrong for the past 27 years, manages to avoid mentioning two very important things.

The differences between the new and old cycle are starkly revealed in attitudes toward the trade deficit. Previously, trade deficits were viewed as a serious problem, being a leakage of demand that undermined employment and output. Since 1980, trade deficits have been dismissed as the outcome of free-market choices.

This is rather missing the elephant. Pre-1980 (actually, mid-70s) we had a system of fixed exchange rates. The Bretton Woods system. Under such a system trade deficits are indeed an important matter. Have a large one and eventually you\’ll find that the currency comes under pressure and you end up having to devalue. Something which the system was at pains to dissuade you from doing.

Since then, we\’ve had (more or less) floating exchange rates. In such a system trade deficits do not matter so much because the currency can (and will, with lags and overshooting to be sure) move around to take account of deficits or surpluses.

Now whether one system or the other is better (I think freely floating exchange rates are a good thing but that isn\’t relevant here) is something that can be discussed. But to mention the different importance attatched to deficits without mentioning the different approach to exchange rates is absurd: for the different approach to exchange rates is what makes the deficits unimportant.

Manufacturing has lost 1.8m jobs. Prior to 1980, manufacturing employment increased during every expansion and always exceeded the previous peak level. Between 1980 and 2000, manufacturing employment continued to grow in expansions, but each time it failed to recover the previous peak. This time, manufacturing employment has actually fallen during the expansion, something unprecedented in American history.

Indeed, unprecedented it is. But it\’s not something unique to the US economy. The whole world is losing manufacturing jobs (no, really, it is). We\’re undergoing a decades long change, similar to the one that led from a predominantly agricultural employment scenario to a manufacturing one. Just as happened a century or so ago, when over a few decades we went from 60% or more of the workforce in agriculture to 60% of it being in manufacturing (to the extent that in the US and UK we now have less than 2% of the workforce in agriculture) we are now seeing a switch from manufacturing to services.

The reason for this switch is rising productivity in manufacturing. We\’re getting ever more efficient at making things. Thus we need to use less labour to do so. And that\’s something which is happening globally, not something unique to the US economy. Complaining about this is exactly the same as complaining that we no longer need 20 men to mow the hay meadow.

Palley\’s thus like one of the Generals: always ready to fight the last war.

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