Deregulation framework

SUPER CAPITALISM, SUPER IMPERIALISM

PART 1: A Structural Link
by Henry C K Liu

Robert B Reich, former US Secretary of Labor and resident neo-liberal in the Clinton administration from 1993 to 1997, wrote in the September 14, 2007 edition of The Wall Street Journal an opinion piece, "CEOs Deserve Their Pay", as part of an orchestrated campaign to promote his new book: Supercapitalism: The Transformation of Business, Democracy, and Everyday Life (Afred A Knopf). Hexter Professor of Social and Economic Policy at the Heller School for Social Policy and Management at Brandeis University. He is currently a professor at the Goldman School of Public Policy at the University of California (Berkley) and a regular liberal gadfly in the unabashed supply-side Larry Kudlow TV show that celebrates the merits of capitalism.

Reich's Supercapitalism brings to mind Michael Hudson's Super Imperialism: The Economic Strategy of American Empire (1972-2003). While Reich, a liberal turned neo-liberal, sees "supercapitalism" as the natural evolution of insatiable shareholder appetite for gain, a polite euphemism for greed, that cannot or should not be reined in by regulation, Hudson, a Marxist heterodox economist, sees "super imperialism" as the structural outcome of post-World War II superpower geopolitics, with state interests overwhelming free market forces, making regulation irrelevant. While Hudson is critical of "super imperialism" and thinks that it should be resisted by the weaker trading partners of the US, Reich gives the impression of being ambivalent about the inevitability, if not the benignity, of "supercapitalism".

The structural link between capitalism and imperialism was first observed by John Atkinson Hobson (1858-1940), an English economist, who wrote in 1902 an insightful analysis of the economic basis of imperialism. Hobson provided a humanist critique of neoclassical economics, rejecting exclusively materialistic definitions of value. With Albert Frederick Mummery (1855-1895), the great British mountaineer who was killed in 1895 by an avalanche while reconnoitering Nanga Parbat, an 8,000-meter Himalayan peak, Hobson wrote The Physiology of Industry (1889), which argued that an industrial economy requires government intervention to maintain stability, and developed the theory of over-saving that was given a glowing tribute by John Maynard Keynes three decades later.

The need for governmental intervention to stabilize an expanding national industrial economy was the rationale for political imperialism. On the other side of the coin, protectionism was a governmental counter-intervention on the part of weak trading partners for resisting imperialist expansion of the dominant power. Historically, the processes of globalization have always been the result of active state policy and action, as opposed to the mere passive surrender of state sovereignty to market forces. Market forces cannot operate in a vacuum. They are governed by man-made rules. Globalized markets require the acceptance by local authorities of established rules of the dominant economy. Currency monopoly of course is the most fundamental trade restraint by one single dominant government.

Adam Smith published Wealth of Nations in 1776, the year of US independence. By the time the constitution was framed 11 years later, the US founding fathers were deeply influenced by Smith's ideas, which constituted a reasoned abhorrence of trade monopoly and government policy in restricting trade. What Smith abhorred most was a policy known as mercantilism, which was practiced by all the major powers of the time. It is necessary to bear in mind that Smith's notion of the limitation of government action was exclusively related to mercantilist issues of trade restraint. Smith never advocated government tolerance of trade restraint, whether by big business monopolies or by other governments in the name of open markets.

A central aim of mercantilism was to ensure that a nation's exports remained higher in value than its imports, the surplus in that era being paid only in specie money (gold-backed as opposed to fiat money). This trade surplus in gold permitted the surplus country, such as England, to invest in more factories at home to manufacture more for export, thus bringing home more gold. The importing regions, such as the American colonies, not only found the gold reserves backing their currency depleted, causing free-fall devaluation (not unlike that faced today by many emerging-economy currencies), but also wanting in surplus capital for building factories to produce for domestic consumption and export. So despite plentiful iron ore in America, only pig iron was exported to England in return for English finished iron goods. The situation was similar to today's oil producing countries where despite plentiful crude oil, refined petrochemical products such as gasoline and heating oil have to be imported.

In 1795, when the newly independent Americans began finally to wake up to their disadvantaged trade relationship and began to raise European (mostly French and Dutch) capital to start a manufacturing industry, England decreed the Iron Act, forbidding the manufacture of iron goods in its American colonies, which caused great dissatisfaction among the prospering colonials. Smith favored an opposite government policy toward promoting domestic economic production and free foreign trade for the weaker traders, a policy that came to be known as "laissez faire" (because the English, having nothing to do with such heretical ideas, refuse to give it an English name). Laissez faire, notwithstanding its literal meaning of "leave alone", meant nothing of the sort. It meant an activist government policy to counteract mercantilism. Neo-liberal free-market economists are just bad historians, among their other defective characteristics, when they propagandize "laissez faire" as no government interference in trade affairs.

Friedrich List, in his National System of Political Economy (1841), asserts that political economy as espoused in England, far from being a valid science universally, was merely British national opinion, suited only to English historical conditions. List's institutional school of economics asserts that the doctrine of free trade was devised to keep England rich and powerful at the expense of its trading partners and it must be fought with protective tariffs and other protective devices of economic nationalism by the weaker countries.

Henry Clay's "American system" was a national system of political economy. US neo-imperialism in the post WWII period disingenuously promotes neo-liberal free-trade against governmental protectionism to keep the US rich and powerful at the expense of its trading partners. Before the October Revolution of 1917, many national liberation movements in European colonies and semi-colonies around the world were influenced by List's economic nationalism. The 1911 Nationalist Revolution in China, led by Sun Yat-sen, was heavily influenced by Lincoln's political ideas - government of the people, by the people and for the people - and the economic nationalism of List, until after the October Revolution when Sun realized that the Soviet model was the correct path to national revival.

Hobson's magnum opus, Imperialism, (1902), argues that imperialistic expansion is driven not by state hubris, known in US history as "manifest destiny", but by an innate quest for new markets and investment opportunities overseas for excess capital formed by over-saving at home for the benefit of the home state. Over-saving during the industrial age came from Richardo's theory of the iron law of wages, according to which wages were kept perpetually at subsistence levels as a result of uneven market power between capital and labor. Today, job outsourcing that returns as low-price imports contributes to the iron law of wages in the US domestic economy. (See my article Organization of Labor Exporting Countries [OLEC]).

Hobson's analysis of the phenology (study of life cycles) of capitalism was drawn upon by Lenin to formulate a theory of imperialism as an advanced stage of capitalism: "Imperialism is capitalism at that stage of development at which the dominance of monopolies and finance capitalism is established; in which the export of capital has acquired pronounced importance; in which the division of the world among the international trusts has begun, in which the division of all territories of the globe among the biggest capitalist powers has been completed." (Vladimir Ilyich Lenin, 1916, Imperialism, the Highest Stage of Capitalism, Chapter 7).

Lenin was also influenced by Rosa Luxemberg, who three year earlier had written her major work, The Accumulation of Capital: A Contribution to an Economic Explanation of Imperialism (Die Akkumulation des Kapitals: Ein Beitrag zur ökonomischen Erklärung des Imperialismus), 1913). Luxemberg, together with Karl Liebknecht a founding leader of the Spartacist League (Spartakusbund), a radical Marxist revolutionary movement that later renamed itself the Communist Party of Germany (Kommunistische Partei Deutschlands, or KPD), was murdered on January 15, 1919 by members of the Freikorps, rightwing militarists who were the forerunners of the Nazi Sturmabteilung (SA) led by Ernst Rohm.

The congenital association between capitalism and imperialism requires practically all truly anti-imperialist movements the world over to be also anti-capitalist. To this day, most nationalist capitalists in emerging economies are unwitting neo-compradors for super imperialism. Neo-liberalism, in its attempts to break down all national boundaries to facilitate global trade denominated in fiat dollars, is the ideology of super imperialism.

Hudson, the American heterodox economist, historian of ancient economies and post-WW II international balance-of-payments specialist, advanced in his 1972 book the notion of 20th century super imperialism. Hudson updated Hobson's idea of 19th century imperialism of state industrial policy seeking new markets to invest home-grown excess capital. To Hudson, super imperialism is a state financial strategy to export debt denominated in the state's fiat currency as capital to the new financial colonies to finance the global expansion of a superpower empire. No necessity, or even intention, was entertained by the superpower of ever having to pay off these paper debts after the US dollar was taken off gold in 1971.

Monetary Imperialism and Dollar Hegemony

Super imperialism transformed into monetary imperialism after the 1973 Middle East oil crisis with the creation of the petrodollar and two decades later emerged as dollar hegemony through financial globalization after 1993. As described in my 2002 AToL article, Dollar hegemony has to go, a geopolitical phenomenon emerged after the 1973 oil crisis in which the US dollar, a fiat currency since 1971, continues to serve as the primary reserve currency for  international trade because oil continues to be denominated in fiat dollars as a result of superpower geopolitics, leading to dollar hegemony in 1993 with the globalization of deregulated financial markets.

Three causal developments allowed dollar hegemony to emerge over a span of two decades after 1973 and finally take hold in 1993. US fiscal deficits from overseas spending since the 1950s caused a massive drain in US gold holdings, forcing the US in 1971 to abandon the 1945 Bretton Woods regime of fixed exchange rate based on a gold-backed dollar. Under that international financial architecture, cross-border flow of funds was not considered necessary or desirable for promoting international trade or domestic development. The collapse of the 1945 Bretton Woods regime in 1971 was the initial development toward dollar hegemony.

The second development was the denomination of oil in dollars after the 1973 Middle East oil crisis. The emergence of petrodollars was the price the US, still only one of two contending superpowers in 1973, extracted from defenseless oil-producing nations for allowing them to nationalize the Western-owned oil industry on their soil. As long as oil transactions are denominated in fiat dollars, the US essentially controls all the oil in the world financially regardless of specific ownership, reducing all oil producing nations to the status of commodity agents of dollar hegemony.

The third development was the global deregulation of financial markets after the Cold War, making cross-border flow of funds routine, and a general relaxation of capital and foreign exchange control by most governments involved in international trade. This neo-liberal trade regime brought into existence a foreign exchange market in which free-floating exchange rates made computerized speculative attacks on weak currencies a regular occurrence. These three developments permitted the emergence of dollar hegemony after 1994 and helped the US win the Cold War with financial power derived from fiat money.

Dollar hegemony advanced super imperialism one stage further from the financial to the monetary front. Industrial imperialism sought to achieve a trade surplus by exporting manufactured good to the colonies for gold to fund investment for more productive plants at home. Super imperialism sought to extract real wealth from the colonies by paying for it with fiat dollars to sustain a balance of payments out of an imbalance in the exchange of commodities. Monetary imperialism under dollar hegemony exports debt denominated in fiat dollars through a permissive trade deficit with the new colonies, only to re-import the debt back to the US as capital account surplus to finance the US debt bubble.

The circular recycling of dollar-denominated debt was made operative by the dollar, a fiat currency that only the US can print at will, continuing as the world's prime reserve currency for international trade and finance, backed by US geopolitical superpower. Dollars are accepted universally because oil is denominated in dollars and everyone needs oil and thus needs dollars to buy oil. Any nation that seeks to denominate key commodities, such as oil, in currencies other than the dollar will soon find itself invaded by the sole superpower. Thus the war on Iraq is not about oil, as former Federal Reserve chairman Alan Greenspan suggested recently. It is about keeping oil denominated in dollars to protect dollar hegemony. The difference is subtle but of essential importance.

Since 1993, central banks of all trading nations around the world, with the exception of the US Federal Reserve, have been forced to hold more dollar reserves than they otherwise need to ward off the potential of sudden speculative attacks on their currencies in unregulated global financial markets. Thus "dollar hegemony" prevents the exporting nations, such as the Asian Tigers, from spending domestically the dollars they earn from the US trade deficit and forces them to fund the US capital account surplus, shipping real wealth to the US in exchange for the privilege of financing further growth of the US debt economy.

Not only do these exporting nations have to compete by keeping their domestic wages down and by prostituting their environment, the dollars that they earn cannot be spent at home without causing a monetary crisis in their own currencies because the dollars they earn have to be exchanged into local currencies before they can be spent domestically, causing an excessive rise in their domestic money supply which in turn causes domestic inflation-pushed bubbles. While the trade-surplus nations are forced to lend their export earnings back to the US, these same nations are starved for capital, as global capital denominated in dollars will only invest in their export sectors to earn more dollars. The domestic sector with local currency earnings remains of little interest to global capital denominated in dollars. As a result, domestic development stagnates for lack of capital.

Dollar hegemony permits the US to transform itself from a competitor in world markets to earn hard money, to a fiat-money-making monopoly with fiat dollars that only it can print at will. Every other trading nation has to exchange low-wage goods for dollars that the US alone can print freely and that can be spent only in the dollar economy without monetary penalty.

The victimization of Japan and China

Japan is a classic victim of monetary imperialism. In 1990, as a result of Japanese export prowess, the Industrial Bank of Japan was the largest bank in the world, with a market capitalization of $57 billion. The top nine of the 10 largest banks then were all Japanese, trailed by Canadian Alliance in 10th place. No US bank made the top-10 list. By 2001, the effects of dollar hegemony have pushed Citigroup into first place with a market capitalization of $260 billion. Seven of the top 10 largest financial institutions in the world in 2001 were US-based, with descending ranking in market capitalization: Citigroup ($260 billion), AIG ($209 billion), HSBC (British-$110 billion), Berkshire Hathaway ($100 billion), Bank of America ($99 billion), Fanny Mae ($80 billion), Wells Fargo ($74 billion), JP Morgan Chase ($72 billion), RBS (British-$70 billion) and UBS (Swiss-$67 billion). No Japanese bank survived on the list.

China is a neoclassic case of dollar hegemony victimization even though its domestic financial markets are still not open and the yuan is still not freely convertible. With over $1.4 trillion in foreign exchange reserves earned at a previously lower fixed exchange rate of 8.2 to a dollar set in 1985, now growing at the rate of $1 billion a day at a narrow-range floating exchange rate of around 7.5 since July 2005, China cannot spend much of it dollar holdings on domestic development without domestic inflation caused by excessive expansion of its yuan money supply. The Chinese economy is overheating because the bulk of its surplus revenue is in dollars from exports that cannot be spent inside China without monetary penalty. Chinese wages are too low to absorb sudden expansion of yuan money supply to develop the domestic economy. And with over $1.4 trillion in foreign exchange reserves, equal to its annual GDP, China cannot even divest from the dollar without having the market effect of a falling dollar moving against its remaining holdings.

The People's Bank of China announced on July 20, 2005 that effective immediately the yuan exchange rate would go up by 2.1% to 8.11 yuan to the US dollar and that China would drop the dollar peg to its currency. In its place, China would move to a "managed float" of the yuan, pegging the currency's exchange value to an undisclosed basket of currencies linked to its global trade. In an effort to limit the amount of volatility, China would not allow the currency to fluctuate by more than 0.3% in any one trading day. Linking the yuan to a basket of currencies means China's currency is relatively free from market forces acting on the dollar, shifting to market forces acting on a basket of currencies of China's key trading partners. The basket is composed of the euro, yen and other Asian currencies as well as the dollar. Though the precise composition of the basket was not disclosed, it can nevertheless be deduced by China's trade volume with key trading partners and by mathematical calculation from the set-daily exchange rate.

Thus China is trapped in a trade regime operating on an international monetary architecture in which it must continue to export real wealth in the form of underpaid labor and polluted environment in exchange for dollars that it must reinvest in the US. Ironically, the recent rise of anti-trade sentiment in US domestic politics offers China a convenient, opportune escape from dollar hegemony to reduce its dependence on export to concentrate on domestic development. Chinese domestic special interest groups in the export sector would otherwise oppose any policy to slow the growth in export if not for the rise of US protectionism which causes shot-term pain for China but long-term benefit in China's need to restructure its economy toward domestic development. Further trade surplus denominated in dollar is of no advantage to China.

Emerging markets are new colonies of monetary imperialism

Even as the domestic US economy declined after the onset of globalization in the early 1990s, US dominance in global finance has continued to this day on account of dollar hegemony. It should not be surprising that the nation that can print at will the world's reserve currency for international trade should come up on top in deregulated global financial markets. The so-called emerging markets around the world are the new colonies of monetary imperialism in a global neo-liberal trading regime operating under dollar hegemony geopolitically dominated by the US as the world's sole remaining superpower.

Denial of corporate social responsibility
In Supercapitalism, Reich identifies corporate social responsibility as a diversion from economic efficiency and an un-capitalistic illusion. Of course the late Milton Friedman had asserted that the only social responsibility of corporations is to maximize profit, rather than to generate economic well-being and balanced growth through fair profits. There is ample evidence to suggest that a single-minded quest for maximizing global corporate profit can lead to domestic economic decline in even the world's sole remaining superpower. The US public is encouraged to blame such decline on the misbehaving trading partners of the US rather than US trade policy that permits US transnational corporation to exploit workers in all trading nations, including those in the US. It is a policy that devalues work by over-rewarding financial manipulation.

Yet to Reich, the US corporate income tax is regressive and inequitable and should be abolished so that after-tax corporate profit can be even further enhanced. This pro-profit position is at odds with even rising US Republican sentiment against transnational corporations and their global trade strategies. Reich also thinks the concept of corporate criminal liability is based on an "anthropomorphic fallacy" that ends up hurting innocent people. Reich sees as inevitable an evolutionary path towards an allegedly perfect new world of a super-energetic capitalism responding to the dictate of all-powerful consumer preference through market democracy.

Reich argues that corporations cannot be expected to be more "socially responsible" than their shareholders or even their consumers, and he implies that consumer preference and behavior are the proper and effective police forces that supersede the need for market regulation. He sees corporations, while viewed by law as "legal persons", as merely value-neutral institutional respondents of consumer preferences in global markets. Reich claims that corporate policies, strategies and behavior in market capitalism are effectively governed by consumer preferences and need no regulation by government. This is essentially the ideology of neo-liberalism.

Yet US transnational corporations derive profit from global operations serving global consumers to maximize return on global capital. These transnational corporations will seek to shift production to where labor is cheapest and environmental standards are lowest and to market their products where prices are highest and consumer purchasing power the strongest. Often, these corporations find it more profitable to sell products they themselves do not make, controlling only design and marketing, leaving the dirty side of manufacturing to others with underdeveloped market power. This means if the US wants a trade surplus under the current terms of trade, it must lower it wages. The decoupling of consumers from producers weakens the conventional effects of market pressure on corporate social responsibility. Transnational corporations have no home community loyalty. Consumers generally do not care about sweat shop conditions overseas while overseas workers do not care about product safety on goods they produce but cannot afford to buy. Products may be made in China, but they are not made by China, but by US transnational corporations which are responsible for the quality and safety of their products.

Further, it is well recognized that corporations routinely and effectively manipulate consumer preference and market acceptance often through if not false, at least misleading advertising, not for the benefit of consumers, but to maximize return on faceless capital raised from global capital markets. The subliminal emphasis by the corporate culture on addictive acquisition of material things, coupled with a structural deprivation of adequate income to satisfy the manipulated desires, has made consumers less satisfied than in previous times of less material abundance. Corporations have been allowed to imbed consumption-urging messages into every aspect of modern life. The result is a disposable culture with packaged waste, an obesity crisis for all age groups, skyrocketing consumer debt, the privatization of public utilities that demand the same fee for basic services from rich and poor alike, causing a sharp disparity in affordability. It is a phenomenon described by Karl Marx as "Fetishism of Commodities".

Marx's concept of Fetishism of Commodities
Marx wrote in Das Kapital:[1]

The relation of the producers to the sum total of their own labor is presented to them as a social relation, existing not between themselves, but between the products of their labor. This is the reason why the products of labor become commodities, social things whose qualities are at the same time perceptible and imperceptible by the senses … The existence of the things qua commodities, and the value relation between the products of labor which stamps them as commodities, have absolutely no connection with their physical properties and with the material relations arising therefrom. It is a definite social relation between men that assumes, in their eyes, the fantastic form of a relation between things. In order, therefore, to find an analogy, we must have recourse to the mist-enveloped regions of the religious world. In that world, the productions of the human brain appear as independent beings endowed with life, and entering into relation both with one another and the human race. So it is in the world of commodities with the products of men's hands. This I call the Fetishism which attaches itself to the products of labor, as soon as they are produced as commodities, and which is therefore inseparable from the production of commodities. This Fetishism of Commodities has its origin … in the peculiar social character of the labor that produces them.

Marx asserts that "the mystical character of commodities does not originate in their use-value" (Section 1, p 71). Market value is derived from social relations, not from use-value which is a material phenomenon. Thus Marx critiques the Marginal Utility Theory by pointing out that market value is affected by social relationships. For example, the marginal utility of door locks is a function of the burglary rate in a neighborhood which in turn is a function of the unemployment rate. Unregulated free markets are a regime of uninhibited price gouging by monopolies and cartels.

Thus the nature of money cannot be adequately explained even in terms of the material-technical properties of gold, but only in terms of the factors behind man's desire and need for gold. Similarly, it is not possible to fully understand the price of capital from the technical nature of the means of production, but only from the social institution of private ownership and the terms of exchange imposed by uneven market power. Market capitalism is a social institution based on the fetishism of commodities.

Democracy threatened by the corporate state
While Reich is on target in warning about the danger to democracy posed by the corporate state, and in claiming that only people can be citizens, and only citizens should participate in democratic decision making, he misses the point that transnational corporations have transcended national boundaries. Yet in each community that these transnational corporations operate, they have the congenital incentive, the financial means and the legal mandate to manipulate the fetishism of commodities even in distant lands.

Moreover, representative democracy as practiced in the US is increasingly manipulated by corporate lobbying funded from high-profit-driven corporate financial resources derived from foreign sources controlled by management. Corporate governance is notoriously abusive of minority shareholder rights on the part of management. Notwithstanding Reich's rationalization of excessive CEO compensation, CEOs as a class are the most vocal proponents of corporate statehood. Modern corporations are securely insulated from any serious threats from consumer revolt. Inter-corporate competition presents only superficial and trivial choices for consumers. Motorists have never been offered any real choice on gasoline by oil companies or alternatives on the gasoline-guzzling internal combustion engine by car-makers.

High pay for CEOs
Reich asserts in his Wall Street Journal piece that modern CEOs in finance capitalism nowadays deserve their high pay because they have to be superstars, unlike their bureaucrat-like predecessors during industrial capitalism. Notwithstanding that one would expect a former labor secretary to argue that workers deserve higher pay, the challenge to corporate leadership in market capitalism has always been and will always remain management's ruthless pursuit of market leadership power, a euphemism for monopoly, by skirting the rule of law and regulations, framing legislative regimes through political lobbying, pushing down wages and worker benefits, increasing productivity by downsizing in an expanding market and manipulating consumer attitude through advertising. At the end of the day, the bottom line for corporate profit is a factor of lowering wage and benefit levels.

Reich seems to have forgotten that the captains of industry of 19th century free-wheeling capitalism were all superstars who evoked public admiration by manipulating the awed public into accepting the Horatio Alger myth of success through hard work, honesty and fairness. The derogatory term "robber barons" was first coined by protest pamphlets circulated by victimized Kansas farmers against ruthless railroad tycoons during the Great Depression.

The manipulation of the public will by moneyed interests is the most problematic vulnerability of US economic and political democracy. In an era when class warfare has taken on new sophistication, the accusation of resorting to class warfare argument is widely used to silence legitimate socio-economic protests. The US media is essentially owned by the moneyed interests. The decline of unionism in the US has been largely the result of anti-labor propaganda campaigns funded by corporations and government policies influenced by corporate lobbyists. The infiltration of organized crime was exploited to fan public anti-union sentiments while widespread corporate white collar crimes were dismissed as mere anomalies. (See Capitalism's bad apples: It's the barrel that's rotten)

Superman capitalism
As promoted by his permissive opinion piece, a more apt title for Reich's new book would be Superman Capitalism, in praise of the super-heroic qualities of successful corporate CEOs who deserve superstar pay. This view goes beyond even fascist superman ideology. The compensation of corporate CEOs in Nazi Germany never reached such obscene levels as those in US corporate land today.

Reich argues that CEOs deserve their super-high compensation, which has increased 600% in two decades, because corporate profits have also risen 600% in the same period. The former secretary of labor did not point out that wages rose only 30% in the same period. The profit/wage disparity is a growing cancer in

the US-dominated global economy, causing over-production resulting from stagnant demand caused by inadequate wages. A true spokesman for labor would point out that enlightened modern management recognizes that the performance of a corporation is the sum total of effective team work between management and labor.

System analysis has long shown that collective effort on the part of the entire work force is indispensable to success in any complex organism. Further, a healthy consumer market depends on a balance between corporate earnings and worker earnings. Reich's point would be valid if US wages had risen by the same multiple as CEO pay and corporate profit, but he apparently thought that it would be poor etiquette to raise embarrassing issues as a guest writer in an innately anti-labor journal of Wall Street. Even then, unless real growth also rose 600% in two decades, the rise in corporate earning may be just an inflation bubble.

An introduction to economic populism

To be fair, Reich did address the income gap issue eight months earlier in another article, "An Introduction to Economic Populism" in the Jan-Feb, 2007 issue of The American Prospect, a magazine that bills itself as devoted to "liberal ideas". In that article, Reich relates a "philosophical" discussion he had with fellow neo-liberal cabinet member Robert Rubin, then treasury secretary under Bill Clinton, on two "simple questions".

The first question was: Suppose a proposed policy will increase the incomes of some people without decreasing the incomes of any others. Of course Reich must know that it is a question of welfare economics long ago answered by the "pareto optimum", which asserts that resources are optimally distributed when an individual cannot move into a better position without putting someone else into a worse position. In an unjust society, the pareto optimum will perpetuate injustice in the name of optimum resource allocation. "Should it be implemented? Bob and I agreed it should," writes Reich. Not exactly an earth-shaking liberal position. Rather, it is a classic neo-liberal posture.

And the second question: But suppose the people whose incomes will rise are already wealthier than everyone else. Although no one will lose ground, inequality will widen. Should it still be implemented? "I won't tell you where he and I came out on that second question," writes Reich without explaining why. He allows that "we agreed that people who don't share in such gains feel relatively poorer. Widening inequality also further tips the balance of political power in favor of the wealthy."

Of course, clear thinking would have left the second question mute because it would have invalidated the first question, as the real income of those whose nominal income has not fallen has indeed fallen relative to those whose nominal income has risen. In a macro monetary sense, it is not possible to raise the nominal income of some without lowering the real income of others. All incomes must rise together proportionally or inequality in after-inflation real income will increase.

Inequality only a new worry?

But for the sake of argument, let's go along with Reich's parable on welfare economics and financial equality. That conversation occurred a decade ago. Reich says in his January 2007 article that "inequality is far more worrisome now", as if it had not been or that the policies he and his colleagues in the Clinton administration, as evidenced by their answer to their own first question, did not cause the now "more worrisome" inequality. "The incomes of the bottom 90% of Americans have increased about 2% in real terms since then, while that of the top 1% has increased over 50%," Reich wrote in the matter of fact tone of an innocent bystander.

It is surprising that a former labor secretary would err even on the record on worker income. The US Internal Revenue Service reports that while incomes have been rising since 2002, the average income in 2005 was $55,238, nearly 1% less than in 2000 after adjusting for inflation. Hourly wage costs (including mandatory welfare contributions and benefits) grew more slowly than hourly productivity from 1993 to late 1997, the years of Reich's tenure as labor secretary. Corporate profit rose until 1997 before declining, meaning what should have gone to workers from productivity improvements went instead to corporate profits. And corporate profit declined after 1997 because of the Asian financial crisis, which reduced offshore income for all transnational companies, while domestic purchasing power remained weak because of sub-par worker income growth.

The break in trends in wages occurred when the unemployment rate sank to 5%, below the 6% threshold of NAIRU (non-accelerating inflation rate of unemployment) as job creation was robust from 1993 onwards. The "reserve army of labor" in the war against inflation disappeared after the 1997 Asian crisis when the Federal Reserve injected liquidity into the US banking system to launch the debt bubble. According to NAIRU, when more than 94% of the labor force is employed, the war on wage-pushed inflation will be on the defensive. Yet while US inflation was held down by low-price imports from low-wage economies, US domestic wages fell behind productivity growth from 1993 onward. US wages could have risen without inflationary effects but did not because of the threat of further outsourcing of US jobs overseas. This caused corporate profit to rise at the expense of labor income during the low-inflation debt bubble years.

Income inequality in the US today has reached extremes not seen since the 1920s, but the trend started three decades earlier. More than $1 trillion a year in relative income is now being shifted annually from roughly 90,000,000 middle and working class families to the wealthiest households and corporations via corporate profits earned from low-wage workers overseas. This is why nearly 60% of Republicans polled support more taxes on the rich.

Carter the granddaddy of deregulation

The policies and practices responsible for today's widening income gap date back to the 1977-1981 period of the Carter administration which is justly known as the administration of deregulation. Carter's deregulation was done in the name of populism but the results were largely anti-populist. Starting with Carter, policies and practices by both corporations and government underwent a fundamental shift to restructure the US economy with an overhaul of job markets. This was achieved through widespread de-unionization, breakup of industry-wide collective bargaining which enabled management to exploit a new international division of labor at the expense of domestic workers.

The frontal assault on worker collective bargaining power was accompanied by a realigning of the progressive federal tax structure to cut taxes on the rich, a brutal neo-liberal global free-trade offensive by transnational corporations and anti-labor government trade policies. The cost shifting of health care and pension plans from corporations to workers was condoned by government policy. A wave of government-assisted compression of wages and overtime pay narrowed the wage gap between the lowest and highest paid workers (which will occur when lower-paid workers receive a relatively larger wage increase than the higher-paid workers with all workers receiving lower pay increases than managers). There was a recurring diversion of inflation-driven social security fund surpluses to the US fiscal budget to offset recurring inflation-adjusted federal deficits. This was accompanied by wholesale anti-trust deregulation and privatization of public sectors; and most egregious of all, financial market deregulation.

Carter deregulated the US oil industry four years after the 1973 oil crisis in the name of national security. His Democratic challenger, Senator Ted Kennedy, advocated outright nationalization. The Carter administration also deregulated the airlines, favoring profitable hub traffic at the expense of traffic to smaller cities. Air fares fell but service fell further. Delays became routine, frequently tripling door-to-door travel time. What consumers save in airfare, they pay dearly in time lost in delay and in in-flight discomfort. The Carter administration also deregulated trucking, which caused the Teamsters Union to support Ronald Reagan in exchange for a promise to delay trucking deregulation.

Railroads were also deregulated by Railroad Revitalization and Regulatory Reform Act of 1976 which eased regulations on rates, line abandonment, and mergers to allow the industry to compete with truck and barge transportation that had caused a financial and physical deterioration of the national rail network railroads. Four years later, Congress followed up with the Staggers Rail Act of 1980 which provided the railroads with greater pricing freedom, streamlined merger timetables, expedited the line abandonment process, and allowed confidential contracts with shippers. Although railroads, like other modes of transportation, must purchase and maintain their own rolling stock and locomotives, they must also, unlike competing modes, construct and maintain their own roadbed, tracks, terminals, and related facilities. Highway construction and maintenance are paid for by gasoline taxes. In the regulated environment, recovering these fixed costs hindered profitability for the rail industry.

After deregulation, the railroads sought to enhance their financial situation and improve their operational efficiency with a mix of strategies to reduce cost and maximize profit, rather than providing needed service to passengers around the nation. These strategies included network rationalization by shedding unprofitable capacity, raising equipment and operational efficiencies by new work rules that reduced safety margins and union power, using differential pricing to favor big shippers, and pursuing consolidation, reducing the number of rail companies from 65 to 5 today. The consequence was a significant increase of market power for the merged rail companies, decreasing transportation options for consumers and increasing rates for remote, less dense areas.

In the agricultural sector, rail network rationalization has forced shippers to truck their bulk commodity products greater distances to mainline elevators, resulting in greater pressure on and damage to rural road systems. For inter-modal shippers, profit-based network rationalization has meant reduced access - physically and economically - to Container on Flat Car (COFC) and Trailer on Flat Car (TOFC) facilities and services. Rail deregulation, as is true with most transportation and communication deregulation, produces sector sub-optimization with dubious benefits for the national economy by distorting distributional balance, causing congestion and inefficient use of land, network and lines.

Carter's Federal Communications Commission's (FCC) approach to radio and television regulation began in the mid-1970s as a search for relatively minor "regulatory underbrush" that could be
cleared away for more efficient and cost-effective administration of the important rules that would remain. Congress largely went along with this updating trend, and initiated a few deregulatory moves of its own to make regulation more effective and responsive to contemporary conditions.

Reagan's anti-government fixation

The Reagan administration under Federal Communications Commission (FCC) chairman Mark Fowler in 1981 shifted deregulation to a fundamental and ideologically-driven reappraisal of regulations away from long-held principles central to national broadcasting policy appropriate for a democratic society. The result was removal of many longstanding rules to permit an overall reduction in FCC oversight of station ownership concentration and network operations. Congress grew increasingly wary of the pace of deregulation, however, and began to slow the pace of FCC deregulation by the late 1980s.

Specific deregulatory moves included (a) extending television licenses to five years from three in 1981; (b) expanding the number of television stations any single entity could own from seven in 1981 to 12 in 1985, with further changes in 1995; (c) abolishing guidelines for minimal amounts of non-entertainment programming in 1985; (d) elimination of the Fairness Doctrine in 1987; (e) dropping, in 1985, FCC license guidelines for how much advertising could be carried; (f) leaving technical standards increasingly in the hands of licensees rather than FCC mandates; and (g) deregulation of television's competition, especially cable which went through several regulatory changes in the decade after 1983.

The 1996 Telecommunications Act eliminated the 40-station ownership cap on radio stations. Since then, the radio industry has experienced unprecedented consolidation. In June 2003, the FCC voted to overhaul limits on media ownership. Despite having held only one hearing on the complex issue of media consolidation over a 20-month review period, the FCC, in a party-line vote, voted 3-2 to overhaul limits on media concentration. The rule would (1) increase the aggregate television ownership cap to enable one company to own stations reaching 45% of our nation's homes (from 35%), (2) lift the ban on newspaper-television cross-ownership, and (3) allow a single company to own three television stations in large media markets and two in medium ones. In the largest markets, the rule would allow a single company to own up to three television stations, eight radio stations, the cable television system, cable television stations, and a daily newspaper. A wide range of public-interest groups filed an appeal with the Third Circuit, which stayed the effective date of the new rules.

According to a BIA Financial Network report released in July 2006, a total of 88 television stations had been sold in the first six months of 2006, generating a transaction value of $15.7 billion. In 2005, the same period saw the sale of just 21 stations at a value of $244 million, with total year transactions of $2.86 billion.

Congress passed a law in 2004 that forbids any network to own a group of stations that reaches more than 39% of the national television audience. That is lower than the 45% limit set in 2003, but more than the original cap of 35% set in 1996 under the Clinton administration - leading public interest groups to argue that the proposed limits lead to a stifling of local voices.

Newspaper-television cross-ownership remains a contentious issue. Currently prohibited, it refers to the "common ownership of a full-service broadcast station and a daily newspaper when the broadcast station's area of coverage (or "contour") encompasses the newspaper's city of publication".

Capping of local radio and television ownership is another issue. While the original rule prohibited it, currently a company can own at least one television and one radio station in a market. In larger markets, "a single entity may own additional radio stations depending on the number of other independently owned media outlets in the market".

Most broadcasters and newspaper publishers are lobbying to ease or end restrictions on cross-ownership; they say it has to be the future of the news business. It allows newsgathering costs to be spread across platforms, and delivers multiple revenue streams in turn. Their argument is also tied to a rapidly changing media consumption market, and to the diversity of opinions available to the consumer with the rise of the Internet and other digital platforms.

The arguments against relaxing media ownership regulations are put forth by consumer unions and other interest groups on the ground that consolidation in any form inevitably leads to a lack of diversity of opinion. Cross-ownership limits the choices for consumers, inhibits localism and gives excessive media power to one entity.

Professional and workers' guilds of the communication industry (the Screen Actors Guild and American Federation of TV and Radio Artists among others) would like the FCC to keep in mind the independent voice, and want a quarter of all prime-time programming to come from independent producers. The Children's Media Policy Coalition suggested that the FCC limit local broadcasters to a single license per market, so that there is enough original programming for children. Other interest groups like the National Association of Black Owned Broadcasters are worried about what impact the rules might have on station ownership by minorities.

Deregulatory proponents see station licensees not as "public trustees" of the public airwaves requiring the provision of a wide variety of services to many different listening groups. Instead, broadcasting has been increasingly seen as just another business operating in a commercial marketplace which did not need its management decisions questioned by government overseers, even though they are granted permission to use public airways. Opponents argue that deregulation violates a key mandate of the Communications Act of 1934 which requires licensees to operate in the public interest. Deregulation allows broadcasters to seek profits with little public service programming.

Clinton and telecommunications deregulation

The Telecommunications Act of 1996 was the first major overhaul of US telecommunications law in nearly 62 years, amending the Communications Act of 1934, and leading to media consolidation. It was approved by Congress on January 3, 1996 and signed into law on February 8, 1996 by President Clinton, a Democrat whom some have labeled as the best president the Republicans ever had.

The act claimed to foster competition, but instead it continued the historic industry consolidation begun by Reagan, whose actions reduced the number of major media companies from around 50 in 1983 to 10 in 1996 and 6 in 2005.

Regulation Q

The Carter administration increased the power of the Federal Reserve through the Depository Institutions and Monetary Control Act (DIDMCA) of 1980 which was a necessary first step in ending the New Deal restrictions placed upon financial institutions, such as Regulation Q put in place by the Glass-Steagall Act of 1933 and other restrictions on banks and financial institutions.

The populist Regulation Q imposed limits and ceilings on bank and savings-and-loan (S&L) interest rates to provide funds for low-risk home mortgages.

But with financial market deregulation, Regulation Q created incentives for US banks to do business outside the reach of US law, launching finance globalization. London came to dominate this offshore dollar business.

The populist Regulation Q, which regulated for several decades limits and ceilings on bank and S&L interest to serve the home mortgage sector, was phased out completely in March 1986. Banks were allowed to pay interest on checking account - the NOW accounts - to lure depositors back from the money markets. The traditional interest-rate advantage of the S&Ls was removed, to provide a "level playing field", forcing them to take the same risks as commercial banks to survive. Congress also lifted restrictions on S&Ls' commercial lending, which promptly got the whole industry into trouble that would soon required an unprecedented government bailout of depositors, with tax money. But the developers who made billions from easy credit were allowed to keep their profits. State usury laws were unilaterally suspended by an act of Congress in a flagrant intrusion on state rights. Carter, the well-intentioned populist, left a legacy of anti-populist policies. To this day, Greenspan continues to argue disingenuously that subprime mortgages helped the poor toward home ownership, instead of generating obscene profit for the debt securitization industry.

The party of Lincoln taken over by corporate interests

During the Reagan administration, corporate lobbying and electoral strategies allowed the corporate elite to wrest control of the Republican Party, the party of Lincoln, from conservative populists.

In the late 1980s, supply-side economics was promoted to allow corporate interests to dominate US politics at the expense of labor by arguing that the only way labor can prosper is to let capital achieve high returns, notwithstanding the contradiction that high returns on capital must come from low wages.

New legislation and laws, executive orders, federal government rule-making, federal agency decisions, and think-tank propaganda, etc, subsequently followed the new political landscape, assisting the implementation of new corporate policies and practices emerging from corporate headquarters rather than from the shop floor. Economists and analysts who challenged this voodoo theory were largely shut out of the media.

Workers by the million were persuaded to abandon their institutional collective defender to fend for themselves individually in the name of freedom. It was a freedom to see their job security eroded and wages and benefits fall with no recourse.

Note
1. Das Kapital, Volume One, Part I: Commodities and Money, Chapter One: Commodities, Section I.

Next: PART 2: Global war on labor

Henry C K Liu is chairman of a New York-based private investment group. His website is at http://www.henryckliu.com.

Copyright 2007, Henry C K Liu

FT.com - Columnists - Martin Wolf - Why Britain has to curb finance By Martin Wolf

May 21 2009 | ft.com

The UK has a strategic nightmare: it has a strong comparative advantage in the world’s most irresponsible industry. So now, in the wake of the biggest financial crisis since the 1930s, the UK must ask itself a painful question: how should the country manage the cuckoo sitting in its nest?

The question is inescapable. London is one of the world’s two most important centres of global finance. Its regulators have, as a result, an influence on the world economy out of proportion to the country’s size. In the years leading up to the crisis, that influence was surely malign: the “light touch” approach led the way in a regulatory race to the bottom.

EDITOR’S CHOICE

Martin Wolf: This crisis is a moment, but may not be a defining one - May-19 Martin Wolf: Why Obama’s conservatism may not prove good enough - May-12 Economists’ forum - Oct-01 Martin Wolf: Tackling Britain’s fiscal debacle - May-07

The fiscal costs of this crisis will be comparable to those of a big war. Thursday’s threatened downgrade by Standard & Poor’s is a reminder of those costs. Loss of jobs and incomes will also scar the lives of hundreds of millions of people around the world.

All this occurred, in part, because institutions replete with highly qualified and highly rewarded people were unable or unwilling to manage risk responsibly. The UK, as a country, the City of London and the broader financial industry bear much responsibility for this calamity. This is a time for self-examination.

A recent report on the future of UK international financial services, produced by a group co-chaired by Sir Win Bischoff, former chairman of Citigroup, and Alistair Darling, chancellor of the exchequer, fails to provide such self-examination. This is partly because the committee consisted of the industry’s “great and good”. It is far more because Mr Darling had already decided that “financial services are critical to the UK’s future”. Thus, the report’s remit was “to examine the competitiveness of financial services globally and to develop a framework on which to base policy and initiatives to keep UK financial services competitive”.

If you ask the wrong question, you will get the wrong answer. The right question is, instead, this: what framework is needed to ensure that the operation of the financial sector is compatible with the long-run health of the UK and world economies?

Quite simply, the sector imposes massive negative externalities (or costs) on bystanders. Thus, the recommendation “that the financial sector be allowed to recalibrate its activities according to the sentiments and demands of the market” is wrong. A market works well if, and only if, decision-makers confront the consequences of their decisions. This is not – and probably cannot be – the case in finance: certainly, people now sit on fortunes earned in activities that have led to unprecedented rescues and the worst recession since the 1930s. Given this, the industry has become too big. If implicit and explicit guarantees and externalities, including volatility, were fully charged, the sector would surely shrink.

So how should one manage a sector that produces such “bads”? The answer is: in the same way as any polluting activity. One taxes it. At this point, the authors of the report will surely ask: “How can you suggest taxing a sector so vital to the UK economy?” The answer is: easily. Financial services generate only 8 per cent of gross domestic product. They are more important for taxation and the balance of payments. But this tax revenue turns out to be perilously volatile. True, in 2007, the last year before the crisis, the UK ran a trade surplus of £37bn in financial services, partially offsetting an £89bn deficit in goods. But smaller net earnings from financial services would have generated a lower real exchange rate and more earnings elsewhere. Given the costs imposed by the financial sector, a more diversified economy would have been healthier. Such sacrilegious ideas are, of course, not to be found in the Bischoff report.

How then should the UK approach policy towards the sector? I would suggest the following guiding ideas.

First, the UK needs to make global regulation work. It should discourage regulatory arbitrage even if it expects to gain in the short run.

Second, it must, in particular, help ensure that owners and managers of financial institutions internalise most of the costs of their actions.

Third, it must reject egregious special pleading from the industry. The sector argues that moving derivatives trading on to exchanges might damage innovation. So what? Maximising innovation is a crazy objective. As in pharmaceuticals, a trade-off exists between innovation and safety. If institutions threaten to take trading activities offshore, banking licences should be revoked.

Fourth, while trying to create a stable and favourable environment for business activities, the UK should try to diversify the economy away from finance, not reinforce its overly strong comparative advantage within it.

Fifth, UK authorities need to ensure that the risks run by institutions they guarantee fall within the financial and regulatory capacity of the British state. They should not let the country be exposed to the risks created by inadequately supported and under-regulated foreign institutions. At the very least, they should not undermine other governments’ efforts to regulate their own institutions.

The “old normal” was simply unsustainable. The “new normal” must be very different. It is far from clear that the industry and government recognise this grim truth.

Self-Regulation Doesn't Work

The last entry in the Blog War over regulation of the financial sector:

Why Self-Regulation of the Financial System Won’t Work, by Mark Thoma: I want to finish up by broadening the discussion beyond the regulation of hedge funds to the more general topic of how attitudes toward regulation have changed in recent years, how that helped to set the stage for the crisis we are in, and what we need to do to prevent it from happening again. In the process, I also want to take on Houman's point that regulators fell down on the job and let this crisis happen, so we cannot trust them in the future.

As I described in my first post, after decades and decades of instability in the 1800s and early 1900s, followed by the massive bank failures of the early 1930s, regulations were imposed to stabilize the banking system. The result was sixty years of calm in the financial sector. That's hardly a failure of regulation. It wasn't until the shadow banking system began growing outside of the regulatory umbrella that problems began to reemerge. A central theme of the posts this week has been that bringing about another decades long period of relative stability will require the regulatory umbrella to be extended to cover all firms within both the traditional and non-traditional (or shadow) banking system, hedge funds included.

I believe we made two regulatory mistakes that contributed to the present financial crisis. First, there was a push for deregulation beginning in the 1970s based upon the belief that markets are self-regulating - even to the extent of self-repairing market failures - and that caused us to go too far toward deregulation. Even the regulation that was left in place was, in many cases, not enforced vigorously, and there was little chance of new, substantial regulatory changes being put in place to match the changes in the financial marketplace brought about by rapid financial innovation. In some cases, deregulation was needed, but in many other cases the deregulation went much too far.

Second, we didn’t focus enough on macroeconomic stability. I think we came to believe that a large crash of the economy was extremely unlikely, particularly one driven by problems in the financial sector. Several factors were responsible for this. The transformative financial innovation of recent decades - particularly the slicing and dicing (securitization) of mortgages and other assets into many complex financial products - was supposed to distribute risk broadly and prevent collapse. We had the "Great Moderation" after the mid 1980s when the variability of output fell significantly and inflation stabilized at low levels, and this was widely attributed to the skill of policymakers and the deregulation of the economy. Because policy had improved, and because we believed the economy was more stable due to deregulation, we let our guard down. We continued to recognize that garden variety fluctuations in output were still possible, though we thought the Fed could mostly handle those, but big crashes were a thing of the past. Or so we thought.

Hopefully, we have been adequately reminded that large recessions can still happen, and that will motivate us to take the regulatory steps needed to bring more stability to the financial system. Some people argue that any new regulation needs to wait until the financial sector has re-stabilized to avoid creating another source of uncertainty, a view that has merit. But the will and hence our ability to impose new regulation tends to diminish when the economy recovers, and if we wait too long to get started, the opposition to any new regulation may carry the day and we'll fail to get the measures we need put into place. The time to start is now.

But what of the charge that regulators blew it and caused this crisis, and therefore we are foolish to rely upon them for stability in the future? First, as I've said, I don't think decades of stability is a failure by any definition, and the recent failure was driven by an ideological belief that markets are self-regulating and hence best left alone. Most markets can be left alone, but as Alan Greenspan has recently acknowledged, financial markets are not among them. Second, I believe the recent failure did not happen because regulators were incapable of doing better than they did, it was their belief in the self-healing power of markets - their belief that what just happened was next to impossible - that stopped them from intervening as needed. With different beliefs and a different framework for approaching the problem, the outcome is much different.

So I am not ready to throw up my hands and say this is too hard, either the private sector finds a way to take care of itself, or it doesn't get done at all. We have the capacity to learn from our mistakes, to drop ideologies and theoretical constructs that led us astray, and I have faith we will do just that (Alan Greenspan's conversion is a prime example). With comprehensive regulation to prevent the excesses that caused the problems we are having, with the flexibility for regulations to evolve as new innovations come to the financial marketplace, and with regulators who have learned the lessons of the past, we can look forward to another decades long period of stability. But if we fail to take the steps that are needed and rely too much on private markets to regulate themselves, we are setting ourselves up for this to happen again.

Houman's response is here (it's partly in response to the previous post).

Posted by Mark Thoma on Monday, April 20, 2009 at 02:07 AM in Economics, Politics, Regulation 

  Permalink  TrackBack (1)  Comments (66)

Lafayette says...

Well-written, well-balanced article, MT.

I fear, nonetheless, that it overlooks a key factor at the cause of the Great Subprime Mess of 2008. That is, human failure.

The Subprime Mess was a Perfect Storm of many confluent factors, but underlying them all was human inadequacy. Whether our deficiency was a matter of laxity or vanity or cupidity, doesn't solve the central issue, which is failure on such as scale as to cause great economic deprivation.

To think that changing Wall Street's infrastructure (as Shadab does) will change human behaviour is seriously naive. (Though the notion that finance boutiques will have better risk management because one’s own wealth is committed, is an enticing argument.) We humans are clever beings, which is why we dominate this planet.

Should we not look at regulating behaviour more than markets? Perhaps we need more/better (regulatory) stop-signs on the road, but surely we need better-behaved drivers (risk managers) at the wheel.

I maintain, as I have for some time, that only confiscatory taxation, beyond a "reasonable level" of total compensation, will change human behaviour. We must take the motivation out of unacceptable human behaviour, regardless of its endeavor.

Let us not forget that grabbing for the Golden Ring was perfectly legal. Commercial lenders and Investment Bankers, responsible for the excesses, were not only taking advantage of regulatory laxity but pushing the envelope of Risk Management into uncharted waters. Why? Because success would bring them pecuniary rewards beyond the wildest imagination.

If we do not change such practices, by both more forceful punishment of contra-regulatory activity and higher marginal rates of taxation, then the cunning creatures on Wall Street will simply devise new ways to beat conventional wisdom in the race to the treasure at the end of the rainbow.

This will not happen next year or within the next decade, but neither will it take another 75 years (which the Subprime Mess needed to repeat the Great Depression). It will come not within three or four generations either, but perhaps only two, because such convulsive evolutions may have accelerated enormously due to the amplitude effects of globalization.

Meaning within the lifetimes or our children.

Oupoot says...

IMHO, the starting point would be to relook at the economic theory underlying regulation. The theory of self-regulation was promoted almost exclusively in most grad schools. The theory I learned in micro-economics in grad school was that market agents (firms/individuals) will discount any adverse future event in the n'th iteration of an iterative game process to the present, which will guide their decisions in the 1st iteration. The assumption was of omnipresent market agents knowing the outcome of future events. The reality that market agents cheat, lie and/or tell half-truths in order to get ahead of the competition and make a profit were conveniently excluded. Neither did the theory adequatly take account of the time value of adverse outcomes, i.e. there maybe incentive to market agents to delay the adverse event from taking place, or for other market agents to know about the adverse event at an earlier date.

The are merits in self-regulation, but as the events over the past year has shown, the assumptions about market agents must be reviewed. Regulation is by design to the benefit of the overall market, but to the detriment of individual market agents who may have benefitted from cheating the market. The "light" regulation of the past decade is not the answer, but neither is "draconian" regulation.

Further, the balance between too much and too little regulation is constantly moving in this everchanging world. But given the severity of the existing crisis, erring on the side of caution is the better option, at least for the medium term.

Posted by: Oupoot | Link to comment | April 20, 2009 at 04:23 AM

save_the_rustbelt says...

We still have thousands of pages of civil regulations and it did not work.

Solution? A certainty that Wall Street fraud will be prosecuted.

Obama just offered immunity from prosecution for 50,000+ tax evaders who used UBS Switzerland accounts, and then Obama waived part of the normal penalties. What is up with that?

Posted by: save_the_rustbelt | Link to comment | April 20, 2009 at 04:37 AM

Lafayette says...

Firstist with the mostest

OuP: The theory I learned in micro-economics in grad school was that market agents (firms/individuals) will discount any adverse future event in the n'th iteration of an iterative game process to the present, which will guide their decisions in the 1st iteration.

I was taught that theory as well. Imagine my surprise when I went to work in industry, where I learned that survival was that of the fittest. That managers could not give a damn about n-iterations, because, by the n-th time, they may have lost their jobs for lack of having met objectives (that were entirely extraneous to economic theory).

I learned that it was not the rules of economics that prevailed but, literally, the rules of war. I was reminded of the Confederate general who, when asked why he won a certain battle, reputedly answered, "Because I got there firstist with the mostest" (and by all means practicable, he forgot to add).

Economics is not well served by a high-minded theory about how "market agents" make decisions. They make them chaotically, randomly. Why search to give them any rational that is not, in fact, pertinent to the situation? Because it suits our need to be rational?

Supply and Demand curves determining optimal pricing are an intellectual abstraction of what is happening on the ground. They make very good common sense, but they are not pertinent to evidenced market activity. An industrial giant, with sufficient market share, can increase Supply AND increase Price. How does that well-known fact jibe with your course in EC101?

Well, your economics professor will tell you that such is not indicative of the economy as a whole. Oh, really?

We have, for almost a century, opted to organize industry as vertically integrated in a quest to create National and International Industrial Champions by seeking the Holy Grail of economies-of-scale. Now, we've chopped the base of the pyramid off and sent it to China (because that enhances even further our cost economies-of-scale and thereby profits).

But corporate captains strive to maintain the pyramid's largeness. The larger the pyramids and the less numerous, we think, the better. We need (supposedly) just enough pyramids, in any given industrial sector, to maintain a modicum of competitiveness.

We should have serious doubts about that conclusion. I doubt competitiveness is all that functional. I doubt that economies-of-scale trickle down to consumers, but I am sure that the average salaries of Top Management are higher. So, what indeed was the point of the integration-exercise, pray tell, except to create a class of well-paid executive managers?

(NB: If you are looking for an example of the above, consider the automotive industry, which has just begun to implode. And should we apply that analogy to Finance, the result is the Great Subprime Mess of 2008.)

I am left to conclude that many smaller pyramids all competing for far smaller market shares, meaning more atomization of industry, perhaps provides a higher economic utility (meaning more employment in more durable jobs). I would be pleased to see seven General Electrics in the US, not the conglomerate of one GE as it stands today. (And I used to work for GE when it was nothing like it is today.)

I also doubt that manufacturing in the US is all that absolute a necessity, except where essential to meet specific customer needs. I see our companies becoming service entities (with engineering, sales and administration) but manufacturing done where cheapest at a guaranteed level of quality.
 

Posted by: Lafayette | Link to comment | April 20, 2009 at 05:39 AM

save_the_rustbelt says...

"I also doubt that manufacturing in the US is all that absolute a necessity, except where essential to meet specific customer needs. I see our companies becoming service entities (with engineering, sales and administration) but manufacturing done where cheapest at a guaranteed level of quality."

Ah, this is not working out so well so far. Except for wealthy white guys.

robertdfeinman says...

I think there was a hidden force behind the ideology. It is true that in the academic world in the US and UK a "free market" ideology was taught and talked up, but why didn't this happen elsewhere?

Western Europe and Japan resisted the wholesale abandonment of the social compact and strengthened the services expected of government. As a consequence they had decent growth, good social services, better wealth equality and less militarism and foreign adventurism.

They also don't have an increasingly multi-generational oligarchy which uses its wealth to promote the "free market" ideology. When one looks under the covers those who fund this type of outlook never subscribe to it themselves. The oligarchs (Koch, Scaife, Walton, Olin, etc) insist on lots of regulations, it is just that they are slanted to favor them.

For example, tilting the tax laws away from inheritance and capital gains befits the personally wealthy. Similarly cutting the corporate tax rate, creating accelerated depreciation and other financial gimmicks favors large firms over smaller ones. The refusal to enforce anti-trust laws also performs the same function.

The ideologues like Greenspan and the crew at Chicago are the useful idiots who created a seemingly logical intellectual structure that allowed the plutocrats to continue their plunder of the commons.

This is a standard tactic of plutocrats throughout history: "do what I say, not what I do". There is no free market, libertarian movement elsewhere because there are no super wealthy keeping the ideology on life support.

If money could buy power and influence to the extent that existing regulations were trashed or ignored what mechanism is being proposed to prevent this from happening again? Money votes not people.

Sorry to sound like a "socialist", but the only cure is to have a truly functioning democracy which means that money has to be removed from the electoral process. This means not only during the campaigns, but the institutionalized lobbying, bribery, fund-raising, revolving door cycle that is now the norm for legislators.

Without an implementation plan talk of lofty goals is just that, talk.

anne says...

What was done methodically done as conservatives gained in political influence was to break down regulatory economic safeguards and peddle a philosophy about the need to break down such safeguards that prevailed even through economic crisis on crisis. The process simply quickened with the Presidency of George Bush and a Republican Congress and increasingly Republican court system. The result was not only the legal breaking down of regulations but the ignoring of regulations that lasted and the astonishing economic abuses we are now trying deal with.

Beyond this, conservatism as beauty must be a joy forever only not nearly so much.

roger says...

The fallacy of the narrative fallacy is obviously that it has to find a narrative - something with a beginning and end - to be fallacious about. But of course finding a beginning and an end is a narrative fallacy. It is rather like criticizing the science of unicorns for saying they all have one horn when, really, we don't know whether they have one horn or two. If one is going to set up shop as a radical skeptic, best not to start out lukewarm.

But getting beyond these issues - the fallacy of de-regulating the shadow financial sector was in the often repeated statement that, given that only the wealthy invest in hedge funds, the government needn't worry about them. The government, see, only exists to protect the "poor". As if the shadow system wasn't so linked and connected to the rest of the system that it could be segregated out. The Guv'mint, and Greenspan in particular, knew, at least since the time of the 98 crisis with LTCM, that their rhetoric about how only the rich would be effected by failures in the shadow financial system was total bs. They bullied and harried the woman at the head of the CFTC (and it is very much to the point that it was a woman, given that one of the bulliers, Larry Summers, seems to have, shall we say, an issue here), Brooksley Born, who actually had two eyes in her head and saw what was going on.

And of course, Born is right, Summers is wrong, and - in a move applauded by the plutocracy-sodden establishment - Summers is the one calling the shots on the economy in D.C.

kthomas says...

Hear hear, Prof. Thoma. Come out swinging: first jab, then vicious right-hook! This is a great way for me to start my week!

I'm not sure I agree with you on Mr Greenspan's conversion. He's a true believer, and they NEVER change thier minds.

pebird says...

The problem is not too aggressive regulation nor a lack of regulation. It is the appearance of regulation where there was little or none. The actual amount of regulation was out of balance with what market participants thought there was.

This led to trust arbitrage - where if I knew where the system was gamed and you didn't ...

The purpose of any regulatory regime is to provide the market a floor of trust level - this is what we know and this is what we don't. With no regulation, the regulatory agency becomes Sargent Schultz "I know nothing". But it keeps its mouth shut.

Self-regulation is an oxymoron. The idea that market participants would freely disclosure information in a spirit of transparency without being forced to is naive at best and more likely disingenuous.

The idea that they would do so due to the threat of potential government intervention requires that someone in the government monitor the market and compare it against some criteria of disclosure. This is the only way to have a credible threat of intervention. In other words, in order to have self-regulated markets you need regulated markets.

Houman's response is a laundry list of why we need regulation:

1. Small is beautiful - how do you maintain smallness without regulation?

2. Over dependence breeds disaster - lets have non-traditional players enter the financial arena "So long as they are properly regulated".

3. Derivatives do work - "encourage participants to increase transparency". Again, how can you measure transparency unless you compare the released information to its truth content, which requires a high-degree of intervention - e.g., regulation.

Why oh why are otherwise intelligent people dancing around the necessity of doing what is painful but obvious?

Posted by: pebird | Link to comment | April 20, 2009 at 09:38 AM

Lafayette says...

s-t-r: Except for wealthy white guys

Can't imagine what that means? Top Management?

Sorry, but when I put my forecasting glasses on, Manufacturing does not come up roses. Heavy manufacturing has the highest probability of staying put. (By heavy, I mean cars as well.)

But light electronics and plastics ... bye, bye -- unless we want to invest in heavy automation. And, if we don't, the Chinese will and they will dominate the market for both low-end (knock-off electronics) and high-end (semiconductor fab plants).

It's a New Global World out there, beyond the subprime mess. The subprime mess will be history one day, but global competition will only get worse. And we need absolutely a strategy to counter the Chinese.

One that will reduce three statistics: (1) import volumes, (2) our resulting chronic trade deficit with them and (3) their sovereign fund US T-note holdings.

Thickheaded says...

First off, regulatory practices were found to featherbed industries, stifle innovation, and disincent investment. Minsky Conference regular Jamie Galbraith will attest that the turn toward deregulation and monetarism resulted from the deadend Keynsianism ran into in the late 1970's with stagflation. Anything was seen as worth a shot.

Second off, twinning deregulation with abandonment of any notion of anti-trust meant that eventually M&A would create a new oligopoly without redress. Excess profits would allow co-opting the academic shills and political hacks into favorable featherbedding. Easy money would cover up the gaps.

The failure of preserving intellectual capital in patents, copyright, and trademarks - the West's only real assets of value after they sold of manufacturing plants - meant that the only solution was rapid innovation and increased financial engineering to facilitate short-term profit maximixing. The so-called moderation was a measure of short-term effect as dislocations in labor were absorbed into lower paying service sector jobs. Easy immigration kept this from boiling over into labor discontent.

The operating environment became a crap shoot and dependent only on making it cheaper, the finance with high returns and "lower" risk looked like a good move. CFO's suddenly became profit centers rather than the disciplinarians they once had been. Collective ethical failures abounded as temptations increased, and the unaccountable Board rooms lined their pockets with the shareholder's money.

The idea that high taxes somehow magically restores virtues ignores the very real organizational realities and the way people work... and the consequent result will surely be that off-shoring accelerates. Regulation as the only answer is also simply a ticket for continued enrichment of the legal community at the expense of the rest. Politicians would love the PAC contributions this engenders... but it is detrimental to real reform of the economy. The notion that anything of enduring value can be accomplished without some reform of the way government itself works and accountability to its people seems a chimera. Ditto for making capitalism work for the shareholders rather than allowing their agents to abscond with their funds.

Present observation suggests that the only discipline democracies respond to tends to come from the outside. One suspects that as Ying follows Yang, that the once suppliant China begins to roar a little more, the West may come to its senses and respond more seriously. Maybe it takes the same outside threat to force accountability also in the Board Room - and if regulation manages this (which it's more timid sort hasn't in 50 years at least), then maybe it is the better of two evils.

Lafayette says...

Dammit

pebird: Small is beautiful - how do you maintain smallness without regulation?

This is an attractive argument because it goes to the core of what went wrong -- HiFi nerds betting millions of someone else's money, breaking the bank, then crowing that they were TBTF.

Still, the incentive to maximize income will be there (at today's present rates of marginal income taxation). Whether there are a big six / seven banks or fifty small banks, the market volumes are for the taking. And the markets will go to those who arbitrage best. These winners will initially not pocket profits, roll onwards their profits by gaming them. When once again large enough, then the will try to sell out to a larger bank, cash in, and buy a megabuck ranch-style house in Palm Beach.

So, they'll be back in business soon, but on a smaller scale. Which does not automatically make them less dangerous. They are still playing the same arbitrage game with their probability models.

These people are so dull as to be perfectly predictable. But they are also perfectly focused on an objective -- the nirvana of megabuck earnings for each one of them.

Dammit if the plan doesn't work ...

anne says...

"By the early 80s, most of the baby boomers were already in the workforce, and if anything, women were leaving the workforce to be stay at home mothers, since they were in their peak childbearing years."

Women if anything were continually entering the workforce through the 1980s and 1990s, the employment-population ratio for women continually increasing from the 1960s and only leveling off during the Bush years as job creation faltered.

Even these last years however women have gained and held employment relatively better than men, which has been especially important in terms of family support through this recession. *

* http://www.bls.gov/webapps/legacy/cpsatab1.htm

anne says...

"By the early 80s, most of the baby boomers were already in the workforce, and if anything, women were leaving the workforce to be stay at home mothers, since they were in their peak childbearing years."

Women if anything were continually entering the workforce through the 1980s and 1990s, the employment-population ratio for women continually increasing from the 1960s and only leveling off during the Bush years as job creation faltered. Even these last years however women have gained and held employment relatively better than men, which has been especially important in terms of family support through this recession. *

* http://www.bls.gov/webapps/legacy/cpsatab1.htm

Posted by: anne | Link to comment | April 20, 2009 at 12:24 PM

rps says...

"....after decades and decades of instability in the 1800s and early 1900s, followed by the massive bank failures of the early 1930s, regulations were imposed to stabilize the banking system. The result was sixty years of calm in the financial sector. That's hardly a failure of regulation."

Sixty years of calm?, Tsk, tsk, tsk here's an F- on your paper. What does one call 1,043 savigs and loans failures? Or how about the insolvency of the FSLIC? How about the Depository Institutions Deregulation and Monetary Control Act (DIDMCA) of 1980 and the Garn-St. Germain Depository Institutions Act of 1982?

How soon one forgets the Savings and Loan Scandal of the 1980's into the 90's. In fact, I would state that the S&L scandal was the primer for today's lack of regulation, incestuous relationships between Congress and the financial industry.

Wiki: "Policies combined with an overall decline in regulatory oversight (known as forbearance), would later be cited as factors in the later collapse of the thrift industry. From 1986 to 1989, FSLIC closed or otherwise resolved 296 institutions with total assets of $125 billion. An even more traumatic period followed, with the creation of the Resolution Trust Corporation in 1989 and that agency’s resolution by mid-1995 of an additional 747 thrifts. [8]

A Federal Reserve Bank panel stated the resulting taxpayer bailout ended up being even larger than it would have been because moral hazard and adverse selection incentives that compounded the system’s losses. [9]

There also were state-chartered S&Ls that failed. Some state insurance funds failed, requiring state taxpayer bailouts."
Sound Familiar?

Due to Congresses contempuous refusal to throw their own under the bus, and instead invoked the Ethics Committee slap on McCain's wrist has led us again down the yellow belly brickroad to today's intentional fraud and once again our millionare Congressmen indulge their BFF's club of greedy, fraudulent, tax evading investment and insurances houses with bailouts onto the backs of the taxpayers.
IF Congress had down their job and thrown McCain and the other 4 senators under the bus, would we be here today? Public humiliation and Orange jumpsuits are a great deterrent for our elected officials.

William Black, Federal Banking Regulator 1984-1994 at keatingeconomics.com speaks candidly about the S&L scandal.

Mattyoung says...

Sometimes it appears we live in an imaginary world.

There is one super monopoly in our economy, Congress, who ultimately control 23% of the economy. This group cannot operate without a big shadow banking system with the job of arbitrating the short term fluctuations that the long term policies of Congress generate.

What happens when Congress screws up, when they get the cash flow for some programs out of whack and cannot fix things in time? The big banks step in with short term hedges and bond purchases to smooth out things out.

Anne would like us to remove Congress from the laws of economics, pretend they can be some sort of referee, but they are big players, the biggest, and the volatility they cause will be with us sooner or later.

roger says...

Women, of course, did not leave the economy (that is, as economists define the economy, where work is what you are paid for) to go home (where work isn't paid for, and thus isn't work) in the 80s. I don't know where that idea came from. Here's a nice little Bureau of Labor chart to illustrate that fact:
http://www.bls.gov/opub/mlr/2003/10/ressum3.pdf

Without women entering (sic) the work force (instead of lazing around all day, raising children, cleaning, cooking, managing household finances, dealing with medical crises, and in general not working) the median American household would have been forced down several percentiles. And it would have occured to the constituency that has supported Reagonomics, white males, that really, they were being cheated.

Not Mark T says...

RE: the Sgt. Schultz as regulator model, an issue that we may be hearing more about is the prevalence of "side letters" used in credit default swaps. In essence these were hidden agreements indicating that issuers such as AIG never intended to pay, and counterparties never intended to collect, on CDS contracts only intended to spruce up a public traded company's balance sheet (see: http://us1.institutionalriskanalytics.com/pub/IRAstory.asp?tag=351). According to a lawyer friend in the insurance industry, state insurance regulators have long been aware of this practice but looked the other way ... until now. All this to say that unless the only objective is to give the patina of legitimacy, rules on paper have to be enforced.

kthomas says...

@ roger "...And it would have occured to the constituency that has supported Reagonomics, white males, that really, they were being cheated." VERY funny. Who's the greater fool, the fool or his poor overworked wife?

Can someone cite just 1 example of a market that has functioned soundly with only self-regulation? C'mon, ye true believers....tell us.

btg says...

anne: Women if anything were continually entering the workforce through the 1980s and 1990s, the employment-population ratio for women continually increasing from the 1960s and only leveling off during the Bush years as job creation faltered. Even these last years however women have gained and held employment relatively better than men, which has been especially important in terms of family support through this recession. *

* http://www.bls.gov/webapps/legacy/cpsatab1.htm

Well, Anne, I was referencing this:

http://findarticles.com/p/articles/mi_m1153/is_n9_v120/ai_20064085/?tag=untagged

During the early 1990's, there was no growth in women's labor force participation rates; since 1994 however, the rate has edged upward, with mothers accounting for most of the rise

From March 1975 to March 1996, the labor force participation rate of women rose from 46 percent to nearly 59 percent (table 1). Although it rose without interruption through 1990, the increase did not proceed at a steady pace; rather the rate of increase slowed gradually over time. Between 1975 and 1980, women's labor force participation rate increased an average of 1 percentage point per year, from 1980 to 1985, the average annual gain fell to 0.7 percentage point. During the next 5 years--1985 to 1990--the gain was slower still, averaging 0.5 percentage point per year.

anne says...

The unemployment rate for women maintaining families, declined from 10% in 1992 to 5.9% in 2000 and is currently 10.8%. During the Reagan years, the unemployment rate did not fall below 10% till 1985 and below 9% till 1988. The rate was lowered however to 5.9% under Clinton, only to rise from there.

Posted by: anne | Link to comment | April 20, 2009 at 05:47 PM

the buggy professor says...

1) Lafayette and Rustbelt (among others) have lamented the decline of US manufacturing industry. Has manufacturing industry actually declined?

Yes and no. It depends on the measure used.

2) If jobs are the measure, then yes --- the percentage of the US workforce in manufacturing declined from about 35% in the early 1970s to around 12% in 2004. But note: the same trend has been at work in all the other large advanced industrial countries: the UK, France, Germany, and Japan. Click here for a publication put out by the Council of Economic Advisers (2004) that captures the trends in the US along with these other four countries, then go to diagram 7. Note that the US had a smaller sector compared to these other countries even in the late 1960s. Note also that the fall has been sharper for the UK and France, with Germany and Japan not falling so fast until the early 1990s.

3) If the percentage of manufacturing in US GDP is the measure, then again a roughly similar picture emerges. It has declined to around 12-13.

4) If the measure, though, is the dollar value of manufacturing output, it was at an all-time peak in 2006-07 at over $1.6 trillion . . . almost double the output a decade ago. According to Business Week yesterday,

”As Stephen Manning of the Associated Press acknowledged in a rare "just the facts" story in mid-February, the U.S. "by far remains the world's leading manufacturer," producing goods valued at a record $1.6 trillion in 2007 — nearly double the $811 billion produced a decade earlier. Indeed, the AP writer noted, "For every $1 of value produced in China's factories [in 2007], America generated $2.50." Not bad for a country that doesn't produce anything anymore.”

Please note carefully: American manufacturing --- including multinational implants here from abroad --- produce 250% more in dollar-calculated output than China does (with a much greater role for foreign implants). A surprise to many of us, no?

Then, too, contrary to largely uninformed opinion, US manufacturing output is larger than that of China’s, Japan’s, or Germany’s as a percentage of total world mfg. output. 21% in 2006.

5) If the measure is investment levels, note the astonishing pace in 2007 for US manufacturing (same Business Week source)
“Not only is the U.S. still the world's leading manufacturer, but there are many good reasons that companies will continue to manufacture here and invest in new plants and equipment. According to the Census Bureau's 2007 Annual Capital Expenditures Survey, released on Jan. 22 of this year, U.S. nonfarm businesses invested $1.36 trillion in new and used structures and equipment in 2007, a 3.9 percent increase over 2006. More than $484 billion was spent on new structures alone.”

6) Enter manufacturing exports.

And US export-manufactures were at an all-time peak in total value in 2007 as well. Note that they are heavily concentrated in capital goods, which in turn depend markedly on R&D, innovation (process or radical product), good marketing, and highly skilled labor . . . not to mention constant investment.. There is no reason to assume that such capital goods production will be easily transferred abroad, the way more standardized consumer-products have been.

7) If the measure is the wage (plus benefits) of workers in manufacturing industry, it was almost double in inflation-adjusted terms last year compared to the early 1970s, when the industrial work force was three times larger as a percentage of total employment: about $66,000 vs. $37,000.

………………………………….

8) All of which leads to a question of importance: what has caused the decline in manufacturing jobs and output as a percentage of total US employment and GDP?

As usual, the causes are multiple:

* Extraordinary leaps forward in manufacturing productivity in the 1980s and 1990s into this decade. Click here again (the Council of Economic Advisers’ study), then go to diagram 5. As the commentary notes, between 1950 and 2000, average nonfarm productivity grew at 2.0% a year; the equivalent stat for manufacturing was 2.8% --- almost double. Note though how both measures soared from 1995 on to 2003 (the last year analyzed in the study), with manufacturing productivity’s growth rate rising over 70% and the service sectors’ by even more from its point at the end of 1994.

*The globalizing influences working everywhere in the world, not least in the industrial leading countries of the 1950s – 1970s, with the growing shift of fairly low-or middle-level skills or at least standardized production to developing countries like Mexico, Brazil, and Pacific Asia. The major driving force here has been multinational manufacturers, taking advantage of disciplined workers who have the skills to work effectively with modern technologies.

Note that there have been no significant work by economists --- or even business school professors (since some pathbreaking work out by Raymond Vernon and others at the Harvard Business School in the 1960s and 1970s) --- on the overall causes and repercussions of such “multi-level” production chains globally. Even Krugman’s original work on geography and trade doesn’t deal with it in depth.

*The trade effects that ensued from the rapid growth of standardized manufacturing in Pacific Asia and parts of Latin America. Compounded, obviously, by the use of neo-mercantile efforts by China --- and earlier, until the late 1980s by Japan and others in East Asia --- to keep their currencies from appreciating against the $US and later the Euro. To note this is not to deny that there has been a lot of controversy on this topic, including the growing dependence of the US economy on capital inflows from abroad . . . along with a cost/benefit analysis of the outcomes.

*And finally, connected with these, the growing importance in the US economy of high-tech service industries, not least financial. Along with the shift of standardized manufacturing to developing countries --- including the use of China’s disciplined, moderately skilled work force for assembly production and exports --- the US pioneer role in creating a knowledge-based economy has, for good or bad, shifted our comparative advantage toward both high-tech services and capital-goods manufactures.

----- A little tantalizing evidence follows here. According to a good study put out last year by Robert Gordon of Northwestern and a British colleague on the slowdown in the EU’s productivity growth after 1995 compared to the US’s --- but, oppositely, a better performance by the EU in creating jobs ---,

“We find that the revival of European employment growth can help explain why European productivity slowed. But we do not explain why European productivity growth did not accelerate as occurred in the US. US productivity took off after 1995, growing at 0.7 percent faster per year, but in Europe a literal reading of the productivity growth data leads to doubt that the internet revolution ever occurred in Europe.

“Some of Europe’s poor recent performance can be explained by reforms that will enhance growth in the long run, but not all of it. Our findings should lead EU policymakers to think about the two-edged effects of policy reforms on employment and productivity, but they should also worry about how to encourage innovation and the adoption of new technologies.1”
Source: Click here.

………

Michael Gordon, AKA the buggy professor

anne says...

http://www.bls.gov/webapps/legacy/cpsatab1.htm

January 9, 2009

Employment-Population Ratio, Women, 1948-2009

1948 31.3 *
1949 31.2 (Low)

1950 32.0
1951 33.1
1952 33.4 Eisenhower
1954 32.5

1955 34.0
1956 35.1
1957 35.1
1958 34.5
1959 35.0

1960 35.5
1961 35.4 Kennedy
1962 35.6
1963 35.8 Johnson
1964 36.3

1965 37.1
1966 38.3
1967 39.0
1968 39.6
1969 40.7 Nixon

1970 40.8
1971 40.4
1972 41.0
1973 42.0
1974 42.6 Ford

1975 42.0
1976 43.2
1977 44.5 Carter
1978 46.4
1979 47.5

1980 47.7
1981 48.0 Reagan
1982 47.7
1983 48.0
1984 49.5

1985 50.4
1986 51.4
1987 52.5
1988 53.4
1989 54.3 Bush

1990 54.3
1991 53.7
1992 53.8
1993 54.1 Clinton
1994 55.3

1995 55.6
1996 56.0
1997 56.8
1998 57.1
1999 57.4

2000 57.5 (High)
2001 57.0 Bush
2002 56.3
2003 56.1
2004 56.0

2005 56.2
2006 56.6
2007 56.6
2008 56.2

March

2009 55.1

* Employment age 16 and over

Posted by: anne | Link to comment | April 20, 2009 at 05:13 PM

anne says...

Periods in which the increase of the employment-population ratio for women whether over 16 or 20 years of age slowed, were periods of recession and slow job creation following recession as notably in the early 1990s. Job creation during the Bush Presidency from 1989 to 1993 was 53,000 monthly, while during the Clinton Presidency job creation was 240,300 monthly. Women worked when there were jobs, and women worked even more when employers accomodated women. *

* http://www.bls.gov/webapps/legacy/cesbtab1.htm

Posted by: anne | Link to comment | April 20, 2009 at 05:21 PM

anne says...

http://findarticles.com/p/articles/mi_m1153/is_n9_v120/ai_20064085/?tag=untagged

"During the early 1990's, there was no growth in women's labor force participation rates; since 1994 however, the rate has edged upward, with mothers accounting for most of the rise."

Duh. During the early 1990s, Bush years, there was minimal job creation. Job creation through the Clinton years that was almost 5 times higher, and more emphasis on work opportunities for women, led to women continually entering the workforce and continually narrowing the employment-population ratio gap with men. The gap is still narrowing, but the Bush years from 2001 were marked by an astonishing 27,000 jobs created monthly.

Posted by: anne | Link to comment | April 20, 2009 at 05:30 PM

anne says...

We went then from 53,000 jobs created monthly during the years of Bush, to 240,300 jobs created monthly under Clinton to 27,000 jobs created monthly during the recent Bush Presidency. Women entered the workforce according to opportunity. We are now at the lowest employment-population ratios for men whether over age 16, or 20, or 25, since 1948 when data was initially recorded.

When looking to employment-population ratios, we need to look to women and men separately, and understand how relatively severe a time this is for men.

Posted by: anne | Link to comment | April 20, 2009 at 05:39 PM

anne says...

The unemployment rate for women maintaining families, declined from 10% in 1992 to 5.9% in 2000 and is currently 10.8%. During the Reagan years, the unemployment rate did not fall below 10% till 1985 and below 9% till 1988. The rate was lowered however to 5.9% under Clinton, only to rise from there.

Posted by: anne | Link to comment | April 20, 2009 at 05:47 PM

the buggy professor says...

1) Lafayette and Rustbelt (among others) have lamented the decline of US manufacturing industry. Has manufacturing industry actually declined?

Yes and no. It depends on the measure used.

2) If jobs are the measure, then yes --- the percentage of the US workforce in manufacturing declined from about 35% in the early 1970s to around 12% in 2004. But note: the same trend has been at work in all the other large advanced industrial countries: the UK, France, Germany, and Japan. Click here for a publication put out by the Council of Economic Advisers (2004) that captures the trends in the US along with these other four countries, then go to diagram 7. Note that the US had a smaller sector compared to these other countries even in the late 1960s. Note also that the fall has been sharper for the UK and France, with Germany and Japan not falling so fast until the early 1990s.

3) If the percentage of manufacturing in US GDP is the measure, then again a roughly similar picture emerges. It has declined to around 12-13.

4) If the measure, though, is the dollar value of manufacturing output, it was at an all-time peak in 2006-07 at over $1.6 trillion . . . almost double the output a decade ago. According to Business Week yesterday,

”As Stephen Manning of the Associated Press acknowledged in a rare "just the facts" story in mid-February, the U.S. "by far remains the world's leading manufacturer," producing goods valued at a record $1.6 trillion in 2007 — nearly double the $811 billion produced a decade earlier. Indeed, the AP writer noted, "For every $1 of value produced in China's factories [in 2007], America generated $2.50." Not bad for a country that doesn't produce anything anymore.”

Please note carefully: American manufacturing --- including multinational implants here from abroad --- produce 250% more in dollar-calculated output than China does (with a much greater role for foreign implants). A surprise to many of us, no?

Then, too, contrary to largely uninformed opinion, US manufacturing output is larger than that of China’s, Japan’s, or Germany’s as a percentage of total world mfg. output. 21% in 2006.

5) If the measure is investment levels, note the astonishing pace in 2007 for US manufacturing (same Business Week source)
“Not only is the U.S. still the world's leading manufacturer, but there are many good reasons that companies will continue to manufacture here and invest in new plants and equipment. According to the Census Bureau's 2007 Annual Capital Expenditures Survey, released on Jan. 22 of this year, U.S. nonfarm businesses invested $1.36 trillion in new and used structures and equipment in 2007, a 3.9 percent increase over 2006. More than $484 billion was spent on new structures alone.”

6) Enter manufacturing exports.

And US export-manufactures were at an all-time peak in total value in 2007 as well. Note that they are heavily concentrated in capital goods, which in turn depend markedly on R&D, innovation (process or radical product), good marketing, and highly skilled labor . . . not to mention constant investment.. There is no reason to assume that such capital goods production will be easily transferred abroad, the way more standardized consumer-products have been.

7) If the measure is the wage (plus benefits) of workers in manufacturing industry, it was almost double in inflation-adjusted terms last year compared to the early 1970s, when the industrial work force was three times larger as a percentage of total employment: about $66,000 vs. $37,000.

………………………………….

8) All of which leads to a question of importance: what has caused the decline in manufacturing jobs and output as a percentage of total US employment and GDP?

As usual, the causes are multiple:

* Extraordinary leaps forward in manufacturing productivity in the 1980s and 1990s into this decade. Click here again (the Council of Economic Advisers’ study), then go to diagram 5. As the commentary notes, between 1950 and 2000, average nonfarm productivity grew at 2.0% a year; the equivalent stat for manufacturing was 2.8% --- almost double. Note though how both measures soared from 1995 on to 2003 (the last year analyzed in the study), with manufacturing productivity’s growth rate rising over 70% and the service sectors’ by even more from its point at the end of 1994.

*The globalizing influences working everywhere in the world, not least in the industrial leading countries of the 1950s – 1970s, with the growing shift of fairly low-or middle-level skills or at least standardized production to developing countries like Mexico, Brazil, and Pacific Asia. The major driving force here has been multinational manufacturers, taking advantage of disciplined workers who have the skills to work effectively with modern technologies.

Note that there have been no significant work by economists --- or even business school professors (since some pathbreaking work out by Raymond Vernon and others at the Harvard Business School in the 1960s and 1970s) --- on the overall causes and repercussions of such “multi-level” production chains globally. Even Krugman’s original work on geography and trade doesn’t deal with it in depth.

*The trade effects that ensued from the rapid growth of standardized manufacturing in Pacific Asia and parts of Latin America. Compounded, obviously, by the use of neo-mercantile efforts by China --- and earlier, until the late 1980s by Japan and others in East Asia --- to keep their currencies from appreciating against the $US and later the Euro. To note this is not to deny that there has been a lot of controversy on this topic, including the growing dependence of the US economy on capital inflows from abroad . . . along with a cost/benefit analysis of the outcomes.

*And finally, connected with these, the growing importance in the US economy of high-tech service industries, not least financial. Along with the shift of standardized manufacturing to developing countries --- including the use of China’s disciplined, moderately skilled work force for assembly production and exports --- the US pioneer role in creating a knowledge-based economy has, for good or bad, shifted our comparative advantage toward both high-tech services and capital-goods manufactures.

----- A little tantalizing evidence follows here. According to a good study put out last year by Robert Gordon of Northwestern and a British colleague on the slowdown in the EU’s productivity growth after 1995 compared to the US’s --- but, oppositely, a better performance by the EU in creating jobs ---,

“We find that the revival of European employment growth can help explain why European productivity slowed. But we do not explain why European productivity growth did not accelerate as occurred in the US. US productivity took off after 1995, growing at 0.7 percent faster per year, but in Europe a literal reading of the productivity growth data leads to doubt that the internet revolution ever occurred in Europe.

“Some of Europe’s poor recent performance can be explained by reforms that will enhance growth in the long run, but not all of it. Our findings should lead EU policymakers to think about the two-edged effects of policy reforms on employment and productivity, but they should also worry about how to encourage innovation and the adoption of new technologies.1”
Source: Click here.

………

Michael Gordon, AKA the buggy professor
 

Posted by: the buggy professor | Link to comment | April 20, 2009 at 05:57 PM

Patricia Shannon says...

According to libertarians, we don't need regulation of things like food safety. Industries will self-regulate. And they will still preach this even during well-publicized recalls of food contaminated by Salmonella, that was sold knowing it was contaminated. Totally idiotic.

Posted by: Patricia Shannon | Link to comment | April 20, 2009 at 06:41 PM

ken melvin says...

Buggy:

Even if your $66k/37k is correct, I don’t believe that it is, this leaves only ~ $23kper, down a bit from your $37, to the work force.

There’s a real question about what should constitutes GDP. If production of goods is only some 12-13%, what the hell is that we’re producing? And, who’s getting paid for it?

Tell us more about this $1.6 trillion worth of manufactured; like the worth part and who bought. Double a decade earlier, you say. What was it that we were manufacturing in 1997 that was so different from what we were manufacturing in 2007?

Driving down Wycliff or East 14th, all one sees is deserted, bombed out hulls of factories, even those we automated in the 80s are gone, so where is this manufacturing taking place. Genentech makes cancer drugs that cost $6k a month; this what you have in mind? The Immunex for arthritis which cost $1.3k a month? Those who held stock options who work there or had stock options did well. Hard to afford these on $23k per. And, it makes insurance and Medicare very expensive.

You real sure about all this investment in plant and equipment in 2007? News to me. And, a few examples please of the capital goods that can’t be manufactured overseas?

Posted by: ken melvin | Link to comment | April 20, 2009 at 09:39 PM

Lafayette says...

Internet shminternet

bp: Has manufacturing industry actually declined? Yes and no. It depends on the measure used.

Yes, I used GDP accounts that show, in the US, that Services account for nearly 70% of economic activity.

Do you know a better method? Pray, show us the way ...

So you think that exports are our salvation? No way, José. Exports are typically less than 10% of GDP.

US productivity took off after 1995, growing at 0.7 percent faster per year, but in Europe a literal reading of the productivity growth data leads to doubt that the internet revolution ever occurred in Europe.

Internet shminternet. It happened here and typically in a better way than stateside. I know no one in France still on dial-up, whereas in the US their numbers are so large that Obama is focusing stimulation money on the problem. (I have friends in central Massachusetts, thirty minutes from Boston's "Silicon Valley" along (old) Route 128 still on dial-up.)

Besides, productivity is, I maintain, intrinsically a matter of hours worked, not Internet penetration. The French were particularly idiotic in forcing the 35-hour week on French industry, and is now paying the consequences of that Socialist stupidity. Everywhere, EU leadership is trying desperately to convince national populations that the "good times" are over and they must get back to work.

But, that is difficult in countries that have become inured to working too hard. See here. Look at the tail-end of countries to the left of that graphic -- all EU ...

It's Europe's version of: "We have met the enemy and he is us."(Pogo by Walt Kelly)
 

Posted by: Lafayette | Link to comment | April 20, 2009 at 11:44 PM

Lafayette says...

When pigs sprout wings

hari: From what I am reading, it seems IMF will not *advise* any more but *manage* global economy from now on....

Oh, come on, "manage" the Global Economy? With what tools? This will happen when pigs sprout wings.

The above sounds like a pompous announcement from Strauss-Kahn, its pompous French Director, who as Minister of Finance in France did f***-all to redress the French economy. And, now he is moving on to manage the global economy? Everybody take cover ... --

Strauss-Kahn is preparing himself for a return to France (according to the buzz at the IMF) as a presidential candidate in 2011. It's written on everything he does.

Frankly, I hope he does run. He ran two years ago ... and came in third as Socialist candidate behind Segolen Royal whom Sarkozy defeated.

But, I cannot abide the notion that Strauss-Kahn, or the IMF, should be managing the Global Economy. The IMF's track record in the matter has been abysmal and the global economy does not need a statist at its helm.
 

Posted by: Lafayette | Link to comment | April 21, 2009 at 01:27 AM

Lafayette says...

Post Scriptum

The make-up of a political class often affects remarkably the destiny of a country. Of course, if one likes, it is perhaps an “exogenous variable”. I doubt that any democracy elects its leaders solely based upon professional background. There are too many other important variables that enter into an election, not the least of which is how we part our hair. (;^)

France is perhaps an exception to that rule, however. As I've opined here before, France must confront the fact its political class is dominated by people who graduated from one university, the Ecole Nationale d'Administration (ENA). They are known as ENArques and have established a crony corporation within French politics. If interested, read here.

John Kenneth Galbraith was fascinated enough to study the school and how it trained France's top Civil Servants. It is indeed impressive. The selection is stringent and, in fact, these people all come from the same social class (and a finite number of French secondary schools). They are by no means, therefore, representative of the French society as a whole.

Unfortunately, under socialist rule, far too many went from the Civil Service to state owned companies, such as Airbus -- where a number of them have had disastrous careers as industrial managers.

It is a popular (mis)conception in France that to become President, one must be either an ENArque or a Freemason and preferably both. An example of how it works: Jacques Chirac, an ENArque promoted another ENArque as his last Prime Minister -- though the man never had been elected to any political office in his life. It was a desperate attempt to block the ascent of Sarkozy, in view of upcoming presidential elections, since both Chirac and Sarkozy have little common friendship though they are both on the Right. (Such is typical of politics around the world, but particularly an attribute of French politics. Methinks.)

Sarkozy (current President of France) was a lawyer by training but Strauss-Kahn is indeed an ENArque. The ENArques can screw-up a free lunch and still find time to blame someone else. By then, however, they are well-ensconced in another job somewhere in the administrative hierarchy.

To wit, I would not want this gentleman "managing the Global Economy" as a promotional run-up to his candidacy as French president. Despite the fact that he is, otherwise, an intelligent person, I doubt that any present-day Socialist could find the exit from within a wet paper-bag, as regards the economy. They have not yet understood a fundamental principle of Political Economy: For the wealth of a nation (or nations) to be shared equitably, it must first be generated. Therein lies the challenge as "Tax and spend" is the easy part.

That simple rule somehow amazingly escapes the Leftist-species of politician and not only in France.

My point: The make-up of a political class often defines the destiny of a country. Their educational backgrounds are indeed important, I find. With this in mind, have a look here
to understand our own political class in the US.

It should surprise no one that the largest contingent is lawyers. Perhaps they are instinctively drawn to politics? Still, it is impressive to see that about 8% are economists!

Wherever are they ... ?
 

Posted by: Lafayette | Link to comment | April 21, 2009 at 01:43 AM

hari says...

Marquis -

You are indeed ranting like hell....

The substance of what I posted did not get into to clever head - for some good reason methinks - because DSK is not your *type* of leader required by IMF

However I'd like to admonish(!) you and the likes of you to consider that G20 Summit decided to inject +$1T
into IMF coffers for a good reason. China and Brazil are funding it - besides G7.

IMF is going to *manage* global financial regulatory platform along with (BIS) Stability Board created by G20. This will be decided during the weekend session of G7 and then G20.

France is a great civilization - notwithstanding your rant about DSK and the rest of the political class.
 

Posted by: hari | Link to comment | April 21, 2009 at 03:04 AM

save_the_rustbelt says...

buggy:

I am aware of all of that.

The lost manufacturing jobs were supposed to be replaced with "high value service jobs." Oops.

Apparently those service jobs consisted largely of originating subprime mortgages and working at Wal-mart.

And much of the construction industry has been turned over to undocumented workers (avoids all that messy stuff like taxes, OSHA, workers comp, etc.).

Blue collar America bleeds so professors and investment bankers can be comfortable.

Posted by: save_the_rustbelt | Link to comment | April 21, 2009 at 05:35 AM

LeeAnne says...

All this gentlemanly talk is pay for bloviating.

"... Because policy had improved, and because we believed the economy was more stable due to deregulation, we let our guard down."

How about that a tsunami of cash to lobby congresspersons to the tune of the $5,000,000,000, the largest percentage of it from the finance sector, combined with collusion in high places PAID to let your guard down.

Sounds more like payoffs to me albeit legal payoffs.

Posted by: LeeAnne | Link to comment | April 21, 2009 at 06:45 AM

Patricia Shannon says...

Lafayette,
This is 2009. Why should we need to work more hours than hunter-gatherers? Where is that productivity people keep talking about going? You may be content to be a piece of machinery to enable the top 1/2 of 1% to live in extreme luxury and decadence, but not all of us are. Some of us actually have our own lives and interests.

Posted by: Patricia Shannon | Link to comment | April 21, 2009 at 08:56 AM

K Ackermann says...

This whole blog war thread is entirely unsatisfying. You guys talk in sweeping generalities that you know will never happen, but on instnaces where you get specific, you are just nibbling at the edges. I get the feeling you want everything to continue the same, but without the problems.

Is it possible the system as a whole is the problem?

The financial system is set up to serve itself, and hence, siphons away wealth from its clients.

You disagree? Then why does the industry spend gobs of money to prevent legislation to disclose the details of fees associated with 401k's? That is just one small example.

The banks wanted deregulation because they said they could manage risk better than anyone. It turns out they are self-serving liars suffering from habitual greed.

Google "Citi Fined", and tell me that Citi is not a major criminal organization. The most crime-infested place on the planet is Wall Street. That's just a fact.

Harry Markopolos spent 7 years pounding on the fortress gates of the SEC to let him in so he could warn about fraud, but they kept telling him to go away.

With that kind of attitude, I am now of the opinion that those on Wall Street who commit crime should pay the ultimate price. Nothing else works, and they are literally doing more damage to this country than all the terrorist acts you could dream up would do.

The system will change. How many bullets will be needed is up to the industry.
 

Posted by: K Ackermann | Link to comment | April 21, 2009 at 09:16 AM

YerMawm says...

More regs...you mean like SOx? That sure did the trick. Laws ONLY keep the honest people honest. Financials among the most regulated industries. Most of this current mess would be solved by growing balls, and prosecute under existing fraud laws.

In fact, as long as there is a Federal Reserve Board, a private banking cartel engaged in the price fixing of money, and theft via inflation targets, there is regulation.

Suggest more concrete examples from history rather than generalizing the 1800's and 1900's as the financial wild west. Some periods during the 1800's were indeed our most prosperous, stable, and productive. We haven't even begun to see instability yet. During TGD many people still lived on farms, and grew their own food. A lesson we need to relearn...NOW.

Posted by: YerMawm | Link to comment | April 21, 2009 at 09:25 AM

Lafayette says...

hari: However I'd like to admonish(!) you and the likes of you to consider that G20 Summit decided to inject +$1T ...

Admonish away! ;^) Sticks and stones ... etc., etc., etc.

1 trillion dollars is to managing world trade as my pissing in the ocean is to desalinating it. The key word is manage, meaning being responsible for exchange rate variations and international transactions (of all sorts).

That can only be done with a UN-type Federated Reserve System and signatories to a Treaty that allows that agency to employ its own reserve currency. It just ain't gonna happen. That sort of treaty will never, ever get passed in the US Senate.

We've been down this road before and I insist on the following: There is meaningful regulation on the national level because banks are regulated by national legislation. There is NO international law (meaning a binding treaty) in the matter of regulating international finance and there never will be. As such, there is no way to "regulate" it.

All that the IMF can do is blow a whistle. Given the scare the Great SubPrime Mess of 2008 has created, that alone may be sufficient to focus attention and get action. Which is goodness.

And about Basel; I think (quite personally) that it is a fine idea. It is an established agreement, but without the force of a treaty. (As I recall, we exchanged on that idea some months ago.) BaselII needs to be tightened down because it proposes using bank-developed business models to regulate financial banking. That just ain't gonna work either.

If Basel2 is to be taken seriously, it must be truly independent in all ways and means from the market agents it is supervising. But, coming up with new models is not Mission Impossible.

Methinks.

Posted by: Lafayette | Link to comment | April 21, 2009 at 10:28 AM

hari says...

What you don't seem to understand is while G20 was Brown's forum to reform Bretton Woods institutions, IMF actually came out stronger because the Chinese felt they were prepared to sleep with the devil they knew...(you know the rest).

That's how G20 decided to inject seed capital to reform IMF itself. [DSK will be a transition man until these changes, in fact, take place].

The other aspect is international trade finance facility - a separate matter altogether.

The q' is if you are going to reform the (existing) structure of IMF, what will become of the hitherto role of US Treasury (the paymaster since WWII) in framework of IMF policy decision-making.

IMO the OECD block, and G7, have made the compelling decision to liberate IMF from their voting majority and to forego IMF Chair by EU to emerging markets.

Who will lead the new IMF set up? Most likley Indians seem to have inside track to management seat because of their professional and other qualifications.

China will more likely takeover WB and its operations.

In sum, we're at a turning point in managing global financial system in a period of globalization.

Posted by: hari | Link to comment | April 21, 2009 at 11:58 AM

Lafayette says...

A matter of values

PS: You may be content to be a piece of machinery to enable the top 1/2 of 1% to live in extreme luxury and decadence, but not all of us are. Some of us actually have our own lives and interests.

I don't decry the French for their way of life. I do for their way of work. And it is the latter that makes for the former.

If I thought the standard of living was better in the US, I'd be a fool to remain in France. So, call me a fool, but I do believe the standard of living in a great many ways is better in France.

That said, I have worked both in the US and in France. We work harder in the US. Tis a pity perhaps that we don't enjoy life better.

But, then, who am I to judge? Maybe Americans enjoy life by working hard. No joke. It could be very true. Cultural diversity is a matter of values. If Americans value work over leisure, they are simply exercising their freedom of choice.

Posted by: Lafayette | Link to comment | April 21, 2009 at 12:06 PM

Phillip Huggan says...

http://en.wikipedia.org/wiki/Human_Development_Index

"So, call me a fool, but I do believe the standard of living in a great many ways is better in France."

The world is waiting for you to improve this methodology. Nepal would literally take your words as policy if accurate. Psychologically and physiologically any policy that gets people in wealthy developed countries their first $10000 in income is a winner and there are no doubt more of these policies in France than in America. I know first-hand America is hostile to foreigners as of 2004. I'm sure I could visit France no problem.

Posted by: Phillip Huggan | Link to comment | April 21, 2009 at 12:38 PM

the buggy professor says...

1) US Exports, by percentage for 2003 --- the latest data, strangely, at the CIA WorldFactBook (imports the same year too)

https://www.cia.gov/library/publications/the-world-factbook/geos/us.html#Econ

"agricultural products (soybeans, fruit, corn) 9.2%, industrial supplies (organic chemicals) 26.8%, capital goods (transistors, aircraft, motor vehicle parts, computers, telecommunications equipment) 49.0%, consumer goods (automobiles, medicines) 15.0% (2003)"

......

2) All these industries --- including US agriculture --- are high-tech ones, depending for their productivity growth on large levels of R&D, well-educated engineers, technicians, and other workers, and continued high levels of investment. In pharmaceuticals, as I remember from a Congresional study I looked at about four years ago, the US has 80-85% of the world market.

Some of the standardized processes --- such as assembling cell-phones --- have been transferred to countries like China.

That's common for virtually all Chinese exported manufacturing goods: about 60-65% of the content used, including built-in technology, belong to the multinational firms implanted there. (The technical term for this is "pass-through" value. Again, when dealing with Chinese official data, these are estimates by specialists . . . a problem compounded by proprietary data of the firms.)

....

An example, to stay with cell phones.

The key technologies are patented to Qualcomm and Broadcomm, with Qualcomm suing just about every cell-phone producer in the world for violating its patents. It sued Nokia, which was already paying a fee to Qualcomm, for patent-violations in 2007 . . . only for the case to be sent to arbitration, and an eventual agreement last year in which Nokia agreed to pay $1 billion in past patent violations . . . as well as to work cordially in a new licensing agreement with Qualcomm.

That was the case with Ericsson in Sweden earlier in the decade (before it merged with Sony), and with Japanese producers.

On the other hand, Broadcomm won a suit against Qualcomm, though I forget who was suing who.

....

As for airplane (civilian) production, Japan tried for two decades starting in the 1980s to build a competitive industry, and failed. Eurobus, a consortium, has done much better . . . with benefits to flying passengers world-wide. It has, though, stuck itself with a huge white-elephant in its new giant transport that can carry up to 700 or more passengers; is very fuel inefficient; and way behind schedule . . . with the partner governments bickering over how to handle the financial losses to date, and cut jobs.

....

Hope this gives you some working idea anyway.

Thanks for the query.

Michael, the buggy professor

 

......

2)

Posted by: the buggy professor | Link to comment | April 21, 2009 at 12:43 PM

the buggy professor says...

KeN:

Just noticed. There are two versions of the CIA Worldfactbook, and the figures above are from the text version . . . which groups exports by percentages slightly more coherently than the other version. Can't say why.

Click here

Buggy

Posted by: the buggy professor | Link to comment | April 21, 2009 at 12:48 PM

Cynthia says...

Lafayatte,

Paul Krugman and Dean Baker both point out that there's been a lot of phoniness in the America's productivity numbers, mainly due to all the phoniness in our financials. So if this is true, it can be safely (and sadly) said that over the past several decades or so Americans have been spinning their wheels big time while keeping their noses firmly to the grindstone.

http://krugman.blogs.nytimes.com/2009/04/16/reconsidering-a-miracle/

Posted by: Cynthia | Link to comment | April 21, 2009 at 01:58 PM

ken melvin says...

Buggy 4/22:
My point being that in this the time of Cherry Blossom Festivals there was some cherry picking going on:
E.g.:
2) If jobs are the measure, then yes --- the percentage of the US workforce in manufacturing declined from about 35% in the early 1970s to around 12% in 2004.
----The per cent decline is: 23/35 = 66%, the number of jobs some .23 x 140million ~ 32million jobs.
4) If the measure, though, is the dollar value of manufacturing output, it was at an all-time peak in 2006-07 at over $1.6 trillion . . . almost double the output a decade ago. According to Business Week yesterday,
----St. Louis Fed: http://research.stlouisfed.org/fred2/series/IPMAN shows a bit story - tremendous increase from 1990 to 2000, 2001 dip and an increase from 2001 to 2007 albeit at a much rate than from 1990 to 2000. I can find no evidence of the ‘doubling’ over the decade; in fact, the Chicago Fed: http://www.chicagofed.org/economic_research_and_data/cfmmi_data_series.cfm shows a -97 index of 99.0 and a 2007 index of 106.7 (presently: it’s about 83.8%).

5) If the measure is investment levels, note the astonishing pace in 2007 for US manufacturing (same Business Week source)
“Not only is the U.S. still the world's leading manufacturer, but there are many good reasons that companies will continue to manufacture here and invest in new plants and equipment. According to the Census Bureau's 2007 Annual Capital Expenditures Survey, released on Jan. 22 of this year, U.S. nonfarm businesses invested $1.36 trillion in new and used structures and equipment in 2007, a 3.9 percent increase over 2006. More than $484 billion was spent on new structures alone.”
---My read: Before 2000, manufacturing investment lead finance by ~ 2 to 1, by 2007, the ratio was almost 1 to 1, equipment to structure is trending from 2 to 1 to ~ 8/5, and, it was 2005 before investment got back to 2000 level.

6) Enter manufacturing exports.
And US export-manufactures were at an all-time peak in total value in 2007 as well. Note that they are heavily concentrated in capital goods, which in turn depend markedly on R&D, innovation (process or radical product), good marketing, and highly skilled labor . . . not to mention constant investment.. There is no reason to assume that such capital goods production will be easily transferred abroad, the way more standardized consumer-products have been.
---Everything’s up to all nations, I’m guessing dollar: http://tse.export.gov/MapFrameset.aspx?MapPage=NTDMapDisplay.aspx&UniqueURL=ng1wed45cg0p2jfwi3xqo055-2009-4-22-8-2-13

 

7) If the measure is the wage (plus benefits) of workers in manufacturing industry, it was almost double in inflation-adjusted terms last year compared to the early 1970s, when the industrial work force was three times larger as a percentage of total employment: about $66,000 vs. $37,000.
---If? No indication that there is any basis for this assertion that I can find or have heard of.

links for 2009-04-22

• How economics lost sight of real world - FT
• Bank tests we should get stressed about - FT
• IMF estimates necessary global write-downs: $4.1 trillion - FP Passport
• For Housing Crisis, the End Probably Isn’t Near - NYTimes.com
• Water wars - Jeffrey D. Sachs
• How house-hunting ants choose the best home - EurekAlert
• Geithner fails to impress - How the World Works
• A flawed first draft of history - FT
• Are Fiscal Stimulus Funds Going to the 'Right' States? - FRBSF
• Why the ‘green shoots’ of recovery could yet wither - FT
• A necessary amendment to the CAP: Insurance, not capital - voxeu.org
• In Adopting Harsh Tactics, No Inquiry Into Their Past Use - NYTimes.com
• The Rule of Law - Matthew Yglesias
• Ireland? - Employment, Interest, and Money
• Reforming property rights and economic development - voxeu.org
• "The Effect of Prayer on God's Attitude Toward Mankind" - Andrew Gelman
• How to Avoid Overpaying for Toxic Assets - Real Time Economics - WSJ
• Larks, Owls and Hummingbirds (sleep cycles) - NYTimes.com

Sachs: Paying for Government's Expanded Economic Role

The Costs of Expanding the Government's Economic Role [Extended version], by Jeffrey D. Sachs, Scientific American: The 10-year budget framework that President Barack Obama released ... is as much a philosophy of government as a fiscal action plan. Gone is the Ronald Reagan view that “government is not a solution to our problem; government is the problem.” Obama rightly sees an expanded role for government in allocating society’s resources as vital to meeting the 21st century challenge of sustainable development. 

The scientific discipline known as public economics describes why government is needed alongside markets to allocate resources. These reasons include: the protection of the poor through a social safety net; the correction of externalities...; the provision of “merit goods” such as health care and education that society deems to be essential for all of its members; and the financing of scientific and technological research that cannot be efficiently captured by private investors. In all these circumstances, the free-market system tends to underprovide the resource in question...

Obama’s budget plan properly focuses on areas that public economics identifies as priorities and where the U.S. discernibly lags behind many parts of Europe: health..., education..., public infrastructure... and research and development... The emphasis is on public-private partnerships (PPP), combining public financing and private sector delivery. ...

Obama’s vision of an expanded federal role is on-target and transformative, but the financing will be tricky. This year’s deficit will reach an astounding $1.75 trillion, or 12 percent of GDP...

Obama’s budget plan aims to reduce the deficit to 3 percent of GNP by 2013, and to level off till 2019..., but ... that target will be very difficult to achieve and sustain as planned. ...[T]he plan is to cut the deficit mainly through higher taxes on the rich, reduced military outlays for Iraq and Afghanistan, new revenues from auctioning carbon-emission permits and, finally, a squeeze on non-defense discretionary spending... Such a squeeze on non-defense spending seems unlikely—and indeed undesirable—at a time when government is launching several much-needed programs in education, health, energy and infrastructure.

The truth is that the U.S. ... will probably have to raise new revenues ... to carry out its vital roles in protecting the poor, promoting health and education and building a modern infrastructure with ... sustainable technology. Ending the Bush-era tax cuts on the rich certainly is merited, but further taxing the rich much beyond that will come up against political and practical limits. Within a few years, we’ll probably see the need for new broader-based taxes, perhaps a national sales or value-added tax such as those widely used in other high-income countries. If we continue to assume that we can have the expanded government that we need but without the tax revenues to pay for it, the unacceptable build-up of public debt will threaten the well-being of our children and our children’s children. ...

I doubt will see any major changes in the tax structure anytime soon, but if we do, value added taxes are regressive, but in countries where they are used, they're an important source of revenue for highly progressive tax-and-transfer systems (but not without problems). So the characteristic of these taxes overall depends upon their implementation, i.e. how the extra revenue from the tax is used.

Posted by Mark Thoma on Wednesday, April 22, 2009 at 12:33 AM in Economics, Market Failure, Taxes 

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links for 2009-04-22

• How economics lost sight of real world - FT
• Bank tests we should get stressed about - FT
• IMF estimates necessary global write-downs: $4.1 trillion - FP Passport
• For Housing Crisis, the End Probably Isn’t Near - NYTimes.com
• Water wars - Jeffrey D. Sachs
• How house-hunting ants choose the best home - EurekAlert
• Geithner fails to impress - How the World Works
• A flawed first draft of history - FT
• Are Fiscal Stimulus Funds Going to the 'Right' States? - FRBSF
• Why the ‘green shoots’ of recovery could yet wither - FT
• A necessary amendment to the CAP: Insurance, not capital - voxeu.org
• In Adopting Harsh Tactics, No Inquiry Into Their Past Use - NYTimes.com
• The Rule of Law - Matthew Yglesias
• Ireland? - Employment, Interest, and Money
• Reforming property rights and economic development - voxeu.org
• "The Effect of Prayer on God's Attitude Toward Mankind" - Andrew Gelman
• How to Avoid Overpaying for Toxic Assets - Real Time Economics - WSJ
• Larks, Owls and Hummingbirds (sleep cycles) - NYTimes.com

Posted by Mark Thoma on Wednesday, April 22, 2009 at 12:06 AM in Economics, Links 

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[April 21, 2009] "The Professionals are not being Held Accountable"

The crisis: holding the professionals to account, by Michael Pomerleano, Economists' Forum: My education (Harvard Business School and economics department) and professional experience prime me to advocate finance’s role in the growth of economies. ... However, the conduct of professionals in the financial crisis leads me to reassess these beliefs. ...

In this context,... the professionals are not being held accountable. As Viral V. Acharya and Rangarajan Sundaram point out: “The US recapitalization scheme ... is ... generous to the banks in that it imposes little direct discipline in the form of replacement of top management or curbs on executive pay, and secures no voting rights for the government“.

We seem to forget one of the successful lessons from the late 1980s savings and loan crisis in structuring positive and negative incentives: holding accountable the directors and officers, lawyers, accountants of the banks, investment banks and the rating agencies. ... The Office of Thrift Supervision, which regulates the US’s thrifts, and its sister agency, the Resolution Trust Corp which was in charge of disposing of the assets of failed S&Ls, embarked on a deliberate deterrence strategy targeting lawyers, accountants, directors and officers of failed thrifts that aided and abetted the excesses leading to the S&L crisis. The intent was to discourage futures abuses and recover some of the lost taxpayer funds. ...

In the US, we are told that there are no culprits in the crisis. The attitude of the policy makers, regulators, bankers and traders involved in the crisis is virtually fatalistic, treating the crisis as an inevitable “force majeure”. All of them were observers and “no one saw it coming”. In short, the crisis is a Lemony Snicket’s “Series of Unfortunate Events”.

In reality the regulators that should have kept a close eye on the rapid growth of the shadow banking system were complacent, and the boards did not have the background in the industry and didn’t understand the risks. It is clear that the policy makers and regulators lack the moral authority to lead us out of the crisis. ...

The US Treasury plans to rely on the same firms and people that were involved in leading to the crisis to get us out of it. ... Clearly, nothing learned, nothing gained from the S&L crisis or the Swedish experience. Maybe this will change.

Saying it's not your fault you crashed the ship into the rock because the rock was underwater and hidden - nobody could have seen it coming - loses its force when you are navigating in waters that are known to be rocky. Even if you have the latest sonar based upon fancy, innovative math that is supposed to detect the rock before you hit it, and even if regulators were supposed to clearly map and mark all danger, if you hit it anyway, there's a reason why captains are expected to go down with - or at best be the last ones off - the ship. It ensures they'll do all they can to avoid hitting it in the first place.

Posted by Mark Thoma on Tuesday, April 21, 2009 at 06:57 PM in Economics, Financial System, Regulation 

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"A Crisis of Ethic Proportions"

John Bogle says "self-interest got out of hand":

A Crisis of Ethic Proportions, by John Bogle, Commentary, WSJ: I recently received a letter from a Vanguard shareholder who described the global financial crisis as "a crisis of ethic proportions." Substituting "ethic" for "epic" is a fine turn of phrase, and it accurately places a heavy responsibility for the meltdown on a broad deterioration in traditional ethical standards. ... Relying on [the] "invisible hand," through which our self-interest advances the interests of society, we have depended on the marketplace and competition to create prosperity and well-being.

But self-interest got out of hand. ... Dollars became the coin of the new realm. Unchecked market forces overwhelmed traditional standards of professional conduct, developed over centuries. ... We've moved from a society in which "there are some things that one simply does not do" to one in which "if everyone else is doing it, I can too." Business ethics and professional standards were lost in the shuffle. ... The old notion of trusting and being trusted ... came to be seen as a quaint relic of an era long gone.

The proximate causes of the crisis are usually said to be easy credit, bankers' cavalier attitudes toward risk, "securitization"..., the extraordinary leverage built into the financial system by complex derivatives, and the failure of our regulators to do their job.

But the larger cause was our failure to recognize the sea change in the nature of capitalism that was occurring right before our eyes. That change was the growth of giant business corporations and giant financial institutions controlled not by their owners in the "ownership society" of yore, but by agents of the owners, which created an "agency society."

The managers of our public corporations came to place their interests ahead of the interests of their company's owners. ... The malfeasance and misjudgments by our corporate, financial and government leaders, declining ethical standards, and the failure of our new agency society reflect a failure of capitalism. ...

What's to be done? We must work to establish a "fiduciary society," where manager/agents entrusted with managing other people's money are required -- by federal statute -- to place front and center the interests of the owners they are duty-bound to serve. The focus needs to be on long-term investment (rather than short-term speculation), appropriate due diligence in security selection, and ensuring that corporations are run in the interest of their owners. ... Making that happen will be no easy task.

Rules will never cover everything, so ethics is part of the problem. But the solution to the agency problem has to come in large part from changing incentives so that the self-interest of the managers coincides with the interests of the people they represent. [Kahneman also talks about agency problems in a section I left out of the next post.]

Posted by Mark Thoma on Tuesday, April 21, 2009 at 01:24 AM in Economics, Market Failure 

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"There were Exactly Five People Who Foresaw This Crisis"

Irrational everything, by Guy Rolnik, Haaretz: Prof. Daniel Kahneman has dozens, perhaps hundreds, of stories about people's irrational behavior when it comes to making economic decisions. ... But the story Kahneman recalls when asked about the economic models at the root of the current financial crisis is actually taken from history, not an experiment. It concerns a group of Swiss soldiers who set out on a long navigation exercise in the Alps. The weather was severe and they got lost. After several days, with their desperation mounting, one of the men suddenly realized he had a map of the region.

They followed the map and managed to reach a town. When they returned to base and their commanding officer asked how they had made their way back, they replied, "We suddenly found a map." The officer looked at the map and said, "You found a map, all right, but it's not of the Alps, it's of the Pyrenees."

According to Kahneman, the moral of the story is that some of our economic models, perhaps those of the investment world, are worthless. But individual investors need security - maps of the Pyrenees - even if they are, in effect, worthless. ...

"In the last half year, the models simply didn't work. So the question arises: Why do people use models? I liken what is happening now to a system that forecasts the weather, and does so very well. People know when to take an umbrella when they leave the house, or when it will snow. Except what? The system can't predict hurricanes. Do we use the system anyway, or throw it out? It turns out they'll use it."

Okay, so they use it. But why don't they buy hurricane insurance?

"The question is, how much will the hurricane insurance cost? Since you can't predict these events, you would have to take out insurance against many things. If they had listened to all the warnings and tried to prevent these things, the economy would look a lot different than it does now. So an interesting question arises: After this crisis, will we arrive at something like that? It's hard for me to believe."

The financial world's models are built on the assumption that investors are rational. You have shown that not only are they not rational, they even deviate from what is rational or statistical, in predictable, systematic ways. Can we say that whoever recognized and accepted these deviations could have seen this crisis coming?

"It was possible to foresee, and some people did. ... I have a colleague at Princeton who says there were exactly five people who foresaw this crisis, and this does not include ... Ben Bernanke. One of them is Prof. Robert Shiller, who also predicted the previous bubble. The problem is there were other economists who predicted this crisis, like Nouriel Roubini, but he also predicted some crises that never came to be."

He was one of those who predicted 10 crises out of three.

"Ten out of three is a pretty good record, relatively. But I conclude from the fact that only five people predicted the current crisis that it was impossible to predict it. In hindsight, it all seems obvious: Everyone seemed to be blind, only these five appeared to be smart. But there were a lot of smart people who looked at the situation and knew all the facts, and they did not predict the crisis." ...

The interesting psychological problem is why economists believe in their theory, but this is the problem with the theory, any theory. It leads to a certain blindness. It's difficult to see anything that deviates from it."

We only look for information that supports the theory and ignore the rest. "Correct..." ...

Let's end with your story of the Swiss soldiers and the map of the Pyrenees. I know why the map helped the soldiers: it gave them confidence. But why didn't they use a map of the Alps? Why don't we use the right economic models, ones that are relevant to extreme cases as well?

"Look, it's possible that there simply is no map of the Alps, that there is nothing that can predict hurricanes."

[full interview]

Posted by Mark Thoma on Tuesday, April 21, 2009 at 01:24 AM in Economics, Methodology 

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Policy and Uncertainty

What Baseball Can Teach Policymakers, by Robert Stavins: ...Uncertainty is an absolutely fundamental aspect of environmental problems and the policies that are employed to address those problems. Any analysis that fails to recognize this runs the risk not only of being incomplete, but misleading as well. ...

To estimate proposed regulations’ benefits and costs, analysts frequently rely on inputs that are uncertain – sometimes substantially so. Such uncertainties in underlying inputs are propagated through analyses, leading to uncertainty in ultimate benefit and cost estimates...

Despite this uncertainty, the most prominently displayed results ... are typically single, apparently precise point estimates of benefits, costs, and net benefits (benefits minus costs), masking uncertainties inherent in their calculation and possibly obscuring tradeoffs among competing policy options. Historically, efforts to address uncertainty ... have been very limited...

Over the years, formal quantitative uncertainty assessments — known as Monte Carlo analyses — have become common in a variety of fields, including engineering, finance, and a number of scientific disciplines...

The first step in a Monte Carlo analysis involves the development of probability distributions of uncertain inputs to an analysis. These probability distributions reflect the implications of uncertainty regarding an input for the range of its possible values and the likelihood that each value is the true value. Once probability distributions of inputs to a benefit‑cost analysis are established, a Monte Carlo analysis is used to simulate the probability distribution of the regulation’s net benefits by carrying out the calculation of benefits and costs thousands, or even millions, of times. With each iteration of the calculations, new values are randomly drawn from each input’s probability distribution and used in the benefit and/or cost calculations. ... Importantly, any correlations among individual items in the benefit and cost calculations are taken into account. The resulting set of net benefit estimates characterizes the complete probability distribution of net benefits.

Uncertainty is inevitable in estimates of environmental regulations’ economic impacts, and assessments of the extent and nature of such uncertainty provides important information for policymakers evaluating proposed regulations. Such information offers a context for interpreting benefit and cost estimates, and can lead to point estimates of regulations= benefits and costs that differ from what would be produced by purely deterministic analyses (that ignore uncertainty). In addition, these assessments can help establish priorities for research.

Due to the complexity of interactions among uncertainties in inputs..., an accurate assessment of uncertainty can be gained only through the use of formal quantitative methods, such as Monte Carlo analysis. Although these methods can offer significant insights, they require only limited additional effort... Much of the data required for these analyses are already obtained...; and widely available software allows the execution of Monte Carlo analysis in common spreadsheet programs on a desktop computer. ...

Formal quantitative assessments of uncertainty can mark a truly significant step forward in enhancing regulatory analysis... They have the potential to improve substantially our understanding of the impact of environmental regulations, and thereby to lead to more informed policymaking.

Macroeconomic policy uses the same type of framework for looking at uncertainty, but with additional twists, the addition of model uncertainty, and the addition of parameter uncertainty within a given model. The steps above are carried out over a variety of different policies, models, and a distribution of parameter values, and the goal is to find the most likely outcomes as well as the distribution of outcomes for each policy. The monetary and fiscal authorities then choose policies that, for example, avoid the chance that the policies will backfire and cause severe problems. But if the true model (or a close approximation to it) is not well represented by the models used in the uncertainty analysis, big policy errors are still possible. That's something we tend to forget when we do these types of analyses characterizing the degree of uncertainty that we face.

Posted by Mark Thoma on Tuesday, April 21, 2009 at 12:24 AM in Economics, Environment, Policy 

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links for 2009-04-21

• Business needs to speak out against greed - FT
• Believing in Fiscal Stimulus 2 - MacroMania
• One Bid to Organize Nurses Faces Setback in Congress - NYTimes.com
• The Banks - Something Doesn't Add Up - No Empty Wallets
• How to pay for inequality reduction: follow-up - Consider the Evidence
• Financial turbulence and early crisis detection - voxeu.org

Posted by Mark Thoma on Tuesday, April 21, 2009 at 12:06 AM in Economics, Links 

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April 20, 2009 Solow: How to Understand the Disaster

How to Understand the Disaster, by Robert M. Solow, NY Review of Books: ...Judge Posner ... has an extraordinarily sharp mind... But I also have to say that, in some respects, his grasp of economic ideas is precarious. ...Posner has taught at the University of Chicago. Much of his thought exhibits an affinity to Chicago school economics: libertarian, monetarist, sensitive to even small matters of economic efficiency, dismissive of large matters of equity, and therefore protective of property rights even at the expense of larger and softer "human" rights.

But not this time, at least not at one central point, the main point of this book. ... The underlying argument—it is not novel but it is sound—goes something like this. A modern ... economy ... can probably adapt to minor shocks ... with just a little help from monetary policy and ... automatic fiscal stabilizers... It is easy to be lulled into the comfortable belief that the system can take care of itself if only do-gooders will leave it alone. But that same financial system has intrinsic characteristics that can make it self-destructively unstable when it meets a large shock. ...

In that kind of world, imagine a period of low interest rates. Once a set of profit opportunities is found, big operators will be tempted to borrow so that they can play with much more than their own capital, and thus make very large profits. This has come to be called "leverage." ...

In the past, 10-to-1 leverage would have been about par for a bank. More recently,... many large financial institutions ... reached for 30-to-1 leverage, sometimes even more. ... [I]t is leverage that turns large banks and financial institutions into ninepins that cannot fall without knocking down others that cannot fall without knocking down still others. That seems to be the key to the potential instability of an unregulated financial system. It happens without any of the private actors violating the canons of self-interested rationality. ...

It is a noteworthy intellectual event that Posner has come to this understanding and expressed it forcefully and fearlessly. This same understanding must ... be the key to designing regulations that can reduce the frequency of financial crises like the current one...

There are ... weaknesses in Posner's remarks... For example, more than once he says that the various antirecessionary measures—like fiscal stimulus, bailouts—are very "costly" and "may do long-term damage to the economy." He does not explain what these costs and damages are. Sometimes he seems to have budgetary costs in mind. But bailouts are mostly transfers from one group in society to another... They are certainly not ethically satisfying transfers, but it is not clear how they do long-term damage to the economy. The components of a fiscal stimulus package are costs to the federal budget; but to the extent that they put otherwise unemployed labor and idle industrial capacity to work, they do not impoverish the economy; in fact, they enrich it. ...

There is an even odder chapter called "A Silver Lining?" In it Posner flirts with the idea that a recession, even a depression, has a good side. It weeds out inefficient firms and practices. This is a little like saying that a plague is not all bad: it cleans up the gene pool. No doubt there is some truth to this idea of a purifying effect. But the notion that it could possibly compensate for years of lost output and lost jobs seems wholly implausible. There is certainly no calculation of economic costs and benefits behind the thought of a "silver lining." I think it is another example of overemphasis on minor gains in efficiency and neglect of first-order facts.

Posner's chapter on "The Way Forward" is all of sixteen pages long, and fairly disorganized... This means he does not seriously try to imagine ... an effective regulatory regime... It seems to me that effective limits on leverage ... are basic to controlling the potential instability of the financial system. ...

The financial system does have a useful social function to perform, and that is to make the real economy operate more efficiently. Some human institution has to collect a nation's savings and put them at the disposal of those who have productive ways to use them. Risks arise in the everyday business of economic life, and some human institution has to transfer them to those who are most willing to bear them. When it goes much beyond that, the financial system is likely to cause more trouble than it averts. I find it hard to believe ... that our overgrown, largely unregulated financial sector was actually fully engaged in improving the allocation of real economic resources. It was using modern financial technology to create fresh risks, to borrow more money, and to gamble it away....

Greed and foolhardiness were not invented just recently. The problem is rather that Panglossian ideas about "free markets" encouraged, on one hand, lax regulation, or no regulation, of a potentially unstable financial apparatus and, on the other, the elaboration of compensation mechanisms that positively encouraged risk-taking and short-term opportunism. When the environment was right, as it eventually would be, the disaster hit.

Posted by Mark Thoma on Monday, April 20, 2009 at 05:22 PM in Economics, Regulation 

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