When the facts change

Economics sometimes changes its mind

The science may be dismal but it is flexible, too

Economics is a “disgrace”, according to Claudia Sahm, a former Federal Reserve researcher, who has chosen to “no longer identify” as an economist. Among several flaws, the profession fails to nurture the young, she argues, or listen to outsiders. A survey by the American Economic Association (aea) found that only 31% of economists under the age of 44 felt valued within the discipline.

All this must be off-putting to youngsters beginning the long (and lengthening) journey into the profession. They may wonder if there is room for their ideas in a discipline that can seem hidebound, hierarchical and homogenous. Will they invigorate economics or will it indoctrinate them?

Budding economists can draw comfort from our series of six economics briefs that begins this week. Each looks at an issue (competition policy, minimum wages, inflation, the dollar, culture and public debt) that has prompted economists to revisit their field’s presumptions. Over the past decade or two, the profession has become more relaxed about minimum wages, inflation and public debt; less relaxed about monopoly power; less enamoured of flexible exchange rates; and more open to deep, institutional explanations of wealth and poverty.

What does it take to change economists’ minds? New ideas are not enough. The theory of monopsony, which explains why a minimum wage may help employment, not hurt it, had been around for at least 60 years before mainstream economics accepted its use in many low-wage labour markets. Recent nonchalance about high levels of public debt may seem new and mould-breaking. But the fresh thinking rests on theories set out in the 1950s and 1960s.

New facts are more compelling. The persistence of low interest rates despite high public debt has left an impression, as has the pre-pandemic combination of low inflation and low unemployment. The dollar’s rally in the global financial crisis showcased its peculiar role in the international financial system, as have various emerging-market tantrums since.

Fresh evidence also matters in microeconomics. New Jersey’s decision to raise its wage floor in 1992 by more than neighbouring states (despite tipping into a recession) provided the natural experiment required to change economists’ minds about minimum wages.

New facts, then, are more persuasive than new ideas. But although an alternative theory is not a sufficient condition for a change of heart, it is often necessary. It takes a model to beat a model, as economists like to say. They sometimes cling to propositions in defiance of the facts simply because they have nothing better to replace them with.

That raises a third condition for persuasiveness. To convert economists to your cause, it is not enough to give them something new to believe. You must also offer them something fruitful to do. Appeal to their hands as well as their heads. Economists will jump on a revolution that gives them new toys or techniques to play with.

This may explain why they have become more enthusiastic about institutional explanations of the wealth and poverty of nations. They cannot rerun history or sprinkle institutions randomly across countries to test their long-term effects. But they have found ingenious proxies for this kind of random variation. Economists, like many others, relish the chance to display their cleverness.

New facts and clever techniques help shift economic opinion. Does this also require new economists? Not necessarily. Some big names have changed their minds, or at least their tone.

Olivier Blanchard is less fiscally cautious today than he was ten years ago as imf chief economist, and Narayana Kocherlakota is much more doveish about monetary policy than when he was first appointed to head a Federal Reserve bank. The heretical tribes on the fringes of economics yearn to sack Rome. But it is more efficient to convert the emperor.

It is nonetheless striking that, in several of the areas covered by our series, vital work was done by economists who were in their 30s at the time (although all of them were already at elite institutions). According to the aea’s survey, only 5% of economists aged under 44 feel they have a great deal of power within the discipline. But the young may have one power denied to their elders: the freedom to imagine a future economics, unencumbered by too heavy an intellectual stake in its past.

Tax and spend is the new economic orthodoxy

Old ‘certainties’ and the interests that defended them will be ditched for good

Martin Sandbu

James Ferguson illustration of Martin Sandbu column ‘Tax and spend is the new economic orthodoxy’
© James Ferguson/Financial Times

The devastation wrought by coronavirus is, above all, a matter of human suffering to be lamented.

But we must also note another casualty of the pandemic: it puts the final nail in the coffin of an economic philosophy that has dominated policymaking for over three decades. 

The experience of “stagflation” of the 1970s, and public debt spikes in the 1980s, produced a reaction in the form of a particular set of ideals of fiscal responsibility. Aiming to keep public deficits and debt to moderate levels became a mark of politicians’ seriousness; so did forswearing an increase in the state’s tax take to fund ever larger public spending as a share of national income. Bien pensants looked askance at “tax and spend” and “borrow to spend” alike. 

Before the pandemic, this perspective had already been losing its grip, as expert opinion was becoming more tolerant of debt and more concerned about the damage of public spending cuts in the aftermath of the 2008 global financial crisis. With the economic fallout from Covid-19, received truths about fiscal responsibility will become impossible to hold on to. 

Since March, governments have rightly embraced enormous deficits to limit the collapse in economic activity, protect incomes and sustain employer-employee relationships. As a result, public debt burdens are rising everywhere to levels not seen for many decades, or even ever before. According to the OECD, many of its member governments could add debt worth 20 to 30 percentage points of gross domestic product this year and next.

This is going to force a simple choice on just about every government. They can tolerate the high debt burdens indefinitely, rather than try to bring them back down to moderate levels. Alternatively, they can permanently increase the state’s tax take to balance the books and start whittling down the debt. Either way, combining “responsible” policies on both debt and tax burdens is no longer an option. 

And even this choice — whether to be “fiscally responsible” with debt or with taxes — is only available in a best-case scenario. We may have to jettison both and learn to live with permanently higher public debt and permanently higher taxes. This will be true if economies never recover to their pre-pandemic growth trend, which seems almost certain if another wave of infections forces a new round of nationwide lockdowns.

The resulting permanent shortfall in government revenues would mean taxes having to be raised not to reduce debt ratios, but simply to prevent them from growing ever bigger. 

Some express the hope — or the fear — that governments could coax their central banks into inflating away the debt instead. That is theoretically possible. But it would, of course, only mean the crumbling of another pillar of the conventional wisdom on what constitutes “serious” economic policy, namely the inflation-stabilising central bank.

The evidence, however, is that central banks struggle to push inflation up even to their own targets, let alone enough to erode public debt meaningfully. Japan’s case is instructive: decades of loose and often pioneering monetary policy has failed to inflate away public debt. 

Equally enlightening is that Japan’s tax take, which used to be well below the rich-country average, has gone up markedly. According to the OECD, Tokyo took in 25.8 per cent of gross domestic output in taxes broadly defined in 2000, or 8 percentage points below the OECD average.

Before the pandemic that had converged to 31.4 per cent of GDP, within 3 percentage points of the OECD average. If Japan is a harbinger of the future for all rich economies, then, expect public debt to stay high and taxes to move higher. 

It is hard to imagine such a shift in governing ideas without a change in politics, too. Bear in mind whose interests were best served by prevailing ideas of fiscal responsibility. Public borrowing, it was long thought, crowds out private investment by making financing costlier for the private sector. Higher taxes, naturally, have been seen as reducing the profitability of private enterprise. 

The old orthodoxy, in other words, has suited the asset rich and those enjoying income from owning or controlling capital. The power of those interests — in terms of defining the reigning ideas of what counts as serious policy, if not also by lobbying directly — can be seen in the response by most countries to the previous jump in public debt, caused by the global financial crisis. Fiscal orthodoxy was behind the drive to cut public spending in many countries. 

It is much harder to imagine significant cuts to public budgets today. Partly because the damage from past cuts is now visible and further ones are more difficult to justify. Partly because the pandemic itself focuses the political spotlight on inadequate public services and underpaid public sector and other key workers. Much more than a decade ago, budget shortfalls will now have to be covered by tax raises.

There is no reason to expect those who benefited from the “fiscal responsibility” of the past to give up the fight for their interests. If significant tax rises are indeed inevitable, the fight will move to where the heavier tax burden falls: which taxes go up and by how much. Expect this to be the fiercest battle over economic policy if, and when, we return to some semblance of normality.

Domesticity Is a Mixed Blessing for Household Brands

Sales at Nestlé and Unilever have benefited during lockdowns. But their out-of-home businesses will be an eyesore from now on

By Carol Ryan

Unilever is ramping up its e-commerce home-delivery service for ice-cream brands such as Ben & Jerry’s. / PHOTO: ROB KIM/GETTY IMAGES

The word “home” was mentioned 50 times on Nestlé’s NSRGY 0.10% second-quarter investor call, compared with just once during the same briefing that took place during 2019. Soon, household-staples companies could sound equally preoccupied with their flagging nondomestic businesses.

Since the Covid-19 pandemic began, consumers have had to spend more time sheltering indoors and preparing their own food. That is a reversal of a long-term trend of people in Europe and the U.S. eating more of their meals out in restaurants, fast-food chains and workplace canteens.

In May 2019, slightly less than half of all U.S. food spending was on goods that were consumed in the home, statistics from the U.S. Agriculture Department show. By the same month of this year, that share had jumped to 61%.

The spending shift has mainly been good news for household-staples companies that make products such as cooking ingredients and home-brew coffee—but only up to a point. Although they got an immediate boost to sales as countries went into lockdown, parts of their businesses will suffer the longer people stay at home.

Nestlé, the world’s biggest packaged-food company, makes 10% of its sales to out-of-home channels, mainly through a division that supplies products such as coffee creamer and spring water to hotels and offices. Add to that food that is usually grabbed on the go, such as candy bars and bottled water, and the company’s out-of-home business counts for 15% of total sales.

French dairy and bottled-water giant Danone DANOY -2.50% has a similar level of sales exposure, while Unilever’s UL -1.21% exposure is as high as 40%, according to estimates from brokerage firm Jefferies.

Pantry loading masked the problem somewhat in the second-quarter reporting season. Unilever’s sales were flat over the period, despite a 56% plunge in sales at its large catering-supplies unit. High demand for the company’s cleaning and hygiene products, as well as stockpiling by consumers in the U.S., provided a buffer.

But as panic buying subsides, consumer-staples companies will find it harder to make up the shortfall in their struggling out-of-home divisions. Nestlé expects sales to grow by just 2% to 3% in 2020 because of the impact of the crisis on its food-service business—a pace below last year’s level.

Companies can try to salvage sales. Unilever is ramping up its e-commerce home-delivery service for ice-cream brands such as Magnum and Ben & Jerry’s, which tend to be eaten outdoors. Nestlé’s chief executive suggested that the company may branch out from supplying beleaguered hotels to food-delivery restaurants that are booming as diners order in.

Household brands have been winners so far during this crisis, but domesticity isn’t good for all parts of their business.

Morgue Testing the US Economy

Owing to the lack of testing capacity, there is no way to know for sure just how bad the COVID-19 epidemic in the United States has become as a result of this summer's "Sunbelt second wave." But judging by the latest data on morbidity and unemployment-insurance claims, no one should bet on economic recovery in the third quarter.

J. Bradford DeLong

delong222_Kevin Dietsch-PoolGetty Images_faucicoronavirus

BERKELEY – US national income and output in the first quarter of 2020 was 1.25% below what it had been in the fourth quarter of 2019, but still 9.5% above would it would be by the second quarter of this year. Now that US national income has plunged 12% below what it was at the start of the year, what should we expect for the third quarter?

From Latin America’s lost decade in the 1980s to the more recent Greek crisis, there are plenty of painful reminders of what happens when countries cannot service their debts. A global debt crisis today would likely push millions of people into unemployment and fuel instability and violence around the world.

America could always turn out to be lucky; but betting on that would not be prudent. According to Austan Goolsbee and Chad Syverson of the University of Chicago Booth School of Business, it was voluntary self-protection, rather than legislated restrictions on activity, that drove most of the decline in consumer spending this spring.

Moreover, they warn that, “If repealing lockdowns leads to a fast enough increase in COVID infections and deaths and a concomitant withdrawal of consumers from the marketplace,” doing so “might ultimately end up harming business activity.”

In fact, we have seen this summer that ending or scaling back lockdowns often does lead to a rapid increase in COVID-19 infections. A sound forecast for the US economy, then, must start by forecasting the future of the pandemic. Yet most of the charts, graphs, and tables concerning the virus and its impact are useless for forecasting purposes.

After all, confirmed COVID-19 deaths tell us only what the virus was doing a month ago, whereas anticipating the virus’s trajectory requires knowledge about what it is doing now.

Similarly, confirmed cases catch only those who have been tested, and one must wait days or even weeks to receive test results. To get a grip on the situation, the number of tests per confirmed case would need to be 5-10 times higher than it is.

How would the past few months have played out if effective testing infrastructure had been in place? My guess is that the true (not just the measured) number of weekly new cases increased 2.5-fold from mid-June to mid-July. Assuming that we can accurately infer true cases in mid-June by multiplying mid-July’s weekly confirmed deaths by 150 (admittedly a big assumption), the cases per week rose from about 600,000 to about 1.5 million as the “Sunbelt second wave” hit.

Since then, the overall picture has been even less clear. As was the case in mid-July, one test in 12 still comes back positive, and there are 150-200 confirmed cases per million people. But we are testing no more now than we were then, and the reporting date of a typical test is now lagging substantially behind the administered data – in some cases by as long as three weeks.

If the US is lucky, the fear caused by the Sunbelt second wave will have led to more vigilance in social distancing and mask-wearing, allowing for the true number of new cases nationwide to stabilize at around 1.5 million per week. But if the country is unlucky, that number will have continued to grow to around 2.5 million per week.

Tragically, we simply will not know where we stand until we can count the bodies later this month. Only then can we determine whether COVID-19 deaths “merely” doubled (from 4,500 to 9,000 per week) between mid-June and mid-July, or continued surging well beyond that level.

America’s widespread testing failure means that it is still flying blind. As such, nobody really knows what would happen if schools were reopened or indoor dining and choral music recitals resumed. The conservative commentator David Frum spent the spring in New York and is now in Toronto. “To walk around a city of 2.8 million with fewer than 5 cases a day feels like the onset of recovery,” he recently tweeted.

He’s right. Canada, the European Union, and Japan are highly likely to see substantial economic recoveries this fall. The same cannot be said of the US. At best, there will be a mechanical bounce-back from the second to the third quarter, mostly because unemployment-insurance claims had fallen from a peak of 24 million to 17.5 million by the start of July.

But, given that claims rose by one million from July 5-11 to July 12-18, there is every reason to fear that they have continued to climb in the ensuing weeks. We will soon have numbers for the first week of . If claims have returned to the 20 million range and remain at that level heading into the fall, much of the mechanical bounce-back will have been reduced.

For the US to have any chance of a real economic recovery this year, it would need to focus on two overarching objectives. The first is to stop the spread of the virus, so that people no longer fear going out and spending. The second task is to put those who have lost their jobs in hospitality and other indoor high-human-contact occupations back to work, either providing online services or working in investment-goods sectors that do not require close contact with people.

It is in America’s power to do these things, in principle. We have the resources, and as John Maynard Keynes once put it, “Anything we can actually do, we can afford.”

But doing what needs to be done would require governance far more competent than anything we have seen from President Donald Trump and his Republican enablers. In the coming months, at least, we should continue to expect the worst.

J. Bradford DeLong is Professor of Economics at the University of California at Berkeley and a research associate at the National Bureau of Economic Research. He was Deputy Assistant US Treasury Secretary during the Clinton Administration, where he was heavily involved in budget and trade negotiations. His role in designing the bailout of Mexico during the 1994 peso crisis placed him at the forefront of Latin America’s transformation into a region of open economies, and cemented his stature as a leading voice in economic-policy debates.