The analysis about the Economic Supreme Court and the ‘natural monopoly’ argument about economic policy advice, actually finds a parallel with respect to the Central Bank. Reading Galbraith (1998) made me aware of this situation.

Let us regard the situation that market forces determine the rate of interest to a large extent, but that the Bank is not without some power and will use its influence on rates to control inflation.

·         Theory dependence: The Bank decides on its policy while using an economic model that contains a mechanism for the determination of the rate of interest - for example the rate of interest will contain anticipated inflation. Hence policy is directly dependent upon the state of economic theory.

·         Self-reference (reflexiveness): Since interest rates are sensitive to Bank policy, Bank policy would be part of the model. Popular thought has it that a good Bank would target at zero inflation, but Bank policy generally would be different. For example, a true zero target would require that a period with inflation is followed by deflation, and Banks generally don’t do that. Also, the true price level should include inventories and capital stocks, but inflation generally is measured as the CPI, which is something totally different. These details, and Bank policies on them, should be put into the model (with error terms to allow for possible discretion).

·         Conflictive self-reference: Clearly, one can conceive the situation that the Bank announces a policy while the true scientific forecast shows that the policy is untenable and will be repealed later. Hence there is an internal source of conflict - the worst kind, not a dysfunctional person, but a logical knot.

·         General conflict of interests: The Central Bank may not only have the objective to control inflation but also other objectives, like for example supporting and supervising the financial system. For example, the US Fed is not purely a governmental body, but it is rooted in the financial system and it is influenced by private interests therein. See Galbraith (1998:221-231) for a discussion on the conflict of interests - for example on the ‘credit crunch’ - and read also Krugman on the Savings &  Loans debacle.

Hence, along the ‘TP & ESC’ line of argumentation, we can clearly see a need for reform in existing Central Banking, and the direction that it would need to take. Interestingly, where economic policy of the state would have to be co-ordinated with the policy of the Central Bank (that should best remain independent), there arise questions of structure and priority. My suggestion is to first create the Economic Supreme Court, and have it advise on how to position the Bank or its separate functions.

This appendix consists of two large quotes from the White House internet site in January 2000, with my comments added.

“There is hereby created in the Executive Office of the President a Council of Economic Advisers (hereinafter called the “Council”). The Council shall be composed of three members who shall be appointed by the President, by and with the advice and consent of the Senate, and each of whom shall be a person who, as a result of his training, experience, and attainments, is exceptionally qualified to analyze and interpret economic developments, to appraise programs and activities of the Government in the light of the policy declared in section 2, and to formulate and recommend national economic policy to promote employment, production, and purchasing power under free competitive enterprise.

It shall be the duty and function of the Council--

1.       to assist and advise the President in the preparation of the Economic Report;

2.       to gather timely and authoritative information concerning economic developments and economic trends, both current and prospective, to analyze and interpret such information in the light of the policy declared in section 2 for the purpose of determining whether such developments and trends are interfering, or are likely to interfere, with the achievement of such policy, and to compile and submit to the President studies relating to such developments and trends;

3.       to appraise the various programs and activities of the Federal Government in the light of the policy declared in section 2 for the purpose of determining the extent to which such programs and activities are contributing, and the extent to which they are not contributing, to the achievement of such policy, and to make recommendations to the President with respect thereto;

4.       to develop and recommend to the President national economic policies to foster and promote free competitive enterprise, to avoid economic fluctuations or to diminish the effects thereof, and to maintain employment, production, and purchasing power;

5.       to make and furnish such studies, reports thereon, and recommendations with respect to matters of Federal economic policy and legislation as the President may request. ”

Quoted from The Economic Journal, 102 (September 1992), “The Council of Economic Advisers and Economic Advising in the United States”, by Martin Feldstein.

Although the term ‘Council’ conjures up the image of a large committee, the CEA actually consists only of a chairman and two members. The chairman is legally responsible for establishing the positions taken by the Council. The other two members direct research activities of the Council in particular fields, represent the Council at meetings with other agencies, and generally work with the chairman to formulate economic advice.

In addition to the chairman and two other members, the CEA has a professional staff that is both small and unusual. A group of about ten economists, generally professors on one- or two-year leaves from their universities, act as the senior staff economists. They in turn are assisted by an additional ten junior staff economists, typically advanced graduate students who also spend only a year or two at the CEA. Four permanent economic statisticians assist the economists in the interpretation and identification of economic data.

The academic nature of the staff and of most CEA members distinguishes the CEA from other government agencies. It generally assures a higher level of technical economic sophistication and of familiarity with current developments in economic thinking. Members and staff also use their strong links in the academic community to obtain advice on technical issues throughout their time in Washington.

How Advice Is Given

The CEA chairman gives advice directly to the President and to the senior members of the administration. There is also a broader role of trying to shape public understanding of the economic issues. The CEA members and staff participate directly in the inter-agency process, in which policy options are evaluated and recommendations developed for presidential decisions.

The specific organization of advice-giving undoubtedly differs from administration to administration, reflecting the overall form of economic policy making and the particular style and interest of the president. I can only describe my own experience.

In the Reagan administration, the cabinet as a whole rarely met. Instead, economic policy issues were discussed through a series of cabinet councils with more specialized responsibilities. These included a cabinet council on commerce and trade that was chaired by the Secretary of Commerce, a cabinet council that dealt with labour and social insurance issues, a cabinet council that dealt with regulatory and legal issues, and a general cabinet council on economic affairs that was chaired by the Secretary of the Treasury. Each of the interested departments was represented at the council by the secretary of that department. Occasionally the deputy secretary or under-secretary substituted for the secretary at those meetings. I generally represented the CEA, although occasionally one of the members took my place at the table. Vice President Bush usually attended these meetings.

The councils generally met without the president. Roughly twice a month the president participated in council meetings when there was a specific issue that required a presidential decision or, occasionally, a broad area that seemed appropriate for general cabinet-level discussion with the president.

Any major proposal for legislative action, whether originated by a department or from Congress, would be assigned to an appropriate cabinet council for consideration to develop an official administration position. Initial meetings would be held at a staff level, with the CEA represented by the senior staff economist with the relevant expertise. Often discussion at this level would be sufficient to dispose of the idea, usually with the conclusion that the proposal was well-meaning but misguided and would not accomplish its stated purpose or would do so only at an unacceptable economic cost. This would quietly bury an internal departmental proposal or lead to a formal administration position to oppose a Congressional initiative.

When there was disagreement about the proposal that could not be resolved unanimously at the level of this working group, a higher-level meeting would be held. Each interested department would be represented at a sub-cabinet level, generally by an assistant secretary. The CEA would be represented by a member or senior staff economist, since with only two members it was often true that the CEA only had the expertise at the senior staff level and preferred to send a real expert rather than, as in the other departments, to send a more senior official who was ‘briefed’ but who did not really understand the issues himself.

Once again, if this group could not reach a consensus the issue would be passed up to the full cabinet council, where the departments were represented at the top level and the CEA by the chairman. If this group reached an agreed recommendation, its conclusion would be sent to the President. When there was disagreement, a summary of the different positions would be prepared by the staff of the council for submission to the president for his decision. These decision memos were carefully prepared so that each side could object to any spurious arguments put forward by others. On some occasions, when it was felt that such written summaries were inadequate, the group would meet with the president to present opposing views.

This process gave the CEA an opportunity to influence both the specific decisions and the way that members of the administration thought about particular issues. This was true at every level from the departmental senior staff that interacted with the CEA economists to the cabinet level.

In addition to these relatively large group meetings with the President, there were also smaller meetings dealing with specific subjects. A central organizing set of meetings each year dealt with the budget. Here the only regular participants, in addition to the president and the vice-president, were the Secretary of the Treasury, the Director of the Office of Management and Budget (OMB), the Chairman of the CEA, and a small number of senior White House staff. The series of budget meetings began with a five-year economic forecast prepared by the CEA. Technical staff discussions and meetings between a CEA member, a Treasury assistant secretary and an associate director of the OMB would review the evidence on which a forecast would be based. In insisted, however, that the CEA alone was responsible for the final forecast in order to avoid a repetition of earlier experience in which the forecast was widely (and correctly) criticized as over-optimistic, and therefore as leading to a substantial underestimate to future budget deficits. Needless to say, this was a source of friction and contention.

Other such small meetings with the president included preparation for the G-7 economic summits, for his televised national press conferences, and for discussions of special subjects like social security reform.

The Secretary of the Treasury and I also met roughly every two weeks with the president and a few senior White House staff to discuss subjects of our choice. The Treasury Secretary frequently used these sessions to discuss monetary policy or issues currently under development at the Treasury. I frequently discussed the budget deficit but also talked about things like the character of unemployment, the nature of the trade imbalance, and other types of general ‘background’ information. These were not intended as decision-making sessions.

In addition to these meetings, I also sent the president brief memos on particular issues. Occasionally these would be my thoughts on some issue being discussed in the administration. There were also almost daily brief memos telling the President how to interpret important economic statistics that would be released the next morning so that he would not be caught unaware of the information (by the press or other visitors) or uninformed about the significance (or lack of significance) of the particular statistic.

The CEA also serves as a source of professional economic advice to other departments and agencies. In some cases, this serves to reinforce the advice being given by that department’s own economist. In other cases, it fills a gap where the department does not have an economist or where the CEA can bring better analysis to a particular problem. As chairman I also met on an individual basis with the department heads to discuss policy issues relevant to their department or more general issues like the budget situation.

A weekly breakfast meeting with the Treasury Secretary and the OMB Director -- the so-called Troika or T-t group -- provided an important opportunity to discuss economic issues with complete candour and without fear of leaks to the press. This small group was occasionally joined by Secretary of State George Shultz and on some rare occasions by Federal Reserve Chairman Paul Volcker.

These breakfast meetings were just about the only time during my time at the CEA when the Fed Chairman participated in a discussion inside the administration. He met privately of course with the Secretary of the Treasury and with various financial regulators. I had breakfast with him every other week and on those occasions we discussed the state of the economy, the direction of monetary policy, banking regulation, and such issues as the developing country debt problem, in which the Fed worked closely with the administration.

As the senior economist in the administration, the CEA chairman is frequently called upon to discuss economic policy issues in public. These include testimony to congressional committees, speeches to a wide array of audiences, occasional television interviews and frequent discussions with the press. I always regarded these as opportunities to teach economics. An important challenge was to explain why the dollar had soared and how that, rather than protectionist policies abroad, was responsible for our trade deficit. Until the recovery was firmly established, I would explain why an expansionary fiscal policy was unnecessary and later I spent endless hours explaining how to assess the structural budget deficit and why reducing it was important.

The Council of Economic Advisers produces an annual report which discusses broad issues of economic policy for a general audience. This report is widely read by the economic press, by Congressional staff and by academic economists and students.

Above description of the US CEA shows that it is very close to the Executive. There is ‘professionalism’ - and we may willingly interprete that to mean that one keeps a distance to political scheming and the illusions of the day - but still, this is not auditing, this is not verification for verification’s sake, this is not vetoing David Stockman, this is not sticking to one’s own perception of what the right model is regardless of what the President likes to think. If there would be an Economic Supreme Court, then, indeed, the President would still have need for advice as currently provided by the CEA. One would imagine that CEA staff members would frequent the Court’s offices, and such. But the constitutional powers would be institutionally separated.

We can see that the CEA is so understaffed and so preoccupied with its duties of ‘running about for the President’, that it failed to pick up an important analysis. In April 1993, I sent a major piece of my work to the CEA. And got no reply.

In August 1993, I actually visited the US Treasury, but with little success. See the appendix on presenting the analysis to the US National Press below, and the autobiographical appendix as well.

At the end of August, 1993, President Clinton announced a major increase in the Earned Income Tax Credit (EITC) - see next appendix. I don’t think that my paper and visit contributed to that. If it has, they should have replied - and could have gone much further. (But I do think that the Clinton EITC measure helped, as one factor, to create the subsequent the long boom in the US economy. There was more competition on the labour market, and this helped to reduce wage growth.)

To prof. Blinder

& prof. Stiglitz

Council of Economic Advisers

White House

Old Executive Office Building

Washington DC 20500

Verenigde Staten van Amerika

April 16 1993

Concerning: unemployment and inflation

Dear professors,

It takes time to get things published, so I overcome my hesitations and send you enclosed paper. It is one of the fruits of 15 years of econometric research, including long term projections with 2000 equations models.

The paper gives a structural analysis of unemployment, regardless the state of inflation. The analysis can be extended on the time path of inflation.

You should read it with a good intuition of the importance of heterogeneous labour and a reduced form analysis.

I am glad to answer any questions.

Kind regards,

Drs. Thomas Cool

Rotterdamsestraat 69

2586 GH Scheveningen

Holland

Enclosed: paper “On the political economy of employment in the welfare state”
[Chapters 39 and 40 of this book]

The following is a bit of an ambarrasment, but modern courage is not fighting wild animals but facing such possible views in public opinion. Anyway, in 1993 my Class of ’73 (of Burbank Highschool, California) had, guess what, a 20 year reunion. I took the opportunity to visit Washington, visit the US Treasury, and also present my analysis at the National Press Building. When I arrived there on August 17, it appeared that almost everyone had taken their holiday, following President Clinton to Martha’s Vineyard. My appointment with the Treasury lasted only some 20 minutes, and my host was too much involved in the Health Plan and showed no interest in my analysis. The journalists subsequently must have been at the beach - or in Europe - since nobody showed up. Perhaps my press release was uninviting too - judge for yourself, below. I took care that it was distributed to all agencies - which was another bill to pay. The idea remains: people have had the opportunity. Note 1: Had I still been at the CPB, then my possibility frontier with US officials of course had been larger. Note 2: My foreign exchange year at Burbank High and participation in the US National Forensics League apparently rubbed off, and I got some editing help from an American friend: so that my presentation was All American.

(The following is quoted from the White House internet site.)

THE WHITE HOUSE
Office of the Press Secretary

PRESIDENT CLINTON PROPOSES TO EXPAND THE EARNED INCOME TAX CREDIT IN ORDER TO INCREASE THE REWARD FOR WORK AND FAMILY

Today President Clinton Will Announce, in his Address to the Democratic Leadership Council, A New $21 Billion Plan to Expand the Earned Income Tax Credit -- A Key Part of His “New Opportunity Agenda.” The President’s proposal would expand the Earned Income Tax Credit (EITC) to provide tax relief for 6.4 million hard-pressed working families. The expansion will cost about $21 billion over 10 years.

Building on the Successes of the 1993 EITC Expansion. In 1993, the President signed into law the largest EITC expansion ever to provide a tax cut for 15 million working families while rewarding work and family. Today, the success of the EITC in reducing poverty and encouraging work is clear:

·         4.3 Million People Directly Lifted Out of Poverty by the EITC in 1998 -- more than double the number lifted out of poverty in 1993.

·         2.3 Million Children Directly Lifted Out of Poverty by the EITC in 1998. This includes 600,000 African-American children and 600,000 Hispanic children..

·         Largest Drop in Poverty and Child Poverty in Over Three Decades. The poverty rate has fallen from 15.1 percent in 1993 to 12.7 percent in 1998 -- the lowest since 1979. At the same time, the child poverty rate fell from 22.7 percent to 18.9 percent -- the lowest child poverty rate since 1980.

·         More Single Mom’s Are Working Than Ever Before. The percentage of single mothers who work and receive no welfare has risen from 60.9 percent in 1992 to 75.0 percent in 1998.

The President’s Proposal Increases the Reward to Work and Family in Four Ways:

·         Expand the Maximum Credit for Working Families with Three or More Children By $500. This would provide a tax break for 2.1 million low- and moderate-income working families. This expansion is targeted at the highest concentration of child poverty: in 1998 the poverty rate for children in families with three or more related children was 28.5 percent -- more than twice the 11.9 percent poverty rate for children in families with one or two related children.

·         Expand the Credit for Married, Two-Earner Couples. This would benefit over 1.3 million married filers. For married, two-earner couples, this provision by itself would provide an average tax break of $250.

·         Increase the Reward to Work While Expanding the Credit for Families with Two or More Children. This would provide an additional tax break, and an additional incentive to work, for families with two or more children by lowering the phase-out rate to give more rewards to families struggling to work their way into the middle class.

·         Encouraging Savings Through Simplification. Currently, when a working family contributes to a 401(k) they may see their EITC reduced. This proposal encourages savings and simplifies the calculation of earned income for the purposes of the EITC.

Here is How These Changes Would Increase the Reward to Work for American Families:

THE PRESIDENT’S PROPOSED INCREASE IN THE EARNED INCOME TAX CREDIT

DETAILS OF THE PRESIDENT’S PROPOSAL

The President’s Proposal Would Expand the Earned Income Tax Credit to Provide Tax Relief for 6.4 Million Hard-pressed Working Families. The average increase for families with three or more children is $544 and some married couples with three or more children could see as much as an additional $1,155 tax credit. The expansion will cost about $21 billion over 10 years. The four major provisions of President’s EITC expansion are:

Expand the Maximum Credit for Working Families with Three or More Children By $500. The President’s proposal would add a “third tier” to the EITC to expand benefits for families with three or more children. Very low-income families will get 45 cents for every additional dollar they earn -- compared to 40 cents under current law. This higher credit rate will increase the maximum credit for a family with three children in 2001 from $3,992 to $4,491 -- a roughly $500 increase. This proposed new “tier” of the EITC is important because 60 percent of all poor children -- 7.7 million children -- are in families with three or more children. Adding a third tier to the EITC would provide a tax break for 2.1 million low- and moderate-income working families.

Expand the Credit for Married, Two-Earner Couples. The President’s proposal would allow married couples to earn an additional $1,450 more before beginning to have their EITC phased out. For example, in 2001 a married, two-earner couple with children would be able to earn up to $14,480 and still receive the maximum EITC, as compared to the $13,030 threshold under current law. The result of this provision would be to provide an additional $250, on average, for married, two-earner couples. This provision would benefit over 1.3 million married filers.

Increase the Reward to Work While Expanding the Credit for Families with Two or More Children. The third provision of the President’s proposal would provide an additional tax break, and an additional incentive to work, for families with two or more children. Under current law the EITC for these families is reduced by 21.06 percent for each dollar they earn above the maximum threshold. The President’s proposal would lower this phase-out rate to 19.06 percent -- a tax break for 5.4 million of America’s hard-pressed working families.

Encouraging Savings Through Simplification. Under current law, 401(k) contributions and other forms of nontaxable earned income are counted as income in computing the EITC. For many families this means that if they increase their contributions to a 401(k) then they will see their EITC reduced. The President proposes to encourage savings for poor people by eliminating nontaxable earned income from the calculation of the EITC. In addition to encouraging savings, this step will simplify the EITC, and continue to increase compliance.

THE PRESIDENT’S 1993 EITC EXPANSION HAS CONTRIBUTED TO THE LARGEST REDUCTION IN POVERTY IN OVER THREE DECADES

In 1993, the President Signed Into Law the Largest EITC Expansion Ever. The President’s policy provided a tax cut for 15 million working families. For every dollar a very low-income working parent with one child earns, the EITC was increased from 23 cents to 34 cents (25 cents to 40 cents for two plus children). The maximum credit was increased by over $1,500. The income limit on eligibility was increased by about $3,700.

Nearly 19 Million Families Claim the EITC. In FY 1999, the total cost of the program was $30.5 billion. In 2001, the average credit for all claimants will be $1,680 and for claimants with children it will be $1,990. [Source: U.S. Department of the Treasury]

In 1998, the EITC Was Directly Responsible for Lifting 4.3 Million People Out of Poverty -- Twice the Number Lifted Out in 1993. Census Department statistics show that the EITC was directly responsible for lifting 4.3 million people out of poverty in 1998 – more than twice the number lifted out of poverty in 1993. The indirect contribution of the EITC to poverty reduction may be even greater given the evidence that the EITC provides a powerful incentive to work. [Source: Calculations using data from the U.S. Census Bureau.]

In 1998, the EITC Was Directly Responsible for Lifting 2.3 Million Children Out of Poverty. The 2.3 million children lifted out of poverty by the EITC include 600,000 African-American children and 600,000 Hispanic children. [Source: Calculations using data from the U.S. Census Bureau.]

Expanded EITC and Higher Minimum Wage Has Led to Large Real Income Growth For Hard-pressed Families. A working parent with two children earning the minimum wage in 1993 made $10,559 with the EITC (in 1998 inflation-adjusted dollars) -- well below the poverty line. With the 1993 increase in the EITC and the 90 cent increase in the minimum wage in 1996 and 1997, a similarly situated family in 1998 was above the poverty line -- making $13,268 -- a 26 percent inflation-adjusted increase in their standard of living.

Poverty Rate Fell To 12.7 Percent in 1998 -- Its Lowest Level Since 1979. The poverty rate has declined from 15.1 percent in 1993 to 12.7 percent in 1998 -- that’s the largest five-year drop in poverty in nearly 30 years (1965-1970). There are now 4.8 million fewer people in poverty than in 1993. (In 1998, the poverty threshold was $16,660 for a family of four.) [Source: U.S. Census Bureau]

The Largest Five-year Drop in Child Poverty in More than Three Decades. While the child poverty rate remains too high, between 1993 and 1998, the child poverty rate has declined from 22.7 percent to 18.9 percent -- that is the lowest child poverty rate since 1980 and the largest five-year drop in nearly 30 years (1965-1970). [Source: U.S. Census Bureau]

The Poverty Rate for Children in Families with Three or More Children is More than Double the Poverty Rate for Children in One or Two-Children Families. Although the poverty rate for children in families with three or more related children has fallen from 32.3 percent in 1993 to 28.5 percent in 1998, this is still more than twice the 11.9 percent poverty rate for children in families with one or two related children. 7.7 million children in families with three or more children were growing up in poverty in 1998. [Source: Calculations by the Department of the Treasury using data from the U.S. Census Bureau.]

THE EVIDENCE IS OVERWHELMING THAT THE EITC ENCOURAGES WORK

More Single Mothers With Children Are Working Than Ever Before. After staying essentially constant in the 1980s and early 1990s, the percentage of singe mothers aged 16 to 45 who work and receive no welfare has risen from 60.9 percent in 1992 to 75.0 percent in 1998. The percentage of single mothers who worked rose from 73.7 percent in 1992 to 86.6 percent in 1998. [Source: Calculations by Professor Jeffrey Liebman using data from the Bureau of Labor Statistics’ March Current Population Surveys.]

According to One Study, More Than 60 Percent of the Increase In the Employment of Single Mothers Has Been Due to Expansions of the EITC. Bruce Meyer and Dan Rosenbaum find that 63 percent of the change in the employment of single mothers between 1984 and 1996 can be explained by the expansions of the EITC. [Source: “Welfare, the Earned Income Tax Credit, and the Labor Supply of Single Mothers.” National Bureau of Economic Research Working Paper No. 7363. September 1999.]

Another Study Predicted That the 1993 EITC Expansion Would Induce 516,000 Families To Move From Welfare to Work. Stacy Dickert, Scott Houser, and John Karl Scholz found that the 1993 EITC expansion would induce 516,000 families to move from welfare to work. [Source: “The Earned Income Tax Credit and Transfer Programs: A Study of Labor Market and Program Participation.” Tax Policy and the Economy No. 9, MIT Press: Cambridge, 1995.]

Another Study Shows that Increasing the Reward to Work, Increases Labor Force Participation. Nada Eissa and Jeffrey Liebman found that the EITC significantly increases labor force participation among single mothers, especially less educated women. [Source: “Labor Supply Response and the Earned Income Tax Credit.” Quarterly Journal of Economics 111(2), 1996.]

Comment January 2000, that still stands in 2004: These are still relatively small effects. In that sense we should not overestimate the impact of the 1993 EITC change on the increase in competition on the labour market and the US booming economy. And having a higher gross minimum wage does not help - the Card & Krueger argument does not convince for the general situation. /TC

There are two papers that have not been included for brevity’s sake. It is useful to include their summaries however. Both papers are available on the internet.

(1) Colignatus (1996d) “An institutional explanation of structural unemployment of low income labour”, presentation for the Dutch “7th Research Day of the Social Sciences”, Amsterdam, ewp-oth/9605001. The idea of this paper is to use results of social psychology to identify the real forces implied by the reduced form theorems. The paper’s summary is:

“Structural unemployment of low income labour has causes in institutional settings. Directly, there is a systematic error in the co-ordination of employment policy and tax policy. Indirectly, the system of co-ordination shows a deficiency in its capacity to repair systematic errors.

Many people see the cause of mass unemployment in technology and ‘globalisation’, which are factors on the demand side. Others see the cause in high benefit levels or in low levels of education or educationability, which are factors on the supply side. These explanations allow little room for policy making, especially when the benefit level is regarded as social subsistence. There however is a third explanation, one that has been put forward by employees of the Dutch Central Planning Bureau (CPB), first Van Schaaijk in 1983, then Bakhoven in 1988 and Colignatus in 1989-1996. In this approach the cause of unemployment must be found in policies on taxes and social security, an area where policy can do a lot. In this third approach, technology and trade have reduced the problem of unemployment, since they have boosted productivity. Since the problem lies with labour costs and the demand for labour, supply factors like the benefit level are less relevant. This third approach does not attract much attention. The three authors are little known, even though they at the time worked at a renowned institute.

This paper intends to raise the attention level towards asking the proper questions about current stagnation. The best way to tackle stagnation likely is the institutional approach. The economy and its management can be regarded as a system, which system comprises the community of economists, officials, politicians, journalists and ‘the general public’. This paper then proceeds by using Aronson’s book on social psychology to discuss various properties of the system and relations within it, and the behaviour of the participants in the collective decision making on this complex issue. The discussion results into a number of questions for further research.”

(2) Colignatus (1998c), “On the paradox of efficiency improvement at the micro level and Productivity Slowdown at the macro level: The case of Efficient Inventory Control”, ewp-get/9805003. The summary is:

“Last decades show a Productivity Slowdown at the macro level, while at the micro level we have seen a huge attention for business economics and operations management - and we now have a decade of booming stock markets. This paper tries to tackle that paradox by singling out the issue of Efficient Inventory Control. This seems to be the part of the business process that comes closest to the problem of the Productivity Slowdown. Namely, when inventories are reduced, then this normally means that part of demand is serviced from inventories, and this means lower production. Estimating stylized relationships for the US, we find that inventories in 1997 are 25% lower than they would have been otherwise, and the level of production is 0.56% lower at an annual basis. However, real GDP growth is not really affected, since the annual change in inventory is a very small percentage of GDP. Thus, business success stories that are based upon inventory reduction - which is regarded as efficiency improvement at the micro level - can be reconciled with stagnation at the macro economic level.”

(The following note was written in 2000 and it still stands in 2004.)

The US economy has shown steady growth from 1992 till 2000, and people have been talking about a New Economy.  The stock exchange has exploded, the Productivity Slowdown seems to be over, unemployment has been dropping below the CWIRU (NAIRU) while prices have remained stable, an Asian Crisis that might have turned into a big depression did not do that: and economists have been looking all over to find causes. The New Economy answer would be that the Volcker - Reagan years have created a stable environment, and that technology now is causing all kinds of revolutions. Computers, the internet, biology, a better understanding of economics and capital markets, you name what, the interaction of all these: they all cause a wholly different world. And billionaires to prove it.

My view on this issue is sensibly guarded.

Yes, the internet indeed has interesting properties, vide Shapiro & Varian (1999). I have been using computers intensively since 1972, have my own software on the internet - see Colignatus (1999). Yes, on biology and other technologies the possibilities are huge, and man can be a creative animal.

No, it all is plain old economics. Shapiro & Varian (1999) make that clear too. Also: (a) It should be obvious by now that my own analysis on unemployment and inflation already provides much of the answers. Many causes why the CWIRU dropped can be identified - e.g. the EITC increase (labour cost reduction) in 1993, and the abolishing of ‘welfare as we know it’. Society has started to accept a lower subsistence level - which is a dubious origin of growth for the rich. (b) Lower taxes for the rich gives them more money e.g. to invest in the stock market. (c) Americans have been borrowing. (d) The fact that 1970-1992 was a low period in post-War US history does not mean that the current ‘high’ is so high. I think that the basic foundation was given by FDR, and hence the creative human energy was provided with a stable environment to prosper. The 1970-1992 period fouled up the FDR heritage. Getting back to that heritage is important - but not something ‘new’. (e) Of course there still are many people in poverty, and many are seduced to crime which ends them up in prison. (f) The New Economy is much coloured by Wall Street, the Jones’s driving up the property price of the Jones’s. The financial system still needs reworking.

I think I could go on, but I’d rather stop. The basic idea is that if there is a new kid on the block then this does not mean that the block has changed. In particular when the kid is someone old who everybody has forgotten about. In economics, though, perceptions are important - and the New Economy idea might be relevant for that.

This 2005 edition of this book is virtually the same as the 2000 edition. This note discusses the points of consideration.

(1)    The major change seems to be that I now use the name Colignatus for my scientific work for better distinction from political or commercial work. I remain of course a single individual but the papers and books can be usefully labelled differently. In some archives you will have to keep searching on the name “Cool”.

(2)    Unfortunately, I have not been able yet to extend the discussion as indicated in chapter 32 on dynamic optimality. The prime cause is a new job in a new field that required much new study.

(3)    The book now uses euro’s. I didn’t use the latest data but use those of Colignatus & Hulst (2003) for consistency. The Enlargement of the EU from 15 to 25 member states on May 1 2004 caused some changes in the data and text however. A discussion with Henk Folmer (Wageningen University) caused an update on OECD data and papers, clarification of some points in the argument, and the longer Abstract below.

(4)    Colignatus (2001) “Voting theory for democracy” is my implementation of the theory on social choice within Mathematica. An earlier suggestion of (1990c) for an algorithm was developed in more detail, which caused me to find a name for it: this became the “Borda fixed point” approach. Further reflection caused the paper Colignatus (2002) “Without time no morality” that now has been adapted to a new chapter in this edition. The total enriches the analysis on Arrow’s Theorem with a practical social choice algorithm.

(5)    The chapter with notes on ethics has been added.

(6)    The chapters on the reduced form have been re-united into Book IX again. In the earlier paper Colignatus (1992b, 1995a) they already formed a unity, but in the first edition of this book they got separated for a reason that appeared unconvincing.

(7)    Since Coligatus (1990) had in its title “After 20 years of mass unemployment”, I could write (2004) “After 35 years of mass unemployment”, and this has been included as a chapter. Since the (1990) paper was hit by censorship and the intermediate years have seen no resolution of that matter, I now advise to a boycott of Holland till that censorship is resolved. Please study the chapter closely.

(8)    The following comments can be included at this very spot:

(a)    Much of current policy focus is on the EU Lissabon Strategy and issues like pensions. This book does not explicitly discuss these but it would be a mistake to conclude that this book would not be relevant for those topics. The point is that this book already had that long term approach to start with. Lissabon and pensions are new kids on the block and one should rather study this book before proceeding with new policy making.

(b)    Advised reading is Skidelsky (2000), the third part of his biography of Keynes.

(c)    Lomborg (2001), “The skeptical environmentalist. Measuring the real state of the world”, gives an impressive review of the problems in this subject. As an economist and non-ecologist it is difficult for me to say anything about his comments on the state of the ecology. Three statements in the realm of political economy are:
(b1) Lomborg does not yet take account of the argument by Hueting (1980) and Van Ierland et al. (2001). Statistical measurement of national income derives from the economic theory of social welfare. To approximate the social welfare function we use the income hyperplane that is tangent to it. Market prices for the environment will not suffice since there are market failures.
(b2) In his discussion on the ‘double dividend’ Lomborg relies on economic papers that do not take into account both the analysis by Hueting and the analysis provided in this book on the Trias Politica, unemployment, the tax void and dynamic marginal rates.
(b3) The case for an Economic Supreme Court appears enhanced. Human flourishing requires proper environmental protection, and monitoring of the information about the environment then requires proper safeguards.

(d)    Shiller (2003), “The new financial order. Risk in the 21st century”, discusses how the market with proper government regulation can give rise to new risk instruments. Part of what I try to do with the constitutional amendment for an Economic Supreme Court, he tries to do with ‘macro-markets’, i.e. financial instruments based upon macro variables: namely, getting better information. My impression is that both approaches have merits of their own, and that it helps to disentangle what the instruments are intended for precisely. Similarly, the analysis in this book on unemployment cannot be replaced by an insurance on the distribution of income. Yet, when these more basic reforms on the Economic Supreme Court and unemployment have been implemented, Shiller is right that welfare can be improved by novel risk instruments.

(e)    Gould (2000:294-297) discusses Sulloway (1996) with sympathy. This seemed relevant given the importance of the latter for the draft constitutional amendment for an Economic Supreme Court. However, Van den Berg (2004) in Dutch NRC-Handelsblad reports that the validity of Sulloway’s finding is seriously questioned in Nature.

(f)     I reread Ayer (1936, 1978), “Language, truth and logic”, and was struck by his discussion of Poincaré. Ayer, page 115: “For a well-chosen definition will call our attention to analytic truths, which would otherwise have escaped us. And the framing of definitions which are useful and fruitful may well be regarded as a creative act.” In the “definition & reality methodology” the idea is that definitions concerning stylized facts are “useful and fruitful”. Williams (2002), “Truth and truthfulness”, is advised reading. What I take from it is that people have a ‘sense’ what is true or not, whether they are right or not, and that society can benefit from giving proper way to this ‘sense’. Now, what would be a proper way ? My approach is to give more attention to science and the scientific attitude.

(g)    Colignatus & Hulst (2003) is a Dutch booklet that summarizes the scientific argument in this book for the Dutch lay public. This booklet also relates to the murder of the Dutch politician Pim Fortuyn in 2002. There is a peculiar streak in Dutch society that is wildly at odds with its reputation for tolerance. Namely, the Dutch can react strongly to someone who threathens their view of the world. A similar phenomenon can be observed in other cultures too, but it is strong in Holland. My inclination is to link this phenomenon to the observation in Cavalli-Sforza (2000:184) of different mentalities in France: “Hervé Le Bras and Emmanual Todd [1981] have recently refined ideas by the French sociologist Fredericq Le Play. They believe three major types of families exist in France. (…) have proposed a controversial but stimulating hypothesis that says family structure influences political structure”. These types are related to the history of Celts, proto-Basque and Franks. My impression is that Dutch society is similarly subject to some cultural mentality.

(h)    When I discussed the consequences of the CPB censorship for public health, this caused developments that led to my dismissal in August 2004 from the Erasmus MC Dept. of Public Health. This is another breach of the integrity of science. Dutch readers are referred to my website. All this is too fresh to include it in this book.

(i)      November 2, 2004, Holland saw Theo van Gogh murdered. He is a grandson of Vincent van Gogh’s brother Theo (the elder). The younger Theo is said to have been a talented though controversial film director. The Van Gogh family had donated its collection of paintings to the state and Theo van Gogh had trouble finding funds to develop his talent. When he was murdered he was completing his film 0605 of the murder of Pim Fortuyn. Van Gogh’s murderer of Moroccan decent expressed his delusion of the 9-11 ideology. This is a new element in Dutch society that can only be understood with the input of the Bush policy on Iraq. It must be noted though that Theo van Gogh protested regularly to that other original streak in Dutch society referred to above, namely that Holland is not as tolerant and open as it may seem. One can summarize the situation as that a truly tolerant Holland would have had no fertile ground for that 9-11 ideology, while the resulting criminal extremist killed the critic of that intolerant streak.

(j)      There are some Dutch books that deserve an English translation. Here I only translate the titles. Klever (1990), “Pure economic science”, takes his position in Spinoza and argues that economic science should be developed from first principles in a deductive fashion. This strikes me as quite similar to the “definition & reality methodology”. Mathematical economics already had the deductive approach, and econometrics assumed that only statistical approximation was feasible, but we can do better if we can find definitions that fit stylized facts. Klever also recovered Franciscus van den Enden (1665, 1992), “Free political theses”. That author was a teacher of Spinoza and his book argues that democracy is the only form of government that can safeguard stability and general welfare. Klever (1981), “Dialectic thinking”, must be mentioned for a better understanding of the deductive method. His discussion of Poincaré and his pupils, for example, clarifies the creative element in mathematics. Guépin (1985) “Civilization” and Guépin (1994) “The difference in opinion” defend classical rhetorics as the essence of civilized mentality. These books provide a wealth of information and are a useful antidote to expecting too much from deduction only. He highlights the tension between rhetorics and deduction by criticizing Socrates that it is rather easy to impress people by goading them into inconsistencies when they have not first defined their terms properly. (Rhetorics cannot make fun of rule based inference if the only goal of rhetorics is to get better inference.) Guépin also highlights that deduction thrives with dichotomy but hesitates with the sorites, i.e. the problem of accumulating grains of sand until the mountain moves.