[Winstonm]

kenberg, on 2011-August-19, 06:56, said:

Real world data, it seems to me, has to be selected and has to be interpreted.

Example:
I was speaking with someone who reads job applications and interviews prospective employees. Apparently the number of applications from people who clearly lack the skills for the job has grown considerably. Why?

Explanation 1: People are really desperate for jobs and will apply anywhere.

Explanation 2: To keep receiving unemployment benefits you must apply for a job. You can see where applying for a job that you know that you will not get might be just what is needed.

Quite possibly one could test these matters to see what is going on. For example, if it turns out that many people find their next job just around the time that unemployment benefits run out, that could plausibly regarded as evidence that their intention was to get their new job offer later rather than sooner. Plausible, but not conclusive.


Data speaks, but like oracles from Delphi, not always clearly.

Good point.

I was thinking more on the lines of those who still believe that the housing crash was caused by the Community Reinvestment Act although there is zero data to support the claim and oodles of data to discredit the idea.

[PassedOut]

kenberg, on 2011-August-19, 06:56, said:

I was speaking with someone who reads job applications and interviews prospective employees. Apparently the number of applications from people who clearly lack the skills for the job has grown considerably.

Reading resumes and (even more so) the cover letters can really be heartbreaking. On so many levels.

[phil_20686]

Winstonm, on 2011-August-19, 07:26, said:

Good point.

I was thinking more on the lines of those who still believe that the housing crash was caused by the Community Reinvestment Act although there is zero data to support the claim and oodles of data to discredit the idea.

The concept of needing an idea before you can examine data is pretty normal in physics. In particular, the LHC and the tevatron produce so much data that you need to select at source, and you select based on what you are looking for, so if the new physics is not what we are looking for, we will never find it (well, sometimes you get lucky).

A good example in economics is how do you interpret the stimulus.

Did it fail because it wasn't big enough. Did it work but the economy was much worse than we thought, or was it largely ineffective? All three are broadly conistent with the data, because the "data" relies on a forecast of what would have happened without the stimulus. All forecasts have large uncertainties, a one or two percent change in the forecast is easy to achieve with believable models, and that will change the "data" on the stimulus hugely.

On the CRA, it cannot be denied that deregulation opened the housing market to more borrowers with smaller deposits and unreliable income. An increase in demand for homes was almost certainly a contributing factor in the steadily rising house prices in the lead up to the financial crisis. Worse, as borrowing got easier it drove up prices which forced everyone to borrow more. Had this not happened it is likely that house prices would have stayed lower and consumers would have less debt which would doubtless aid the recovery now.

Of course, had the banks and rating agencies been pricing correctly the banks would not have been so eager to lend, so that could also have put the brakes on. Had china not been buying T-bills to suppress its currency it would have been impossible for western governments to run up debts as large as we have as cheaply as we have, and this would doubtless have left governments with more room to maneuver now. Governments did not have to sell so much debt anyway, and had they not done so china's currency would have appreciated by now, which would also be helping us by increasing consumerism in china.

As ever with major financial crisis, they sneak up on you with a thousand increments any one of which offered someone somewhere a choice which could have averted disaster. Which of these mistakes you choose to place the lions share of the blame on is very much a matter of taste, which is to say, idealogical. If you think debt is bad you mich choose to blame the CRA and governments. If you think that rising house prices are a good thing you probably like the CRA and blame the ratings agencies. If you are nationalistic you probably blame china for buying US debt.

I think a better decision on any of these issues would have materially lessened the impact of the crisis. You are free to disagree.

[blackshoe]

Winstonm, on 2011-August-19, 06:09, said:

FICA and general budgetetary are not supposed to be comingled funds.

ROFLMAO!!!

[PassedOut]

Donald Trump is no longer pretending to run for president, but he's still giving political interviews: Donald Trump Would 'Put Country First' and Pay More Taxes

Quote

Donald Trump backed up fellow billionaire Warren Buffett’s op-ed in the New York Times and said he’d be willing to pay more in taxes – but he doesn’t think Wall Street would go along with it.

“I would be willing to George, but a lot of people wouldn't be. A lot of people would leave the country. I'm talking about big people, job-producing people. Would I be willing? Yeah, I'd be willing. I’d put country first. Lot of people don't necessarily put country first,” he said.

Trump said these “unpatriotic” businessmen would take their money elsewhere leaving the U.S. with nothing.

Should be a no-brainer, but it hits the news these days whenever rich people agree with paying more taxes.

[y66]

phil_20686, on 2011-August-19, 11:32, said:

As ever with major financial crisis, they sneak up on you with a thousand increments any one of which offered someone somewhere a choice which could have averted disaster. Which of these mistakes you choose to place the lions share of the blame on is very much a matter of taste, which is to say, idealogical. If you think debt is bad you mich choose to blame the CRA and governments. If you think that rising house prices are a good thing you probably like the CRA and blame the ratings agencies. If you are nationalistic you probably blame china for buying US debt.
I think a better decision on any of these issues would have materially lessened the impact of the crisis. You are free to disagree.

re: ideology

It’s hard to believe that the guy who gave this speech in 1998 is the same guy who testified before Congress 10 years later thusly:

Quote

"Those of us who have looked to the self-interest of lending institutions to protect shareholder's equity — myself especially — are in a state of shocked disbelief."[47] Referring to his free-market ideology, Greenspan said: “I have found a flaw. I don’t know how significant or permanent it is. But I have been very distressed by that fact.” Rep. Henry Waxman (D-CA) then pressed him to clarify his words. “In other words, you found that your view of the world, your ideology, was not right, it was not working,” Waxman said. “Absolutely, precisely,” Greenspan replied. “You know, that’s precisely the reason I was shocked, because I have been going for 40 years or more with very considerable evidence that it was working exceptionally well.”

Greenspan was not alone in opposing regulation as has been mentioned elsewhere on this thread. But yeah, a little more timely circumspection on that front might have lessened the impact of the crisis, which would have been nice.

As for the lion's share of the blame, I think we should just keep pinning that on Bush.

[Winstonm]

phil_20686, on 2011-August-19, 11:32, said:

The concept of needing an idea before you can examine data is pretty normal in physics. In particular, the LHC and the tevatron produce so much data that you need to select at source, and you select based on what you are looking for, so if the new physics is not what we are looking for, we will never find it (well, sometimes you get lucky).

A good example in economics is how do you interpret the stimulus.

Did it fail because it wasn't big enough. Did it work but the economy was much worse than we thought, or was it largely ineffective? All three are broadly conistent with the data, because the "data" relies on a forecast of what would have happened without the stimulus. All forecasts have large uncertainties, a one or two percent change in the forecast is easy to achieve with believable models, and that will change the "data" on the stimulus hugely.

On the CRA, it cannot be denied that deregulation opened the housing market to more borrowers with smaller deposits and unreliable income. An increase in demand for homes was almost certainly a contributing factor in the steadily rising house prices in the lead up to the financial crisis. Worse, as borrowing got easier it drove up prices which forced everyone to borrow more. Had this not happened it is likely that house prices would have stayed lower and consumers would have less debt which would doubtless aid the recovery now.

Of course, had the banks and rating agencies been pricing correctly the banks would not have been so eager to lend, so that could also have put the brakes on. Had china not been buying T-bills to suppress its currency it would have been impossible for western governments to run up debts as large as we have as cheaply as we have, and this would doubtless have left governments with more room to maneuver now. Governments did not have to sell so much debt anyway, and had they not done so china's currency would have appreciated by now, which would also be helping us by increasing consumerism in china.

As ever with major financial crisis, they sneak up on you with a thousand increments any one of which offered someone somewhere a choice which could have averted disaster. Which of these mistakes you choose to place the lions share of the blame on is very much a matter of taste, which is to say, idealogical. If you think debt is bad you mich choose to blame the CRA and governments. If you think that rising house prices are a good thing you probably like the CRA and blame the ratings agencies. If you are nationalistic you probably blame china for buying US debt.

I think a better decision on any of these issues would have materially lessened the impact of the crisis. You are free to disagree.

Blaming the CRA is beyond voodoo economics - it's witch-doctor hocus pocus.

From Robert Gordon, a senior fellow at the Center for American Progress:

Quote

It’s telling that, amid all the recent recriminations, even lenders have not fingered CRA. That’s because CRA didn’t bring about the reckless lending at the heart of the crisis. Just as sub-prime lending was exploding, CRA was losing force and relevance. And the worst offenders, the independent mortgage companies, were never subject to CRA — or any federal regulator. Law didn’t make them lend. The profit motive did. And that is not political correctness. It is correctness.

It is ludicrous to blame a 1977 law that required lending to depositors in inner city areas with the housing bubble in 2006 in areas totally unaffected by the CRA and with 80% of subprime loans originating from non-CRA covered, non-regulated mortgage companies.

The "CRA caused the housing crisis" urban legend is much more than looking at data with an ideological eye; this myth requires blinding oneself to all the data and picking through ancient political history to find a way to blame a Democrat - in this case Bill Clinton - for everything bad that has ever happened to mankind.

Even worse, it is an attempt to deflect blame onto a scapegoat - a red herring in this case - and redirect serious inspection away frm the real basis of the housing bubble and subsequent crash.

Fortunately, no one but hard-line right-wingers take the CRA Dun It argument seriously.

[phil_20686]

Winstonm, on 2011-August-19, 21:48, said:

It is ludicrous to blame a 1977 law that required lending to depositors in inner city areas with the housing bubble in 2006 in areas totally unaffected by the CRA and with 80% of subprime loans originating from non-CRA covered, non-regulated mortgage companies.

The "CRA caused the housing crisis" urban legend is much more than looking at data with an ideological eye; this myth requires blinding oneself to all the data and picking through ancient political history to find a way to blame a Democrat - in this case Bill Clinton - for everything bad that has ever happened to mankind.

Even worse, it is an attempt to deflect blame onto a scapegoat - a red herring in this case - and redirect serious inspection away frm the real basis of the housing bubble and subsequent crash.

Fortunately, no one but hard-line right-wingers take the CRA Dun It argument seriously.

Firstly, to claim its a 1977 law is pretty ludicrous. It has been extensively revised at least ten times since then. At each revision the aim was to improve the provision of credit to low income families. As recently as 2007 Ben bernanke was claiming that the SRA had been a great success in improving home ownership rates by increasing the provision of credit. More importantly he claimed it was responsible even for those banks that were not under CRA oversight, because the availability of data made it cheaper for new players to enter the market. I do not think one should underestimate the `cultural effects` of this type of legislation, which makes providing cheap credit into a `moral` activity which lets bankers feel good about themselves. There is also no doubt that the CRA led to rising house prices, which affected the indebtedness of even well off households. Housing advocacy groups repeatedly warned that the rise in house prices was hurting tenants who rented in low income areas.

Everyone in the policy narrative beliived that the CRA was achieving its aim, right up until we realised the aim of providing credit to people on low income might not be a good idea. That said, it is also true that the worst abuses of unsafe lending came for the institutions with the lowest level of oversight, including mostly those who were not covered by the CRA. However, if Ben berranke was right about there being a first mover problem, then no one would have entered this market. Its all complicated, and data will not tell you how much these laws affected the culture of lending, or not. But the culture has shifted, forty years ago people would just not have engaged in this type of lending because everyone thought it was a bad idea. Did a change in culture cause a change in governance, or vice versa? Probably a bit of both.

I do nto claim that the CRA was solely, or even mostly, the cause of this crisis, but to claim it has no part at all seems naive.

[y66]

Quote

There are many causes to the collapse of the housing market and the recent financial turmoil, but the contribution of the CRA appears marginal.

Source: Subprime Lending and the Community Reinvestment Act (pdf) by Kevin Park, Joint Center for Housing Studies, Harvard University, November 2008

[Winstonm]

Quote

right up until we realised the aim of providing credit to people on low income might not be a good idea

Quote

There is also no doubt that the CRA led to rising house prices, which affected the indebtedness of even well off households.

The purpose of the CRA was never "providing credit to people on low income". The object of CRA was to make the playing field equal.

It is pretty imaginative stretch to claim that eliminating redlining by some banks of some areas like inner-city Philadelphia caused the overpricing of McMansions in Las Vegas, Miami, and San Diego. Also, prior to the CRA a good credit risk living in a redlined area had no access to credit - CRA was not designed to promote subprime home loans, but to prevent banks from discriminating against its own depositors.

If you really want to pin down a substantial cause of the asset bubble, it was the mad scramble for yield brought about by the early 2000s interest rate actions of the Federal Reserve. Without reasonable safe haven yields, money poured into riskier investments, and the spigot to cheap debt stayed wide open for much too long.

Edit: Although I have expressed "greed" as a reason, this can only be attributed to the very last stages of the irrational exuberance of the bubble.

When I state "scramble for yield", I do not mean in any way that this was anything but a reasonable attempt by reasonable people to do their jobs well.

But it was the scramble for yield that created the demand for MBS and CDOs - it wasn't because some poor minority family in East Saint Louis tried to get a home loan from the neighborhood branch of Bank of America.

[Winstonm]

y66, on 2011-August-20, 08:38, said:

Source: Subprime Lending and the Community Reinvestment Act (pdf) by Kevin Park, Joint Center for Housing Studies, Harvard University, November 2008

I escpecially enjoyed the last sentence in this paper: "The data suggests that far from being forced into risky corners of the market, the institutions under scrutiny of the CRA were crowded out by unregulated lenders."

[PassedOut]

Following the London riots, here is a view from the UK: We've been warned: the system is ready to blow

Quote

For a while in the late 1980s, the easy availability of money provided the illusion of wealth but there was a shift from a debt-averse world where financial crises were virtually unknown to a debt-sodden world constantly teetering on the brink of banking armageddon.

Currency markets lost their anchor in 1971 when the US suspended dollar convertibility. Over the years, financial markets have lost their moral anchor, engaging not just in reckless but fraudulent behaviour. According to the US economist James Galbraith, increased complexity was the cover for blatant and widespread wrongdoing.

Looking back at the sub-prime mortgage scandal, in which millions of Americans were mis-sold home loans, Galbraith says there has been a complete breakdown in trust that is impairing the hopes of economic recovery.

"There was a private vocabulary, well-known in the industry, covering these loans and related financial products: liars' loans, Ninja loans (the borrowers had no income, no job or assets), neutron loans (loans that would explode, destroying the people but leaving the buildings intact), toxic waste (the residue of the securitisation process). I suggest that this tells you that those who sold these products knew or suspected that their line of work was not 100% honest. Think of the restaurant where the staff refers to the food as scum, sludge and sewage."

Finally, there has been a big change in the way that the spoils of economic success have been divvied up. Back when Nixon was berating the speculators attacking the dollar peg, there was an implicit social contract under which the individual was guaranteed a job and a decent wage that rose as the economy grew. The fruits of growth were shared with employers, and taxes were recycled into schools, health care and pensions. In return, individuals obeyed the law and encouraged their children to do the same. The assumption was that each generation would have a better life than the last.

This implicit social contract has broken down. Growth is less rapid than it was 40 years ago, and the gains have disproportionately gone to companies and the very rich. In the UK, the professional middle classes, particularly in the southeast, are doing fine, but below them in the income scale are people who have become more dependent on debt as their real incomes have stagnated. Next are the people on minimum wage jobs, which have to be topped up by tax credits so they can make ends meet. At the very bottom of the pile are those who are without work, many of them second and third generation unemployed.

I find the increasing gap in the US between rich and poor, and the weakening of the middle class here, quite disturbing. With the breakdown of the social contract, we see more anger here and less regard for the common good.

During the prosperous times when I was growing up, "spreading the wealth" was considered a good thing, part of the social contract. These days advocating that policy subjects one to criticism. Nevertheless, it's the right thing to do for a lot of reasons. Avoiding riots is just one of them.

[blackshoe]

"Spreading the wealth" is a good thing. Doing it by taking wealth from one group of citizens and giving it to another is not.

[Winstonm]

blackshoe, on 2011-August-20, 18:08, said:

"Spreading the wealth" is a good thing. Doing it by taking wealth from one group of citizens and giving it to another is not.

By this I guess you are against regressive taxes like FICA, excise, and sales taxes that disproportionately take a higher percentage of monies from the middle and lower classes in order to subsidize the tax cuts on corporations and the upper incomes?

[phil_20686]

Winstonm, on 2011-August-20, 19:45, said:

By this I guess you are against regressive taxes like FICA, excise, and sales taxes that disproportionately take a higher percentage of monies from the middle and lower classes in order to subsidize the tax cuts on corporations and the upper incomes?

I think VAT is normally better than a sales tax. You can make VAT relatively balanced by removing food stuffs.

I think coorporation tax (basically a tax on the income) is basically paid by consumers and makes everything more expensive. A corporation profits tax makes more sense to me. (Inventiveising companies to make less profit should lead to cheaper goods, while restriciting the income streams of the very rich rather better than a corporation tax.

But basically I think Income taxes should be sufficient if they are set up correctly. Tax seems to have become unbeleiveably complicated mostly through a series of historical accidents coupled with a political incentive to make sure no one really understands where the tax is coming from.

[helene_t]

I have always thought that if I was the ruler of Europe there would be no VAT as income tax should be sufficient, but I am not sure if that would work. When I studied economics in the 80s the arguments given for introducing VAT (which was done in Denmark in 1967 although a detail-only VAT was in place from 62) was that there was a need for an extra tuning parameter in the tax system as a VAT increase has a different impact on inflation than an income tax increase has. Also, VAT is good for the balance of payments as income generated from producing exportable commodities is not subject to VAT.

I suspect other reasons were that VAT can be used to subsidize specific industries by granting them VAT exemption (in Denmark you don't pay VAT on newpapers and education, and some countries also have lower VAT rates on food). And maybe there is a psychological advantage of having multiple types of tax - paying 25% VAT on top of 40% income tax is effectively (complications with savings and interest payments disregarded) the same as a 52% income tax but maybe to consumers it does not feel that way, at least not if the VAT is not specified on the supermarket bill.

[PassedOut]

Historian Alexander Keyssar has a piece in the Post describing the rise of the social contract that brought good times to the US, and systematic dismantling of it that (I think it's fair to say) is bringing the US down very quickly today: The real grand bargain, coming undone

Quote

Despite all the recent talk of “grand bargains,” little attention has been paid to the unraveling of a truly grand bargain that has been at the center of public policy in the United States for more than a century.

That bargain — which emerged in stages between the 1890s and 1930s — established an institutional framework to balance the needs of the American people with the vast inequalities of wealth and power wrought by the triumph of industrial capitalism. It originated in the widespread apprehension that the rapidly growing power of robber barons, national corporations and banks (like J.P. Morgan’s) was undermining fundamental American values and threatening democracy.

Such apprehensions were famously expressed in novelist Frank Norris’s characterization of the nation’s largest corporations — the railroads — as an “octopus” strangling farmers and small businesses.

From the viewpoint of an ordinary businessman -- as opposed to the huge and powerful corporations -- what is happening these days is very unfortunate. It makes no sense to insist that tax cuts for the rich will create jobs when most folks have no money to buy additional goods or services. A large and prosperous middle class provides the customer base for most businesses, including ours.

It is interesting to contrast the dismal economic record of the US this century compared with that of Brazil, a country that under Lula focused on spreading its wealth to all: How President Lula changed Brazil

Quote

Brazil's business community has come to appreciate its one-time bogeyman.

In the breakfast room of my Sao Paulo hotel, gaggles of Blackberry-wielding entrepreneurs begin their deals for the day - riding the wave of an economy that will grow by about 7.5% and create some 2.5 million jobs in 2010.

"We've done well by Lula, so no-one is complaining," one suited diner told me.

"And he's spread the wealth around the country, which in Brazil is good politics," he said.

Under Lula, to the horror of his opponents, Brazil began paying poor families to send their kids to school (I suspect most of you already know that). That created a demand for products that led to the creation of businesses that needed new workers, and the upward spiral is still continuing. In the US we are rapidly taking money out of the hands of all but the very rich, and businesses are retrenching, with no end in sight.

[Winstonm]

Quote

Secondly, if you think that deficit spending can prop up demand, then that must be what has already happened in the racking up of household debt. If you beleive that then you must think (like I do) that demand prior to the recession was un-sustainably high, driven by easy credit, and a painful adjustment is needed when demand falls and debt is paid off. If the government continues sustaining demand at that unsustainable level that is only putting off a painful contraction in demand until another day. When there is pain to be had best to get it over with quickly.

Phil,

I've been meaning to get to these comments for some time - sorry for the digression.

I think your analysis of the conditions is spot on - what we are experiencing worlwide is a debt-deflation contracture brought about be deleveraging. Where we differ is in the cause of the problem and the best method for a permanent solution.

What is of interest to me is that the wage-productivity gap during the time periods preceding this current economic collapse has been nearly matched once before in the U.S. - during the 1920s. The end result both times has been a debt-deflation.

(1)From The Economic Report of the President, 2004. (Production workers)
(2)From The Historical Statistics of the United States, U.S. Dept. of Commerce (1975)
Year---(1)Wage gap---Year---(2)Wage gap
1962---21------------1919---111
1965---21------------1921---128
1970---23------------1923---130
--------------------------1925---148
1975---26------------1927---154
1980---30------------1929---156
1985---33
1990---37
1995---40
2000---43
2003---45

The differences in absolute values caused by methodologies is relatively unimportant - what matters most is the percentage of change. Notice that the gap was fairly stable from 1962-1970, then quickly gained momentum after 1980. From 1980-2003 the increase was 50%, while from 1919-1929 the increase was around a 40% increase. Both eras were known for higher-than-normal debt levels.

Demand is primarily the result of wages + investment. When productivity (supply basically = productivity x employment) increases without a compensating increase in the percentage of wages (demand) to productivity, the only way to absorb the increased supply is with new debt.

Wage gap is defined as productivity divided by wages. If the normal ratio is 5/4, for example, but the productivity doubles while wages lag, say at a 10/6 ratio, then the only means to close the gap is new debt in lieu of wages.

This is what occured in the U.S. It was compounded by ultra-low interest rate decisions by the Federal Reserve that created the climate and conditions for spiraling home prices, which led to excessive consumer borrowing based on the home ATM model.

The longterm fix is a repair of the wage-productivity percentage.

The austerity measures of eliminating debts at both the personal and governmental levels will lead to a reproduction of the 1930s.

When a boat capsizes the first thing to do is right the ship - once you are sailing again, then you can deal with longstanding holes and design flaws.

Quote

*Yes, I know most construction companies can make other things than houses. I was looking for an example and this seemed to make my point. Obviously, they could build roads and stuff and that would be a good think in the US.

I think you underestimate the ease of correcting malinvestment. A homebuilder in no way can change overnight into a road builder or another type of contractor. At the same time, re-education and retraining of all the unnecessary job descriptions that surround a housing boom is a decades-long phenomenon.

I don't think there is a great awareness of how close we came to a reliving of The Great Depression and we are not completely out of the woods, yet, as deleveraging is still ongoing and will be for years to come.

Although I agree that in the long haul debt has to be addressed, in the meantime preventing a debt-deflation is much higher on the priority list.

[kenberg]

It's this pesky mathematician again, trying to figure out what the wage productivity gap actually means.

Winston says "Wage gap [You meant wage productivity gap?] is defined as productivity divided by wages. This seemed unlike, I would expect that to be called something like the productivity wage ratio. So I went fishing on the internet. I found, at
http://leftfocus.blo...sed-crisis.html
"The wage-productivity gap is the gap between the real wage and labor productivity, the real wage being the purchasing power of an average salary. "

This seems more likely.

From the same reference:
"The wage-productivity gap concept is rarely brought up in modern textbooks on economics, but in fact it should be because the economists I have mentioned see this disparity as the main cause of the crisis."

This is somewhat short of a ringing endorsement. Some economists somewhere think it's important.

If the upshot of this is that the falling standard of living for the working guy is not only bad for him but bad for the economy, I agree and I imagine quite a few others (eg Phil? Blackshoe?) do as well. Where this rare agreement (if agreement there is) will lead us is less clear.

The cited reference goes on for a while about the misery of it all and concludes with

Quote

Since debts are assets for the financial system, writing off household debts will be a scary step to take since massive collapses of credit institutions will be inevitable. Besides, the powerful Wall-Street lobbyists will be more willing to shoot themselves in the head than allow any write-offs to occur. But any measures that do not address the wage-productivity gap will only be beating about the bush and continue to confuse cause with effect. The re-introduction of gold- or silver-backed currencies will be of little help as well. Thus, it is rather difficult to come up with a solution when the entire economic model caves in. This only proves that the existing economic paradigm (including college courses in economics and MBA’s) that serviced that model must change as soon as possible.

OK, order the new textbook. And then?

I grew up in what I pretty much think of as a golden age for the working class. We had what we needed. I am still struggling with whether that has actually changed for the typical worker or whether perceived needs have just gotten completely out of hand.

[Winstonm]

Ken,

You are right that wage-productivity gap is the accurate terminology. In a stable economy, there is a ratio between productivity and wages, and that ratio should remain relatively constant when productivity rises.

To really grasp the wage-productivity element of the economy, it is necessary to simplify the argument to exclude irrelevancies.

For example, to concentrate on what happens with wage-productivity, imagine a simple economy with no trade imbalances and where there is no government debt or surplus. In such an economy, the main components of aggregate spending (demand) is spending by consumers for consumption and by businesses for investments on newly produced goods and services.

This leads to a simple formula: Demand=Consumption + Investment

Furthermore, we assume that workers save nothing and spend all their salaries for consumption. (Not far off the 2% national savings rate, anyway.)

This leads to Consumption=wage income X employment.

On the other side, national supply in this simplistic economy consists of worker's productivity X Employment, or Supply=Productivity X Employment.

Taking the above and creating a simplistic economic model where government revenues equal expenditures and there is no trade imbalance, and there are no debts, we can use for example a 10-worker economy where each worker produces $5 annual goods and has wages of $4 annually and end up with an economy that creates $50 of supply with $40 of demand, which leaves $10 difference as investment. In this simple model, Supply=Demand.

Profits in this model would equal Business Revenue - wage costs (unsold good subtraction is not necessary in this idealistic model). We end up with Profit=Business Revenue - wage costs.

So, in our model economy we have total national productivity of $50 (which equals total business revenues), wages that cost $40, and profits that equal $10 (which is the same as investment.)

In this economy, investment is financed by profits.

Now, suppose over time that technology increases productivity and wages keep proportional pace, such that national output is now $10 per worker and wages rise to $8. In this scenario, investment would most likely double to keep pace with increased demand, so we end up with an economy that has Supply of $100 = Demand of Wages($80) + Investment ($20).

Now, suppose instead that unions are disallowed and the wage/productivity ratio widens so that instead of $8 workers are only compensated at $6. What occurs now? With our formulas, we can see that Supply ($100) = Demand ($60) + Investment ($20) breaks down, leaving unsold goods on the shelves of at least $20, and that is assuming investment increases from $10 to $20.

The unsold goods lead to layoffs and unemployment.

There is another method to plug the gap left by wages. New Debt. Businesses love the idea of new debt replacing wages because it has a massive influence on profits.

Let's suppose our simple economy acts as shown, with a doubling of productivity but only a 1/3rd increase in wages but add debt to the equation.

Supply ($100) = Demand (Wages $60) + (Investment $20) + (New Debt $20) We are now in balance. But how are profits affected?

Without consumer debt it would be: Profits = Supply ($100) - (Wages $60) - (unsold goods = $20) = $20.
If wages had kept the normal ratio, though, profits would look like this: Profits = Supply ($100) - Wages ($80)= $20.
With consumer debt it becomes warped: Profits = Supply ($100) - (Wages $60) = $40.

By utilizing consumer debt instead of increased wages, profits double in our make-believe economy.

Although simplified, this illustration is useful in understanding the basics of how wages and productivity interact, and the fact that it is simplified does not detract from its basic argument that in healthy economies the wage-productivity ratio is important to maintain with as little variance as possible.