The current crisis is a phase in the Great Stagflation since 1970. Let us first understand this cause before we consider the cure.
The term stagflation was coined by MP Iain Macleod in a speech in the UK parliament in 1965. The inability of economists and governments to solve the problem right then and there allows us to choose the rounder year of 1970 as the moment when a simple affliction turned into what we now can call the Great Stagflation.
In the period 1965-1980 the world tried a vulgar Keynesian stimulus of the ‘demand side’. Accelerating inflation caused a switch to monetarism and the ‘supply side’. Since the presidency of Reagan in 1981 governments tend to follow a policy that also is called ‘neoliberal’ because of deregulation and the encouragement of the free market. The deregulation also implied a massive demand stimulus, because the deregulation of financial markets released vast sums to search for investment opportunities. Eventually that deregulation caused massive leveraging, so that finally there came the ‘Minsky moment’ with the collapse of Bear Stearns in August 2007. That moment is taken by many as the official beginning of the current crisis, though it is only a new phase in the longer problem history.
Now that we are reregulating again, stagflation rears its ugly head again in high unemployment and stagnating investments for growth, while there is also the threat that inflation is going to be used again to reduce government debt.
The events since 2007 cause economists and governments to focus on the financial sector, monetary policy and national debt. This is reasonable to a large extent since the mess must be cleaned up and the sector needs regulation again. There are limits to what can be achieved here however. It is also necessary to look at fiscal policy, investments and labour. In these areas the tendency exists to look back only a couple of decades, say to the period of president Clinton 1993-2001 when the world economy seemed to do well. We must look deeper into the past however, because the periode 1950-1970 contributed to the Great Staflation that we are in.
One might hold that the current problems are aggravated by the imbalances in Europe because of the euro, and the imbalance between the US and China on trade and debt. In an alternate history a managed float in Europe (instead of the common euro) might have caused havoc as well. The relationship between the US and China is quite special anyway. Thus these issues deserve attention but are not the main ones. The key aspects of the Great Stagflation are internal to each nation in the OECD and cannot be resolved by exchange rates.
What, then, are those key aspects, and what is the cure of the Great Stagflation ?
First of all, taxes and social security premiums neglect the need for an adequate exemption for subsistence. The policy that is co-ordinated in the OECD is to adjust for inflation but it should be for the rise in the general welfare, i.e. both inflation and real growth. The levies at the minimum wage raise those labour costs, with subsequent unemployment. When labour demand shifts to higher productive workers, these workers can demand a higher wage, which contributes to inflation. The higher unemployment and inflation are depicted in an unfavourable shift of the Phillipscurve.
A second point is that economists who study taxation and the labour market concentrate on partial derivatives and neglect the total differential. In lay terms this is the difference between static and dynamic marginal tax rates. The static rate can be found in the tax statute. The dynamic rate arises over time when rates are adjusted. Official policy has been to reduce exemption and static rates, and to switch from income tax to VAT (that has no exemption at all). This contrasts with the optimal policy, which is to maintain high exemption, while VAT could be one percent.
The third point is the failure of economic co-ordination. One cannot look back at the period since 1950 with the various crises without concluding that there is something seriously amiss in the co-ordination of economic policy. The advice is to extend the checks and balances of the Trias Politica into a Tessera Politica with the addition of an Economic Supreme Court (ESC). A draft constitutional amendment can be found in my book DRGTPE.
The economy has had crises but there have been similar crises in economic theory itself. In that respect it might be silly to have an Economic Supreme Court (ESC), with its members in similar disarray as politicians or the stock markets. However, consider what we see now. A problem caused by failure in taxation has been approached subsequently by vulgar keynesians then monetarists then neoliberals and now reregulators, each trying to solve the errors of the predecessor. The current system allows each solver to take a rather narrow view. The ESC will be grounded both in science and society so that such a narrow view is much less likely. For comparison, we have an independent Judiciary that will surely not be perfect, but it is better to discuss its faults under the regime of such an independent court rather than under a regime like we now have in economics.
It may be observed that I have been explaining the core of this analysis since 1990 and that it met with censorship by the directorate of the Dutch Central Planning Bureau (CPB) over the whole period since then. This proves that the information has been available and could have been used if there had been a scientifically based ESC. The current arrangements in Europe apparently allow such censorship of science, which surely seems suboptimal. In this difficult situation, my best advice is to boycott Holland till the issue is resolved.
Thomas Colignatus is an econometrician and teacher of mathematics in Scheveningen, Holland. He worked at the Dutch Central Planning Bureau in 1982-1991. See http://thomascool.eu.
Colignatus (2011), Definition & Reality in the General Theory of Political Economy, (DRGTPE) 3rd edition, Thomas Cool Consultancy & Econometrics, http://thomascool.eu.
Colignatus (2012), Common Sense: Boycott Holland, MijnBestseller.nl