March 13, 2018
A recent online exchange between Steve Roth and my colleague Matthew Klein contains much food for thought. It started with a post by Roth titled “Why economists don’t know how to think about wealth”, which alleged, in simplified terms, that mainstream economists miss much of what goes on in the economy by focusing largely on flows of income, spending and saving rather than the stocks of wealth, assets and liabilities. Klein’s retort warned against “dangers in making capital gains and losses more central than they already are”. And Roth has replied to some of Klein’s comments.
Those interested would do well to read the whole exchange. Here I want to dwell on a particular point. Roth urges economists to take a wider view of saving, and uses the term “comprehensive saving” for the sum of, on the one hand, income that is, so to speak, put aside (the amount produced but not consumed in a given period of time), and on the other, the change in value of the stock of wealth. The former is what economists call just “saving” in national income account: it is just the amount of economic activity not consumed (but instead devoted to capital goods — investment — or serving users abroad — net exports). There is an analogous concept of comprehensive income, which includes not just the amount produced in a time period but the increase in the value of things already owned.
This may seem commonsensical: it is how an individual person, household or business experiences their financial situation. Adding it up for a whole economy gives a picture of something that undoubtedly has an effect on their individual economic behaviour and how it may change. But precisely because an economy behaves differently than the sum of its parts, this approach brings important pitfalls of its own.
One reason is pointed out by Klein. A focus on “net worth” and capital gains and losses draws our attention to assets — but liabilities, and the composition of each, matter hugely as well. When growing assets of fickle cash value — think houses or productive business capital — are matched with debt liabilities (which are designed so as to have a relatively stable value in monetary terms), large swings in perceived wealth are likely to occur. Klein, for example, gives the example of US housing wealth (charted below). This is why I and others have advocated better mechanisms for debt restructuring so as not to saddle an economy with unpayable debts.
Another reason is that while measured stocks of wealth (and liability) clearly play into the economic decisions of companies and households, economic activity is itself inherently a flow concept. “Saving” in the sense of valuation increases does not correspond to anything on the ground, as it were. The same is true of “comprehensive income”. An individual can “save” more or less depending on the revaluation of the assets they own, and can spend their “comprehensive income”. But an economy as a whole cannot spend out of its financial wealth without devoting more of its actual current production to consumption (we ignore foreign financial investments here). Nor can it spend its “comprehensive” income; it can only spend (consume) out of what it produces, and spending more means saving less.
This, indeed, is why stock measures of assets and liabilities are important. In a nutshell, the run-up to the financial crisis involved increased measured wealth due to the positive revaluation of assets driven by both money-printing and exuberant expectations. But that nominal wealth lost any relation to what was and would be available to spend out of actual current or future production. When that realisation sank in, the measured wealth plummeted as expectations of asset values readjusted. And as a result, people chose to save more in the only way they collectively can: by spending less. The result was the biggest recession in generations.
Finally, all this means that we should use different terms than income, saving and wealth when referring to stock measures and changes in their value. A better term is “pseudo-wealth”, the term pioneered by Martin Guzman and Joseph Stiglitz in an important paper. By pseudo-wealth they mean “individuals’ perceived wealth that is derived from heterogeneous beliefs and expectations of gains in a bet”. This captures two crucial facts: the “wealth” in question is a perception of wealth, and that this perception may well be unwarranted. In fact it is more likely to be wrong than not, since market values of assets (and liabilities, but perhaps not to the same extent) are not “real” in the sense that they can be realised for the economy as a whole.
Similarly, we should talk of pseudo-saving and pseudo-income when talking about valuation changes in asset (and liability) values. “Pseudo” does not mean it does not have real effects. It is precisely because stock measures of wealth are perceptions that they have unpredictable effects on real economic activity — and that these effects can be bigger the more unwarranted the perceptions are. But it is still real economic activity — as captured by conventional national income flow measures — that we should ultimately care about.
- My colleague Rochelle Toplensky’s analysis of the ever-shrinking tax paid by multinational corporations is a must-read. The tax rates companies report to be paying turns out to bear little relation to the amount of cash actually handed over to governments, as the chart below shows.
- The Five Star Movement is a very well-behaved insurgency, if we are to believe the op-ed by its candidate for minister of economic development. For example, “we intend to operate within the eurozone framework” and “reduc[e] the national public debt in line with the IMF’s recommendations”.
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