Thrifty Business

In the run-up to the UK General Election 2015, I ended up writing so many similar posts on facebook on why Austerity doesn't work that I thought I'd turn it into a blog entry.

Nobel Prize-winning economist Paul Krugman has written an excellent piece in the Guardian about the Austerity delusion. He covers the historical developments over the past 5 years and provides evidence for a negative correlation between austerity and economic growth.

All I want to do is show why the common-sense argument of the analogy from thrift isn't correct.

 The thrift argument is that, if I'm in debt, I have to cut back on my own spending until everything's under control and I can (and have) paid it off.

[*]And that's the right thing to do, however, it's not the whole story. In reality what happens is that when you cut back to pay off your debt, the people you trade with lose income. In a sense, they're soaking up the imbalance of your finances, but it works, because they're only losing a little bit when you cut back by a lot. The key thing is that your income stays the same while your outgoings shrink (a lot), and their income shrinks (a bit) while their outgoings stay the same - so you're passing on your debt, they take a bit of a hit too.

And therefore, it won't work if everyone is simultaneously in debt. When everyone starts cutting back, everyone's income shrinks and so they become less able to repay their debts. That's what happens when governments enact austerity: the private purse shrinks, internal trade stalls (and this in fact is what happened - banks stopped lending and started calling in debts, which is why businesses failed) and if the government acts along with it by reducing its spending in accordance with its lower tax revenue, it just adds to the problem.

The right thing to do then, if private lenders won't lend, is for the government to provide the cash to keep the economy going - and that means public borrowing during a financial crisis. That's half of Keynesianism, in essence.

Keynesianism, relies on another insight - that cash isn't a substitute for goods as we normally think, instead, cash is a medium for exchange. That is, cash operates as a pipe for transporting goods; the size of the pipe is the amount of cash we have, it determines the rate we can exchange and trade; it's not a representation of what we have.

So, if we go back to [*], we can see that's what's happening in the example. Your original debt is distributed across the entire system. It's the capacity of your input pipes (income+loans), which is the same as your output pipes capacity (spending), which determines the sizes of others' input pipes (income). When you cut back, the whole network capacity shrinks. Which is to say your debt was distributed everywhere all along. It's a really powerful concept to get one's head around, I've barely scratched the surface.

Gini Sim

The Gini Index is a measure of wealth distribution.

GiniSim is a simple Javascript program which demonstrates, in simple terms, flaws in free market economics, by showing that trading freely will lead to gross inequality. Copy the program into a .html file; save it and then open it in a browser: you can stop it by pressing the Stop button. Alternatively, you can download and run a simple Java version, GiniSim.jar from here.

Each bar is the wealth of a person, and the simulation starts with everyone having $10 (or £10, or 10€).

Each step simulates a free trade transaction, two monetary notes are picked at random and the person the first one belongs to pays the person the second one belongs to. Intuitively, you’d think this would average out: sometimes some people win and sometimes others would.

In reality what happens is that whenever a person accumulates wealth, it makes it more likely that someone poorer will give money to them. This is due to the fact that the chances of being paid in a transaction is proportional to their wealth - so if someone loses money from a transaction, they become less likely to gain in a future transaction.

How does this correspond to an idealism of the free market? It corresponds, because exchanges take place on the basis of being indifferent towards cash. Therefore when people gain wealth, their wealth acts as a bigger wealth footprint and people (who want to buy things) notice the cash more. If you’re poorer, that doesn’t happen, you’re not noticed, because your visible presence is the cash you hold - you literally disappear.

The important thing to note is that GiniSim demonstrates inequality without the agents involved behaving maliciously. All it does is play fairly towards cash (rather than people). It's a demonstration of a power law.

How does GiniSim1 not correspond to classical economics? GiniSim1 correspond to free trade under mercantilism, which is a zero-sum economic theory.

Here’s GiniSim, copy everything in yellow:

<!DOCTYPE html>

<html>

<body>

<button onclick="clearInterval(timer)">Stop</button>

<canvas id="myCanvas" width="800" height="600" style="border:1px solid #c3c3c3;">

Your browser does not support the HTML5 canvas tag.

</canvas>

<script>

  var c=document.getElementById("myCanvas");

  var ctx=c.getContext("2d");

  var timer;

  var rects=0;

  var cash=[0],people=[0];

  var kStartCash=10;

  var kNumPeople=100;

  function initGini() {

    var ix,iy;

    for(ix=0;ix<kNumPeople;ix++) {

      people[ix]=kStartCash; // everyone starts with $10.

      for(iy=0;iy<kStartCash;iy++) {

        cash[ix*kStartCash+iy]=ix; // each $1 is owned by a person.

      }

    }

  }

 

  function incomeSwap(from,too) {

    var ix;

    for(ix=0;ix<kNumPeople*kStartCash;ix++) {

      if(cash[ix]==from)

        cash[ix]=too;

      else if(cash[ix]==too)

        cash[ix]=from;

    }

    ix=people[from];

    people[from]=people[too];

    people[too]=ix;

  }

 

  function exchange() {

    var aNote=Math.floor(Math.random()*kStartCash*kNumPeople);

    var aOwner=cash[aNote];

    var aNewNote=Math.floor(Math.random()*kStartCash*kNumPeople);

    var aNewOwner=cash[aNewNote];

    if(people[aOwner]>0 ) {

      // can't take cash from people who have nothing.

      //}while(aNewOwner==aOwner);

      people[aOwner]-=1;

      people[aNewOwner]+=1;

      cash[aNote]=aNewOwner;

      while(aOwner>0 && people[aOwner]<people[aOwner-1]) {

          incomeSwap(aOwner,aOwner-1);

          aOwner--;

          if(aOwner==aNewOwner)

            aNewOwner++;

      }

      while(aNewOwner<kNumPeople-1 && people[aNewOwner]>people[aNewOwner+1]) {

          incomeSwap(aNewOwner,aNewOwner+1);

          aNewOwner++;

      }

    }

  }

 

  function drawImage() {

    var ix;

    for(ix=0;ix<kNumPeople;ix++) {

      ctx.fillStyle="#c0c0c0";

      ctx.fillRect(ix*8,0,8,600-people[ix]);

      ctx.fillStyle="#000000";

      ctx.fillRect(ix*8,600-people[ix],8,600);

    }

    exchange();

  }

  initGini();

  timer=setInterval(drawImage,1);

</script>

</body>

</html>

[Edit: Added link to GiniSim.jar on 20150321. Edit: I knew from the simulations that wealth always gravitates to the rich, but my reasoning for the mechanism was incorrect, because I was trying to derive it from the probabilities of a single transaction. In reality, the mechanism is due to how the probabilities change between one transaction and the next. 20150626.]

Global Crunch Twin Pack

Most of my blogs are techie, but occasionally I stray into politics. It looks like the global economy is about to take a second bite at the same, un-nutritious Global Crunch candy bar, I don't think it has to happen.

In 2008 I wrote a post about the Global Economy Crunch. In it I compared it with previous major economic collapses. My assessment at the time meant I connected those crashes with an unsustainable boom due to market deregulation and the following depressions due to protectionist (i.e. austerity) measures and only overcome due to practical implementations of Keynsian economic theory. I predicted that this crash would last at least as long as the worst of the previous ones.

Since then, although we managed to avoid a meltdown by the courageous step of major bailouts for banks and global financial institutions, governments have followed the predictably damaging path of Austerity to the point where it looks to me like we're heading for another, worse crunch than in 2008. Here's why.

Austerity measures in the UK mean that we're back in recession (as Labour predicted in 2010), whereas the US is not (though their crash was worse). The conservative government have been championing manufacturing, yet manufacturing is shrinking in the UK today (at its fastest pace for 3 years). So, there's no fall-back in the public sector (which has been downsized) and no pick-up from the service sector either.

Manufacturing in Spain and Greece is shrinking; there are major issues with the funding of banks in Spain and unemployment there is at a record 24% plus; Italy's bond yields are virtually unsustainable, Greece is about to vote on whether they exit the Euro (it'll be awful for them either way); Ireland's just voted for a heavier austerity package.

More disturbingly though is what's happening in East Asia as everywhere you look there the economy is slowing down. China's growth is down and even internal growth is slowing. India's growth is similarly slowing (an article just one hour before I've linked this argues whether India's growth is over) and it's manufacturing sector recently even shrank. South Korea is suffering a slow-down. In my opinion this is all relevant, because a major reason why we survived the original Crunch in 2008 was because the far East was doing so well and could basic bail-out the West; and doing so well to the point where it was understood that even if the West went under they'd continue pretty well.

The other concerning aspect is the way right-wing think tanks are continually arguing for business deregulation; eliminating workers rights through, for example no fault dismissals, which are supported by the PM, and more flexible working. Similarly in Europe, right-wing economists are arguing for more Austerity.

I don't believe that Austerity works at a macro-economic level, though it can work at a personal level. The reason is that at a personal level if you're frugal, everyone else can cope with you spending less - they only lose a fraction of a % of their income; but if everyone cuts back to suddenly make ends meet then the result is a self-inflicted vicious circle of deprivation. For example, tying the Greek bail-out to austerity meant that Greece becomes deprived of the engine (i.e. the workforce) they need to get out of their debt crisis. In that sense it's better to tie European a mandatory trade boost with Greece to internal cut-backs; which would be analogous to personal frugality, with the Greeks making do with an average lower standard of living, but gaining full employment (by virtue of the trade agreement) and thereby the means to overcome debts. Europe here would be taking up the economic strain, but we're in a better position to do so.

On the other hand, I think there's a better way: cooperative economics. Rather than penalising the very people who lost the most in the initial Crunch we would be better off by Enfranchising The Workforce; making it ludicrously easy for people to form cooperative micoenterprises and for working people to have a greater stake in their companies in lieu of the pay-rises they're not going to get for the foreseeable future. The thing is, we already have the resources with us; we don't need to Crunch twice on the same disastrous candy bar.