Category Archives: Economics 101

Straight Talk on Trade. Ideas for a Sane World Economy – Dani Rodrik.

Are economists responsible for Donald Trump’s shocking victory in the US presidential election?

Adam Smith and David Ricardo would turn over in their graves if they read the details of, say, the Trans Pacific Partnership on intellectual property rules or investment regulations.

Economists’ failure to provide the full picture on trade, with all the necessary distinctions and caveats, has made it easier to tar trade, often wrongly, with all sorts of ill effects.

It is impossible to have hyperglobalization, democracy, and national sovereignty all at once; we can have at most two out of three.

We need to place the requirements of liberal democracy ahead of those of international trade and investment.

Globalization’s ills derive from the imbalance between the global nature of markets and the domestic nature of the rules that govern them.

Who needs the nation-state? We all do.

Nearly two decades ago, as my book Has Globalization Gone Too Far? went to press, I approached a well known economist to ask him if he would provide an endorsement for the back cover. I claimed in the book that, in the absence of a more concerted government response, too much globalization would deepen societal divisions, exacerbate distributional problems, and undermine domestic social bargains, arguments that have become conventional wisdom since.

The economist demurred. He didn’t really disagree with any of the analysis but worried that my book would provide “ammunition for the barbarians.” Protectionists would latch on to the book’s arguments about the downsides of globalization to provide cover for their narrow, selfish agenda.

It’s a reaction I still get from my fellow economists. One of them will hesitantly raise his hand following a talk and ask: Don’t you worry that your arguments will be abused and serve the demagogues and populists you are decrying?

There is always a risk that our arguments will be hijacked in the public debate by those with whom we disagree. But I have never understood why many economists believe this implies we should skew our argument about trade in one particular direction. The implicit premise seems to be that there are barbarians on only one side of the trade debate. Apparently, those who complain about World Trade Organization rules or trade agreements are dreadful protectionists, while those who support them are always on the side of the angels.

In truth, many trade enthusiasts are no less motivated by their own narrow, selfish agendas. Pharmaceutical firms pursuing tougher patent rules, banks pushing for unfettered access to foreign markets, or multinationals seeking special arbitration tribunals have no greater regard for the public interest than protectionists do. So when economists shade their arguments, they effectively favor one set of self-interested parties, “barbarians” over another.

It has long been an unspoken rule of public engagement for economists that they should champion trade and not dwell too much on the fine print. This has produced a curious situation. The standard models of trade with which economists work typically yield sharp distributional effects: income losses by certain groups of producers or workers are the flip side of the “gains from trade.” And economists have long known that market failures, including poorly functioning labor markets, credit market imperfections, knowledge or environmental externalities, and monopolies, can interfere with reaping those gains.

They have also known that the economic benefits of trade agreements that reach beyond borders to shape domestic regulations, as with the tightening of patent rules or the harmonization of health and safety requirements, are fundamentally ambiguous.

Nonetheless, economists can be counted on to parrot the wonders of comparative advantage and free trade whenever trade agreements come up. They have consistently minimized distributional concerns, even though it is now clear that the distributional impact of, say, the North American Free Trade Agreement or China’s entry into the World Trade Organization was significant for the most directly affected communities in the United States. They have overstated the magnitude of aggregate gains from trade deals, though such gains have been relatively small since at least the 1990s. They have endorsed the propaganda portraying today’s trade deals as “free trade agreements,” even though Adam Smith and David Ricardo would turn over in their graves if they read the details of, say, the Trans-Pacific Partnership on intellectual property rules or investment regulations.

This reluctance to be honest about trade has cost economists their credibility with the public. Worse still, it has fed their opponents’ narrative. Economists’ failure to provide the full picture on trade, with all the necessary distinctions and caveats, has made it easier to tar trade, often wrongly, with all sorts of ill effects.

For example, as much as trade may have contributed to rising inequality, it is only one factor contributing to that broad trend, and in all likelihood a relatively minor one, compared to technology. Had economists been more upfront about the downside of trade, they may have had greater credibility as honest brokers in this debate.

Similarly, we might have had a more informed public discussion about social dumping if economists had been willing to recognize that imports from countries where labor rights are not protected raise serious questions about distributive justice. It may have been possible then to distinguish cases where low wages in poor countries reflect low productivity from cases of genuine rights violations. And the bulk of trade that does not raise such concerns may have been better insulated from charges of “unfair trade.”

Likewise, if economists had listened to their critics who warned about currency manipulation, trade imbalances, and job losses, instead of sticking to models that assumed away unemployment and other macroeconomic problems, they might have been in a better position to counter excessive claims about the adverse impact of trade deals on employment.

In short, had economists gone public with the caveats, uncertainties, and skepticism of the seminar room, they might have become better defenders of the world economy. Unfortunately, their zeal to defend trade from its enemies has backfired. If the demagogues making nonsensical claims about trade are now getting a hearing, and actually winning power, it is trade’s academic boosters who deserve at least part of the blame.

This book is an attempt to set the record straight, and not just about trade, as the title suggests, but about several areas in which economists could have offered a more balanced, principled discussion. Though trade is a central aspect of those areas, and in large part emblematic of what’s happened in all of them, the same failures can be observed in policy discussions about financial globalization, the euro zone, or economic development strategies.

The book brings together much of my recent popular and nontechnical work on globalization, growth, democracy, politics, and the discipline of economics itself. The material that follows has been drawn from a variety of sources, my monthly syndicated columns for Project Syndicate as well as a few other short and lengthier pieces. In most cases, I have done only a light edit of the original text, updating it, providing connections with other parts of the book, and adding some references and supporting material. In places, I have rearranged the material from the original sources to provide a more seamless narrative. The full set of sources is listed at the back of the book.

The book shows how we could have constructed a more honest narrative on the world economy, one that would have prepared us for the eventual backlash and, perhaps, even rendered it less likely. It also suggests ideas for moving forward, to create better functioning national economies as well as a healthier globalization.

Chapter One

A Better Balance

The global trade regime has never been very popular in the United States. Neither the World Trade Organization (WTO) nor the multitudes of regional trade deals such as the North American Free Trade Agreement (NAFTA) and the Trans Pacific Partnership (TPP) have had strong support among the general public. But opposition, while broad, tended to be diffuse.

This has enabled policy makers to conclude a succession of trade agreements since the end of World War II. The world’s major economies were in a perpetual state of trade negotiations, signing two major global multilateral deals: the General Agreement on Tariffs and Trade (GATT) and the treaty establishing the World Trade Organization. In addition, more than five hundred bilateral and regional trade agreements were signed, the vast majority of them since the WTO replaced the GATT in 1995.

The difference today is that international trade has moved to the center of the political debate. During the most recent US election, presidential candidates Bernie Sanders and Donald Trump both made opposition to trade agreements a key plank of their campaigns. And, judging from the tone of the other candidates, standing up for globalization amounted to electoral suicide in the political climate of the time. Trump’s eventual win can be chalked up at least in part to his hard line on trade and his promise to renegotiate deals that he argued had benefited other nations at the expense of the United States.

Trump’s and other populists’ rhetoric on trade may be excessive, but few deny any longer that the underlying grievances are real. Globalization has not lifted all boats. Many working families have been devastated by the impact of Iow-cost imports from China, Mexico, and elsewhere. And the big winners have been the financiers and skilled professionals who can take advantage of expanded markets. Although globalization has not been the sole, or even the most important, force driving inequality in the advanced economies, it has been a key contributor. Meanwhile, economists have struggled to find large gains from recent trade agreements for the economy as a whole.

What gives trade particular political salience is that it often raises fairness concerns in ways that the other major contributor to inequality, technology, does not. When I lose my job because my competitor innovates and introduces a better product, I have little cause to complain. When he outcompetes me by outsourcing to firms abroad that do things that would be illegal here, for example, prevent their workers from organizing and bargaining collectively, may have a legitimate gripe. It is not inequality per se that people tend to mind. What’s problematic is unfair inequality, when we are forced to compete under different ground rules.

During the 2016 US presidential campaign, Bernie Sanders forcefully advocated the renegotiation of trade agreements to reflect better the interests of working people. But such arguments immediately run up against the objection that any standstill or reversal on trade agreements would harm the world’s poorest, by diminishing their prospect of escaping poverty through export-led growth. “If you’re poor in another country, this is the scariest thing Bernie Sanders has said,” ran a headline in the popular and normally sober Vox.com news site.

But trade rules that are more sensitive to social and equity concerns in the advanced countries are not inherently in conflict with economic growth in poor countries. Globalization’s cheerleaders do considerable damage to their cause by framing the issue as a stark choice between existing trade arrangements and the persistence of global poverty. And progressives needlessly force themselves into an undesirable trade-off.

The standard narrative about how trade has benefited developing economies omits a crucial feature of their experience. Countries that managed to leverage globalization, such as China and Vietnam, employed a mixed strategy of export promotion and a variety of policies that violate current trade rules. Subsidies, domestic-content requirements, investment regulations, and, yes, often import barriers were critical to the creation of new, highervalue industries. Countries that rely on free trade alone (Mexico comes immediately to mind) have languished.

That is why trade agreements that tighten the rules, such as TPP would have done, are in fact mixed blessings for developing countries. China would not have been able to pursue its phenomenally successful industrialization strategy if the country had been constrained by WTO-type rules during the 1980s and 1990s. With the TPP, Vietnam would have had some assurance of continued access to the US market (existing barriers on the US side are already quite low), but in return would have had to submit to restrictions on subsidies, patent rules, and investment regulations.

And there is nothing in the historical record to suggest that poor countries require very low or zero barriers in the advanced economies in order to benefit greatly from globalization. In fact, the most phenomenal export-oriented growth experiences to date, Japan, South Korea, Taiwan, and China, all occurred when import tariffs in the United States and Europe were at moderate levels, and higher than where they are today.

So, for progressives who worry both about inequality in the rich countries and poverty in the rest of the world, the good news is that it is indeed possible to advance on both fronts. But to do so, we must transform our approach to trade deals in some drastic ways.

The stakes are extremely high. Poorly managed globalization is having profound effects not only in the United States but also in the rest of the developed world, especially Europe, and the low-income and middle-income countries in which a majority of the world’s workers live. Getting the balance between economic openness and policy space management right is of huge importance.

Europe on the Brink

The difficulties that deep economic integration raises for governance and democracy are nowhere in clearer sight than in Europe. Europe’s single market and single currency represent a unique experiment in what I havecalled in my previous work “hyperglobalization.” This experiment has opened a chasm between extensive economic integration and limited political integration that is historically unparalleled for democracies.

Once the financial crisis struck and the fragility of the European experiment came into full view, the weaker economies with large external imbalances needed a quick way out. European institutions and the International Monetary Fund (IMF) had an answer: structural reform. Sure, austerity would hurt. But a hefty dose of structural reform, liberalization of labor, product, and service markets, would make the pain bearable and help get the patient back on his feet. As I explain later in the book, this was a false hope from the very beginning.

It is undeniable that the euro crisis has done much damage to Europe’s political democracies. Confidence in the European project has eroded, centrist political parties have weakened, and extremist parties, particularly of the far right, are the primary beneficiaries. Less appreciated, but at least as important, is the damage that the crisis has done to democracy’s prospects outside the narrow circle of eurozone countries.

The sad fact is that Europe is no longer the shining beacon of democracy it was for other countries.

A community of nations that is unable to stop the unmistakable authoritarian slide in one of its members, Hungary, can hardly be expected to foster and cement democracy in countries on its periphery. We can readily see the consequences in a country like Turkey, where the loss of the “European anchor” has played a facilitating role in enabling Erdogan’s repeated power plays, and less directly in the faltering of the Arab Spring.

The costs of misguided economic policies have been the most severe for Greece. Politics in Greece has exhibited all the symptoms of a country being strangled by the trilemma of deep integration. It is impossible to have hyperglobalization, democracy, and national sovereignty all at once; we can have at most two out of three. Because Greece, along with others in the euro, did not want to give up any of these, it ended up enjoying the benefits of none. The country has bought time with a succession of new programs, but has yet to emerge out of the woods. It remains to be seen whether austerity and structural reforms will eventually return the country to economic health.

History suggests some grounds for skepticism. In a democracy, when the demands of financial markets and foreign creditors clash with those of domestic workers, pensioners, and the middle class, it is usually the locals who have the last say.

As if the economic ramifications of a full-blown eventual Greek default were not terrifying enough, the political consequences could be far worse. A chaotic eurozone breakup would cause irreparable damage to the European integration project, the central pillar of Europe’s political stability since World War II. It would destabilize not only the highly indebted European periphery but also core countries like France and Germany, which have been the architects of that project.

The nightmare scenario would be a 1930s style victory for political extremism. Fascism, Nazism, and communism were children of a backlash against globalization that had been building since the end of the nineteenth century, feeding on the anxieties of groups that felt disenfranchised and threatened by expanding market forces and cosmopolitan elites.

Free trade and the gold standard had required downplaying domestic priorities such as social reform, nationbuilding, and cultural reassertion. Economic crisis and the failure of international cooperation undermined not only globalization but also the elites that upheld the existing order. As my Harvard colleague Jeff Frieden has written, this paved the path for two distinct forms of extremism.

Faced with the choice between equity and economic integration, communists chose radical social reform and economic self-sufficiency. Faced with the choice between national assertion and globalism, fascists, Nazis, and nationalists chose nation-building.

Fortunately, fascism, communism, and other forms of dictatorships are passe today. But similar tensions between economic integration and local politics have long been simmering. Europe’s single market has taken shape much faster than Europe’s political community has; economic integration has leaped ahead of political integration.

The result is that mounting concerns about the erosion of economic security, social stability, and cultural identity could not be handled through mainstream political channels. National political structures became too constrained to offer effective remedies, while European institutions still remain too weak to command allegiance.

It is the extreme right that has benefited most from the centrists’ failure. In France, the National Front has been revitalized under Marine Le Pen and has turned into a major political force mounting a serious challenge for the presidency in 2017. In Germany, Denmark, Austria, Italy, Finland, and the Netherlands, right-wing populist parties have capitalized on the resentment around the euro to increase their vote shares and in some cases play kingmaker in their national political systems.

The backlash is not confined to eurozone members. In Scandinavia, the Sweden Democrats, a party with neoNazi roots, were running ahead of Social Democrats and had risen to the top of national polls in early 2017. And in Britain, of course, the antipathy toward Brussels and the yearning for national autonomy has resulted in Brexit, despite warnings of dire consequences from economists.

Political movements of the extreme right have traditionally fed on anti-immigration sentiment. But the Greek, Irish, Portuguese, and other bailouts, together with the euro’s troubles, have given them fresh ammunition. Their euro skepticism certainly appears to be vindicated by events. When Marine Le Pen was asked if she would unilaterally withdraw from the euro, she replied confidently, “When I am president, in a few months’ time, the eurozone probably won’t exist.”

As in the 1930s, the failure of international cooperation has compounded centrist politicians’ inability to respond adequately to their domestic constituents’ economic, social, and cultural demands. The European project and the eurozone have set the terms of debate to such an extent that, with the eurozone in tatters, these elites’ legitimacy has received an even more serious blow.

Europe’s centrist politicians have committed themselves to a strategy of “more Europe” that is too rapid to ease local anxieties, yet not rapid enough to create a real Europe-wide political community. They have stuck for far too long to an intermediate path that is unstable and beset by tensions.

By holding on to a vision of Europe that has proven unviable, Europe’s centrist elites have endangered the idea of a unified Europe itself.

The short-run and long-run remedies for the European crisis are not hard to discern in their broad outlines, and they are discussed below. Ultimately, Europe faces the same choice it always faced: it will either embark on political union or loosen the economic union. But the mismanagement of the crisis has made it very difficult to see how this eventual outcome can be produced amicably and with minimal economic and political damage to member countries.

Fads and Fashions in the Developing World

The last two decades have been good to developing countries. As the United States and Europe were reeling under financial crisis, austerity, and the populist backlash, developing economies led by China and India engineered historically unprecedented rates of economic growth and poverty alleviation. And for once, Latin America, Sub-Saharan Africa, and South Asia could join the party alongside East Asia. But even at the height of the emerging markets hype, one could discern two dark clouds.

First, would today’s crop of low income economies be able to replicate the industrialization path that delivered rapid economic progress in Europe, America, and East Asia? And second, would they be able to develop the modern, liberal-democratic institutions that today’s advanced economies acquired in the previous century? I suggest that the answers to both of these questions may be negative.

On the political side, the concern is that building and sustaining liberal democratic regimes has very special pre-requisites. The crux of the difficulty is that the beneficiaries of liberal democracy, unlike in the case of electoral democracies or dictatorships, typically have neither numbers nor resources on their side. Perhaps we should not be surprised that even advanced countries are having difficulty these days living up to liberal democratic norms. The natural tendency for countries without long and deep liberal traditions is to slide into authoritarianism. This has negative consequences not just for political development but economic development as well.

The growth challenge compounds the democracy challenge. One of the most important economic phenomena of our time is a process I have called “premature deindustrialization.” Partly because of automation in manufacturing and partly because of globalization, low income countries are running out of industrialization opportunities much sooner than their earlier counterparts in East Asia did. This would not be a tragedy if manufacturing was not traditionally a powerful growth engine, for reasons I discuss below.

With hindsight, it has become clear that there was in fact no coherent growth story for most emerging markets. Unlike China, Vietnam, South Korea, Taiwan, and a few other manufacturing miracles, the recent crop of growth champions did not build many modern, export-oriented industries. Scratch the surface, and you find high growth rates driven not by productive transformation but by domestic demand, in turn fueled by temporary commodity booms and unsustainable levels of public or, more often, private borrowing. Yes, there are plenty of world-class firms in emerging markets, and the expansion of the middle class is unmistakable. But only a tiny share of these economies’ labor is employed in productive enterprises, while informal, unproductive firms absorb the rest.

Is liberal democracy doomed in developing economies, or might it be saved by giving it different forms than it took in today’s advanced economies? What kind of growth models are available to developing countries if industrialization has run out of steam? What are the implications of premature deindustrialization for labor markets and social inclusion? To overcome these novel future challenges, developing countries will need fresh, creative strategies that deploy the combined energies of both the private and public sectors.

No Time for Trade Fundamentalism

“One of the crucial challenges” of our era “is to maintain an open and expanding international trade system.” Unfortunately, “the liberal principles” of the world trade system “are under increasing attack.” “Protectionism has become increasingly prevalent.” “There is great danger that the system will break down or that it will collapse in a grim replay of the 1930s.”

You would be excused for thinking that these lines are culled from one of the recent outpourings of concern in the business and financial media about the current backlash against globalization. In fact, they were written thirty-six years ago, in 1981.

The problem then was stagflation in the advanced countries. And it was Japan, rather than China, that was the trade bogeyman, stalking, and taking over, global markets. The United States and Europe had responded by erecting trade barriers and imposing “voluntary export restrictions” on Japanese cars and steel. Talk about the creeping “new protectionism” was rife.

What took place subsequently would belie such pessimism about the trade regime. Instead of heading south, global trade exploded in the 1990s and 2000s, driven by the creation of the World Trade Organization, the proliferation of bilateral and regional trade and investment agreements, and the rise of China. A new age of globalization, in fact something more like hyperglobalization was launched.

In hindsight, the “new protectionism” of the 1980s was not a radical break with the past. It was more a case of regime maintenance than regime disruption, as the political scientist John Ruggie has written. The import “safeguards” and “voluntary” export restrictions (VERs) of the time were ad hoc, but they were necessary responses to the distributional and adjustment challenges posed by the emergence of new trade relationships.

The economists and trade specialists who cried wolf at the time were wrong. Had governments listened to their advice and not responded to their constituents, they would have possibly made things worse. What looked to contemporaries like damaging protectionism was in fact a way of letting off steam to prevent an excessive buildup of political pressure.

Are observers being similarly alarmist about today’s globalization backlash? The International Monetary Fund, among others, has recently warned that slow growth and populism might lead to an outbreak of protectionism. “It is vitally important to defend the prospects for increasing trade integration,” according to the IMF’s chief economist, Maurice Obstfeld.

So far, however, there are few signs that governments are moving decidedly away from an open economy. President Trump may yet cause trade havoc, but his bark has proved worse than his bite. The website globaltradealert.org maintains a database of protectionist measures and is a frequent source for claims of creeping protectionism. Click on its interactive map of protectionist measures, and you will see an explosion of fireworks, red circles all over the globe. It looks alarming until you click on liberalizing measures and discover a comparable number of green circles.

The difference this time is that populist political forces seem much more powerful and closer to winning elections, partly a response to the advanced stage of globalization achieved since the 1980s. Not so long ago, it would have been unimaginable to contemplate a British exit from the European Union, or a Republican president in the United States promising to renege on trade agreements, build a wall against Mexican immigrants, and punish companies that move offshore. The nation-state seems intent on reasserting itself.

But the lesson from the 1980s is that some reversal from hyperglobalization need not be a bad thing, as long as it serves to maintain a reasonably open world economy. In particular, we need to place the requirements of liberal democracy ahead of those of international trade and investment. Such a rebalancing would leave plenty of room for an open global economy; in fact, it would enable and sustain it.

What makes a populist like Donald Trump dangerous is not his specific proposals on trade. It is the nativist, illiberal platform on which he seems intent to govern. And it is as well the reality that his economic policies don’t add up to a coherent vision of how the United States and an open world economy can prosper side by side.

The critical challenge facing mainstream political parties in the advanced economies today is to devise such a vision, along with a narrative that steals the populists’ thunder. These center-right and center-left parties should not be asked to save hyperglobalization at all costs. Trade advocates should be understanding if they adopt unorthodox policies to buy political support.

We should look instead at whether their policies are driven by a desire for equity and social inclusion or by nativist and racist impulses, whether they want to enhance or weaken the rule of law and democratic deliberation, and whether they are trying to save the open world economy, albeit with different ground rules, rather than undermine it.

The populist revolts of 2016 will almost certainly put an end to the last few decades’ hectic deal making in trade. Though developing countries may pursue smaller trade agreements, the two major regional deals on the table, the Trans Pacific Partnership and the Transatlantic Trade and Investment Partnership, were as good as dead immediately after the election of Donald Trump as US president.

We should not mourn their passing. We should instead have an honest, principled discussion on putting globalization and development on a new footing, cognizant of our new political and technological realities and placing the requirements of liberal democracy front and center.

Getting the Balance Right

The problem with hyperglobalization is not just that it is an unachievable pipe dream susceptible to backlash, after all, the nation-state remains the only game in town when it comes to providing the regulatory and legitimizing arrangements on which markets rely. The deeper objection is that our elites’ and technocrats’ obsession with hyperglobalization makes it more difficult to achieve legitimate economic and social objectives at home, economic prosperity, financial stability, and social inclusion.

The questions of our day are: How much globalization should we seek in trade and finance? Is there still a case for nation-states in an age where the transportation and communications revolutions have apparently spelled the death of geographic distance? How much sovereignty do states need to cede to international institutions? What do trade agreements really do, and how can we improve them? When does globalization undermine democracy? What do we owe, as citizens and states, to others across the border? How do we best carry out those responsibilities?

All of these questions require that we restore a sane, sensible balance between national and global governance. We need a pluralist world economy where nationstates retain sufficient autonomy to fashion their own social contracts and develop their own economic strategies. I will argue that the conventional picture of the world economy as a “global commons”, one in which we would be driven to economic ruin unless we all cooperate, is highly misleading. If our economic policies fail, they do so largely for domestic rather than international reasons. The best way in which nations can serve the global good in the economic sphere is by putting their own economic houses in order.

Global governance does remain crucial in those areas such as climate change where the provision of global public goods is essential. And global rules sometimes can help improve domestic economic policy, by enhancing democratic deliberation and decision-making. But, I will argue, democracy-enhancing global agreements would look very different than the globalization-enhancing deals that have marked our age.

We begin with an entity at the very core of our political and economic existence, but which has for decades been under attack: the nation-state.

Chapter Two

How Nations Work

In October 2016, British Prime Minister Theresa May shocked many when she disparaged the idea of global citizenship. “If you believe you’re a citizen of the world,” she said, “you’re a citizen of nowhere.” Her statement was met with derision and alarm in the financial media and among liberal commentators. “The most useful form of citizenship these days,” one analyst lectured her, “is one dedicated not only to the wellbeing of a Berkshire parish, say, but to the planet.” The Economist called it an “illiberal” turn. A scholar accused her of repudiating Enlightenment values and warned of “echoes of 1933” in her speech.

I know what a “global citizen” looks like: I make a perfect specimen myself. I grew up in one country, live in another, and carry the passports of both. I write on global economics, and my work takes me to far-flung places. I spend more time traveling in other countries than I do within either country that claims me as a citizen. Most of my close colleagues at work are similarly foreign-born. I devour international news, while my local paper remains unopened most weeks. In sports, I have no clue how my home teams are doing, but I am a devoted fan of a football team on the other side of the Atlantic.

And yet May’s statement strikes a chord. It contains an essential truth, the disregard of which says much about how we, the world’s financial, political, and technocratic elite, distanced ourselves from our compatriots and lost their trust.

Economists and mainstream politicians tend to view the backlash as a regrettable setback, fueled by populist and nativist politicians who managed to capitalize on the grievances of those who feel they have been left behind and deserted by the globalist elites. Nevertheless, today globalism is in retreat and the nation-state has shown that it is very much alive.

For years, an intellectual consensus on the declining relevance of the nation-state reigned supreme. All the craze was about global governance, the international rules and institutions needed to underpin the apparently irreversible tide of economic globalization and the rise of cosmopolitan sensibilities.

Global governance became the mantra of our era’s elite. The surge in cross-border flows of goods, services, capital, and information produced by technological innovation and market liberalization has made the world’s countries too interconnected, their argument went, for any country to be able to solve its economic problems on its own. We need global rules, global agreements, and global institutions. This claim is still so widely accepted today that challenging it may seem like arguing that the sun revolves around Earth.

To understand how we got to this point, let’s take a close look at the intellectual case against the nationstate and the arguments in favor of globalism in governance.

The Nation-State Under Fire

The nation-state is roundly viewed as an archaic construct that is at odds with twenty-first-century realities. The assault on the nation-state transcends traditional political divisions and is one of the few things that unite economic liberals and socialists. “How may the economic unity of Europe be guaranteed, while preserving complete freedom of cultural development to the peoples living there?” asked Leon Trotsky back in 1934. The answer was to get rid of the nation-state: “The solution to this question can be reached by completely liberating productive forces from the fetters imposed upon them by the national state.”

Trotsky’s answer sounds surprisingly modern in light of the eurozone’s current travails, it is one to which most neoclassical economists would subscribe. Many moral philosophers today join liberal economists in treating national borders as irrelevant, if not descriptively then certainly prescriptively. Here is Peter Singer:

If the group to which we must justify ourselves is the tribe, or the nation, then our morality is likely to be tribal, or nationalistic. If, however, the revolution in communications has created a global audience, then we might need to justify our behavior to the whole world. This change creates the material basis for a new ethic that will serve the interests of all those who live on this planet in a way that, despite much rhetoric, no previous ethic has done.

And Amartya Sen:

There is something of a tyranny of ideas in seeing the political divisions of states (primarily, national states) as being, in some way, fundamental, and in seeing them not only as practical constraints to be addressed, but as divisions of basic significance in ethics and political philosophy.

Sen and Singer think of national borders as a hindrance, a practical obstacle that can and should be overcome as the world becomes more interconnected through commerce and advances in communications. Meanwhile, economists deride the nation-state because it is the source of the transaction costs that block fuller global economic integration. This is so not just because governments impose import tariffs, capital controls, visas, and other restrictions at their borders, impeding the global circulation of goods, money, and people. More fundamentally, it is because the multiplicity of sovereigns creates jurisdictional discontinuities and associated transaction costs. Differences in currencies, legal regimes, and regulatory practices are today the chief obstacles to a unified global economy. As overt trade barriers have come down, the relative importance of such transaction costs has grown. Import tariffs now constitute a tiny fraction of total trade costs. James Anderson and Eric van Wincoop estimated these costs to be a whopping 170 percent (in ad valorem terms) for advanced countries, an order of magnitude higher than import tariffs themselves.

To an economist, this amount is equivalent to leaving $100 bills on the sidewalk. Remove the jurisdictional discontinuities, the argument goes, and the world economy would reap large gains from trade, similar to the multilateral tariff liberalization experienced over the postwar period. So, the global trade agenda has increasingly focused on efforts to harmonize regulatory regimes, everything from sanitary and phytosanitary standards to financial regulations. That is also why European nations felt it was important to move to a single currency to make their dream of a common market a reality. Economic integration requires repressing nation-states’ ability to issue their own money, set different regulations, and impose different legal standards.

The Continued Vitality of the Nation-State

The death of the nation-state has long been predicted. “The critical issue for every student of world order is the fate of the nation-state,” wrote political scientist Stanley Hoffman in 1966. Sovereignty at Bay was the title of Raymond Vernon’s 1971 classic. Both scholars would ultimately pour cold water on the passing of the nationstate, but their tone reflects a strong current of prevailing opinion. Whether it was the European Union (on which Hoffman focused) or the multinational enterprise (Vernon’s topic), the nation-state has been widely perceived as being overwhelmed by developments larger than it.

Yet the nation-state refuses to wither away. It has proved remarkably resilient and remains the main determinant of the global distribution of income, the primary locus of market-supporting institutions, and the chief repository of personal attachments and affiliations. Consider a few facts.

To test my students’ intuition about the determinants of global inequality, I ask them on the first day of class whether they would rather be rich in a poor country or poor in a rich country. I tell them to consider only their own consumption level and to think of rich and poor as referring to the top and bottom 5 percent of a country’s income distribution. A rich country, in turn, is one in the top 5 percent of the inter country distribution of per capita incomes, while a poor country is one in the bottom. Armed with this background, typically a majority of the students respond that they would rather be rich in a poor country.

They are in fact massively wrong. Defined the way I just did, the poor in a rich country are almost five times richer than the rich in a poor country. The optical illusion that leads the students astray is that the superrich with the BMWs and gated mansions they have seen in poor countries are a miniscule proportion of the population, significantly fewer than the top 5 percent on which I asked them to focus. By the time we consider the average of the top ventile as a whole, we have taken a huge leap down the income scale.

The students have just discovered a telling feature of the world economy: our economic fortunes are determined primarily by where (which country) we are born and only secondarily by our location on the income distribution scale. Or to put it in more technical but also more accurate terms, most global inequality is accounted for by inequality across rather than within nations. So much for globalization having revoked the relevance of national borders.

Second, consider the role of national identity. One may imagine that attachments to the nation-state have worn thin between the push of transnational affinities, on the one hand, and the pull of local connections, on the other hand. But this does not seem to be the case. National identity remains alive and well, even in some surprising corners of the world. And this was true even before the global financial crisis and the populist backlash that has unfolded since.

To observe the continued vitality of national identification, let us turn to the World Values Survey, which covers more than eighty thousand individuals in fifty-seven countries (http://www.worldvaluessurvey.org/). The respondents to the survey were asked a range of questions about the strength of their local, national, and global attachments. I measured the strength of national attachments by computing the percentages of respondents who “agreed” or “strongly agreed” with the statement “I see myself as a citizen of [country, nation].” I measured the strength of global attachments, in turn, by the percentages of respondents who “agreed” or “strongly agreed” with the statement “I see myself as a world citizen.” In each case, I subtracted these percentages from analogous percentages for “I see myself as a member of my local community” to provide for some kind of normalization. In other words, I measured national and global attachments relative to local attachments. I rely on the 2004-2008 round of the survey since it was carried out before the financial crises in Europe and the United States and isolates the results from the confounding effects of the economic downturn.

Figure 2.1 National, global, and EU citizenship (relative to attachment to local community). Percentages of respondents who “agree” or “strongly agree” with the statements “I see myself as a citizen of [country, nation]” and “I see myself as a worId citizen,” subtracted from analogous percentages for “I see myself as a member of my local community.” Source: D. Rodrik, “Who Needs the Nation State?” Economic Geography, 89(1), January 2013: 1-19.

Figure 2.1 shows the results for the entire global sample, as well as for the United States, the European Union, China, and India individually. What stands out is not so much that national identity is vastly stronger than identity as a “global citizen”, that much was predictable. The surprising finding is how it apparently exerts a stronger pull than membership in the local community, as can be observed in the positive percentages for normalized national identity. This tendency is true across the board and the strongest in the United States and India, two vast countries where we may have expected local attachments to be, if anything, stronger than attachment to the nation-state.

I find it also striking that European citizens feel so little attachment to the European Union. In fact, as Figure 2.1 shows, the idea of citizenship in the European Union seems as remote to Europeans as that of global citizenship, despite long decades of European integration and institution building.

It is not a surprise to find that global attachments have worn even thinner since 2008. Measures of world citizenship have gone down significantly in some of the European countries especially: from -18 percent to -29 percent in Germany and -12 percent to -22 percent in Spain. (These are comparisons between the 2010-2014 and 2004-2008 waves.)

One may object that such surveys obfuscate differences among subgroups within the general population.

We would expect mainly the young, the skilled, and the well educated to have been unhinged from their national mooring and to have become global in their outlook and attachments. As Figure 2.2 indicates, there are indeed differences among these groups that go in the predicted direction. But they are not as large as one may have thought and do not change the overall picture. Even among the young (less than twenty-five years old), those with a university education and professionals, national identity trumps local and, even more massive, global attachments.

Finally, any remaining doubts about the continued relevance of the nation-state must have been dispelled by the experience in the aftermath of the global financial crisis of 2008. It was domestic policy makers who had to step in to prevent an economic meltdown: it was national governments that bailed out banks, pumped liquidity, provided a fiscal stimulus, and wrote unemployment checks. As Bank of England chairman Mervyn King once memorably put it, banks are global in life and national in death.

Figure 2.2 Effect of socio-demographics. Percentages of respondents who “agree” or “strongly agree” with the statements “I see myself as a citizen of [country, nation]” and “I see myself as a world citizen,” subtracted from analogous percentages for “I see myself as a member of my local community.” Source: D. Rodrik, “Who Needs the Nation State?” Economic Geography, 89(1), January 2013: 1-19.

The International Monetary Fund and the newly upgraded Group of 20 were merely talking shops. In the eurozone, it was decisions taken in national capitals from Berlin to Athens that determined how the crisis would play out, not actions in Brussels (or Strasbourg). And it was national governments that ultimately took the blame for everything that went wrong, or the credit for the little that went right.

A Normative Case for the Nation-State

Historically, the nation-state has been closely associated with economic, social, and political progress. It curbed internecine violence, expanded networks of solidarity beyond local communities, spurred mass markets and industrialization, enabled the mobilization of human and financial resources, and fostered the spread of representative political institutions.

Civil wars and economic decline are the usual fate of today’s “failed states.” For residents of stable and prosperous countries, it is easy to overlook the role that the construction of the nation-state played in overcoming such challenges. The nation-state’s fall from intellectual grace is in part a consequence of its achievements.

But has the nation-state, as a territorially confined political entity, truly become a hindrance to the achievement of desirable economic and social outcomes in view of the globalization revolution? Or does the nation-state remain indispensable to the achievement of those goals? In other words, is it possible to construct a more principled defense of the nation-state, one that goes beyond stating that it exists and that it has not withered away?

Let me begin by clarifying my terminology. The nation-state evokes connotations of nationalism. The emphasis in my discussion will be not on the “nation” or “nationalism” part but on the “state” part. In particular, I am interested in the state as a spatially demarcated jurisdictional entity. From this perspective, I view the nation as a consequence of a state, rather than the other way around. As Abbe Sieyes, one of the theorists of the French revolution, put it: “What is a nation? A body of associates living under one common law and represented by the same legislature.” I am not concerned with debates over what a nation is, whether each nation should have its own state, or how many states there ought to be.

Instead, I want to develop a substantive argument for why robust nation-states are actually beneficial, especially to the world economy. I want to show that the multiplicity of nation-states adds rather than subtracts value. My starting point is that markets require rules and that global markets would require global rules. A truly borderless global economy, one in which economic activity is fully unmoored from its national base, would necessitate transnational rule-making institutions that match the global scale and scope of markets. But this would not be desirable, even if it were feasible. Market supporting rules are nonunique. Experimentation and competition among diverse institutional arrangements therefore remain desirable. Moreover, communities differ in their needs and preferences regarding institutional forms. And history and geography continue to limit the convergence in these needs and preferences.

So, I accept that nation-states are a source of disintegration for the global economy. My claim is that an attempt to transcend them would be counterproductive. It would get us neither a healthier world economy nor better rules.

My argument can be presented as a counterpoint to the typical globalist narrative, depicted graphically in the top half of Figure 2.3. In this narrative, economic globalization, spurred by the revolutions in transportation and communication technologies, breaks down the social and cultural barriers among people in different parts of the world and fosters a global community. It, in turn, enables the construction of a global political community, global governance, that underpins and further reinforces economic integration.

Figure 2.3 Alternative reinforcing dynamics Source: D. Rodrik, “Who Needs the Nation State?” Economic Geography, 89(1), January 2013: 1-19.

My alternative narrative (shown at the bottom of Figure 2.3) emphasizes a different dynamic, one that sustains a world that is politically divided and economically less than fully globalized. In this dynamic, preference heterogeneity and institutional nonuniqueness, along with geography, create a need for institutional diversity. Institutional diversity blocks full economic globalization. Incomplete economic integration, in turn, reinforces heterogeneity and the role of distance. When the forces of this second dynamic are sufficiently strong, as I will argue they are, operating by the rules of the first can get us only into trouble.

The Futile Pursuit of Hyperglobalization

Markets depend on nonmarket institutions because they are not self-creating, self-regulating, self-stabilizing, or self-legitimating. Anything that goes beyond a simple exchange among neighbors requires investments in transportation, communications, and logistics; enforcement of contracts, provision of information, and prevention of cheating; a stable and reliable medium of exchange; arrangements to bring distributional outcomes into conformity with social norms; and so on. Well-functioning, sustainable markets are backed by a wide range of institutions that provide the critical functions of regulation; redistribution, monetary and fiscal stability, and conflict management.

These institutional functions have so far been provided largely by the nation-state. Throughout the postwar period, this not only did not impede the development of global markets but it facilitated it in many ways. The guiding philosophy behind the Bretton Woods regime, which governed the world economy until the 1970s, was that nations, not only the advanced nations but also the newly independent ones, needed the policy space within which they could manage their economies and protect their social contracts.

Capital controls, restricting the free flow of finance between countries, were viewed as an inherent element of the global financial system. Trade liberalization remained limited to manufactured goods and to industrialized nations; when imports of textiles and clothing from low-cost countries threatened domestic social bargains by causing job losses in affected industries and regions, these, too, were carved out as special regimes.

Yet trade and investment flows grew by leaps and bounds, in no small part because the Bretton Woods recipe made for healthy domestic policy environments. In fact, economic globalization relied critically on the rules maintained by the major trading and financial centers. As John Agnew has emphasized, national monetary systems, central banks, and financial regulatory practices were the cornerstones of financial globalization. In trade, it was more the domestic political bargains than GATT rules that sustained the openness that came to prevail.

The nation-state was the enabler of globalization, but also the ultimate obstacle to its deepening. Combining globalization with healthy domestic polities relied on managing this tension well. Veer too much in the direction of globalization, as in the 1920s, and we would erode the institutions’ underpinning markets. Veer too much in the direction of the state, as in the 1930s, and we would forfeit the benefits of international commerce.

From the 1980s on, the ideological balance took a decisive shift in favor of markets and against governments. The result internationally was an all-out push for what I have called “hyperglobalization’”, the attempt to eliminate all transaction costs that hinder trade and capital flows. The World Trade Organization was the crowning achievement of this effort in the trade arena. Trade rules were new extended to services, agriculture, subsidies, intellectual property rights, sanitary and phytosanitary standards, and other types of what were previously considered to be domestic policies. In finance, freedom of capital mobility became the norm, rather than the exception, with regulators focusing on the global harmonization of financial regulations and standards. A majority of European Union members went the furthest by first reducing exchange-rate movements among themselves and ultimately adopting a single currency.

The upshot was that domestic governance mechanisms were weakened while their global counterparts remain incomplete. The flaws of the new approach became evident soon enough. One type of failure arose from pushing rule making onto supranational domains too far beyond the reach of political debate and control. This failure was exhibited in persistent complaints about the democratic deficit, lack of legitimacy, and loss of voice and accountability. These complaints became permanent fixtures attached to the World Trade Organization and Brussels institutions.

Where rule making remained domestic, another type of failure arose. Growing volumes of trade with countries at different levels of development and with highly dissimilar institutional arrangements exacerbated inequality and economic insecurity at home. What was even more destructive, the absence of institutions at the global level that have tamed domestic finance (a lender of last resort, deposit insurance, bankruptcy laws, and fiscal stabilizers) rendered global finance a source of instability and periodic crises of massive proportions. Domestic policies alone were inadequate to address the problems that extreme economic and financial openness created. Suitably enough, the countries that did the best in the new regime were those that did not let their enthusiasm for free trade and free flows of capital get the better of them.

China, which engineered history’s most impressive poverty reduction and growth outcomes, was, of course, a major beneficiary of others’ economic openness. But for its part, it followed a highly cautious strategy that combined extensive industrial policies with selective, delayed import liberalization and capital controls. Effectively, China played the globalization game by Bretton Woods rules rather than by hyperglobalization rules.

Is Global Governance Feasible or Desirable?

By now it is widely understood that globalization’s ills derive from the imbalance between the global nature of markets and the domestic nature of the rules that govern them. As a matter of logic, the imbalance can be corrected in only one of two ways: expand governance beyond the nation-state or restrict the reach of markets. In polite company, only the first option receives much attention.

Global governance means different things to different people. For policy officialdom, it refers to new intergovernmental forums, such as the Group of 20 and the Financial Stability Forum. For some analysts, it means the emergence of transnational networks of regulators setting common rules from sanitary to capital adequacy standards. For other analysts, it is “private governance” regimes, such as fair trade and corporate social responsibility. Yet others imagine the development of accountable global administrative processes that depend “on local debate, is informed by global comparisons, and works in a space of public reasons.” For many activists, it signifies greater power for international nongovernmental organizations.

It remains without saying that such emergent forms of global governance remain weak. But the real question is whether they can develop and become strong enough to sustain hyperglobalization and spur the emergence of truly global identities. I do not believe they can.

I develop my argument in four steps: (1) market-supporting institutions are not unique, (2) communities differ in their needs and preferences regarding institutional forms, (3) geographic distance limits the convergence in those needs and preferences, and (4) experimentation and competition among diverse institutional forms is desirable.

Market-supporting Institutions Are Not Unique

It is relatively straightforward to specify the functions that market-supporting institutions serve, as I did previously. They create, regulate, stabilize, and legitimate markets. But specifying the form that institutions should take is another matter altogether. There is no reason to believe that these functions can be provided only in specific ways or to think that there is only a limited range of plausible variation. In other words, institutional function does not map uniquely into form.

All advanced societies are some variant of a market economy with dominantly private ownership. But the United States, Japan, and the European nations have evolved historically under institutional setups that differ significantly. These differences are revealed in divergent practices in labor markets, corporate governance, social welfare systems, and approaches to regulation. That these nations have managed to generate comparable amounts of wealth under different rules is an important reminder that there is not a single blueprint for economic success. Yes, markets, incentives, property rights, stability, and predictability are important. But they do not require cookie-cutter solutions.

Economic performance fluctuates, even among advanced countries, so institutional fads are common. In recent decades, European social democracy, Japanese style industrial policy, the US model of corporate governance and finance, and Chinese state capitalism have periodically come into fashion, only to recede from attention once their stars faded. Despite efforts by international organizations, such as the World Bank and the Organisation for Economic Co-operation and Development (OECD), to develop “best practices,” institutional emulation rarely succeeds.

One reason is that elements of the institutional landscape tend to have a complementary relationship to each other, dooming partial reform to failure. For example, in the absence of labor market training programs and adequate safety nets, deregulating labor markets by making it easier for firms to fire their workers can easily backfire. Without a tradition of strong stakeholders that restrain risk taking, allowing financial firms to selfregulate can be a disaster. In their well known book Varieties of Capitalism, Peter Hall and David Soskice identified two distinct institutional clusters among advanced industrial economies, which they called “liberal market economies” and “coordinated market economies.”We can certainly identify additional models as well if we turn to Asia.

The more fundamental point has to do with the inherent malleability of institutional designs. As Roberto Unger has emphasized, there is no reason to think that the range of institutional divergence we observe in the world today exhausts all feasible variation. Desired institutional functions, aligning private incentives with social optimality, establishing macrostability, achieving social justice, can be generated in innumerable ways, limited only by our imagination.

The idea that there is a best-practice set of institutions is an illusion.

This is not to say that differences in institutional arrangements do not have real consequences. Institutional malleability does not mean that institutions always perform adequately: there are plenty of societies whose institutions patently fail to provide for adequate incentives for production, investment, and innovation, not to mention social justice. But even among relatively successful societies, different institutional configurations often have varying implications for distinct groups. Compared to coordinated market economies, liberal market economies, for example, present better opportunities for the most creative and successful members of society, but also tend to produce greater inequality and economic insecurity for their working classes. Richard Freeman has shown that more highly regulated labor market environments produce less dispersion in earnings but not necessarily higher rates of unemployment.

There is an interesting analogy here to the second fundamental theorem of welfare economics. The theorem states that any Pareto-efficient equilibrium can be obtained as the outcome of a competitive equilibrium with an appropriate distribution of endowments. Institutional arrangements are, in effect, the rules that determine the allocation of rights to a society’s resources; they shape the distribution of endowments in the broadest term. Each Pareto-efficient outcome can be sustained by a different set of rules. And conversely, each set of rules has the potential to generate a different Pareto-efficient outcome. (I say potential because “bad” rules will clearly result in Pareto-inferior outcomes.)

It is not clear how we can choose ex ante among Pareto-efficient equilibria. It is precisely this indeterminacy that makes the choice among alternative institutions a difficult one, best left to political communities themselves.

Heterogeneity and Diversity

Immanuel Kant wrote that religion and language divide people and prevent a universal monarchy. But there are many other things that divide us. As I discussed in the previous section, institutional arrangements have distinct implications for the distribution of well-being and many other features of economic, social, and political life.

We do not agree on how to trade equality against opportunity, economic security against innovation, stability against dynamism, economic outcomes against social and cultural values, and many other consequences of institutional choice. Differences in preferences are ultimately the chief argument against institutional harmonization globally.

Consider how financial markets should be regulated. There are many choices to be made. Should commercial banking be separated from investment banking? Should there be a limit on the size of banks? Should there be deposit insurance, and, if so, what should it cover? Should banks be allowed to trade on their own account? How much information should they reveal about their trades? Should executives’ compensation be set by directors, with no regulatory controls? What should the capital and liquidity requirements be? Should all derivative contracts be traded on exchanges? What should be the role of credit-rating agencies? And so on.

A central trade-off here is between financial innovation and financial stability. A light approach to regulation will maximize the scope for financial innovation (the development of new financial products), but at the cost of increasing the likelihood of financial crises and crashes. Strong regulation will reduce the incidence and costs of crises, but potentially at the cost of raising the cost of finance and excluding many from its benefits. There is no single ideal point along this trade-off. Requiring that communities whose preferences over the innovation-stability continuum vary all settle on the same solution may have the virtue that it reduces transaction costs in finance. But it would come at the cost of imposing arrangements that are out of sync with local preferences. This is the conundrum that financial regulation faces at the moment, with banks pushing for common global rules and domestic legislatures and policy makers resisting.

Here is another example from food regulation. In a controversial 1998 case, the World Trade Organization sided with the United States in ruling that the European Union’s ban on beef reared on certain growth hormones violated the Agreement on Sanitary and Phytosanitary Standards (SP8). It is interesting that the ban did not discriminate against imports and applied to imported and domestic beef alike. There did not seem to be a protectionist motive behind the ban, which had been pushed by consumer lobbies in Europe that were alarmed by the potential health threats. Nonetheless, the World Trade Organization judged that the ban violated the requirement in the SPS agreement that policies be based on “scientific evidence.” (In a similar case in 2006, the World Trade Organization also ruled against the European Union’s restrictions on genetically modified food and seeds [GMOs], finding fault once again with the adequacy of the European Union’s scientific risk assessment.)

There is indeed scant evidence to date that growth hormones pose any health threats. The European Union argued that it had applied a broader principle not explicitly covered by the World Trade Organization, the “precautionary principle,” which permits greater caution in the presence of scientific uncertainty. The precautionary principle reverses the burden of proof. Instead of asking, “Is there reasonable evidence that growth hormones, or GMOs, have adverse effects?” it requires policy makers to ask, “Are we reasonably sure that they do not?” In many unsettled areas of scientific knowledge, the answer to both questions can be no. Whether the precautionary principle makes sense depends both on the degree of risk aversion and on the extent to which potential adverse effects are large and irreversible.

As the European Commission argued (unsuccessfully), regulatory decisions here cannot be made purely on the basis of science. Politics, which aggregates a society’s risk preferences, must play the determining role. It is reasonable to expect that the outcome will vary across societies. Some (like the United States) may go for low prices; others (like the European Union) will go for greater safety.

The suitability of institutional arrangements also depends on levels of development and historical trajectory.

Alexander Gerschenkron famously argued that lagging countries would need institutions, such as large banks and state-directed investments, that differed from those present in the original industrializers. To a large extent, his arguments have been validated. But even among rapidly growing developing nations, there is considerable institutional variation. What works in one place rarely does in another.

Consider how some of the most successful developing nations joined the world economy. South Korea and Taiwan relied heavily on export subsidies to push their firms outward during the 1960s and 1970s and liberalized their import regime only gradually. China established special economic zones in which export-oriented firms were allowed to operate under different rules than those applied to state enterprises and to others focused on the internal market. Chile, by contrast, followed the textbook model and sharply reduced import barriers to force domestic firms to compete with foreign firms directly in the home market. The Chilean strategy would have been a disaster if applied in China, because it would have led to millions of job losses in state enterprises and incalculable social consequences. And the Chinese model would not have worked as well in Chile, a small nation that is not an obvious destination for multinational enterprises.

Alberto Alesina and Enrico Spolaore have explored how heterogeneity in preferences interacts with the benefits of scale to determine endogenously the number and size of nations. In their basic model, individuals differ in their preferences over the type of public goods, or, in my terms, the specific institutional arrangements provided by the state? The larger the population over which the public good is provided, the lower the unit cost of provision. On the other hand, the larger the population, the greater the number of people who find their preferences ill served by the specific public good that is provided. Smaller countries are better able to respond to their citizens’ needs. The optimum number of jurisdictions, or nation-states, trades off the scale benefits of size against the heterogeneity costs of the provision of public good.

The important analytical insight of the Alesina-Spolaore model is that it makes little sense to optimize along the market-size dimension (and eliminate jurisdictional discontinuities) when there is heterogeneity in preferences along the institutional dimension. The framework does not tell us whether we have too many nations at present or too few. But it does suggest that a divided world polity is the price we pay for institutional arrangements that are, in principle at least, better tailored to local preferences and needs.

Distance Lives: The Limits to Convergence

We need to consider an important caveat to the discussion on heterogeneity, namely, the endogenous nature of many of the differences that set communities apart. That culture, religion, and language are in part a side product of nation-states is an old theme that runs through the long trail of the literature on nationalism. From Ernest Renan down, theorists of nationalism have stressed that cultural differences are not innate and can be shaped by state policies. Education, in particular, is a chief vehicle through which national identity is molded. Ethnicity has a certain degree of exogeneity, but its salience in defining identity is also a function of the strength of the nation-state. A resident of Turkey who defines himself as Muslim is potentially a member of a global community, whereas a “Turk” owes primary loyalty to the Turkish state.

Much the same can be said about other characteristics along which communities differ. If poor countries have distinctive institutional needs arising from their low levels of income, we may perhaps expect these distinctions to disappear as income levels converge. If societies have different preferences over risk, stability, equity, and so on, we may similarly expect these differences to narrow as a result of greater communication and economic exchange across jurisdictional boundaries. Today’s differences may exaggerate tomorrow’s differences. In a world where people are freed from their local moorings, they are also freed from their local idiosyncrasies and biases. Individual heterogeneity may continue to exist, but it need not be correlated across geographic space.

There is some truth to these arguments, but they are also counterweighed by a considerable body of evidence that suggests that geographic distance continues to produce significant localization effects despite the evident decline in transportation and communication costs and other man-made barriers. One of the most striking studies in this vein was by Anne-Celia Disdier and Keith Head, which looked at the effect of distance on international trade over the span of history. It is a stylized fact of the empirical trade literature that the volume of bilateral trade declines with the geographic distance between trade partners. The typical distance elasticity is around 1.0, meaning that trade falls by 10 percent for every 10 percent increase in distance. This is a fairly large effect. Presumably, what lies behind it is not just transportation and communication costs but the lack of familiarity and cultural differences. (Linguistic differences are often controlled for separately.)

Disdier and Head undertook a meta-analysis, collecting 1,467 distance effects from 103 papers covering trade flows at different points in time, and stumbled on a surprising result: distance matters more now than it did in the late nineteenth century. The distance effect seems to have increased from the 1960s, remaining persistently high since then (see Figure 2.4). If anything, globalization seems to have raised the penalty that geographic distance imposes on economic exchange. This apparent paradox was also confirmed by Matias Berthelon and Caroline Freund, who found an increase in the (absolute value) of the distance elasticity from -1 .7 to -1.9 between 1985 and 1989 and between 2001 and 2005 using a consistent trade data set. Berthelon and Freund showed that the result was not due to a compositional switch from low-to high-elasticity goods but to “a significant and increasing impact of distance on trade in almost 40 percent of industries.”

Figure 2.4 Estimated distance effect (H) over time. Source: Disdier, A.-C., and Head, K. 2008. “The Puzzling Persistence of the Distance Effect on Bilateral Trade,” The Review of Economics and Statistics 90(1): 37-48. With permission from MIT Press Journals.

Leaving this puzzle aside for the moment, let us turn to an altogether different type of evidence. In the mid-1990s a new housing development in one of the suburbs of Toronto engaged in an interesting experiment. The houses were built from the ground up with the latest broadband telecommunications infrastructure and came with a host of new Internet technologies. Residents of Netville (a pseudonym) had access to high-speed lnternet, a videophone, an online jukebox, online health services, discussion forums, and a suite of entertainment and educational applications. These new technologies made the town an ideal setting for nurturing global citizens. The people of Netville were freed from the tyranny of distance. They could communicate with anyone in the world as easily as they could with a neighbor, forge their own global links, and join virtual communities in cyberspace. One might expect they would begin to define their identities and interests increasingly in global, rather than in local, terms.

What actually transpired was quite different. Glitches experienced by the telecom provider left some homes without a link to the broadband network. This situation allowed researchers to compare wired and nonwired households and reach some conclusions about the consequences of being wired. Far from letting local links erode, wired people actually strengthened their existing local social ties. Compared to nonwired residents, they recognized more of their neighbors, talked to them more often, visited them more frequently, and made many more local phone calls. They were more likely to organize local events and mobilize the community around common problems. They used their computer network to facilitate a range of social activities, from organizing barbecues to helping local children with their homework.

Netville exhibited, as one resident put it, “a closeness that you don’t see in many communities.” What was supposed to have unleashed global engagement and networks had instead strengthened local social ties.

There are plenty of other examples that belie the death of distance. One study identified strong “gravity” effects on the Internet: “Americans are more likely to visit websites from nearby countries, even controlling for language, income, immigrant stock, etc.” For digital products related to music, games, and pornography, a 10 percent increase in physical distance reduces the probability that an American will visit the website by 33 percent, a distance elasticity even higher (in absolute value) than for trade in goods.

Despite the evident reduction in transportation and communication costs, the production location of globally traded products is often determined by regional agglomeration effects. When the New York Times recently examined why Apple’s iPhone is manufactured in China, rather than in the United States, the answer turned out to have little to do with comparative advantage. China had already developed a massive network of suppliers, engineers, and dedicated workers in a complex known informally as Foxconn City that provided Apple with benefits that the United States could not match.

More broadly, incomes and productivity do not always exhibit a tendency to converge as markets for goods, capital, and technology become more integrated. The world economy’s first era of globalization produced a large divergence in incomes between the industrializing countries at the center and lagging regions in the periphery that specialized in primary commodities. Similarly, economic convergence has been the exception rather than the rule in the postwar period.

Economic development depends perhaps more than ever on what happens at home. If the world economy exerts a homogenizing influence, it is at best a partial one, competing with many other influences that go the other way.

Relationships based on proximity are one such offsetting influence. Many, if not most, exchanges are based on relationships, rather than textbook style anonymous markets. Geographic distance protects relationships. As Ed Learner put it, “geography, whether physical or cultural or informational, limits competition since it creates cost-advantaged relationships between sellers and buyers who are located ‘close’ to one another.” But relationships also create a role for geography. Once relationship-specific investments are made, geography becomes more important. The iPhone could have been produced anywhere, but once relationships with local suppliers were established, there are lock-in effects that make it difficult for Apple to move anywhere else.

Technological progress has an ambiguous effect on the importance of relationships. On the one hand, the decline in transportation and communication costs reduces the protective effect of distance in market relationships. It may facilitate the creation of long-distance relationships that cross national boundaries. On the other hand, the increase in complexity and product differentiation, along with the shift from Fordist mass production to new, distributed modes of learning, increases the relative importance of spatially circumscribed relationships. The new economy runs on tacit knowledge, trust, and cooperation, which still depend on personal contact. As Kevin Morgan put it, spatial reach does not equal “social depth.”

Hence, market segmentation is a natural feature of economic life, even in the absence of jurisdictional discontinuities. Neither economic convergence nor preference homogenization is the inevitable consequence of globalization.

Experimentation and Competition

Finally, since there is no fixed, ideal shape for institutions and diversity is the rule rather than exception, a divided global polity presents an additional advantage. It enables experimentation, competition among institutional forms, and learning from others. To be sure, trial and error can be costly when it comes to society’s rules. Still, institutional diversity among nations is as close as we can expect to a laboratory in real life. Josiah Ober has discussed how competition among Greek city-states during 800-300 BCE fostered institutional innovation in areas of citizenship, law, and democracy, sustaining the relative prosperity of ancient Greece.

There can be nasty sides to institutional competition. One of them is the nineteenth-century idea of a Darwinian competition among states, whereby wars are the struggle through which we get progress and seIf-realization of humanity. The equally silly, if less bloody, modern counterpart of this idea is the notion of economic competition among nations, whereby global commerce is seen as a zero-sum game.

Both ideas are based on the belief that the point of competition is to lead us to the one perfect model. But competition works in diverse ways. In economic models of “monopolistic competition,” producers compete not just on price but on variety, by differentiating their products from others’.

Similarly, national jurisdictions can compete by offering institutional “services” that are differentiated along the dimensions I discussed earlier.

One persistent worry is that institutional competition sets off a race to the bottom. To attract mobile resources, capital, multinational enterprises, and skilled professionals, jurisdictions may lower their standards and relax their regulations in a futile dynamic to outdo other jurisdictions. Once again, this argument overlooks the multidimensional nature of institutional arrangements. Tougher regulations or standards are presumably put in place to achieve certain objectives: they offer compensating benefits elsewhere. We may all wish to be free to drive at any speed we want, but few of us would move to a country with no speed limit at all where, as a result, deadly traffic accidents would be much more common. Similarly, higher labor standards may lead to happier and more productive workers; tougher financial regulation to greater financial stability; and higher taxes to better public services, such as schools, infrastructure, parks, and other amenities. Institutional competition can foster a race to the top.

The only area in which some kind of race to the bottom has been documented is corporate taxation. Tax competition has played an important role in the remarkable reduction in corporate taxes around the world since the early 1980s. In a study on OECD countries, researchers found that when other countries reduce their average statutory corporate tax rate by 1 percentage point, the home country follows by reducing its tax rate by 0.7 percentage points. The study indicated that international tax competition takes place only among countries that have removed their capital controls. When such controls are in place, capital and profits cannot move as easily across national borders and there is no downward pressure on capital taxes. So, the removal of capital controls appears to be a factor in driving the reduction in corporate tax rates.

On the other hand, there is scant evidence of similar races to the bottom in labor and environmental standards or in financial regulation. The geographically confined nature of the services (or public goods) offered by national jurisdictions often presents a natural restraint on the drive toward the bottom. If you want to partake of those services, you need to be in that jurisdiction. But corporate tax competition is also a reminder that the costs and benefits need not always neatly cancel each other. Although it is not a perfect substitute for local sourcing, international trade does allow a company to serve a high-tax market from a low-tax jurisdiction. The problem becomes particularly acute when the arrangement in question has a “solidarity” motive and is explicitly redistributive (as in many tax examples). In such cases, it becomes desirable to prevent “regulatory arbitrage” even if it means tightening controls at the border.

What Do Global Citizens Do?

Let’s circle back to Teresa May’s comments at the beginning of this chapter. What does it even mean to be a “global citizen”? The Oxford English Dictionary defines “citizen” as “a legally recognized subject or national of a state or commonwealth.” Hence, citizenship presumes an established polity, “a state or commonwealth”, of which one is a member. Countries have such polities; the world does not.

Proponents of global citizenship quickly concede that they do not have a literal meaning in mind. They are thinking figuratively. Technological revolutions in communications and economic globalization have brought citizens of different countries together, they argue. The world has shrunk, and we must act bearing the global implications in mind. And besides, we all carry multiple, overlapping identities. Global citizenship does not, and need not, crowd out parochial or national responsibilities.

All well and good. But what do global citizens really do?

Real citizenship entails interacting and deliberating with other citizens in a shared political community. It means holding decision makers to account and participating in politics to shape the policy outcomes. In the process, my ideas about desirable ends and means are confronted with and tested against those of my fellow citizens.

Global citizens do not have similar rights or responsibilities. No one is accountable to them, and there is no one to whom they must justify themselves. At best, they form communities with like-minded individuals from other countries. Their counterparts are not citizens everywhere but self-designated “global citizens” in other countries.

Of course, global citizens have access to their domestic political systems to push their ideas through. But political representatives are elected to advance the interests of the people who put them in office. National governments are meant to look out for national interests, and rightly so. This does not exclude the possibility that constituents might act with enlightened self-interest, by taking into account the consequences of domestic action for others.

But what happens when the welfare of local residents comes into conflict with the wellbeing of foreigners as it often does? Isn’t disregard of their compatriots in such situations precisely what gives so-called cosmopolitan elites their bad name?

Global citizens worry that the interests of the global commons may be harmed when each government pursues its own narrow interest. This is certainly a concern with issues that truly concern the global commons, such as climate change or pandemics. But in most economic areas, taxes, trade policy, financial stability, fiscal and monetary management, what makes sense from a global perspective also makes sense from a domestic perspective. Economics teaches that countries should maintain open economic borders, sound prudential regulation, and full-employment policies, not because these are good for other countries but because they serve to enlarge the domestic economic pie.

Of course, policy failures, for example, protectionism, do occur in all of these areas. But these reflect poor domestic governance, not a lack of cosmopolitanism. They result either from policy elites’ inability to convince domestic constituencies of the benefits of the alternative, or from their unwillingness to make adjustments to ensure that everyone does indeed benefit.

Hiding behind cosmopolitanism in such instances when pushing for trade agreements, for example, is a poor substitute for winning policy battles on their merits. And it devalues the currency of cosmopolitanism when we truly need it, as we do in the fight against global warming.

Few have expounded on the tension between our various identities, local, national, global, as insightfully as the philosopher Kwame Anthony Appiah. In this age of “planetary challenges and interconnection between countries,” he wrote in response to May’s statement, “the need has never been greater for a sense of a shared human fate.” It is hard to disagree.

Yet cosmopolitans often come across like the character from Fyodor Dostoyevsky’s The Brothers Karamazov who discovers that the more he loves humanity in general, the less he loves people in particular. Global citizens should be wary that their lofty goals do not turn into an excuse for shirking their duties toward their compatriots.

We have to live in the world we have, with all its political divisions, and not the world we wish we had. The best way to serve global interests is to live up to our responsibilities within the political institutions that matter: those that exist, within national borders.

Who Needs the Nation-State?

The design of institutions is shaped by a fundamental trade-off. On the one hand, relationships and preference heterogeneity push governance down. On the other hand, the scale and scope of the benefits of market integration push governance up. A corner solution is rarely optimal. An intermediate outcome, a world divided into diverse polities, is the best that we can do.

Our failure to internalize the lessons of this simple point leads us to pursue dead ends. We push markets beyond what their governance can support. We set global rules that defy the underlying diversity in needs and preferences. We downgrade the nation-state without compensating improvements in governance elsewhere. The failure lies at the heart of globalization’s unaddressed ills as well as the decline in our democracies’ health.

Who needs the nation-state? We all do.

Chapter 3

Europe’s Struggles

The eurozone was an unprecedented experiment. Its members tried to construct a single, unified market, in goods, services, and money, while political authority remained vested in the constituting national units. There would be one market, but many polities.

The closest historical parallel was that of the Gold Standard. Under the Gold Standard, countries effectively subordinated their economic policies to a fixed parity against gold and the requirements of free capital mobility. Monetary policy consisted of ensuring the parity was not endangered. Since there was no conception of countercyclical fiscal policy or the welfare state, the loss of policy autonomy that these arrangements entailed had little political cost. Or so it seemed at the time. Starting with Britain in 1931, the Gold Standard would eventually unravel precisely because the high interest rates required to maintain the gold parity became politically unsustainable in view of domestic unemployment.

The postwar arrangements that were erected on the ashes of the gold standard were consciously designed to facilitate economic management by national political authorities. John Maynard Keynes’s signal contribution to saving capitalism was recognizing that it required national economic management. Capitalism worked only . . .

*

from

Straight Talk on Trade. Ideas for a Sane World Economy

by Dani Rodrik

get it at Amazon.com

Trump’s phony, blowhard trade war just got real, the Economic Consequences – Barry Eichengreen.

For those who observe that the economic and financial fallout from US President Donald Trump’s trade war has been surprisingly small, the best response is that a lagged effect is exactly what we should expect, just wait.

US President Donald Trump’s phony, blowhard trade war just got real.

The steel and aluminum tariffs that the Trump administration imposed at the beginning of June were important mainly for their symbolic value, not for their real economic impact. While the tariffs signified that the United States was no longer playing by the rules of the world trading system, they targeted just $45 billion of imports, less than 0.25% of GDP in an $18.5 trillion US economy.

On July 6, however, an additional 25% tariff on $34 billion of Chinese exports went into effect, and China retaliated against an equivalent volume of US exports. An angry Trump has ordered the US trade representative to draw up a list of additional Chinese goods, worth more than $400 billion, that could be taxed, and China again vowed to retaliate. Trump has also threatened to impose tariffs on $350 billion worth of imported motor vehicles and parts. If he does, the European Union and others could retaliate against an equal amount of US exports.

We are now talking about real money: nearly $1 trillion of US imports and an equivalent amount of US export sales and foreign investments.

The mystery is why the economic and financial fallout from this escalation has been so limited. The US economy is humming along. The Purchasing Managers’ Index was up again in June. Wall Street has wobbled, but there has been nothing resembling its sharp negative reaction to the Smoot-Hawley Tariff of 1930. Emerging markets have suffered capital outflows and currency weakness, but this is more a consequence of Federal Reserve interest-rate hikes than of any announcements emanating from the White House.

There are three possible explanations. First, purchasing managers and stock market investors may be betting that sanity will yet prevail. They may be hoping that Trump’s threats are just bluster, or that the objections of the US Chamber of Commerce and other business groups will ultimately register.

But this ignores the fact that Trump’s tariff talk is wildly popular with his base. One recent poll found that 66% of Republican voters backed Trump’s threatened tariffs against China. Trump ran in 2016 on a protectionist vow that he would no longer allow other countries to “take advantage” of the US. His voters expect him to deliver on that promise, and he knows it.

Second, the markets may be betting that Trump is right when he says that trade wars are easy to win. Other countries that depend on exports to the US may conclude that it is in their interest to back down. In early July, the European Commission was reportedly contemplating a tariff-cutting deal to address Trump’s complaint that the EU taxes American cars at four times the rate the US taxes European sedans.

But China shows no willingness to buckle under US pressure. Canada, that politest of countries, is similarly unwilling to be bullied; it has retaliated with 25% tariffs on $12 billion of US goods. And the EU would contemplate concessions only if the US offers some in return such as eliminating its prohibitive tariffs on imported light pickup trucks and vans and only if other exporters like Japan and South Korea go along.

Third, it could be that the macroeconomic effects of even the full panoply of US tariffs, together with foreign retaliation, are relatively small. Leading models of the US economy, in particular, imply that a 10% increase in the cost of imported goods will lead to a one-time increase in inflation of at most 0.7%.

This is simply the law of iterated fractions at work. Imports are 15% of US GDP. Multiply 0.15 by 0.10 (the hypothesized tariff rate), and you get 1.5%. Allow for some substitution away from more expensive imported goods, and the number drops below 1%. And if growth slows because of the higher cost of imported intermediate inputs, the Fed can offset this by raising interest rates more slowly. Foreign central banks can do likewise.

Still, one worries, because the standard economic models are notoriously bad at capturing the macroeconomic effects of uncertainty, which trade wars create with a vengeance. Investment plans are made in advance, so it may take, say, a year for the impact of that uncertainty to materialize, as was the case in the United Kingdom following the 2016 Brexit referendum. Taxing intermediate inputs will hurt efficiency, while shifting resources away from dynamic high-tech sectors in favor of old-line manufacturing will depress productivity growth, with further negative implications for investment. And these are outcomes that the Fed cannot easily offset.

So, for those who observe that the economic and financial fallout from Trump’s trade war has been surprisingly small, the best response is: just wait.

*

Barry Eichengreen is Professor of Economics at the University of California, Berkeley, and a former senior policy adviser at the International Monetary Fund. His latest book is The Populist Temptation: Economic Grievance and Political Reaction in the Modern Era.

‘Puer Aeternus’, Failure to Launch, The Millenial dilemma – Gillian McCann, and Gitte U Bechsgaard * Millennials who leave home before moving back in are causing havoc for their families – Emilia Mazza * Millennials May Never Be Able To Move Out Of Their Parents’ Homes.

From Italy to Britain to Canada, more and more millennials are failing to launch and remain at home well into their thirties.

If the child cannot move into adulthood their parents also cannot move onto the next stage of their lives.

No one is saying we need to return to early marriages but clearly our rites of passage have not kept up with the times.

When an adult child moves back home after they’ve left, parents can start to feel resentful, especially if their child is acting the same way they did before they left home.

“Puer Aeternus: Someone who remains too long in adolescent psychology.” Marie-Louise Von Franz

It is disturbing to think we have come to this but without an alternative it is likely we will see more court cases where parents take extreme measures in order to launch their adult children.

Recently the eyes of the world were riveted on a court case in Upstate New York. At the centre of the media storm was a couple, pictured sitting stoically in a courtroom, who were using the legal system to remove their 30-year-old son from the family home. How could it have come to this? Journalists, news anchors, and radio discjockeys rushed in to try and make sense of this story which seemed to resonate around the world.

There was good reason for British journalists to show up on the lawn of this family, this is not just an American problem. From Italy to Britain to Canada, more and more millennials are failing to launch and remain at home well into their thirties. The 2016 Canadian census showed a record-breaking 34.7% of young adults remained in the family home.

While economics, longer education times and helicopter parenting clearly have something to do with this situation we will leave those aspects to others to examine. We want to look at the psychology that is contributing to the increasingly common phenomenon of children who are seemingly unable to move into adulthood. A number of changes have occurred within our societies in the last 40 years to contribute to this seemingly baffling situation.

Beginning in the 1960s Jungian analyst Marie-Louise Von Franz gave a series of lectures on a complex that she referred to as the puer aeternus. Von Franz described this syndrome as someone who “remains too long in adolescent psychology.” At the time that she was giving these lectures this was a very rare psychological problem, but societal changes have resulted in it becoming increasingly common. Across the western world sociological surveys are registering a sea change in how people move, or don’t, into adulthood.

More and more people seem to be getting caught in the phase of adolescence in both their attitudes and lifestyles, unable to move into full adulthood. This inability has implications both for the psychological health of the individual and the well-being of their families.

If the child cannot move into adulthood their parents also cannot move onto the next stage of their lives.

What few have seemed to note amid all the public discussion is that adulthood is not a given but is defined by family, culture and society. We are not born knowing what a adult is or how one is supposed to act. However, many millennials are left without clear definitions about what a mature person would look or act like. Along with many progressive changes some of the negative impact of the 1960’s has been an obsession with youth and a suspicion of adulthood that continues to linger long after the hippie generation crossed the 30-year mark and thus were unable to trust themselves.

Contributing to this problem is the fact that many in our society have discarded the rituals that used to usher us through the different phases of life. Without these rites of passage and clearly marked changes in status it is very easy to become caught in what anthropologist van Gennep referred to as a liminal state betwixt and between. With the deciine of religious practice and community life fewer people now have access to the rites of passage that structure human and community life. As van Gennep writes, these rituais “enable the individual to pass from one defined position to another which is equaily well defined.“

Around the world there are a wide variety of usually religiously based rituals that signal to the individual, and their community that they are moving into adulthood. These range from the confirmation ceremonies of Christianity to the bar and bat mitzvahs of Judaism and the Tirundukuli of Hinduism and many more. These ceremonies witnessed by family and community, formal clothes and party are all a clear indication that the person’s status was changing. These rituals were meant to signal to their community the individuals new maturity and also to reinforce this psychologically as they took on more outer signs of independence such as a job and learning how to handle money.

Another feature of the failure to launch is that fewer and fewer people are getting married or are getting married later. For our parents’ generation the transition to adulthood happened in one fell swoop: You got married and moved out of the house often starting your own family shortly thereafter.

Michael Rotondo’s parents sued him to get him out of their house.

No one is saying we need to return to early marriages but clearly our rites of passage have not kept up with the times.

It is clear that we need as a society to determine what we mean by adulthood and then help the younger generation to makes these transitions. This requires a clear sense of what being an adult entails for example: the ability to think beyond one’s narrow selfinterest, emotional maturity, financial independence, and participation in community. If we ourselves don’t know it is impossible to expect the younger generation to embody these characteristics and they are left flailing. Life can become like a vast ocean without any markers to indicate where we are in the journey.

Lacking the ability to enforce these passages in the traditional manner the Rotondo family was forced to take it all to the next level and use the courts in order to enforce independence on their son. This may seem absurd but is perhaps not really surprising. For a period of time the Italian government was considering legislation to move their legion of mammones out of the house. In Italy currently 66% of 18-34 year olds live at home.

It is disturbing to think we have come to this but without an alternative it is likely we will see more cases where parents take extreme measures in order to launch their adult children.

The boomerang kids who are ruining their parents’ lives: Generation of millennials who leave home before moving back in are causing havoc for their families

Emilia Mazza

Adult children who move out of home and then move back, or those who simply refuse to leave the comforts of family life, are ruining parents lives.

Adult children who fly the coop and return home if their situation doesn’t work out have been dubbed the ‘Boomerang Generation’, while those who don‘t want to move out because they are at university longer or struggling with the cost of living have earned themselves the title of ‘adult-escents’, fully grown children who still live at home and act like teenagers.

Dr Justin Coulson says that although a move home by an adult child may be justified, this can have an effect on the well being of parents. He explained how research by the London School of Economics found adult children who return to the family home after leaving can cause a significant decline in their parents’ quality of life.

“Parents experience the same frustrations as they did when their kids lived at home but these seem to be multiplied because they have had a reprieve. They can start to feel as if their parenting duties have to start all over again.”

The author of 10 Things Every Parent Needs to Know said when children leave home parents enter a new phase of life, one that’s far less burdened with the responsibility of bringing up kids.

“You start to do things your way, you do things that are convenient for you when they are convenient. And you don’t have to put yourself out for anyone else anymore. When an adult child moves back home after they’ve left, parents can start to feel resentful, especially if their child is acting the same way they did before they left home. They may start to worry about who left the garbage in the bin, or who left socks under the dining table or forgot to lock the house.”

Then there is the question of who is going to contribute and how. Whether or not they are going to pay rent, if they are, will they need to be chased.

“The accumulation of these smaller problems can be a real source of tension for parents who may have been thinking they no longer needed to worry about these things. Once a child has moved out, they are considered an adult so if parents have to pick up after them again then this can be a source of frustration and difficulty.”

Dr Coulson also explained there are adult children who simply refuse to take any responsibility for their lives, despite the fact they are of an age where they could. As well as a rise in millennials moving back home, adult children were also staying at home longer because the transition to adulthood was taking longer.

“Not only are we seeing more move back in, we’re seeing fewer kids moving out in the first place… We call it “adult-essence” instead of adolescence.

Grown children who haven’t moved out might become too cosy at home; they might fail to pull their weight around the house, or not pay their way.

They’re sloppy, they don’t clean up the dishes or they won’t clean their room. We feel like they’re at uni or at work but we’re still waking them up and they’re grown ups.”

Dr Coulson said although parents could face certain challenges when children do return home, there were times when offering a child a safe place was important.

“If parents can be responsive to the reasons that have led them to moving back home then they are less likely to experience the decline in satisfaction.”

Dr Coulson’s advice on how do deal with kids who do move back

* Parents shouldn’t be afraid to ask their adult children for rent

* Establish guidelines from the outset and expect your child to adhere to these

* Allocate responsibility, this can be a weekly chore such as taking out the rubbish, moving the lawns or helping to care for younger siblings

* If you feel you are being taken advantage it is okay to ask your adult children to leave

“Just because the research says you will be unhappy doesn’t mean we should say no to our kids if they have struck a difficult situation. We need to remember to be compassionate and offer to help.”

One important thing parents need to watch out for is a child who is trying to take advantage of the situation. Some kids are just looking for a free ride and that’s when the resentment and negative feelings can come up even more. If we can establish effective guidelines, living with adult children can be fantastic, they can contribute financially, do certain chores or babysit younger kids.

“It really doesn’t have to be bad but it comes down to having conversations from the outset, and being clear that if they don’t live up to these expectations it’s okay to ask them to leave.”

Millennials May Never Be Able To Move Out Of Their Parents’ Homes – Narcity

Studies show that millennials are, well, screwed.

‘Generation Screwed’ is the latest epithet assigned to millennials by boomers, and while it may be a rather harsh characterization, it does bear some truth. While it’s common for young adults to move back home with their parents after university, many of them are staying there for longer than expected, and sometimes it’s for reasons that are beyond their control.

Often times the current circumstances just don’t work in their favour. While the economy is somewhat looking up, graduates today are still faced with an unwelcoming job market and a real estate situation that is more volatile than ever. The combination of these two factors makes it difficult for millennials to establish the stable footing they require to leave the nest.

Most Canadian millennials have difficulty finding a job, with the unemployment rate for 15 to 24 year olds at a concerning 13.2%. Those that do manage to find work (that is, 48% of young Canadian adults), often land parttime or precarious jobs that end up being nothing more than temporary gigs. And those who can’t land a job at all resort to unpaid positions that garner as many as 300,000 willing interns across the country.

Without stable work, other life milestones like getting married or owning a house become fleeting fantasies rather than achievable ideals. It doesn’t help that the real estate market in Canada is out of control. According to the Canadian Real Estate Association (CREA), national sales are to drop by 3.3% this year, with the average price of a home in Canada now being more than $500,000. The millennials that do move out resort to renting; but even that presents some financial burden with rent increases doubling in some areas.

All of this is to say that those who stay at home with one’s parents shouldn’t automatically be misjudged as lazy and entitled individuals. Because the reality is that, for many people, staying home isn’t a choice, it’s necessity.

FINDING THE MONEY, Modern Monetary Theory – Bryan Gould.

Most of the money in our economy sits in bank accounts, and a large proportion of that money is created by the banks when they make loans, usually on mortgage.

Money, in a developed economy, is what the government says it is.

Governments all around the world have over recent years pursued policies of “quantitative easing”, and on a very large scale and “quantitative easing” is just another way of describing the creation of new money.

So, the chickens are coming home to roost, and with a vengeance. The tragedy for the new government is that the chickens were bred and raised by the previous government, and are only now flying in, in large numbers and with hefty price tags.

We are now getting some idea of the price that has to be paid for those ”business-friendly” policies that were celebrated for their success in producing a “surplus” (at least for the government).

That price includes large numbers of underpaid public servants nurses, teachers, midwives, care workers, Inland Revenue workers and underfunded public services health care, schools, keeping our water and rivers clean, and bio-security at our borders. The bio-security failure alone will cost the current government around $900 million the amount awarded by the courts for the previous government’s negligence in allowing PSA to decimate the kiwifruit industry (and that’s to say nothing of the cost of the myco plasma bovis outbreak).

Through no fault of its own, the new government is having to pay up for the mess made by its predecessor, and that costs money that cannot, it seems, be easily found. Every dollar paid to clean up the mess is said to be a dollar less for the government’s real aims to improve our public services, to rescue our environment, to save families from poverty, to provide recent housing for everyone.

But is that really the case? There may be other shortages labour or land, or skills or technology, or materials but a shortage of money should not be one of them. How do we know that? Because, as an increasing number of experts recognise, and as our own experience teaches us, the government of a sovereign country need never be short of money.

This is because money, in a developed economy, is what the government says it is. Indeed, it is often called fiat money because it exists only by the sayso of the government and, as the economist, Ann Pettifor, says, that means that “we can afford what we can do.”

Most of the money in our economy sits in bank accounts, and a large proportion of that money is created by the banks when they make loans, usually on mortgage. The fact that the commercial banks create over 90% of the money in circulation out of nothing is still disputed by some (including by those who should know better) but is now attested to by the world’s central banks, by top monetary economists (such as Lord Adair Turner, former Chair of the UK’s Financial Services Authority and a leading advocate of “helicopter money”) and by leading economic journals such as the Financial Times and The Economist.

This raises the question if the banks are allowed to create money out of nothing (and then to charge interest on it), why should governments be inhibited about doing so? And indeed, they are not so inhibited, governments all around the world have over recent years pursued policies of “quantitative easing”, and on a very large scale and “quantitative easing” is just another way of describing the creation of new money.

The money created in this way has been directed to building up the balance sheets of the banks in the wake of the Global Financial Crisis, but there is no reason why it should not be applied to other (and more productive) purposes as it has been in many countries, as well as New Zealand, in the past. Japan, for example, both today and immediately after the Second World War, used this technique to get their economy moving and to build the strength of their manufacturing industry; in doing so, they followed the precepts of the great Japanese economist, Osamu Shimomura, who is virtually unknown in the West.

The Chinese government today follows similar policies. President Roosevelt in the US did likewise, before the US entered the Second World War, so as to build the strength of American industry and military capability; and, in New Zealand, Michael Joseph Savage authorised the Reserve Bank to issue interest-free credit in the 1930s so as to take us out of recession and finance the building of thousands of state houses.

All that inhibits our current government from using this technique is the fear that some will disapprove and regard it as taking risks with infiation. But, as John Maynard Keynes observed, “there may be good reasons for a shortage of land but there are no good reasons for a shortage of capital.” He went on to say that, if an increase in the money supply is applied to productive purposes so that output is increased, it cannot be inflationary.

As the new Labour-led government faces financial constraints not of its own making, why not emulate Michael Joseph Savage and authorise the issuing of interest-free credit to be applied to investment in stimulating new production? The Provincial Growth Fund would seem to be an ideal vehicle; funding investment in new infrastructure in this way would free up financial resources that could then be applied to current expenditure, such as paying the nurses and teachers what they deserve.

‘You deserve what you get?’. Modern Monetary Theory and Practice – William Mitchell, L. Randall Wray and Martin Watts.

“There is no such thing as society” Margaret Thatcher.

Neoliberal Economics: ‘You have no one to blame for your meagre allocation but yourself’. Downsizing government and especially reducing the social safety net is consistent with the view that government only needs to ‘get the incentives right’.

Since human survival requires cooperation, selfishness would actually be irrational as it would reduce one’s chances of survival. In all known societies, elaborate rituals and traditions are designed to promote cooperation and even sacrifice for the common good.

Human behaviour is surprisingly malleable, and complexly influenced by custom and tradition. There is nothing natural about humans having ‘unlimited‘ wants. While it is true that modern advertising operates to continually expand our desires. this can be countered through education.

It is ironic that neoclassical economics starts from the presumption that resources are scarce, when the obvious empirical fact is that labour is unemployed. Any theory that begins with the presumption that labour is always fully employed, and hence scarce, is ignoring a glaring inconsistency.

Heterodox Definition of Economics: the study of social creation and social distribution of society’s resources.

Modern Monetary Theory (MMT) is distinguished from other approaches to macroeconomics because it places the monetary arrangements at the centre of the analysis.

The reality is that currency issuing governments such as those of Australia, Britain, Japan and the US can never run out of money. These governments always have the capacity to spend in their own currencies.

Most of the analysis appearing in macroeconomics textbooks, which filters into the public debate and underpins the cult of austerity, is derived from ‘gold standard’ logic and does not apply to modern fiat monetary systems. Economic policy ideas that dominate the current debate are artefacts from the old system, which was abandoned in 1971.

MMT: The sum of the sectoral balances nets to zero when we consider the government, private, domestic and external sectors.

Whereas households have to save (spend less than they earn) to spend more in the future, governments can purchase whatever they like, as long as there are goods and services for sale in the currency they issue.

Our own personal budget experience generates no knowledge relevant to consideration of government matters.

Chapter 1. Introduction

What is Economics? Two Views

US President Harry Truman is said to have sought a one armed economist because he was so frustrated by the propensity of economists to provide policy advice framed as ‘Well. on the one hand‘ X. but on the other hand. Y’, where ‘Y’ typically would be the precise opposite policy path to ‘X’.

The story is. of course. funny but it does bring up a problem that is ubiquitous to all social sciences. Even if we know the result we would like to achieve (say, smarter and happier kids), we do not know with certainty which policy choices would produce the desired outcome. Since the main topic of the social sciences, human behaviour, is complex, we often do not understand its causes, or even its nature, and much less do we know how to influence it in a desired manner. Economics is as difficult as the other social sciences, such as psychology and political science, as it concerns human behaviour in a social sphere that we designate as ‘the economy‘, which itself is hard to define and to delineate from other spheres of social interaction.

Unfortunately, economics is sometimes equated to something like the ‘study of business decision making’, or even relegated to a narrow sub discipline as a ‘decision science’, in a highly artificial hypothesised world of hyper rational automatons that maximise pleasure and avoid pain.

Some even see economics as just a branch of mathematics, a view fuelled in part by the heavy use of mathematics and models in much of the discipline.

This textbook will take a broader perspective of the economics discipline, including it within the social sciences. While we do think it is useful to carve off ‘the economy’ from the rest of social life, and to apply ‘economics’ to the study of that area of life, we recognise that the division is necessarily arbitrary. In truth, there is no completely separate sphere of ‘economic life’, so economics is linked to, and incorporates findings from, the other social science disciplines.

Further, we want to stress that there is no single ‘right’ way to do economics. In this textbook we will use a variety of methods and approaches to build our understanding of ‘the economy’. We will occasionally bring in research and methods from other disciplines. We will use some mathematics and modelling As we believe that economic history as well as history of economic thought helps us to understand our economy today, we will look back in time, both in terms of economic events, but also to examine the insights of the great thinkers of the past.

In the rest of this section we will briefly outline the two main approaches to economics taken by those thinkers, as well as by today‘s economists. It is always risky to pigeon hole individuals and their theories into categories. Just as a politician in a particular political party (say, Labor in Australia. or the Republican Party in America) will hold many views shared by most members of that party, they will likely also hold some views more consistent with those of a rival party. This is true of economists, too. Still. it is useful to identify two approaches to economics that have dominated much of the debate over the past two centuries.

Recalling the story about President Truman’s frustration, we can think of the ‘two hands’ of economics as the orthodox, or neoclassical approach and the Heterodox or Keynesian/Institutionalist/Marxist approach. Let us examine each in turn, while recognising that we must generalise.

Orthodox, Neoclassical approach

‘You deserve what you get’

In the neoclassical approach, there is a presumed, natural human nature: individuals maximise pleasure and avoid pain. Pleasure is defined as ‘utility’, so individuals pursue utility maximising behaviour, avoiding the ‘disutility’ of pain. Further, rational individuals are self interested seeking to maximise their own utility, and they do not receive either utility or disutility from the experiences of others.

Neoclassical economics presumes individuals are ‘rational’, meaning they maximise utility, given constraints. If there were no constraints, individuals would maximise with infinite utility, but they are constrained by their resources that they have at their disposal, which are referred to as ‘individual resource endowments’. Mutually beneficial exchange redistributes resources according to preferences, increasing the utility of both parties to the trade.

In the hypothesised free market, exchanges take place at competitively determined relative prices. (Relative prices are ratios; for example: 1 deer, 3 beavers, 6 rabbits, 2 bushels of wheat, 10 hours of labour services.) Participants in markets take relative prices as signals. Relative scarcity will cause the price to rise, inducing suppliers to produce more of a particular traded commodity, and buyers to demand less. For example. if the supply of students trained in economics is insufficient to meet the demand for economists. the relative wage of economists to (say) that of historians, rises. This signals to students that they ought to switch from the study of history to the study of economics.

At the same time. employers try to find close but cheaper substitutes, say, political science students. As the supply of economists increases, the relative wage advantage for students trained in economics falls. Of course, other factors enter into decisions, but the important point is that relative prices function as signals to both suppliers (economics students) and demanders (employers of economists).

Equilibrium is defined as the set of relative prices that ‘clear’ markets; a ‘general equilibrium’ is a complete set of prices to clear all markets. One interpretation of Adam Smith’s famous ‘invisible hand” analogy is that by producing market clearing prices, the market provides the signals that guide individuals to maximise their utility while also providing the social or public good of ensuring that demand and supply are equilibrate. The hand is “invisible”, guiding individuals and the economy as a whole toward equilibrium, with no need of an authority. For that reason, there is little need for government management of the economy.

Certainly government has some role to play in setting and enforcing rules, in providing national security, and (perhaps) for providing a social safety net. But according to this interpretation of Smith, there is no need for the govemment to direct individuals to serve the public interest because by reacting to price signals and pursuing their own interests, individuals actually act in the public interest.

There is one more important conclusion reached by neoclassical economics: ‘you deserve what you get”. If we all come to the free market to make mutually beneficial exchanges, all seeking to maximise our own individual utility subject to our resource constraints, then the equilibrium allocation is in an important sense ‘fair’. That does not mean that the allocation is equal, some will have more (and achieve greater utility) and others will have less. However, that is because some start with greater endowments (of resources, ability, and drive).

Technically, the idea is that one receives an allocation of resources based on one’s own contribution to the market. If your final allocation is low, it is because you did not bring enough to market: maybe you were born with few resources, you made a constrained choice to obtain little education, and you prefer leisure over work. In other words, you have no one to blame for your meagre allocation but yourself.

To be sure, neoclassical economics also allows for bad luck, congenital disabilities, and so on. Hence, there is a role for social policy to get involved in altering the allocation in order to protect the poorest and least advantaged. However, generally speaking, allocations ought to be left to the market because it will reward each participant according to productive contributions to the market, a dimension of fairness.

In recent years, the neoclassical approach to economics has been invoked in support of the conservative backlash against post war economic and social reforms in Western nations (this is generally called neoliberal outside the USA or neoconservative within the USA). This ‘anti government” movement is closely associated with the terms in office of President Ronald Reagan in the USA and Prime Minister Margaret Thatcher in the UK. When running for President in 1980, President Reagan promised to “get the government off the backs of the people”; Prime Minister Thatcher was famous for arguing that there is no such thing as society, reflecting the individualistic framework shared by neoclassical economics

Ronald Reagan and Maggie Thatcher

Downsizing government and especially reducing the social safety net is consistent with the view that government only needs to ‘get the incentives right’, and then the ‘free market’ would maximise individual welfare while the invisible hand will ensure that signals coming from markets guide individuals to do what is best for the economy as a whole.

While the neoliberal/neoconservative policies are most closely associated with conservative political parties, even the moderate parties continued the policies throughout the 1990s and 2000s. For example. President Clinton (a Democrat) echoed President Reagan’s distaste for social welfare programs when he promised to “end welfare as we know it” in his 1992 election campaign, eliminating the biggest USA anti poverty program (Aid to Families with Dependent Children) and replacing it with a term limited program that tries to force aid recipients to work for their benefits (‘workfare’ rather than ‘welfare’).

Outside the USA the more left wing parties such as the Labour Party in the UK pursued similar strategies (such as ‘work for the dole‘). Neoclassical economic theory provided a strong justification for these economic and social ‘reforms’ as policy would rely more heavily on ‘market outcomes’ while reducing ‘govemment interference” into the workings of the ‘invisible hand’.

Economics, ‘The Dismal Science’: While resources are scarce, our wants are unlimited.

Finally, let us tum to the neoclassical definition of economics, as it provides a very nice summary of the approach taken.

Neoclassical Definition of Economics: The study of the allocation of scarce resources among unlimited wants.

This is often framed as ‘the economic problem”: while resources are scarce, our wants are unlimited. The ‘problem‘ is that we cannot ever satisfy our wants. Many call economics ‘the dismal science’, which comes from this statement of ‘the problem’. While we all try to ‘maximise utility’, resource constraints prevent us from ever achieving maximal bliss.

Another common statement attributed to economists is that ‘there‘s no such thing as a free lunch”, which also derives from the definition. Since resources are scarce, there is always a trade off: if we move resources from one use to another. we necessarily reduce enjoyment in the first use in favour of enjoyment in the second. For example, if we want to have more ‘guns’, we must have less ‘butter’. Or if we want to improve the standard of living enjoyed by ‘Bob’, we must reduce the living standard of ‘Jill”.

Strictly speaking. this would be true only at full employment of all resources However. with the invisible hand guiding the allocation of resources, flexible relative prices ensure that all scarce resources are fully employed. The idea is that prices will always fall until supply equals demand so that no resource is left idle.

Note also that the trade off might only be temporary. For example, if we move resources out of the production of consumption goods and into the production of investment goods that raise productive capacity, then in the future we can have more consumer goods. Through economic growth we can increase the quantity of resources so that both ‘Bob‘ and ‘Jill‘ can have more. This does not violate the admonition that there is no free lunch, however. If we axe to have more production in the future, we need to sacrifice some consumption today, we suffer today with lower consumption, but we are willing to endure the ‘pain’ on the promise that in the future we can enjoy more consumption.

We will have much more to say about the neoclassical approach later in the text. However, it is time to move on to the second approach to economics.

Heterodox, Keynesian, Institutionalist, Marxist approach

Since human survival requires cooperation, selfishness would actually be irrational as it would reduce one’s chances of survival.

There is a second, long, tradition in economics that adopts a quite different framework. Unfortunately, there is no strong consensus about what to call it. Sometimes it is called ‘nonorthodox‘, which appears to define it in opposition to ‘orthodox’ or neoclassical economies. In recent years, many of those working in this tradition have settled on the term ‘heterodox’, but that, too, is usually defined as ‘not in agreement with accepted beliefs”. Yet at one time, those views now associated with ‘heterodox‘ economics were dominant, while the ‘orthodox’ views were considered by most economists as ‘unorthodox’ in the sense that they were not in agreement with the beliefs held by most economists!

Further, unlike neoclassical theory. which is substantially accepted by all orthodox theorists, ‘heterodoxy’ is made up of a number of well established and coherent economic schools of thought. While these share a common approach, they also deviate from one another in important ways.

The three most imponant of these schools of thought are the Marxist (following the work of Karl Marx), the Institutionalist (following the work of Thorstein Veblen), and the Keynesian (followers of John Maynard Keynes).

What are we to do? In spite of the objections we raised, we will conform to the convention and call this second approach the heterodox or Keynesian/Institutionalist/Marxist approach.

Let us examine the shared framework adopted.

First, according to this approach there is no ‘natural’ human behaviour; rather, it is shaped by institutions, culture, and society. There is nothing ‘natural’ about self interested (or, better, ‘selfish’) behaviour, nor would such behaviour be ‘rational‘ in the neoclassical sense. Humans are social animals and in many cultures, selfish behaviour is punished and selfish individuals are ostracised. Since human survival requires cooperation, selfishness would actually be irrational as it would reduce one’s chances of survival. In any event, in all known societies, elaborate rituals and traditions are designed to promote cooperation and even sacrifice for the common good.

Human behaviour varies significantly across societies, and the economic system is one factor that helps to determine appropriate behaviour within any particular society. Selfinterested behaviour is more acceptable in some societies than in others. It is not a coincidence that neoclassical economic theory was developed largely in Western capitalist societies, and particularly in England. The ‘rational’ behaviour attributed by neoclassical economists to all humans actually comes reasonably close as a description of the behaviour of early British capitalists. In the social environment in which they operated, pursuit of their own self interest without regard to the welfare of others (especially that of their employees), may have increased their probability of success as capitalists. Further, they operated in a hostile political climate in which the Crown and their feudal lord cronies wanted to increase their own share of the nation’s rather feeble output.

Government ‘intervention’ was almost always a bad thing, from the perspective of the first capitalists because government operated substantially in the interest of the Crown and the feudal lords.

We will not go into economic history now. What we wish to emphasise is that human behaviour is surprisingly malleable and complexly influenced by custom and tradition.

Further, most decisions are not ‘rational‘ for another reason: the future is uncertain, and even the present and past are uncertain in the sense that we do not fully understand what happened and what is now happening. Clearly, we do not know the future, and we know that we do not. Hence, we cannot know for cenain that any action we take is truly ‘utility maximising’. Should I buy the Renault or the Mazda? Once the decision is made and with the passage of time, I might have a better idea of the best choice, but it is probable that even a decade down the road I will not know which would have been best. Obviously, that choice is relatively unimportant and even simple compared to most economic choices one must make. In truth, we almost never know whether we are ‘maximising’ utility, indeed even with hindsight we often cannot tell if we made the right decision.

According to the heterodox approach, most decisions are not ‘rational’ in the neoclassical sense of the term. Decisions and behaviour depend on a range of other factors, including uncertainty, power, discrimination. prejudice, and segregation. Optiuns available depend on status, social class, race, religion, and gender, for example. These ‘noneconomic’ factors heavily influence and even constrain our choices.

Heterodoxy rejects the notion that economic outcomes are arbitrated by an impersonal market that only seeks to equilibrate ‘demand and supply‘. Actually, market prices are largely administered by firms with market power that allows them to discriminate. Wages are set not to ‘clear‘ the labour market, but rather reflect the outcome of conflicted bargaining processes.

Capitalism is a system defined by class conflict. In general, workers want to earn as much as they can for the effort they expend, while bosses want workers to produce as much as they can but pay them as little as possible. And, as will be discussed later, unemployment cannot be eliminated through wage reductions that eliminate relative excess labour supply; indeed wage reductions can actually reduce the demand for labour and thus increase unemployment.

More generally, wages and other prices are not simply signals of the invisible hand. but rather determine incomes and thus influence business sales and decisions going forward. For that reason, price and wage determination are not usually left to the invisible hand of the market.

Heterodoxy holds a different view of the so called ‘economic problem” of scarce resources and unlimited wants. Wants are largely socially created. and there is nothing natural about humans having ‘unlimited‘ wants. While it is true that modern advertising operates to continually expand our desires. this can be countered through education.

Further, resources are also largely socially created. While it is true that some natural resources have a limited supply, innovations continually produce substitutes. For example. Western societies faced their first major energy crisis in the l9th century when whalers had significantly reduced the number of whales, the source of whale oil used for lighting and other purposes. However, the production of petroleum and then electricity quickly replaced whale oil.

Moreover. the most important resource in any economy is labour. Ironically, in capitalist economies labour is virtually always in excess supply that is, many workers are left unemployed. It is ironic that neoclassical economics starts from the presumption that resources are scarce, when the obvious empirical fact is that labour is unemployed. Any theory that begins with the presumption that labour is always fully employed, and hence scarce, is ignoring a glaring inconsistency.

Let us look at the heterodox definition of economics.

Heterodox Definition of Economics: the study of social creation and social distribution of society’s resources.

Note that unlike the orthodox definition. this one focuses on the creation of resources. Further, most of that creation is social, rather than individual: people work together to produce society’s resources. Distribution, too, is socially determined, rather than determined by a technical relation (one‘s contribution to the production process). For example, labour unions engage in collective bargaining with their employers, who also band together to keep wages low.

The political process is also important in determining distribution; not only does government directly provide income to large segments of society, but it also puts in place minimum wages, benefits, and working conditions that must be met by employers Government is also a creator of resources; it is not just a user of them. It organises and funds innovative research and development (often in its own labs) that is then used to create resources (frequently by private firms). It also purchases directly from firms, encouraging them to increase hiring and output.

Not only do these government activities increase production, but they also affect distribution. This is well understood by voters and their representatives in government as policy creates winners and losers and not usually in a zero sum manner: some policies can create winners while others might create more losers.

Power, discrimination, collusion, and cooperation all play a role in determining ‘who gets what’. The point is that society does not have to let ‘the market’ decide that women should be paid less than men, for example, or that those with less education should remain jobless and thus poor.

Economics, like all social sciences. is concerned with a society that is complex and continually undergoing change. Since economists study human behaviour in the economic sphere, their task is very difficult. Whatever humans do. they could have done something different. Humans have some degree of free will, and their behaviour is largely based on what they think they ought to do. That in turn depends on their expectations of an unknowable future they do not know precisely what the outcome of their actions will be, and they do not know what others will do.

Indeed. humans do not know exactly what happened in the past. nor do they fully understand what is happening today. They must interpret the environment in which they live. and realise that they cannot fully understand it. They can never know if they have truly ‘maximised’ their pleasure. They make plans in conditions of existential uncertainty, and do the best they can do given their circumstances. Their actions are almost always taken with consideration given to the impacts on others, humans are above all social animals and that is why economics must be a branch of the social sciences.

What do economists do?

Like sociologists and political scientists economists are trying to understand particular aspects of human behaviour, for example decisions about levels and patterns of spending, choices about enrolment in post school education and types of employment to pursue, which we argue above, are influenced by institutions; culture; and society; in addition to economic variables. such as income: the prices of goods: and prospective wage rates for different occupations.

In microeconomics our focus is the behaviour of individual consumers and firms. whereas in macroeconomics the focus is the aggregate impacts of these decisions on outcomes. including total output and employment and the rate of inflation. We elaborate on these definitions of microeconomics and macroeconomics below.

In trying to understand particular forms of economic behaviour we need to develop theories that require us to decide on those factors that we think influence the particular economic decisions of interest. In other words, we need to make simplifying assumptions (engage in abstraction). which means we necessarily ignore those factors that we consider to be irrelevant. Otherwise we are trying to replicate the complex reality, as we see it, and we are engaging in description rather than theorising. In the development of theory, concepts are formulated, which can be viewed as the building blocks of theory. A model can be viewed as the formalisation of a theory (see below). To understand any theory (model). it is important that students comprehend the underlying concepts.

Social scientists seek to confront their abstract theoretical models, expressed in the form of conjectures about real world behaviour, with the empirical data that the real world provides. For example. we might form the conjecture that if disposable income rises, household consumption will rise. We would then collect the relevant data for disposable income and household consumption and any other information we thought might bear on the relationship and use various statistical tools (for example, regression analysis) to enumerate the relationship between disposable income and household consumption to see whether our conjecture was data consistent.

In engaging in this sort of exercise, the responsible social scientist is not seeking to establish whether the theoretical model is true, for that is an impossible task, given there is no way of knowing what the truth is anyway. Instead, we seek to develop theories or conjectures that provide the best correspondence with the empirical world we live in. This means our current, accepted body of knowledge comprises theories and conjectures that explain the real world data in the most comprehensive way when compared to the competing theories.

Further, we can rarely refute a theory. As President Truman complained, there are two or more sides to the most important economic questions, so there are competing theoretical approaches yielding different conclusions. Even when a researcher resorts to the analysis of relevant data, (which often entails the use of econometrics), they can never refute a theory with 100 per cent confidence. Often the acceptance of a theory is driven by ideology and politics, rather than a balanced assessment of the competing theories and associated evidence.

Implications for research and policy

Many students, like President Truman. find the inability of economists to come up with definitive answers to economic questions to be rather frustrating. Here it is important to emphasise that, like physical sciences and other social sciences, economics is a contested discipline, as is illustrated by our brief discussion of the two schools of thought. Students will be exposed to some major contemporary debates in macroeconomics later in this textbook, but below we outline a long standing debate in developed economies, such as the UK, USA and Australia, about the impact of an increase in the minimum wage on unemployment.

If there are longstanding debates in economics (and other disciplines), which appear to be unresolved, how can there be progress in our understanding of economic phenomena? This is an important question because decisions made by macroeconomic policymakers have profound effects on the welfare of the population in terms of for example, employment opportunities and wages. Thomas Kuhn developed a way of understanding how progress is made in the social and physical sciences.

What is Macroeconomics?

The study of employment, output and inflation.

In macroeconomics we study the aggregate outcomes of economic behaviour. The word ‘macro’ is derived from the Greek word ‘makro’, which means large and so we take an economy wide perspective.

Macroeconomics is not concerned with analysing how each individual person, household or business firm behaves or what they produce or earn that is the terrain of the other major branch of economic analysis, microeconomics. Macroeconomics focuses on a selected few outcomes at the aggregate level and is rightly considered to be the study of employment, output and inflation in an international context. A coherent macroeconomic theory will provide consistent insights into how each of these aggregates is determined and change.

In this regard, there are some key macroeconomic questions that we seek to explore:

1. What factors determine the flow of total output produced in the economy over a given period and its growth over time?

2. What factors determine total employment and why does mass unemployment occur?

3. What factors determine the evolution of prices in the economy (inflation)?

4. How does the domestic economy interact with the rest of the world and what are the implications of that interaction?

A central idea in economics, whether it is microeconomics or macroeconomics, is efficiency getting the best out of what you have available. The concept is extremely loaded and is the focus of many disputes, some more arcane than others. But there is a general consensus among economists that at the macroeconomic level, the ‘efftciency frontier’ (which defines the best outcome achievable from an array of possible outcomes) is normally summarised in terms of full employment. The hot debate that has occupied economists for years is the exact meaning of the term full employment.

We will consider that issue in full in Chapters 11 and 12. But definitional disputes aside, it is a fact that the concept of full employment is a central focus of macroeconomic theory. Using the available macroeconomic resources including labour to the limit is a key goal of macroeconomics. The debate is over what the actual limit is. The related macroeconomic challenge is how to maintain full employment but at the same time achieve price stability, which means that prices are growing at a low and stable rate.

The clear point is that if you achieve that goal then you will be contributing to the prosperity and welfare of the population by ensuring real output levels are high within an environment of stable prices.

This book develops a framework for understanding the key determinants of these aggregate outcomes, the level and growth in output; the rate of unemployment; and the rate of inflation within the context of what we call a monetary system.

All economies use currencies as a way to facilitate transactions. The arrangements by which the currency enters the economy and the role that the currency issuer, the national government, has in influencing the outcomes at the aggregate level, is a crucial part of macroeconomics. Modern Monetary Theory (MMT), which is briefly outlined below, develops a macroeconomic framework that incorporates the unique features of the monetary system.

The MMT approach to macroeconomics

Modern Monetary Theory (MMT) is distinguished from other approaches to macroeconomics because it places the monetary arrangements at the centre of the analysis. Learning macroeconomics from an MMT perspective requires you to understand how money ‘works’ in the modern economy and to develop a conceptual structure for analysing the economy as it actually exists.

Most people are unaware that a major historical event occurred in 1971, when US President Nixon abandoned gold convertibility and ended the system of fixed exchange rates. Under that system, which had endured for about 80 years (with breaks for war), currencies were convertible into gold, exchange rates were fixed, and governments could expand their spending only by increasing taxes or borrowing from the private sector. After 1971, most governments issued their own currencies by legislative fiat; the currencies were not convertible into anything of value, and were floated and traded freely in foreign currency markets.

It is thus essential to understand the notion of a currency regime, which can range through a continuum from fixed exchange rate systems to floating exchange rate systems with varying degrees of exchange rate management in between. Understanding the way the exchange rate is set is important because it allows us to appreciate the various policy options that the currency issuer, the government has in relation to influencing the main objects of our study; employment, output and inflation.

A flexible exchange rate releases monetary policy from defending a fixed parity against a foreign currency. Fiscal and monetary policy can then concentrate on ensuring domestic spending is sufficient to maintain high levels of employment. A consequence of this is that governments that issue their own currencies no longer have to ‘fund‘ their spending. They never need to ‘finance’ their spending through taxes or selling debt to the private sector.

The reality is that currency issuing governments such as those of Australia, Britain, Japan and the US can never run out of money. These governments always have the capacity to spend in their own currencies.

Most of the analysis appearing in macroeconomics textbooks, which filters into the public debate and underpins the cult of austerity, is derived from ‘gold standard’ logic and does not apply to modern fiat monetary systems. Economic policy ideas that dominate the current debate are artefacts from the old system, which was abandoned in 1971.

At the heart of macroeconomics is the notion that at the aggregate level, total spending equals total income and total output. In turn, total employment is related to the total output in the economy. So to understand employment and output determination we need to understand what drives total spending and how that generates income, output and the demand for labour.

In this context, we will consider the behaviour and interactions of the two economic sectors that is, government and non govemment. Then we will unpack the non government into its component sectors, the private domestic sector (consumption and investment) and the external sector (trade and capital flows). In Chapter 4 we analyse in detail the so called National Accounts, drawing on these broad macroeconomic sectors. This approach is called the sectoral balance approach, which builds on the accounting rule that a deficit in one sector must be offset by surpluses in the other in the case of the government non government dichotomy.

More generally, the sum of the sectoral balances nets to zero when we consider the government, private, domestic and external sectors.

If one sector spends more than its income, at least one of the others must spend less than its income because for the economy as a whole, total spending must equal total receipts or income. While there is no reason why any one sector has to mm a balanced budget, the National Accounts framework shows that the system as a whole must. Often though, but not always, the private domestic sector rus a surplus, spending less than its income. This is how it accumulates net financial wealth. Overall private domestic sector saving (or surplus) is a leakage from the overall expenditure cycle that must be matched by an injection of spending from another sector. The current account deficit (the so called external sector account) is another leakage that drains domestic demand. That is, the domestic economy is spending more overseas than foreigners are spending in the domestic economy.

Here it is useful to differentiate between a stock and a flow. The latter is a magnitude per period of time. For example, spending is always a flow of currency per period (for example, households might spend $100 billion dollars in the first three months of 2016). On the other hand, a stock is measured at a point in time. For example, a student’s financial wealth could consist of a deposit account at a local bank, with a balance of $1000 on January 1, 2016.

The sectoral balances framework, outlined later, shows that a sectoral deficit (a flow, say per year) accumulates, as a matter of accounting to a financial debt (a stock). On the other hand, a sequence of sectoral surpluses accumulate to a financial asset which is also a stock.

MMT is thus based on what is known as a stock flow consistent approach to macroeconomics where all flows and resulting stocks are accounted for in an exhaustive fashion. The failure to adhere to a stock flow consistent approach can lead to erroneous analytical conclusions and poor policy design.

From the perspective of fiscal policy choices, an important aspect of the stock flow consistent approach that will be explained in greater detail in Chapter 5, is that one sector’s spending flow equals its income flow plus changes to its financial balance (stock of assets).

The textbook will show that a country can only run a current account deficit if the rest of the world wishes to accumulate financial claims on the nation (financial debt). Often these claims are in the form of government debt. The MMT framework shows that for most govemments, there is no default risk on government debt, and therefore such a situation is ‘sustainable’ and should not be interpreted to be necessarily undesirable. Any assessment of the fiscal position of a nation must be taken in the light of the usefulness of the govemment’s spending program in achieving its national socio-economic goals.

This is what Abba Lerner (1943) called the ‘functional finance” approach. Rather than adopting some desired budgetary outcome, government ought to spend and tax with a view to achieving ‘functionally’ defined outcomes, such as full employment.

0n matters of terminology, we avoid using the term ‘budget’ to describe the spending and taxation outcomes for the currency issuing government. Instead, we use to the term fiscal balance. A government fiscal deficit occurs when its spending exceeds its taxation revenue, whereas a fiscal surplus occurs when govemment spending is less than its taxation revenue.

The use of the term ‘budget’ to describe the fiscal balance invokes the idea that the currency issuing government faces the same ‘budget’ constraints as a household.

A careful understanding of the monetary system will make it obvious that the government is not a ‘big household”. The government can consistently spend more than its revenue because it creates the currency.

Households use the currency issued by the government and must finance their spending. Our access is constrained by the sources of available funds, including income from all sources, asset sales, and borrowings from external parties.

Whereas households have to save (spend less than they earn) to spend more in the future, governments can purchase whatever they like, as long as there are goods and services for sale in the currency they issue.

A sovereign government must spend first before it can subsequently tax or borrow. A household cannot spend more than its revenue indefinitely because continuously increasing private debt is unsustainable. The budget choices facing a household are thus limited and prevent permanent deficits. A currency issuing government can never be revenue constrained in a technical sense and can sustain deficits indefinitely without solvency risk.

In other words, our own personal budget experience generates no knowledge relevant to consideration of government matters.

The alternative narrative, which we present in this book, highlights the special characteristics of the government’s currency monopoly.

Fiscal surpluses provide no greater capacity to governments to meet future needs, nor do fiscal deficits erode that capacity. Governments always have the capacity to spend in their own currencies. The consequences of a fiscal surplus, the government spending less than it is taking out of the economy by way of taxation when a nation runs an external deficit will also be outlined.

In summary, budget surpluses force the non government sector into deficit and the domestic private sector is forced to accumulate ever increasing levels of indebtedness to maintain its expenditure. The textbook will explain why this is an unsustainable growth strategy and how eventually the private domestic sector is forced to reduce its risky debt levels by saving more and the resulting drop in non government spending will reinforce the negative impact of the government fiscal surplus on total spending.

The macro model

To organise the way of thinking in this regard we use a conceptual structure sometimes referred in the economics literature as a model, in this case a macroeconomic model. A model is just an organising framework and is a simplification of the system that is being investigated. In this textbook, we will develop a macroeconomic model, which combines narrative and some algebra to advance your understanding of how the real world economy operates. We will necessarily stylise where complexity hinders clarity, but we will always focus on the real world rather than an assumed world that has no relevance to the actual economy.

All disciplines develop their own language as a way of communicating. One might think that this just makes it harder to understand the ideas and we have sympathy for that view. But we also understand that students of a specific discipline, in this case macroeconomics should be somewhat conversant with the language of the discipline they are studying.

A macroeconomic model draws on concepts and algebraic techniques to advance our understanding of the main economic aggregates (such as output, employment and price level). This textbook design is unique because it specifically develops the MMT macroeconomic model, which will be applicable to the real world issues including economic policy debates. The application to policy is important because macroeconomics is what might be termed a policy science.

By placing government as the currency issuer at the centre of the monetary system we immediately focus on how it spends and how that spending influences the major macroeconomic aggregates that we seek to explain.

The framework will at first, provide a general analysis of government spending that applies to all currency exchange rate systems before explaining the constraints (policy options) that apply to governments as we move from a flexible exchange rate to a fixed exchange rate system. We will consider how the design of the monetary system impacts on the domestic policy choices open to government and the outcomes of specific policy choices in terms of output, employment and inflation.

Fiscal and monetary policy

The two main policy tools that influence what is termed the demand or spending side of the economy are monetary and fiscal policy.

Fiscal policy is represented by the spending and taxation choices made by the government (the ‘treasury’). The net financial accounting outcomes of these decisions are summarised periodically by the government fiscal position. Fiscal policy is one of the major means by which the government seeks to influence overall spending in the economy and achieve its aims.

The textbook will show that a nation will have maximum fiscal space:

– If it operates with a sovereign currency; that is. a currency that is issued by the sovereign government and its value is not pegged to foreign currencies; and

– If it avoids incurring debt in foreign currencies. and avoids guaranteeing the foreign currency debt of domestic entities (firms, households, and state, province, or city debts).

Under these conditions, the national government can always afford to purchase anything that is available for sale in its own currency. This means that if there are unemployed resources, the government can always mobilise them putting them to productive use through the use of fiscal policy. Such a government is not revenue constrained. which means it does not face the financing constraints that a private household or firm faces in framing its expenditure decisions.

To put it as simply as possible ~ this means that if there are unemployed workers who are willing to work, a sovereign government can afford to hire them to perform useful work in the public interest.

From a macroeconomic efficiency argument, a primary aim of public policy is to fully utilise available resources.

The central bank in the economy is responsible for the conduct of monetary policy, which typically involves the setting of a short term policy target interest rate (Fed Funds in the USA, also called bank rate in many counuies). In the recent global economic crisis the ambit of monetary policy has broadened considerably and these developments will be considered in Chapter 15.

The typical roles of a central bank include not only the conduct of monetary policy via the overnight interbank lending rate, but also operating the interbank clearing mechanism (so that bank cheques clear among banks), acting as lender of last resort (to stop bank runs), and regulating and supervising the banks.

MMT considers the treasury and central bank functions to be part of what is termed the consolidated government sector. In many textbooks, students are told that the central bank is independent from government. The MMT macroeconomic model will demonstrate how it is impossible for the two parts of government to work independently if the monetary system is to operate smoothly.

Policy implications for sovereign nations

MMT provides a broad theoretical macroeconomic framework based on the recognition that sovereign currency systems are in fact public monopolies per se, and that the imposition of taxes coupled with insufficient govemment spending generates unemployment.

An understanding of this point will be developed to allow the student to appreciate the role that government can play in maintaining its near universal dual mandates of price stability and full employment. The student will learn that there are two broad approaches to control inflation available to government in designing its fiscal policy choices.

Both approaches draw on the concept of a buffer stock to control prices. We will examine the differences between the use of:

a) Unemployment buffer stocks: The neoclassical approach, which describes the current policy orthodoxy, seeks to control inflation through the use of high interest rates (tight monetary policy) and restrictive fiscal policy (austerity). which leads to a buffer stock of unemployment. In Chapters 11 and 12. students will learn that this approach is very costly and provides an unreliable target for policy makers to pursue as a means for inflation proofing; and

b) Employment buffer stocks: Under this approach the government exploits its fiscal capacity, inherent in its currency issuing status, to create an employment buffer stock. In MMT, this is called the Job Guarantee (JG) approach to full employment and price stability. This model. which is considered by MMT to be the superior buffer stock option, is explained in detail in Chapter 12.

The MMT macroeconomic framework shows that a superior use of the labour slack necessary to achieve price stability is to implement an employment program for those who are otherwise unemployed as an activity floor in the real output sector, which both anchors the general price level to the price of employed labour of this (currently unemployed) buffer and can produce useful output with positive supply side effects.

Macro and the Public Purpose

The households and business firms in a modern capitalist economy make many of the important economic decisions that contribute to determination of the level of employment and output, the composition of that output, the distribution of income, and the prices at which output is sold. Claims are sometimes made that a ‘free market‘ economy comprised of individuals seeking only their own self interest can operate ‘harmoniously’ as if guided by an ‘invisible hand’.

In fact, economists had rigorously demonstrated by the 1950s that the conditions under which such a stylised economy could reach such a result couldn’t exist in the real world. In other words:

There is no scientific basis for the claim that ‘free markets’ are best.

In any case, these claims, even if true for some hypothesised economy, are irrelevant for the modem capitalist economies that actually exist. This is because all modern capitalist economies are ‘mixed‘, with huge corporations (including multinational firms), labour organisations, and big government. Individuals and firms operate within socio political cultural economic structures that are constraining but also enabling.

Sometimes the goals of individuals and firms coincide with what might be called the public purpose, while often they do not. In this section we will discuss the public purpose and the role played by government in trying to align private interests with socially progressive goals.

What is the public purpose? It is not easy to define or to identify the public purpose. One of the basic functions of any social organisation is to provide the necessary food, clothing, shelter, education, health care, legal framework, and socialisation for survival of the society.

While the subject of this course is economics, there is no sharp distinction between the sphere of economics and the spheres of other social sciences that study social processes. We usually think of the economy as the part of the social organisation that is responsible for provision of the material means of survival, the food. clothing, shelter, and so on. However, the economy is always embedded in the social organisation as a whole, affecting and affected by culture, politics, and social institutions.

Even if we can agree that any successful economic organisation should be able to produce adequate food for its population, that still leaves open many questions: What kind of food?; How should it be produced?; How should it be distributed?; and even, What does adequate mean?

Further, the society is comprised of harmonious individuals and groups. There are always conflicting claims and goals that must be moderated. There is no single, obvious public purpose to which all members of a society wish to strive. Even if we can identify a set of goals that the majority of society would like to work toward, that set will surely change over time as hopes and dreams evolve. The public purpose is an evolving concept.

The position taken in this book is that there is no ‘invisible hand’ that ensures that private interests are consistent with the public purpose. Indeed, the economy is just one component of the social organisation that is necessary to establish the always evolving public purpose and that is necessary to work towards achievement of the public purpose.

The ‘market’ is just one institution among a wide variety of social institutions working to delineate social goals that comprise the social and private purposes. Other institutions include political organisations, labour unions, manufacturers. and NGOs (non governmental organisations).

As we noted at the beginning of this Chapter, the national government must play an important role in society as it can help to identify the social purpose and to establish a social structure in which individuals and groups will work toward achieving the social purpose.

While it is admittedly difficult to outline what defines the social purpose, it is possible to identify widely accepted goals. For example, the United Nations Universal Declaration of Human Rights (1948) commits signatory nations to a common set of relatively well defined goals.

The declaration is outlined on the United Nations Home Page:

Now, Therefore THE GENERAL ASSEMBLY proclaims THIS UNIVERSAL DECLARATION OF HUMAN RIGHTS as a common standard of achievement for all peoples and all nations, to the end that every individual and every organ of society, keeping this Declaration constantly in mind, shall strive by teaching and education to promote respect for these rights and freedoms and by progressive measures, national and international, to secure their universal and effective recognition and observance, both among the peoples of Member States themselves and among the peoples of territories under their jurisdiction.

The Articles that define the Declaration include:

– Everyone has the right to life, liberty and security of person.

– No one shall be held in slavery or servitude; slavery and the slave trade shall be prohibited in all their forms.

– Everyone has the right to an effective remedy by the competent national tribunals for acts violating the fundamental rights granted them by the constitution or by law.

– Everyone has the right to freedom of movement and residence within the borders of each State.

– Everyone has the right to a nationality.

– Men and women of full age, without any limitation due to race, nationality or religion, have the right to marry and to found a family. They are entitled to equal rights as to marriage, during marriage and at its dissolution.

– Everyone has the right to own property alone as well as in association with others.

– Everyone has the right to freedom of thought, conscience and religion; this right includes freedom to change their religion or belief, and freedom, either alone or in community with others and in public or private, to manifest their religion or belief in teaching, practice, worship and observance.

– Everyone has the right to freedom of opinion and expression; this right includes freedom to hold opinions without interference and to seek, receive and impart infomation and ideas through any media and regardless of frontiers.

– Everyone has the right to freedom of peaceful assembly and association.

– Everyone has the right to take part in the government of their country, directly or through freely chosen representatives.

– Everyone has the right of equal access to public service in their country.

– Everyone, as a member of society, has the right to social security and is entitled to realisation, through national effort and international co-operation and in accordance with the organisation and resources of each State, of the economic, social and cultural rights indispensable for their dignity and the free development of their personality.

– Everyone has the right to work, to free choice of employment, to just and favourable conditions of work and to protection against unemployment

– Everyone, without any discrimination, has the right to equal pay for equal work.

– Everyone who works has the right to just and favourable remuneration ensuring for themselves and their family an existence worthy of human dignity, and supplemented, if necessary, by other means of social protection.

– Everyone has the right to form and to join trade unions for the protection of their interests.

– Everyone has the right to rest and leisure, including reasonable limitation of working hours and periodic holidays with pay.

– Everyone has the right to a standard of living adequate for the health and well being of themselves and of their family, including food, clothing, housing and medical care and necessary social services, and the right to security in the event of unemployment, sickness, disability, widowhood, old age or other lack of livelihood in circumstances beyond their control.

– Everyone has the right to education. Education shall be free, at least in the elementary and fundamental stages. Elementary education shall be compulsory. Technical and professional education shall be made generally available and higher education shall be equally accessible to all on the basis of merit.

– Everyone has the right freely to participate in the cultural life of the community, to enjoy the arts and to share in scientific advancement and its benefits.

It is obvious that many of these identified human rights, especially near to the end of this list, are connected to the operation of the economy. For example, we argued above that any successful economy should provide adequate food, clothing, and shelter, and many of the human rights listed in the UN Charter address the material well being of a nation‘s population.

Further, other human rights that superficially appear to be unrelated to economic performance actually presuppose fulfilment of other human rights that are directly related to material well being.

For example, in a modern capitalist economy access to employment (one of the recognised rights) is necessary for full participation in society. Not only does a job provide income that allows one to purchase food, clothing, and shelter, but it also provides access to social networks, generates feelings of self worth as one contributes to social production, enhances social prestige, and helps to provide for retirement in old age.

Indeed, employment has been shown to have a wide range of other benefits to individuals and to society including better physical and psychological health, reduced crime and drug abuse, lower child and spouse abuse, and greater participation in other social and political activities.

To be sure, this list (which is itself only a partial listing of the agreed universal rights) includes many rights that have not been fully achieved even in the wealthiest and most democratic nations. In that sense, these rights are ‘aspirational’, with the signatory nations committing to striving toward achieving them. Again, if we look at the example of the right to work and to an adequate standard of living, those are rights that are routinely violated even in the best of times in the wealthiest of nations. Still, these universally recognised rights provide a measure against which nations can measure their progress.

Concluding thoughts on the public purpose

We conclude with three important points.

First, this reason the public purpose is broad and evolving over time, and for these reasons it varies across time and place. It should include rising living standards, particularly for those at the bottom of society. Environmental sustainability must be included. Reduction of racial, ethnic, and gender inequalities across the full socio political economic spectrum is an important component of the public purpose. This must go beyond simple economic measures such as family income to include full participation in the life of the community. The public purpose also should include reductions of crime. corruption, cronyism, invidious distinction, conspicuous consumption, and other social pathologies.

Second the UN Charter lays out what it sees as ‘universal’ human rights This is a useful, but not wholly satisfactory list to be included in a statement of the public purpose. What is considered to be a human right today might have appeared to be radically Utopian a century ago; and today’s list will appear far too cautiously conservative at some date in the future.

The public purpose is inherently a progressive agenda that strives to continually improve the material, social, physical, cultural, and psychological well being of all members of society. It is inherently ‘aspirational‘ in the sense that there is no end point as the frontiers of the public purpose will continually expand.

Third, the national government as well as international organisations (such as the United Nations) must play important roles in shaping our vision regarding the types of societies to which we aspire. And beyond setting these goals, governments at all levels must take the lead in developing sets of institutions, rules of behaviour, and sanctions for undesirable behaviour in order to move toward reaching the goals set as the public purpose.

As an example that demonstrates these points, a half century ago national governments and international organisations set about to eliminate the devastating disease known as smallpox. While markets and for profit production played a role in helping to develop vaccines, in distributing the vaccines, and in formulating information campaigns, private initiative alone would never have eliminated the disease.

The task was too big, it was not completely consistent with the self interest of profit seeking behaviour, and it required intemational cooperation beyond the reach of even the largest firms.

Hence, governmental organisations had to play a role.

With respect to the aspirational nature of the public purpose, successful elimination of smallpox would not be the end, but rather would serve as the beginning of a new campaign, to eliminate another disease, and then another and yet another.

Perhaps in a long distant future, a human right to a disease free life would be recognised, adding to an ever increasing list of established rights that all nations would be expected to protect.

While we cannot, of course, imagine such a future, it was not so long ago that the Congress of the US did not recognise the voting rights of women and African Americans. Today, any nation that denies the vote to members of society on the basis of gender, religion, race or ethnicity, or national origin is considered to be in violation of human rights, and thus, to be an international pariah, even though such restrictions were considered acceptable just a few generations ago. For example, white US women over the age of 21 did not secure the vote until the 1920 Presidential election, whereas in the UK suffrage was extended to all women over the age of 21 in 1928. In Australia aborigines were granted the right to enrol and vote in Federal elections in 1962. Many developed countries did not give women or minorities the vote until the 20th Century.

The public purpose is inherently progressive; it can never be finished.

Chapter 2:. How to Think and Do Macroeconomics

. . .

from

Modern Monetary Theory and Practice. An Introductory Text

by William Mitchell, L. Randall Wray and Martin Watts

get it at Amazon.com

Why even supply-siders know Trickle Down is rubbish. Even if you build it, the poor can’t come – Mark R Reiff.

Supply creates its own demand?

Wrong!

When you build more stuff, it is not true that all the costs of production are introduced into the economy as new money. You have merely injected new money to the extent you have incurred additional marginal costs, labour and materials mostly. Most fixed costs don’t rise with the increased production.

And it is unlikely that a producer would take the risk of ramping up production in a troubled economic environment if all that could be recovered was the marginal costs.

And no reasonable business person thinks that enough new money can be introduced by increasing production alone. If they did, record amounts of cash wouldn’t be sitting in corporate bank accounts doing nothing.

Obviously, the people who control this cash don’t believe that supply creates its own demand. They think that increasing production without first seeing an increase in demand would be foolhardy.

‘If you build it, they will come.’

It’s a Latin saying, Si tu id aeficas, ei venient, but it’s probably more recognisable because it sounds like what that disembodied voice says to Kevin Costner in the film Field of Dreams (1989). And in the film, Costner does build it, a baseball field, and people do come. In either case, it’s a good way of summing up the case for supply-side economics.

But to understand that case, we need to break it down into its constituent elements. And the thinking behind it goes like this: if you want to stimulate the economy, then cut taxes on the rich, those who invest in and build things, and they will use this extra money to produce more stuff. Why? Because supply creates its own demand, so if they produce more they will sell more, and the economy will expand. An expanding economy, in turn, benefits everybody. There will be more jobs, wages will be higher, and government budget deficits will shrink.

This latter effect, of course, might seem counterintuitive. But the argument is that even though tax rates go down, the amount of economic activity these cuts unleash will grow everyone’s income to such an extent that the total tax collected by the government, even at these lower rates, will actually go up.

That’s what the supply-siders contend.

Given that the supply-side approach has been the policy of the Republican Party for decades, this argument has proved convincing to a lot of people. But let’s look at it a little more carefully.

The notion that supply creates its own demand is known as Say’s law, after the French economist Jean Baptiste Say (1767-1832) who is credited with its formulation. The thought is that when you produce more, you have to spend additional money to do so. This additional spending, in turn, provides people with extra income, and therefore the wherewithal to buy the additional goods you have created.

Of course, you cannot just build anything. To sell more of something, it has to be something that people actually want. Say himself acknowledged this. But let’s focus on the mechanics of how increasing production is supposed to give people the wherewithal to purchase more of what they do want. Unfortunately, the presumptions here just don’t make sense.

First, at most, building more goods simply introduces funds equivalent to their cost of production into the economy. But things don’t sell for their cost of production no one builds anything unless they think they can price it at a profit. And if you don’t think people will have enough new money to pay this price, why would you increase production?

Second, a lot of the costs of production are what economists call ‘fixed’ costs; that is, the cost of big things such as factories and office buildings and expensive machines and equipment, rather than the costs of the additional labour and supplies necessary to build one extra thing, which are called ‘marginal’ costs. The total cost of production combines fixed and marginal costs, and fixed costs usually represent the far greater share. This means that when you build more stuff, it is not true that all the costs of production are introduced into the economy as new money.

You have merely injected new money to the extent you have incurred additional marginal costs.

And it is unlikely that a producer would take the risk of ramping up production in a troubled economic environment if all that could be recovered was the marginal costs.

Third, producers receive many of the goods needed in the production of further goods from their suppliers on credit. Why presume that all the marginal costs of additional production have actually been paid at the time the goods hit the shelves? Or that the ultimate consumer is going to be willing to use credit to increase consumption in troubled times, even if those higher up the chain have used credit to increase production?

More concerning still, if consumers do use credit, unless we later provide them with more income, we will have simply set ourselves up for another financial collapse when the teaser rates on their loans time out and further payments become unaffordable, as happened in 2008.

None of these problems with supply-side thinking will come as a surprise to anyone who runs a business. They are happy to see their taxes cut, sure, but they are not going to use this extra money to increase production unless they think that their customers will have enough new money to buy these additional goods. And no reasonable business person thinks that enough new money can be introduced by increasing production alone. If they did, record amounts of cash wouldn’t be sitting in corporate bank accounts doing nothing, which is what has been happening for years now. Obviously, the people who control this cash don’t believe that supply creates its own demand. They think that increasing production without first seeing an increase in demand would be foolhardy.

History is also not on the supply-siders’ side. To see the failure of the supply-side approach at the national level, all we need do is look at the 2001 and 2003 tax cuts signed into law by the then president of the United States, George W Bush.

These tax cuts did not increase investment or production. Rather, the rich either hoarded this additional money or used it to bid up the price of existing assets, creating asset bubbles and exponentially increasingly economic inequality. And because economic activity did not increase enough to offset the loss of government revenue from reduced taxes, the deficit exploded. To see a similar result on the state level, in turn, we can look at the recent supply-side ‘Kansas experiment’. There, massive tax cuts on the rich and corporations almost bankrupted the state.

Remember also that in the 19th century, when Say devised his law, there was a huge amount of untapped demand for new goods; most costs were marginal costs; and most transactions were for cash, not credit. At that time, perhaps it seemed like supply did create its own demand. But not today.

Today, to stimulate the economy, we need to increase demand first. And the best way to do this is by putting more money in the hands of the people whom the economist John Maynard Keynes described in 1936 as having the highest ‘marginal propensity to consume’.

These are not the rich, but rather the poor and middle-class. For, as a group, these are the people who can be counted on to spend all their income whereas, as we have already seen, the rich are likely to keep a chunk of it in cash.

Once demand is increased among the poor and middle class, Keynes argued, production will rise to meet it.

In deciding whether to go with the supplyside or the Keynesian approach to stimulating the economy, there is one more consideration that is relevant.

Recent history has shown that we can’t be sure that economic expansion alone will solve our wider economic problems. Almost all of the benefits of economic growth during the past 30 years or so have accrued to the rich, and mostly to the super-rich. Real income for most people has been stagnant or even declined. The new jobs that have been created are mostly temporary, low-wage, nobenefit jobs. Permanent, good-wage jobs with benefits have continued to disappear.

Rather than giving money to the rich in these circumstances and hoping that it trickles down to the rest of us, as the supply-siders suggest, it would be better to give money to the poor and middle-class, as the Keynesians suggest. The Keynesian approach, after all, has worked many times in the past. Indeed, it’s how the West emerged from the Great Depression. But most importantly, if for some reason it doesn’t work, at least we will have made the right people better off.

Mark R Reiff has taught political, legal and moral philosophy at the University of Manchester, the University of Durham and the University of California, Davis, and he was a Faculty Fellow at the Safra Center for Ethics at Harvard University.

Why the Only Answer is to Break Up the Biggest Wall Street Banks – Robert Reich * Twenty Years after the Fall of the Berlin Wall: Rethinking the Role of Money and Markets in the Global Economy – W. Lee Hoskins and Walker F. Todd.

If you took the greed out of Wall Street all you’d have left is pavement.

Trump would rather stir up public rage against foreigners than address the true abuses of power inside America.

Why should banks ever be permitted to use peoples’ bank deposits insured by the federal government to place risky bets on the banks’ own behalf?

Government managed intervention in financial markets around the world and unpredictable monetary policy continue to encourage inappropriate risk taking.

What, if anything, should those who do not want to be serfs or slaves do about this situation?

Congress needs to prohibit regulators from bailing out failed banks, other types of financial institutions, and nonfinancial institutions (or foreign banking systems), be they large or small.

On Wednesday, Federal bank regulators proposed to allow Wall Street more freedom to make riskier bets with federally insured bank deposits such as the money in your checking and savings accounts.

The proposal waters down the so-called “Volcker Rule” (named after former Fed chair Paul Volcker, who proposed it). The Volcker Rule was part of the Dodd-Frank Act, passed after the near meltdown of Wall Street in 2008 in order to prevent future near meltdowns.

The Volcker Rule was itself a watered down version of the 1930s Glass Steagall Act, enacted in response to the Great Crash of 1929. Glass Steagall forced banks to choose between being commercial banks, taking in regular deposits and lending them out, or being investment banks that traded on their own capital.

Glass-Steagall’s key principle was to keep risky assets away from insured deposits. It worked well for more than half century. Then Wall Street saw opportunities to make lots of money by betting on stocks, bonds, and derivatives (bets on bets) and in 1999 persuaded Bill Clinton and a Republican congress to repeal it.

Nine years later, Wall Street had to be bailed out, and millions of Americans lost their savings, their jobs, and their homes.

Why didn’t America simply reinstate Glass Steagall after the last financial crisis? Because too much money was at stake. Wall Street was intent on keeping the door open to making bets with commercial deposits. So instead of Glass Steagall, we got the Volcker Rule almost 300 pages of regulatory mumbo jumbo, riddled with exemptions and loopholes.

Now those loopholes and exemptions are about to get even bigger, until they swallow up the Volcker Rule altogether. If the latest proposal goes through, we’ll be nearly back to where we were before the crash of 2008.

Why should banks ever be permitted to use peoples’ bank deposits insured by the federal government to place risky bets on the banks’ own behalf? Bankers say the tougher regulatory standards put them at a disadvantage relative to their overseas competitors.

Baloney. Since the 2008 Bnancial crisis, Europe has been more aggressive than the United States in clamping down on banks headquartered there. Britain is requiring its banks to have higher capital reserves than are so far contemplated in the United States.

The real reason Wall Street has spent huge sums trying to water down the Volcker Rule is that far vaster sums can be made if the Rule is out of the way. If you took the greed out of Wall Street all you’d have left is pavement.

As a result of consolidations brought on by the Wall Street bailout, the biggest banks today are bigger and have more clout than ever. They and their clients know with certainty they will be bailed out if they get into trouble, which gives them a financial advantage over smaller competitors whose capital doesn’t come with such a guarantee. So they’re becoming even more powerful.

The only answer is to break up the giant banks. The Sherman Antitrust Act of 1890 was designed not only to improve economic efficiency by reducing the market power of economic giants like the railroads and oil companies but also to prevent companies from becoming so large that their political power would undermine democracy.

The sad lesson of Dodd-Frank and the Volcker Rule is that Wall Street is too powerful to allow effective regulation of it. America should have learned that lesson in 2008 as the Street brought the rest of the economy and much of the world to its knees.

If Trump were a true populist on the side of the people rather than powerful financial interests, he’d lead the way, as did Teddy Roosevelt starting in 1901.

But Trump is a fake populist. After all, he appointed the bank regulators who are now again deregulating Wall Street. Trump would rather stir up public rage against foreigners than address the true abuses of power inside America.

So we may have to wait until we have a true progressive populist president. Or until Wall Street nearly implodes again robbing millions more of their savings, jobs, and homes. And the public once again demands action.

Twenty Years after the Fall of the Berlin Wall: Rethinking the Role of Money and Markets in the Global Economy

W. Lee Hoskins, Pacific Research Institute

Walker F. Todd, Middle Tennessee State University

June 2018

Many of the hopes arising from the 1989 fall of the Berlin Wall were still unrealized in 2010 and remain so today, especially in monetary policy and financial supervision. The major players that helped bring on the 2008 financial crisis still exist, with rising levels of moral hazard, including Fannie Mae, Freddie Mac, the too big to fail banks, and even AIG. In monetary policy, the Federal Reserve has only just begun to reduce its vastly increased balance sheet, while the European Central Bank has yet to begin.

The Dodd Frank Act of 2010 imposed new conditions but did not contract the greatly expanded federal safety net and failed to reduce the substantial increase in moral hazard. The larger budget deficits since 2008 were simply decisions to spend at higher levels instead of rational responses to the crisis. Only an increased reliance on market discipline in financial services, avoidance of Federal Reserve market interventions to rescue financial players while doing little or nothing for households and firms, and elimination of the Treasury’s backdoor borrowings that conceal the real costs of increasing budget deficits, can enable the American public to achieve the meaningful improvements in living standards that were reasonably expected when the Berlin Wall fell.

My comments focus on the continuing failure of regulations to limit disruptions in financial markets and the concomitant increase in moral hazard, as well as the purely discretionary monetary policy conducted by the Federal Reserve. State managed intervention in financial markets and a disruptive monetary policy combined to impose large costs on the economy. Yet Congress is likely to reward the Fed with more power and continues to rely on regulatory intervention. Lawmakers and regulators do not follow thoughtful economic advice that focuses on market solutions because it is rarely in their self interest to do so. Only a citizenry, educated about the values of free markets, private enterprise, and a stable monetary order, can roll back the tide of government intervention by exercising its power at the ballot box.

THEN

The Berlin Wall fell on November 9, 1989. The United States was embroiled in a financial disruption involving commercial banks and savings and loan associations. When it was over, some 1,400 banks and over 1,000 savings and loan associations failed at a then estimated present value cost of $150 billion dollars to taxpayers. Two pieces of legislation were passed to deal with the problem. The Financial Institutions Reform Recovery and Enforcement Act was enacted in August 1989, followed by the Federal Deposit Insurance Corporation Improvement Act in December 1991.

These statutes were enacted to deal with the worst collapse of financial institutions since the 1930s (at the time). They relied on more regulation, more capital, and more diligent regulators. Yet it was clear that this set of regulations would fare no better than the mountain of regulations already on the books. Loopholes would develop, and regulators would forbear. At the time, those of us who were hopeful about reform thought that the regulators would heed the message from Congress, especially the House of Representatives. The too big to fail doctrine, in which the regulators colluded throughout the 1980s, was declared against public policy by the words of the 1991 statute.

Representatives of large banks (lobbyists), however, acting through the regulators and the Treasury Department, managed to have the “systemic risk exception” codified. That exception has been invoked several times now since early 2008. Simultaneously, Senator Christopher Dodd, acting on behalf of lobbyists for the Securities Industry Association, introduced an amendment of Section 13(3) of the Federal Reserve Act that appeared to enable the Fed to make emergency loans to securities firms and other nonbanks, a power that had not been used since 1936. In the next session of Congress, the lobbyists began their multi decade rout of the forces of reform by enacting the Riegle-Neel Act of 1993.

The Founding Fathers of the Republic might have been misguided, but they were persuaded profoundly that a system of checks and balances, including preservation of the capacity of minority forces (which they called “factions”) to push back against excess on the part of other forces, was essential to preserve the forms and processes of a constitutional Republic. They clearly did not contemplate that one force or faction always would win all the battles for decades on end. Those who wanted to game the system did, in fact, win all the legislative and regulatory battles from 1992 forward. The outcome of their victories is plain for all to see after 2008.

What, if anything, should those who do not want to be serfs or slaves do about this situation?

Classical constitutional theory, which is at odds with utilitarian economic theories of efficiency on this point, says, “Make sure that those who would resist the gamers retain the capacity to push back effectively within the legitimate processes of the system.” It is not necessarily more efficient, and certainly not constitutional, to argue that nothing should stand in the way of those who advocate more and bigger games at public risk or public expense.

For decades before the 2016 election, a large section of the public was asking for a choice other than, “Decide whose boots you want to lick.” At least at the beginning, around 2010, the Tea Parties essentially were saying, “We don’t want to lick bankers’ boots.” The Republican leaders, unfortunately, essentially began to say, “When you lick, we’ll make them taste better.” The Democrat leaders of that day gave lip service to part of the public’s pleas (they enacted the Consumer Financial Protection Board [CFPB]), but they did not really want to turn aside bankers’ financial offerings as campaign contributions either (they structured the CFPB so as to leave it vulnerable to constitutional challenge).

The only good news was that government authorities still had the backbone as late as the early 1990s to let large financial institutions fail and to punish their shareholders, counterparties, and creditors.

Of course, most of the institutions that failed were relatively small. Three months after the Berlin Wall went down, Drexel Burnham, a large investment bank that served as the lynchpin for the junk bond market, was allowed to fail with the blessings of the Treasury and the Federal Reserve’s Board of Governors. At the March 1990 Federal Open Market Committee (FOMC) meeting, Peter Stemlight of the New York Fed (FRBNY) remarked on how smoothly the markets handled the Drexel bankruptcy. Yet too big to fail policy already began for large commercial banks, beginning with Franklin National Bank of New York in 1974 and culminating with the failure of Continental Illinois in 1984. The moral hazard problem associated with bank bailouts became well known.

Many academics and at least two Federal Reserve Bank presidents argued in the early 1990s for limiting federal deposit insurance and pricing it for the risk of the institution, as well as reducing the rest of the federal safety net, in particular dumping the too big to fail policy. The essence of financial exchange is creditor and counterparty scrutiny, knowing one’s customer and bearing the costs and benefits of doing so. Government intervention that shields depositors, creditors, and counterparties from losses weakens the market restraint on inappropriate risk taking. By the mid 1990s, the federal safety net no longer was reduced; instead, more regulation and more empowered (but more spineless) regulators was the congressional solution.

This choice by Congress in the 1990s proved to be a bad one, for in fewer than two decades we arrived at another “worst banking crisis since the 1930s.”

When the Berlin Wall fell, central banks were focusing on lower inflation rates and exchange rate stability. At the December 1989 FOMC meeting, the Board’s staff presented a model simulation of the cost of reaching zero inflation by 1995 from the then prevalent 4.5 percent inflation rate. The Committee had not agreed on a target inflation rate, but most members seemed to prefer something between zero and 2 percent.

At the same FOMC meeting, Sam Cross of the FRBNY reported that the German mark (this was in pre euro days) had soared against the dollar and that there was some speculation in the market that the Fed might intervene. The Fed already had intervened to the tune of $20 billion, and the Treasury, using its Exchange Stabilization Fund and the Fed’s warehousing facility, also held that same amount of foreign currency from interventions. This warehousing facility (the Fed lent the Treasury dollars in exchange for its foreign currencies) was simply a way for the Treasury to evade Congressional appropriations. In short, it was and still is a way for the Fed to fund the Treasury directly. While the warehouse is dormant now, it is still on the statute books and could be used again. The Fed’s former sterilized interventions in currency markets produced nothing but uncertainty.

During the 1990s the Fed did manage to lower the inflation rate. It did so with no monetary rules or targets, nothing but pure discretion. But the Fed developed a pattern of lowering interest rates at every potential downturn in GDP and every dislocation in financial markets. This practice encouraged investors to take on riskier assets, knowing that the Fed would bail them out with lower interest rates should a problem occur.

This practice came to be known as the “Greenspan put,” and monetary policy began to produce moral hazard on a grand scale.

NOW

Today we bear the fruits of state managed intervention and seat of the pants monetary policy. Many of the interventions from the 1930s are still with us, the Federal Housing Administration, Fannie Mae, and Freddie Mac, to name just a few, and they all played a major role in the housing bubble and its collapse in 2008.

Many new housing and mortgage programs were put in place during the recent troubles, and they will probably be around for the next financial disruption. Financial Services committee chairmen Dodd and Frank chose to travel the road of more regulation despite the fact that a mountain of regulation on the books failed to prevent the 1980s savings and loan and banking debacles, as well as the latest meltdown in financial markets. The integrated nature of global financial markets means that our problems quickly can become theirs. Governments around the globe are also going down the regulation road, despite the post 2007 failure of the Basel bank regulatory agreements and their own homegrown regulations.

Meanwhile, government guarantees and insurance programs for financial assets, along with bank bailouts, have produced, arguably, the largest increase in moral hazard in the history of financial markets. The Fed’s zero interest rate policy lasted so long (2008-15) that it encouraged excessive risk taking, certainly riding the yield curve for banks (funding short and lending long). Unless reversed, these policies will plant the seeds for the next bubble. A major consequence of these policies has been a surge in the already troubling problem of growing federal debt. Public debt levels abroad also have increased as a result of these failed policies.

The bailouts by the Federal Reserve doubled its balance sheet (emergency lending) with dubious assets, but also made it more of a development bank than a modern central bank. The bailouts of Bear Stearns and AIG put the Fed in the business of making fiscal policy, a function that belongs to Congress.

The Fed’s purchase of $1.7 trillion of mortgage backed securities was pure credit allocation that favored one sector of the economy over another.

Will Congress learn that if the Fed can allocate credit for the mortgage market, it also can do so for the municipal securities market or small business loans? Credit allocation also is something that Congress does, usually unsuccessfully, as with Fannie Mae and Freddie Mac before 2008, which were predicted to cost taxpayers upward of $400 billion, ignoring subsequent recoveries, before the housing bust ran its course (Morgenson and Rosner 2011).

The terrible decision to bail out the creditors of Bear Stearns set a precedent that did much damage. Other banks with troubled portfolios did not feel the urgency to clean themselves up. Creditors did not run on troubled institutions because they believed that they would be bailed out. Buyers of other troubled banks expected the Fed to be an investor for $30 billion, as it was with Bear Steams, and sellers expected to receive $10 a share instead of nothing, the same as Bear’s stockholders. This market expectation was not met with the failure of Lehman Brothers in September 2008, which is one very big reason why potential buyers of Lehman walked away.

Monetary policy at the Fed for nearly a decade now [2010] has been to hold short term rates near zero until the unemployment rate falls. Because unemployment is a lagging indicator, the Fed ran the risks of rising inflation and inflation expectations. Because the Fed essentially operated as an arm of the Treasury, its credibility as an inflation fighter fell into doubt.

Unwinding the balance sheet is going to be tricky because of the mortgage backed securities that dominate the Fed’s balance sheet. As interest rates rise, these long term assets will fall in value, leaving the Fed with large losses. The Fed needs to sell these assets now before it raises rates, as some in the Fed have argued. A governance issue for the Fed as it anticipates raising interest rates is which body within the Fed makes the decision on changes in excess reserve interest rates. Congress gave the power to the Board of Governors, not the FOMC, which makes monetary policy decisions. These decisions need to be linked (i.e., the same entity, preferably the FOMC, needs to decide on both monetary policy and excess reserve interest rates) if monetary policy is to have any chance of success.

In sum, today we have a greatly expanded federal safety net, a substantial increase in moral hazard, and a surge in federal debt that can be attributed only partially to the recession. A higher inflation rate must seem appealing to many in Washington. Much the same can be said for the majority of our friends abroad. The universal response so far is a call for more regulation, more capital and more far seeing regulators. The lessons from past banking busts go unlearned.

Government managed intervention in financial markets around the world and unpredictable monetary policy continue to encourage inappropriate risk taking.

TOMORROW

The principled economic position is to have government remove itself from intervening in financial markets and move to some form of a commodity standard for money or perhaps a regime of competitive money supplies. Over time, creditors, counterparties, and depositors would seek out prudent banks with high capital ratios. Weaker banks would adjust or fail. Some institutions might drop limited liability corporate charters and put stockholders at risk for capital calls. Existing clearing houses would provide risk sharing arrangements and thus would play a much stronger role in supervising the practices of participating banks. There would be no central bank to feed bubbles and busts.

Market disruptions still would occur, but they would be fewer, smaller, and quickly self correcting. The day the public and politicians are ready to accept such a system is probably some time off, perhaps after the bankruptcy of some major governments.

In the meantime, doing what is politically achievable, guided by the principled economic position, is about our best hope. Start by debunking the notion that only the government can prevent systemic risk. There is no bank that is too big to fail. That idea exists in the minds of regulators and politicians. If the failure of a large, insolvent bank causes runs on solvent institutions, then a lender of last resort lends freely at penalty rates against sound collateral until the run stops.

The second source of systemic risk is related to the effects of a bank failure on the payment system. The fear is that the failure of a large bank could cause failure of other banks connected to the payment system. Participants in clearing houses routinely limit their risk to individual counterparties so that the loss for each bank would be small. Also, risk sharing arrangements are in place in many clearing houses.

Congress needs to prohibit regulators from bailing out failed banks, other types of financial institutions, and nonfinancial institutions (or foreign banking systems), be they large or small.

Federal guarantees and deposit insurance need to be scaled back drastically. Mandatory closure rules are needed and should be enforced by bankruptcy judges and not a gaggle of regulators. Federal Reserve emergency lending powers should be removed [Section 13(3)]. This would prevent future bailouts of any company, banking or otherwise, by the Fed. The Fed also needs to have its warehousing relationship with the Treasury closed permanently. It is a nonstatutory arrangement that has been used since the 1960s for foreign exchange holdings of the Treasury, but it could be used for any Treasury asset for as long as this facility exists. All of these arrangements amount to backdoor Treasury borrowing. In the conduct of monetary policy, arrangements that provide backdoor funding for Treasury intervention in financial markets are particularly objectionable.

The Fed’s monetary policy should have a single objective, domestic price level stability. No more chasing after short term fluctuations in the real economy with a Section 13(3) fire extinguisher or after financial market disruptions with the fire hose of large changes in interest rates.

The Fed’s policy independence should not be unconditional. It should be expected to achieve its monetary policy objective in a defined amount of time and should face a penalty for failure, such as replacing members of the FOMC (preferably those whose policy choices led to or exacerbated the failure).

*

Pushing even the modest reforms proposed here through Congress will prove difficult without an educated public changing the political calculus at the ballot box. In the United States, an already restless public became even more so after 2008 regarding the size of government, the amount of debt (both foreign and domestic) that it is creating, and its intrusions into the private sector, particularly bank bailouts perceived as doing little or nothing to alleviate pressures on households and most firms.

The midterm elections of 2010 (the first Tea Party election) offered the first opportunity for the public to send a message to politicians that it was in their self interest to reduce the role of the state in our lives and in our economic affairs. The failure of the governing elites of both major parties to restrain the intrusive government that they had created led to the election of 2016, when the populist revolt erupted in both parties (Sanders for the Democrats and Trump for the Republicans). Those wishing for a different outcome in 2018 or 2020 need to explain what they propose to do about the factors causing public restlessness already in 2010.

A Primer. A Conversation about Economics – Richard Werner CMA/CFM.

Today most nations focus on managing the balance of trade rather than seeking out ways to increase trade in a fair and sustainable way. Sustainable trade is critical to the long-term success of our modern society.


We have all had them, that conversation at work around the coffee station or with family on a holiday visit. We discuss, we listen, and we learn. Certainly it’s not like a school setting but nonetheless we are in a situation where we are immersed in an interesting conversation that often ends up teaching us something. The conversation might be about politics, cars, restaurants, or why your employer’s business is or is not doing so well.

You may have conversations that regularly touch on the subject of economics, or maybe you have overheard others discussing economic concepts, or perhaps you just have a natural and healthy curiosity about a subject that impacts every aspect of your life. Whatever your reason, and in the hope of developing a better understanding of how economics impacts your world, you scoured the earth (or internet) to find this informative, yet entertaining, book.

On the other hand, you may have accidently tripped and stumbled nose first into this book and you may be thinking… “I might like to read up on economics sometime after I have finished watching the paint dry or have counted all the sand grains on the beach”. If you are harboring any thoughts along these lines then I suspect I had best pique your interest quickly.

Much like a car enthusiast might want to engage another person in talking about what makes their car exceptional or someone who has a medical issue may want to delve into a discussion about their condition, someone who is affected by the economy (and that would be all of us) might want to spend some time trying to understand what makes our world tick. All of us have a vested interest in the economics of our world, we are all involved in our economy and through our decisions (including our choices at the polls) we all play a leadership role in how effective our local, national, and world economies perform.

Most of us, at one time or another, have played a game (be it football, golf, or a board game) and at some point in time we chose to learn the rules and strategies of that game. The reason we made the effort and found the time to learn is obvious… we wanted to understand what we needed to do in order to be successful. No reasonable person would want to spend their time doing something without knowing the rules or at least having some semblance of what it takes to win the game. And, just like you wouldn’t play a board game without reading the rules first, it’s important to develop an understanding as to how economics affect you in the game of life especially since you’re already playing the game… every day when you go to work, make a trip to the store, or choose where to invest your retirement savings you are interacting with the economy.

Economics is fundamental to living in a free society and it’s important to understand it in order to know how and why you should try to preserve it. Every day there are reports in the news citing economic concepts and no shortage of talking heads engaging in debates related to them, yet the concepts remain a mystery to many of us. We hear terms on the news such as “the economy grew 0.5 percent in March” or “consumer confidence is down which forebodes a potential recession” but few truly understand what they mean and how, or in what ways, they affect us. My hope is to help you understand basic economic concepts, help you put them into context, and help you to understand how any number of factors in our economy often, but not always, can lead to certain resulting economic conditions.

If you are still toying with counting the sand on the beach you may be asking yourself about now, “Why should I, or anyone, else take the time to learn more about economics?” or more importantly “Why did I buy a book on the subject?” Well, if you watch any amount of news or engage in political debates with friends and family, you will not be able to avoid the topic of economics for very long and chances are pretty good that you would like to come across as knowledgeable and well informed and, while economics is too complicated to glean a competent understanding and knowledge level of from a talk show or from a commercial, you don’t need a Ph.D. on the subject to be an informed citizen. Going a step further, a significant part of our political decision making process is driven by economics which means understanding the basic processes of economics is essential to performing that most important of civic responsibilities… informed voting.

Economics, at least the parts we expect our government to influence, is in many ways like tinkering with an old car or developing a better cooking recipe. More of the same is unlikely to fix a problem, like adding more salt to a favorite dish, at some point more becomes too much and you need to reverse direction. A mechanic working with an old car might start by adjusting the fuel mixture to make it richer but at some point it becomes too rich. Economic topics like taxes, jobs, and entitlement programs (to name just a few) cannot be addressed by the same answer every time. But by understanding the interworking of factors within the economy and how one affects the others, you can then be better able to make sense of the news and intelligently engage in political debates about economic matters.

Like many complex subjects, economics is one that most of us tend to develop opinions about based on what experts tell us. As an example, one such expert and a noted economist, made a comment that he thought it was impossible to effectively prosecute white collar crime. If you know more than a little about business, or have worked in situations where you have come into direct or indirect contact with any type of white collar crime, you might be appalled by the thought that an expert would propose that we cannot hold white collar workers to any kind of legal standard. As a society, whether we realize it or not, we all support or oppose beliefs, such as the one put forward by this economist, and through our voting we either support or reject these concepts. Knowing a little more about economics can help you make informed judgments and the better informed our voting population is on matters affecting economics the more likely we are to enjoy a better economy. Among the objectives of this book will be to explore concepts embodied in statements, such as the one about regulations and white collar crime, in order to give you a better understanding of the workings of our economy.

Why should you or anyone else take the time to learn more about how the economy works? There are many reasons but I am of the opinion that the two most important are (1) to be a more competent consumer and (2) to be able to make better decisions as a member of the voting population.

The reason for the first is fairly obvious, (if you don’t know just smile and nod your head, I’ll explain it in a second), and the reasons for the second are as varied as the population (I’ll get to this too, just give me a minute).

What does being a more competent consumer mean?

If you, as a consumer, are aware of how prices are set and why prices rise, you can better judge the value you are giving up (your cash) in exchange for the value in the good or service you are buying. By educating yourself on what works and does not work in economics, can clue you into what is real value and what is hyperbole. I will provide an example of this later in the book (chapter sixteen) when we delve into why marketing people earn very good livings convincing consumers (us) to spend money buying what may be just an image of greater value. This image of value conflicts with what is best for the consumer whose focus should be on the more tangible attributes of the good being purchased. For example, as a consumer buying a chair, would you be better served to buy a product based on a sexy commercial or based upon careful research of the chair manufacturer’s quality record? (and don’t say “sexy commercial”).

Throughout this book I will use examples to demonstrate how understanding economics can help shine light on what may be faulty thinking. So as not to keep you in suspense let’s get started with my first example. Suppose you are shopping for a can of chicken soup and you have two choices, a nationally recognized brand name and a lesser known brand that costs 50% less. When you do your homework you may find that both products have been made at the exact same factory using the same formulas and quality controls. So in this case what are you getting for the added cost, nothing, right? Or, maybe you might find that the cheaper soup is exactly that a cheaper, lower quality, and a less satisfying product. Now while you might not want to spend a lot of time researching soups, there are purchases that do warrant a consumer taking the time to evaluate which purchase choice is a better use of their financial resources.

Making better decisions as a member of the voting population

Earlier I mentioned that we each play a leadership role at the polls… as voters we choose which leaders to hire to manage our society. Being a knowledgeable person in the voting booth is probably the best way we can avoid our country becoming another Nazi Germany, Soviet Union, or some other failed society. This truth is probably something that extends well beyond economic knowledge but, within the confines of this text, we will stick to the economic reasons.

Opinions are strong and varied on this point, but arguably many voters do not go to the polls armed with sufficient facts and therefore cannot reflect and make decisions based upon the facts. Having moved around a bit in my career I have had the benefit of living in districts that leaned in opposing political party directions. I have personally thought that in some overwhelmingly Christian districts, Jesus himself could run against Satan and, if Jesus was of the district’s minority party, he would maybe generate the closest race in the district’s history but would still lose by a comparative landslide. Look, it’s normal to become indoctrinated into one party or the other due to family leanings or that of the city, town, or county in which you live and it’s just human nature to adopt the values of those close to you. The goal of this book is not to try to make independents out of Democrats or Republicans, but instead to help develop an understanding of what economics is and how the system works. In this way, as a voter, you can come to a more informed decision when listening to a candidate’s position on the various economic issues.

Further to the point, let me share a brief personal observation about politics, economics, and some possibly less informed voters I have known. A relative of mine is very vocal about his political leanings, his history has been one of frequent unemployment, lengthy stints on workers compensation, and prone to often be on public assistance. Another family member, who is also very politically vocal, is church going, hardworking, has never taken a dime of the government’s money, and staunchly defends the other political party. If you think the first one leans democratic and the second republican guess again. By all accounts both of these individuals are good people, never ones to cheat another and equally likely to help a stranger who has a disabled car. The point is not that either one is wrong but that neither one really understands fully what their party of choice tends to support as economic or social policy.

I am not trying to say that strong supporters of one party or the other are ignorant or that they blindly vote based on what they grew up with as children, I’m just saying that many subjects, including economics, are more mysterious than they need be. Just like the cave men of 10,000 BC, because the knowledge was not yet available to them, did not understand the movements of the Sun and the Moon in the same way if we don’t have the knowledge of basic economics the workings of our society will be just as mysterious to us. So let’s focus on taking the mystery out of economic concepts.

My intention throughout this book is to steer away from political arguments and stands on the many economic issues such as taxes (on who and how much) and whether government should or should not have a role in healthcare. Instead my goal will be to put into view how economics, within a free nation, can work in a pure state and provide insight into what really happens and why. With that said I believe everyone is subject to some form of intellectual blindness on any subject and, while I will try to keep my prejudices from tainting the descriptions here, you should keep in mind that I, like every other writer, have preconceived notions as to what is correct and as a result it is possible that facts I present may be twisted by those influences. That warning not only applies here but it also applies every time you tune into MSNBC, Fox News, or CNN and while you may not frequently hear that warning elsewhere please remember it as you go forward through this book and beyond.

In providing insight into the world of economics I will share with you stories from my life where l was confronted by economic concepts in action, description of historic events and how they demonstrate an economic concept, and the story of a fictional island where the economic concepts come to light through working examples. Often seeing the humor in a situation can be an aid to understanding and hopefully you will be amused occasionally along the way.

In terms of opinion, I will share many but in doing so will endeavor to keep my explanations closely aligned with recognized economic theory. I will only intentionally try to sell the reader on one concept… that free enterprise is a powerful economic model, one that has beaten out all challengers thus far on the planet Earth. Understanding free enterprise economics is everyone’s responsibility whether you are a voter, a parent, or a participant in an economy. I hope you will find reading this book both enjoyable and informative.

Chapter 1

The Beginning

Most Americans do not have a good understanding of the workings of our economy or how the global economy interacts with the United States’ economy. This is unfortunate because the important concepts of economics do not require an advanced degree in this science; our basic education, as provided in the United States, along with a little outside reading will provide what we need to know about economics. This book will help put the concepts in terms that will take away a good part of the mystery.

While understanding economics, or at least the basics of economics, is within the grasp of most Americans, developing that understanding does require a little study and the willingness to consider dependent activities.

Much of economics in action is just simple common sense… a matter of considering what logical choices people will make when trying to fulfill their wants and needs. If you keep in mind that the root of economics is based on that simple concept you will have set for yourself the foundation for understanding economics.

Each day you play a role in the United States’ economy whether you are a producer or a consumer of products and/or services. Your contribution to the economy can be obvious (as in a worker producing a product in a factory) or less obvious (as in an ad designer who, though not directly connected to making a good, works to facilitate the sale of that good). The economy is a complex web of people producing goods and services for each other’s consumption.

Obvious contributions to the economy can be easy for us to understand, such as how the person who makes the proverbial indispensable widget adds something of value for the rest of the population to consume. However the value of other roles in the economy, such as finance and marketing, can be more difficult to understand because the connection between what is being produced and the end value to the consumer is not as obvious. I will attempt in this text to provide the context necessary to understand what makes the economy go, what causes the economy to not work so well at times, and how interconnected jobs and resources all work together.

Economic terms, such as inflation and productivity, are used every day in the news and are as much misunderstood as they are understood. Throughout this text we will attempt to help you develop a working knowledge of what is meant by many basic economic terms. The approach we will use is to provide both real world and fictional examples using easily understood language to walk you through a demonstration of the economic concept

Since we all participate in the economy (by helping to guide our economy through the choices we make at the polls and by producing and consuming resources) it is crucial that we understand economics and develop the knowledge we need to make wise decisions. As a contributor to the economy, understanding your role will enable you to make better choices in your life whether you are a top level executive or an entry level worker.

Anyone who has ever spent time among entry level employees knows that there is no shortage of stories describing mind boggling missteps by management. These perceived missteps may simply be a case of the story teller not understanding the bigger picture but it is also just as likely that management, not having a clear understanding of what happens on the front line, made decisions that have led to a waste of economic resources.

Why should we care about economics as it relates to our work? Does it really matter if entry level workers mistake good management decisions for foolish actions? Among the selfish reasons to care about economics is any waste of economic resources diminishes the quality of life for everyone.

After graduating from high school I spent my last year as a teenager working in a high end, small lot production, furniture factory, which meant most of the jobs we ran only consisted of a couple dozen pieces up to a few hundred pieces. This factory used a job costing system that involved each employee, who performed a step in the production process, to fill out a time card for that job. To explain by example let’s say there is a job to make 30 chairs. One person in the process has the responsibility for making the chair legs; this person retrieves a rough cut board from the lumber pile and cuts it to the appropriate length. For 30 chairs this person will make 120 cuts. In our example it takes this person 30 minutes to complete the 120 cuts (four chair leg pieces per minute). This employee then fills out a time card for the job reporting he spent 30 minutes on the 30 chair project. This data leads factory management to assign a cost of one minute of work by this employee to each chair. As the chair passes through all the steps in the factory the dollar cost of each of these manufacturing operations are added together providing a cumulative labor cost per chair. The cumulative labor cost plus the cost of materials (i.e. wood, fabric, finishing chemicals, and etc.) are then totaled together to give us the final cost of the chair.

I, as the factory newbie unschooled in the ways of the factory world, was assigned to work with a very large man, who went by the nickname of Mule. Mule ran one of the most complex machines in the factory called a sticker machine. This machine took in the cut-to-length and -width pieces of wood and made all four sides’ smooth and uniform and, in some cases, applied an additional shape to one or more sides of the wood. My job was to take the finished pieces coming off the machine and stack them on a factory production cart. In this arrangement I could only work as hard as Mule chose to run the machine. Mule was very good at what he did so he could get a lot of production out in a short time. I grew up on a family farm so for me work meant getting the work done as quickly as possible and staying at the job until it was complete. Mom and Dad drilled into the heads of all of the kids in my family this approach to work, which I was soon to find out ran into conflict with this factory’s generally accepted approach to work.

From our first day in kindergarten we have had to learn to adapt to our social environment and I quickly learned that a big part of fitting into the environment and the socialization process of my new job was learning the “art” of time card completion. As you might suspect, what was reported on the cards was not a true reflection of what actually happened on the factory floor. On any given day, Mule and I would run ten to twenty jobs each requiring a separate time card. Our day would start at 7 am and for an hour an fifteen minutes we would run several jobs. Mule would then sit down with me to fill out our time cards and would account for a full two hours of work (including the 45 minutes between 8:15 and 9 am that we hadn’t worked yet). Mule would assign that 45 minutes to the various jobs we had just completed and then head off to the restroom for about a half hour, spend the next 15 minutes visiting some of his buddies around the factory, and then start his 9 am general factory break.

Mule was an intimidating guy who was nearly twice my size so I guess I could maintain that it was out of fear that I adopted a work style that was very foreign to me but, in all honesty, my true motivation came from the desire to fit in with this sub element of the local society. Unfortunately, this work style was not unique to Mule (and now me); it was a plant-wide behavior that only varied based on the creative ways individuals could come up with to waste time. The cumulative result was 25% to 50% of wasted time was absorbed into each day’s work.

What I didn’t realize, and I am sure Mule didn’t either, was that by our actions we were making the cost of furniture produced by that factory more expensive. For simplicity’s sake, let’s assume that one chair had a manufacturing cost of $100 and that the final cost included 20% materials and 80% labor (a good part which was wasted time) then taking the math forward some $20 to $40 dollars of each chair’s cost was due to this socially enforced “art” of time card completion.

Because of these shenanigans you might think that the company where Mule and I worked would have gone out of business fairly quickly but it continued producing expensive high quality furniture for more than twenty more years. Now you may be thinking, “This was probably a union plant where the union was the cause of the bad work habits”. Well you would be partly right, it was a union plant but, from the best that I could tell, the union had nothing to do with these costly work habits. I can say this because this particular union was pretty weak and all it seemed capable of achieving was securing the lowest pay and worst benefits in the area… I might go so far as to say that, at its best, this union could not get its members sunlight on a sunny day. So to blame the union environment for the inefficient use of the factory labor is most likely wrong.

What causes this type of mentality among workers, management, and others within our society? The most likely cause… a lack of understanding amongst workers as to the connection between low productivity and employee rewards, the next most likely reason is poor management. But, at the root of both, is the lack of understanding economics.

Let’s focus on the workers first, is it reasonable to assume the workers in this plant, in 1975, were not taking actions to deliberately put the plant out of business or lessen the company’s ability to give raises to its workers? Obviously neither of these goals was driving the workers to act in this wasteful way. So why did this happen?

In order to answer this question let us first examine the motivations of management; we assume that management would have more information than the plant’s nonmanagement workers on the effects of lower productivity. Anyone who has ever managed people knows how difficult it can be to motivate people to work harder. So how do we do it? Well, the easiest means to motivate people is to get them invested in the results. This is not necessarily invested in the company, in terms of stock ownership, but, in general terms, invested in working to insure its success. This brings us to a basic and well known principle known as the carrot and stick motivation approach.

Almost every company seeks to employ the carrot and stick approach in order to achieve company objectives. During my short youthful stint with this furniture company I was able to see both techniques in practice with a heavy focus on the “stick”.

On a daily basis the plant manager and foreman would look to discipline poor performance, verbal and written warnings, suspensions without pay, and firings happened frequently. One of the most talented employees, we’ll call him Jerry, went through all the discipline processes twice during his career, including being fired. Jerry was brought back about the time I was hired so I got to see him start the process all over.

Jerry taught me how to run a machine that was probably forty years old at the time and in doing so I was able to learn more than a little about what made him tick. Jerry primarily wanted to take care of Jerry. He was a man of action however his actions seldom benefited the company or his standing within the company. Jerry would prioritize his work based on which jobs he liked to run the most, he was as adept as anyone at taking the long bathroom breaks during the day, and he felt entitled to use company equipment, time and materials to complete personal projects. At different times, Jerry used the company equipment to convert company lumber into finished pieces for home projects. At one point he found some rosewood in the lumberyard and decided to use it for knife handles and we spent the better part of a couple days using the wood along with some metal from the factory to make ourselves two knives.

Jerry had the skills and intelligence to be a major contributor at this plant, he was talented and capable of doing great work and could be very productive when he wanted to, he just seldom wanted to unless of course it was for one of his personal projects. Jerry just never stayed focused on using his skills, talent, and intelligence to the benefit of the company and ultimately he chose to leave and work for another local company, a company that was known for offering the best wages and benefits.

At this point in my career I was already studying accounting and I found it curious that this free spirited and intelligent man went to work for a company that had a reputation for running a tight ship (an employer that would on the surface seem ill suited for Jerry and his propensity to avoid productive work) while at the same time the furniture company, which desperately needed a person with his skills, seemed incapable of retaining him.

The underlying reason for an individual and company mismatch, like in the case with Jerry and the furniture company, is a lack of understanding of what each needs from the other. Just like in the workplace, our role in the economy is often not clear to us and we are not able to see a clear correlation between doing well at work and being more financially successful. Understanding the workings of economics is the key to remedying this, for example, if Jerry had a clear understanding between how working hard and efficiently affected his pay and/or job security, Jerry possibly would have been more likely to perform better. Additionally, if management had been better educated in the psychology of the worker and the workings of economics they might have been better able to construct an effective method of managing and motivating Jerry. Absent this Jerry consistently underperformed and the company lost valuable production output and ultimately a very skillful employee.

As an example of this let’s say that Jerry, working at his optimum capacity, could generate an extra chair’s worth of production each day. If that chair sells for $200 then the economic cost of this lost productivity is $200 minus the cost of any direct materials going into the chair, in this case and let’s say that is $50. If you told the workers that their lack of effort was costing the company $150 each day per employee I doubt you would have heard much of an outcry from the workers. If, however, you could convince the company and the employees that the $150, if earned, would benefit both the company and employees then the collective team would view this lost productivity differently.

The company, at one point, contracted with outside consultants to create the proverbial “carrot” to provide motivation for employees to improve productivity. Unfortunately, the “carrot” that the consultants developed and implemented, a gain sharing plan, was so complex that no one, other than a finance guru, had any chance of understanding it. At that point I was well into completing an accounting degree, and though still far short of a guru, I would like to think I had enough knowledge to at least see some vague connection between my performance and a potential financial reward but the dots just weren’t there for me to connect. But let’s not digress into a commentary on the design and implementation of gain sharing plans. The important point here is that even though management knew, to some degree, it needed to gain the cooperation of the workforce in order to drive better performance, and despite knowing and attempting to do the right things, they were still unsuccessful in gaining the workers’ cooperation.

The struggle described here is a common one within working environments across our planet but, even though the goal is simple enough, you seldom hear of companies who are successful in gaining optimal employee participation in the company’s success. You can make an argument that there are simply not enough workers who have a strong work ethic in our economy. It’s certainly true that some people would not work hard on a consistent basis even under the threat of physical harm, but this does not accurately describe all or even most American workers. Generally speaking, people in this country desire to work for successful companies and want to be a success at what they do.

We all have a universal desire for many of the same basic things, food, security, and love. Within the sciences of psychology and economics these are described as a hierarchy of needs. Each person has their own weighting for these needs and because of this it makes finding a single solution to universal motivation difficult. For our purposes here it is simply important to recognize the fulfillment of these needs is desired by most people and concurrently most humans are willing to work to satisfy their various needs.

Opposing desires and needs coexist within people, among these is the need for leisure time, and it’s this need for leisure time that often comes into conflict with the need to be productive. It is this desire for leisure that prompted workers at the aforementioned furniture factory to spend hours each week in the bathroom sleeping, resting, or reading rather than working. Most would agree that few people would choose to spend hours in a restroom as their first leisure time destination. Given the choice Mule, Jerry, or I would have worked our butts off to get to go home twenty minutes early or to make an extra ten bucks. The collective failure of employees and employers to align their economic and social desires caused the loss of the productivity to be spent, among other places, in the company restrooms resulting in a waste of resources. Given the incentive of going home early or making a few extra dollars, versus taking the half hour all expenses paid vacation in the john, most employees (there will always be the exception) would have willingly forgone extended bathroom breaks in order to put out the production of an extra job or two.

Our purpose in this text is not to do an exposé on the waste at a factory several decades past but, instead, to enable you to develop an understanding of how the science of economics works. Possibly the next time you read a news story regarding a drop in factory productivity in the United States, you can now envision what that loss looks like and more importantly what that means to our economy. (I offer apologies to any reader who has just had the disturbing vision pop in their head of several thousand workers sleeping seated in innumerable company bathrooms throughout the United States). If you can, after finishing this book, better understand the connection between higher productivity and a better lifestyle for society, then the time you spent reading and the time I spent writing this book will have been worthwhile for both of us.

Chapter 2

The Island Economy

Imagine there is a small island, we will call it Adam’s Island named for a famous Scotsman, Adam Smith, who visited the island during the time it was being first settled in eighteenth century. On Adam’s Island there live three families, Farmer, Sheppard and Fisher who, in the beginning, made up the entire population of the island. These families split the island into three parcels, Farmer’s parcel is rich farm land, Sheppard’s parcel is made up of rolling grassland, and Fisher’s parcel has a bay with the best fishing access on the island.

This island represents a complete economy that has everything needed to sustain the simple needs of these three families. For a number of years each family has subsisted only on what they have been able to produce on their part of this island. Each family has 180 hours a week that they are able to devote towards producing products for their family’s consumption and, by working very hard, each family has been able to be met their basic needs without any dependence on the other two families.

Each family’s part of the island has very different capabilities in terms of producing the basic goods needed to survive.

The Farmer parcel has six hundred acres of land, the best of which can produce forty bushels of wheat per acre, requiring eight hours of work per week per acre to farm. The parcel can also be used to raise sheep however, the land is not well drained so it cannot be used for pasture much of the year and, in order to raise the sheep, the land must be used to grow hay which then needs to be harvested, stored and feed to the sheep. The family can raise three sheep per acre and each sheep requires the family to spend twelve hours per week per acre caring for them. The Farmer parcel also has access to the sea but it is a challenging walk that involves going down a steep path to the sea. The Farmer family can catch one fifth of a pound of fish per hour spent fishing.

The Sheppard family also has six hundred acres of land most of which they can use to either raise sheep or grow wheat. The family can raise five sheep per acre and the labor required to care for the sheep is twelve hours per week per acre. The land is well drained and the family must irrigate the land part of the year in order to produce wheat. Even with irrigation the best yield possible is thirty bushels of wheat per acre and requires ten and half hours of work per week per acre to produce. There is also access to water for fishing however, the waters have difficult currents resulting in poor fishing and the family is only able catch one sixth of a pound of fish per hour fishing.

The Fisher parcel, also six hundred acres, is mostly in a low lying area of which only forty acres are suitable for farming or pasturing sheep and another twenty acres can only be used for pasture. The forty acres can produce thirty-two bushels of wheat per acre but it requires fourteen hours per week per acre to grow the wheat. The land, if used for sheep pasture, can support four sheep per acre and requires eleven hours of labor per week per acre. The family has the best fishing access on the island enabling them to catch one quarter pound of fish per hour spent fishing.

To survive on this island each family needs to have a minimum of two hundred bushels of wheat, wool from twenty sheep, and five hundred pounds of fish each year. Each family can, on their own, produce enough of each of these essential goods. The following table shows the number of hours each family will spend to obtain the minimum amount of wool, fish, and wheat needed to survive.

Each family, based upon their need for the three products, is working almost every available hour and still is only just meeting their minimum needs for each of these essentials.

Much of the early history of man was spent as subsistence hunter-gatherers where each person, or family, sought to find what they needed in order to feed and clothe only their selves. Trading, which no doubt developed overtime, most likely came about when one family, who found themselves with an excess of one type of good, offered to exchange the excess for another good held by another family. You can possibly imagine a family ten thousand years ago who successfully hunted a wooly mammoth offering their near term excess supply of meat to a family who had an excess supply of dried berries.

Later in the history of mankind, humans began making a habit out of being inter-reliant. For example, tool makers provided hunting supplies to hunters and in return the hunters provided meat to the tool makers. This reciprocal type of relationship led the way for individuals to focus on improving their skill set and to become experts at generating a specific commodity that they could then trade to an expert who specialized in another type of commodity. So, as in our example, our expert tool maker could craft, not only more but, more effective weapons and then trade them to our hunters who could then spend more of their time hunting. This arrangement allowed both groups to live better than when they lived their lives completely independent from each other. Even our ancient ancestors were likely to have had special skills that set them apart from each other. If you lived in the days of our cave dwelling forefathers, you may have been the person who could rapidly make a very sharp and deadly arrowhead but could not hit a deer with a bow and arrow if it was standing still ten feet in front of you. If this was your situation, to survive in ten thousand BC, you would have needed to find a great hunter whose ability to quickly make a quality arrowhead was less than stellar.

As humans our natural tendency is to continually work towards improving our lifestyles and the same is true for our islanders.

On our little island, the heads of the Farmer and Fisher families met one day to discuss the struggle to meet their family’s respective needs. Farmer recognized that Fisher was able to catch fish faster and in greater quantities because his family’s parcel offered easy access to great fishing areas that were only available on the Fisher side of the island. Fisher, on the other hand, realized that the Farmer family was able to more easily produce greater quantities of wheat than his family could produce on their parcel. To take advantage of each family’s core commodity, Farmer offered to raise an extra eighty bushels of wheat in trade for five pounds of fish per week. Fisher gladly accepted and the two heads of family shock on the deal. Farmer returned home to her family to boast of her deal making prowess, the results of which will have the family working an additional sixteen hours per week producing wheat but, in exchange, the family will save twenty-five hours per week previously spent fishing. At the same time Fisher tells his family that by spending only twenty extra hours per week fishing they will save thirty-two hours the family would have spent each week raising wheat. Both families were very pleased with this new arrangement.

You can probably think of a time when you struck a good deal where you thought you got the better end of the bargain because the other party overvalued the good being sold or traded to them. In this case did Farmer take advantage of Fisher or vice versa? You can do the math because you have the benefit of knowing the intimate details of both families’ production capabilities but, in most trading situations, those trading or selling goods would generally not have knowledge of those details. In the case of the Fisher and Farmer families, both believed they cut a great deal and neither knew exactly how good the deal was for the other party. The important thing in trading is not that one or the other got the better deal but that both parties are better off following the trade than either was before the deal.

After the first year under this arrangement the head of the Sheppard family inquired how the other two families could have so much free time without any apparent reduction in their quality of life. After a little prodding Farmer could no longer resist telling Sheppard of the shrewd deal she had made with the Fisher family. Sheppard, being particularly sharp, recognized that Farmer had better farmland and Fisher had better fishing access and that somehow the two families were capitalizing on their respective strengths. After some thought Sheppard suggested to Farmer that his family had some unused pasture land which was superior to Farmer’s and they would be willing to use a portion of this to produce additional wool to exchange for wheat. After a bit of haggling, Sheppard agreed to produce wool from five sheep in exchange for eighty bushels of wheat from Farmer each year.

Farmer once again told her family of her negotiating prowess. By working two additional acres of wheat, adding sixteen wheat production hours per week, they could have Sheppard raise five sheep for their family. This new trade would save the Farmer family twenty hours per week. Sheppard too, thrilled his family with the news that they will save twenty-eight hours per week they would have spent growing wheat and to do so they would only need to work an extra twelve hours per week raising the five additional sheep, or a net savings of sixteen hours of work per week.

At this point all three families are trading with one another resulting in a reduction in time spent working each week… the Farmer family has saved thirteen hours each week, the Fisher family twelve hours, and Sheppard family sixteen hours. This savings will initially become an increase in the amount of leisure time each family gets to enjoy increasing the quality of life for everyone on the island.

Trade on the island continued to develop until Farmer grew all the wheat, Fisher caught all the fish, and Sheppard raised all the sheep. Under this arrangement, the following table shows the average hours per week each of the families worked in order to meet the islander’s needs.

The families each reduced their work week by more than thirty hours so, at least initially, all three families were very happy with the trade agreements and the resulting lifestyle improvements. However, despite the universal improvement not every family benefited equally. As you can see by the table, the Sheppard family is working twenty-four hours more per week than either the Farmer or Fisher families. Later we will see how this disparity in the benefits from the trading arrangement will come to cause problems for our island families.

Once trading on the island had fully evolved each family began to use a portion of their free time to produce more of what they were most efficient at. They used some of their additional production for their own consumption and the remainder they traded to the other families. Farmer grew more wheat, Sheppard produced more wool, and Fisher caught more fish. Each family began to consume more, worked less than before, and had a higher quality of life. The result was growth in the collective wealth of the island and this is exactly how the world economy has benefited since the dawn of trade.

Unfortunately throughout history most nations, and more importantly the individuals within those nations, failed to grasp the benefits of trading. If you consider what has happened on the island and how logical this move to trading appears to be, why then in the real world do people resist trading? Doesn’t it seem obvious to have the people who can create goods most efficiently do so and then trade those goods for other products the people need? Let’s return to the island to consider why this kind of change might not be welcomed.

One of Fishers son’s, Sam, was the family expert in raising wheat on their property and as such was held in high regard up until the families began trading. Once the Fisher family began to trade for its wheat instead of growing it, Sam had to join the family on the boat each day. While Sam enjoyed a shorter work week and more food and clothing as a result the intra-family trading, he did not feel like it was worth it to him personally. Sam enjoyed working the land, when he was out on the fishing boat he would often get seasick and then dockside at the end of the day he found cleaning fish to be disgusting. Sam lobbied his father constantly to allow him to resume growing some of the family’s wheat and to get out the fishing work. Ultimately Fisher relented and allowed Sam to grow wheat thereby reducing the trading with Farmer and forcing Farmer to do some of their own fishing.

What happened on our island is what happens in the real world when a good, let’s say shoes, are imported from a foreign economy at a lower cost. Most people are happy to be able to buy shoes at a lower price. But what about the shoemakers, how does this benefit them? Unfortunately they quickly lose their jobs and lobby their representatives to put a stop to the foreign shoe imports. You, as a well educated economist, meet with the shoemakers in order to convince them not to resist the new shoe import agreement because they, along with everyone else, will benefit from the increase in trade. You explain to them, using well laid out charts and graphs, how all shoemakers will have the opportunity to go to work in a new industry and that this will allow our country to operate more efficiently. If you are successful in doing so, stop studying economics and begin your career in sales you will make a fortune! The reality is the shoemakers will not see how importing shoes will do them any good. In the real world changing careers is scary, costly, and difficult and those forced into changing careers, as a result of cheaper imports, are almost never happy about having to do so.

Today we have the benefit of some education in economics being included as a part of our high school and/or college experience; however, early in the history of trade, economics education was not prevalent in most of the population and honestly, in the earliest years of trade, even the best educated people did not understand how the mutual benefit of trade worked. Most trade occurred based solely on the desire to achieve a profit and the benefit to the respective economies was accidental. Even today most nations focus on managing the balance of trade rather than seeking out ways to increase trade in a fair and sustainable way. Later in this book we will delve deeper into why sustainable trade is critical to the long-term success of our modern society.

Throughout this book I will try to show the various sides of the arguments around economic concepts especially those concepts which are controversial. Let’s start with looking at an example of a managed trade program and the negative aspects of a long-term imbalance in trade. At the start of the twenty-first century, China rose to be the preeminent area of low cost manufacturing. China has been accused of trading unfairly with the West by manipulating exchange rates of its currency (which appears to be a fair criticism in that China is managing to grow its exports and minimize its imports). The product of this manipulation resulted in the accumulation of foreign funds rather than allowing the Chinese consumers to use the currency received in trading to purchase goods and services from the West. By doing this, China has held down the cost of goods coming out of China thereby enticing further foreign investment and accelerating the movement of manufacturing from the western economies and into China. The result of China’s managed trading program has been a more rapid development of the Chinese economy and industrial base at the short-term expense of the quality of life for the consumers in China. Opponents of free trade are often quick to point to this example and others like it where trade with a foreign partner hurts one partner and benefits the other (very unlike the example I used with Adam’s Island).

One of the goals of this text is to examine why overly manipulating trade in the long-term hurts the overall world economy. Admittedly trade and the underlying economic effects are not simple enough to understand without some education on how this complex exchange works best. As we proceed, keep in mind how sensible the trade gains achieved by Farmer and Sheppard were and how that concept often works for us every day in the real world.

Chapter 3

The Introduction of Money

….

from

A Conversation about Economics

by Richard Werner CMA/CFM

get it at Amazon.com

NZ is balancing a mortgage debt time bomb. Will it blow? – Liam Dann.

We kid ourselves we’re wealthier because of capital gains on our homes but in reality our collective balance sheet is looking worse than ever.

Last week I wrote about the world’s total debt hitting a record $230 trillion.

That’s a big pile of money. The rate at which it has been growing worries the International Monetary Fund which tallied it up. The IMF fears it could be a trigger for the next financial crisis.

Most of last week’s column got side-tracked by government debt and the debate about whether ours can afford to borrow more. ANZ economists made a good case for doing that.

As expected finance minister Grant Robertson ruled it out last week, reiterating his preelection commitment to fiscal responsibility.

The Government’s target of net core crown debt (20 per cent ofGDP) makes us look very conservative, the US Government owes more than 80 per cent of the country’s GDP.

But, as numerous correspondents pointed out, it’s New Zealand’s private debt that is the real problem for this county.

We are up to our neck in it and that creates a serious risk particularly if interest rates rise rapidly as they did before the global financial crisis (GFC) in 2008.

The Reserve Bank’s latest tally puts the total at $433.07 billion a whopping 160 per cent of GDP. That includes mortgages, credit cards, business borrowing and agricultural debt.

It will come as no surprise that our overcooked housing market is to blame for a big rise in mortgage debt over the past decade. That sits at $247.37b 91 per cent of GDP.

It has risen by 57 per cent in the past decade. As house prices have soared so has the amount Kiwis have to borrow to buy.

We kid ourselves we’re wealthier because of capital gains on our homes but in reality our collective balance sheet is looking worse than ever.

This is no revelation, of course. To be fair, it is the issue that probably tops the Reserve Bank’s long list of things to worry about. It is one of the reasons the Bank moved to introduce tough loan to value ratio (LVR) restrictions between 2013 and 2016 as annual growth in mortgage lending neared 10 percent (it peaked at 9.3 per cent in December 2016).

High private debt levels are one of the reasons the Government can’t afford to be reckless on the borrowing front.

New Zealand isn’t unique in this.

As the IMF pointed out, throughout the developed world we have seen debt mount rapidly in an environment of easy money and super low credit, essentially due to the radical policies put in place by central banks to avoid total meltdown in the GFC.

The next crunch will come when we find out how serviceable that debt mountain is, when interest rates rise to more normal levels.

That process is under way now and it worries many economists. They see this a time bomb. Some even predict another massive financial crisis coming our way.

I’m not going to argue this couldn’t happen. But I think it is important to keep the relative scale of the risk in perspective. Debt will almost certainly be at the centre of the next financial mess however it unfolds. But at a certain point that becomes about as meaningful as saying the next crisis will be caused by money.

Debt is effectively a form of currency that enables value transactions to take place in the future rather than just the present. Like money it works as long as there is confidence in the system that accounts for it and enforces payment.

So could the whole thing come tumbling down? Sure.

But let’s look at some reasons why it might not, at least anytime soon.

What’s happening with interest rates is not a shock for markets in fact it’s a slow, orderly process. New Zealand’s official cash rate is 1.75 per cent and it is not expected to go up for at least a year.

Mortgage rates could still rise because local banks need offshore funds to cover their lending costs.

But the proportion they need has fallen. Ten years ago when the GFC hit about 40 per cent of bank funding was sourced offshore. Now it’s less than 30 per cent.

We have learned and made some progress since the GFC.

There are plenty of headlines about US rates rising right now. Even then, the US Fed’s forecasts are for 2.9 per cent by the end of 2019 and 3.4 per cent by the end of 2020. That is hardly apocalyptic. In Europe they are still extremely low. Their forecasts suggest they’ll still be just 0.75 per cent by the end of 2020.

The other positive is that local house prices have flattened out without crashing. That has meant the annual rate of growth in the nation’s mortgage debt has stabilised at about 5.8 per cent.

If rates rise slowly and the growth in housing debt stays steady, if the Government pays down debt and if New Zealand keeps a top grade credit rating then we should be okay.

That is a lot of ”ifs”.

It is not a formula likely to reassure many of the gloomier economy watchers.

But it’s about as much optimism as I can muster on the issue. The risks are real and this country can’t afford to relax about its private debt levels.

How Will Capitalism End? Essays on a Failing System – Wolfgang Streeck.

Capitalism is subject to ‘a long-term structural weakness’, namely ‘the technological displacement of labor by machinery. Electronicization will do to the middle class what mechanization has done to the working class, and it will do it much faster.

Only one thing is certain: that capitalism will end, and much sooner than one may have thought.

CAPITALISM:

ITS DEATH AND AFTERLIFE

Capitalist society may be described in shorthand as a ‘progressive’ society in the sense of Adam Smith and the enlightenment, improbable social formation, full of conflicts and contradictions, therefore permanently unstable and in flux, and highly conditional on historically contingent and precarious supportive as well as constraining events and institutions.

Capitalist society may be described in shorthand as a ‘progressive’ society in the sense of Adam Smith and the enlightenment, a society that has coupled its ‘progress’ to the continuous and unlimited production and accumulation of productive capital, effected through a conversion, by means of the invisible hand of the market and the visible hand of the state, of the private vice of material greed into a public benefit.

Capitalism promises infinite growth of commodified material wealth in a finite world, by conjoining itself with modern science and technology, making capitalist society the first industrial society, and through unending expansion of free, in the sense of contestable, risky markets, on the coat-tails of a hegemonic carrier state and its market opening policies, both domestically and internationally.

As a version of industrial society, capitalist society is distinguished by the fact that its collective productive capital is accumulated in the hands of a minority of its members who enjoy the legal privilege, in the form of rights of private property, to dispose of such capital in any way they see fit, including letting it sit idle or transferring it abroad.

One implication of this is that the vast majority of the members of a capitalist society must work under the direction, however mediated, of the private owners of the tools they need to provide for themselves, and on terms set by those owners in line with their desire to maximize the rate of increase of their capital. Motivating non-owners to do so to work hard and diligently in the interest of the owners requires artful devices, sticks and carrots of the most diverse sorts, that are never certain to function that have to be continuously reinvented as capitalist progress continuously renders them obsolescent.

The tensions and contradictions within the capitalist political economic configuration make for an ever present possibility of structural breakdown and social crisis. Economic and social stability under modern capitalism must be secured on a background of systemic restlessness, produced by competition and expansion, a difficult balancing act with a constantly uncertain outcome. Its success is contingent on, among other things, the timely appearance of a new technological paradigm or the development of social needs and values complementing changing requirements of continued economic growth.

For example, for the vast majority of its members, a capitalist society must manage to convert their everpresent fear of being cut out of the productive process, because of economic or technological restructuring, into acceptance of the highly unequal distribution of wealth and power generated by the capitalist economy and a belief in the legitimacy of capitalism as a social order. For this, highly complicated and inevitably fragile institutional and ideological provisions are necessary. The same holds true for the conversion of insecure workers kept insecure to make them obedient workers into confident consumers happily discharging their consumerist social obligations even in the face of the fundamental uncertainty of labour markets and employment?

In light of the inherent instability of modern societies founded upon and dynamically shaped by a capitalist economy, it is small wonder that theories of capitalism, from the time the concept was first used in the early 1800s in Germany and the mid-1800s in England, were always also theories of crisis. This holds not just for Marx and Engels but also for writers like Ricardo, Mill, Sombart, Keynes, Hilferding, Polanyi and Schumpeter, all of whom expected one way or other to see the end of capitalism during their lifetime? What kind of crisis was expected to finish capitalism off differed with time and authors’ theoretical priors; structuralist theories of death by overproduction or underconsumption, or by a tendency of the rate of profit to fall (Marx), coexisted with predictions of saturation of needs and markets (Keynes), of rising resistance to further commodification of life and society (Polanyi), of exhaustion of new land and new labour available for colonization in a literal as well as figurative sense (Luxemburg), of technological stagnation (Kondratieff), financial-political organization of monopolistic corporations suspending liberal markets (Hilferding), bureaucratic suppression of entrepreneurialism aided by a worldwide trahison des clercs (Weber, Schumpeter, Hayek) etc., etc.

While none of these theories came true as imagined, most of them were not entirely false either. In fact, the history of modern capitalism can be written as a succession of crises that capitalism survived only at the price of deep transformations of its economic and social institutions, saving it from bankruptcy in unforeseeable and often unintended ways. Seen this way, that the capitalist order still exists may well appear less impressive than that it existed so often on the brink of collapse and had continuously to change, frequently depending on contingent exogenous supports that it was unable to mobilize endogenously.

The fact that capitalism has, until now, managed to outlive all predictions of its impending death, need not mean that it will forever be able to do so; there is no inductive proof here, and we cannot rule out the possibility that, next time, whatever cavalry capitalism may require for its rescue may fail to show up.

A short recapitulation of the history of modern capitalism serves to illustrate this point. Liberal capitalism in the nineteenth century was confronted by a revolutionary labour movement that needed to be politically tamed by a complex combination of repression and cooptation, including democratic power sharing and social reform. In the early twentieth century, capitalism was commandeered to serve national interests in international wars, thereby converting it into a public utility under the planning regimes of a new war economy, as private property and the invisible hand of the market seemed insufficient for the provision of the collective capacities countries needed to prevail in international hostilities.

After the First World War, restoration of a liberal-capitalist economy failed to produce a viable social order and had to give way in large parts of the industrial world to either Communism or Fascism, while in the core countries of what was to become ‘the West’ liberal capitalism was gradually succeeded, in the aftermath of the Great Depression, by Keynesian, stateadministered capitalism. Out of this grew the democratic welfare-state capitalism of the three post-war decades, with hindsight the only period in which economic growth and social and political stability, achieved through democracy, coexisted under capitalism, at least in the OECD world where capitalism came to be awarded the epithet, ‘advanced’.

In the 1970s, however, what had with hindsight been called the ‘post-war settlement’ of social-democratic capitalism began to disintegrate, gradually and imperceptibly at first but increasingly punctuated by successive, ever more severe crises of both the capitalist economy and the social and political institutions embedding, that is, supporting as well as containing it. This was the period of both intensifying crisis and deep transformation when ‘late capitalism’, as impressively described by Werner Sombart in the 1920s, gave way to neoliberalism.

Crisis Theory Redux

Today, after the watershed of the financial crisis of 2008, critical and indeed crisis-theoretical reflection on the prospects of capitalism and its society is again en vogue. Does Capitalism Have a Future? is the title of a book published in 2013 by five outstanding social scientists: Immanuel Wallerstein, Randall Collins, Michael Mann, Georgi Derluguian and Craig Calhoun. Apart from the introduction and the conclusion, which are collectively authored, the contributors present their views in separate chapters, and this could not be otherwise since they differ widely. Still, all five share the conviction that, as they state in the introduction, ‘something big looms on the horizon: a structural crisis much bigger than the recent Great Recession, which might in retrospect seem only a prologue to a period of deeper troubles and transformations’. On what is causing this crisis, however, and how it will end, there is substantial disagreement which, with authors of this calibre, may be taken as a sign of the multiple uncertainties and possibilities inherent in the present condition of the capitalist political economy.

To give an impression of how leading theorists may differ when trying to imagine the future of capitalism today, I will at some length review the prospects and predictions put forward in the book.

A comparatively conventional crisis theory is probably the one offered by Wallerstein, who locates contemporary capitalism at the bottom of a Kondratieff cycle (Kondratieff B) with no prospect of a new (Kondratieff A) upturn. This is said to be due to a ‘structural crisis’ that began in the 1970s, as a result of which ‘capitalists may no longer find capitalism rewarding’.

Two broad causes are given, one a set of long-term trends ‘ending the endless accumulation of capital’, the other the demise, after the ‘world revolution of 1968’, of the ‘dominance of centrist liberals of the geoculture’. Structural trends include the exhaustion of virgin lands and the resulting necessity of environmental repair work, growing resource shortages, and the increasing need for public infrastructure. All of this costs money, and so does the pacification of a proliferating mass of discontented workers and the unemployed. Concerning global hegemony, Wallerstein points to what he considers the final decline of the U.S.-centred world order, in military and economic as well as ideological terms. Rising costs of doing business combine with global disorder to make restoration of a stable capitalist world system impossible.

Instead Wallerstein foresees ‘an ever-tighter gridlock of the system. Gridlock will in turn result in ever wilder fluctuations, and will consequently make short term predictions both economic and political ever more unreliable. And this in turn will aggravate popular fears and alienation. It is a negative cycle’. For the near future Wallerstein expects a global political confrontation between defenders and opponents of the capitalist order, in his suggestive terms: between the forces of Davos and of Porto Alegre.

Their final battle ‘about the successor system’ is currently fomenting. Its outcome, according to Wallerstein, is unpredictable, although ‘we can feel sure that one side or the other will win out in the coming decades, and a new reasonably stable worldsystem (or set of world-systems) will be established’.

Much less pessimistic, or less optimistic from the perspective of those who would like to see capitalism close down, is Craig Calhoun, who finds prospects of reform and renewal in what he, too, considers a deep and potentially final crisis. Calhoun assumes that there is still time for political intervention to save capitalism, as there was in the past, perhaps with the help of a ‘sufficiently enlightened faction of capitalists’. But he also believes ‘a centralized socialist economy’ to be possible, and even more so ‘Chinese-style state capitalism’: ‘Markets can exist in the future even while specifically capitalist modes of property and finance have declined’. Far more than Wallerstein, Calhoun is reluctant when it comes to prediction.

His chapter offers a list of internal contradictions and possible external disruptions threatening the stability of capitalism, and points out a wide range of alternative outcomes. Like Wallerstein, Calhoun attributes particular significance to the international system, where he anticipates the emergence of a plurality of more or less capitalist political-economic regimes, with the attendant problems and pitfalls of coordination and competition. While he does not rule out a ‘large-scale, more or less simultaneous collapse of capitalist markets not only bringing economic upheaval but also upending political and social institutions’, Calhoun believes in the possibility of states, corporations and social movements reestablishing effective governance for a transformative renewal of capitalism. To quote,

The capitalist order is a very large-scale, highly complex system. The events of the last forty years have deeply disrupted the institutions that kept capitalism relatively well organized through the postwar period. Efforts to repair or replace these will change the system, just as new technologies and new business and financial practices may. Even a successful renewal of capitalism will transform it. The question is whether change will be adequate to manage systemic risks and fend off external threats. And if not, will there be widespread devastation before a new order emerges?

Even more agnostic on the future of capitalism is Michael Mann (‘The End May Be Nigh, But for Whom?’). Mann begins by reminding his readers that in his ‘general model of human society’, he does ‘not conceive of societies as systems but as multiple, overlapping networks of interaction, of which four networks ideological, economic, military and political power relations are the most important. Geopolitical relations can be added to the four …’ Mann continues:

Each of these four or five sources of power may have an internal logic or tendency of development, so that it might be possible, for example, to identify tendencies toward equilibrium, cycles, or contradictions within capitalism, just as one might identify comparable tendencies within the other sources of social power.

Interactions between the networks, Mann points out, are frequent but not systematic, meaning that ‘once we admit the importance of such interactions we are into a more complex and uncertain world in which the development of capitalism, for example, is also influenced by ideologies, wars and states’. Mann adds to this the possibility of uneven development across geographical space and the likelihood of irrational behaviour interfering with rational calculations of interest, even of the interest in survival. To demonstrate the importance of contingent events and of cycles other than those envisaged in the Wallerstein Kondratieff model of history, Mann discusses the Great Depression of the 1930s and the Great Recession of 2008. He then proceeds to demonstrate how his approach speaks to the future, first of U.S. hegemony and second of ‘capitalist markets’.

As to the former, Mann offers the standard list of American weaknesses, both domestic and international, from economic decline to political anomy to an increasingly less effective military, weaknesses that ‘might bring America down’ although ‘we cannot know for sure’. Even if US. hegemony were to end, however, ‘this need not cause a systemic crisis of capitalism’. What may instead happen is a shift of economic power ‘from the old West to the successfully developing Rest of the world, including most of Asia’. This would result in a sharing of economic power between the United States, the European Union and (some of) the BRICS, as a consequence of which ‘the capitalism of the medium term is likely to be more statist’.

Concerning ‘capitalist markets’, Mann believes, pace Wallerstein, that there is still enough new land to conquer and enough demand to discover and invent, to allow for both extensive and intensive growth. Also, technological fixes may appear any time for all sorts of problems, and in any case it is the working class and revolutionary socialism, much more than capitalism, for which ‘the end is nigh’. In fact, if growth rates were to fall as predicted by some, the outcome might be a stable low-growth capitalism, with considerable ecological benefits. In this scenario, ‘the future of the left is likely to be at most reformist social democracy or liberalism. Employers and workers will continue to struggle over the mundane injustices of capitalist employment […] and their likely outcome will be compromise and reform …’

Still, Mann ends on a considerably less sanguine note, naming two big crises that he considers possible, and one of them probable, crises in which capitalism would go under, although they would not be crises of capitalism, or of capitalism alone, since capitalism would only perish as a result of the destruction of all human civilization. One such scenario would be nuclear war, started by collective human irrationality, the other an ecological catastrophe resulting from ‘escalating climate change’. In the latter case, capitalism figures together with the nation state and with ‘citizen rights’, defined as entitlements to unlimited consumption as one of three ‘triumphs of the modern period’ that happen to be ecologically unsustainable. ‘All three triumphs would have to be challenged for the sake of a rather abstract future, which is a very tall order, perhaps not achievable’. While related to capitalism, ecological disaster would spring from ‘a causal chain bigger than capitalism’. However, ‘policy decisions matter considerably’, and ‘humanity is in principle free to choose between better or worse future scenarios and so ultimately the future is unpredictable’.

The most straightforward theory of capitalist crisis in the book is offered by Randall Collins, a theory he correctly characterizes as a ‘stripped-down version of a fundamental insight that Marx and Engels had formulated already in the 1840s’. That insight, as adapted by Collins, is that capitalism is subject to ‘a long-term structural weakness’, namely ‘the technological displacement of labor by machinery’. Collins is entirely unapologetic for his strictly structuralist approach, even more structuralist than Wallerstein’s, as well as his mono-factorial technological determinism. In fact, he is convinced that ‘technological displacement of labor’ will have finished capitalism, with or without revolutionary violence, by the middle of this century earlier than it would be brought down by the, in principle, equally destructive and definitive ecological crisis, and more reliably than by comparatively difficult-to-predict financial bubbles.

‘Stripped-down’ Collins’s late Marxist structuralism is, among other things, because unlike Marx in his corresponding theorem of a secular decline of the rate of profit, Collins fails to hedge his prediction with a list of countervailing factors, as he believes capitalism to have run out of whatever saving graces may in the past have retarded its demise. Collins does allow for Mann’s and Calhoun’s non-Marxist, ‘Weberian’ influences on the course of history, but only as secondary forces modifying the way the fundamental structural trend that drives the history of capitalism from below will work itself out. Global unevenness of development, dimensions of conflict that are not capitalism-related, war and ecological pressures may or may not accelerate the crisis of the capitalist labour market and employment system; they cannot, however, suspend or avert it.

What exactly does this crisis consist of? While labour has gradually been replaced by technology for the past two hundred years, with the rise of information technology and, in the very near future, artificial intelligence, that process is currently reaching its apogee, in at least two respects: first, it has vastly accelerated, and second, having in the second half of the twentieth century destroyed the manual working class, it is now attacking and about to destroy the middle class as well in other words, the new petty bourgeoisie that is the very carrier of the neocapitalist and neoliberal lifestyle of ‘hard work and hard play’, of careerism-cum-consumerism, which, as will be discussed infra, may indeed be considered the indispensable cultural foundation of contemporary capitalism’s society.

What Collins sees coming is a rapid appropriation of programming, managerial, clerical, administrative, and educational work by machinery intelligent enough even to design and create new, more advanced machinery.

Electronicization will do to the middle class what mechanization has done to the working class, and it will do it much faster.

The result will be unemployment in the order of 50 to 70 per cent by the middle of the century, hitting those who had hoped, by way of expensive education and disciplined job performance (in return for stagnant or declining wages), to escape the threat of redundancy attendant on the working classes. The benefits, meanwhile, will go to ‘a tiny capitalist class of robot owners’ who will become immeasurably rich. The drawback for them is, however, that they will increasingly find that their product ‘cannot be sold because too few persons have enough income to buy it. Extrapolating this underlying tendency’, Collins writes, ‘Marx and Engels predicted the downfall of capitalism and its replacement with socialism’, and this is what Collins also predicts.

Collins’s theory is most original where he undertakes to explain why technological displacement is only now about to finish capitalism when it had not succeeded in doing so in the past. Following in Marx’s footsteps, he lists five ‘escapes’ that have hitherto saved capitalism from self-destruction, and then proceeds to show why they won’t save it any more.

They include the growth of new jobs and entire sectors compensating for employment losses caused by technological progress (employment in artificial intelligence will be miniscule, especially once robots begin to design and build other robots);

the expansion of markets (which this time will primarily be labour markets in middle-class occupations, globally unified by information technology, enabling global competition among educated job seekers);

the growth of finance, both as a source of income (‘speculation’) and as an industry (which cannot possibly balance the loss of employment caused by new technology, and of income caused by unemployment, also because computerization will make workers in large segments of the financial industry redundant);

government employment replacing employment in the private sector (improbable because of the fiscal crisis of the state, and in any case requiring ultimately ‘a revolutionary overturn of the property system’);

and the use of education as a buffer to keep labour out of employment, making it a form of ‘hidden Keynesianism’ while resulting in ‘credential inflation’ and ‘grade inflation’ (which for Collins is the path most probably taken, although ultimately it will prove equally futile as the others, as a result of demoralization within educational institutions and problems of financing, both public and private).

All five escapes closed, there is no way society can prevent capitalism from causing accelerated displacement of labour and the attendant stark economic and social inequalities.

Some sort of socialism, so Collins concludes, will finally have to take capitalism’s place. What precisely it will look like, and what will come after socialism or with it, Collins leaves open, and he is equally agnostic on the exact mode of the transition. Revolutionary the change will be, but whether it will be a violent social revolution that will end capitalism or a peaceful institutional revolution accomplished under political leadership cannot be known beforehand.

Heavy taxation of the super-rich for extended public employment or a guaranteed basic income for everyone, with equal distribution and strict rationing of very limited working hours by more or less dictatorial means a la Keynes, we are free to speculate on this as Collins’s ‘stripped-down down Marxism’ does not generate predictions as to what kind of society will emerge once capitalism will have run its course.

Only one thing is certain: that capitalism will end, and much sooner than one may have thought.

Something of an outlier in the book’s suite of chapters is the contribution by Georgi Derluguian, who gives a fascinating inside account of the decline and eventual demise of Communism, in particular Soviet Communism. The chapter is of interest because of its speculations on the differences from and the potential parallels with a potential end of capitalism.

As to the differences, Derluguian makes much of the fact that Soviet Communism was from early on embedded in the ‘hostile geopolitics’ of a ‘capitalist world-system’. This linked its fate inseparably to that of the Soviet Union as an economically and strategically overextended multinational state.

That state turned out to be unsustainable in the longer term, especially after the end of Stalinist despotism. By then the peculiar class structure of Soviet Communism gave rise to a domestic social compromise that, much unlike American capitalism, included political inertia and economic stagnation. The result was pervasive discontent on the part of a new generation of cultural, technocratic and scientific elites socialized in the revolutionary era of the late 1960s. Also, over-centralization made the state based political economy of Soviet Communism vulnerable to regional and ethnic separatism, while the global capitalism surrounding it provided resentful opponents as well as opportunistic apparatchiks with a template of a preferable order, one in which the latter could ultimately establish themselves as self-made capitalist oligarchs.

Contemporary capitalism, of course, is much less dependent on the geopolitical good fortunes of a single imperial state, although the role of the United States in this respect must not be underestimated. More importantly, capitalism is not exposed to pressure from an alternative political-economic model, assuming that Islamic economic doctrine will for a foreseeable future remain less than attractive even and precisely to Islamic elites (who are deeply integrated in the capitalist global economy).

Where the two systems may, however, come to resemble each other is in their internal political disorder engendered by institutional and economic decline. When the Soviet Union lost its ‘state integrity’, Derluguian writes, this ‘undermined all modern institutions and therefore disabled collective action at practically any level above family and crony networks. This condition became self-perpetuating’. One consequence was that the ruling bureaucracies reacted ‘with more panic than outright violence’ when confronted by ‘mass civic mobilizations like the 1968 Prague Spring and the Soviet perestroika at its height in 1989’, while at the same time ‘the insurgent movements failed to exploit the momentous disorganization in the ranks of dominant classes’.

For different reasons and under different circumstances, a similar weakness of collective agency, due to de-institutionalization and creating comparable uncertainty among both champions and challengers of the old order, might shape a future transition from capitalism to postcapitalism, pitting against each other fragmented social movements on the one hand and disoriented political-economic elites on the other.

My own view builds on all five contributors but differs from each of them. I take the diversity of theories on what all agree is a severe crisis of capitalism and capitalist society as an indication of contemporary capitalism having entered a period of deep indeterminacy, a period in which unexpected things can happen any time and knowledgeable observers can legitimately disagree on what will happen, due to long-valid causal relations having become historically obsolete. In other words, I interpret the coexistence of a shared sense of crisis with diverging concepts of the nature of that crisis as an indication that traditional economic and sociological theories have today lost much of their predictive power. As I will point out in more detail, below, I see this as a result, but also as a cause, of a destruction of collective agency in the course of capitalist development, equally affecting Wallerstein’s Davos and Porto Alegre people and resulting in a social context beset with unintended and unanticipated consequences of purposive, but in its effects increasingly unpredictable, social action.

Moreover, rather than picking one of the various scenarios of the crisis and privilege it over the others, I suggest that they all, or most of them, may be aggregated into a diagnosis of multi-morbidity in which different disorders coexist and, more often than not, reinforce each other. Capitalism, as pointed out at the beginning, was always a fragile and improbable order and for its survival depended on ongoing repair work. Today, however, too many frailties have become simultaneously acute while too many remedies have been exhausted or destroyed. The end of capitalism can then be imagined as a death from a thousand cuts, or from a multiplicity of infirmities each of which will be all the more untreatable as all will demand treatment at the same time.

As will become apparent, I do not believe that any of the potentially stabilizing forces mentioned by Mann and Calhoun, be it regime pluralism, regional diversity and uneven development, political reform, or independent crisis cycles, will be strong enough to neutralize the syndrome of accumulated weaknesses that characterize contemporary capitalism. No effective opposition being left, and no practicable successor model waiting in the wings of history, capitalism’s accumulation of defects, alongside its accumulation of capital, may be seen, with Collins, as an entirely endogenous dynamic of self-destruction, following an evolutionary logic moulded in its expression but not suspended by contingent and coincidental events, along a historical trajectory from early liberal via state administered to neoliberal capitalism, which culminated for the time being in the financial crisis of 2008 and its aftermath.

For the decline of capitalism to continue, that is to say, no revolutionary alternative is required, and certainly no masterplan of a better society displacing capitalism. Contemporary capitalism is vanishing on its own, collapsing from internal contradictions, and not least as a result of having vanquished its enemies who, as noted, have often rescued capitalism from itself by forcing it to assume a new form.

What comes after capitalism in its final crisis, now under way, is, I suggest, not socialism or some other defined social order, but a lasting interregnum, no new world system equilibrium a la Wallerstein, but a prolonged period of social entropy, or disorder (and precisely for this reason a period of uncertainty and indeterminacy).

It is an interesting problem for sociological theory whether and how a society can turn for a significant length of time into less than a society, a post-social society as it were, or a society life, until it may or may not recover and again become a society in the full meaning of the term. I suggest that one can attain a conceptual fix on this by drawing liberally on a famous article by David Lockwood” to distinguish between system integration and social integration, or integration at the macro and micro levels of society. An interregnum would then be defined as a breakdown of system integration at the macro level, depriving individuals at the micro level of institutional structuring and collective support, and shifting the burden of ordering social life, of providing it with a modicum of security and stability, to individuals themselves and such social arrangements as they can create on their own. A society in interregnum, in other words, would be a de-institutionalized or under-institutionalized society, one in which expectations can be stabilized only for a short time by local improvisation, and which for this very reason is essentially ungovernable.

Contemporary capitalism, then, would appear to be a society whose system integration is critically and irremediably weakened, so that the continuation of capital accumulation for an intermediate period of uncertain duration becomes solely dependent on the opportunism of collectively incapacitated individualized individuals, as they struggle to protect themselves from looming accidents and structural pressures on their social and economic status. Undergoverned and undermanaged, the social world of the postcapitalist interregnum, in the wake of neoliberal capitalism having cleared away states, governments, borders, trade unions and other moderating forces, can at any time be hit by disaster; for example, bubbles imploding or violence penetrating from a collapsing periphery into the centre.

With individuals deprived of collective defences and left to their own devices, what remains of a social order hinges on the motivation of individuals to cooperate with other individuals on an ad hoc basis, driven by fear and greed and by elementary interests in individual survival. Society having lost the ability to provide its members with effective protection and proven templates for social action and social existence, individuals have only themselves to rely on while social order depends on the weakest possible mode of social integration, Zweckrationalitat.

As pointed out in chapter 1 of this book, and partly elaborated in the rest of this introduction, I anchor this condition in a variety of interrelated developments, such as declining growth intensifying distributional conflict; the rising inequality that results from this; vanishing macroeconomic manageability, as manifested in, among other things, steadily growing indebtedness, a pumped-up money supply, and the ever-present possibility of another economic breakdown; the suspension of post-war capitalism’s engine of social progress, democracy, and the associated rise of oligarchic rule; the dwindling capacity of governments and the systemic inability of governance to limit the commodification of labour, nature and money; the omnipresence of corruption of all sorts, in response to intensified competition in winner take all markets with unlimited opportunities for self-enrichment; the erosion of public infrastructures and collective benefits in the course of commodification and privatization; the failure after 1989 of capitalism’s host nation, the United States, to build and maintain a stable global order; etc., etc.

These and other developments, I suggest, have resulted in widespread cynicism governing economic life, for a long time if not forever ruling out a recovery of normative legitimacy for capitalism as a just society offering equal opportunities for individual progress, a legitimacy that capitalism would need to draw on in critical moments and founding social integration on collective resignation as the last remaining pillar of the capitalist social order, or disorder.

Moving Disequilibrium

In my own recent work, much of it assembled in this volume, I have argued that OECD capitalism has been on a crisis trajectory since the 1970s, the historical turning point being when the postwar settlement was abandoned by capital in response to a global profit squeeze. To be precise, three crises followed one another: the global inflation of the 1970s, the explosion of public debt in the 1980s, and rapidly rising private indebtedness in the subsequent decade, resulting in the collapse of financial markets in 2008.

This sequence was by and large the same for all major capitalist countries, whose economies have never been in equilibrium since the end of post-war growth at the end of the 1960s. All three crises began and ended in the same way, following an identical political-economic logic: inflation, public debt and the deregulation of private debt started out as politically expedient solutions to distributional conflicts between capital and labour (and, in the 1970s, between the two and the producers of raw material, the cost of which had ceased to be negligible), until they became problems themselves: inflation begot unemployment as relative prices became distorted and owners of monetary assets abstained from investment; mounting public debt made creditors nervous and produced pressures for consolidation in the 1990s; and the pyramid of private debt that had filled the gaps in aggregate demand caused by public spending cuts imploded when the bubbles produced by easy money and excessive credit blew up.

Solutions turned into problems requiring new solutions which, however, after another decade or so, became problems themselves, calling for yet other solutions that soon turned out to be as short-lived and selfdefeating as their predecessors. Government policies vacillated between two equilibrium points, one political, the other economic, that had become impossible to attain simultaneously: by attending to the need for democratic political legitimacy and social peace, trying to live up to citizen expectations of steadily increasing economic prosperity and social stability, they found themselves at risk of damaging economic performance while efforts to restore economic equilibrium tended to trigger political dissatisfaction and undermine support for the government of the day and the capitalist market economy in general.

In fact, the situation was even more critical than that, although it was not perceived as such for a long time, since it unfolded only gradually, over roughly two political generations. Intertwined with the crisis sequence of the post 1970s was an evolving fiscal crisis of the democratic-capitalist state, again basically in all countries undergoing the secular transition from ‘late’ to neoliberal capitalism. While in the 1970s governments still had a choice, within limits, between inflation and public debt to bridge the gap between the combined distributional claims of capital and labour and what was available for distribution, after the end of inflation at the beginning of the 1980s the ‘tax state’ of modern capitalism began to change into a ‘debt state’. In this it was helped by the growth of a dynamic, increasingly global financial industry headquartered in the rapidly de-industrializing hegemonic country of global capitalism, the United States.

Concerned about the power of its new clients who were after all sovereign states to unilaterally cancel their debt, the rising financial sector soon began to seek reassurance from governments with respect to their economic and political ability to service and repay their loans. The result was another transformation of the democratic state, this time into a ‘consolidation state’, which began in the mid-1990s. To the extent that consolidation of public finances through spending cuts resulted in overall gaps in demand or in citizen discontent, the financial industry was happy to step in with loans to private households, provided credit markets were sufficiently deregulated. This began in the 1990s at the latest and ultimately caused the financial crisis of 2008.

Unfolding alongside the crisis sequence and the transformation of the tax state into a consolidation state were three long term trends, all starting more or less at the end of the postwar era and running in parallel, again, through the entire family of rich capitalist democracies: declining growth, growing inequality, and rising debt public, private and overall. Over the years the three seem to have become mutually reinforcing: low growth contributes to inequality by intensifying distributional conflict; inequality dampens growth by restricting effective demand; high levels of existing debt clog credit markets and raise the prospect of financial crises; an overgrown financial sector both results from and adds to economic inequality etc., etc.

Already the last growth cycle before 2008 was more imagined than real, and post 2008 recovery remains anaemic at best, also because Keynesian stimulus, monetary or fiscal, fails to work in the face of unprecedented amounts of accumulated debt. Note that we are talking about long term trends, not just a momentary unfortunate coincidence, and indeed about global trends, affecting the capitalist system as a whole and as such. Nothing is in sight that seems only nearly powerful enough to break the three trends, deeply engrained and densely intertwined as they have become.

Phase IV

Since 2008, we have lived in a fourth stage of the post-1970s crisis sequence, and the by now familiar dialectic of problems treated with solutions that turn into problems themselves is again making itself felt. The three apocalyptic horsemen of contemporary capitalism, stagnation, debt, inequality are continuing to devastate the economic and political landscape. With ever lower growth, as recovery from the Great Recession is making little or no progress, deleveraging has been postponed ad calendas graecas and overall indebtedness is higher than ever. Within a total debt burden of unprecedented magnitude, public debt has climbed again, not only annihilating all gains made in the first phase of consolidation, but also effectively blocking any fiscal effort to restart growth.

Thus unemployment remains high throughout the OECD world, even in a country like Sweden where it has for some time now settled on a plateau of around 8 per cent.

Where employment has to some extent been restored it tends to be at lower pay and inferior conditions, due to technological change, to ‘reforms’ in social security systems lowering workers’ effective reservation wage, and to deunionization, with the attendant increase in the power of employers. Indeed, often enough, ‘recovery’ amounts to replacement of unemployment with underemployment.

Although interest rates are at a record low, investment and growth refuse to respond, giving rise to discussions among policymakers about lowering interest rates further, to below zero. While in the 1970s inflation was public enemy number one, now desperate efforts are being made throughout the OECD world to raise it to at least 2 per cent, hitherto without success. By comparison with the 1970s, when it was the coincidence of inflation and unemployment that left economists clueless, now it is very cheap money coexisting with deflationary pressures, raising the spectre of ‘debt deflation’ and of a collapse of a pyramid of accumulated debt by far exceeding in size that of 2008.

How much of a mystery the present phase of the long crisis of contemporary capitalism presents to its would-be management is nowhere more visible than in the practice of ‘quantitative easing’, adopted, under different names, by the leading central banks of the capitalist world. Since 2008, central banks have been buying up financial assets of diverse kinds, handing out new cash, produced out of thin air, to private financial firms. In return they receive titles to future income streams from debtors of all sorts, turning private debt into public assets, or better: into assets of public institutions with the privilege unilaterally to determine an economy’s money supply. Right now, the balance sheets of the largest central banks have increased in the past seven years from around eight to more than twenty trillion dollars, not yet counting the gigantic asset buying programme started by the European Central Bank in 2014.

In the process, central banks, in their dual roles as public authorities and guardians of the health of private financial firms, have become the most important, and indeed effectively the only, players in economic policy, with governments under strict austerity orders and excluded from monetary policymaking. Although quantitative easing has completely failed to counter the deflationary pressures in an economy like Japan where it has been relied upon for a decade or more on a huge scale it is steadfastly pursued for lack of alternatives, and nobody knows what would happen if cash-production by debt-purchasing was ended.

Meanwhile in Europe, banks sell their no-longer-secure securities, including government papers, to the European Central Bank, either letting the cash they get in return sit with it on deposit, even if they have to pay negative interest on it, or they lend it to cash strapped governments in countries where central banks are not allowed to finance governments directly, collecting interest from them at a rate above what they could earn in the private credit market. To this extent, quantitative easing at least serves to rescue, if nothing else, the financial sector.

Decoupling Democracy

As the crisis sequence took its course, the postwar shotgun marriage between capitalism and democracy came to an end. Again this was a slow, gradual development. There was no putsch: elections continue to take place, opposition leaders are not sent to prison, and opinions can still by and large be freely expressed in the media, both old and new. But as one crisis followed the next, and the fiscal crisis of the state unfolded alongside them, the arena of distributional conflict shifted, moving upwards and away from the world of collective action of citizens towards ever more remote decision sites where interests appear as ‘problems’ in the abstract jargon of technocratic specialists. In the age of inflation in the 19703, labour relations were the main conflict arena, and strikes were frequent throughout the OECD world, offering ordinary people an opportunity to engage with others in direct action against a visible adversary. In this way, they could experience conflict and solidarity directly and personally, with often life-changing consequences. When inflation ended in the early 19803, strikes came to an end as well, and the defence of redistributive interests against the logic of capitalist markets shifted to the electoral arena where the issue of contestation was the social welfare state and its future role and size. Then, when fiscal consolidation got under way, income gains began to depend on access to credit, as determined by increasingly loose legal regulations of financial markets and by the profit interests of the financial industry. This left little if any space for collective action, also because it was hard for most people in financial markets to understand their own interests and identify their exploiter. Today, in Phase IV, with monetary expansion and fiscal austerity coinciding, the prosperity, relative and absolute, of millions of citizens depends on decisions of central bank executives, international organizations, and councils of ministers of all sorts, acting in an arcane space remote from everyday experience and entirely impenetrable to outsiders, dealing with issues so complex that even insiders often cannot be sure what they are to do and are in fact doing.

The upward shift of conflict arenas during the decades of neoliberal progress was accompanied by a gradual erosion of the postwar standard model of democracy, pushed fonNard by, as well as allowing for, the gradual emergence of a new, ‘Hayekian’ growth model for OECD capitalism. By the standard model of democracy, I mean the peculiar combination, as had come to be considered normal in OECD capitalism after 1945, of reasonably free elections, government by established mass parties, ideally one of the Right and one of the Left, and strong trade unions and employer associations under a firmly institutionalized collective bargaining regime, with legal rights to strike and, sometimes, lock-out. This model reached its peak in the 19703, after which it began to disintegrate23. The advance of neoliberalism coincided with steadily declining electoral turnout in all countries, rare and short|ived exceptions notwithstanding. The shrinking of the electorate was, moreover, highly asymmetrical: those that dropped out of electoral politics came overwhelmingly from the lower end of the income scale ironically where the need for egalitarian democracy is greatest. Party membership declined as well, in some countries dramatically; party systems fragmented; and voting became volatile and often erratic. In a rising number of countries, the gaps in the electorate have begun to be filled in part by so-called ‘populist’ parties, mostly of the Right but lately also from the Left, who mobilize marginalized groups for protest against ‘the system’ and its ‘elites’. Also declining is tradeunion membership a trend reflected in an almost complete disappearance of strikes, which like elections have long served as a recognized channel of democratic participation.

The demise of standard post-war democracy was and is of the highest significance. Coupled to state-managed capitalism, democracy functioned as an engine of economic and social progress. By redistributing parts of the proceeds of the capitalist market economy downward, through both industrial relations and social policy, democracy provided for rising standards of living among ordinary people and thereby procured legitimacy for a capitalist market economy; at the same time it stimulated economic growth by securing a sufficient level of aggregate demand. This twofold role was essential for Keynesian politics-cum-policies, which turned the political and economic power of organized labour into a productive force and assigned democracy a positive economic function. The problem was that the viability of that model was contingent on labour mobilizing a sufficient amount of political and economic power, which it could do in the more or less closed national economies of the post-war era. Inside these, capital had to content itself with low profits and confinement in a strictly delimited economic sphere, a condition it accepted in exchange for economic stability and social peace as long as it saw no way out of the national containers within which its hunting licence had been conditionally renewed after 1945. With the end of post-war growth, however, as distributional margins shrunk, the profitdependent classes began to look for an alternative to serving as an infrastructure of social democracy, and found it in denationalization, also known as ‘globalization’. As capital and capitalist markets began to outgrow national borders, with the help of international trade agreements and assisted by new transportation and communication technologies, the power of labour, inevitably locally based, weakened, and capital was able to press for a shift to a new growth model, one that works by redistributing from the bottom to the top. This was when the march into neoliberalism began, as a rebellion of capital against Keynesianism, with the aim of enthroning the Hayekian model in its place;9 Thus the threat of unemployment returned, together with its reality, gradually replacing political legitimacy with economic discipline. Lower growth rates were acceptable for the new powers as long as they were compensated by higher profit rates and an increasingly inegalitarian distribution.341 Democracy ceased to be functional for economic growth and in fact became a threat to the performance of the new growth model; it therefore had to be decoupled from the political economy. This was when ‘post-democracy’ was born.

*


from

How Will Capitalism End? Essays on a Failing System

by Wolfgang Streeck

get it at Amazon.com

GUNS & BOMBS. Donald Trump’s hair-raising level of debt could bring us all crashing down – Ambrose Evans-Pritchard.

If there is such a thing as a capital crime in economics, it is Donald Trump’s exorbitant fiscal stimulus at the top of the cycle.

The effects are entirely pernicious. Such deficit spending at this juncture can only provoke a ferocious monetary response, threatening to bring the global expansion to a shuddering and climactic end sooner rather than later, and with particular violence.

Twin reports by the International Monetary Fund sketch a chain reaction of dangerous consequences for world finance.

The policy if, you can call it that, puts the US on an untenable debt trajectory. It smacks of Latin American caudillo populism, a Peronist contagion that threatens to destroy the moral foundations of the Great Republic.

The IMF’s Fiscal Monitor estimates that the US budget deficit will spike to 5.3 per cent of GDP this year and 5.9 per cent in 2019. This is happening at a stage of the economic cycle when swelling tax revenues should be reducing net borrowing to zero.

The deficit will still be 5 per cent in 2023. By then the ratio of public debt will have ballooned to 117 per cent (it was 61 per cent in 2007). Franklin Roosevelt defeated fascism with a total war economy at lower ratios.

The IMF does not take into account the near certainty of a global downturn at some point over the next five years. A deep recession would push the deficit into double digits, and send the debt ratio spiralling towards 140 per cent in short order.

There is no justification for Trump’s stimulus. The output gap has already closed. The fiscal “multiplier” is less than one. The US unemployment rate is approaching a 48-year low. The New York Fed’s “underlying inflation gauge” surged to 3.14 per cent in March, the highest since 2005.

As an aside, the IMF’s Fiscal Monitor noted that the lion’s share of Trump’s tax cuts go to the rich. The poorest two quintiles enjoy crumbs at first, but are ultimately left worse off.

He has betrayed the very descamisados who elected him. It is worth thumbing through the IMF’s Global Financial Stability Report for a glimpse of the gothic horror story that lies ahead of us.

”Term premiums could suddenly decompress, risk premiums could rise, and global financial conditions could tighten sharply. Although no major disruptions were reported during the episode of volatility in early February, market participants should not take too much comfort,” it said.

The report is a forensic study of hair-raising excess. The US stock market has broken with historic valuations and risen to 155 per cent of GDP, up from 95 per cent even in 2011. Margin debt on Wall Street the bellwether of speculation has rocketed to US$550 billion.

The Fund warned of “late-stage credit cycle dynamics” all too like 2007, and behaviour “reminiscent of past episodes of investor excesses? Leveraged loans in the US have doubled to USSl trillion since the pre-Lehman peak. There is a risk that defaults could spin out of control, leading to a complete “shutdown of the market”, with grave economic implications.

The shadiest “Cov-lite” loans made up 75 per cent of new loan issuance last year, with a deteriorating quality of covenant protection. This is a sure sign that debt markets are throwing caution to the wind. ”Embedded leverage” through derivatives has become endemic. US and European bond funds have raised their derivative leverage ratio from 215 per cent to 268 per cent of assets since 2014, with gross exposure reaching ”worrisome” levels. And so it goes on.

There are two elephants in the room. One is well-understood: the world is leveraged to the hilt.

“The combination of excessive public and private debt levels can be dangerous in the event of a downturn because it would prolong the ensuing recession,” said the Fund. It calculates that the global debt ratio has risen by 12 per cent of GDP since the last peak. The Bank for International Settlements thinks it is at least 40 per cent of GDP higher.

The point remains the same. Every region of the global economy has been drawn into the morass by the leakage effects of zero rates and quantitative easing, compounded by unrestricted capital flows.

The world is therefore ever more sensitive to rising borrowing costs. It lacks the fiscal buffers to cope with a shock. Countries may be forced into contractionary “pro-cyclical” policies, the fate of Greece, Spain, Portugal and Italy in the EMU austerity tragedy. It may soon happen on a global scale.

The IMF says the interest rate burden as a share of tax revenues has doubled over the last 10 years for poorer countries, leaving them acutely vulnerable to “rollover” risks if liquidity dries up.

Private debt ratios in emerging markets have jumped from 60 per cent to 120 per cent in a decade.

The second elephant is global dollar debt. This is less understood. Offshore dollar debt has risen fourfold to US$16t since the early 2000s, or USS30t when equivalent derivatives are included. “The international dollar banking system faces a structural liquidity mismatch,” said the Fund.

The world has a vast “short position” on the dollar. This is harmless in good times but prone to a sudden margin call akin to late 2008 as the Fed raises rates and drains dollar liquidity.

Much of this lending is carried out by European and Japanese banks using short term instruments such as commercial paper and interbank deposits, leaving them “structurally vulnerable to liquidity risks”. French banks have shockingly low dollar liquidity ratios.

The IMF says markets should not be beguiled by the current calm in the currency swap markets, used to hedge this edifice of dollar lending. The so-called “cross-currency basis” can move suddenly. “Swap markets may not be a reliable backstop in periods of stress,” it said.

The Fund warned that banks may find that they cannot roll over short term dollarfunding currently taken for granted. “Banks could then act as an amplifier of market strains. Funding pressure could induce banks to shrink dollar lending to non-US borrowers. Ultimately, there is a risk that banks could default on their dollar obligations,” it said.

So there you have it. While the IMF is coy, the awful truth is that the world is just as vulnerable to a financial crisis as it was in 2007. The scale is now larger. The authorities have fewer safety buffers, and far less ammunition to fight a depression.

This time China cannot come to the rescue. It is itself the epicentre of risk.

The detonator for the denouement is selfevidently Fed tightening and should it ever happen a surging dollar.

Trump may have thought he was being clever in thinking that fiscal prime pumping this year and next would greatly help his re-election chances.

He may instead have brought forward global forces that he does not begin to understand, and guaranteed a frightening crisis under his own watch.

Left Should Stop Equating Labour with Work – Guy Standing.

It is intellectually excusable for those on the political right to want to restrict the meaning of work to labour, or income earning activity. It is inexcusable for those on the political left to do so.

Social democrats are paying a heavy political price for having done so throughout the 20th century. They fell into their own political trap, putting the notion of Full Employment on a pedestal, when that meant little more than maximising the number of people in labour, in positions of subordination to bosses.

Unless the left can escape from the folly of equating labour with work, they will continue to haemorrhage support and drift into the political margins. Why should putting as many people as possible in ‘jobs’ be construed as defining progressive politics?

Social democrats, who have based their politics on labour, should be reminded that the objective of employment stability, or security, was originally advocated by employers in the mid-19th century, not workers’ representatives. For many decades, the term ’in employment’ was a matter of regret, a recognition of low social status, typically applied to single women obliged to take low-paid positions serving in households headed by the bourgeoisie or aristocracy.

Through the 20th century, a peculiar alliance of political ideologies made labour obligatory, except by the landed gentry and the ‘idle rich’. What should at most have been regarded as an onerous necessity in a capitalist system became a pathological necessity in the Soviet Constitution in the Leninist phrase, ’He that doth not labour should not eat’, and took an equally antiemancipatory form in all forms of social democracy.

Very deliberately, entitlement to decent social security was limited to those who performed labour for bosses, or who demonstrated in demeaning ways a willingness to perform labour, or who, in a derivative subordinated way, were married to someone who was performing labour, or who had spent a long period in service doing so.

Forced Labour

Heroes and heroines of social democracy took all that to logical conclusions. Thus Beatrice Webb, mother of Fabian socialism, openly advocated labour camps, using force if necessary, giving Blairite Ministers a justification for advocating workfare several generations later. Meanwhile, William Beveridge, patron saint of the British welfare state, an avowed liberal currently being feted in a celebratory year in the LSE, believed in ’the whip of starvation’ to force workers to labour. At best, this perspective is paternalistic; at worst, anti-emancipatory.

These prejudices were taken forward into ILO Conventions, the embodiment of the social democratic model. They crystallised in Convention 102 of 1952, the Social Security Convention, which speaks of ‘breadwinners’, dependent wives and year of ‘service’ in labour, earning entitlementt protection. This quaint piece of legislation may seem like a throwback to the 1930s that led social democrats to work for it after 1945. However, in 2001 the trades unions of Europe and social democratic governments led the way in demanding that it be kept as one of the ‘up-to-date’ international conventions.

These inconvenient truths must be confronted, not brushed out of the left’s history. Social democrats have been remarkably silent on the systematic distortion of work as labour. They have, for a start, done nothing to alter the rhetoric or to question the statistical representation of work that has been used in national accounts and labour statistics since the 1930s. Unless they change, they cannot hope to recapture the political heights, and they will not deserve to do so.

If you spend six hours a day caring for an elderly relative, that in social democratic and neoliberal parlance is not work. If you spend three hours a day looking after somebody else’s elderly relative for a wage, that is called work, you are elevated to decency as an ’employee’, and you are likely to be protected in some way by labour and social security laws. This discrimination is absurd.

At this point, one should mention the common social democratic impertinence, the assertion that being in a job gives someone ’dignity’, ’status’ and the means of social integration, a sense of belonging in society. I should declare an interest here, perhaps shared by a few readers. I have never felt more dignity or more integrated in society than since I ceased to have a job.

Rather more germanely, tell a man going down a sewer to fix pipes that he is gaining dignity and a sense of belonging to society, and you may receive an unwelcome retort. Indeed, if you did not, one might be inclined to think of false consciousness. Tell a woman who reluctantly goes out in the morning to clean bed pans that she is being integrated and should be grateful for having a job, and you may receive an earful, as they say.

For most people, jobs are instrumental, not to be vilified or romanticised. There is no justifiable reason for elevating them above other forms of work. It is this that social democrats have done. That is not a progressive position. Marx was right in calling labour ’alienated activity’.

Populist Fallacy

However, today there are two other reasons for saying that all progressives should be more radical and intellectually honest about work.

First, the dualisms of labourism that made a rough-and-ready basis for social democracy in an era of industrial capitalism are breaking down. It is increasingly distortionary to persist with the pretence that they still apply as norms. The growing precariat know this all too well. That is one reason why they are tending to turn to new progressive movements that old social democrats are all too keen to dismiss as ‘populist’.

The two dualisms that were the base of social democratic social and labour policy were the ’workplace’ vs other places and ‘labour time’ vs other time uses. More and more work is being done away from formal workplaces and outside labour time, as l have argued at length elsewhere. Those in the precariat often spend more time doing work-for-labour and work-for-the-state than actual labour. Social democrats implicitly tell them that this is not real work.

If one accepts this reality, then one should recognise that existing national labour statistics increasingly distort the images of work and the way people are living. Making social policy dependent on observed labour is correspondingly indefensible for anybody claiming to be on the left. For somebody on the right, the distortion is fantastic. Protection should only be given to those in visible labour.

It was Third Way social democracy that went furthest down that road, claiming there should be no rights without responsibility, and that the poor should demonstrate that in labour, by being in jobs.

One should leave it to the conscience of social democrats to explain why they have been silent on the nature of national labour statistics. The end game of the acceptance of the labourist model is workfare, which is inevitable if one accepts means-testing and labour market flexibility. Matteo Renzi in Italy was the latest to go in that direction, and his social democratic party (PD) is the latest to pay the price of implosion, to become ‘dead men walking’.

Wim Kok, who forged the Third Way, set the way for the Dutch Labour Party entering the abyss, the Hartz IV reforms condemned Germany’s social democrats to its long decline, and New Labour with its lurch to means-testing and workfare lost the British precariat, and allowed the spectre of Universal Credit to emerge as the most illiberal social policy for many decades.

Ageing social democrats spend much more time vehemently attacking basic income, which besides offering prospective income security, encourages work rather than labour, than to critiquing workfare, forcing the unemployed into menial labour.

Unless social democrats can reverse their commitment to labourism, they are surely finished as a political force.

It is that fundamental. However, it is the other reason for wanting to refashion progressive thinking about work that is even more important in the context of the ecological crisis rushing towards us.

Sadly, the left in general and social democrats in particular have a bad record in ecological terms. Whenever there has been a conflict between job creation and the environment, they have given precedence to jobs, so-called ’working class’ jobs. At best, social democrats have been left with a residual policy of dealing with ’externalities’ and pollution control, rather than advocating a sustainable development strategy.

Green Left Growth

That aside, the left must restart. Consider the following dilemma. If only labour is captured by national statistics, and if only labour is accepted by the bureaucrats operating social policy, then ‘economic growth’ is underestimated and we give too much emphasis to activities that result in resource depletion. If instead, a nonlabourist approach were taken, the value of work that is not labour commonly called ’use value’ would be given at least equal weight to the value of labour exchange value.

For anybody on the ‘Green-Left’, this should have wonderful appeal. It would enable them to overcome the awkwardness of the term ’de-growth’.

If activities designed to conserve resources and reproduce ourselves and our communities, our commons, are given equal value to resource depleting activities, then shifting from the latter to the former would not lower ’growth’ or be ‘de-growth’.

It is hard to sustain a political campaign of de-growth if that means lowering economic growth, since with conventional statistics that implies lowering the standard of living on average. To a sophisticated Green, that might make one feel virtuous and principled, but it is unlikely to appeal on the doorstep of the typical voter.

If work that is not labour were given equal (or ideally more) weight and attention in statistics, in progressive rhetoric, and in articles and books written by progressives, that would enable everybody to measure ’growth’ in a more ecologically sensible way. I am sure many of us on the left feel uncomfortable with calls by quasi Keynesians and others on the left for more growth when that might just mean more rapid resource depletion, global warming and loss of work in favour of labour.

There is no escape from the social democratic trap, in conventional thinking, if you shift from doing a boring job going to an office each day to spending the same time looking after elderly relatives or your local community, economic growth goes down, which is regarded as ’bad’. If that care work were valued at no more but no less than that office job, the shift would not lower growth. Some of us would wish to be more radical still. But that would be a great start


Guy Standing is Professorial Research Associate at SOAS University of London and author of The Corruption of Capitalism: Why Rentiers Thrive and Work Does Not Pay (Biteback, 2016) and Basic Income: And How We Can Make It Happen (Penguin, 2017). He also wrote The Precariat: The New Dangerous Class (Bloomsbury, 2011), and A Precariat Charter: From Denizens to Citizens (Bloomsbury, 2014).

He is honorary co-president of the Basic Income Earth Network (BIEN), an international NGO that promotes basic income.

Powerless: How Lax Antitrust and Concentrated Market Power Rig the Economy Against Workers, Consumers, and Communities.

Marshall Steinbaum, Eric Harris Bernstein and John Sturm.

As workers, as consumers, and as citizens, Americans are increasingly powerless in today’s economy. A 40 year assault on antitrust and competition policy, the laws and regulations meant to guard against the concentration of power in private hands has tipped the economy in favor of powerful corporations and their shareholders. Under the false assumption that the unencumbered ambitions of private business will align with the public good, the pro-monopoly policies of the “Chicago School” of antitrust lurk behind today’s troubling trends: high profits, low corporate investment, rising markups, low wages, declining entrepreneurship, and lack of access to unbiased information. Market power and lax competition policy ensure our economy serves the few over the many.

In a new report, Marshall Steinbaum, Eric Harris Bernstein and John Sturm build on the growing progressive consensus that the economic threat of market power goes far beyond prices. The paper demonstrates the disastrous consequences that unrestrained market power has had on workers, communities, and democracy.

The authors begin by explaining the dangers of market power and the role of competition policy in maintaining a level playing field. They then outline how lax competition policy has handed incumbent corporations and their shareholders an unfair advantage and a more generous slice of the economic pie. They document the consolidation and exploitation of market power that has occurred in this environment and highlight key pieces of evidence that illustrate how weak competition is harming the economy, holding back new businesses, investment, wages, and growth.

The subsequent section reviews recent research that shows how concentrated corporate power impacts the everyday lives of Americans, surveying these effects through three lenses: the effects on consumers, on workers, and on society at large. In the final section, the authors propose policy remedies that could help rebuild inclusive growth, foster economic innovation, and restore an equitable economy that serves all of its stakeholders.


Executive Summary

As workers, as consumers, and as citizens, Americans are increasingly powerless in today’s society. Rhetoric extolling the virtues and power of free markets belie this fact, but instinctively, Americans understand that something is wrong:

The vast majority of Americans believe the economy is “rigged” in favor of corporations. And they are correct: A 40 year assault on antitrust and competition policy, the laws and regulations meant to guard against the concentration of power in private hands has helped tip the economy in favor of powerful corporations under the false pretense that the unencumbered ambitions of private business will align with the public good.

The single biggest problem with this simplistic view of “free” markets is that it ignores power dynamics and implies the existence of some natural state in which markets flourish without oversight.

In reality, no state of natural market equilibrium exists. Healthy markets depend on rules to create an equitable balance of market power between workers, consumers, and businesses. And when those rules skew the balance of power, markets favor the most powerful to the detriment of others.

In reality, firms use market power to extract from other participants rather than compete to create the best products. This not only hurts those targeted, but also results in less growth and innovation overall. Accordingly, while corporate profits have risen, wages and investment have stagnated; rather than investing in research and development (R&D) to generate innovative products, corporations have relied on lax merger regulation to buy out competitors, or they have employed a litany of anti competitive practices to prevent them from entering markets in the first place.

Knowing that consumers and workers have few alternatives, powerful corporations have jacked up prices and lowered wages. Additionally, in many instances, technological developments, free of regulatory oversight, have exacerbated these problems, allowing companies like Google, Facebook, and Amazon to achieve market dominance by collecting reams of data and acting as an all knowing middleman between customers and upstream suppliers.

The pro monopoly ideology of the so called “Chicago School” lurks behind all of these trends, ceding already dominant incumbent firms and their shareholders more and more power that they can wield to their sole benefit and at the expense of society at large.

Although the evidence of rising market power and its impact on the economy are often found in broad economic data, the consequences of market power are anything but theoretical. From rising prices, to low wages, to the way we access information, market power and lax competition policy are entrenching the intrinsic advantages of wealth and power in society. Private interests increasingly determine access to critical goods and services, prioritizing privileged groups and thus exacerbating existing inequities of race, gender, and class.

In this paper, we provide evidence supporting our thesis, as well as illustrative examples of how this behavior has manifested itself in the lived experiences of regular Americans.

Finally, we discuss the antitrust reforms that can begin to rebalance the economy in favor of equity, inclusion, and democratic rule.

Introduction

In Massachusetts, a 19 year old is forced to forego her summer job as a camp counselor because of a non compete clause she unknowingly signed with a different summer camp the year before.‘

In Chicago, a 69 year old United Airlines passenger is beaten and forced off a plane for refusing to give up his seat to a United Airlines employee.

In Hedgesville, West Virginia, two parents overdose on heroin at their daughter’s softball practice. Like millions of Americans, they became addicted to opioids after being prescribed OxyContin, a painkiller manufactured and marketed under false pretenses by Purdue Pharmaceuticals. OxyContin part of a class of drugs responsible for 33,000 US. deaths in 2015, according to the American Society of Addiction Medicine (2016) has churned out $35 billion in revenue for Purdue. The company has yet to face legal repercussions.‘

Despite calls for disaster relief and gun control in the fall of 2017, as citizens in Puerto Rico were without water and electricity following the devastation of Hurricane Maria and the city of Las Vegas was reeling after yet another mass shooting, Congress’s attention was elsewhere: Heeding Wall Street lobbyists, the Senate voted to strip Americans of their right to hold banks and credit providers accountable for malfeasance.

As workers, as consumers, and as citizens, Americans are increasingly powerless in today’s society. Rhetoric extolling the virtues and power of free markets belie this fact, but instinctively, Americans understand that something is wrong: The vast majority of Americans believe the economy is “rigged” in favor of corporations, according to a poll by Edison Research (2016). And they are correct: A 40 year assault on antitrust and competition policy, the laws and regulations meant to guard against the concentration of power in private hands, has helped tip the economy in favor of powerful corporations and wealthy shareholders over regular Americans

Beginning in the 1970s, a concerted movement referred to as the “Chicago School” of antitrust beat back anti monopoly policy through like minded executive and judicial appointments, court rulings, and agency actions. The Chicago School argued that large corporations were large because they were efficient and because the free market incentivized them to operate in the best interest of consumers, If they didn’t, so the story went, then new entrants were always at hand to ensure the economy “naturally” served the broad public interest. Government action to break up or regulate corporations, the Chicago School argued, would only impede their efficiency or protect incumbents at the expense of entrants.

Under this regime, corporations and corporate conduct were presumed pro competitive, or economically efficient. Even for potentially anti competitive behavior, the burden of proof was raised high enough to forestall regulatory relief.

This created a dramatic departure from vigorous antitrust protections that helped make the United States the world’s most robust economy, and among the most equitable, during the postwar era. Prior to the 1970s, dating back to the age of Teddy Roosevelt and railroad robber barons, but especially after the late 1930s, regulators took an active role in ensuring equal footing for workers, consumers, and small businesses. Authorities blocked mergers that would result in dominant businesses, broke up monopolies, and closely regulated networked industries like telecommunications, banning restrictive contractual arrangements likely to benefit incumbents at the expense of consumers and new entrants. In combination with a comprehensive social safety net and powerful labor unions, antitrust protections fostered healthy competition in which firms could succeed only by offering valuable products at reasonable prices and by attracting good workers with fair wages; firms that failed to innovate or satisfy customers were out competed by new entrants. In this environment, wages and investment boomed and small businesses fueled strong employment.

In stark contrast, the results of the 40 year experiment in Chicago School antitrust have spelled disaster for the American workforce, middle class, and economy overall. While corporate profits have risen, wages and investment have stagnated.

A recent study by De Loecker and Eeckhout (2017) shows that average firm level markups, the amount charged over the cost of production, have more than tripled since 1980. And while waves of mergers have led to larger and more powerful corporations, small businesses form less often and struggle to survive. Recovery from the 2008 financial crisis hastened by government bailouts for those at the top has yet to benefit those at the middle and the bottom of income distribution.

The pro monopoly policies of the Chicago School lurk behind all of these trends, ceding already dominant incumbent firms and their shareholders more and more power that they can wield to their sole benefit and at the expense of society at large. Rather than investing in research and development (R&D) to generate innovative products, corporations have relied on lax merger regulation to buy out competitors, or they have employed a litany of anti competitive practices to prevent them from entering the market in the first place. Knowing that consumers and workers have few alternatives, powerful corporations have jacked up prices and lowered wages. In many instances, technological developments, free of regulatory oversight, have exacerbated these problems, allowing companies like Google, Facebook, and Amazon to achieve market dominance by collecting reams of data and acting as an all knowing middleman between customers and upstream suppliers. When firms achieve such power, their incentive to produce better products and services disappears, and they act instead to maintain their market stranglehold by any means necessary.

We define “market power” as the ability to skew market outcomes in one’s own interest, without creating value or serving the public good.

We argue that market power, and the anti competitive behavior that it enables, is a negative sum game: Anti competitive economies, like the one we have today, produce fewer jobs at lower wages, with more expensive goods and less innovation. We aim to both document the rise of market power and illustrate how it has affected the day to day lives and general well being of American workers, consumers, and the productivity of the economy overall. In short, we show that Chicago School inspired deregulation has enabled the rich and powerful to profit by taking a larger share of the economic pie, rather than making the pie bigger by offering valuable products and services at better prices.

Increased market power of consolidated firms is especially threatening to marginalized communities, which tend to have the fewest alternatives to exploitative goods and services providers. ACA exchanges in large swathes of rural America have only one health insurance provider, and that provider is free to charge exorbitant rates. For many urban neighborhoods, gentrification is the only hope of attracting a decent broadband connection, in which case the threat of rising rent sours the payoff. In markets for labor, consumer goods, or financial services, the first victims of predatory practices are the most vulnerable, be they young people, women, or people of color.

The Chicago School has championed the benefits of “free markets” but has in fact worked to thwart them. Conflating power with freedom, the Reagan era ideology has used the free market as a rallying cry to justify policy changes that in reality benefit wealthy incumbent businesses at the expense of all others. This is the antithesis of the diffusion of economic power that is required to ensure that the economy rewards honest work, erodes privileged rent extraction in all of its forms, and ultimately operates in the public interest.

While professing to champion competition, the Chicago School has acted only to protect the unearned profits of monopolists while stifling entrepreneurship.

A recommitment to active antitrust policy is key not only to overturning the accumulations of wealth and power we see today, but also to reaping all of the societal benefits that come from undoing market power.

This report begins by explaining the dangers of market power and the role of competition policy in maintaining a level playing field. We then outline how lax competition policy has handed incumbent corporations and their shareholders an unfair advantage and a more generous slice of the economic pie. We document the consolidation and exploitation of market power that has occurred in this environment and highlight key pieces of evidence that illustrate how weak competition is harming the economy holding back new businesses, investment, wages, and growth. In the subsequent section, we review recent research that shows how concentrated corporate power impacts the everyday lives of Americans. We survey these effects through three lenses: the effects on consumers, on workers, and on society at large. In the final section, we discuss policy remedies that could help rebuild inclusive growth, foster economic innovation, and restore an equitable economy that serves all of its stakeholders.

SECTION ONE

The Theoretical and Institutional Background for Antitrust and Competition Policy

THE “FREE” MARKET IN THEORY

Market economies rest on the theory that private self interest can be aligned with the public good. In its simplest form, this theory holds that, because market interactions require the willing participation of workers, consumers, and businesses, each party will only participate in an interaction if it makes that party better off. If a worker is paid a satisfactory wage, a business owner receives a return on his or her investment, and a consumer is able to purchase a product they value at an acceptable price, then each individual benefits. In this context, firms that develop better products or reduce prices are rewarded with a larger share of the market and are thus incentivized to innovate; similarly, firms that offer a higher quality of life for employees through better pay and working conditions will attract the most productive workers and are therefore encouraged to raise wages. Competition among firms thus drives productive innovation and higher standards of living. Conversely, firms that overcharge for their products, fail to innovate, or pay low wages will lose out.

It is an elegant and important theory, but it is also just that: theory.

THE RULES MATTER

The single biggest problem with this simplistic view of markets is that it ignores power dynamics and implies the existence of some natural state in which markets flourish without oversight. In reality, no state of natural market equilibrium exists, and the entrenched power of wealth poses an omnipresent threat to the equity of outcomes;

healthy markets depend on rules to create an equitable balance of market power between workers, consumers, and businesses,

and when those rules skew the balance of power, markets favor the most powerful to the detriment of others. Thus, an economy with no labor protections will favor employers over workers, while a society with confiscatory tax rates on investment returns will make it difficult for shareholders to exercise power over the businesses they own.

As this analysis implies, setting the rules to achieve an equitable balance of power between market participants is crucial. Furthermore, beyond laws and regulations, the rules include all manner of social, cultural, and political factors, from the things we invest in and the things we neglect, to which groups are discriminated against and which are privileged. When rules preference one group over another, that group may skew transactions in their own favor, driving up profits at others’ expense. For example, redlining policies of the New Deal’s federal housing finance agencies made it impossible for black communities to accumulate wealth through homeownership.

Historically, marginalized communities have been underserved by public goods, including transportation and communications infrastructure. Physically and economically isolated, these populations became prey for firms that could get away with offering poor service and high prices due to a lack of alternatives, leading to today’s discriminatory, segmented markets. Examples like this illustrate how the rules bear a deep and complex relationship to market outcomes.

We define market power as the ability to skew market outcomes in one’s own interest, without creating value or serving the public good.

This definition acknowledges that harm to workers, consumers, or other businesses can be wrought in a number of ways not connected directly to price. For example, if a firm eliminates the threat of competition by raising barriers to entry, consumers can feel the negative impact through the reduction in service, even if quoted prices remain the same. This definition allows us to consider the broader impact that market power has on innovation, wages, and other considerations beyond consumer price.

MARKET POWER AND MARKET FAILURE

When firms possess market power and use it to extract from other participants rather than compete to create the best products, it not only hurts those targeted, but also results in less growth and innovation overall. In the 1990s, for example, Microsoft sought to dominate the software market by leveraging its ubiquitous operating system, Windows.

At the time, Microsoft made its Office software compatible only with its Windows operating system, and Microsoft also ensured that Windows was the exclusive option for newly purchased desktop hardware. Crucially, it tied licensing contracts for Windows to its proprietary web browser, Internet Explorer. Thus, the company attempted to systemically eliminate competition in every market where it competed. This drove up Microsoft’s share of the market for both operating systems and software-at the direct expense of its competitors. Since it sought to exclude rather than out perform competitors, at every level of the supply chain, and because it interfered with healthy competition, this sort of behavior is referred to as “predatory” or “anti competitive”, behavior that the federal government sought to address in its eventual antitrust suit against Microsoft in the late 1990s and early 2000s.

Anti competitive behavior redistributes the surplus from market transactions away from less advantaged firms, customers, and workers and toward the wealthy and powerful. Taking the analogy of a basketball game, we can liken anti competitive behavior to repeatedly elbowing an opponent in the face, bribing referees, or rigging the scoreboard. Such strategies can lead to victory in a narrow sense, but to anyone with an understanding of basketball, it is anathema to the sport and defeats the purpose of the game. If a basketball game turns into a brawl, it’s not “bad basketball” or “tough basketball”, it’s not basketball at all.

It bears repeating that market power and the exercise of anti competitive strategies shrink the economic pie overall. When firms like Microsoft erect barriers to entry, they prevent new competitors from entering the market, strangling new businesses and depriving the economy of the benefits of those businesses namely, jobs and innovation. Thus, “anti-competitive” strategies do not simply result in higher prices for consumers, but in a slower pace of innovation and growth for the economy as a whole, notwithstanding empirically questionable research that ostensibly shows monopoly power promotes innovation. In short, when firms exercise market power, everyone else loses. Markets are only valuable when the rules provide for an even playing field between market participants.

MAKING MARKETS WORK: COMPETITION POLICY AND ITS ORIGINS

Recognizing the threat that disproportionate corporate power posed to the economy and our society, policymakers sought tools to combat market domination by large firms as early as the late 19th century. When the monopoly power of trusts like Standard Oil and the Pennsylvania Railroad sparked public outrage over high prices and poor service, Congress passed the Sherman and Clayton Antitrust acts, providing the legal means by which to regulate firms so that their size and power, and their use of predatory behavior, would not upend markets.

This new body of laws and regulations dubbed antitrust in the United States and, more generally and in an international context, “competition policy” was intended to guarantee that firms competed with one another on a level playing field, and that they did not become so powerful as to dominate workers, consumers, or smaller firms. In concert with labor and consumer protections, antitrust laws are one of three policy prongs intended to create an equitable balance of power between market actors. So, while competition policy cannot wholly eliminate market power from the economy, it is an important tool in limiting the ways in which market power can be deployed. Antitrust laws seek do this through three primary objectives:

1. Limiting the consolidation of power by regulating market structure.

Market structure generally refers to the number of firms in a given market, as well as their relationship to consumers and suppliers. The structure of a market plays a large part in determining how much influence certain firms have over a market and how they are able to use it. So, in some ways, regulating market structure is the most foundational component of competition policy.

In the era of active antitrust regulation, this was accomplished by policing a range of factors that included:

Merger enforcement: Regulating concentration was primarily accomplished by reviewing the impact of mergers. If authorities deemed that a merger resulted in a detrimental reduction in competition, they would seek to block or undo it.

Monopoly regulation: When a firm becomes the sole seller of a given good or service, it is a monopoly. When a firm achieved a monopoly, authorities would either attempt to break up the firm or begin to closely regulate its practices to ensure it did not abuse its powerful position.

Vertical integration: Firms active in more than one market, especially when they compete with their own suppliers or customers, were once considered anti competitive due to the ability to favor themselves and exclude entrants, leveraging market power in one market to dominate others. But under the influence of the Chicago School, scrutiny of vertical integration was reduced almost to nonexistence; consequently, vertically integrated firms and even whole industries are far more prevalent today.

2. Curtailing anti-competitive behaviors.

Firms are often able to engage in anti competitive practices when structural regulation fails to eliminate market power or when firms simply break the rules. Collusion, for example through which would be competitors collaborate to set prices artificially high, is always possible, even in a theoretically competitive market. In Microsoft’s case, its attempt to limit competition in software markets was based, in part, on the fact that it held a large share of the market for operating systems, but it was also based on the technological advantage that competing software companies depended on the same operating systems to run, an example in which market structure creates the scope for anti competitive conduct.

So, while anti competitive practices are often enabled by some market power advantage, which structural regulation failed to address, they must sometimes be dealt with on a sectoral or case by case basis. Antitrust laws, therefore, made anti competitive practices expressly illegal, and agencies tasked with identifying and prosecuting violations were created. Some key concerns included:

Collusion or “price fixing”: As described above, collusion is when multiple ostensibly competing firms conspire to create a defacto monopoly and set prices artificially high.

Predatory pricing: In order to drive out would be competitors, powerful firms sometimes sold goods and services under the cost of production. Seeing how such behavior threatened entrepreneurship and robust competition, authorities prohibited this practice.

Vertical restraints: This involves imposing restrictive contractual arrangements on counterparties (e.g., Microsoft requiring any hardware equipped with its Windows operating system to also carry Internet Explorer).

Barriers to entry: Once they are established, firms may seek to prevent competition by erecting barriers to entry. Such strategies can vary enormously, but some popular methods include: aggressive patent protections, leveraging relationships with federal regulators responsible for approving products, or collaborating with outside businesses to squeeze out new entrants.

3. Establishing public utility regulation of essential industries and “natural monopolies.”

Certain goods, such as water or electricity, are necessities of modern life. Consumers cannot simply choose to eschew these goods or find substitutes like they can with other products. This places firms that sell these goods and services at an enormous advantage. In many instances, the need for universal provision, combined with the cost of the infrastructure necessary to supply them, naturally lends these industries to monopoly, especially within a given region. Recognizing this, and also recognizing that limited private sector competition for the provision of utilities could be positive, authorities established laws to more strictly regulate these markets. This guaranteed access and prevented firms from exploiting the widespread need for their products or services essentially holding consumers hostage, in order to extract undue profits. Some key industries included: Telephone networks, Railroads and Electricity.

Beyond these economic concerns, 20th century antitrust was founded on the notion that the concentration of private power threatens not just economic equality, but democratic legitimacy as well. This view was perhaps best articulated and championed by Supreme Court Justice Louis Brandeis, who argued that, if left unchecked, wealthy firms and individuals would leverage their power to exert disproportionate influence over government decision making. The danger of lax protections was not just the potential for runaway economic inequality, but also for the deterioration of democratic governance.

THE LIMITS OF ANTITRUST

Though antitrust protections of the mid 20th century were crucially important, recent history has proven that they were not enough. The success of these laws hinged on how they were interpreted and enforced by regulators and the judiciary. As interpretations have grown more lax, unanticipated threats have multiplied. Data aggregation and the proliferation of digital platforms like Google and Amazon, for example, pose new, unforeseen threats to workers, consumers, and society as a whole that remain completely unaddressed by existing competition policy. These challenges will require new laws, as well as new applications of existing ones.

Although antitrust reform is essential to limiting the consolidation of power by the wealthiest corporations and individuals, it will by no means ensure a just and equitable society on its own. Reining in dominance of those at the top will be impossible without also building power to oppose it through worker organizing. Political reform, to curtail or outlaw the sort of big money lobbying and advocacy that currently dominates our political system is also essential, as is a stronger social safety net, to ensure that the price of economic competition is not widespread poverty. So, although this report is focused on the evolution and challenges presented by market power, stronger antitrust is by no means a panacea to all economic challenges. Reform in these and many other areas, including on issues of gender and race inequality, is essential to the health of the economy and American society.

ANTITRUST IN PERIL

As early as the 1940s despite the clear success of revolutions in antitrust and pro labor policies wealthy firms and conservative political interests began a concerted effort to roll back strong competition policies in the hopes of taking a larger share of the economic pie for themselves. Ultimately, these interests hit on a novel argument: Private firms were naturally inclined to innovate, so any regulation only impeded growth and efficiency; rules that favored large firms would benefit consumers through lower prices; and any price markups in the event of reduced competition would be more than offset by cost savings in production.

But what this theory offered in novelty and an appealing sort of counter intuitive logic, it lacked in empirical support and rigor. The pro business camp placed enormous faith in optimistic predictions of firm behavior based on theoretical assumptions that were never tested. In doing so, it wholly ignored the importance of an equitable balance of power between market participants.

Despite the lack of evidence for the theories they articulated, the Chicago School’s intellectual proponents, academics like George Stigler, Harold Demsetz, and Robert Bork benefitted from an air of scholarly and technocratic authority. Emanating from reputable institutions and influential think tanks in Washington, proponents of this new laissez faire competition policy claimed superior insight on the basis of their original work in economic theory. They downplayed the risks of consolidated private power and labeled Brandeis’s approach to antitrust as dated and simplistic. (in reality, Brandeis himself had been noted for his introduction of empirical research into his jurisprudence?)

Bork and others from the Chicago School hoped to cast out all but the most minimal of antitrust enforcements. As Baker (2015) summarizes, they held that “law should be reformed and refocused to strike at only three classes of behavior: ‘naked’ horizontal agreements to fix prices or divide markets, horizontal mergers to duopoly or monopoly, and a limited class of exclusionary conduct.” This view reflected the Chicago School’s founding assumption that other than in the most extreme cases, firms would only ever work to increase market share through price reduction, and that, thus, regulation of all but the most blatant forms of anti competitive conduct could be eliminated.

Starting in the 1980s, this formed the dominant view of competition policy in the United States, and with the election of the enthusiastically supportive Ronald Reagan, the Chicago School’s vision began a swift conversion to reality.

Soon, a wave of executive and judicial appointees beholden to its core beliefs set to work, regulating markets in the mold of the philosophy’s pro corporation, anti statist beliefs, benefiting large incumbent firms over consumers, workers, and small businesses.

The success and prevalence of this ideology has been so profound that today, even Democratic Party appointed senior antitrust regulators assert “we are all Chicago School now” in their public appearances. The economic impact of that elite consensus is clear.

KEY CHANGES IN ANTITRUST UNDER THE CHICAGO SCHOOL:

Relaxed merger guldelines: Under this new regime, mergers that may once have been deemed anti competitive were increasingly permissible. leading to higher levels of consoiidation along with the proliferation of market power.

An end to the scrutiny of vertical Integration: Mergers, in which the parties did not compete directly, were presumed to be motivated by efficiences in production rather than the ability to exclude rivals from the market and siphon their market share.

Elevated burdens of proof: Very broadly, the Chicago School raised the burdens of proof for a range of predatory behavior. Thus, while the behaviors remained potentially illegal, it became increasingly difficult to prevent or punish harmful practices because spurious defenses were given undue credence, eg, that through some convoluted and empirically unproven mechanism, exclusionary conduct benefited consumers.

SECTION TWO

The Market Power Economy

In this lax regulatory environment, we have seen precisely the sort of economic outcomes that we would expect from a lopsided economy. A growing body of evidence indicates that whatever mechanism once translated economic surplus into shared growth is now broken. As seen in Figure 1, corporate profits when measured as a share of the economy-are at a historic peak. And even though the cost of borrowing is low, incumbents are not investing or expanding operations to out compete one another (Furman and Orszag, 2015; Barkai 2016; Gutierrez and Phillippon, 2017).

This suggests that powerful firms, operating with little competition, have been able to profit by raising prices and cutting wages, rather than by investing in new, valuable products. Recent work by De Loecker and Eeckhout (2017) finds that firm level markups have increased from 18 percent to 67 percent since 1980 a pattern that holds across all industries.

In keeping with the market power hypothesis, we also see that profits have increased most in the industries that have become more concentrated, and that wage growth has been most stagnant in these same concentrated industries (Barkai 2016; Gutierrez and Philippon, 2017; Grullon, 2016).

Of course, concentration is not synonymous with market power, but when combined with substantial policy changes at the federal level and a host of qualitative observations, the case that rising market power and anti competitive behavior have caused our current growth and wage stagnation looks compelling. Below we present six pieces of evidence that, when taken together, strongly support this view:

Fact 1: Fewer firms, less competition

Since the rise of the Chicago School antitrust policy, US. markets have consolidated dramatically. The number of mergers and acquisitions has skyrocketed, increasing from less than 2,000 in 1980 to roughly 14,000 per year since 2000. As a result, Grullon et al. (2016) found that between 1997 and 2012. more than 75 percent of U.S. industries became more concentrated, meaning a smaller number of larger firms account for most of the revenues. The number of publicly traded corporations and their share of the total market are also lower than at any time in the last 100 years.

Furthermore, conventional measures of concentration do not even capture concerns over common ownership: As institutional investors have come to dominate stock markets, they have bought shares of multiple firms in the same industry. Azar et al. (2016) document that individual institutional investors, firms like Vanguard and Blackrock, own large fractions of all main “competitors” in the technoloy, drug store, banking, and airlines industries.

It is increasingly apparent that this consolidation has had detrimental effects on the overall economy. Recent research highlights several key indicators.

Fact 2: Higher prices

A spate of recent studies shows consumer prices rising in conjunction with consolidation. Gutierrez and Philippon (2017) document that markups of prices over the cost of production have increased in line with aggregate trends in consolidation, and that these shifts are driven by large firms and concentrating industries.

Kwoka (2013) conducts a meta analysis of merger retrospectives studies comparing prices that companies charged before and after they merged. Combining the data from retrospectives on 46 mergers since 1970, Kwoka finds an average price increase of 729 percent. This study doesn’t include enough mergers to conclusively settle the debate, but it’s enough to cast serious doubt on the theory that underlies the past 40 years of competition policy.

Most recently, De Loecker and Eeckhout (2017) use a database of publicly traded firms to find that markups, the amount a firm charges above its costs, have risen to an astounding average of 67 percent, compared to just 18 percent in 1980. Although De Loecker and Eeckhout do not offer a causal analysis, other studies of markups and consolidation lend credence to the link between consolidation, market power, and rising prices.

But consolidation is not the only way that market power can impact prices in today’s economy. The increasing role of institutional investors in capital markets has exacerbated the lack of competition and the rise of prices in consumer markets. As previously noted, investors like Vanguard and BlackRock own large shares of multiple businesses within an industry. In terms of competition and price, this “common ownership” can have similar, or even more severe, ramifications as a merger.

In a recent paper, Azar, Schmalz, and Tecu (2016) measure the effects of common ownership in the airline industry. Comparing routes of independent airlines to those owned by similar shareholders, the economists find that prices would be 3 to 7 percent lower if all airlines were owned independently Importantly, these studies did not count the much documented rise of ancillary fees, which, in addition to being a thorn in the side of cash strapped flyers, have grown appreciably in recent years.“ In other work, Azar, Raina, and Schmalz (2016) show that common ownership of banks decreases interest rates and increases fees for depositors.

Fact 3: New and small businesses are struggling while large incumbents thrive

Furman (2016) documents that for 40 years, the rate of firm entry has decreased, as has the share of sales and employment corresponding to young businesses. This suggests that it has become harder for new companies, facing larger, often predatory incumbents, to overcome barriers to entry. This is especially problematic, given that new businesses, as disproportionate creators of jobs, are essential to a healthy economy.

At the same time, the largest firms are thriving: Gutierrez and Phillipon (2017) document that since 1980, measures of profitability have increased for the largest firms while remaining constant for small ones. Other data shows that the gap between the profitability of median and high performing firms has increased dramatically with time, and that the most profitable firms tend to maintain their high returns year after year.

Fact 4: Corporate investment is low, especially in concentrated industries

If barriers to entry and other predatory practices are indeed isolating incumbents from competition, then we would expect them to exercise their monopoly power by producing less and charging more, rather than by making new investments to scale up operations or develop cost cutting technologies. And indeed, evidence shows this is precisely what is occurring. Gutierrez and Philippon (2016) document that corporate investment is low compared to what firms’ market values would predict, and that this lowered investment corresponds to more consolidated industries.

In a 2017 paper, the same authors go a step further, using two methods to show that this relationship is causal. First, they demonstrate that leading manufacturing firms invested and innovated more in response to increases in Chinese competition. Second, they document higher levels of investment in industries that, likely due to bubbles or optimistic venture capitalists in the 1990s were less concentrated during the 2000s.

Fact 5: Workers are more productive, but their pay has stagnated

For 40 years, median wages have stagnated, even as workers become more productive, and the share of GDP paid as income to workers has declined since 2000. While economists have tested many explanations for these shifts technological change and automation, global competition between workers, the rising cost of benefits, none of the factors considered explains why corporate profits have grown over the same period. Indeed, Barkai (2016) documents that while corporations have paid out less of their revenue as wages, they have also spent less on capital assets like machines, offices, and software, further increasing their profits. Barkai’s work points to a different theory: The labor share of income has decreased most in consolidating industries, suggesting that corporations are paying low wages simply because their power and the lack of competition with other firms allow them to.

Even as the total share of private sector revenue paid as wages has declined, the rise of market power has increased wage inequality, by contributing to median wage stagnation and enabling runaway gains at the top. For example, the ratio of a top CEO’S compensation to that of an average worker has increased roughly ten fold, from 30 to 1 in 1978, to 271 to 1 in 2016. This relates to market power because, rather than simply paying employees less, large firms have sought to lower labor costs by pushing workers out of direct employment altogether, outsourcing them instead. Powerful “lead firms” are thereby able to avoid liability under substantial components of US. labor law, while leveraging their market power to drive down wages through a litany of extractive tactics aimed at the outside firms employing their former workers. This is related both to the “tissured workplace,” described by David Wei] (2014), and to interfirm inequality, described by Song et al. (2016) and Furman and Orszag (2015).

Fact 6: Workers have a harder time changing and accessing jobs

Trends of consolidation and declining wage growth coincide with decreases in geographic, job, and occupational mobility. Konczal and Steinbaum (2016) argue that with fewer alternative employers, workers are receiving fewer offers to work at other firms, thus forcing them to stay at the same job and tolerate lower wage growth.

Song et al. (2016) compare wages across firms and reveal that workers with similar levels of education and experience receive starkly different pay depending on their employers, and that the degree of wage segregation by firm has increased starkly over the same period in which inequality has risen (since 1980) In a competitive labor market, firm pay differentials for similar work done by similar workers should be driven to zero. Therefore, inequality in interfirm earnings suggests that pay may have less to do with an individual’s productivity and more to do with their ability to bargain or to gain access to particular firms and individuals and benefit from those personal connections. The idea that worker side variables cannot explain observed wage inequality is a fundamental challenge to the notion that the labor market is competitive.

On their own, these aggregate trends cannot establish individual instances of anti competitive behavior, but they do imply that there is a significant and growing problem of consolidated market power.

In the following sections, we delve deeper into this body of research, considering evidence of market power and exploring how it affects the everyday lives of American consumers and workers, as well as society at large.

SECTION THREE

Market Power in Everyday Life

Economic data on rising prices and stagnating wages helps to drive home the point that the ill effects of market power and Chicago School policies are anything but theoretical. Corporations increasingly exert unopposed influence over the lived experience of American consumers, workers, and citizens.

From rising prices, to low wages, to the way we access information, market power and lax competition policy are entrenching the intrinsic advantages of wealth and power in society.

Private interests increasingly determine access to critical goods and services, prioritizing privileged groups and thus exacerbating existing inequities of race, gender, and class.

In this section, we aim to illustrate how the broad policy changes discussed above result in poor outcomes for American consumers, workers, and society. We show how consolidation and predatory behavior lead not only to higher prices, worse service, and less choice for consumers, but also threaten the pace of innovation. We show how consolidation results in fewer jobs and lower pay for workers, and how firms are using anti competitive and predatory practices in order to further entrench their labor market dominance. Finally, we provide a broader view on the impacts of market power and Chicago School antitrust, showing how the consolidation of power affects geographic inequality, the flow of information, and the long term health of our democratic system.

MARKET POWER AND CONSUMERS: LESS INNOVATION, HIGHER PRICES

Although it has hinged on alleged benefits to consumers, the Chicago School’s lax approach to competition policy has allowed corporations to pursue promarket making strategies through which consumers lose twice: first, because powerful firms facing little competition are able to raise prices at will; second, because these firms choose to reinvest profits in attaining more market power, which not only reduces consumer choice, but also detracts from investment and competition aimed at developing better products and lowering prices.

In this predatory environment, the most significant innovations have been new methods of obtaining unfair gains, by misleading customers, entrapping them, or discriminating to extract consumer surplus. Even when the resulting conglomerates do invest in new technology and gain an innovative edge, weak competition means they face no pressure to pass the value created along to consumers. Across the board, market power enables corporations to profit by taking advantage of consumers, rather than by serving them.

Fewer choices, worse service, less innovation

Massive consolidation has left consumers with fewer choices and firms with less incentive to compete for customers. Walk into a retailer to buy a new pair of eyeglasses and you will likely find yourself overwhelmed with options. Upon closer inspection, however, you may notice striking similarities between models. You may also notice prices that are similarly high. That is because, whether buying from Prada, Oakley, or Target brand, you actually have a 4 in 5 chance of buying Luxottica, the Italian monopoly that owns 80 percent of major eyewear brands. Likewise, think of every food brand you have ever seen on the shelves of any major grocery store. Chances are these products are owned by one, often international conglomerates like Unilever, Kellogg’s, and General Mills.

Until the Chicago School successfully beat back regulatory standards, competition authorities closely monitored such market dominance.

Today, we are left to ask: With such large shares in their respective markets, how hard will companies work to develop new, appealing products and win over new consumers? The ramifications of such broad consolidation and the erosion of competition are severe.

Fewer firms holding more and more power not only means fewer choices for consumers, but also creates less of an incentive for firms to focus on providing the best products and service. Tim Wu (2012) points out that a firm can invest in stifling competitors directly by erecting barriers to entry or acquiring other firms, rather than investing in capital or R&D that would help it outcompete them in the marketplace. Indeed as mentioned in the previous section recent research shows that corporations are investing at record low levels, especially in the most consolidated markets. The outcome for consumers can range from irksome to deadly.

Instead of investing in R&D, many pharmaceutical companies plan their business models around their ability to purchase smaller firms that have shouldered the burden of developing new products. Strategies like these are predicated on the notion that lax competition policy will green light mergers with minimal scrutiny, even though this environment holds innovation back: Ornaglu’ (2009) finds that after merging, pharmaceutical companies have lower R&D spending, fewer new patents, and fewer patents per R&D spending, compared to non consolidated competitors. Among pharmaceutical firms in Europe, Haucup and Stiebale (2016) find that even competitors of merged companies innovate less, Nowhere else could the costs of market power and anti competitive behavior be more clear or more severe:

Even when the discovery of a new product could save thousands of lives, powerful pharmaceutical companies have based their business strategies on acquiring and maintaining market power.

Even in more benign examples, we can observe that less competition has translated into worsening consumer experience. A regular survey conducted by Arizona State University’s W.P. Carey School of Business (2017) found that customer dissatisfaction in the US. has climbed 20 percentage points over the past 40 years, while customer satisfaction has fallen. Comporting with the thesis that much of this is driven by consolidation and lacking competition, we observe that the decline in service has been led by TV, phone, and Internet service providers, some of the most concentrated industries in the country, with customer satisfaction ratings routinely below that of the IRS. As firms become more powerful, their incentive to please customers will almost always decrease.

Amazon’s activity in shoe retail serves as another good illustration of the connection between competition policy, market power, and threats to consumer well being. When Zapposcom executives refused to sell the company to Amazon in 2007, Amazon began lowering its prices on Zappos shoes and offering additional services like free express shipping in an effort to out compete the popular online shoe retailer. Normally, this sort of competition would be a good thingfor consumers, since it results in lower prices. Amazon’s strategy, however, was based on power not innovation:

Over the course of a two year battle with Zappos, Amazon drew on its vast wealth, pre existing distribution network, and large customer base, running up losses of $150 million in an effort to eliminate its competitors. Lacking Amazon‘s vast wealth and power, Zappos capitulated and sold to Amazon in 2009. The tactic of lowering prices below cost in order to starve competitors known as predatory pricing is technically illegal, but Chicago School policymakers have raised the burden of proof so high that companies can employ this strategy without fear of triggering regulatory scrutiny. Amazon alone has used this precise tactic in several high profile cases, including with Diapers.com, which Amazon purchased and shut down in 2017.

Given Amazon’s professed commitment to service in the Zappos example, some may assume that consumers, despite having lost a popular vendor, are not much worse off; this, however, is shortsighted. In the long run, anti competitive behavior not only reduces the incentive to improve products and services, but also may deter entrepreneurs from entering consolidated industries to begin with. With the disappearance of customer first firms like Zappos, Amazon lacks the competitive pressure to maintain the high level of service and low prices it offered in the effort to drive them out of business. And while Amazon’s customer satisfaction ratings remain high, there is no guarantee that this behavior won’t fade as competition dries up. The decision to offer good service, in other words, has been left entirely to the good graces of Amazon’s management. This dynamic is true wherever competition is appreciably reduced and should weigh heavily on the minds of consumers and regulators alike.

Examples of the slowed pace of innovation and evaporating consumer choice suggest that lax antitrust may be far from optimal, even if consolidation does drive lower prices, as Chicago School dogma suggests it should. Even in the narrow category of consumer prices, however, we find ample evidence that our anti competitive economy has actually led to higher prices.

Higher prices

If Chicago School antitrust deregulation purported one thing for Americans, it was a dramatic reduction in the costs of the goods and services they rely on to survive. And yet, as described in Fact 2, numerous studies across many industries suggest that consolidation and other anti competitive practices have actually caused prices to rise for American consumers.

Although undetected by most Americans, the issues of market power and anti competitive behavior have dramatic consequences in daily life. If less competition results in an additional 5 percent markup on grocery prices, that increase can be enough to break the bank for a working class family. Lower prices can give consumers flexibility, relieve financial burdens, and make it possible to save for investments like college tuition, but the alleged cost benefits of consolidation, if they do arise, must also be considered. Meanwhile, higher prices seen today mean higher profits for shareholders and CEOs.

The realization that markups might actually be rising elevates the false promise of Chicago School policies: The implicit trade off offered by the Chicago School antitrust authorities was one of lower prices for less competition. But if less competition actually results in higher prices, as the data suggests it does, then American consumers are being subjected to a lose lose agreement.

TARGETED PREDATORY BEHAVIOR

Firms also exercise their market power by charging different prices to different customers a practice called price discrimination. This can be benign, as in the case of discounted movie tickets for children and the elderly, but price discrimination can also serve as a tool for corporations to exploit the most desperate and least informed consumers With the fewest alternatives.

Price discrimination often targets neighborhoods of color, whose populations are disproportionately low income and where firms make use of the structural absence of market access. Bayer, Ferreira. and Ross (2016) show that after controlling for credit scores and other risk factors, African American and Hispanic borrowers are roughly twice as likely to have high cost home mortgages because they are served by higher cost mortgage providers, so called “market segmentation.”

A recent analysis by Angwin et al. (2016) of ProPublica finds similar trends In auto insurance. Across several states, auto insurers charge higher premiums in minority neighborhoods, relative to the actual cost of paying out liability claims. ProPublica also discovered a similar trend within the test prep industry. Princeton Review clients of Asian descent are almost twice as likely to be offered a higher price as their non Asian counterparts (Angwin and Larson 2015).

Price discrimination is an especially pertinent risk online, where sellers can use IP addresses and browsmg data to differentiate between consumers, and where dominant platforms like Amazon may be able to corner whole markets, thus allowing them to target prices individually, without fear of being undercut by competition. Hannak et al (2014) find instances where major retailers and travel websites show different results and prices depending on a customer’s digital activity. Due to their private and algorithmic nature these practices are difficult to regulate and are likely to proliferate as companies develop new ways to gather and analyze data.

Crucially, the theoretical possibility of online alternatives has not proven sufticient to discipline behavior and prevent these explotative practices.

MARKET POWER AND WORKERS: FEWER JOBS, LOWER WAGES, AND LESS POWER

Contemporary antitrust policy mostly ignores the plight of American workers and, as a result, has spelled fewer jobs, lower pay, and worse conditions. For much of the 20th century, American wages grew in accordance with the productivity of American workers. But around the start of the Reagan era, the growth of workers’ wages and worker productivity began to diverge. Despite productivity having climbed nearly 75 percent from 1973 to 2016, wages only climbed by 12 percent. As consolidation, corporate profits, and top incomes skyrocketed, workers were left behind; the typical male worker made more in 1973 than he did in 2014. And while declining worker protections and union density explain a substantial portion of this stagnation, the runaway power of employers can be seen as the other side of the same coin.

Modern antitrust policy does little to protect and in fact actively hurts the standing of the American workforce. Ignoring the impact that market power and anti competitive behavior has on workers is a feature, not a defect, of Chicago School antitrust policies. Today, in addition to merger related job loss, we see ample evidence of just how effective these policies have been at weakening worker standing. Firms engage in predatory wage suppressing collusion across industries with “no poaching” agreements, and they have standardized anti competitive contracts designed to strip workers of their mobility and bargaining power. These tactics, endorsed by permissive antitrust policy when it comes to non price vertical restraints, are remaking the American labor market to resemble indentured servitude. Part of the solution must come from antitrust, specifically, a ban on such exploitative contract provisions.

Structurally, powerful firms have abused poor antitrust enforcement in order to restructure labor markets to their own liking. Since the consumer welfare paradigm ignores upstream “monopsony”, the power a firm can wield over its suppliers, including suppliers of labor, firms outsource workers into upstream contractors, which they could more easily dominate thanks to the weakening of antitrust scrutiny for vertical contractual provisions, both price and non price. Outsourcing labor into subservient contractors not only enabled so called “lead firms” to avoid meaningful negotiation, but has also turned wage setting into competitive bidding.

In this sub section, we document how corporate consolidation and the rise of market power hurt the labor market. We discuss three primary mechanisms: First, we analyze the reduction of wages, employment, and worker power that has occurred as a result of general consolidation and decreased economic activity. Second, we outline a number of discrete anti competitive strategies used by employers to stifle worker mobility and power. And finally, building on our description of predatory labor market practices, we outline the antitrust implications of corporate disaggregation and the so called “fissured workplace,” showing how this trend places workers at a systematic disadvantage.

Fewer jobs, lower wages

As firms accrue market power and consolidate, employment and wages decrease through two mechanisms. First, firms in concentrated industries tend to lower production and raise prices, reducing the demand for labor. Second, less competition between firms means fewer options and less mobility for workers.

Just like reducing consumers’ options allows businesses to charge more, reducing workers’ options allows businesses to payless.

Such power is referred to as monopsony, the labor market equivalent of monopoly power in product markets. As Jason Furman and Peter Orszag explain in a 2015 paper, “firms are wage setters rather than wage takers in a less than perfectly competitive marketplace.” The same is true for working conditions: In a concentrated economy, workers are forced to take what they are given. Monopsonistic firms, then, are no less a threat to America’s economic well being than monopolistic ones.

These theories are easy to square with the experiences of working Americans: In 2009, pharmaceutical giant Pfizer acquired Wyeth and announced it would cut 20,000 jobs worldwide; after combining in 2015, Kraft Heinz announced plans to cut 5 percent of its workforce; most recently, rumors swirled about cuts to Whole Foods’s workforce following its sale to Amazon. And while Chicago School advocates claim that consolidation brings cost savings for consumers, something we called into question in the previous section, the concurrent claim that such savings stimulate enough demand to create more jobs than they destroy is an even greater stretch.

While the impact of consolidation and competition policy on labor markets is a relatively new question for economists, evidence that consolidation is leading to fewer jobs is already mounting. Barkai (2016) shows that the largest decreases in the labor share of income, that is, the total fraction of private sector revenue paid to workers, have come in industries with the largest increases in concentration. This suggests that weak competition causes firms to cut jobs and reduce wages. Konczal and Steinbaum (2016) relate low wage growth to patterns of low job to job mobility, scarce outside job offers, and low geographic mobility. They argue that these trends are all indicative of weak labor demand and monopsony power.

The impact of such monopsony power can be every bit as economically damaging as monopoly power, and it is only due to the Chicago School’s myopic focus on consumer welfare that policymakers and the public more broadly eschewed such considerations. In our current environment, the anti competitive threats to labor markets have multiplied and intensified.

Again, addressing the loss of worker standing will largely rely on rebuilding worker power, but allowing large firms to accrue and wield unlimited market power is a substantial contributor to existing labor market power disparities, which require a multi faceted solution.

MARKET POWER AND LABOR MARKET DISCRIMINATION

Similar monopsonistic wage setting effects also help to explain pay gaps between demographic groups. Several studies document that wage gaps between employees of the same business can be explained by assuming that employers systematically pay workers less who they know are less likely to quit as a result, a practice called wage discrimination. If systemically disadvantaged workers tend to be less sensitive to wages, then they may sort into industries that underpay all of their workers, possibly contributing to the concentration of women of color in the low paying care industry, as discussed In Folbre and Smlth (2017) Looking at data from the Portuguese workforce, Card et al. (2016) show that the combined effects of within firm wage discrimination and between firm sorting, account for about one fifth of the gender pay gap.

In perfectly competitive labor markets where workers are pald according to the value they create, such effects would not exist.

Antitrust policies that examine the effects of monopsony would not only be good for all workers but would be best for society’s most vulnerable workers.

Strategic attacks on worker standing

In addition to increased leverage over workers gained from consolidation, employers use other anti competitive tactics to increase their labor market power. The tactics we describe here are expressly anti competitive, intended to prevent positive competition among employers in order to reduce labor costs and suppress workers. Despite the seeming conflict with the core principles of antitrust policy, the brazen use of anti competitive practices in labor markets has become increasingly widespread in the Chicago School era.

Non compete contracts, for instance, prevent workers from joining competing firms until after they have left their employer and waited, presumably unemployed, for extended periods of time. While non competes have some merit in protecting trade secrets and incentivizing investment in workers, the Treasury Department (2015) points out that they are used with startling frequency among low income workers and those without a college degree, less than half of whom profess to possess trade secrets.

Far from promoting innovation and investment, these agreements simply discourage workers from searching for new jobs, allowing their employers to pay less and demand more. Crucially, they are best understood as both a symptom and a cause of declining labor market mobility and worker power: A symptom because in an earlier era, employers would never have been able to get away with inserting such terms in employment agreements; and a cause because any worker who signs one has effectively voided their ability to attract a higher wage or better job in the industry of their choice

The tactics we describe here are expressly anti-competitive, intended to prevent positive competition among employers in order to reduce labor costs and suppress workers.

Mandatory arbitration is another combination symptom and cause of low worker standing. Gupta and Khan (2017) discuss the severe impact of contractual clauses which force workers to surrender their right to sue their employer, insisting instead that employees enter into confidential arbitration in the event of a dispute. Depriving workers of this core democratic right is a win for powerful corporations, who are able to keep misdeeds out of the media and away from the eyes and ears of other employees. Like non compete clauses, mandatory arbitration is both a cause and an effect of labor market monopsony. Indeed, it would be difficult to think of a tactic more indicative of massive monopsony power than a firm forcing workers to surrender their legal rights as a condition of employment; as with non compete agreements, such a clause would never have proliferated in a more pro worker environment. Meanwhile, mandatory arbitration diminishes worker power by curtailing a worker’s ability to push back against unfair labor practices in cases of abuse.

Labor market power and the fissured workplace

These more granular examples of anti competitive labor market practices are only part of a broader pattern of firms leveraging their market power to circumvent labor protections and obtain a structural advantage over workers. In his landmark book, The Fissured Workplace, David Weil shows how powerful corporations shifted workers out of formal employment and into alternate arrangements, such as subcontracting and franchising, in order to lessen their obligations to workers. By pushing low pay workers into separate subcontracting firms, lead firms are able to wield their market power over other firms, rather than having to do so directly over workers, which could raise issues of liability under labor law.

Once pushed outside of the firm ’s organizational structure, workers receive a smaller share of the company’s revenue and face steep barriers to bargain for more.

Whereas direct employees simply receive a regular salary, outsourced workers are forced to competitively bid against one another for every contract, driving costs down for the lead firm and wages for subcontracted workers. Once pushed outside of the firm’s organizational structure, workers receive a smaller share of the company’s revenue and face steep barriers to bargain for more.

With less power and wealth than the firms that ultimately pay them, and with competing contractors threatening to under cut them, outsourced workers are driven to the lowest common denominator for workplace standards. Indeed, Dube and Kaplan (2008) find that subcontracted security guards and janitors suffer a wage penalty of up to 8 and 24 percent, respectively, while a 2013 study by ProPublica found that temp workers, another large category of outsourced Labor, were between 36 and 72 percent more likely to be injured on the job than their full time counterparts.

Weil’s analysis shows how powerful lead firms place the onus of maintaining brand standards on franchisees and their employees even as they squeeze them to reduce costs otten resulting in the low wages, dangerous work conditions, and labor law violations that are widely observed today. Outsourcing strategies are utilized up and down the supply chains of large companies from Walmart, which outsources its shipping and logistics operations, to Verizon, which outsources the sale and installation of broadband services. This system allows corporations to have their cake and eat it too; they can secure favorable contracts with suppliers while maintaining a high degree of control over an outsourced workforce.

The National Labor Relations Board’s (NLRB) recent ruling in Browning Ferris supports this view, by asserting that firms contracting out workers from external partners may be considered joint employers. But until this view is more widely embodied in the economy, standards will continue to sink as powerful firms subjugate the workers of less powerful firms.

All of these practices are predicated on the immense power of lead firms, from internationally recognized franchises like McDonald’s, to retail powerhouses like Walmart, that are only able to get away with such broad wage and condition setting power because they each represent such large shares of their industries. Although the topic is still nascent among economists, it is not a stretch to say that lax antitrust protection is largely to blame for the fissuring practices of powerful firms.

In fact, hard evidence linking anti competitive behavior and poor labor market outcomes continues to emerge. In addition to non compete and mandatory arbitration clauses, Krueger and Ashenfelter (2017) call attention to the negative wage and employment effects of “no poaching” agreements through which franchises have agreed not to hire workers from rival businesses, in order to suppress wages and worker power. These agreements are plainly anti competitive, created expressly to disrupt healthy competition in the labor market.

The ill effects of weak antitrust and disaggregation are echoed in the gig economy: Workers who would once have operated either as employees or as truly independent businesses are now finding work in a quasi independent role for centralized tech firms like Uber and TaskRabbit. Legally, they remain independent contractors without employee benefits; however, they lack the degree of control over their own operations that independent contractors are typically afforded. In fact, research shows these platforms exercise substantial control over participant behavior, disciplining workers for undesirable behavior and controlling the prices they set, despite their lack of employer status.

Like the franchising and subcontracting firms in Weil’s fissured workplace, these firms are leveraging market power, as well as proprietary technology, to have it both ways, controlling their labor supply without shouldering responsibility for it. Much has been said about misclassification of Uber drivers, but few have made the opposite point: If Uber drivers are not employees, then they are businesses, and thus Uber’s price setting amounts to a cartel, an organizational structure that is illegal under existing antitrust policy.

Addressing deficiencies in competition policy will be essential in combatting the structural abuse of workers. As we have stated, pro big business deregulatory competition policies were sold on the explicit grounds that consumer effects were the only effects that should be considered with regard to competition policy. As long as the consumer came out ahead, in other words, any negative ramifications for small business, and especially for workers, could be tolerated. To anyone concerned with the overall health of the American economy, this begs a simple question, which the Chicago School is unprepared to answer: What good are consumer savings if consumers have no income to save?

AMAZON’S ANTITRUST THREAT

Founded In 1994 as an onllne book retailer, Amazon has grown into the world’s fourth most valuable company, commanding a sprawling supply chain that offers everythmg from cloud computing services to audlo books. Amazon’s recent purchase of Whole Foods for $14.3 billion reignited concerns about the company‘s immense size, and yet policymakers and journalists find It dlflicult to grasp the precise threat that the tech giant poses to competition.

Through Amazon’s example, we aim to illustrate how such powerful tech firms imperil healthy competition in ways that do not align with the Chlcago School’s conception of the role of competition policy.

In some respects Amazon’s devotion to growth and investment is laudable. Rather than passing what would be enormous profits from existing business lines back to its shareholders, the company largely reinvests the proceeds into new product lines and technologIes.

The fact that Amazon employs over 1,000 people working on far off AI technology, for example, is potentially good for the economy. This is to say nothing of the fact that Amazon is wildly popular with a large, devoted user base, compelled by its low prices, streamlined service and delivery system, and wide product offerings. Indeed, it has been evident on many occasions that not only do consumers value the company, but so do the competition authorities, for they have used their regulatory and enforcement powers to put would be competitors out of business. Despite investments in innovation and consumer favorability, the fact remains many aspects of Amazon’s conduct are deeply problematic.

To see the threat posed by Amazon, it’s important to understand how the company has risen to its current status. With nearly half of all ecommerce passing through the platform, Amazon’s success is predicated by what economists call “network effects”: The more vendors sell through Amazon, the more customers will want to use it; and the more customers use Amazon, the more vendors will be forced to sell through It.

Even if a new platform were to offer a superIor service, say, by taking a smaller cut of sales no one would use it, simply because no one else was. And to compete with Amazon’s unparalleled logistics network at this point would require an unimaginable upfront investment, one that Amazon could quickly make into a debacle by further cutting its prices and denying placement to suppliers who did business with the competitor.

This special barrier to entry affords Amazon the ability to set the terms for consumers and vendors. Amazon is able, for instance, to keep 15 percent of every sale on its platform and to attract even reluctant vendors like Nike, who after resisting to sell directly on Amazon due to copyright infringement that occurs through the sale of unlicensed products on their website, eventually caved in 2017. In another prominent example of Amazon flexing its power, the retailer suspended pre-orders of all books published by Hatchett, including House Speaker Paul Ryan’s The Way Forward in order to gain leverage and secure better terms in its ebook agreements.

The Institute for Local Self Reliance (2016), among others, has underscored Amazon’s use of predatory pricing, as is commonly understood, though impossmle to prove under existing antitrust, precedent to eliminate competitors such as Zappos.com and Diapers.com.

If established firms are powerless to resist Amazon’s platform, the implications for small businesses selling on Amazon‘s Marketplace are enormous. Satirically attributed to Amazon CEO Jeff Benzos, a recent article from The Onion captured the problem well. “My advice to anyone starting a business is to remember that someday I Will crush you.”

Amazon compounds its platform advantage with a technological one. Since Amazon both runs a retail platform and sells goods. It not only competes With its own partners. but also unilaterally sets the terms of that competition. Amazon preferences its own goods in search results, and, by collecting data on all of its transactions and customers, knows both buyers and sellers, including the stategic use of its dominant cloud computing bussiess, Amazon Web Services, to monitor profitable third party vendors and consumer behavior that lets Amazon plan future acquisitions. It’s well established that Amazon uses this data to make personalized recommendations to induce customers to make purchases.

More alarming is that the company reorders options so as to extract more from customers whose past purchases and other characteristics indicate a wlllingness to pay more. This is not the kind of price discrimination that can be found in a grocery store, where quantities are priced differently in order to entlce different buyers (e g . moms and dads opting for a gallon of milk for an additional $1 instead of a quart), but a secretive and personalized form that ensures each consumer pays their maximum and that Amazon captures the difference.

Jeff Bezos, Amazon founder, 1998

MARKET POWER AND SOCIETY: SEGREGATION, CONTROL OF INFORMATION, AND POLITICAL MANIPULATION

Although market power’s impact on workers, consumers, and businesses is severe, the narrow economic analyses can overlook the dangers it poses for society as a whole. Franklin D. Roosevelt recognized these threats in 1938 when he said:

“The first truth is that the liberty of a democracy is not safe if the people tolerate the growth of private power to a point where it becomes stronger than their democratic state itself. That, in its essence, is Fascism, ownership of Government by an individual, by a group, or by any other controlling private power.”

As relevant now as they were then, FDR‘s comments suggest that beyond lost jobs, innovation, and businesses, concentrated market power poses a threat to our democracy and national sovereignty. Today, this threat manifests in a number of ways, ranging from the obvious, such as the consequences of corporate lobbying on democracy, to the more subtle, such as the massive power a small number of tech platforms now hold over the distribution of information. In this section, we discuss three broad societal threats posed by market power.

Geography and economic segregation

Increasingly, the wealthy and powerful have isolated themselves geographically and used their market power to prey on vulnerable areas and populations. The stark divide between urban and rural voting patterns in the 2016 election is just one recent example of how economic, social, and political divisions manifest geographically. Market power reinforces this new geography, threatening to calcify a class stratification that is anathema to American values.

Market power redistributes wealth and opportunity away from disadvantaged communities, be they poor, minority, or physically isolated. Wealthy Americans, clustered in wealthy suburbs and a few large cities, do not patronize local businesses, pay taxes, or otherwise engage with the economies of poor rural or urban communities.“ Nonetheless, they are able to extract profits from them. A merger may result in windfall profits, but Wall Street and Silicon Valley will absorb that money as distant plants close and local economies across the country are decimated from the deal.

In Hanover, Illinois, for example, the purchase of machine pan manufacturer Invensys spelled the end of a 50 year old factory, despite its 18 percent profit margin. The jobs were sent to Mexico, and the profits were shifted to Sun Capital in New York City.

Today, many hollowed out cities and towns remain trapped in a cycle of dependence on the very same corporate giants that eroded their communities.

Unbridled market power threatens locally owned businesses, which play an essential role in their communities, and which cannot be replaced by externally owned and managed corporations. Writing for Washington Monthly, Brian S. Feldman (2017) presents numerous examples of black owned businesses that were consumed by larger competitors as a result of the relaxed antitrust regime. Not only had these businesses provided jobs and wealth to black workers, but they also served as pillars of the community in a time when many larger, white-owned businesses were either indifferent or actively hostile to the priorities of the black community. Black business owners in Selma, Alabama, for example, provided a physical foothold for civil rights activities in the 1960s. But without antitrust protections, these small businesses could not withstand the power of consolidating giants like Walmart, which used anti competitive practices, including predatory pricing, to drive small competitors out.

Meanwhile, Bentonville, Arkansas, home of Walmart’s Walton family flourishes, with a plethora of privately funded parks and schools.

To make matters worse, weak local economies are self reinforcing: Less economic activity means less tax revenue for schools, public transportation, and other basic needs, which, as shown by Chetty and Hendren (2017), results in less economic mobility for future generations. As geographic segregation becomes more entrenched, it has become easier and easier for firms to identify and prey on vulnerable populations. As Hwang et al. (2015) demonstrate, this predatory behavior has been prevalent in both home mortgages and car insurance, where providers charge high prices and provide restricted service in areas with large minority populations. If areas continue to segregate racially and economically, this behavior will only intensify.

Nowhere is the self reinforcing mechanism of geographic segregation more evident than in the contemporary struggle to expand broadband coverage to underserved communities, both rural and urban. Many Internet service providers (ISPs) have avoided expanding service to such areas because doing so is less profitable. Through economic, political, and legal means, they have blocked efforts to provide multiple options directly. As Internet access becomes an effective (even necessary) prerequisite to entering the job market, underserved populations remain economically isolated and exploitable by powerful local monopolists. Market power compounds these issues: ISPs spend millions of dollars lobbying against the creation or expansion of proven municipal broadband networks (see introduction). In protecting their market share, entrenched incumbents not only reinforce social inequities but also actively prevent some of the least privileged Americans from accessing the modem economy.

Market power and the flow of information

Recognizing that access to unbiased information was no less essential to a democracy than water is to survival, and seeing the threat that industry consolidation and market power posed to that freedom of information, antitrust regulators once closely monitored the structure and content of newspapers and other media. Ownership of multiple competing news outlets was capped, and the Federal Communications Commission’s (FCC) Fairness Doctrine required media outlets to fairly cover issues of national importance. In the wake of the Chicago School revolution, many of these regulations fell by the wayside with severe consequences for society and our democracy.

Just as the decline of antitrust protections altered the flow of firm revenue, it has also altered the flow of information with grave ramifications for society. The weakening, and in some cases the repeal, of key protections have greatly contributed to the obstruction of quality information that was so evident during the 2016 election. In print, radio, TV, and online, our sources of information have consolidated under openly biased ownership; media conglomerates have purchased local newsrooms en masse and geared them for profit over quality; online news is increasingly filtered by social media giants, with no eye for credibility or fairness, but with ultimate discretion as gatekeepers between readers and journalists; and television and radio stations held by politically biased media companies spew false information with little oversight.

After decades of consolidation, local news, a key source of information for nearly half of all Americans, according to Pew Research (2017) can scarcely be described as such. In 2016, the five largest local TV companies owned 37 percent of all stations. This pattern will likely worsen under Trump’s FCC Chairman, Ajit Pai, who hinted that he would further relax merger scrutiny shortly after his appointment.

As consumers of media, the information we receive is increasingly controlled by a small select group of very powerful corporations. The decline of quality local reporting is problematic alone, but, as the Knight Commission (2009) points out, will be even more harmful if the loss contributes to the further erosion of community engagement, helping to worsen already substantial distrust of local institutions.

The erosion of decades old antitrust protections has had serious ramifications for the freedom and quality of journalistic institutions, but online, there is doubt as to whether antitrust authorities will address emerging threats at all. Gatekeepers like Google and Facebook threaten to end the era of democratized information that the Internet was supposed to create. Every day, millions log on to Facebook to see which stories their friends are sharing, creating advertising revenue for Facebook but not for the organizations that created the content. Likewise, Google’s “Incognito Window” feature enables users to avoid pay walls put in place by publishers to protect copyrighted material. This is to say nothing of outright discrimination within search results, which recently drew the ire of European authorities.

Platforms not only capture profits of journalism, they also control who sees what. Emily Bell, Director of the Tow Center for Digital Journalism, discussed this concern in a 2016 piece for the Columbia Journalism Review.

“In truth, we have little or no insight into how each company is sorting its news. If Facebook decides, for instance, that video stories will do better than text stories, we cannot know that unless they tell us or unless we observe it. This is an unregulated field. There is no transparency into the internal working of these systems… We are handing the controls of important parts of our public and private lives to a very small number of people, who are unelected and unaccountable.”

Examples of the problems created by this centralized, unaccountable control of information are everywhere: During the 2016 election, the proliferation of fake news articles on Facebook and automated “bots” on Twitter interfered with the honest and free exchange of information. Unregulated “news” sharing on Facebook and Twitter popularized numerous conspiracy theories. And since Facehook has no obligation to provide a neutral platform, electoral campaigns, interest groups, and repositories of outside “dark money” are free to spend whatever it takes to not only get their content in front of targeted users but also prevent the opposition’s content from reaching its intended audience. Meanwhile, Woolley and Guilbeault (2017) show how Twitter bots sought to obstruct social media messaging of supporters on both sides.

When it comes to something as essential for democracy as the free flow of accurate information, the power is simply too great to be left unregulated, in the hands of a few powerful corporations.

By keeping revenue from content creators, by lending a voice to biased and false news outlets, and by artificially amplifying chosen content, powerful platforms will reduce the amount of legitimate news produced (and shared) and will instead encourage the production of whatever content their opaque algorithms favor. Rather than democratizing the spread of information, many online platforms have consolidated this process for private gain. This is a new question for antitrust authorities, and one that must be addressed soon.

Compromising the political system

The influence of large campaign donors and highly paid corporate lobbyists on American politics is no secret, but bears repeating: Individual corporations and industry trade associations, not to mention a host of more secretive “dark money” pools, leverage their wealth to exert enormous influence on legislators, executives, and other government officials at all levels. This influence amplifies the voice of the powerful and, as Jacob Hacker (2011) discusses in Winner Take All Politics, was key in bringing about the Chicago School revolution in antitrust policy in the first place.

Less discussed than the influence of money in politics is how economic policy reinforces the phenomenon. By creating larger firms and enabling them to generate excess profits, consolidation increases the number of businesses with the means necessary to invest in serious lobbying efforts, including the number of firms whose business models depend on doing so. Rather than attempting to satisfy broad constituencies of disparate interests, politicians are tempted to cater to a select few: those who can afford to both amplify their voices and offer campaign funds in exchange for political favors.

Close ties to large corporations not only help politicians fundraise, but also let them access the lucrative “revolving door” to high paying jobs in the private sector throughout or after a political career. Politicians, then, have a considerable incentive to demonstrate their usefulness to the large corporations that hold power over their political and professional wellbeing. The same goes for appointed public officials and bureaucrats.

By enhancing the ability of large corporations to win, not by innovating or improving, but by buying government favoritism, a compromised political system entrenches the concentration of corporate market power. That is why, at the dawn of an earlier revolution in antitrust, Louis Brandeis noted that we may have concentrations of wealth, or we may have democracy, but not both.

Indeed, today’s mega corporations are so large and so powerful that individual politicians may feel powerless to oppose them. Even those with enough integrity or personal wealth to avoid direct dependence on corporate funders still face pressure to conform to the views of their caucuses. And voters are watching, it’s hardly surprising that, according to Gallup polls, the percentage of Americans reporting a “great deal” or “fair amount” of confidence in the federal government has hit record lows in recent years.

Ultimately, the problem of money in politics, and its interplay with market power threatens to erode the possibility of effective government, both directly and through the trust of its citizens.

SECTION FOUR

Restoring Competition Policy to Build Healthy Markets and Inclusive Growth

This report has explained the theoretical threat of concentrated market power and demonstrated its real world consequences: Instead of creating shared value, powerful businesses, specifically their owners and executives, extract wealth from workers, consumers, disadvantaged competitors, and entire communities. This section describes the role that competition policy can play in realigning incentives and reshaping markets to create a level playing field and an equitable, inclusive economy.

Competition policy is the set of laws and institutions that aim to realign private and public interests by changing the structure of markets and governing the actions taken within them. It can be understood as serving three distinct roles:

(1) To regulate market structure and prevent the aggregation of private power, primarily by blocking mergers that concentrate too much power and breaking up pre existing, overly powerful firms

(2) To curtail anti competitive behavior by banning firms from and punishing firms for engaging in extractive practices like colluding to raise prices or deceiving consumers, including practices that may persist even without full monopolization

(3) To regulate “natural monopolies” as utilities and intervene when competition fails, either through more comprehensive regulation or the provision of public options, especially in key natural monopolies like telecommunications and energy with high fixed costs of doing business, where fierce private competition tends to give rise to boom and bust cycles that impair the steady provision of necessary services.

To limit the consolidation of power by regulating market structure, authorities should:

– Revise merger guidelines to scrutinize the potential for anti competitive behavior throughout supply chains, not merely targeting consumers

– Closely examine negative effects of vertical integration and vertical restraints that are likely to arise from proposed and consummated mergers

– Use Section 2 of the Sherman Act to break up existing monopolies and firms whose structure and business models threaten other market participants and the economy more broadly

– Scrutinize the many ways in which ownership and management have consolidated, including the common ownership of multiple firms in an industry by the same major shareholders

– Implement intellectual property (IP) reform to encourage entrepreneurship and weaken protections for incumbents, including by compelling free licensing of patent portfolios

In many instances, market power arises from the structure of a given market, that is, the number and size of firms and the ties between them. Consolidated markets lack competition, often allowing firms to charge high prices, offer bad service, and pay low wages. Such market power can therefore be addressed by preventing consolidation, either by limiting mergers between competitors or by breaking up excessively large firms. Merger review has always been a key facet of competition policy, but it is much less stringent today than it was prior to the 1980.

Under existing merger guidelines, antitrust agencies assess mergers primarily on their expected short run effect on price and output. But as we have discussed this narrow approach overlooks important effects on innovation, wages, jobs, and supply chains; even its track record on price effects is mixed at best. Congress should enact antitrust legislation that would require agencies to revise existing merger guidelines to consider the merging parties’ ability to engage in anti competitive behavior throughout the supply chain, to look for ways it may harm any and all market participants, not just consumers. That would enable the Department of Justice (DOJ) and the Federal Trade Commission (FTC) to scrutinize vertical consolidation as well as a merger’s effects on innovation, labor markets, data privacy, and discrimination by race, gender, and geography.

The agencies should also consider exercising their authority under Section 2 of the Sherman Act to break up existing firms whose structure and business models render them impossible to regulate in accord with the new standard. Finally, an increase in the antitrust resources of regulatory agencies would complement this agenda.

In some cases, market power arises not through consolidation but through intellectual property rights (IPRs) exclusive, government enforced rights to profit from an innovation. While IPRs are intended to incentivize investment in R&D, current laws may actually be hindering innovation by slowing the spread of existing knowledge and hindering knock on discoveries, new ideas built on previous innovations. Policymakers should consider weakening such protections; doing so can promote growth and simultaneously lower prices and expand access to goods, especially medicines.

While policies to prevent and reverse consolidation and restrict anti competitive behavior at the firm level are necessary to maintain competition, another aspect of our market power crisis is the combination of management with shareholders into one corporate interest, a relationship that is then used to profit at the expense of other stakeholders.

Examples of this broad phenomenon can be seen in the rise of private equity, the lifting of regulations on corporate stock buybacks, the use of dual classes of shareholders, the decline in initial public offerings (IP0s) and the reduction in the share of the economy accounted for by traditional publicly traded corporations, and the so called “common ownership” of multiple firms in an industry by the same small set of large institutional investors.

This issue is of sufficient concern to warrant an investigation by a temporary panel with representatives from a number of government agencies with access to the data that are necessary to understand the potential threat of shareholder management consolidation. These agencies include the IRS, the U.S. Census, the Bureau of Economic Analysis, and the Bureau of Labor Statistics, as well as the competition authorities at the FTC and DOJ. The core issue to investigate is whether the various mechanisms that shareholders have for influencing firm behavior and benefiting from firm profits are used for their private benefit (and at other stakeholders’ expense) versus for the public good. Such a panel should examine corporate structures, such as private equity, tiered shareholding, private partnerships, and common ownership, as well as behavior like labor outsourcing, stock buybacks, and dividend recapitalization, that arguably serve to benefit shareholders at the expense of everyone else.

To curtail anti-competitive behaviors, policy must:

– Increase enforcement at the state and federal level

– Increase funding of federal and state competition authorities

– Increase punishments for anti competitive behavior

– Expand the scope of antitrust action at the state level

– Use antitrust law against the fissured workplace

– Challenge the ability of tech platforms to extract rents from their supply chain

_ Scrutinize price discrimination enabled by “Big Data”

– Protect low skill workers from non compete and anti poaching clauses

– Reform the Federal Arbitration Act

While preventing the accumulation of market power through large scale consolidation is important, this tactic does not guarantee that firms will always compete fairly. Even in less concentrated markets, firms may seek an advantage through anti competitive tactics, especially where vertical integration enables them to exploit a strategic position in one market for advantage in another.

Businesses can collude to charge more, take advantage of workers with contracts they don’t understand and cannot litigate, and maneuver consumers into disadvantageous terms of service or discriminate among them using data consumers do not realize has been harvested from them. And although many of these tactics are illegal, weak enforcement and judicial precedents establishing impossibly high burdens of proof and excessively narrow theories about how conduct can be anti competitive encourage abuse among firms who see no threat of repercussion.

To deter anti competitive practices and realign market incentives with the public interest, we advocate strengthening the enforcement of existing antitrust law and broadening the application of that law in key areas, especially as it relates to the emergence of new and unregulated technology.

Ultimately, anti competitive practices will only be curbed when firms operate on the assumption that nefarious behavior will be discovered and duly punished. Therefore, more prosecutorial action against anti competitive behavior and harsher penalties are necessary to discourage firms from abusing power.

Larger regulatory budgets for the DOJ Antitrust Division and for enforcement at the FTC will help achieve this goal by providing regulators with more staff and resources to carry out investigations. Most importantly, the burden on plaintiffs for winning an anti competitive conduct case is far too high.

At the federal level, of course, neither more aggressive prosecution of private firms nor a significant increase in regulatory funding seems likely in the current political climate, so we also propose expanded activity and funding of these activities at the state level. Generally, state attorneys have a well established tradition of antitrust action, and in many cases, are unburdened by the ideological baggage that plagues federal agencies and judicial precedent. These activities should be expanded wherever possible.

While poor enforcement has permitted some anti competitive behaviors, narrow court interpretations have pushed others out from under regulation entirely. For example, predatory pricing has long been a violation of antitrust statutes, but under current jurisprudence, it can only be recognized when the defendant is found to have both intent to remove competition and the ability to recoup losses incurred by selling below cost. This extremely high legal hurdle has prevented the prosecution of predatory pricing, despite evident instances of it, such as Amazon‘s behavior towards Diapers.com.

The crucial issue for prosecuting conduct cases under Section 2 of the Sherman Act is the requirement to prove monopoly power, generally by a preponderant share of the relevant market. This means that conduct in which powerful companies use their domination of one market to extract concessions in another is very hard to prove. For example, Google has used its dominance in the search market to redirect advertising revenues from content companies back to itself, Those companies have to make their content available to Google for fear of losing all Internet traffic, which then means that Google is the market participant earning the ad revenue. Google claims that it is not a monopolist in Search, “competition is just a click away,” as the saying goes and yet the observed behavior of users of its mobile platform and the restrictions that Google places on third party applications all but guarantee the tech giant will control the flow of information. (And hence reaps the reward therefrom.)

Finally, the rise of digital platforms has revived concerns about the abuse of vertical consolidation and price discrimination, issues the Chicago School had rendered largely dormant. Because they not only host sellers but also compete with them directly, platforms like Google and Amazon have ample opportunity to profit by placing other firms at a disadvantage.

The European Commission recently fined Google 2.4 billion euros for prioritizing its own Comparison shopping service over that of competitors. Regulators must either bar firms from competing on their own platforms, in effect, enact a ban on vertical integration for platform companies, or at the very least closely regulate such behavior by imposing neutrality on crucial internet era utilities.

A similar principle applies to platforms like Uber who have used their power to extract gains from workers. Since Uber drivers are technically independent businesses, the competition authorities should regard Uber’s price setting as price fixing.

Finally, access to data has enabled a new wave of advanced price discrimination through which platforms are able to charge different customers different amounts based on past behavior and other factors. Antitrust authorities must pursue vigorous enforcement of existing price discrimination laws.

To establish public utility regulation of essential industries and “natural monopolies,” policymakers should:

– Explore public utility regulation to rein in Google, Facebook, Amazon

– Promote expansion of municipal broadband networks

– Consider creation of public options for financial services

Private markets are not always able to sustain competition. This can happen when there are high fixed costs to production, as with utilities or airlines or when firms experience “network effects” that make it more useful to have one large platform than several small competitors, as with Facebonk or Amazon. In these instances, it maybe impossible to generate competition by breaking up large corporations horizontally; at the same time, outright bans on abusive practices may be too blunt an instrument to properly regulate firms’ behavior. Such situations call for further intervention, either through more fine tuned “public utility” regulation or through the introduction of public market players.

Historically, public utility regulation has been used to ensure that essential goods and services are provided accessibly and at fair prices. In domains such as telecommunications, where network effects prevented robust competition, the imposition of a “common carrier” status required providers to serve all comers at reasonable rates and without unjust discrimination. More recently, the FCC harkened back to these principles in the context of net neutrality, preventing internet service providers from exercising bias based on the content (such as a competitor’s service) they are transmitting.

Looking forward, policymakers should consider a public utility approach to regulating prominent technology firms. As gatekeepers to essential economic and social goods, Google and Facebook to news and information, and Amazon to avast logistics and shipping architecture these businesses threaten to limit or influence participation in markets and civil society. Regulatory firewalls could prevent such platforms from privileging their own content (say, in search results), thus maintaining a level playing field for smaller competitors. Further oversight could require firms to respect the interests of the users whose data they collect and sell and could guard against discriminatory treatment, including as an “unintended” consequence of revenue optimizing algorithms.

In some instances, barriers to entry prevent competition in a market, even though there is no inherent advantage to consolidation. Here, the government can intervene by simply becoming a competitor, by offering a so called public option. This approach is not a new one: The Tennessee Valley Authority’s provision of rural electrification dates back to the New Deal.

Public options have three main advantages:

First, they offer an additional, straightforward option to consumers at reasonable rates and without discrimination.

Second, they increase market competition, encouraging pre existing businesses to lower prices and offer better service.

Third, they can expand subsidized access to consumers unable to afford essential goods at market prices.

Policymakers should promote this approach in key areas, such as municipal broadband and banking.

Conclusion

For roughly 40 years, the American economy has been remade to serve the powerful and the wealthy, with no regard for everyday consumers, workers, or the health of our society.

Today, we see just how effectively policymakers and regulators have championed the needs of the few over those of the many. Ironically, the policies that helped get us here were sold on the notion that they would deliver the most good to the most people, the precise opposite of what ultimately occurred.

Furthermore, Chicago School policies were predicated on the idea that providing for the public good is simple. This was a convenient view for policymakers and other parties whose key interest amounted to diminishing the role that government plays in administering society.

But Chicago School ideology was also, as ample evidence shows, precisely incorrect.

Robust competition is every bit as important for economic well being as scions of the Chicago School suggested, but this school of thought presented false and misleading ideas about how to best achieve it. Here, we have combined emerging research with historical narrative aimed at explaining how antitrust policy has been a key contributor to an increasingly top heavy economy.

In the simplest way possible, we aim to show that competition is as essential as it is delicate, and that economies work best when power is evenly distributed among market actors. In this regard, competition policy is an essential tool.

‘Thriftiness is sexy’: exhibition examines Germans’ mania for saving – Kate Connolly * Rich vs. poor: How fair and equal is Germany? * Vorsprung durch Angst.

The desire to conserve cash is seen not just as a question of personal morality but a way to support the country’s interests.

Kate Connolly

The German habit of saving money is so entrenched it has come to define the national character, according to the curators of an exhibition who say they hope to spark a much needed debate about whether the obsession is healthy.

Saving History of a German Virtue at the German Historical Museum in Berlin seeks to uncover why saving money is central to most Germans’ lives even in times of historically low interest rates.

“In Germany everyone takes it for granted that they should save, both privately and on a state level,” said Robert Muschalla, an economic historian and the main curator. “The idea of making sure you stay in the black, is seen as a goal that is worth striving for at all costs, and is fetishistically stuck to.”

Saving boxes, money socks and piggy banks from every era since the foundation of the German nation in 1871 are on display in the exhibition. They illustrate the everyday acceptance of saving in Germany, as well as the extent to which it has been linked not just with personal morality but with serving a national purpose.

“The fate of the nation rests solely in our own strength,” reads the epithet on one box from the Nazi era. Another from 1900 reads: “Without saving your chest will be empty. If you have nothing, you’ll be a burden.”

Muschalla, together with the director of the museum, Raphael Gross, say the exhibition believed to be the first ever on the subject anywhere was largely a response to the international exasperation felt towards Germany during the the eurozone crisis. Germany was accused of traumatising southern Europeans, particularly the Greeks, with its insistence that they bring their unmanageable deficits into line by imposing German style austerity measures.

“The question is, why are Germans often so proud to be the world’s champion savers?” Gross said before the exhibition’s opening at the weekend.

It includes media coverage that reflects the anger towards the unyielding German obsession with fiscal discipline. The cover of one Greek magazine shows Angela Merkel, the German chancellor, depicted as a terrorist in an orange jumpsuit.

Most Germans are appalled at such insinuations. But many will readily admit that belt tightening and putting off enjoying the fruits of their labour are German specific traits. Some put it down to the Protestant work ethic that has a great influence on German life to this day. The state where saving is most prevalent, however, is Baden Wiirttemberg, which is mainly Catholic.

The exhibition also explores certain advertising slogans including the highly successful “Geiz ist Geil”, or “Thriftiness is Sexy”. which was used by a major electronics retailer for several years.

“This is the worst phrase to have been invented in this country since ‘Heil Hitler’,” says Henryk M Broder, a controversial commentator for the daily Die Welt and a speaking head on a Video loop in the exhibition.

“While I would myself baulk at paying €24 for a salade nicoise, I think saving can sometimes be pathological.” He calls the “national sport” of collecting coupons and driving considerable distances between supermarkets to pick up the money off deals “a waste of a life”.

The exhibition examines the origin of savings banks. The first savings bank in the world was founded in Hamburg in 1778. It was inspired by the enlightenment ideals of social progress and was set up to serve the urban poor and help them emerge from their plight.

Later, from around the 1850s, saving developed into something of a national movement. Schools were encouraged to teach their pupils to save with the introduction of a schools savings bank. Simultaneously, there was an exponential rise in the number of savings accounts. Far from just being a means to light poverty, people started to save for the national good. By 1875, at least a quarter of the German population had savings accounts. Local savings banks, or sparkassen, were used by municipal authorities to help fund the new Germany’s infrastructure.

The popularity of personal savings grew even more in the flrst world war when people were encouraged to invest in war bonds, enticed by slogans that insisted this would help shorten the conflict and help Germany to victory.

In 1923, Germans’ savings were eroded by hyperinflation. In May of that year 150bn marks was enough to build an apartment block while six months later it was just enough to buy 625g of meat. “This trauma is one which continues to haunt the nation even today,” said Muschalla.

Before Hitler came to power, the Nazis, keen to blame Jews for everything, were able to successfully sell the idea that “Jewish finance capital” was the reason for the hyperinflation that had robbed Germans of their savings. This also exacerbated the View that savers were morally upright and hardworking, and investors more like wayward gamblers, receiving gains despite having not worked for them. It also helped them to encourage so called “iron saving”, to finance the war.

A poignant exhibit that shows how the regime’s pernicious antisemitic ideology deeply infected savings culture is the savings book given to the Jewish baby Gabriele Samson in May 1933 by her parents’ savings bank. It became worthless only a short time later under the Nazi racial laws that forbade Jews from having savings accounts or any private property.

Muschalla points out that even having their savings wiped out entirely firstly after the first world war and once again after the second did nothing to discourage Germans from continuing to save. “This shows us that saving is something very habitual, it is an entrenched custom, rather than just an economic strategy,” he said.


Rich vs. poor: How fair and equal is Germany?

DW.com
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Germany is one of the world’s strongest economies but it’s also grappling with increasing poverty and inequality. Nina Haase and Sumi Somaskanda went to Bremen, one of the country’s poorest regions, to find out more.

You don’t have to go very far in Bremen to see the splendor of the city’s past. The historic central plaza and its majestic buildings bear the signs of the seafaring port city’s wealth and riches hundreds of years ago.

Yet look a little closer and you’ll find a shadow beneath the glimmering facades. Bremen is also one of Germany’s poorest regions. According to the Cologne Institute for Economic Research, one in every four adults and one in every three children are considered poor; Bremen’s purchasing power is the lowest in Germany as well.

We stumbled upon the weekly Monday Demonstration in the central plaza on our first day. Five men taped up signs across the square reading “Unemployment Can Affect Everyone” and “Stop Temp Work.” The demonstrators told us they’ve been holding rallies every Monday for years, fighting for a more fair and equal society. Manfred Seitz blames the unregulated job sector, calling temp work companies “‘modern slave drivers.”

We traveled to one of Bremen’s most disadvantaged districts, Oslebshausen, and a sprawling building complex at the heart of the neighborhood. One of the district’s social workers, Renate Dwerlkotte, says unemployment in Oslebshausen is at around 80 percent. Still, the community has united around the central recreation center and playground; it’s an oasis for the children and their parents, who help and support one another.

Katja Dreher says she chose to live in Oslebshausen for the sense of community and the affordable rent. She was selfemployed working for an online company but had to quit due to health problems. Now she draws welfare benefits and supplements that income by running the neighborhood’s clothing exchange shop.

Dreher says she wants to work again but she has realized she is better off now: She now has 100 to 150 euros more per month as her income from the clothing exchange is added onto her welfare benefits.

“It’s a shame, it’s important to say that. Working is not a bad thing, people should work. And I miss working,” she said. “I grappled with the idea of working again or not, but in the end I have to think of what’s best for me.”

Do the poor have a voice in politics?

The debate surrounding poverty and inequality is heated. Germany is Europe’s most powerful economy. Unemployment is at record lows and wages are rising. Yet at the same time, an increasing number of Germans are being left behind. In its yearly poverty report, the “Paritatischer Wohlfahrtsverband,” a national welfare association, reported that the percentage of Germans facing poverty is the highest since reunification at 15.7 percent. Retirees, single parents, children, and the long-term unemployed are the highest risk groups.

It’s important to note that the welfare association tracks relative poverty, a standard measure that describes anyone living on less than 60 percent of the medium household income. And that is why the question of poverty is so controversial.

Germany still boasts a strong welfare system to provide a basic living standard for the poor, and progressive tax structure to redistribute wealth.

Economists and critics have poked holes in the association’s yearly reports, pointing out that students most often fall below the relative poverty line, skewing statistics. The welfare association in turn argues that it does not include thousands of homeless in its surveys.

The question of how fair and equal Germany is today depends very much upon who you ask. Yet most analysts agree Germany has seen a rise of the working poor sector workers who hold jobs yet struggle to get by.

Labor unions and critics point to Agenda 2010 as the trigger. The sweeping labor reforms enacted by former Chancellor Gerhard Schroder’s government in 2005 served to deregulate the labor market, slashing unemployment benefits and ushering in a new sector of flexible and temporary work.

Frank Nullmeier, an expert in welfare states and social inequality with Socium, an inequality research institute at the University of Bremen, says economists are divided over whether the Agenda 2010 reforms contributed to growing inequality today.

“But nobody can deny that (the reforms) certainly did not lead to more equality,” added Nullmeier.


Vorsprung durch Angst

The Economist

The good and bad in Germany’s economic model are strongly linked.

Germany is admired for its stability but derided for persistent trade surpluses.

TALK to Germany’s policymakers in Berlin or Frankfurt and the chances are that somebody will invoke Goethe, the nation’s foremost literary figure, on the perils of inflation. In “Faust”, his masterpiece, an indebted emperor is persuaded by the devil to print “phantom money”, prices rise and economic disaster looms. Foreign interlocutors might counter with a quote of their own from the great poet. “The Germans”, he said, “make everything difficult, both for themselves and everyone else.”

For many years “everyone else” has complained that Germany’s economy causes difficulties for the rest of the world. They grumble that the country saves too much and spends too little and that Germany exports far more goods than it imports. In most years since 1950, Germany has run a surplus on its current account, a broad measure of the balance of trade. When in surplus, domestic savings exceed domestic investments, with the excess lent abroad.

These surpluses mean other countries must run current account deficits (in other words, borrow) in order to ensure there is enough aggregate demand to keep people in work. Last year, Germany’s surplus was a mammoth 8.3% of GDP. At almost $300bn that is far larger than China’s surplus, which was once a target of angry American congressmen. Now Germany is accused of piggybacking on other countries’ spending and of exporting job losses. Donald Trump has castigated Germany’s surplus as “very bad” and bemoaned the number of German cars sold in America, “we will stop this”.

Within the euro club, the gripe is that Germany, as the most creditworthy member, has insisted on austerity for countries with heavy debts, without recognising that its own tight rein on spending makes that adjustment harder.

Yet Germany’s economy is also admired. The unemployment rate has fallen to 3.9%, lower than almost all rich countries. The economy was brutally sideswiped by the “Great Recession” of 2008-09 but employment was barely affected, in stark contrast with other countries. The political shocks of the past year in Britain and America are linked to the steady loss of well-paid blue-collar jobs to automation and to cheaper imports, notably from China. Germany has bucked this trend. The share of manufacturing jobs has not fallen anything like as far. Other countries, notably France, are again hoping to emulate Germany’s system of apprenticeships, by which those not suited for university can instead acquire vocational skills.

Germans are proud of this record. The idea that the country’s trade surplus is a malignancy is dismissed in policy circles. “It would be a worry if it is down to an economic-policy distortion,” says an official. “But it’s not.” Its thrift is defended as rightful prudence. The country needs to save hard, the argument runs, because it is ageing faster than other countries. Not everyone sees it that way. The IMF counters that Germany’s trade surpluses are bigger than can be justified or than is desirable for global economic stability. The dialogue continues, at cross-purposes, just as it has for decades. “What do you want us to do-export less?” says another official, weary of the same debate.

What makes the issue so difficult to resolve, or even to acknowledge, is that Germany’s savings surpluses are not the outcome of explicit economic policy. Instead, their roots lie in a tacit business model from which emerge both the admired and disparaged facets of Germany’s economy.

To understand this model, go back to the late 1990s when the economy was failing. Unemployment was above 4m, a tenth of the workforce. Germany’s share of merchandise exports was shrinking. The current account was in a rare deficit. The economy’s struggles were in part a legacy of devaluations against the Deutschmark earlier in the decade, when speculators broke the bounds of Europe’s exchange-rate mechanism, a system that limited currency fluctuations. The orders and jobs lost to Italy’s capital-goods industry in the 1990s are part of German business folklore.

The funk also reflected overgenerous wage rises, especially in East Germany, after reunification in 1990. Crises in Asia and Russia, two big export markets for Germany, did not help matters, but the problems ran deeper. It became routine to refer to Germany as the “sick man of Europe”. Yet remarkably, just as things seemed hopeless, an old reflex began to kick in. When the Bretton Woods system of fixed exchange rates collapsed in the 1970s, the Deutschmark soared, making Germany’s exports more expensive. German industry then found a way to regain competitiveness. Now it did so again.

Competing values

German firms slowly began to claw back the export competitiveness they had lost in the reunification boom. An important gauge of this is a country’s relative unit labour costs, which shifts downwards as wages fall, productivity relative to other countries improves or the currency weakens. The index for Germany fell by 1600 between 1999 and 2007. Pay growth was a modest 1% a year between 2000 and 2007, compared with an OECD average of 3.5%.

What made this possible, according to a study by Christian Dustmann of University College London, and his co-authors, was a deeply-rooted system of co-operative industrial relations.

An important feature of the system is that unions have representatives on company boards: they can see at first hand how pay rises may hurt competitiveness. For their part, firms see negotiations on pay as a means to pursue other areas of common interest, such as training or flexible hours.

Good labour relations, governed by norms rather than legislation, meant firms were flexible enough to adapt to new challenges. One such was the accession to the EU of lowcost neighbours, including Poland, Hungary and the Czech Republic. Another was the emergence of China as an exporter of global significance. By the late 1990s, firms and unions had already started to move away from a system of industry-wide wage deals to one where pay was set to suit the challenges faced by individual companies.

A consequence of the greater reliance on company-level pay deals was a growing dispersion in wages: those for the best-paid workers rose faster than average while wages at the bottom of the scale fell sharply. The falling cost to manufacturers of local services, where pay was most constrained, played a big role in Germany’s export revival.

This was not the whole story. In 2002 Gerhard Schroder, the leader of the SPD government, asked a commission, chaired by Peter Hartz, an executive at Volkswagen, and including company bosses and union chiefs, for a blueprint to tackle unemployment, which was still rising. The proposals, which became part of a broader package of reforms, known as Agenda 2010, were implemented in four stages. The final leg, Hartz IV, came into effect in January 2005. It controversially restricted benefits for the long-term jobless to a flat rate, irrespective of previous earnings. To qualify for benefits, the jobless had to show they were actively looking for work.

The Hartz reforms should take at least as much credit as pay restraint for the jobs recovery, says Michael Burda of the Humboldt University in Berlin. The reforms are still celebrated by the Mittelstand, Germany’s much-admired legion of medium-sized, mostly family-owned firms. “The journey from sick man to number one economy is because of Schroder’s Agenda 2010,” says Mario Ohoven, head of BVMW, the Mittelstand association. But the success came with a political cost. The SPD lost blue-collar support and has not led a government since.

The culture of co-operation cuts both ways. When the Great Recession struck, firms in other rich countries laid off workers. In Germany, companies held on to staff despite a slump in orders and output. In this they were aided by the widespread adoption of workingtime accounts, first used in the 1990s. Workers could bank overtime hours to take as paid holiday at a later date. Short-time working schemes also helped to limit the damage to jobs. But the response by the Mittelstand was a reflection of a system of conventions that standard economics ignores, says Dennis Snower of the Kiel Institute for the World Economy. Firms had stuck by an implicit deal with their workers.

Pay restraint put Germany back on track but at a cost. It has left the economy more unbalanced than ever. Exports are supercompetitive. In last year’s annual health-check, the IMF said Germany’s real effective exchange rate was undervalued by 10-20%. Consumer spending, meanwhile, remains depressed.

Despite abundant jobs growth. the share of GDP going to households has fallen from 65% in the early 1990s to 60% or below, to the benefit of corporate profits. The rate of household saving, however, has not changed much: it is currently 9.8%, exactly in line with its 20-year average.

As a consequence, the share of consumer spending has fallen to 54% of GDP, far lower than in America or Britain. If workers were paid more, they could buy more. That would mean fewer exports (because firms would produce for a bigger domestic market) and more imports. But Germany is hopelessly locked into a model that always puts exports ahead of anything else.

Following the form book

The exports-first response to the adversity of the late 1990s is a refinement of a tried and trusted German model. The country’s talent for precision engineering means that for decades it has had an edge in luxury cars, chemicals and machinery. To have industries of the required scale in these areas requires a global market: a national market is too small to be efficient.

Germany’s particular talents thus naturally gave rise to an economy that is led by exports rather than domestic spending. A lot of highwage jobs relied on exports, either directly or indirectly. Sustained success in such high-end manufacturing required a commitment to vocational training and to research and development. For German firms to stay ahead and sustain a premium for their superior products, profits had to be continuously ploughed back into innovation and skills. These requirements have over decades shaped the norms and institutions that govern Germany’s economy, according to an insightful paper by David Soskice and David Hope, of the London School of Economics, and Torben Iversen, of Harvard University.

Wage restraint in export industries was a crucial strut. The bargaining power of skilled workers makes this tricky to enforce. Before Germany joined the euro and ceded its monetary policy to the European Central Bank (ECB), the Bundesbank acted as policeman. Inflationary wage bargains would be “punished” by higher interest rates. Another strut was a strict fiscal policy to keep publicsector wages in check and thus in line with those in industry. But the state supported vocational training to ensure an ample supply of skilled workers.

The cement for this is a society with a strong preference for stability, notes Mr Snower. There is a culture of responsibility, of hewing to rules, of extreme risk aversion. A high level of savings helps guard against an uncertain future. People work hard but in return expect job security. To provide it, firms combine their domestic operations with more flexible plants overseas, acquired using surplus profits.

Steady state

Two changes make the resulting savings higher than in the past. First, competition from lowcost emerging markets has made unions even less willing to ask for big pay rises. Job security is paramount. Second, German companies are less likely, or able, to recycle higher profits into investment at home. Marcel Fratzscher of the German Institute for Economic Research reckons half of Germany’s current-account surplus reflects an “investment gap”. A dearth of public investment is one cause. Others are red tape and a tax system that is not conducive to startups.

German firms will argue that it makes more sense to invest abroad, Where populations are growing, than in a domestic market in relative decline. The figures offer some backing. A study by the Bundesbank found that annual returns on German foreign direct investment were a healthy 7.25% between 2005 and 2012. What is more, Germany’s rate of domestic investment is not obviously weak by comparison with other countries. Indeed it is the share of consumer spending that looks unduly low.

Peter Bofinger, one of the German Council of Economic Experts, which advises the government, believes there is a simpler explanation for the surpluses. “It’s all about wages,” he says. Pay restraint is not iust a problem for German workers, particularly the low-paid. Other euro-area countries must keep an even tighter lid on wage growth to claw back their competitiveness. That imparts a deflationary bias throughout the zone: almost all euro-area countries now run current account surpluses. It is in large part why inflation in the bloc has fallen short of the ECB’s target.

A surge in German wages might be good for all sorts of reasons. But can it happen? German pay rates are subject to two influences: the bargaining institutions and the economic fundamentals, says Henrik Enderlein of the Hertie School of Governance in Berlin. The institutions are set up for wage restraint: employers want it; unions will trade it for job security. But economics pushes against all this.

It is not just that, with unemployment below 4%, the jobs market is tight. The indigenous working population is likely to shrink faster than the rate of immigration. For the first time in decades, firms are facing a scarcity of workers. House prices, which had been flat or falling in real terms for decades, have been rising since 2009. Workers who were content to keep a lid on wages when property prices were dormant are more likely to push for higher wages when the price of a home is moving out of reach. Moreover, interest rates are low and unlikely to rise soon: the ECB sets monetary policy for the euro area, where there is still plenty of economic slack, not just for Germany, where there is little.

Faster wage and price growth in Germany would be welcomed by the ECB, which is falling short of its inflation goal because of weak price pressures in the rest of the currency area. This is the first boom that the Bundesbank cannot snuff out, says Mr Enderlein. The habit of wage restraint among union bosses is ingrained but their influence is steadily eroding. Union membership has shrunk from 35% of workers in 1990 to 18% in 2013, even if more than half of the workforce is still covered by union-brokered wage deals.

Nominal wage growth last year, at 2.3%, might have been stronger were it not for unusually low consumer-price inflation, of 0. 4% (thanks to a slump in the oil price). Anxiety about China’s economy may also have nudged unions towards their customary caution. Even so, since 2010, Germany ties with Canada for the fastest wage growth among G7 countries. Mr Enderlein expects nominal pay rises of 3-4% over the next few years in Germany. Allow for productivity growth of 1% and unit-wage inflation will be 2-3%. Such a pickup in wages would gradually shift demand away from exports towards consumption. A stronger euro would help this rebalancing.

Pay or conditions?

Old habits are hard to shift, however. A few years ago, Mr Bofinger argued in favour of faster wage rises in Germany, instead of pay cuts in southern Europe, as a better way to restore balance to the euro zone. He was taken to task by a union leader who reasoned that Germany would lose jobs to China as a consequence.

The impulse for caution is hard-wired into the country’s psyche and institutions. Reiner Hoffmann, leader of the DGB, a big union federation, says the key issues for his members go beyond simply pay. Flexible working time that suits the interests of employees is becoming increasingly relevant. “Wages are negotiated sector by sector, so you first look at how each sector is doing.” In the tug-of-war between buoyant economic conditions in Germany and the institutions of pay restraint, the former is starting to gain momentum. The national instinct against pay rises is formidable, nevertheless.

Germany’s economy has many buttresses: an over-sized trade surplus; lots of foreign assets; an enviable share of global trade; solid public finances; and full employment. Yet its business leaders are anxious about Germany’s readiness for the digital economy, the prestige of luxury brands in a world of driverless cars and the prospect of higher inflation when interest rates remain so low. The fundamentals say Germany is long overdue a pay rise. The form book says don’t hold your breath.

Real Facts about Tariffs. Trump’s plan brings a gun to a knife fight, a gun aimed at his foot – Greg Jericho.

It wasn’t a total surprise that Australia was spared the steel and aluminium tariffs as Trump’s bluster of levelling tariffs for everyone is weakening.

This week saw leaders around the world trying to remember whether they were meant to take Donald Trump seriously, but not literally, or literally but not seriously, and also wondering if they have a Greg Norman somewhere they could use.

When US president Trump announced early in the week he was going to levy a 25% tariff on steel and a 15% tariff on aluminium imports, he suggested it was in order to protect national security. As with most Trump utterances, it left everyone trying to decipher just what he meant, because the US imports nearly half its steel from four nations Canada, Brazil, South Korea and Mexico which are hardly enemies of the US.

Was he doing this to attack China? He did write a series of tweets that suggested trade with China is in his sights, but while China is the biggest producer of steel, it only exports a small percentage of it to the US.

Some of his other tweets suggested that Trump was instead targeting Europe, but again, hitting steel imports was an odd way to go about it, given Europe made it quickly obvious that it would retaliate with tariffs of its own and the European Union is one of the few economies with enough grunt not to get pushed around by the US.

Then came the suggestion that Trump was using this to negotiate with Canada and Mexico over Nafta but that was also odd because that shot down his national security reasoning and opened the US up to retaliation under the World Trade Organisation rules (which would be likely anyway, given his national security reasoning was clearly bogus).

And using the threat of increasing tariffs in free trade negotiations is a weird way to go about things.

The tariffs do hurt the countries that export steel and aluminium to the US, because they force them to charge more for their product, thereby giving American steel companies an advantage, but they also hurt the US.

Tariffs are effectively consumption taxes designed to give local industries an advantage (or at least an equal footing with international competitors), and they work by raising the price of imports. Now that is great for the owners and possibly workers of those industries, but not so good for anyone else who wants to buy those goods, because now they have to pay more.

A tariff on steel and aluminium imports might help create a few extra jobs in the steel industry, but it also increases the price of all things made with steel and aluminium. That leads to job losses in those industries and also reduces the living standards for everyone because suddenly they have to pay more for things like canned goods, beer, and cars.

One study suggested that for every job gained in the steel and aluminium industries, five would be lost elsewhere.

That does not mean all free trade is a win for everyone and international trade does not occur in a textbook, but rather in the real world where governments subsidise and assist industries. But the general rule is that the costs to the economy increase with the size of the tariff and the number of industries affected (and similarly the benefits of lowering them reduce as the tariff gets closer to zero). A 25% tariff on steel is thus a rather hefty whack.

Trump is in effect going to the negotiating table with a massive weapon, a bit like taking a gun to a knife fight. The only problem is he has the gun aimed at his own foot.

And so it wasn’t a total surprise to see Trump back down and exempt Canada and Mexico, and then later give one to Australia. As the trade minister, Steve Ciobo noted this week, our steel exports to the US amount to about 0.800 of the US market and our aluminium exports account for about 1.5% so exempting Australia makes little difference.

To that end, reports that we have engaged Greg Norman to do some lobbying on our behalf seem eminently sensible. Not because Norman is some master trade negotiator, but because when dealing with Trump, nations always need to realise he is an insecure, ego driven fool who needs praise for doing the most ordinary of activities, and who sees every discussion and issue through the prism of how it makes him look.

Norman is probably the only Australian Trump has heard of, and the fact that Norman is famous and successful and would be seeking a favour from Trump would appeal to Trump’s vanity.

We could bemoan the fact that America’s electoral college system has selected this vainglorious ignoramus, or we can suck it up and use it to our advantage.

For now it appears his bluster of levelling tariffs for everyone is weakening. Trump clearly believes this the best way to negotiate trade deals, like any good swindler he’ll ignore the costs and talk only of the benefits.

The danger for Australia has always been not from a direct US tariff but should retaliation come from Europe and China. The last thing a small open economy needs is for the large economies of the world to start playing like it is 1930.

For now everyone is trying to work out just what Trump is after, mostly he is after things that he can call a win (even if they are really not). So I; nations will be thinking of things they give Trum that don’t matter in order for him to claim victory in the negotiation.

Or they can see if Greg Norman is available for hire.

The Guardian

Inequality and Economic Growth – Joseph Stiglitz.

“Even if we act to erase material poverty, there is another greater task, it is to confront the poverty of satisfaction – purpose and dignity – that afflicts us all.

Too much and for too long, we seemed to have surrendered personal excellence and community values in the mere accumulation of material things. Our Gross National Product, now, is over $800 billion dollars a year, but that Gross National Product – if we judge the United States of America by that – that Gross National Product counts air pollution and cigarette advertising, and ambulances to clear our highways of carnage.
It counts special locks for our doors and the jails for the people who break them. It counts the destruction of the redwood and the loss of our natural wonder in chaotic sprawl.

It counts napalm and counts nuclear warheads and armored cars for the police to fight the riots in our cities. It counts Whitman’s rifle and Speck’s knife, and the television programs which glorify violence in order to sell toys to our children. Yet the gross national product does not allow for the health of our children, the quality of their education or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials.
It measures neither our wit nor our courage, neither our wisdom nor our learning, neither our compassion nor our devotion to our country, it measures everything in short, except that which makes life worthwhile.
And it can tell us everything about America except why we are proud that we are Americans.
If this is true here at home, so it is true elsewhere in the world

Bobby Kennedy, 1968

*

In the middle of the twentieth century, it came to be believed that ’a rising tide lifts all boats’: economic growth would bring increasing wealth and higher living standards to all sections of society. At the time, there was some evidence behind that claim. In industrialised countries in the 1950s and 1960s every group was advancing, and those with lower incomes were rising most rapidly.

In the ensuing economic and political debate, this ’rising-tide hypothesis’ evolved into a much more specific idea, according to which regressive economic policies, policies that favour the richer classes, would end up benefiting everyone. Resources given to the rich would inevitably ‘trickle down’ to the rest.

It is important to clarify that this version of old-fashioned ‘trickle-down economics’ did not follow from the postwar evidence. The ’rising-tide hypothesis’ was equally consistent with a ’trickle-up’ theory, give more money to those at the bottom and everyone will benefit; or with a ’build-out from the middle’ theory-help those at the centre, and both those above and below will benefit.

Today the trend to greater equality of incomes which characterised the postwar period has been reversed. Inequality is now rising rapidly. Contrary to the rising-tide hypothesis, the rising tide has only lifted the large yachts, and many of the smaller boats have been left dashed on the rocks. This is partly because the extraordinary growth in top incomes has coincided with an economic slowdown.

The trickle-down notion, along with its theoretical justification, marginal productivity theory, needs urgent rethinking. That theory attempts both to explain inequality, why it occurs, and to justify it, why it would be beneficial for the economy as a whole. This essay looks critically at both claims.

It argues in favour of alternative explanations of inequality, with particular reference to the theory of rent-seeking and to the influence of institutional and political factors, which have shaped labour markets and patterns of remuneration. And it shows that:

Far from being either necessary or good for economic growth, excessive inequality tends to lead to weaker economic performance.

In light of this, it argues for a range of policies that would increase both equity and economic well-being.

The great rise of inequality

Let us start by examining the ongoing trends in income and wealth. In the past three decades, those at the top have done very well, especially in the US. Between 1980 and 2014, the richest 1 per cent have seen their average real income increase by 169 per cent (from $469,403, adjusted for inflation, to $1,2b0508) and their share of national income more than double, from 10 per cent to 21 per cent. The top 0.1 per cent have fared even better. Over the same period, their average real income increased by 281 per cent (from $1,597, 080, adjusted for inflation, to $6,087,113) and their share of national income almost tripled, from 3.4 to l0 3 per cent.

Over the same thirty-four years, median household income grew by only 11 per cent. And this growth actually occurred only in the very first years of the period: by 2014 it was only .7 per cent higher than in 1989, after peaking in 1999. But even this underestimates the extent to which those at the bottom have suffered, their incomes have only done as well as they have because hours worked have increased. Median hourly compensation (adjusted for inflation) increased by only 9 per cent from 1973 to 2014, even though at the same time productivity grew by 72.2 per cent.

To understand how significant this divergence of productivity and wages is, consider that from 1948 to 1973 both increased at the same pace, about doubling over the period.

And these statistics underestimate the true deterioration in workers’ wages, for education levels have increased (the percentage of Americans who are college graduates has nearly doubled since 1980, to more than 30 per cent), so that one should have expected a significant increase in wage rates. In fact, average real hourly wages for all Americans with only a high school diploma have decreased in the past three decades.

In the first three years of the so-called recovery from the Great Recession of 2008-2009, in other words, since the US economy returned to growth, fully 91 per cent of the gains in income went to the top 1 per cent.

By 2014, the rest of the income distribution had experienced a bit more of a boost, but even accounting for that, 58 per cent of the gains in total income have gone to the top 1 per cent since 2009. During that period, the income of the bottom 99 per cent has grown by just 4 per cent.

Presidents Bush and Obama both tried a trickle-down strategy, giving large amounts of money to the banks and the bankers. The idea was simple: by saving the banks and bankers, all would benefit. The banks would restart lending: The wealthy would create more jobs. This strategy, it was argued, would be far more efficacious than helping homeowners, businesses or workers directly.

The US Treasury typically demands that when money is given to developing countries, conditions be imposed on them to ensure not only that the money is used well, but also that the country adopts economic policies that, according to the Treasury’s economic theories, will lead to growth. But no conditions were imposed on the banks, not even, for example, requirements that they lend more or stop abusive practices. The rescue worked in enriching those at the top; but the benefits did not trickle down to the rest of the economy.

The Federal Reserve, too, tried trickle-down economics. One of the main channels by which quantitative easing was supposed to rekindle growth was by leading to higher stock market prices, which would generate higher wealth for the very rich, who would then spend some of that, which in turn would benefit the rest.

As Yeva Nersisyan and Randall Wray argue in their chapter in this volume, both the Fed and the Administration could have tried policies that more directly benefited the rest of the economy: helping homeowners, lending to small and medium-sized enterprises and fixing the broken credit channel. These trickle-down policies were relatively ineffective, one reason why seven years after the US slipped into recession, the economy was still not back to health.

Wealth is even more concentrated than income, by one estimate more than ten times so. The wealthiest 1 per cent of Americans hold 41.8 per cent of the country’s wealth; the top 0.1 per cent alone control more than 22 per cent of total wealth. Just one example of the extremes of wealth in America is the Walton family: the six heirs to the Walmart empire command a wealth of $145 billion, which is equivalent to the net worth of 1,782,020 average American families.”

Wealth inequality too is on the upswing. For the four decades before the Great Recession, the rich were getting wealthier at a more rapid pace than everyone else. Between 1978 and 2013 the share of wealth owned by the top I per cent rose dramatically, from less than 25 per cent to its current level above 40 per cent; the share of the top 10 per cent from about two-thirds to well over three-quarters! By 2010, the crisis had depleted some of the richest Americans’ wealth because of the decline in stock prices, but many Americans also had had their wealth almost entirely wiped out as their homes lost value. After the crisis, the average wealthiest l per cent of households still had 165 times the wealth of the average American in the bottom 90 per cent, more than double the ratio of thirty years ago.

In the years of ‘recovery’, as stock market values rebounded (in part as a result of the Fed’s lopsided efforts to resuscitate the economy through increasing the balance sheet of the rich), the rich have regained much of the wealth that they had lost; the same did not happen to the rest of the country.

Inequality plays out along ethnic lines in ways that should be disturbing for a country that had begun to see itself as having won out against racism. Between 2005 and 2009, a huge number of Americans saw their wealth drastically decrease. The net worth of the typical white American household was down substantially, to $113,149 in 2009, a 16 per cent loss of wealth from 2005. But the recession was much worse for other groups.

The typical African American household lost 53 per cent of its wealth, putting its assets at a mere 5 per cent of the median white American’s. The typical Hispanic household lost 66 per cent of its wealth.”

Probably the most invidious aspect of America’s inequality is that of opportunities: in the US a young person’s life prospects depend heavily on the income and education of his or her parents, even more than in other advanced countries. The ’American dream’ is largely a myth.

A number of studies have noted the link between inequality of outcomes and inequality of opportunities. When there are large inequalities of income, those at the top can buy for their offspring privileges not available to others, and they often come to believe that it is their right and obligation to do so. And, of course, without equality of opportunity those born in the bottom of the distribution are likely to end up there: inequalities of outcomes perpetuate themselves. This is deeply troubling: given our low level of equality of opportunity and our high level of inequality of income and wealth, it is possible that the future will be even worse, with still further increases in inequality of outcome and still further decreases in equality of opportunity.

A generalised international trend

While the US has been winning the race to be the most unequal country (at least within developed economies), much of what has just been described for it has also been going on elsewhere. In the past twenty-five to thirty years the Gini index, the widely used measure of income inequality, has increased by roughly 29 per cent in the United States, 17 per cent in Germany, 9 per cent in Canada, 14 per cent in UK, 12 per cent in Italy and ll per cent in Japan.”

The more countries follow the American economic model, the more the results seem to be consistent with what has occurred in the United States. The UK has now achieved the second highest level of inequality among the countries of Western Europe and North America, a marked change from its position before the Thatcher era. Germany, which had been among the most equal countries within the OECD, now ranks in the middle.

The enlargement of the share of income appropriated by the richest 1 per cent has also been a general trend, and in Anglo-Saxon countries it started earlier and it has been more marked than anywhere else. In rich countries, such as the US, the concentration of wealth is even more pronounced than that of income, and has been rising too. For instance, in the UK the income share of the top 1 per cent went up from 5.7 per cent in 1978 to 14.7 per cent in 2010, while the share of wealth owned by the top 1 per cent surged from 22.6 per cent in 1970 to 28 per cent in 2010 and the top 10 per cent’s wealth share increased from 64 per cent to 70.5 per cent over the same period.

Also disturbing are the patterns that have emerged in transition economies, which at the beginning of their movement to a market economy had low levels of inequality in income and wealth (at least according to available measurements). Today, China’s inequality of income, as measured by its Gini coefficient, is roughly comparable to that of the United States and Russia. Across the OECD, since 1985 the Gini coefficient has increased in seventeen of twenty two countries for which data is available, often dramatically.

Moreover, recent research by Piketty and his co-authors has found that the importance of inherited wealth has increased in recent decades, at least in the rich countries for which we have data. After displaying a decreasing trend in the first postwar period, the share of inheritance flows in disposable income has been increasing in the past decades.

Explaining inequality

Marginal Productivity Theory

How can we explain these worrying trends? Traditionally, there has been little consensus among economists and social thinkers on what causes inequality. In the nineteenth century, they strived to explain and either justify or criticise the evident high levels of disparity. Marx talked about exploitation. Nassau Senior, the first holder of the first chair in economics, the Drummond Professorship at All Souls College, Oxford, talked about the returns to capital as a payment for capitalists’ abstinence, for their not consuming. It was not exploitation of labour, but the. just rewards for their forgoing consumption. Neoclassical economists developed the marginal productivity theory, which argued that compensation more broadly reflected different individuals’ contributions to society.

While exploitation suggests that those at the top get what they get by taking away from those at the bottom, marginal productivity theory suggests that those at the top only get what they add. The advocates of this View have gone further: they have suggested that in a competitive market, exploitation (eg. as a result of monopoly power or discrimination) simply couldn’t persist, and that additions to capital would cause wages to increase, so workers would be better off thanks to the savings and innovation of those at the top.

More specifically, marginal productivity theory maintains that, due to competition, everyone participating in the production process earns remuneration equal to her or his marginal productivity.

This theory associates higher incomes with a greater contribution to society. This can justify, for instance, preferential tax treatment for the rich: by taxing high incomes we would deprive them of the ’just deserts’ for their contribution to society, and, even more importantly, we would discourage them from expressing their talent?‘ Moreover, the more they contribute, the harder they work and the more they save, the better it is for workers, whose wages will rise as a result.

The reason why these ideas justifying inequality have endured is that they have a grain of truth in them. Some of those who have made large amounts of money have contributed greatly to our society, and in some cases what they have appropriated for themselves is but a fraction of what they have contributed to society.

But this is only a part of the story: there are other possible causes of inequality. Disparity can result from exploitation, discrimination and exercise of monopoly power. Moreover, in general, inequality is heavily influenced by many institutional and political factors: industrial relations, labour market institutions, welfare and tax systems, for example, which can both work independently of productivity and affect productivity.

That the distribution of income cannot be explained just by standard economic theory is suggested by the fact that the before-tax and transfer distribution of income differs markedly across countries. France and Norway are examples of OECD countries that have managed by and large to resist the trend of increasing inequality. The Scandinavian countries have a much higher level of equality of opportunity, regardless of how that is assessed.

Marginal Productivity Theory is meant to have universal application. Neoclassical theory taught that one could explain economic outcomes without reference, for instance, to institutions. It held that a society’s institutions are simply a facade; economic behaviour is driven by the underlying laws of demand and supply, and the economist’s job is to understand these underlying forces. Thus, the standard theory cannot explain how countries with similar technology, productivity and per capita income can differ so much in their before-tax distribution.

The evidence, though, is that institutions do matter. Not only can the effect of institutions be analysed, but institutions can themselves often be explained, sometimes by history, sometimes by power relations and sometimes by economic forces (like information asymmetries) left out of the standard analysis.

Thus, a major thrust of modern economics is to understand the role of institutions in creating and shaping markets. The question then is: what is the relative role and importance of these alternative hypotheses? There is no easy way of providing a neat quantitathe answer, but recent events and studies have lent persuasive weight to theories putting greater focus on rent-seeking and exploitation. We shall discuss this evidence in the next section, before turning to the institutional and political factors which are at the root of the recent structural changes in income distribution.

Rent-seeking and top incomes

The term ’rent’ was originally used to describe the returns to land, since the owner of the land receives these payments by virtue of his or her ownership and not because of anything he or she does. The term was then extended to include monopoly profits (or monopoly rents), the income that one receives simply from control of a monopoly and, in general returns due to similar ownership claims.

Thus, rent-seeking means getting an income not as a reward for creating wealth but by grabbing a larger share of the wealth that would have been produced anyway. Indeed, rent-seekers typically destroy wealth, as a by-product of their taking away from others. A monopolist who overcharges for her or his product takes money from those whom she or he is overcharging and at the same time destroys value. To get her or his monopoly price, she or he has to restrict production.

Growth in top incomes in the past three decades has been driven mainly in two occupational categories: those in the financial sector (both executives and professionals) and non-financial executives.” Evidence suggests that rents have contributed on a large scale to the strong increase in the incomes of both.

Let us first consider executives in general. That the rise in their compensation has not reflected productivity is indicated by the lack of correlation between managerial pay and firm performance. As early as 1990 Jensen and Murphy, by studying a sample of 2,505 CEOs in 1,400 companies, found that annual changes in executive compensation did not reflect changes in corporate performance. Since then, the work of Bebchuk, Fried and Grinstein has shown that the huge increase in US executive compensation since 1993 cannot be explained by firm performance or industrial structure and that, instead, it has mainly resulted from flaws in corporate governance, which enabled managers in practice to set their own pay. Mishel and Sabadish examined 350 firms, showing that growth in the compensation of their CEOs largely outpaced the increase in their stock market value. Most strikingly, executive compensation displayed substantial positive growth even during periods when stock market values decreased?“

There are other reasons to doubt standard marginal productivity theory. In the United States the ratio of CEO pay to that of the average worker increased from around 20 to 1 in 1965 to 354 to 1 in 2012. There was no change in technology that could explain a change in relative productivity of that magnitude, and no explanation for why that change in technology would occur in the US and not in other similar countries. Moreover, the design of corporate compensation schemes has made it evident that they are not intended to reward effort: typically, they are related to the performance of the stock, which rises and falls depending on many factors outside the control of the CEO, such as market interest rates and the price of oil. It would have been easy to design an incentive structure with less risk, simply by basing compensation on relative performance, relative to a group of comparable companies. The struggles of the Clinton administration to introduce tax systems encouraging so-called performance pay (without imposing conditions to ensure that pay was actually related to performance) and disclosure requirements (which would have enabled market participants to better assess the extent of stock dilution associated with CEO stock option plans) clarified the battle lines: those pushing for favourable tax treatment and against disclosure understood well that these arrangements would have facilitated greater inequalities in income.

For specifically the rise in top incomes in the financial sector, the evidence is even more unfavourable to explanations based on marginal productivity theory. An empirical study by Philippon and Reshef shows that in the past two decades workers in the financial industry have enjoyed a huge ’pay-premium’ with respect to similar sectors, which cannot be explained by the usual proxies for productivity (such as the level of education or unobserved ability). According to their estimates, financial sector compensations have been about 40 per cent higher than the level that would have been expected under perfect competition.

It is also well documented that banks deemed ’too big to fail’ enjoy a rent due to an implicit state guarantee. Investors know that these large financial institutions can count, in effect, on a government guarantee, and thus they are willing to provide them funds at lower interest rates. The big banks can thus prosper not because they are more efficient or provide better service but because they are in effect subsidised by taxpayers.

There are other reasons for the super-normal returns to the large banks and their bankers. In certain of the activities of the financial sector, there is far from perfect competition. Anti competitive practices in debit and credit cards have amplified pro-existing market power to generate huge rents. Lack of transparency (e.g. in over-the-counter Credit Default Swaps (CD55) and derivatives too have generated large rents, with the market dominated by four players. It is not surprising that the rents enjoyed in this way by big banks translated into higher incomes for their managers and shareholders.

In the financial sector even more than in other industries, executive compensation in the aftermath of the crisis provided convincing evidence against marginal productivity theory as an explanation of wages at the top: the bankers who had brought their firms and the global economy to the brink of ruin continued to receive high rates of pay compensation which in no way could be related either to their social contribution or even their contribution to the firms for which they worked (both of which were negative).

For instance, a study that focused on Bear Stems and Lehman Brothers in 2000-2008 has found that the top executive managers of these two giants had brought home huge amounts of ‘performance-based’ compensations (estimated at around $1 billion for Lehman and $1.4 billion for Bear Stearns), which were not clawed back when the two firms collapsed.

Still another piece of evidence supporting the importance of rent-seeking in explaining the increase in inequality is provided by those studies that have shown that increases in taxes at the very top do not result in decreases in growth rates. If these incomes were a result of their efforts, we might have expected those at the top to respond by working less hard, with adverse effects on GDP.

The Increase in rents

Three striking aspects of the evolution of most rich countries in the past thirty-five years are (a) the increase in the wealth-to-income ratio; (b) the stagnation of median wages; and (c) the failure of the return to capital to decline.

Standard neoclassical theories, in which ’wealth’ is equated with ’capital’, would suggest that the increase in capital should be associated with a decline in the return to capital and an increase in wages. The failure of unskilled workers’ wages to increase has been attributed by some (especially in the 1990s) to skill-biased technological change, which increased the premium put by the market on skills. Hence, those with skills would see their wages rise, and those without skills would see them fall. But recent years have seen a decline in the wages paid even to skilled workers. Moreover, as my recent research shows,” average wages should have increased, even if some wages fell. Something else must be going on.

There is an alternative, and more plausible, explanation. It is based on the observation that rents are increasing (due to the increase in land rents. intellectual property rents and monopoly power). As a result, the value of those assets that are able to provide rents to their owners-such as land, houses and some financial claims, is rising proportionately. So overall wealth increases, but this does not lead to an increase in the productive capacity of the economy or in the mean marginal productivity or average wage of workers. On the contrary, wages may stagnate or even decrease, because the rise in the share of rents has happened at the expense of wages.

The assets which are driving the increase in overall wealth, in fact, are not produced capital goods. In many cases, they are not even ’productive’ in the usual sense; they are not directly related to the production of goods and services?” With more wealth put into these assets, there may be less invested in real productive capital. In the case of many countries where we have data (such as France) there is evidence that this is indeed the case:

A disproportionate part of savings in recent years has gone into the purchase of housing, which has not increased the productivity of the ‘real’ economy.

Monetary policies that lead to low interest rates can increase the value of these ’unproductive’ fixed assets, an increase in the value of wealth that is unaccompanied by any increase in the flow of goods and services. By the same token, a bubble can lead to an increase in wealth, for an extended period of time, again with possible adverse effects on the stock of ’real’ productive capital Indeed, it is easy for capitalist economies to generate such bubbles (a fact that should be obvious from the historical record, but which has also been confirmed in theoretical models.) While in recent years there has been a ’correction’ in the housing bubble (and in the underlying price of land), we cannot be confident that there has been a full correction. The increase in the wealth-income ratio may still have more to do with an increase in the value of rents than with an increase in the amount of productive capital. Those who have access to financial markets and can get credit from banks (typically those already well off) can purchase these assets, using them as collateral. As the bubble takes off, so does their wealth and society’s inequality. Again, policies amplify the resulting inequality: favourable tax treatment of capital gains enables especially high after-tax returns on these assets and increases the wealth especially of the wealthy, who disproportionately own such assets (and understandably so, since they are better able to withstand the associated risks).

The role of institutions and politics

The large influence of rent-seeking in the rise of top incomes undermines the marginal productivity theory of income distribution, The income and wealth of those at the top comes at least partly at the expense of others, just the opposite conclusion from that which emerges from trickle-down economics. When, for instance, a monopoly succeeds in raising the price of the goods which it sells, it lowers the real income of everyone else. This suggests that institutional and political factors play an important role in influencing the relative shares of capital and labour.

As we noted earlier, in the past three decades wages have grown much less than productivity, a fact which is hard to reconcile with marginal productivity theory” but is consistent with increased exploitation. This suggests that the weakening of workers’ bargaining power has been a major factor. Weak unions and asymmetric globalisation, where capital is free to move while labour is much less so, are thus likely to have contributed significantly to the great surge of inequality.

The way in which globalisation has been managed has led to lower wages in part because workers’ bargaining power has been eviscerated. With capital highly mobile and with tariffs low, firms can simply tell workers that if they don’t accept lower wages and worse working conditions, the company will move elsewhere. To see how asymmetric globalisation can affect bargaining power, imagine, for a moment, what the world would be like if there was free mobility of labour, but no mobility of capital. Countries would compete to attract workers. They would promise good schools and a good environment, as well as low taxes on workers. This could be financed by high taxes on capital. But that’s not the world we live in.

In most industrialised countries there has been a decline in union membership and influence; this decline has been especially strong in the Anglo-Saxon world. This has created an imbalance of economic power and a political vacuum.

Without the protection afforded by a union, workers have fared even more poorly than they would have otherwise. Unions’ inability to protect workers against the threat of job loss by the moving of jobs abroad has contributed to weakening the power of unions. But politics has also played a major role, exemplified in President Reagan’s breaking of the air traffic controllers” strike in the US in 1981 or Margaret Thatcher’s battle against the National Union of Mineworkers in the UK.

Central bank policies focusing on inflation have almost certainly been a further factor contributing to the growing inequality and the weakening of workers’ bargaining power. As soon as wages start to increase, especially if they increase faster than the rate of inflation, central banks focusing on inflation raise interest rates. The result is a higher average level of unemployment and a downward ratcheting effect on wages: as the economy goes into recession, real wages often fall; and then monetary policy is designed to ensure that they don’t recover.

Inequalities are affected not just by the legal and formal institutional arrangements (such as the strength of unions) but also by social custom, including whether it is viewed as acceptable to engage in discrimination.

At the same time, governments have been lax in enforcing anti-discrimination laws. Contrary to the suggestion of free-market economists, but consistent with even casual observation of how markets actually behave, discrimination has been a persistent aspect of market economies, and helps explain much of what has gone on at the bottom. The discrimination takes many forms-in housing markets, in financial markets (at least one of America’s large banks had to pay a very large fine for its discriminatory practices in the run-up to the crisis) and in labour markets. There is a large literature explaining how such discrimination persists.

Of course, market forces, the demand and supply for skilled workers, affected by changes in technology and education, play an important role as well, even if those forces are partially shaped by politics. But instead of these market forces and politics balancing each other out, with the political process dampening the increase in inequalities of income and wealth in periods when market forces have led to growing disparities, in the rich countries today the two have been working together to increase inequality.

The price of inequality

The evidence is thus unsupportive of explanations of inequality solely focused on marginal productivity. But what of the argument that we need inequality to grow?

A first justification for the claim that inequality is necessary for growth focuses on the role of savings and investment in promoting growth, and is based on the observation that those at the top save, while those at the bottom typically spend all of their earnings. Countries with a high share of wages will thus not be able to accumulate capital as rapidly as those with a low share of wages. The only way to generate savings required for longterm growth is thus to ensure sufficient income for the rich.

This argument is particularly inapposite today, where the problem is, to use Bernanke’s term, a global savings glut. But even in those circumstances where growth would be increased by an increase in national savings, there are better ways of inducing savings than increasing inequality. The government can tax the income of the rich, and use the funds to finance either private or public investment; such policies reduce inequalities in consumption and disposable income, and lead to increased national savings (appropriately measured).

A second argument centres on the popular misconception that those at the top are the job creators, and giving more money to them will thus create more jobs. Industrialised countries are full of creative entrepreneurial people throughout the income distribution. What creates jobs is demand: when there is demand, firms will create the jobs to satisfy that demand (especially if we can get the financial system to work in the way it should, providing credit to small and medium-sized enterprises).

In fact, as empirical research by the IMF has shown, inequality is associated with economic instability. In particular, lMF researchers have shown that growth spells tend to be shorter when income inequality is high. This result holds also when other determinants of growth duration (like external shocks, property rights and macroeconomic conditions) are taken into account:

On average, a 10 percentile decrease in inequality increases the expected length of a growth spell by one half.

The picture does not change if one focuses on medium-term average growth rates instead of growth duration. Recent empirical research released by the OECD shows that income inequality has a negative and statistically significant effect on medium-term growth. It estimates that in countries like the US, the UK and Italy, overall economic growth would have been six to nine percentage points higher in the past two decades had income inequality not risen.”

There are different channels through which inequality harms the economy:

First, inequality leads to weak aggregate demand. The reason is easy to understand: those at the bottom spend a larger fraction of their income than those at the top. The problem may be compounded by monetary authorities’ flawed responses to this weak demand. By lowering interest rates and relaxing regulations, monetary policy too easily gives rise to an asset bubble, the bursting of which leads in turn to recession.

Many interpretations of the current crisis have indeed emphasised the importance of distributional concems. Growing inequality would have led to lower consumption but for the effects of loose monetary policy and lax regulations, which led to a housing bubble and a consumption boom. It was, in short, only growing debt that allowed consumption to be sustained. But it was inevitable that the bubble would eventually break. And it was inevitable that, when it broke, the economy would go into a downturn.

Second, inequality of outcomes is associated with inequality of opportunity. When those at the bottom of the income distribution are at great risk of not living up to their potential, the economy pays a price not only with weaker demand today, but also with lower growth in the future. With nearly one in four American children growing up in poverty?” many of them facing not just a lack of educational opportunity but also a lack of access to adequate nutrition and health, the country’s long-term prospects are being put into jeopardy.

Third, societies with greater inequality are less likely to make public investments which enhance productivity, such as in public transportation, infrastructure, technology and education. If the rich believe that they don’t need these public facilities, and worry that a strong government, which could increase the efficiency of the economy, might at the same time use its powers to redistribute income and wealth, it is not surprising that public investment is lower in countries with higher inequality. Moreover, in such countries tax and other economic policies are likely to encourage those activities that benefit the financial sector over more productive activities.

In the United States today returns on long-term financial speculation (capital gains) are taxed at approximately half the rate of labour, and speculative derivatives are given priority in bankruptcy over workers. Tax laws encourage job creation abroad rather than at home. The result is a weaker and more unstable economy. Reforming these policies-and using other policies to reduce rent-seeking would not only reduce inequality; it would improve economic performance.

It should be noted that the existence of these adverse effects of inequality on growth is itself evidence against an explanation of today’s high level of inequality based on marginal productivity theory. For the basic premise of marginal productivity is that those at the top are simply receiving just deserts for their efforts, and that the rest of society benefits from their activities. lf that were so, we should expect to see higher growth associated with higher incomes at the top. In fact, we see just the opposite.

Reversing inequality

A wide range of policies can help reduce inequality. Policies should be aimed at reducing inequalities both in market income and in the post-traumatic and-transfer incomes. The rules of the game play a large role in determining market distribution, in preventing discrimination, in creating bargaining rights for workers, in curbing monopolies and the powers of CEOs to exploit firms’ other stakeholders and the financial sector to exploit the rest of society. These rules were largely rewritten during the past thirty years in ways which led to more inequality and poorer overall economic performance. Now they must be rewritten once again, to reduce inequality and strengthen the economy, for instance, by discouraging the short-termism that has become rampant in the financial and corporate sector.

Reforms include more support for education, including pre-school; increasing the minimum wage; strengthening earned-income tax credits; strengthening the voice of workers in the workplace, including through unions; and more effective enforcement of anti-discrimination laws. But there are four areas in particular that could make inroads in the high level of inequality which now exists.

First, executive compensation (especially in the US) has become excessive, and it is hard to justify the design of executive compensation schemes based on stock options. Executives should not be rewarded for improvements in a firm’s stock market performance in which they play no part. If the Federal Reserve lowers interest rates, and that leads to an increase in stock market prices, CEOS should not get a bonus as a result. If oil prices fall, and so profits of airlines and the value of airline stocks increase, airline CEOs should not get a bonus.

There is an easy way of taking account of these gains (or losses) which are not attributable to the efforts of executives: basing performance pay on the relative performance of firms in comparable circumstances, the design of good compensation schemes that do this has been well understood for more than a third of a century, and yet executives in major corporations have almost studiously resisted these insights. They have focused more on taking advantage of deficiencies in corporate govemance and the lack of understanding of these issues by many shareholders, to try to enhance their earnings, getting high pay when share prices increase, and also when share prices fall. In the long run, as we have seen, economic performance itself is hurt?

Second, macroeconomic policies are needed that maintain economic stability and full employment. High unemployment most severely penalises those at the bottom and the middle of the income distribution. Today, workers are suffering thrice over: from high unemployment, weak wages and cutbacks in public services, as government revenues are less than they would be if economies were functioning well.

As we have argued, high inequality has weakened aggregate demand. Fuelling asset price bubbles through hyper-expansive monetary policy and deregulation is not the only possible response. Higher public investment, in infrastructures, technology and education, would both revive demand and alleviate inequality, and this would boost growth in the long-run and in the short-run. According to a recent empirical study by the IMF, we’ll designed public infrastructure investment raises output both in the short and long term, especially when the economy is operating below potential. And it doesn’t need to increase public debt in terms of GDP: well implemented infrastructure projects would pay for themselves, as the increase in income (and thus in tax revenues) would more than offset the increase in spending.

Third, public investment in education is fundamental to address inequality. A key determinant of workers’ income is the level and quality of education. If govemments ensure equal access to education, then the distribution of wages will reflect the distribution of abilities (including the ability to benefit from education) and the extent to which the education system attempts to compensate for differences in abilities and backgrounds. If, as in the United States, those with rich parents usually have access to better education, then one generation’s inequality will be passed on to the next, and in each generation, wage inequality will reflect the income and related inequalities of the last.

Fourth, these much needed public investments could be financed through fair and full taxation of capital income. This would further contribute to counteracting the surge in inequality: it can help bring down the net return to capital, so that those capitalists who save much of their income won’t see their wealth accumulate at a faster pace than the growth of the overall economy, resulting in growing inequality of wealth. Special provisions providing for favourable taxation of capital gains and dividends not only distort the economy, but, with the vast majority of the benefits going to the very top, increase inequality.

At the same time they impose enormous budgetary costs: 2 trillion dollars from, 2013 to 2023 in the US, according to the Congressional Budget Office. The elimination of the special provisions for capital gains and dividends, coupled with the taxation of capital gains on the basis of accrual, not just realisations, is the most obvious reform in the tax code that would improve inequality and raise substantial amounts of revenues. There are many others, such as a good system of inheritance and effectively enforced estate taxation.

Conclusion: redefining economic performance

We used to think of there being a trade-off: we could achieve more equality, but only at the expense of overall economic performance. It is now clear that, given the extremes of inequality being reached in many rich countries and the manner in which they have been generated, greater equality and improved economic performance are complements.

This is especially true if we focus on appropriate measures of growth. If we use the wrong metrics, we will strive for the wrong things. As the international Commission on the Measurement of Economic Performance and Social Progress argued, there is a growing global consensus that GDP does not provide a good measure of overall economic performance. What matters is whether growth is sustainable, and whether most citizens see their living standards rising year after year.

Since the beginning of the new millennium, the US economy, and that of most other advanced countries, has clearly not been performing. In fact, for three decades, real median incomes have essentially stagnated. Indeed, in the case of the US, the problems are even worse and were manifest well before the recession: in the past four decades average wages have stagnated, even though productivity has drastically increased.

As this chapter has emphasised, a key factor underlying the current economic difficulties of rich countries is growing inequality. We need to focus not on what is happening on average, as GDP leads us to do, but on how the economy is performing for the typical citizen, reflected for instance in median disposable income. People care about health, fairness and security, and yet GDP statistics do not reflect their decline. Once these and other aspects of societal well-being are taken into account, recent performance in rich countries looks much worse.

The economic policies required to change this are not difficult to identify. We need more investment in public goods; better corporate governance, antitrust and anti-discrimination laws; a better regulated financial system; stronger workers’ rights; and more progressive tax and transfer policies. By ’rewriting the rules’ goveming the market economy in these ways, it is possible to achieve greater equality in both the pre and post tax and transfer distribution of income, and thereby stronger economic performance.

Joseph Stiglitz

The Great Slump of 1930 – John Maynard Keynes.

The world has been slow to realize that we are living this year in the shadow of one of the greatest economic catastrophes of modern history.

But now that the man in the street has become aware of what is happening, he, not knowing the why and wherefore, is as full to-day of what may prove excessive fears as, previously, when the trouble was iirst coming on, he was lacking in what would have been a reasonable anxiety. He begins to doubt the future. Is he now awakening from a pleasant dream to face the darkness of facts? Or dropping off into a nightmare which will pass away?

He need not be doubtful. The other was not a dream. This is a nightmare, which will pass away with the morning. For the resources of nature and men’s devices are just as fertile and productive as they were. The rate of our progress towards solving the material problems of life is not less rapid. We are as capable as before of affording for everyone a high standard of life, high, I mean, compared with, say, twenty years ago, and will soon learn to afford a standard higher still.

We were not previously deceived. But to-day we have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand. The result is that our possibilities of wealth may run to waste for a time, perhaps for a long time.

I doubt whether I can hope, in these articles, to bring what is in my mind into fully effective touch with the mind of the reader. I shall be saying too much for the layman, too little for the expert. For, though no one will believe it, economics is a technical and difficult subject. It is even becoming a science. However, I will do my best, at the cost of leaving out, because it is too complicated, much that is necessary to a complete understanding of contemporary events.

First of all, the extreme violence of the slump is to be noticed. In the three leading industrial countries of the world, the United States, Great Britain, and Germany, 10,000,000 workers stand idle. There is scarcely an important industry anywhere earning enough profit to make it expand, which is the test of progress. At the same time, in the countries of primary production the output of mining and of agriculture is selling, in the case of almost every important commodity, at a price which, for many or for the majority of producers, does not cover its cost. In 1921, when prices fell as heavily, the fall was from a boom level at which producers were making abnormal profits; and there is no example in modern history of so great and rapid a fall of prices from a normal figure as has occurred in the past year. Hence the magnitude of the catastrophe.

The time which elapses before production ceases and unemployment reaches its maximum is, for several reasons, much longer in the case of the primary products than in the case of manufacture. In most cases the production units are smaller and less well organized amongst themselves for enforcing a process of orderly contraction; the length of the production period, especially in agriculture, is longer; the costs of a temporary shut-down are greater; men are more often their own employers and so submit more readily to a contraction of the income for which they are willing to work; the social problems of throwing men out of employment are greater in more primitive communities; and the financial problems of a cessation of production of primary output are more serious in countries where such primary output is almost the whole sustenance of the people. Nevertheless we are fast approaching the phase in which the output of primary producers will be restricted almost as much as that of manufacturers; and this will have a further adverse reaction on manufacturers, since the primary producers will have no purchasing power wherewith to buy manufactured goods; and so on, in a vicious circle.

In this quandary individual producers base illusory hopes on courses of action which would benefit an individual producer or class of producers so long as they were alone in pursuing them, but which benefit no one if everyone pursues them. For example, to restrict the output of a particular primary commodity raises its price, so long as the output of the industries which use this commodity is unrestricted; but if output is restricted all round, then the demand for the primary commodity falls off by just as much as the supply, and no one is further forward. Or again, if a particular producer or a particular country cuts wages, then, so long as others do not follow suit, that producer or that country is able to get more of what trade is going. But if wages are cut all round, the purchasing power of the community as a whole is reduced by the same amount as the reduction of costs; and, again, no one is further forward.

Thus neither the restriction of output nor the reduction of wages serves in itself to restore equilibrium.

Moreover, even if we were to succeed eventually in re-establishing output at the lower level of money-wages appropriate to (say) the pre-war level of prices, our troubles would not be at an end. For since 1914 an immense burden of bonded debt, both national and international, has been contracted, which is fixed in terms of money. Thus every fall of prices increases the burden of this debt, because it increases the value of the money in which it is fixed.

For example, if we were to settle down to the prewar level of prices, the British National Debt would be nearly 40 per cent. greater than it was in 1924 and double what it was in 1920; the Young Plan would weigh on Germany much more heavily than the Dawes Plan, which it was agreed she could not support; the indebtedness to the United States of her associates in the Great War would represent 40-50 per cent. more goods and services than at the date when the settlements were made; the obligations of such debtor countries as those of South America and Australia would become insupportable without a reduction of their standard of life for the benefit of their creditors; agriculturists and householders throughout the world, who have borrowed on mortgage, would find themselves the victims of their creditors.

In such a situation it must be doubtful whether the necessary adjustments could be made in time to prevent a series of bankruptcies, defaults, and repudiations which would shake the capitalist order to its foundations.

Here would be a fertile soil for agitation, seditions, and revolution. It is so already in many quarters of the world. Yet, all the time, the resources of nature and men’s devices would be just as fertile and productive as they were. The machine would merely have been jammed as the result of a muddle. But because we have magneto trouble, we need not assume that we shall soon be back in a rumbling waggon and that motoring is over.

We have magneto trouble. How, then, can we start up again? Let us trace events backwards:

1. Why are workers and plant unemployed? Because industrialists do not expect to be able to sell without loss what would be produced if they were employed.

2. Why cannot industrialists expect to sell without loss? Because prices have fallen more than costs have fallen-indeed, costs have fallen very little.

3. How can it be that prices have fallen more than costs? For costs are what a business man pays out for the production of his commodity, and prices determine what he gets back when he sells it. It is easy to understand how for an individual business or an individual commodity these can be unequal. But surely for the community as a whole the business men get back the same amount as they pay out, since what the business men pay out in the course of production constitutes the incomes of the public which they pay back to the business men in exchange for the products of the latter? For this is what we understand by the normal circle of production, exchange, and consumption.

4. No! Unfortunately this is not so; and here is the root of the trouble.

It is not true that what the business men pay out as costs of production necessarily comes back to them as the saleproceeds of what they produce. It is the characteristic of a boom that their sale-proceeds exceed their costs; and it is the characteristic of a slump that their costs exceed their sale-proceeds. Moreover, it is a delusion to suppose that they can necessarily restore equilibrium by reducing their total costs, whether it be by restricting their output or cutting rates of remuneration; for the reduction of their outgoings may, by reducing the purchasing power of the earners who are also their customers, diminish their sale-proceeds by a nearly equal amount.

5. How, then, can it be that the total costs of production for the world’s business as a whole can be unequal to the total sale-proceeds? Upon what does the inequality depend? I think that I know the answer. But it is too complicated and unfamiliar for me to expound it here satisfactorily. (Elsewhere I have tried to expound it accurately.) So I must be somewhat perfunctory.

Let us take, first of all, the consumption-goods which come on to the market for sale. Upon what do the profits (or losses) of the producers of such goods depend? The total costs of production, which are the same thing as the community’s total earnings looked at from another point of view, are divided in a certain proportion between the cost of consumption-goods and the cost of capital-goods. The incomes of the public, which are again the same thing as the community‘s total earnings, are also divided in a certain proportion between expenditure on the purchase of consumption-goods and savings.

Now if the first proportion is larger than the second, producers of consumption-goods will lose money; for their sale proceeds, which are equal to the expenditure of the public on consumption-goods, will be less (as a little thought will show) than what these goods have cost them to produce. If, on the other hand, the second proportion is larger than the first, then the producers of consumption-goods will make exceptional gains. It follows that the profits of the producers of consumption goods can only be restored, either by the public spending a larger proportion of their incomes on such goods (which means saving less), or by a larger proportion of production taking the form of capital-goods (since this means a smaller proportionate output of consumption-goods).

But capital-goods will not be produced on a larger scale unless the producers of such goods are making a profit. So we come to our second question, upon what do the profits of the producers of capital-goods depend? They depend on whether the public prefer to keep their savings liquid in the shape of money or its equivalent or to use them to buy capital-goods or the equivalent. If the public are reluctant to buy the latter, then the producers of capital-goods will make a loss; consequently less capital-goods will be produced; with the result that, for the reasons given above, producers of consumption goods will also make a loss. In other words, all classes of producers will tend to make a loss; and general unemployment will ensue. By this time a vicious circle will be set up, and, as the result of a series of actions and reactions, matters will get worse and worse until something happens to turn the tide.

This is an unduly simplified picture of a complicated phenomenon. But I believe that it contains the essential truth. Many variations and fugal embroideries and orchestrations can be superimposed; but this is the tune.

If, then, I am right, the fundamental cause of the trouble is the lack of new enterprise due to an unsatisfactory market for capital investment. Since trade is international, an insufficient output of new capital-goods in the world as a whole affects the prices of commodities everywhere and hence the profits of producers in all countries alike.

Why is there an insuflicient output of new capital-goods in the world as a whole? It is due, in my opinion, to a conjunction of several causes. In the first instance, it was due to the attitude of lenders, for new capital-goods are produced to a large extent with borrowed money. Now it is due to the attitude of borrowers, just as much as to that of lenders.

For several reasons lenders were, and are, asking higher terms for loans, than new enterprise can afford:

First, the fact, that enterprise could afford high rates for some time after the war whilst war wastage was being made good, accustomed lenders to expect much higher rates than before the war.

Second, the existence of political borrowers to meet Treaty obligations, of banking borrowers to support newly restored gold standards, of speculative borrowers to take part in Stock Exchange booms, and, latterly, of distress borrowers to meet the losses which they have incurred through the fall of prices, all of whom were ready if necessary to pay almost any terms, have hitherto enabled lenders to secure from these various classes of borrowers higher rates than it is possible for genuine new enterprise to support.

Third, the unsettled state of the world and national investment habits have restricted the countries in which many lenders are prepared to invest on any reasonable terms at all. A large proportion of the globe is, for one reason or another, distrusted by lenders, so that they exact a premium for risk so great as to strangle new enterprise altogether.

For the last two years, two out of the three principal creditor nations of the world, namely, France and the United States, have largely withdrawn their resources from the international market for long-term loans.

Meanwhile, the reluctant attitude of lenders has become matched by a hardly less reluctant attitude on the part of borrowers. For the fall of prices has been disastrous to those who have borrowed, and anyone who has postponed new enterprise has gained by his delay. Moreover, the risks that frighten lenders frighten borrowers too.

Finally, in the United States, the vast scale on which new capital enterprise has been undertaken in the last five years has somewhat exhausted for the time being, at any rate so long as the atmosphere of business depression continues, the profitable opportunities for yet further enterprise. By the middle of 1929 new capital undertakings were already on an inadequate scale in the world as a whole, outside the United States. The culminating blow has been the collapse of new investment inside the United States, which today is probably 20 to 30 per cent less than it was in 1928. Thus in certain countries the opportunity for new profitable investment is more limited than it was; whilst in others it is more risky.

A wide gulf, therefore, is set between the ideas of lenders and the ideas of borrowers for the purpose of genuine new capital investment; with the result that the savings of the lenders are being used up in financing business losses and distress borrowers, instead of financing new capital works.

At this moment the slump is probably a little overdone for psychological reasons. A modest upward reaction, therefore, may be due at any time. But there cannot be a real recovery, in my judgment, until the ideas of lenders and the ideas of productive borrowers are brought together again; partly by lenders becoming ready to lend on easier terms and over a wider geographical field, partly by borrowers recovering their good spirits and so becoming readier to borrow.

Seldom in modern history has the gap between the two been so wide and so diflicult to bridge. Unless we bend our wills and our intelligences, energized by a conviction that this diagnosis is right, to find a solution along these lines, then, if the diagnosis is right, the slump may pass over into a depression, accompanied by a sagging price level, which might last for years, with untold damage to the material wealth and to the social stability of every country alike. Only if we seriously seek a solution, will the optimism of my opening sentences be confirmed, at least for the nearer future.

It is beyond the scope of this article to indicate lines of future policy. But no one can take the first step except the central banking authorities of the chief creditor countries; nor can any one Central Bank do enough acting in isolation. Resolute action by the Federal Reserve Banks of the United States, the Bank of France, and the Bank of England might do much more than most people, mistaking symptoms or aggravating circumstances for the disease itself, will readily believe.

In every way the more effective remedy would be that the Central Banks of these three great creditor nations should join together in a bold scheme to restore confidence to the international long-term loan market; which would serve to revive enterprise and activity everywhere, and to restore prices and profits, so that in due course the wheels of the world’s commerce would go round again. And even if France, hugging the supposed security of gold, prefers to stand aside from the adventure of creating new wealth, I am convinced that Great Britain and the United States, like-minded and acting together, could start the machine again within a reasonable time; if, that is to say, they were energized by a confident conviction as to what was wrong. For it is chiefly the lack of this conviction which today is paralyzing the hands of authority on both sides of the Channel and of the Atlantic.

How Economics Survived the Economic Crisis – Robert Skidelsky * Good enough for government work? Macroeconomics since the crisis – Paul Krugman.

Unlike the Great Depression of the 1930s, which produced Keynesian economics, and the stagflation of the 1970s, which gave rise to Milton Friedman’s monetarism, the Great Recession has elicited no such response from the economics profession. Why?

The tenth anniversary of the start of the Great Recession was the occasion for an elegant essay by the Nobel laureate economist Paul Krugman, who noted how little the debate about the causes and consequences of the crisis have changed over the last decade. Whereas the Great Depression of the 1930s produced Keynesian economics, and the stagilation of the 1970s produced Milton Friedman’s monetarism, the Great Recession has produced no similar intellectual shift.

This is deeply depressing to young students of economics, who hoped for a suitably challenging response from the profession.

Why has there been none?

Krugman’s answer is typically ingenious: the old macroeconomics was, as the saying goes, “good enough for government work.” It prevented another Great Depression. So students should lock up their dreams and learn their lessons.

A decade ago, two schools of macroeconomists contended for primacy: the New Classical or the “freshwater” School, descended from Milton Friedman and Robert Lucas and headquartered at the University of Chicago, and the New Keynesian, or “saltwater,” School, descended from John Maynard Keynes, and based at MIT and Harvard.

Freshwater-types believed that budgets deficits were always bad, whereas the saltwater camp believed that deficits were beneficial in a slump. Krugman is a New Keynesian, and his essay was intended to show that the Great Recession vindicated standard New Keynesian models.

But there are serious problems with Krugman’s narrative. For starters, there is his answer to Queen Elizabeth II’s nowfamous question: “Why did no one see it coming?” Krugman’s cheerful response is that the New Keynesians were looking the other way. Theirs was a failure not of theory, but of “data collection.” They had “overlooked” crucial institutional changes in the financial system. While this was regrettable, it raised no “deep conceptual issue” that is, it didn’t demand that they reconsider their theory.

Faced with the crisis itself, the New Keynesians had risen to the challenge. They dusted off their old sticky-price models from the 1950s and 1960s, which told them three things. First, very large budget deficits would not drive up near zero interest rates. Second, even large increases in the monetary base would not lead to high inflation, or even to corresponding increases in broader monetary aggregates. And, third, there would be a positive national income multiplier, almost surely greater than one, from changes in government spending and taxation.

These propositions made the case for budget deficits in the aftermath of the collapse of 2008. Policies based on them were implemented and worked “remarkably well.” The success of New Keynesian policy had the ironic effect of allowing “the more inflexible members of our profession [the New Classicals from Chicago] to ignore events in a way they couldn’t in past episodes.” So neither school, sect might be the better word, was challenged to re-think first principles.

This clever history of pre- and post-crash economics leaves key questions unanswered.

First, if New Keynesian economics was “good enough,” why didn’t New Keynesian economists urge precautions against the collapse of 2007-2008? After all, they did not rule out the possibility of such a collapse a priori.

Krugman admits to a gap in “evidence collection.” But the choice of evidence is theory-driven. In my view, New Keynesian economists turned a blind eye to instabilities building up in the banking system, because their models told them that financial institutions could accurately price risk. So there was a “deep conceptual issue” involved in New Keynesian analysis: its failure to explain how banks might come to “underprice risk worldwide,” as Alan Greenspan put it.

Second, Krugman fails to explain why the Keynesian policies vindicated in 2008-2009 were so rapidly reversed and replaced by fiscal austerity. Why didn’t policymakers stick to their stodgy fixed-price models until they had done their work? Why abandon them in 2009, when Western economies were still 4-5% below their precrash levels?

The answer I would give is that when Keynes was briefly exhumed for six months in 2008-2009, it was for political, not intellectual, reasons. Because the New Keynesian models did not offer a sufficient basis for maintaining Keynesian policies once the economic emergency had been overcome, they were quickly abandoned.

Krugman comes close to acknowledging this: New Keynesians, he writes, “start with rational behavior and market equilibrium as a baseline, and try to get economic dysfunction by tweaking that baseline at the edges.” Such tweaks enable New Keynesian models to generate temporary real effects from nominal shocks, and thus justify quite radical intervention in times of emergency. But no tweaks can create a strong enough case to justify sustained interventionist policy.

The problem for New Keynesian macroeconomists is that they fail to acknowledge radical uncertainty in their models, leaving them without any theory of what to do in good times in order to avoid the bad times. Their focus on nominal wage and price rigidities implies that if these factors were absent, equilibrium would readily be achieved. They regard the financial sector as neutral, not as fundamental (capitalism’s “ephor,” as Joseph Schumpeter put it).

Without acknowledgement of uncertainty, saltwater economics is bound to collapse into its freshwater counterpart. New Keynesian “tweaking” will create limited political space for intervention, but not nearly enough to do a proper job. So Krugman’s argument, while provocative, is certainly not conclusive. Macroeconomics still needs to come up with a big new idea.

*

Robert Skidelsky, Professor Emeritus of Political Economy at Warwick University and a fellow of the British Academy in history and economics, is a member of the British House of Lords. The author of a three-volume biography of John Maynard Keynes.

Project Syndicate

Oxford Review of Economic Policy, 2018

Good enough for government work? Macroeconomics since the crisis

Paul Krugman

Abstract:

This paper argues that when the financial crisis came policy-makers relied on some version of the Hicksian sticky-price IS-LM as their default model; these models were ”good enough for government work’.

While there have been many incremental changes suggested to the DSGE model. there has been no single ‘big new idea” because the even simpler lS-LM type models were what worked well. In particular, the policy responses based on lS-LM were appropriate.

Specifically, these models generated the insights that large budget deficits would not drive up interest rates and, while the economy remained at the zero lower bound, that very large increases in monetary base wouldn’t be inflationary, and that the multiplier on government spending was greater than 1.

The one big exception to this satisfactory understanding was in price behaviour. A large output gap was expected to lead to a large fall in inflation, but did not. If new research is necessary. it is on pricing behaviour. While there was a failure to forecast the crisis, it did not come down to a lack of understanding of possible mechanisms, or of a lack of data, but rather through a lack of attention to the right data.

I. Introduction

It’s somewhat startling, at least for those of us who bloviate about economics for a living, to realize just how much time has passed since the 2008 financial crisis. Indeed, the crisis and aftermath are starting to take on the status of an iconic historical episode, like the stagflation of the 1970s or the Great Depression itself, rather than that of freshly remembered experience. Younger colleagues sometimes ask me what it was like during the golden age of economics blogging, mainly concerned with macroeconomic debates, which they think of as an era that ended years ago.

Yet there is an odd, interesting difference, both among economists and with a wider audience, between the intellectual legacies of those previous episodes and what seems to be the state of macroeconomics now.

Each of those previous episodes of crisis was followed both by a major rethinking of macroeconomics and, eventually, by a clear victor in some of the fundamental debates. Thus, the Great Depression brought on Keynesian economies, which became the subject of fierce dispute, and everyone knew how those disputes turned out: Keynes, or Keynes as interpreted by and filtered through Hicks and Samuelson, won the argument.

In somewhat the same way, stagflation brought on the Friedman Phelps natural rate hypothesis, yes, both men wrote their seminal papers before the 1970s, but the bad news brought their work to the top of the agenda. And everyone knew, up to a point anyway, how the debate over that hypothesis ended up: basically everyone accepted the natural rate idea, abandoning the notion of a long-run trade-off between inflation and unemployment. True, the profession then split into freshwater and saltwater camps over the effectiveness or lack thereof of short-run stabilization policies, a development that I think presaged some of what has happened since 2008. But I’ll get back to that.

For now, let me instead just focus on how different the economics profession response to the post-2008 crisis has been from the responses to depression and stagflation. For this time there hasn’t been a big new idea, let alone one that has taken the profession by storm. Yes, there are lots of proclamations about things researchers should or must do differently, many of them represented in this issue of the Oxford Review. We need to put finance into the heart of the models! We need to incorporate heterogeneous agents! We need to incorporate more behavioural economics! And so on.

But while many of these ideas are very interesting, none of them seems to have emerged as the idea we need to grapple with. The intellectual impact of the crisis just seems far more muted than the scale of crisis might have led one to expect. Why?

Well, I’m going to offer what I suspect will be a controversial answer: namely, macroeconomics hasn’t changed that much because it was. in two senses, what my father’s generation used to call ‘good enough for government work”. On one side, the basic models used by macroeconomists who either practise or comment frequently on policy have actually worked quite well, indeed remarkably well. On the other, the policy response to the crisis, while severely lacking in many ways, was sufficient to avert utter disaster, which in turn allowed the more inflexible members of our profession to ignore events in a way they couldn‘t in past episodes.

In what follows I start with the lessons of the financial crisis and Great Recession, which economists obviously failed to predict. I then move on to the aftermath, the era of fiscal austerity and unorthodox monetary policy, in which I’ll argue that basic macroeconomics, at least in one version, performed extremely well. I follow up with some puzzles that remain. Finally, I turn to the policy response and its implications for the economics profession.

II. The Queen’s question

When all hell broke loose in financial markets, Queen Elizabeth II famously asked why nobody saw it coming. This was a good question but maybe not as devastating as many still seem to think.

Obviously, very few economists predicted the crisis of 2008-9; those who did, with few exceptions I can think of, also predicted multiple other crises that didn’t happen. And this failure to see what was coming can’t be brushed aside as inconsequential.

There are, however, two different ways a forecasting failure of this magnitude can happen, which have very different intellectual implications. Consider an example from a different field, meteorology. In 1987 the Met Office dismissed warnings that a severe hurricane might strike Britain; shortly afterwards, the Great Storm of 1987 arrived, wreaking widespread destruction. Meteorologists could have drawn the lesson that their fundamental understanding of weather was fatally flawed which they would presumably have done if their models had insisted that no such storm was even possible. Instead, they concluded that while the models needed refinement, the problem mainly involved data collection that the network of weather stations, buoys, etc. had been inadequate, leaving them unaware of just how bad things were looking.

How does the global financial crisis compare in this respect? To be fair, the DSGE models that occupied a lot of shelf space in journals really had no room for anything like this crisis. But macroeconomists focused on international experience, one of the hats I personally wear, were very aware that crises triggered by loss of financial confidence do happen, and can be very severe. The Asian financial crisis of 1997-9, in particular, inspired not just a realization that severe l930s-type downturns remain possible in the modern world, but a substantial amount of modelling of how such things can happen.

So the coming of the crisis didn’t reveal a fundamental conceptual gap. Did it reveal serious gaps in data collection? My answer would be, sort of, in the following sense: crucial data weren’t so much lacking as overlooked.

This was most obvious on the financial side. The panic and disruption of financial markets that began in 2007 and peaked after the fall of Lehman came as a huge surprise, but one can hardly accuse economists of having been unaware of the possibility of bank runs. lf most of us considered such runs unlikely or impossible in modern advanced economies, the problem was not conceptual but empirical: failure to take on board the extent to which institutional changes had made conventional monetary data inadequate.

This is clearly true for the United States, where data on shadow banking on the repo market, asset-backed commercial paper, etc. were available but mostly ignored. In a less obvious way, European economists failed to pay sufficient intention to the growth of interbank lending as a source of finance. In both cases the institutional changes undermined the existing financial safety net, especially deposit insurance. But this wasn’t a deep conceptual issue: when the crisis struck, I’m sure I wasn’t the only economist whose reaction was not ‘How can this be happening?” but rather to yell at oneself, ‘Diamond Dybvig, you idiot!’

(The Diamond-Dybvig model is an influential model of bank runs and related financial crises. The model shows how banks’ mix of illiquid assets (such as business or mortgage loans) and liquid liabilities (deposits which may be withdrawn at any time) may give rise to selffulfilling panics among depositors.)

In a more subtle way, economists were also under-informed about the surge in housing prices that we now know represented a huge bubble, whose bursting was at the heart of the Great Recession. In this case, rising home prices were an unmistakable story. But most economists who looked at these prices focused on broad aggregates say, national average home prices in the United States. And these aggregates, while up substantially, were still in a range that could seemingly be rationalized by appealing to factors like low interest rates. The trouble, it turned out, was that these aggregates masked the reality, because they averaged home prices in locations with elastic housing supply (say, Houston or Atlanta) with those in which supply was inelastic (Florida or Spain); looking at the latter clearly showed increases that could not be easily rationalized.

Let me add a third form of data that were available but largely ignored: it’s fairly remarkable that more wasn’t made of the sharp rise in household debt, which should have suggested something unsustainable about the growth of the 2001-7 era. And in the aftermath of the crisis macroeconomists, myself included (Eggertsson and Krugman, 2012) began taking private-sector leverage seriously in a way they should arguably have been doing before.

So did economists ignore warning signs they should have heeded? Yes. One way to summarize their (our) failure is that they ignored evidence that the private sector was engaged in financial overreach on multiple fronts, with financial institutions too vulnerable, housing prices in a bubble, and household debt unsustainable. But did this failure of observation indicate the need for a fundamental revision of how we do macroeconomics? That’s much less clear.

First, was the failure of prediction a consequence of failures in the economic framework that can be fixed by adopting a radically different framework? It’s true that a significant wing of both macroeconomists and financial economists were in the thrall of the efficient markets hypothesis, believing that financial overreach simply cannot happen or at any rate that it can only be discovered after the fact, because markets know what they are doing better than any observer. But many macroeconomists, especially in policy institutions, knew better than to trust markets to always get it right especially those who had studied or been involved with the Asian crisis of the 1990s. Yet they (we) also missed some or all of the signs of overreach. Why?

My answer may seem unsatisfying, but I believe it to be true: for the most part what happened was a demonstration of the old line that predictions are hard, especially about the future. It’s a complicated world out there, and one’s ability to track potential threats is limited. Almost nobody saw the Asian crisis coming, either. For that matter, how many people worried about political disruption of oil supplies before 1973? And so on. At any given time there tends to be a set of conventional indicators everyone looks at, determined less by fundamental theory than by recent events, and big, surprise crises almost by definition happen due to factors not on that list. If you like, it’s as if meteorologists with limited resources concentrated those resources in places that had helped track previous storms, leading to the occasional surprise when a storm comes from an unusual direction.

A different question is whether, now that we know whence the 2008 crisis came, it points to a need for deep changes in macroeconomic thinking. As I’ve already noted, bank runs have been fairly well understood for a long time; we just failed to note the changing definition of banks. The bursting of the housing bubble, with its effects on residential investment and wealth, was conceptually just a negative shock to aggregate demand.

The role of household leverage and forced deleveraging is a bigger break from conventional macroeconomics, even as done by saltwater economists who never bought into efficient markets and were aware of the risk of financial crises. That said, despite the impressive empirical work of Mian and Sufi (2011) and my own intellectual investment in the subject, I don’t think we can consider incorporating debt and leverage a fundamental new idea, as opposed to a refinement at the margin.

It’s true that introducing a role for household debt in spending behaviour makes the short-run equilibrium of the economy dependent on a stock variable, the level of debt. But this implicit role of stock variables in short-run outcomes isn‘t new: after all, nobody has ever questioned the notion that investment flows depend in part on the existing capital stock, and I’m not aware that many macroeconomists consider this a difficult conceptual issue.

And I’m not even fully convinced that household debt played that large a role in the crisis. Did household spending fall that much more than one would have expected from the simple wealth effects of the housing bust?

My bottom line is that the failure of nearly all macroeconomists, even of the saltwater camp, to predict the 2008 crisis was similar in type to the Met Office failure in 1987, a failure of observation rather than a fundamental failure of concept. Neither the financial crisis nor the Great Recession that followed required a rethinking of basic ideas.

III. Not believing in (confidence) fairies

Once the Great Recession had happened, the advanced world found itself in a situation not seen since the 1930s, except in Japan, with policy interest rates close to zero everywhere. This raised the practical question of how governments and central banks should and would respond, of which more later.

For economists, it raised the question of what to expect as a result of those policy responses. And the predictions they made were, in a sense, out-of-sample tests of their theoretical framework: economists weren’t trying to reproduce the historical time-series behaviour of aggregates given historical policy regimes, they were trying to predict the effects of policies that hadn’t been applied in modern times in a situation that hadn’t occurred in modern times.

In making these predictions, the deep divide in macroeconomics came into play, making a mockery of those who imagined that time had narrowed the gap between saltwater and freshwater schools. But let me put the freshwater school on one side, again pending later discussion, and talk about the performance of the macroeconomists, many of them trained at MIT or Harvard in the 1970s, who had never abandoned their belief that activist policy can be effective in dealing with short-run fluctuations. I would include in this group Ben Bernanke, Olivier Blanchard, Christina Romer, Mario Draghi, and Larry Summers, among those close to actual policy, and a variety of academics and commentators, such as Simon Wren-Lewis, Martin Wolf, and, of course, yours truly, in supporting roles.

I think it’s fair to say that everyone in this group came into the crisis with some version of Hicksian sticky-price IS-LM as their default, back-of-the-envelope macroeconomic model. Many were at least somewhat willing to work with DSGE models, maybe even considering such models superior for many purposes. But when faced with what amounted to a regime change from normal conditions to an economy where policy interest rates couldn’t fall, they took as their starting point what the Hicksian approach predicted about policy in a liquidity trap. That is, they did not rush to develop new theories, they pretty much stuck with their existing models.

These existing models made at least three strong predictions that were very much at odds with what many inhuential figures in the political and business worlds (backed by a few economists) were saying.

First. Hicksian macroeconomics said that very large budget deficits, which one might normally have expected to drive interest rates sharply higher, would not have that effect near the zero lower bound.

Second, the same approach predicted that even very large increases in the monetary base would not lead to high inflation, or even to corresponding increases in broader monetary aggregates.

Third, this approach predicted a positive multiplier, almost surely greater than 1, on changes in government spending and taxation.

These were not common-sense propositions. Non-economists were quite sure that the huge budget deficits the US ran in 2009-10 would bring on an attack by the ‘bond vigilantes’. Many financial commentators and political figures warned that the Fed’s expansion of its balance sheet would ‘debase the dollar’ and cause high inflation. And many political and policy figures rejected the Keynesian proposition that spending more would expand the economy, spending less lead to contraction.

In fact, if you‘re looking for a post-2008 equivalent to the kinds of debate that raged in the 1930s and again in the 1970s, a conflict between old ideas based on pre-crisis thinking, and new ideas inspired by the crisis, your best candidate would be fiscal policy. The old guard clung to the traditional Keynesian notion of a government spending multiplier somewhat limited by automatic stabilizers, but still greater than 1. The new economic thinking that achieved actual real-world influence during the crisis and aftermath-as opposed, let’s be honest, to the kind of thinking found in this issue mostly involved rejecting the Keynesian multiplier in favour of the doctrine of expansionary austerity, the argument that cutting public spending would crowd in large amounts of private spending by increasing confidence (Alesina and Ardagna, 2010). (The claim that bad things happen when public debt crosses a critical threshold also played an important real-world role, but was less a doctrine than a claimed empirical observation.)

So here, at least, there was something like a classic crisis-inspired confrontation between tired old ideas and a radical new doctrine. Sad to say, however, as an empirical matter the old ideas were proved right, at least insofar as anything in economics can be settled by experience, while the new ideas crashed and burned. Interest rates stayed low despite huge deficits. Massive expansion in the monetary base did not lead to infiation. And the experience of austerity in the euro area, coupled with the natural experiments created by some of the interregional aspects of the Obama stimulus, ended up strongly supporting a conventional, Keynesian view of fiscal policy, Even the magnitude of the multiplier now looks to be around 1.5, which was the number conventional wisdom suggested in advance of the crisis.

So the crisis and aftermath did indeed produce a confrontation between innovative new ideas and traditional views largely rooted in the 1930s. But the movie failed to follow the Hollywood script: the stodgy old ideas led to broadly accurate predictions, were indeed validated to a remarkable degree, while the new ideas proved embarrassingly wrong. Macroeconomics didn’t change radically in response to crisis because old-fashioned models, confronted with a new situation, did just fine.

IV. The case of the missing deflation

I’ve just argued that the lack of a major rethinking of macroeconomics in the aftermath of crisis was reasonable, given that conventional, off-the-shelf macroeconomics performed very well. But this optimistic assessment needs to be qualified in one important respect: while the demand side of economy did just about what economists trained at MIT in the 1970s thought it would, the supply side didn’t.

As I said, the experience of stagflation effectively convinced the whole profession of the validity of the natural-rate hypothesis. Almost everyone agreed that there was no long-run inflation unemployment trade-off. The great saltwater freshwater divide was, instead, about whether there were usable short-run trade-offs.

But if the natural-rate hypothesis was correct, sustained high unemployment should have led not just to low inflation but to continually declining inflation, and eventually deflation. You can see a bit of this in some of the most severely depressed economies, notably Greece. But deflation fears generally failed to materialize.

Put slightly differently, even saltwater, activist-minded macroeconomists came into the crisis as ‘accelerationists’: they expected to see a downward-sloping relationship between unemployment and the rate of change of inflation. What we’ve seen instead is, at best, something like the 1960s version of the Phillips curve, a downward-sloping relationship between unemployment and the level of inflation and even that relationship appears weak.

Obviously this empirical failure has not gone unnoticed. Broadly, those attempting to explain price behaviour since 2008 have gone in two directions. One side, e.g. Blanchard (2016), invokes ‘anchored’ inflation expectations: the claim that after a long period of low, stable inflation, price-setters throughout the economy became insensitive to recent inflation history, and continued to build 2 per cent or so inflation into their decisions even after a number of years of falling below that target. The other side. e.g. Daly and Hobijn (2014), harking back to Tobin (1972) and Akerlof er a1. (1996), invokes downward nominal wage rigidity to argue that the natural rate hypothesis loses validity at low inflation rates.

In a deep sense, I’d argue that these two explanations have more in common than they may seem to at first sight. The anchored-expectations story may preserve the outward form of an accelerationist Phillips curve, but it assumes that the process of expectations formation changes, for reasons not fully explained, at low inflation rates. The nominal rigidity story assumes that there is a form of money illusion. opposition to outright nominal wage cuts, that is also not fully explained but becomes significant at low overall inflation rates.

Both stories also seem to suggest the need for aggressive expansionary policy when inflation is below target: otherwise there’s the risk that expectations may become unanchored on the downward side, or simply that the economy will suffer persistent, unnecessary slack because the downward rigidity of wages is binding for too many workers.

Finally. I would argue that it is important to admit that both stories are ex post explanations of macroeconomic behaviour that was not widely predicted in advance of the post-2008 era. Pre-2008, the general view even on the saltwater side was that stable inflation was a sufficient indicator of an economy operating at potential output, that any persistent negative output gap would lead to steadily declining inflation and eventually outright deflation. This view was, in fact, a key part of the intellectual case for inflation targeting as the basis of monetary policy. If inflation will remain stable at, say, 1 per cent even in a persistently depressed economy. it’s all too easy to see how policymakers might give themselves high marks even while in reality failing at their job.

But while this is a subjective impression, I haven’t done a statistical analysis of recent literature, it does seem that surprisingly few calls for a major reconstruction of macroeconomics focus on the area in which old-fashioned macroeconomics did, in fact, perform badly post-crisis.

There have, for example, been many calls for making the financial sector and financial frictions much more integral to our models than they are, which is a reasonable thing to argue. But their absence from DSGE models wasn’t the source of any major predictive failures. Has there been any comparable chorus of demands that we rethink the inflation process, and reconsider the natural rate hypothesis? Of course there have been some papers along those lines, but none that have really resonated with the profession.

Why not? As someone who came of academic age just as the saltwater freshwater divide was opening up, I think I can offer a still-relevant insight: understanding wage and price-setting is hard, basically just not amenable to the tools we as economists have in our kit. We start with rational behaviour and market equilibrium as a baseline, and try to get economic dysfunction by tweaking that baseline at the edges; this approach has generated big insights in many areas, but wages and prices isn’t one of them.

Consider the paths followed by the two schools of macroeconomics.

Freshwater theory began with the assumption that wage and price-setters were rational maximizers, but with imperfect information, and that this lack of information explained the apparent real effects of nominal shocks. But this approach became obviously untenable by the early 1980s, when inflation declined only gradually despite mass unemployment. Now what?

One possible route would have been to drop the assumption of fully rational behaviour, which was basically the New Keynesian response. For the most part, however, those who had bought into Lucas-type models chose to cling to the maximizing model, which was economics as they knew how to do it, despite attempts by the data to tell them it was wrong. Let me be blunt: real business cycle theory was always a faintly (or more than faintly) absurd enterprise, a desperate attempt to protect intellectual capital in the teeth of reality.

But the New Keynesian alternative, while far better, wasn’t especially satisfactory either. Clever modellers pointed out that in the face of imperfect competition the aggregate costs of departures from perfectly rational price-setting could be much larger than the individual costs. As a result, small menu costs or a bit of bounded rationality could be consistent with widespread price and wage stickiness.

To be blunt again. however, in practice this insight served as an excuse rather than a basis for deep understanding. Sticky prices could be made respectable just allowing modellers to assume something like one-period-ahead price-setting, in turn letting models that were otherwise grounded in rationality and equilibrium produce something not too inconsistent with real-world observation. New Keynesian modelling thus acted as a kind of escape clause rather than a foundational building block.

But is that escape clause good enough to explain the failure of deflation to emerge despite multiple years of very high unemployment? Probably not. And yet we still lack a compelling alternative explanation, indeed any kind of big idea. At some level, wage and price behaviour in a depressed economy seems to be a subject for which our intellectual tools are badly fitted.

The good news is that if one simply assumed that prices and wages are sticky, appealing to the experience of the 1930s and Japan in the 1990s (which never experienced a true deflationary spiral), one did reasonably well on other fronts.

So my claim that basic macroeconomics worked very well after the crisis needs to be qualified by what looks like a big failure in our understanding of price dynamics but this failure didn’t do too much damage in giving rise to bad advice, and hasn’t led to big new ideas because nobody seems to have good ideas to offer.

V. The system sort of worked

In 2009 Barry Eichengreen and Kevin O’Rourke made a splash with a data comparison between the global slump to date and the early stages of the Great Depression; they showed that at the time of writing the world economy was in fact tracking quite close to the implosion that motivated Keynes’s famous essay ‘The Great Slump of 1930’ (Eichengreen and O’Rourke, 2009)

Subsequent updates, however, told a different story. Instead of continuing to plunge as it did in 1930, by the summer of 2009 the world economy first stabilized, then began to recover. Meanwhile, financial markets also began to normalize; by late 2009 many measures of financial stress were more or less back to pre-crisis levels.

So the world financial system and the world economy failed to implode. Why?

We shouldn’t give policy-makers all of the credit here. Much of what went right, or at least failed to go wrong, refiected institutional changes since the 1930s. Shadow banking and wholesale funding markets were deeply stressed, but deposit insurance still protected at good part of the banking system from runs. There never was much discretionary fiscal stimulus, but the automatic stabilizers associated with large welfare states kicked in, well, automatically: spending was sustained by government transfers, while disposable income was buffered by falling tax receipts.

That said, policy responses were clearly much better than they were in the 1930s. Central bankers and fiscal authorities officials rushed to shore up the financial system through a combination of emergency lending and outright bailouts; international cooperation assured that there were no sudden failures brought on by shortages of key currencies. As a result, disruption of credit markets was limited in both scope and duration. Measures of financial stress were back to pre-Lehman levels by June 2009.

Meanwhile, although fiscal stimulus was modest, peaking at about 2 per cent of GDP in the United States, during 2008-9 governments at least refrained from drastic tightening of fiscal policy, allowing automatic stabilizers, which, as I said, were far stronger than they had been in the 1930s to work.

Overall, then, policy did a relatively adequate job of containing the crisis during its most acute phase. As Daniel Drezner argues (2012), ‘the system worked’-well enough, anyway, to avert collapse.

So far, so good. Unfortunately, once the risk of catastrophic collapse was averted, the story of policy becomes much less happy. After practising more or less Keynesian policies in the acute phase of the crisis, governments reverted to type: in much of the advanced world, fiscal policy became Hellenized, that is, every nation was warned that it could become Greece any day now unless it turned to fiscal austerity. Given the validation of Keynesian multiplier analysis, we can confidently assert that this turn to austerity contributed to the sluggishness of the recovery in the United States and the even more disappointing, stuttering pace of recovery in Europe.

Figure 1 sums up the story by comparing real GDP per capita during two episodes: Western Europe after 1929 and the EU as a whole since 2007. In the modern episode, Europe avoided the catastrophic declines of the early 1930s, but its recovery has been so slow and uneven that at this point it is tracking below its performance in the Great Depression.

Now, even as major economies turned to fiscal austerity, they turned to unconventional monetary expansion. How much did this help? The literature is confusing enough to let one believe pretty much whatever one wants to. Clearly Mario Draghi’s “whatever it takes’ intervention (Draghi, 2012) had a dramatic effect on markets, heading off what might have been another acute crisis, but we never did get a clear test of how well outright monetary transactions would have worked in practice, and the evidence on the effectiveness of Fed policies is even less clear.

The purpose of this paper is not, however, to evaluate the decisions of policy-makers, but rather to ask what lessons macroeconomists should and did take from events. And the main lesson from 2010 onwards was that policy-makers don’t listen to us very much, except at moments of extreme stress.

This is clearest in the case of the turn to austerity, which was not at all grounded in conventional macroeconomic models. True, policy-makers were able to find some economists telling them what they wanted to hear, but the basic Hicksian approach that did pretty well over the whole period clearly said that depressed economies near the zero lower bound should not be engaging in fiscal contraction. Never mind, they did it anyway.

Even on monetary policy, where economists ended up running central banks to a degree I believe was unprecedented, the influence of macroeconomic models was limited at best. A basic Hicksian approach suggests that monetary policy is more or less irrelevant in a liquidity trap. Refinements (Krugman, 1998; Eggertsson and Woodford, 2003) suggested that central banks might be able to gain traction by raising their inflation targets, but that never happened.

The point, then, is that policy failures after 2010 tell us relatively little about the state of macroeconomics or the ways it needs to change, other than that it would be nice if people with actual power paid more attention. Macroeconomists aren’t, however, the only researchers with that problem; ask climate scientists how it’s going in their world.

Meanwhile, however, what happened in 2008-9, or more precisely, what didn’t happen, namely utter disaster, did have an important impact on macroeconomics. For by taking enough good advice from economists to avoid catastrophe, policy-makers in turn took off what might have been severe pressure on economists to change their own views.

VI. That 80s show

Why hasn’t macroeconomics been transformed by (relatively) recent events in the way it was by events in the 1930s or the 1970s? Maybe the key point to remember is that such transformations are rare in economics, or indeed in any field. ‘Science advances one funeral at a time,’ quipped Max Planck: researchers rarely change their views much in the light of experience or evidence. The 1930s and the 1970s, in which senior economists changed their minds, eg. Lionel Robbins converting to Keynesianism, were therefore exceptional.

What made them exceptional? Each case was marked by developments that were both clearly inconsistent with widely held views and sustained enough that they couldn’t be written off as aberrations. Lionel Robbins published The Great Depression, a very classical/Austrian interpretation that prescribed a return to the gold standard, in 1934. Would he have become a Keynesian if the Depression had ended by the mid-1930s? The widespread acceptance of the natural-rate hypothesis came more easily, because it played into the neoclassical mindset, but still might not have happened as thoroughly if stagflation had been restricted to a few years in the early 1970s.

From an intellectual point of view, I’d argue, the Great Recession and aftermath bear much more resemblance to the 1979-82 Volcker double-dip recession and subsequent recovery in the United States than to either the 1930s or the 1970s. And here I can speak in part from personal recollection.

By the late 1970s the great division of macroeconomics into rival saltwater and freshwater schools had already happened, so the impact of the Volcker recession depended on which school you belonged to. But in both cases it changed remarkably few minds.

For saltwater macroeconomists, the recession and recovery came mainly as validation of their pre-existing beliefs. They believed that monetary policy has real effects, even if announced and anticipated; sure enough, monetary contraction was followed by a large real downturn. They believed that prices are sticky and inflation has a great deal of inertia, so that monetary tightening would produce a ‘clockwise spiral’ in unemployment and inflation: unemployment would eventually return to the NAIRU (non-accelerating inflation rate of unemployment) at a lower rate of inflation, but only after a transition period of high unemployment. And that’s exactly what we saw.

Freshwater economists had a harder time: Lucas-type models said that monetary contraction could cause a recession only if unanticipated, and as long as economic agents couldn’t distinguish between individual shocks and an aggregate fall in demand. None of this was a tenable description of 1979-82. But recovery came soon enough and fast enough that their worldview could, in effect, ride out the storm. (I was at one conference where a freshwater economist, questioned about current events, snapped ‘I’m not interested in the latest residual.’)

What I see in the response to 2008 and after is much the same dynamic. Half the macroeconomics profession feels mainly validated by events-correctly, I’d say, although as part of that faction I would say that, wouldn’t I? The other half should be reconsidering its views but they should have done that 30 years ago, and this crisis, like that one, was sufficiently well-handled by policy-makers that there was no irresistible pressure for change. (Just to be clear, I’m not saying that it was well-handled in an objective sense: in my view we suffered huge, unnecessary losses of output and employment because of the premature turn to austerity. But the world avoided descending into a full 1930s-style depression, which in effect left doctrinaire economists free to continue believing what they wanted to believe.)

If all this sounds highly cynical, well, I guess it is. There’s a lot of very good research being done in macroeconomics now, much of it taking advantage of the wealth of new data provided by bad events. Our understanding of both fiscal policy and price dynamics are, I believe, greatly improved. And funerals will continue to feed intellectual progress: younger macroeconomists seem to me to be much more flexible and willing to listen to the data than their counterparts were, say, 20 years ago.

But the quick transformation of macroeconomics many hoped for almost surely isn’t about to happen, because events haven’t forced that kind of transformation. Many economists myself included are actually feeling pretty good about our basic understanding of macro. Many others, absent real-world catastrophe, feel free to take the blue pill and keep believing what they want to believe.

What happened when the US last introduced tariffs? – Dominic Rushe.

Anyone?

Willis Hawley and Reed Smoot were reviled for a bill blamed for triggering the Great Depression. Will Trump follow their lead?

America inches towards a potential trade war over steel prices, can Donald Trump hear whispering voices?

Alone in the Oval Office in the wee dark hours, illuminated by the glow of his Twitter app, does he feel the sudden chill flowing from those freshly hung gold drapes? It is the shades of Smoot and Hawley.

Willis Hawley and Reed Smoot have haunted Congress since the 1930s when they were the architects of the Smoot Hawley tariff bill, among the most decried pieces of legislation in US history and a bill blamed by some for not only for triggering the Great Depression but also contributing to the start of the second world war.

Pilloried even in their own time, their bloodied names have been brought out like Jacob Marley’s ghost every time America has taken a protectionist turn on trade policy. And America has certainly taken a protectionist turn.

Successful presidents including Barack Obama and Bill Clinton have campaigned on the perils of free trade only to drop the rhetoric once installed in the White House. Trump called Mexicans “rapists” on the campaign trail. And China? “There are people who wish I wouldn’t refer to China as our enemy. But that’s exactly what they are,” Trump said.

As commander in chief he has shown no signs of softening and this week took major action announcing steel imports would face a 25% tariff and aluminium 10%.

Canada and the EU said they would bring forward their own countermeasures. Mexico, China and Brazil have also said they are considering retaliatory steps.

Trump doesn’t seem worried. “Trade wars are good,” he tweeted even as the usually friendly Wall Street Journal thundered that “Trump’s tariff folly ”is the “biggest policy blunder of his Presidency”.

It is not his first protectionist move. In his first days in office the president has vetoed the Trans Pacific Partnership (TPP), the biggest trade deal in a generation, said he will review the North American Free Trade Agreement (Nafta), a deal he has called “the worst in history”, and had his visit with Mexico’s president cancelled over his plans to make them pay for a border wall.

Free traders may have become complacent after hearing tough talk on trade from so many presidential candidates on the campaign trail only to watch them furiously back pedal when they get into ofhce, said Dartmouth professor and trade expert Douglas Irwin. “Unfortunately that pattern may have been broken,” he says. “It looks like we have to take Trump literally and seriously about his threats on trade.”

Not since Herbert Hoover has a US president been so down on free trade. And Hoover was the man who signed off on Smoot and Hawley’s bill.

Hawley, an Oregon congressman and a professor a history and economics, became a stock figure in the textbooks of his successors thanks to his partnership with the lean, patrician figure of Senator Reed Smoot, a Mormon apostle known as the “sugar senator” for his protectionist stance towards Utah’s sugar beet industry.

Before he was shackled to Hawley for eternity Smoot was more famous for his Mormonism and his abhorrence of bawdy books, a disgust that inspired the immortal headline “Smoot Smites Smut” after he attacked the importation of Lady’s Chatterley’s Lover, Robert Burns’ more risque poems and similar texts as “worse than opium I would rather have a child of mine use opium than read these books.”

But it was imports of another kind that secured Smoot and Hawley’s place in infamy.

The US economy was doing well in the 1920s as the consumer society was being born to the sound of jazz. The Tariff Act began life largely as a politically motivated response to appease the agricultural lobby that had fallen behind as American workers, and money, consolidated in the cities.

Foreign demand for US produce had soared during the first world war, and farm prices doubled between 1915 and 1918. A wave of land speculation followed and farmers took on debt as they looked to expand production. By the early 1920s farmers had found themselves heavily in debt and squeezed by tightening monetary policy and an unexpected collapse in commodity prices.

Nearly a quarter of the American labor force was then employed on the land, and Congress could not ignore heartland America. Cheap foreign imports and their toll on the domestic market became a hot issue in the 1928 election. Even bananas weren’t safe. Irwin quotes one critic in his book Peddling Protectionism: Smoot Hawley and the Great Depression: “The enormous imports of cheap bananas into the United States tend to curtail the domestic consumption of fresh fruits produced in the United States.”

Hoover won in a landslide against Albert E Smith, an out of touch New Yorker who didn’t appeal to middle America, and soon after promised to pass “limited” tariff reforms.

Hawley started the bill but with Smoot behind him it metastasized as lobby groups shoehorned their products into the bill, eventually proposing higher tariffs on more than 20,000 imported goods.

Siren voices warned of dire consequences. Henry Ford reportedly told Hoover the bill was “an economic stupidity”.

Critics of the tariffs were being aided and abetted by “internationalists” willing to “betray American interests”, said Smoot. Reports claiming the bill would harm the US economy were decried as fake news. Republican Frank Crowther, dismissed press criticism as “demagoguery and untruth, scandalous untruth”.

In October 1929 as the Senate debated the tariff bill the stock market crashed. When the bill finally made it to Hoover’s desk in June 1930 it had morphed from his original “limited” plan to the “highest rates ever known”, according to a New York Times editorial.

The extent to which Smoot and Hawley were to blame for the coming Great Depression is still a matter of debate. “Ask a thousand economists and you will get a thousand and five answers,” said Charles Geisst, professor of economics at Manhattan College and author of Wall Street: A History.

What is apparent is that the bill sparked international outrage and a backlash. Canada and Europe reacted with a wave of protectionist tariffs that deepened a global depression that presaged the rise of Hitler and the second world war. A myriad other factors contributed to the Depression, and to the second world war, but inarguably one consequence of Smoot Hawley in the US was that never again would a sitting US president be so avowedly anti trade. Until today.

Franklin D Roosevelt swept into power in 1933 and for the first time the president was granted the authority to undertake trade negotiations to reduce foreign barriers on US exports in exchange for lower US tariffs.

The backlash against Smoot and Hawley continued to the present day. The average tariff on dutiable imports was 45% in 1930; by 2010 it was 5%.

The lessons of Smoot Hawley used to be taught in high schools. Presidents from Lyndon Johnson to Ronald Reagan have enlisted the unhappy duo when facing off with free trade critics. “I have been around long enough to remember that when we did that once before in this century, something called Smoot Hawley, we lived through a nightmare,” Reagan, who came of age during the Great Depression, said in 1984.

They even got a mention in Ferris Bueller’s Day Off when actor Ben Stein’s teacher bores his class with it. “I don’t think the current generation are taught it. It’s in the past and we are more interested in the future.”

But that might be about to change. “The main lesson is that you have to worry about what other countries do. Countries will retaliate,” said Irwin. “When Congress was considering Smoot Hawley in the 1930s they didn’t consider what other countries might do in reaction. They thought other countries would remain passive. But other countries don’t remain passive.”

The consequences of a trade war today are far worse than in the 1930s. Exports of goods and services account for about 13% of US gross domestic product (GDP) the broadest measure of an economy. It was roughly 5% back in 1920.

“The US is much more engaged in trade, it’s much more a part of the fabric of the country, than it was in the 1920s and 1930s. That means the ripple effects are widespread. Many more industries will be hit by it and the scope for foreign retaliation, which in the case of Smoot Hawley was quite limited, is going to be much more widespread if a trade war was to start.”

“When you start talking about withdrawing from trade agreements or imposing tariffs of 35%, if you are doing that as a protectionist measure, that would be blowing up the system.”

That the promise of “blowing up the system” got Trump elected may be why the ghosts of Smoot and Hawley are once again walking the halls of Congress.

The Guardian

Adults in the room. My battle with Europe’s Deep Establishment – Yanis Varoufakis.

What happens when you take on the establishment? In this blistering, personal account, world-famous economist Yanis Varoufakis blows the lid on Europe’s hidden agenda and exposes what actually goes on in its corridors of power.


Varoufakis sparked one of the most spectacular and controversial battles in recent political history when, as finance minister of Greece, he attempted to re-negotiate his country’s relationship with the EU. Despite the mass support of the Greek people and the simple logic of his arguments, he succeeded only in provoking the fury of Europe’s political, financial and media elite. But the true story of what happened is almost entirely unknown not least because so much of the EU’s real business takes place behind closed doors.

In this fearless account, Varoufakis reveals all: an extraordinary tale of brinkmanship, hypocrisy, collusion and betrayal that will shake the deep establishment to its foundations.

As is now clear, the same policies that required the tragic and brutal suppression of Greece’s democratic uprising have led directly to authoritarianism, populist revolt and instability throughout the Western world.

Adults In The Room is an urgent wake-up call to renew European democracy before it is too late.

Yanis Varoufakis is the former finance minister of Greece and now the figurehead of an international grassroots movement, DiEM25, campaigning for the revival of democracy in Europe. He speaks to audiences of thousands worldwide and is the author of the international bestseller And the Weak Suffer What They Must? Born in Athens in 1961, he was for many years a professor of economics in Britain, Australia and the USA before he entered government. He is currently Professor of Economics at the University of Athens.

*

A Note on Quoted Speech

In a book of this nature, in which so much depends on who said what to whom, I have made every effort to ensure the accuracy of quoted speech. To this end, l have been able to draw on audio recordings that I made on my phone, as well as on notes I made at the time, of many of the official meetings and conversations that appear in this book. Where my own recordings or notes are unavailable, I have relied on memory and, where possible, the corroboration of other witnesses.

The reader should note that many of the discussions reported in this book took place in Greek. This includes all conversations that occurred with my staff at the finance ministry, in parliament, on the streets of Athens, with the prime minister, in cabinet, and between my partner Danae and me. Necessarily, l have translated those conversations into English.

The only discussions I report that took place in neither Greek nor English were those I had with Michel Sapin, the French finance minister. Indeed, Mr Sapin was the only member of the Eurogroup not to address the meetings in English. Either we communicated through translators or, quite often, he would address me in French and I would reply in English, our grasp of the other’s language being good enough to carry on those conversations.

In every instance I have confined my account strictly to exchanges that are in the public interest and have therefore included only those that shed important light on events that affected the lives of millions.

Preface

My previous book, And the Weak Suffer What They Must?: Europe, Austerity and the Threat to Global Stability, offered an historical explanation of why Europe is now in the process, decades in the making, of losing its integrity and forfeiting its soul. Just as l was finishing it in January 2015 I became finance minister of Greece and found myself thrust into the belly of the beast I had been writing about. By accepting the position of finance minister of a chronically indebted European country in the midst of a tumultuous clash with its creditors, Europe’s most powerful governments and institutions, I witnessed first hand the particular circumstances and immediate causes of our continent’s descent into a morass from which it may not escape for a long, long while.

This new book tells that story. It could be described as the story of an academic who became a government minister for a while before turning whistle-blower. Or as a kissand-tell memoir featuring powerful personages such as Angela Merkel, Mario Draghi, Wolfgang Schauble, Christine Lagarde, Emmanuel Macron, George Osborne and Barack Obama. Or as the tale of a small bankrupt country taking on the Goliaths of Europe in order to escape from debtors’ prison before suffering a crushing if fairly honourable defeat. But none of these descriptions convey my real motivation for writing this book.

Shortly after the ruthless suppression of Greece’s rebellion in 2015, also known as the Greek Spring or the Athens Spring, the leftwing party Podemos lost its momentum in Spain; no doubt many potential voters feared a fate similar to ours at the hands of a ferocious EU. Having observed the EU’s callous disregard for democracy in Greece, many supporters of the Labour Party in Britain then went on to vote for Brexit. Brexit boosted Donald Trump. Donald Trump’s triumph blew fresh wind into the sails of xenophobic nationalists throughout Europe and the world.

Vladimir Putin must be rubbing his eyes in disbelief at the way the West has been undermining itself so fabulously.

The story in this book is not only symbolic of what Europe, Britain and the United States are becoming; it also provides real insights into how and why our polities and social economies have fractured. As the so-called liberal establishment protests at the fake news of the insurgent alt-right, it is salutary to be reminded that in 2015 this same establishment launched a ferociously effective campaign of truth-reversal and character assassination against the pro-European, democratically elected government of a small country in Europe.

But as useful as I hope insights such as this may be, my motivation for writing this book goes deeper. Beneath the specific events that I experienced, I recognised a universal story, the story of what happens when human beings find themselves at the mercy of cruel circumstances that have been generated by an inhuman, mostly unseen network of power relations.

This is why there are no ‘goodies’ or ‘baddies’ in this book. Instead, it is populated by people doing their best, as they understand it, under conditions not of their choosing. Each of the persons I encountered and write about in these pages believed they were acting appropriately, but, taken together, their acts produced misfortune on a continental scale. Is this not the stuff of authentic tragedy? Is this not what makes the tragedies of Sophocles and Shakespeare resonate with us today, hundreds of years after the events they relate became old news?

At one point Christine Lagarde, managing director of the International Monetary Fund, remarked in a state of exasperation that to resolve the drama we needed ‘adults in the room’. She was right. There was a dearth of adults in many of the rooms where this drama unfolded.

As characters, though, they fell into two categories: the banal and the fascinating. The banal went about their business ticking boxes on sheets of instructions handed down to them by their masters. In many cases though, their masters, politicians such as Wolfgang Schauble and functionaries like Christine Lagarde and Mario Draghi were different. They had the ability to reflect on themselves and their role in the drama, and this ability to enter into dialogues with themselves made them fascinatingly susceptible to the trap of self-fulfilling prophecy.

Indeed, watching Greece’s creditors at work was like watching a version of Macbeth unfold in the land of Oedipus. Just as the father of Oedipus, King Laius of Thebes, unwittingly brought about his own murder because he believed the prophecy that he would be killed by his son, so too did the smartest and most powerful players in this drama bring about their own doom because they feared the prophecy that foretold it. Keenly aware of how easily power could slip through their fingers, Greece’s creditors were frequently overpowered by insecurity. Fearing that Greece’s undeclared bankruptcy might cause them to lose political control over Europe, they imposed policies on that country that gradually undermined their political control, not just over Greece but over Europe.

At some point, like Macbeth, sensing their power mutate into insufferable powerlessness, they felt compelled to do their worst. There were moments I could almost hear them say

I am in blood

Stepped in so far that, should I wade no more, Returning were as tedious as go o’er. Strange things I have in head, that will to hand; Which must be acted ere they may be scann’d.

Macbeth, iii. iv.

An account by any one of the protagonists in a cut-throat drama such as this cannot escape bias nor the desire for vindication. So, in order to be as fair and impartial as possible, I have tried to see their actions and my own through the lens of an authentic ancient Greek or Shakespearean tragedy in which characters, neither good nor bad, are overtaken by the unintended consequences of their conception of what they ought to do. I suspect that l have come closer to succeeding in this task in the case of those people whom I found fascinating and rather less so in the case of those whose banality numbed my senses. For this I find it hard to apologize, not least because to present them otherwise would be to diminish the historical accuracy of this account.

PART ONE

Winters of our discontent

Introduction

The only colour piercing the dimness of the hotel bar was the amber liquid flickering in the glass before him. As I approached, he raised his eyes to greet me with a nod before staring back down into his tumbler of whiskey. I sank onto the plush sofa, exhausted.

On cue, his familiar voice sounded imposingly morose. ‘Yanis,’ he said, ‘you made a big mistake.’

In the deep of a spring night a gentleness descends on Washington, DC that is unimaginable during the day. As the politicos, the lobbyists and the hangers-on melt away, the air empties of tension and the bars are abandoned to the few with no reason to be up at dawn and to the even fewer whose burdens trump sleep. That night, as on the previous eighty-one nights, or indeed the eighty-one nights that were to follow, I was one of the latter.

It had taken me fifteen minutes to walk, shrouded in darkness, from 700 19th Street NW, the International Monetary Fund’s building, to the hotel bar where l was to meet him. I had never imagined that a short solitary stroll in nondescript DC could be so restorative. The prospect of meeting the great man added to my sense of relief: after fifteen hours across the table from powerful people too banal or too frightened to speak their minds, l was about to meet a figure of great influence in Washington and beyond, a man no one can accuse of either banality or timidity.

All that changed with his acerbic opening statement, made more chilling by the dim light and shifting shadows.

Faking steeliness, I replied, ‘And what mistake was that, Larry?’

‘You won the election!’ came his answer.

It was 16 April 2015, the very middle of my brief tenure as finance minister of Greece. Less than six months earlier I had been living the life of an academic, teaching at the Lyndon B. Johnson School of Public Affairs at the University of Texas at Austin while on leave from the University of Athens. But in January my life had changed utterly when l was elected a member of the Greek parliament. I had made only one campaign promise: that I would do everything I could to rescue my country from the debt bondage and crushing austerity being imposed on it by its European neighbours and the IMF. It was that promise that had brought me to this city and with the assistance of my close team member Elena Paraniti, who had brokered the meeting and accompanied me that night to this bar.

Smiling at his dry humour and to hide my trepidation, my immediate thought was, Is this how he intends to stiffen my resolve against an empire of foes? I took solace from the recollection that the seventy-first secretary of the United States Treasury and twenty-seventh president of Harvard is not known for his soothing style.

Determined to delay the serious business ahead of us a few moments more, I signalled to the bartender for a whiskey of my own and said, ‘Before you tell me about my “mistake”, let me say, Larry, how important your messages of support and advice have been in the past weeks. I am truly grateful. Especially as for years I have been referring to you as the Prince of Darkness.’

Unperturbed, Larry Summers replied, ‘At least you called me a prince. l have been called worse.’

For the next couple of hours the conversation turned serious. We talked about technical issues: debt swaps, fiscal policy, market reforms, ‘bad’ banks. On the political front he warned me that I was losing the propaganda war and that the ‘Europeans’, as he called Europe’s powers that be, were out to get me. He suggested, and I agreed, that any new deal for my long-suffering country should be one that Germany’s chancellor could present to her voters as her idea, her personal legacy.

Things were proceeding better than I had hoped, with broad agreement on everything that mattered. It was no mean feat to secure the support of the formidable Larry Summers in the struggle against the powerful institutions, governments and media conglomerates demanding my government’s surrender and my head on a silver platter. Finally, after agreeing our next steps, and before the combined effects of fatigue and alcohol forced us to call it a night, Summers looked at me intensely and asked a question so well rehearsed that I suspected he had used it to test others before me.

‘There are two kinds of politicians,’ he said: ‘insiders and outsiders. The outsiders prioritize their freedom to speak their version of the truth. The price of their freedom is that they are ignored by the insiders, who make the important decisions. The insiders, for their part, follow a sacrosanct rule: never turn against other insiders and never talk to outsiders about what insiders say or do. Their reward? Access to inside information and a chance, though no guarantee, of influencing powerful people and outcomes.’ With that Summers arrived at his question. ‘So, Yanis,’ he said, ‘which of the two are you?’

Instinct urged me to respond with a single word; instead I used quite a few.

‘By character I am a natural outsider,’ I began, ‘but,’ I hastened to add, ‘I am prepared to strangle my character if it would help strike a new deal for Greece that gets our people out of debt prison. Have no doubt about this, Larry: I shall behave like a natural insider for as long as it takes to get a viable agreement on the table for Greece, indeed for Europe. But if the insiders I am dealing with prove unwilling to release Greece from its eternal debt bondage, I will not hesitate to turn whistleblower on them to return to the outside, which is my natural habitat anyway.’

‘Fair enough,’ he said after a thoughtful pause.

We stood up to leave. The heavens had opened while we were talking. As I saw him to a taxi, the downpour soaked my spring clothes in seconds. With his taxi speeding away, I had the opportunity to realize a wild dream of mine, one that had kept me going during the interminable meetings of the previous days and weeks: to walk alone, unnoticed, in the rain.

Powering through the watery curtain in pristine solitude, I took stock of the encounter. Summers was an ally, albeit a reluctant one. He had no time for my government’s left-wing politics, but he understood that our defeat was not in America’s interest. He knew that the eurozone’s economic policies were not just atrocious for Greece but terrible for Europe and, by extension, for the United States too. And he knew that Greece was merely the laboratory where these failed policies were being tested and developed before their implementation everywhere across Europe.

This is why Summers offered a helping hand. We spoke the same economic language, despite different political ideologies, and had no difficulty reaching a quick agreement on what our aims and tactics ought to be. Nevertheless, my answer had clearly bothered him, even if he did not show it. He would have got into his taxi a much happier man, I felt, had I demonstrated some interest in becoming an insider. As this book’s publication confirms, that was never likely to happen.

Back at my hotel, getting dry and with two hours to go before the alarm clock would summon me back to the front line, I pondered a great anxiety: how would my comrades back home, the inner circle of our government, answer Summers’s question in their hearts? On that night l was determined to believe that they would answer it as I had done.

Less than two weeks later I began to have my first real doubts.

Super black boxes

Yiorgos Chatzis went missing on 29 August 2012. He was last sighted at the social security office in the small northern Greek town of Siatista, where he was told that his monthly disability allowance of €280 had been suspended. Eyewitnesses reported that he did not utter a word of complaint. ‘He seemed stunned and remained speechless,’ a newspaper said. Soon after, he used his mobile phone for the last time to call his wife. No one was at home, so he left a message: ‘I feel useless. I have nothing to offer you any more. Look after the children.’ A few days later his body was found in a remote wooded area, suspended by the neck over a cliff, his mobile phone lying on the ground nearby.

The wave of suicides triggered by the great Greek depression had caught the attention of the international press a few months earlier after Dimitris Christoulas, a seventy-seven-year-old retired pharmacist, shot himself dead by a tree in the middle of Athens’s Syntagma Square, leaving behind a heart-wrenching political manifesto against austerity. Once upon a time the silent, dignified grief of Christoulas’s and Chatzis’s loved ones would have shamed into silence even the most hardened bailiff, except that in Bailoutistan, my satirical term for post-2010 Greece, our bailiffs keep their distance from their victims, barricading themselves in five-star hotels, whizzing around in motorcades and steadying their occasionally flagging nerves with baseless statistical projections of economic recovery.

During that same year, 2012, three long years before Larry Summers was to lecture me on insiders and outsiders, my partner Danae Stratou presented an art installation at a downtown Athens gallery. She called it, It is time to open the black boxes! The work comprised one hundred black metal boxes laid out geometrically on the floor. Each contained a word selected by Danae from the thousands that Athenians had contributed through social media in response to her question, ‘In a single word, what are you most afraid of, or what is the one thing you want to preserve?’

Danae’s idea was that unlike, say, the black box of a downed aircraft, these boxes would be opened before it was too late. The word that Athenians had chosen more than any other was not jobs, pensions or savings. What they feared losing most was dignity. The island of Crete, whose inhabitants are renowned for their pride, experienced the highest number of suicides once the crisis hit. When a depression deepens and the grapes of wrath grow ‘heavy for the vintage’, it is the loss of dignity that brings on the greatest despair.

In the catalogue entry I wrote for the exhibition I drew a comparison with another kind of black box. In engineering terms, I wrote, a black box is a device or system whose inner workings are opaque to us but whose capacity to turn inputs into outputs we understand and use fluently. A mobile phone, for instance, reliably converts finger movements into a telephone call or the arrival of a taxi, but to most of us, though not to electrical engineers, what goes on within a smartphone is a mystery. As philosophers have noted, other people’s minds are the quintessential black boxes: ultimately we can have no idea of precisely what goes on inside another’s head. (During the 162 days that this book chronicles I often caught myself wishing that the people around me, my comrades-in-arms in particular, were less like black boxes in this regard.)

But then there are what I called ‘super black boxes’, whose size and import is so great that even those who created and control them cannot fully understand their inner workings: for example, financial derivatives whose effects are not truly understood even by the financial engineers who designed them, global banks and multinational corporations whose activities are seldom grasped by their CEOs, and of course governments and supranational institutions like the International Monetary Fund, led by politicians and influential bureaucrats who may be in office but are rarely in power. They too convert inputs money, debt, taxes, votes into outputs profit, more complicated forms of debt, reductions in welfare payments, health and education policies. The difference between these super black boxes and the humble smartphone or even other humans is that while most of us have barely any control over their inputs, their outputs shape all our lives.

This difference is encapsulated in a single word: power. Not the type of power associated with electricity or the crushing force of the ocean’s waves, but another, subtler, more sinister power: the power held by the ‘insiders’ that Larry Summers referred to but which he feared I would not have the disposition to embrace, the power of hidden information.

During and after my ministry days people constantly asked me, ‘What did the IMF want from Greece? Did those who resisted debt relief do so because of some illicit hidden agenda? Were they working on behalf of corporations interested in plundering Greece’s infrastructure its airports, seaside resorts, telephone companies and so on?’ If only matters were that straightforward.

When a large-scale crisis hits, it is tempting to attribute it to a conspiracy between the powerful. Images spring to mind of smoke-filled rooms with cunning men (and the occasional woman) plotting how to profit at the expense of the common good and the weak. These images are, however, delusions. If our sharply diminished circumstances can be blamed on a conspiracy, then it is one whose members do not even know that they are part of it. That which feels to many like a conspiracy of the powerful is simply the emergent property of any network of super black boxes.

The keys to such power networks are exclusion and opacity. Recall the ‘Greed is great’ ethos of Wall Street and the City of London in the years before the 2008 implosion. Many decent bank employees were worried sick by what they were observing and doing. But when they got their hands on evidence or information foreshadowing terrible developments, they faced Summers’s dilemma: leak it to outsiders and become irrelevant; keep it to themselves and become complicit; or embrace their power by exchanging it for other information held by someone else in the know, resulting in an impromptu two-person alliance that turbocharges both individuals’ power within the broader network of insiders. As further sensitive information is exchanged, this two-person alliance forges links with other such alliances. The result is a network of power within other pre-existing networks, involving participants who conspire de facto without being conscious conspirators.

Whenever a politician in the know gives a journalist an exclusive in exchange for a particular spin that is in the politician’s interest, the journalist is appended, however unconsciously, to a network of insiders. Whenever a journalist refuses to slant their story in the politician’s favour, they risk losing a valuable source and being excluded from that network. This is how networks of power control the flow of information: through co-opting outsiders and excluding those who refuse to play ball. They evolve organically and are guided by a supraintentional drive that no individual can control, not even the president of the United States, the CEO of Barclays or those manning the pivotal nodes in the IMF or national governments.

Once caught in this web of power it takes an heroic disposition to turn whistle-blower, especially when one cannot hear oneself think amid the cacophony of so much money-making. And those few who do break ranks end up like shooting stars, quickly forgotten by a distracted world.

Fascinatingly, many insiders, especially those only loosely attached to the network, are oblivious to the web that they reinforce, courtesy of having relatively few contacts with it. Similarly, those embedded in the very heart of the network are usually too far inside to notice that there is an outside at all. Rare are those astute enough to notice the black box when they live and work inside one. Larry Summers is one such rare insider. His question to me was in fact an invocation to reject the lure of the outside. Underpinning his belief system was the conviction that the world can only be made better from within the black box.

But this was where, I thought, he was very wrong.

Theseus before the labyrinth

Before 2008, while the super black boxes functioned stably, we lived in a world that seemed balanced and self-healing. Those were the times when the British chancellor Gordon Brown was celebrating the end of ‘boom and bust’ and the soon-to-be-chairman of the Federal Reserve Ben Bernanke was heralding the Great Moderation. Of course it was all an illusion generated by the super black boxes whose function no one understood, especially not the insiders running them. And then, in 2008, they broke down spectacularly, generating our generation’s 1929, not to mention little Greece’s fall.

It is my view that the 2008 financial crisis, which is still with us almost a decade later, is due to the terminal breakdown of the world’s super black boxes of the networks of power, the conspiracies without conspirators, that fashion our lives. Summers’s blind faith that the remedies to this crisis will spring from those same broken down networks, through the normal operations of insiders, struck me even at the time as touchingly naive. Perhaps that is not surprising. After all, three years earlier I had written in Danae’s catalogue that ‘opening these super black boxes has now become a prerequisite to the survival of decency, of whole strata of our fellow humans, of our planet even. Put simply, we have run out of excuses. It is, therefore, time to open the black boxes!’ But in real terms, what would this entail?

First, we need to acquire a readiness to recognize that we may very well, each one of us, already be a node in the network; an ignorant de facto conspirator. Secondly, and this is the genius of Wikileaks, if we can get inside the network, like Theseus entering the labyrinth, and disrupt the information flow; if we can put the fear of uncontrollable information leaking in the mind of as many of its members as possible, then the unaccountable, malfunctioning networks of power will collapse under their own weight and irrelevance. Thirdly, by resisting any tendency to substitute old closed networks with new ones.

By the time I entered that Washington bar three years later I had tempered my stance. My priority was not to leak information to outsiders but to do whatever it took to get Greece out of debtors’ prison. If that meant pretending to be an insider, so be it. But the instant the price of admission to the insiders’ circle became acceptance of Greece’s permanent incarceration, I would leave. Laying down an Ariadne’s thread inside the insiders’ labyrinth and being ready to follow it to the exit is, I believe, a prerequisite for the dignity on which the Greek people’s happiness relies.

The day after my meeting with Larry Summers I met Jack Lew, the incumbent US Treasury secretary. After our meeting at the Treasury, an official seeing me out startled me with a friendly aside: ‘Minister, I feel the urge to warn you that within a week you will face a character assassination campaign emanating from Brussels.’ Larry’s pep talk about the importance of staying inside the proverbial tent, along with his warning that we were losing the media war, suddenly came into sharp focus.

Of course, it was no great surprise. Insiders, I had written in 2012, would react aggressively to anyone who dared open up their super black box to the outsiders’ gaze: ‘None of this will be easy. The networks will respond violently, as they are already doing. They will turn more authoritarian, more closed, more fragmented. They will become increasingly preoccupied with their own “security” and monopoly of information, less trusting of common people.

The following chapters relate the networks’ violent reaction to my stubborn refusal to trade Greece’s emancipation for a privileged spot inside one of their black boxes.

Sign here!

It all boiled down to one small doodle on a piece of paper whether I was prepared to sign on the dotted line of a fresh bailout loan agreement that would push Greece further into its labyrinthine jail of debt.

The reason why my signature mattered so much was that, curiously, it is not presidents or prime ministers of fallen countries that sign bailout loan agreements with the IMF or with the European Union. That poisoned privilege falls to the hapless finance minister. It is why it was crucial to Greece’s creditors that I be bent to their will, that I should be co-opted or, failing that, crushed and replaced by a more pliant successor. Had I signed, another outsider would have turned insider and praise would have been heaped upon me. The torrent of foul adjectives directed at me by the international press, arriving right on cue only a little more than a week after that Washington visit, just as the US official had warned me it would, would never have descended onto my head. I would have been ‘responsible’, a ‘trustworthy partner’, a ‘reformed maverick’ who had put his nation’s interests above his ‘narcissism’.

Judging by his expression as we walked out of the hotel and into the pouring rain, Larry Summers seemed to understand. He understood that the ‘Europeans’ were not interested in an honourable deal with me or with the Greek government. He understood that, in the end, I would be pressurised inordinately to sign a surrender document as the price of becoming a bona fide insider. He understood that l was not willing to do this. And he believed that this would be a pity, for me at least.

For my part I understood that he wanted to help me secure a viable deal. I understood too that he would do what he could to help us, provided it did not violate his golden rule: insiders never turn against other insiders and never talk to outsiders about what insiders do or say. What I was not sure about was whether he would ever understand why there was no chance in heaven or hell for that matter that I would sign a non-viable new bailout loan agreement. It would have taken too long to explain my reasons, but even if there had been time I feared that our backgrounds were too different for my explanation to make any sense to him.

My explanation, had I offered it, would have come in the form of a story or two.

The first would have probably begun inside an Athenian police station in the autumn of 1946, when Greece was on the brink of a communist insurgency and the second phase of its catastrophic civil war. A twenty-year-old chemistry student at Athens University named Yiorgos had been arrested by the secret police, roughed up and left in a cold cell for a few hours until a higher-ranking officer took him to his office ostensibly to apologize. I am sorry for the rough treatment, he said. You are a good boy and did not deserve this. But you know these are treacherous times and my men are on edge.

Forgive them. Just sign this and off you go. With my apologies.

The police officer seemed sincere and Yiorgos was relieved that his earlier ordeal at the hands of the thugs was at an end. But then, as he read the typewritten statement the officer was asking him to sign, a cold chill ran down his spine. The page read, I hereby denounce, truly and in all sincerity, communism, those who promote it, and their various fellow travellers.

Trembling with fear, he put the pen down, summoned all the gentleness that his mother Anna had instilled in him over the years, and said, Sir, I am no Buddhist but I would never sign a state document denouncing Buddhism. I am not a Muslim but I do not think the state has the right to ask me to denounce Islam. Similarly, I am not a communist but I see no reason why I should be asked to denounce communism.

Yiorgos’s civil liberty argument stood no chance. Sign or look forward to systematic torture and indefinite detention the choice is yours! shouted the enraged officer. The officer’s ire was based on perfectly reasonable expectations. Yiorgos had all the makings of a good boy, a natural insider. He had been born in Cairo to a middle-class family within the large Greek community, itself embedded in a cosmopolitan European enclave of French, Italian and British expats, and raised alongside sophisticated Armenians, Jews and Arabs. French was spoken at home, courtesy of his mother, Greek at school, English at work, Arabic on the street and Italian at the opera.

At the age of twenty, determined to connect with his roots, Yiorgos had given up a cushy job in a Cairo bank and moved to Greece to study chemistry. He had arrived in Athens in January 1945 on the ship Corinthia only a month after the conclusion of the first phase of Greece’s civil war, the first episode of the Cold War. A fragile détente was in the air, and so it had seemed reasonable to Yiorgos when student activists of both the Left and the Right had approached him as a compromise candidate for president of his school’s students’ association.

Shortly after his election, however, the university authorities had increased tuition fees at a time when students wallowed in absolute poverty. Yiorgos had paid the dean a visit, arguing as best as he could against the fee hike. As he left, secret policemen had manhandled him down the school’s marble steps and into a waiting van. and he had ended up with a choice that makes Summers’s dilemma seem like a walk in the park.

Given the young man’s bourgeois background, the police had every expectation that Yiorgos would either sign gladly or break quickly once torture began. However, with every beating Yiorgos felt less able to sign, end the pain and go home. As a result, he ended up in a variety of cells and prison camps that he could have escaped at any point simply by putting his signature on a single sheet of paper. Four years later, a shadow of his former self, Yiorgos emerged from prison into a grim society that neither knew of his peculiar choice nor really cared.

Meanwhile, during the period of Yiorgos’s incarceration, a young woman four years his junior had become the first female student to gain admittance to the University of Athens Chemistry School, despite their best efforts to keep her out. Eleni, for that was her name, began university as a rebellious proto-feminist but nevertheless felt a powerful dislike for the Left: during the years of the Nazi occupation she had been abducted as a very young girl by left-wing partisans who mistook her for a relative of a Nazi collaborator. Upon enrolling at the University of Athens, a fascist organization called X recruited her on the strength of her anticommunist feelings. Her first and, as it would turn out, her last mission for them was to follow a fellow chemistry student who had just been released from the prison camps.

This, in a nutshell, is the story of how I came about. For Yiorgos is my father, and Eleni, who ended up a leading member of the 1970s feminist movement, was my mother. Blessed with this history, signing on the dotted line in return for the mercy shown to insiders was never on the cards for me. Would Larry Summers have understood? I don’t think so.

Not for me

The other story is as follows. I met Lambros in the Athens apartment I share with Danae a week or so before the January 2015 election that brought me to office. It was a mild winter’s day, the campaign was in full swing, and I had agreed to give an interview to lrene, a Spanish journalist. She came to the apartment accompanied by a photographer and by Lambros, an Athens-based Greek-Spanish translator. On that occasion Lambros’s services were unnecessary as lrene and I talked in English. But he stayed, watching and listening intensely. After the interview, as Irene and the photographer were packing up their gear and heading for the door, Lambros approached me. He shook my hand, refusing to let go while addressing me with the concentration of a man whose life depends on getting his message across: ‘I hope you did not notice it from my appearance. I do my best to cover it up, but in fact I am a homeless person.’ He then told me his story as briefly as he could.

Lambros used to have a flat, a job teaching foreign languages and a family. In 2010, when the Greek economy tanked, he lost his job, and when they were evicted from their flat he lost his family. For the past year he had lived on the street. His only income came from providing translation services to visiting foreign journalists drawn to Athens by yet another demonstration in Syntagma Square which turned ugly and thus newsworthy. His greatest concern was finding a few euros to recharge his cheap mobile phone so that the foreign news crews could contact him.

Feeling he needed to wrap up his soliloquy, he rushed to the one thing he wanted from me:

I want to implore you to promise me something. l know you will win the election. I talk to people on the street and there is no doubt that you will. Please, when you win, when you are in office, remember those people. Do something for them. Not for me! I am finished. Those of us whom the crisis felled, we cannot come back. It is too late for us. But, please, please do something for those who are still on the verge. Who are clinging by their fingernails. Who have not fallen yet. Do it for them. Don’t let them fall. Don’t turn your back to them. Don’t sign what they give you like the previous ones did. Swear that you won’t. Do you swear?

‘I swear,’ was my two-word answer to him.

A week later I was taking my oath of office as the country’s finance minister. During the months that followed, every time my resolve weakened I had only to think back to that moment. Lambros will never know of his influence during the bleakest hours of those 162 days.

Bailoutistan

By early 2010, some five years before I took office, the Greek state was bankrupt. A few months later the European Union, the International Monetary Fund and the Greek government organized the world’s greatest bankruptcy cover-up. How do you cover up a bankruptcy? By throwing good money after bad. And who financed this cover-up? Common people, ‘outsiders’ from all over the globe.

The rescue deal, as the cover-up was euphemistically known, was signed and sealed in early May 2010. The European Union and the IMF extended to the broke Greek government around €110 billion, the largest loan in history. Simultaneously a group of enforcers known as the troika so called because they represent three institutions: the European Commission (EC), which is the EU’s executive body, the European Central Bank (ECB) and the International Monetary Fund (IMF) was dispatched to Athens to impose measures guaranteed to reduce Greece’s national income and place most of the burden of the debt upon the weakest Greeks. A bright eight-year-old would have known that this couldn’t end well. Forcing new loans upon the bankrupt on condition that they shrink their income is nothing short of cruel and unusual punishment.

Greece was never bailed out. With their ‘rescue’ loan and their troika of bailiffs enthusiastically slashing incomes, the EU and lMF effectively condemned Greece to a modern version of the Dickensian debtors’ prison and then threw away the key.

Debtors’ prisons were ultimately abandoned because, despite their cruelty, they neither deterred the accumulation of new bad debts nor helped creditors get their money back. For capitalism to advance in the nineteenth century, the absurd notion that all debts are sacred had to be ditched and replaced with the notion of limited liability. After all, if all debts are guaranteed, why should lenders lend responsibly? And why should some debts carry a higher interest rate than other debts, reflecting the higher risk of going bad?

Bankruptcy and debt write-downs became for capitalism what hell had always been for Christian dogma unpleasant yet essential but curiously bankruptcy denial was revived in the twenty-first century to deal with the Greek state’s insolvency. Why? Did the EU and the IMF not realize what they were doing?

They knew exactly what they were doing. Despite their meticulous propaganda, in which they insisted that they were trying to save Greece, to grant the Greek people a second chance, to help reform Greece’s chronically crooked state and so on, the world’s most powerful institutions and governments were under no illusions. They appreciated that you could squeeze blood out of a stone more easily than make a bankrupt entity repay its loans by lending it more money, especially if you shrink its income as part of the deal. They could see that the troika, even if it managed to confiscate the fallen state’s silverware, would fail to recoup the money used to refinance Greece’s public debt. They knew that the celebrated ‘rescue’ or ‘bailout’ package was nothing more than a one-way ticket to debtors’ prison.

How do I know that they knew? Because they told me.

Prisoners of their own device

As finance minister five years later, I heard it straight from the horse’s mouth. From top IMF officials, from Germany’s finance minister, from leading figures in the ECB and the European Commission they all admitted, each in their own way, that it was true: they had dealt Greece an impossible hand. But having done so, they could see no way back.

Less than a month after my election, on 11 February 2015, in one of those spirit-numbing, windowless, neon-lit meeting rooms that litter the EU’s Brussels buildings, I found myself sitting opposite Christine Lagarde, the lMF’s managing director, France’s ex-finance minister and a former Washington-based high-flying lawyer. She had waltzed into the building earlier that day in a glamorous leather jacket, making me look drab and conventionally attired. This being our first encounter, we chatted amicably in the corridor before moving into the meeting room for the serious discussion.

Behind closed doors, with a couple of aides on each side, the conversation turned serious but remained just as friendly. She afforded me the opportunity to present my basic analysis of the causes and nature of the Greek situation as well as my proposals for dealing with it, and nodded in agreement for much of the time. We seemed to share a common language and were both keen to establish a good rapport. At the meeting’s end, walking towards the door, we got a chance for a short, relaxed but telling téte-a-téte. Taking her cue from the points I had made, Christine seconded my appeals for debt relief and lower tax rates as prerequisites for a Greek recovery. Then she addressed me with calm and gentle honesty: You are of course right, Yanis. These targets that they insist on can’t work. But, you must understand that we have put too much into this programme. We cannot go back on it. Your credibility depends on accepting and working within this programme.

So, there I had it. The head of the IMF was telling the finance minister of a bankrupt government that the policies imposed upon his country couldn’t work. Not that it would be hard to make them work. Not that the probability of them working was low. No, she was acknowledging that, come hell or high water, they couldn’t work.

With every meeting, especially with the troika’s smarter and less insecure officials, the impression grew on me that this was not a simple tale of us versus them, good versus bad. Rather, an authentic drama was afoot reminiscent of a play by Aeschylus or Shakespeare in which powerful schemers end up caught in a trap of their own making. In the real-life drama I was witnessing, Summers’s sacred rule of insiders kicked in the moment they recognized their powerlessness. The hatches were battened down, official denial prevailed, and the consequences of the tragic impasse they’d created were left to unfold on autopilot, imprisoning them yet further in a situation they detested for weakening their hold over events.

Because they, the heads of the IMF, of the EU, of the German and French governments, had invested inordinate political capital in a programme that deepened Greece’s bankruptcy, spread untold misery and led our young to emigrate in droves, there was no alternative: the people of Greece would simply have to continue to suffer.

As for me, the political upstart, my credibility depended on accepting these policies, which insiders knew would fail, and helping to sell them to the outsiders who had elected me on the precise basis that I would break with those same failed policies.

It’s hard to explain, but not once did I feel animosity towards Christine Lagarde. I found her intelligent, cordial, respectful. My view of humanity would not be thrown into turmoil were it to be shown that she actually had a strong preference for a humane Greek deal. But that is not relevant. As a leading insider, her top priority was the preservation of the insiders’ political capital and the minimization of any challenge to their collective authority.

Yet credibility, like spending, comes with tradeoffs. Every purchase means an alternative opportunity lost. Boosting my standing with Christine and the other figures of power meant sacrificing my credibility with Lambros, the homeless interpreter who had sworn me to the cause of those people who, unlike him, had not yet been drowned in the torrent of bankruptcy ravaging our land. This trade-off never came close to becoming a personal dilemma. And the powers that be realized this early on, making my removal from the scene essential.

A little more than a year later, in the run-up to the UK referendum on 23 June 2016, I was travelling across Britain giving speeches in support of a radical remain platform, the argument that the UK ought to stay within the EU to oppose this EU, to save it from collapse and to reform it. It was a tough sell. Convincing Britain’s outsiders to vote remain was proving an uphill struggle, especially in England’s north, because even my own supporters in Britain, women and men closer in spirit and position to Lambros than to Christine, were telling me they felt compelled to deliver a drubbing to the global establishment. One evening I heard on the BBC that Christine Lagarde had joined the heads of the world’s other top financial institutions (the World Bank, the OECD, the ECB, the Bank of England and so on) to warn Britain’s outsiders against the lure of Brexit. I immediately texted Danae from Leeds, where l was speaking that night, ‘With such allies, who needs Brexiteers?’

Brexit won because the insiders went beyond the pale. After decades of treating people like me as credible in proportion to our readiness to betray the outsiders who had voted for us, they still confused outsiders with people who gave a damn about their counsel. Up and down America, in Britain, in France and in Germany everywhere the insiders are feeling their authority slip away. Prisoners of their own device, slaves to the Summers dilemma, they are condemned, like Macbeth, to add error upon error until they realize that their crown no longer symbolizes the power they have but the power that has slipped away. In the few months I spent dealing with them, I caught glimpses of that tragic realization.

It was the (French and German) banks, stupid!

Friends and journalists often ask me to describe the worst aspect of my negotiations with Greece’s creditors. Not being able to shout from the rooftops what the high and mighty were telling me in private was certainly frustrating, but worse was dealing with creditors who did not really want their money back. Negotiating with them, trying to reason with them, was like negotiating a peace treaty with generals hell-bent on continuing a war safe in the knowledge that they, their sons and their daughters are out of harm’s way.

What was the nature of that war? Why did Greece’s creditors behave as if they did not want their money back? What led them to devise the trap in which they now found themselves? The riddle can be answered in seconds if one takes a look at the state of France’s and Germany’s banks after 2008.

Greece’s endemic underdevelopment, mismanagement and corruption explain its permanent economic weakness. But its recent insolvency is due to the fundamental design faults of the EU and its monetary union, the euro.

The EU began as a cartel of big business limiting competition between central European heavy industries and securing export markets for them in peripheral countries such as Italy and, later, Greece. The deficits of countries like Greece were the reflection of the surpluses of countries like Germany. While the drachma devalued, these deficits were kept in check. But when it was replaced by the euro, loans from German and French banks propelled Greek deficits into the stratosphere.

The Credit Crunch of 2008 that followed Wall Street’s collapse bankrupted Europe’s bankers who ceased all lending by 2009. Unable to roll over its debts, Greece fell into its insolvency hole later that year.

Suddenly three French banks faced losses from peripheral debt at least twice the size of the French economy. Numbers provided by the Bank of International Settlements reveal a truly scary picture: for every thirty euros they were exposed to, they had access to only one. This meant that if only 3 per cent of that exposure went bad that is, if €106 billion of the loans they had given to the periphery’s governments, households and firms could not be repaid then France’s top three banks would need a French government bailout.

The same three French banks’ loans to the Italian, Spanish and Portuguese governments alone came to 34 per cent of France’s total economy, €627 billion to be exact. For good measure, these banks had in previous years also lent up to €102 billion to the Greek state. If the Greek government could not meet its repayments, money men around the globe would get spooked and stop lending to the Portuguese, possibly to the Italian and Spanish states as well, fearing that they would be the next to go into arrears.

Unable to refinance their combined debt of nearly €1.76 trillion at affordable interest rates, the Italian, Spanish and Portuguese governments would be hard pressed to service their loans to France’s top three banks, leaving a black hole in their books. Overnight, France’s main banks would be facing a loss of 19 per cent of their ‘assets’ when a mere 3 per cent loss would make them insolvent.

To plug that gap the French government would need a cool €562 billion overnight. But unlike the United States federal government, which can shift such losses to its central bank (the Fed), France had dismantled its central bank in 2000 when it joined the common currency and had to rely instead on the kindness of Europe’s shared central bank, the European Central Bank. Alas, the ECB was created with an express prohibition: no shifting of Graeco-Latin bad debts, private or public, onto the ECB’s books. Full stop. That had been Germany’s condition for sharing its cherished Deutschmark with Europe’s riff-raff, renaming it the euro.

It’s not hard to imagine the panic enveloping President Sarkozy of France and his finance minister, Christine Lagarde, as they realized that they might have to conjure up €562 billion from thin air. And it’s not difficult to picture the angst of one of Lagarde’s predecessors in France’s finance ministry, the notorious Dominic Strauss-Kahn, who was then managing director of the IMF and intent on using that position to launch his campaign for France’s presidency in two years’ time.

France’s top officials knew that Greece’s bankruptcy would force the French state to borrow six times its total annual tax revenues just to hand it over to three idiotic banks.

It was simply impossible. Had the markets caught a whiff that this was on the cards, interest rates on France’s own public debt would have been propelled into the stratosphere, and in seconds €1.29 trillion of French government debt would have gone bad. In a country which had given up its capacity to print banknotes the only remaining means of generating money from nothing that would mean destitution, which in turn would bring down the whole of the European Union, its common currency, everything.

In Germany, meanwhile, the chancellor’s predicament was no less taxing. In 2008, as banks in Wall Street and the City of London crumbled, Angela Merkel was still fostering her image as the tight-fisted, financially prudent Iron Chancellor. Pointing a moralizing finger at the Anglosphere’s profligate bankers, she made headlines in a speech she gave in Stuttgart when she suggested that America’s bankers should have consulted a Swabian housewife, who would have taught them a thing or two about managing their finances. Imagine her horror when, shortly afterwards, she received a barrage of anxious phone calls from her finance ministry, her central bank, her own economic advisers, all of them conveying an unfathomable message:

“Chancellor, our banks are bust too! To keep the ATMs going, we need an injection of €406 billion of those Swabian housewives’ money by yesterday!”

It was the definition of political poison. How could she appear in front of those same members of parliament whom she had for years lectured on the virtues of penny-pinching when it came to hospitals, schools, infrastructure, social security, the environment, to implore them to write such a colossal cheque to bankers who until seconds before had been swimming in rivers of cash? Necessity being the mother of enforced humbleness, Chancellor Merkel took a deep breath, entered the splendid Norman Foster designed federal parliament in Berlin known as the Bundestag, conveyed to her dumbfounded parliamentarians the bad news and left with the requested cheque. At least it’s done, she must have thought. Except that it wasn’t. A few months later another barrage of phone calls demanded a similar number of billions for the same banks.

Why did Deutsche Bank, Finanzbank and the other Frankfurt-based towers of financial incompetence need more? Because the €406 billion cheque they had received from Mrs Merkel in 2009 was barely enough to cover their trades in USbased toxic derivatives. It was certainly not enough to cover what they had lent to the governments of Italy, Ireland, Portugal, Spain and Greece a total of €477 billion, of which a hefty €102 billion had been lent to Athens. lf Greece lost its capacity to meet its repayments? German banks faced another loss that would require of Mrs Merkel another cheque for anything between €340 billion and €406 billion, but consummate politician that she is, the chancellor knew she would be committing political suicide were she to return to the Bundestag to request such an amount.

Between them, the leaders of France and Germany had a stake of around €1 trillion in not allowing the Greek government to tell the truth; that is, to confess to its bankruptcy.

Yet they still had to find a way to bail out their bankers a second time without telling their parliaments that this was what they were doing. As Jean-Claude Juncker, then prime minister of Luxembourg and later president of the European Commission, once said, ‘When it becomes serious, you have to lie.’

After a few weeks they figured out their fib: they would portray the second bailout of their banks as an act of solidarity with the profligate and lazy Greeks, who while unworthy and intolerable were still members of the European family and would therefore have to be rescued. Conveniently, this necessitated providing them with a further gargantuan loan with which to pay off their French and German creditors, the failing banks.

There was, however, a technical hitch that would have to be overcome first: the clause in the eurozone’s founding treaty that banned the financing of government debt by the EU. How could they get round it? The conundrum was solved by a typical Brussels fudge, that unappetizing dish that the Europeans, especially the British, have learned to loathe.

First, the new loans would not be European but international, courtesy of cutting the IMF into the deal. To do this would require the IMF to bend its most sacred rule: never lend to a bankrupt government before its debt has had a ‘haircut’, been restructured. But the lMF’s then managing director, Dominic Strauss-Kahn, desperate to save the banks of the nation he planned to lead two years down the track, was on hand to persuade the IMF’s internal bureaucracy to turn a blind eye. With the IMF on board, Europeans could be told that it was the international community, not just the EU, lending to the Greeks for the higher purpose of underpinning the global financial system. Perish the thought that this was an EU bailout for an EU member state, let alone for German and French banks!

Second, the largest portion of the loans, to be sourced in Europe, would not come from the EU per se; they would be packaged as a series of bilateral loans that is to say, from Germany to Greece, from Ireland to Greece, from Slovenia to Greece, and so on with each bilateral loan of a size reflecting the lender’s relative economic strength, a curious application of Karl Marx’s maxim ‘from each according to his capacity to each according to his need’.

So, of every €1000 handed over to Athens to be passed on to the French and German banks, Germany would guarantee €270, France €200, with the remaining €530 guaranteed by the smaller and poorer countries.

This was the beauty of the Greek bailout, at least for France and Germany: it dumped most of the burden of bailing out the French and German banks onto taxpayers from nations even poorer than Greece, such as Portugal and Slovakia. They, together with unsuspecting taxpayers from the lMF’s co-funders such as Brazil and Indonesia, would be forced to wire money to the Paris and Frankfurt banks.

Unaware of the fact that they were actually paying for the mistakes of French and German bankers, the Slovaks and the Finns, like the Germans and the French, believed they were having to shoulder another country’s debts. Thus, in the name of solidarity with the insufferable Greeks, the Franco-German axis planted the seeds of loathing between proud peoples.

From Operation Offload to bankruptocracy

As soon as the bailout loans gushed into the Greek finance ministry, ‘Operation Offload’ began: the process of immediately siphoning the money off back to the French and German banks. By October 2011, the German banks’ exposure to Greek public debt had been reduced by a whopping €27.8 billion to €91.4 billion. Five months later, by March 2012, it was down to less than €795 million. Meanwhile the French banks were offloading even faster: by September 2011 they had unburdened themselves of €63.6 billion of Greek government bonds, before totally eliminating them from their books in December 2012. The operation was thus completed within less than two years. This was what the Greek bailout had been all about.

Were Christine Lagarde, Nicolas Sarkozy and Angela Merkel naive enough to expect the bankrupt Greek state to return this money with interest? Of course not. They saw it precisely as it was: a cynical transfer of losses from the books of the FrancoGerman banks to the shoulders of Europe’s weakest taxpayers. And therein lies the rub:

The EU creditors I negotiated with did not prioritize getting their money back because, in reality, it wasn’t their money. Socialists, Margaret Thatcher liked to say, are bound to make a mess of finance because at some point they run out of other people’s money. How would the iron Lady have felt if she’d known that her dictum would prove so fitting a description of her own self-proclaimed disciples, the neoliberal apparatchiks managing Greece’s bankruptcy? Did their Greek bailout amount to anything other than the socialization of the French and German banks’ losses, paid for with other people’s money?

In my book The Global Minotaur, which I was writing in 2010 while Greece was imploding, I argued that free-market capitalist ideology expired in 2008, seventeen years after communism kicked the bucket.

Before 2008 free-market enthusiasts portrayed capitalism as a Darwinian jungle that selects for success among heroic entrepreneurs. But in the aftermath of the 2008 financial collapse, the Darwinian natural selection process was stood on its head: the more insolvent a banker was, especially in Europe, the greater his chances of appropriating large chunks of income from everyone else: from the hard-working, the innovative, the poor and of course the politically powerless.

Bankruptocracy is the name I gave to this novel regime.

Most Europeans like to think that American bankruptocracy is worse than its European cousin, thanks to the power of Wall Street and the infamous revolving door between the US banks and the US government. They are very, very wrong. Europe’s banks were managed so atrociously in the years preceding 2008 that the inane bankers of Wall Street almost look good by comparison. When the crisis hit, the banks of France, Germany, the Netherlands and the UK had exposure in excess of $30 trillion, more than twice the United States national income, eight times the national income of Germany, and almost three times the national incomes of Britain, Germany, France and Holland put together.

A Greek bankruptcy in 2010 would have immediately necessitated a bank bailout by the German, French, Dutch and British governments amounting to approximately $10,000 per child, woman and man living in those four countries. By comparison, a similar market turn against Wall Street would have required a relatively tiny bailout of no more than $258 per US citizen.

If Wall Street deserved the wrath of the American public, Europe’s banks deserved 38.8 times that wrath.

But that’s not all. Washington could park Wall Street’s bad assets on the Federal Reserve’s books and leave them there until either they started performing again or were eventually forgotten, to be discovered by the archaeologists of the future. Put simply, Americans did not need to pay even that relatively measly $258 per head out of their taxes. But in Europe, where countries like France and Greece had given up their central banks in 2000 and the ECB was banned from absorbing bad debts, the cash needed to bail out the banks had to be taken from the citizenry.

If you have ever wondered why Europe’s establishment is so much keener on austerity than America’s or Japan’s, this is why. It is because the ECB is not allowed to bury the banks’ sins in its own books, meaning European governments have no choice but to fund bank bailouts through benefits cuts and tax hikes.

Was Greek’s unholy treatment a conspiracy? If so, it was one without conscious conspirators, at least at the outset. Christine Lagarde and her ilk never set out to found Europe’s bankruptocracy. When the French banks faced certain death, what choice did she have as France’s finance minister, alongside her European counterparts and the IMF, but to do whatever it took to save them even if this entailed lying to nineteen European parliaments at once about the purpose of the Greek loans? But having lied once and on such a grand scale, they were soon forced to compound the deceit in an attempt to hide it beneath fresh layers of subterfuge. Coming clean would have been professional suicide. Before they knew it, bankruptocracy had enveloped them too, just as surely as it had enveloped Europe’s outsiders.

This is what Christine was signalling to me when she confided that ‘they’ had invested too much in the failed Greek programme to go back on it. She might as well have used Lady Macbeth’s more graceful words: ‘What’s done cannot be undone.’

‘National traitor’ the origins of a quaint charge

My career as ‘national traitor’ has its roots in December 2006. In a public debate organized by a former prime minister’s think tank I was asked to comment on the 2007 Greek national budget. Looking at the figures, something compelled me to dismiss them as the pathetic window-dressing exercise that they were:

“Today we are threatened by the bubble in American real estate and in the derivatives market If this bubble bursts, and it is certain it will, no reduction in interest rates is going to energize investment in this country to take up the slack, and so none of this budget’s figures will have a leg to stand on. The question is not whether this will happen but how quickly it will result in our next Great Depression.”

My fellow panellists, who included two former finance ministers, looked at me the way one looks at an inconvenient fool.

Over the next two years I would encounter that look time and again. Even after Lehman Brothers went belly up, Wall Street crumpled, the credit crunch hit and a great recession engulfed the West, Greece’s elites were living in a bubble of self-deluded bliss. At dinner parties, in academic seminars, at art galleries they would harp on about Greece’s invulnerability to the ‘Anglo disease’, secure in the conviction that our banks were sufficiently conservative and the Greek economy fully insulated from the storm.

In pointing out that nothing could have been further from the truth I sounded a jarring dissonance, but it would only get worse.

In reality, states never repay their debt. They roll it over, meaning they defer repayment endlessly, paying only the interest on the loans. As long as they can keep doing this, they remain solvent.

It helps to think of public debt as a hole in the ground next to a mountain representing the nation’s total income. Day by day the hole gets steadily deeper as interest accrues on the debt, even if the state does not borrow more. But during the good times, as the economy grows, the income mountain is steadily getting taller. As long as the mountain rises faster than the debt hole deepens, the extra income added to the mountain’s summit can be shovelled into the adjacent hole, keeping its depth stable and the state solvent. Insolvency beckons when the economy stops growing or starts to contract: recession then eats into a country’s income mountain, doing nothing to slow the pace at which the debt hole continues to grow. At this point alarmed money men will demand higher interest rates on their loans as the price for continuing to refinance the state, but increased rates operate like overzealous excavators, digging yet faster and making the debt hole even deeper.

*

from

Adults in the room. My battle with Europe’s Deep Establishment

by Yanis Varoufakis

get it at Amazon.com

The New Keynesian fiscal rules that mislead British Labour – Bill Mitchell.

The British Labour Party is currently leading the Tories in the latest YouGov opinion polls (February 19-20, Tories 40 per cent (and declining), Labour 42 per cent (and rising). They should be further in front, given the disarray of the Conservatives as they try to negotiate within their own party something remotely acceptable about Brexit.

When there is this degree of political capital available, in this case for the Labour Party, a party should use it to redefine policy agendas that have gone awry. To build a narrative that will advance their cause for the future decades.

British Labour has a chance to break out of its recent Blairite neoliberal past and present a truly progressive manifesto to the British people that will force the Tories to move closer to the centre and squeeze the extreme right-wing elements.

In part, under Jeremy Corbyn and John McDonnell, Labour is making progressive noises on a number of fronts. But ultimately, where it really matters, the macroeconomic narrative, they are remaining firmly neoliberal and this will blight their chances of pursuing a truly progressive agenda.

One of the glaring mistakes the Labour Party has made is to accept advice from neoliberal economists (so-called New Keynesians) who have instilled in them a need for fiscal rules. This is an analysis of the sort of advice that Jeremy Corbyn and John McDonnell are getting and why they should ignore it.

l have written about fiscal rules in the past. There is only one fiscal rule that a progressive government should adhere to and I outlined that in this blog post The full employment fiscal deficit condition (April 13, 2011).

See also the suite of blog posts Fiscal sustainability 101 Part 1 Fiscal sustainability 101 Part 2 Fiscal sustainability 101 Part 3 to learn how Modern Monetary Theory (MMT) constructs the concept of fiscal sustainability.

The discussion in those blog posts rejects fiscal rules that are defined exclusively in terms of financial ratios, the type that the neoliberals use to reduce the scope of government and bias policy towards austerity and elevated levels of labour underutilisation.

I wrote about the madness in the British Labour Party signing up to neoliberal ’fiscal rules’ in this blog post, British Labour Party is mad to sign up to the ’Charter of Budget Responsibility’ (September 28, 2015).

One discussion paper that seems to have influenced the Shadow Chancellor in entering these type of neoliberal agreements was published on May 20, 2014 as Discussion Paper No. 429 from the National Institute of Economic and Social Research.

The NIESR paper Issues in the Design of Fiscal Policy Rules was written by Jonathan Portes (who is the Director of the NIESR) and an Oxford academic, Simon Wren-Lewis.

l have noticed that SWL seems to get involved with vituperative exchanges with Twitter participants who challenge him on matters relating to Modern Monetary Theory (MMT). He seems to think it is smart to label people, who refuse to accept his New Keynesian blather on Twitter, as being plain dumb.

SWL was a member of Labour’s economic advisory committee that John McDonnell formed after becoming the Shadow Chancellor. He later fell out with Corbyn it seems and urged the Party to dump Corbyn as leader and install Owen Smith instead.

On July 26, 2016, he wrote that “What seems totally clear to me is that given recent events a Corbyn-led party cannot win in 2020, or even come close.”

Well that prediction might still be relevant in 2020, but the last national election outcome, where Corbyn went close (even with many of the Blairites in his own party whiteanting him) suggested that SWL hasn’t much grip on reality.

Anyway, we digress.

In their discussion of issues that arise in the design of fiscal rules, Portes and SWL fail to mention the concept of full employment in the NIESR article. Their discussion is pitched entirely in terms of ‘financial ratios’.

It is hard to see that the general public will be enamoured with a government that delivers a target fiscal deficit (for example) but at the expense of elevated levels of unemployment and poverty. Fiscal policy has to relate to things that matter.

The belief (assertion) that by running fiscal surpluses or getting a public debt below some threshold will automatically deliver prosperity (jobs for all, growing real wages, first-class public services, etc) is one of the greatest con jobs that mainstream economists have foisted upon us. Fiscal policy has to relate to targets that matter like jobs, wages growth, and the like.

Depending on what the external and the private domestic sectors are doing (with respect to spending and saving), a fiscal deficit of 10 per cent of GDP might be appropriate just as a fiscal deficit of 2 per cent, or even a fiscal surplus of 4 per cent. Context matters not some particular ratio.

As an aside, the NIESR was a foremost Keynesian research group after being founded in 1938, as the academy was embracing the rejection of neoclassical thinking (which has morphed into the modern day neoliberalism) and recognising the positive role that government fiscal policy could play.

lts capacity to engage in quantitative research to support policy was valuable.

In more recent times, it has declined and is part of the neoliberal misinformation machine. The Keynesian roots has become New Keynesian, which eliminates all the meaningful insights of the original.

I have been asked by a lot of people to comment on the NIESR paper (cited above) and I have been reluctant to do so, given how flawed it is.

But given it has been so influential in framing the way in which the British Labour Party hierarchy thinks about macroeconomics, l have decided to consider it. It is hard to discuss the paper though in non-technical terms accessible to my broad readership, given the way it is framed. So at times, this essay will disappear into jargon. Not much though. I am trying to bring the message as fairly and simply as I can, so as to demonstrate the stupidity of the analysis but not be unfair (misrepresent) the authors.

Generally, the NIESR paper falls into the realm of what I call fake knowledge.

The simple response is that it spends several pages outlining the theory of optimal debt and fiscal policy then admits such a thesis “undeveloped”.

Not to be discouraged by the inability of the ‘optimal theory’ to say anything definitive about the real world, the authors, then proceed to draw conclusions from the theory anyway, which just amount to standard assertions.

Wren-Lewis just should stick to Twitter. He seems to like that. It would save us the time reading the other stuff. in effect, the substantive conclusions from the paper have no basis in theory and could have been tweets.

Let me explain why.

The motivation of the authors is to discuss what might be a “simple rule to guide fiscal policymakers”.

They point out that central bankers have used the “Taylor rule for monetary policy”, which is a simplification in itself. But I won’t get bogged down in discussing whether decision-making in central banks has or had become so mechanistic. It has not been but that is another story.

Mainstream monetary economists certainly teach students that central banks operate in the mechanistic way described by the Taylor rule, which is just a formula the textbooks claim is used to set interest rates.

But then these characters also teach students that central banks can control the money supply, that the money multiplier is responsible for determining how the monetary base scales up into the broad money supply, that expanding bank reserves will allow banks to make loans more easily, that expanding bank reserves is inflationary and al st of the litany of lies.

None of the central propostions that are taught to macroeconomics students in this regard are valid. They are fake knowledge, a stylised world of how these neoliberal economists want to imagine the real world works because they can then derive their desired policy regimes from it.

In the real world central banks and commercial banks do not function in this way.

Some of these monetary myths spill over into the analysis presented by Portes and SWL, which I will indicate presently.

Their motivation is to “search for such a rule” that might apply to fiscal policy, although they conclude at the outset that “one single simple rule to guide fiscal policy may never be found”.

They surmise that this is because:

1. “basic theory suggests that fiscal policy actions should be very different when monetary policy is constrained in a fundamental way. They cite the case of the so-called zero lower bound” as constraining fiscal policy options. In fact, no such constraint exists. Whether interest rates are zero or something else, the currency-issuing government has the same capacities and options.

There is no evidence that monetary policy suddenly becomes effective as a counter-stabilising tool at some positive target policy rate and should be preferred over fiscal policy.

The authors also suggest that the exchange rate regime will constrain fiscal policy. This is correct, which is why Modern Monetary Theory (MMT) theorists argue against pegged arrangements, they reduce the sovereignty of the government.

If a nation pegs its exchange rate then it strictly loses its sovereignty because the central bank has to conduct monetary policy with a view of stabilising the external value of the currency, which then limits the flexibility of domestic policy.

That is why the Bretton Woods fixed exchange rate system collapsed in August 1971. It biased nations running external deficits towards elevated levels of unemployment and crippling interest rates, which proved to be politically unsustainable.

2. Portes and SWL then say: “The second reason why a fiscal equivalent of a Taylor rule may be elusive also reflects national differences, but in this case differences in political structure.”

Here we get the bizarre notion introduced that theory describes an “optimal policy” but that ”there may be a trade-off between rules that mimic optimal policy, and rules that are effective in countering deficit bias” because politicians cannot be trusted to exhibit the ‘correct’ degree of austerity and instead become drunk on net spending (their concept of a “deficit bias”).

These ‘deficit drunk’ governments are labelled “non benevolent” because they allegedly trash the future of our children. Heard that one before? Sure you have, along with ‘governments running out of money’, ‘tipping points’, etc. To solve the problem of these ‘deficit drunk’ governments, Portes and SWL think technocratic constraints are needed to prevent governments responding to the desires of the population as represented by their mandate.

Of course, imposing technocratic constraints against a democratically elected government has become a major characteristic of the neoliberal era. Portes and SWL fit right in with that trend.

All this is part of the ‘depoliticisation’ trend that has seen elected governments shed political responsibility for key decisions that have damaged the well-being of the vast majority of people in their nations by appealing to ‘external’ authorities.

The ‘we had to do it, we had no choice’ ruse, the ‘Dennis Healey, we had to borrow from the IMF because we were running out of money‘ ruse, the ‘we need to outsource fiscal policy to economic experts because politicians just want votes’ ruse.

These external authorities might be so-called independent central banks (even though they are not independent see later), the IMF, and fiscal boards (such as the Office of Budget Responsibility in the UK).

We examine that trend in our new book Reclaiming the State: A Progressive Vision of Sovereignty for a Post-Neoliberal World (Pluto Books, September 2017)

Further, the term ‘deficit bias’ is loaded. Portes and SWI would claim that continuous fiscal deficits illustrate this bias. However, in most nations, such continuity is necessary to support the saving desires of the non-government sector, while sustaining full employment.

There would be no ‘bias’ there. Just responsible fiscal practice. I will discuss that in more detail presently. Refer back to the blog post The full employment fiscal deficit condition.

Further, the so-called New Keynesian ‘optimum‘ is unlikely to have any relevance for the well-being of the population, and, in particular, the most disadvantaged citizens in society.

The standard New Keynesian ‘model’ didn’t even have unemployment in it.

If you understand the dominant New Keynesian framework, which has become the basis for a new consensus emerging among orthodox macroeconomists like Portes and SWL, then you will know the following.

1. The basic New Keynesian approach has three equations which in themselves are problematic. They claim authority based on the microfoundations that are alleged to represent rigourous optimising behaviour by all agents (people, firms, etc) captured by the model structure.

2. Because the ‘optimal’ theory, specified in the basic structure (Calvo pricing, rational expectations, intertemporal utility maximising behaviour by consumers, who face a trade-off between consumption and leisure, etc) cannot say anything much about real world data, the empirical models are modified (adjustment lags are added, etc). As a result ad hocery enters the applied domain where substantive results that are meant to apply to policy are generated.

3. But it is virtually impossible to builds these ‘modifications’ into their theoretical models from the first principles (intertermporal optimisation, etc) that they start with.

4. Which means that like most of the mainstream body of theory the claim to micro-founded ‘rigour’ is unsustainable once they respond to real world anomalies (of their theory) with ad hoc (non rigourous) tack ons.

5. The results they end up producing in empirical papers are not ‘derivable’ from first-order, microfounded principles at all. Their claim to theoretical rigour fails, At the end of the process there is no rigour at all. It becomes a false authority that they hide behind to justify their assertions.

The Portes-SWL paper is no exception.

Further, the ’Great Moderation’ was considered a move closer to the New Keynesian utopia (‘the business cycle’ was declared ‘dead’, for example).

Yet all we witnessed during this period in the 1990s and up to the onset of the GFC, was the redistribution of national income capital as real wages failed to keep pace with productivity growth, increased inequality and private debt, elevated levels of unemployment, the emergence of underemployment, and the dynamics being put in place which manifested as the GFC.

And, the burden of the GFC was not borne by the banksters or the top-end-of-town. Their criminality largely escaped unscathed while millions of workers lost their jobs and many became impoverished.

The belief that one can derive ‘optimal’ rules from a New Keynesian model that have any relevance to people or the world we live in is another characteristic of the neoliberal era. My profession basically went from bad to worse over this period.

However, none of that reality discourages Portes and SWL, who begin their analytical section by outlining this so-called New Keynesian “Optimal debt policy”.

Two propositions enter immediately:

1. taxes impose costs in terms of social welfare because they “are distortionary”. This means that they prevent people from making ‘optimal’ decisions.

The microeconomic theory these authors rely on claims that tax distortions include workers not working hard enough because the imposition of taxes create incentives for them to take more leisure.

This is a body of theory that also says unemployment is a choice workers make when the real wage (after tax) is so high that they prefer to take leisure instead of working. No problem, the workers are ‘optimising real income’ by being unemployed leisure is part of this ‘real’ income measure in these models.

If you thought that sounded like nonsense then you are right. Quits do not behave countercyclically, which would be required if unemployment was a choice made by workers.

Further, the research evidence suggests that the imposition of taxes does not alter the desire of workers to offer hours off work in any significant way.

For a start, most workers do not have continuous (hours) choices available to them. They work 40 hours (or whatever) or not at all.

But this is a digression.

Further what about carbon taxes and other similar taxes, which, even in the mainstream theory, correct market failure and enhance efficiency?

2. Then we read the “government would like to minimise these costs [from the taxes] but they need taxes to pay for government spending and any interest on debt.

Which is an absolute lie in terms of the intrinsic nature of a monetary system where the national government issues its own currency.

It is a convenient lie because they rely on it to derive the results in their paper. They also need this ‘optimality’ smokescreen to persuade politicians to take the results seriously as if their ‘assumptions’ are, in reality, natural constraints on governments.

The lie also implicitly biases the reader to accepting the ‘lower’ taxes are better than higher taxes, a proposition that depends on other assumptions they choose not to disclose because they are smart enough to know that that would push the discussion into the ideological domain and these characters want us to pretend that economics is ‘value free’ and everything they are writing is derivable from ‘optimal’ theory.

One of the first lectures an economics student is forced to endure contains assertions that there is a divide between what mainstream economists call ‘positive’ economics (value free) and ‘normative’ statements (value laden).

Mainstream theory holds itself out as being ‘positive’ and then blames dysfunctional outcomes on the ‘normative’ interventions of policy makers, who choose to depart from the ‘optimal’ world of positive economics.

If you thought this was an elaborate joke played on the students then you would be correct.

And in terms of the above, the correct statement would be that governments impose voluntary constraints on themselves, engineered by conservative ideologues. They have created accounting processes that ‘account‘ for tax receipts into, say Account A, which they then ‘account’ for their spending from. A sort of administrative fiction to give the impression that the tax receipts provide the wherewithal for government spending.

But anyone knows that these institutional practices can be altered by the government whenever they choose (unless they are embedded in constitutions and then it takes more time).

The reality is that unlike the assertion on of Portes and SWL (which drive their overall results):

Governments do not need taxes to pay for government spending. That is an ideological constraint designed to limit spending. Intrinsically, a sovereign government is never revenue constrained because it is the monopoly issuer of the currency.

Modern Monetary Theory (MMT) tells us that taxation serves to create real resource space (idle non-government productive resources), which governments can then bring into productive use to fulfill its elected socio-economic mandate. That taxation reduces the inflation risk of such spending but does not ‘fund’ it.

The fact is that a currency-issuing government can purchase anything that is for sale in its own currency including all idle labour.

MMT also recognises other roles for taxation such as taxes on bads designed to divert consumers or producers away from these goods and services. But that is another story.

Further, a government never needs to issue debt to ‘fund’ deficits.

That is another institutional practice that carries over from the fixed-exchange rate, gold standard days. It is no longer necessary and an understanding of MMT leads one to realise it is largely an exercise in the provision of corporate welfare that should be abandoned.

The point is that if you build ‘economic models’ based on these voluntary constraints, as if they are intrinsic constraints, then the results turn out radically different to the outcomes of an analytical exercise where you assume, correctly, that the government does not need taxes to ‘fund’ spending or to issue debt to fund deficits. Then the mainstream results largely collapse.

I suspect the authors in question implicitly know this. If they don’t then you can draw your own conclusions.

*

The paper I am using to represent the New Keynesian approach has, by all indications, been somewhat influential in the formation of the macroeconomic approach currently being espoused by the British Labour Party. In that sense, the critique aims to disabuse the Labour politicians and their apparatchiks of building policy options based on fake economic knowledge, and, instead, embrace the principles of Modern Monetary Theory (MMT), which provides an accurate depiction of how the monetary system actually operates and the policy options for a currency-issuing government such as in Britain, and the likely consequences of deploying these options.

The one major lesson that comes out is that the New Keynesian approach is an elaborate fraud. It plays around with so-called ‘optimising’ models asserting human behaviour that no other social scientist believes remotely captures the essence of human decision-making, and then derives conclusions from these models that are claimed to apply to the world we live in. Prior to the GFC, these ‘models’ didn’t even consider the financial sector.

The fact is that nothing of value in terms of specifying what a government should do can be gleaned from a New Keynesian approach. It is barren.

Above, we noted that one discussion paper that seems to have influenced the Shadow British Chancellor was published on May 20, 2014 as Discussion Paper No. 429 from the National Institute of Economic and Social Research.

The NIESR paper Issues in the Design of Fiscal Policy Rules was written by Jonathan Portes (who at the time of writing was the Director of the NIESR before he was ‘let go’) and an Oxford academic, Simon Wren-Lewis.

Here I begin by examining the way that the authors try to use the New Keynesian theory as an authority for specific policy conclusions, which they essentially admit (not in those words) cannot, in fact, be derived from the ‘optimal’ theory.

To specify what they call the ‘optimal’ state, Portes and SWL write out some simple mathematical expressions and note: that the government must satisfy its budget constraint (there is no default), and we ignore financing through printing money.

It is interesting that in defending the New Keynesian position against say Modern Monetary Theory (MMT), proponents make a claim for superiority based on their mathematical reasoning and the apparent absence of such optimising mathematics in MMT.

When useful, MMT uses formal language (mathematics) sparingly. Mostly, propositions can be established without resort to mathematics, which avoids creating a wall of comprehension that most people cannot break down.

Further, there is nothing sophisticated about the mathematics that New Keynesians use. It is just simple calculus really, the sort that I learned as an undergraduate studying mathematics. Hardcore mathematicians laugh at the way economists deploy these tools and parade them as if they are generating something deep and meaningful.

We move on.

Note that while the imposition of taxes is deemed a “cost” by Portes and SWL (discussed in earlier), their ‘model’ doesn’t allow the interest payments on the debt to be a ‘beneflt’. They are silent on that. Conveniently so.

Anyway, the equation they write out which captures the constrained optimisation process is claimed to be an ex ante financial constraint, akin to the financial constraints facing a household that must earn income, borrow, reduce savings or sell assets in order to spend.

As we know, the ‘household budget analogy’ applied to a currency-issuing government is wrong at the most elemental level.

Nothing relating to the experience of a household (the currency user) is relevant to assessing the capacities of or the choices available to such a government (currency issuer).

Further, why do they ignore “financing through printing money”? Not that “printing money” is a term that could be associated with the real world practice of government spending anyway.

They ignore it because it would not allow them to generate the results they desire.

The reality is that these so-called ‘budget constraints’ do not depict real ex ante financial constraints. They are, at best, ex post accounting statements, meaning they have to add up. There is nothing much more about them than that.

They may also reflect current institutional practice which is a political rather than an intrinsic financial artifact.

But, if the authors were to be stock-flow (accounting) consistent (which most mainstream models are not meaning they deliberately leave things out and that flows do not accumulate properly into the corresponding stocks), then they would have to include the change in bank reserves arising from central bank monetary operations associated with fiscal policy (for example, crediting banks accounts on behalf of the government).

But those operations are absent in their approach, which means their analysis is incomplete in an accounting sense. Conveniently so.

Of course, one of the glaring omissions of the New Keynesian models that people learned about after the GFC was that they didn’t even have a financial sector embedded in their basic structure. But that is also another story again.

The upshot of Portes and SWL’s mathematical gymnastics, simple though they are, is that the ‘optimal’ fiscal policy requires “tax smoothing”, so that:

if for a period government spending has to be unusually high (classically a war, but also perhaps because of a recession or natural disaster), it would be wrong to try and match this higher spending with higher tax rates. Instead taxes should only be raised by a small amount, with debt increasing instead, but taxes should stay high after government spending has come back down, to at least pay the interest on the extra debt and perhaps also to bring debt back down again.

So, they are saying:

1. Taxes are necessary to fund government spending but temporary deficits (to cope with wars or deep recessions) should be funded by debt.

2. When economic activity improves, there should be a primary fiscal surplus (”taxes at least pay the interest on the extra debt”) and spending should be cut to allow that outcome.

3. Public debt should be a target policy variable (the lower the better) but in the short-term is a “shock absorber to avoid sharp movements in taxes or government spending”.

4. This is a ‘deficit dove’ construction. We will have austerity but it will be delayed.

The questions one needs to ask is under what conditions would a primary surplus be a responsible state for a government to achieve? Portes and SWL want the primary surpluses to be a target goal for government. But such a target is unlikely to be a desirable state.

Remember, a primary fiscal balance is the difference between government spending and taxation flows less payments on outstanding public debt.

One could imagine a situation where a government would sensibly run a primary surplus or even an overall fiscal surplus (inclusive of interest payments on public debt) if it was accompanied by a robust external surplus, which was pumping net spending in the economy and financing the desire of the private domestic sector to save overall.

Then a fiscal surplus would be required to prevent inflationary pressures from emerging. But it would also be consistent with full employment, the provision of first-class public services, and the fulfillment of the overall saving desires by the private domestic sector. Think Norway.

That is not remotely descriptive of where the UK (or most nearly all nations) are at or have been at in recent decades.

The absurdity of the reasoning that arises from the sort of economic framework that Portes and SWL deploy is illustrated when they start tinkering with the parameters of the ‘model’ to see what transpires.

The exercise is trivial. The model has some equations with parameters that link the variables that describe the equation structures. The parameters are conceptual but to get certain results one has to make assumptions about their values (at the most basic level whether they are positive or negative or above or below unity, etc).

Then one muses about what specific assumptions imply for the results.

One such tinkering by Portes and SWL generates an interpretation that taxes:

gradually fall to zero. How can this happen, given that the government has spending to finance? The answer is that debt gradually declines to zero, and then the government starts to build up assets. Eventually it has enough assets that it can finance all its spending from the interest on those assets, and so taxes can be completely eliminated.

Which then raises the question of how the government gets access to any of the real resources that are available for productive use in the society.

If taxes are zero, why would people offer their labour (and other resources) for the public use? And, how will government make non-inflationary real resource space in order for them to spend (command real resources from the non-government sector)?

But discussing those issues will take us away from the main focus.

In essence, none of their mathematical ‘cases’ (the scenarios they defined with differing parameter values) can be established in reality. This is a common problem of this sort of economic reasoning.

What happens next? They ditch the ‘optimal’ results derived from the calculus and start making stuff up asserting their ‘priors’.

So as not to spoil their story, the authors just assert that “there are two reasons for believing that policy should aim to steadily reduce debt in normal times” even if the ‘optimal’ condition indicates the opposite.

First, they introduce the standard argument that “shocks may be asymmetric” with “large negative shock”(s) not being offset in the other direction.

This is a sort of ‘war chest’ argument. That a government will not be able to respond fully in a major downturn if it starts with high levels of public debt.

Why? It will not be attractive to bond investors, it will run out of money, etc.

Tell that to Japan! Fake knowledge.

Second, they write that:

large negative shocks like a financial crisis might mean that we enter a liquidity trap, so that fiscal expansion is required to assist monetary policy, while large positive shocks could be dealt with by monetary rather than fiscal contraction. There is no equivalent upper bound for interest rates, so prudent policy would reduce debt in normal times to make room for the liquidity trap possibility.

This is the standard mainstream claim that monetary policy is the more effective counter-stabilising (and preferred) policy, except in a deep recession when interest rates are cut to zero and have no further room to fall.

So to counter that ineffectiveness when rates are zero, fiscal policy has to be used. But, in general, monetary policy should be prioritised.

But then the same assertion follows. So that fiscal policy can be on standby for those times when interest rates are zero, the government should have low levels of outstanding debt.

Why? The same argument. It will not be able to fund a new fiscal stimulus if it hasn’t eliminated the impacts from a previous stimulus exercise.

That is a plain lie.

The authors just assert that the capacity of a government to net spend is inversely related to the current stock of outstanding debt.

Why? No reason can be derived from their ‘optimal’ models to justify that assertion.

And, again, tell that to Japan!

The post-GFC period has demonstrated that ’monetary policy’ is not a very effective counter-stabilising tool. Governments that used fiscal policy aggressively in the GFC resumed growth much more quickly than those that didn’t. The stimulatory effects of monetary policy are, at best, ambiguous.

Further, the truth is that the capacity of the government to spend is in no way constrained by its past fiscal stance whether it be surplus, balance or deficit.

A surplus today does not mean that the government is better placed to run a deficit tomorrow. It can always run a deficit if the non-government spending and saving decisions push it that way.

The same goes for outstanding debt, which under current institutional arrangements, will be influenced by the shifts in the flows that make up fiscal policy.

But the level of debt doesn’t constrain or alter the government’s ability to net spend.

The authors might claim that bond markets will rebel and stop funding the deficits. Even if the recipients of this corporate welfare decided to cut off their noses to spite their faces and stopped buying the debt that would not alter the government’s capacity to spend.

First, if it persisted in the unnecessary practice of issuing debt, it could instruct the central bank to set the yield and buy all the debt that the private bond markets didn’t want at that (low to zero) yield. Including all of it!

In other words, the government can always play the private bond markets out of the game if it chooses. Even in the Eurozone, where the Member States are not sovereign, the ECB has demonstrated it can set yields at whatever level it chooses. It can drive yields on long-term public debt into the negative! Who would have thought? No New Keynesian that is for sure. They think deficits ‘crowd out’ private investment spending via higher rates (see below).

Second, the government can also alter a rule or two or change legislation that embodies these voluntary accounting constraints that I noted earlier. That is the right of the legislature and beyond the power of bond markets!

In another one of their musings about parameter values, Portes and SWL tell us that:

there is an additional reason why it might be desirable to eliminate government debt completely, and that is because it crowds out productive capital. In simple overlapping generation models, agents save to fund their retirement, and this determines the size of the capital stock. If agents have an alternative means of saving, which is to invest in government debt, then this debt displaces productive capital.

Really now!

Again, the authors are just rehearsing the standard and deeply flawed mainstream macroeconomic theory, which has the loanable funds model of financial markets embedded.

According to this specious approach, savings are finite and investment competes for the scarce resources. The ‘interest rate’ on loans then brings the two into balance.

The logic then says if there is a shift in the investment demand outwards (capturing in this instance the entry of the government bond to compete with corporate bonds), then the interest rate has to rise to ration off the higher demand for loans, given the finite supply (savings). Wrong at the most elemental level.

First, savings are not finite. They rise with income and if net public spending increases (rising deficit) then national income will rise and so will saving.

Second, and more importantly, real world banks do not remotely operate in a loanable funds way. They will generally extend loans to creditworthy borrowers. This lending is not reserve constrained. Banks do no wait around for depositors to drop their cash off, which they can then on lend.

Loans create deposits (liquidity). Not the other way around, as is assumed by the ‘crowding out’ argument which these authors introduce to their analysis.

So even if the government is selling debt to the non-government sector, the banks still have the capacity (under our current system) to increase private investment.

Further, there is the standard ideological assertion that public spending is ‘less efficient’ (unproductive) compared to “productive capital” (private investment).

The research evidence doesn’t support that assertion. it is just a made up claim to justify privatisation and cuts to government activities.

It has been used to justify the handing out of millions of dollars of public funds to investment bankers, lawyers, accountants etc to sell off public assets at well below market prices to grasping private investors.

We have a long record now of how disastrous most of these selloffs have been from the perspective of the quality, scope and affordability of services that were previously provided by the state.

The next furphy that Portes and SWL introduce is the intergenerational equity argument aka government debt imposes burdens on our grand kids claim.

They claim that lower debt will mean that “Future generations will enjoy a world with lower distortionary taxes, while the current generation will bear the cost of achieving that goal.”

Again, this conclusion follows their assumption that taxes pay back the debt so deficits today force future generations to incur higher costs.

Refer to the previous discussion of the actual role of taxes in a flat monetary system.

The reality is that each generation chooses its own tax and public spending profile via the political process. The way in which intergenerational inequities occur is via real resource utilisation.

We can kill the planet and the kids will then miss out. Alternativelv. we can ensure the kids get access to first-class public infrastructure (education, health, recreation, etc) and have jobs to go to when they develop their skills and knowledge.

Then the kids benefit from today’s fiscal deficits.

But after all of their tinkering with mathematical coefficients (which I have only skimmed here), the authors admit that the “analysis of the optimum long run target for government debt is undeveloped” but:

the case for aiming for a gradual reduction in debt levels seems to be reasonably strong in practice, particularly given the currently high levels of debt in most countries

In other words, the mathematical reasoning leads to nothing definitive so we will just assert things anyway.

It helps economists like this gain promotion as academics and other status that they might enjoy such as picking up ’Inside Job’ type commissions and misrepresenting ideological reports as independent research.

Remember Mishkin in Iceland?

Please read my blog Universities should operate in an ethical and socially responsible manner for more discussion on this point.

I make that comment generally rather than specifically about the authors (Portes and SWL) in question. I don’t know what they do on the side.

So, after all that, what have Portes and SWL to fall back on? Not much. Assertion based on false assumptions.

That doesn’t stop them though.

In Section 3, they still claim ‘authority’ from the discussion on optimal fiscal rules to make the following assertion:

It follows from the previous section that a welfaremaximising government would in general be expected to follow fiscal policies which broadly satisfied the following conditions: a gently declining path of debt over the medium term, but with blips in response to shocks broadly stable tax rates and recurrent government consumption.

Noting it doesn’t follow at all from any results about “welfaremaximising” behaviour that they present. The simple optimising model presented, by the authors’ own admission, is “undeveloped” and incapable of any definitive result.

The results that they claim were derived from the “previous section” are assertions.

But their point is clear. They claim that OECD governments (in general) have not followed these rules and instead the public debt ratios have “steadily increased since the 1970s”, which is evidence of what they call “deficit bias”.

Their claim then is that for various reasons, governments have been acting contrary to “welfare-maximising” behaviour meaning they are acting badly.

Simple isn’t it. Make up a benchmark using flawed assumptions that you know does not apply in the real world. Then label any departures from that fantasy world ‘bad’ and QED, you can then claim in the ‘real world’ that the government is behaving badly.

However, one can contest the benchmark.

If public debt is such an issue, why is the 10-year bond yield for Japanese government bonds at 0.058 per cent (at the time of writing) and why did ‘investors’ pay the Japanese government for the privilege of buying that debt (negative yields) at certain times last year?

Moreover, why are ‘investors’ agreeing to negative yields on all government bond maturities from 1-Year to 8-Years at present.

Further, back in the 1990s, the financial commentators and mainstream macroeconomists were claiming the outstanding Japanese government debt was the mother of all ticking time bombs and they have used this scare tactic long and hard for decades across all nations.

I recall reading some commentator claiming long ago Japan was facing the “mother of all debt-bunnies”, whatever that meant. I guess the ‘bunnies’ hopped away somewhere.

I have gone back through the records I keep and found regular references over the last 27 years to the impending insolvency of Japan because it is violating the economists’ notion of welfare maximising’ debt behaviour.

Across the Pacific, the US was apparently “near to insolvency” on Thursday, September 26, 1940.

Here is an Associated Press story from The Portsmouth Times (Ohio), which was headlines in the New York Times on the same day.

The story quotes one Robert M. Hanes, who at the time was the President of the American Bankers’ Association:

“The evangelists of the new social order are undermining the confidence of the American people in political and economic freedom.

It is a matter of grave concern that we have come to accept deficit financing as a permanent fiscal policy. We not only proceed from year to year on an unbalanced federal budget, but we have permitted the compounding of the federal debt to a huge total which threatens the entire country.

Unless we put an end to deficit financing, to profligate spending, and to indifference to the nature and extent of government borrowing, we shall surely take the road to dictatorship.

By subtle propaganda, special pleading and similar devious device The American people are being persuaded to surrender more and more of their independence to the direction and control of government. This is an evil that feeds on itself.

Deficits and borrowings call for continually larger taxation, which must be met by private enterprise.”

We can find similar remarks throughout history. And, yet, nothing happens. I guess you can cut the Americans some slack such is their penchant for OTT way of doing things.

The point is these economic models that claim public debt should be minimised to prevent costly tax burdens are pie-in-the-neoliberaI-sky sort of stuff.

Further, higher public debt to GDP ratios means that the nongovernment sector has more risk free debt as a proportion of GDP than previously and corresponding income flows.

A Superpower Trade War Looms – Liam Dann. 

“If America, China relations become very difficult, our position becomes tougher because then we will be coerced to choose.”

It’s a nightmare scenario for a small trading nation with historic cultural and political links to the US, but an increasing economic reliance on China. A full blown trade war between China and the US could have devastating political consequences for us all.

In this case, it’s not New Zealand’s Prime Minister doing the worrying, it’s Singaporean leader Lee Hsien Loong.

His simple, blunt assessment of the risk posed by Donald Trump’s anti-China trade rhetoric caused a minor uproar in the diplomatically cautious Asian nation.

Here in New Zealand, where we face the same risks, we’re yet to officially confront the issue. And as issues go, it’s a big one: in the year to June 2016, New Zealand’s total trade (imports and exports) with China was $22.86 billion, compared to $16.25b with the US.

Reserve Bank governor Graeme Wheeler has spoken most openly about his fears for the economic risk to New Zealand if the Trump Administration does some of the things it has threatened to do.

In a speech last month, Wheeler suggested that Trump’s Administration represents the greatest source of uncertainty for our economy – both in terms of his impact on the domestic economy and his potential to increase global trade protectionism. “Rationally speaking, there shouldn’t be a reason we should go into a trade war. But we have to be prepared,” says Auckland University Business School trade economist Dr Asha Sandra. China and the US are like Siamese twins, she says. In other words, their economies are now so intertwined that doing damage to one must hurt the other.

“I think they both know that if they start this, they will both go down. So I don’t think it should be a big risk. But the thing with Donald Trump, is you just don’t know. He has been running the most incoherent Administration we have seen,” Sandaram says. “What he says today is not correlated with what he says tomorrow … and what he’ll actually do. So we have to consider the possibility of an escalating trade war.”

For anyone who relies on global trade, Trump has said some frightening things. On the campaign trail, he talked about hitting Chinese imports with 45 per cent tariffs and accused China of currency manipulation. Since becoming President, he has pulled the US out of the Trans-Pacific Partnership free trade agreement. In a leaked recording, he has talked about imposing 10 per cent tariffs on all imports and is said to be considering border taxes.

His key trade adviser has been China hawk Peter Navarro, author of Death by China: Confronting the Dragon. And he has nominated Robert Lighthizer – who has accused China of unfair trade practices – as his US Trade Representative. Bloomberg has surfaced an article Lighthizer wrote in 2011 praising Ronald Reagan’s aggressive trade stance when Japan’s economic rise threatened the US.

There are concerns that Trump may look to follow those Reagan-era tactics, invoking section 301 of the US Trade Act, which allows a President to bestow “unfavourable trading status” on certain nations. It’s a measure the US hasn’t used since it adopted World Trade Organisation rules in 1995. And, as the many critics have warned, the world has changed. China is not like Japan, politically and militarily dependent on the US.

Last month, Wheeler told the Herald that his trade concerns deepened after visiting Washington DC at the start of the year. “I was in Washington recently talking to a number of senior people – very well connected to the Trump Administration. They were saying that the concerns around China are deeply felt. In other words, the Trump Administration has very strong views about currency manipulation and trade practices out of China. I found that deeply worrying.” Wheeler warns that the Trump risk comes on top of a protectionist trend which is already dampening global trade and threatening growth.

Long-time New Zealand trade advocate Stephen Jacobi agrees. “Undoubtedly it is a concern,” he says of Trump’s protectionist rhetoric. “It was already a concern. Protection was already on the rise and we had seen a slowing in trade growth as well.” The advent of the Trump Administration has thrown the spotlight on this he says. Jacobi, who was head of the NZ US Council as executive director from 2005 to 2014, is now executive director of the NZ China Council, so has a good perspective on New Zealand’s relationship with both economies.

“It is early days for the [Trump] Administration,” he says. “In fact the Administration isn’t even in place yet. We just have to withhold our judgment for a bit, however much it might pain us to do so, to see what actually happens.” From discussions he has had in Wellington, Jacobi believes New Zealand officials are very much taking that wait and see approach. That said, the Government has been working on a new trade policy strategy and is expected to release it this month. It will have to acknowledge the growing risks and look at alternatives to the TPP, Jacobi says. “But I doubt whether they will have given up on the US just yet. “So concern, yes. Panic no,”

Professor Natasha Hamilton-Hart, with the Department of Management and International Business at Auckland University, says one of the direct risks to New Zealand is the prospect that Trump scores an own goal with his economic policies. “I know the markets seem to be pricing in good times on the horizon but I’m pretty sceptical that that is going to last. She doesn’t see a sustainable growth trajectory coming out of either the tax or infrastructure programme.

Things like border taxes and tariffs would be distortionary and depress consumer spending, she says. “We will see an increase in military spending and with the tax cut will start to see an increase in the deficit, which is going to have implications for US interest rates. “There are potentially quite contractionary processes in the medium term. They just don’t seem to have a coherent, workable plan.”

Then there are the diplomatic risks around a President who tweets his midnight thoughts to the world.. Trump’s impact on Asia-Pacific trading relationships is a serious concern. “This might be overly optimistic,” Hamilton-Hart says. “I’m doubtful that it will come to a 45 per cent tariff on Chinese exports because that would be so disrupting and damaging to US firms and US consumers. It’s going to double the price of everything in Walmart.”

“What I think is more likely is that we will see a stronger line of creeping protectionism … so cancelling the TPP, looking at alternatives to dispute settlements outside the WTO, that kind of thing. I imagine we’ll see a lot more of that. And I imagine that is what China is gearing up for. So yeah, a less rule based trading system.”

The irony of Trump’s trade deficit obsession is that running big deficits is what actually gives you power on the global economic stage, Hamilton-Hart says. In other words, a big net importer is the customer and the customer is always right. “So if you stop running those trade deficits, then you no longer have the ability to throw your weight around. If Donald Trump were to significantly withdraw the US from world trade by putting up barriers and shrinking the US economy … that can only go with a reduction in US influence.”

China, for its part, doesn’t appear keen on a trade war and isn’t rushing to fill the trade leadership void left by the US . For example, it appears to be carefully maintaining the strength of the Renminbi to avoid inflaming US currency hawks. “They certainly do not want a trade war,” Jacobi says. “They’ve got enormous economic interests with the United States. And I think you can rely on the Chinese to manage all of that in a very sensible way.”

What worries Jacobi more is the risk of America over-playing its hand on security and sovereignty issues – like Taiwan. “That’s much more worrying because you can’t always guarantee how a nationalistic China might react,” he says. “When you touch on issues of national sovereignty with the Chinese, you don’t get the same sort of reaction that you do on other things.”

Jacobi does have faith that the US system, with its constitutional checks and balances on executive power, will work – in time. “But he [Trump] has a lot of power to do things in the short term. While congress catches up.” Likewise, there will be powerful lobbying forces in the US business community who will push back at things he might want to do. “But they also take time,” Jacobi says. “I’m confident that over time the right decisions should be made. But what damage will be done in the meantime is a bit of an unknown. And the world has lost a whole lot of leadership around open markets and free trade.”

So where does that leave the New Zealand and its Asia-Pacific trading partners?

The remaining TPP signatories head to Chile later this month to discuss what, if anything, is salvageable without America. The Americans have said they will send a representative to that meeting, although it’s not clear who that will be or what level of interest they will take, say Jacobi. “And China will also be around. Because there is a Pacific Alliance meeting [a Latin American trading bloc] and the Chinese have been invited to that.”

There is a need for quiet diplomacy behind the scenes and New Zealand could play a key role in that, says Jacobi. But we need to be careful not to upset the other members of the TPP. Particularly the Japanese who, says Jacobi, “are in a very invidious position”. “They had this ballistic missile sent from North Korea the other day. They have got real security concerns, for which they have to rely on the US. They are not going to be drawn to take issue with the United States unnecessarily.”

China is already a member of an alternative multilateral trade group – the Regional Comprehensive Economic Partnership (RCEP), which also includes New Zealand. If completed, that free trade agreement (FTA) would include the 10 member states of ASEAN (Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand, Vietnam) and the six states with which ASEAN has existing free trade agreements (Australia, China, India, Japan, South Korea and New Zealand).

There have been suggestions that China may look to push this deal as a TPP alternative. But China hasn’t yet shown any signs of taking the lead, says Jacobi. On the one hand, we’ve heard rhetoric from Chinese President Xi Jinping about China’s global leadership, but the reality is that they haven’t taken a major role in multilateral negotiations yet, Jacobi says. “Maybe it’s time. They do have an enormous ability now to fill a vacuum.”

It is a different game now, says Hamilton-Hart, who believes the TPP is effectively dead. “So do we make a much better effort to get on board with RCEP?” she says. “Or are we going to hang in there and hope that we could do a bilateral with the US … which I think would be a bad thing to do as we’d be massively disadvantaged in the negotiations.” 

Jacobi agrees that the bilateral path is problematic. “We can’t afford not to push on any open door,” he says. “But the reality is that is bloody hard going. Look at the experience we had with Korea, very complicated.”

Trump has said he’ll do bilateral deals with TPP partners. But we would want dairy concessions and the US would want a lot of movement on medicines, says Jacobi. And neither would play well politically for either nation. “We’ve got to talk, but will we be high up on the list? And will it be better than TPP? Most unlikely”

“I don’t want to be too pessimistic,” says Auckland University’s Sandaram. “There may be some opportunities as a small country where you could fly under the radar. It’s harder for a big country to be non-aligned.” This could be a unique opportunity, she says. “We could try and stay neutral and expand into both markets.” Sandaram, who has been based in New Zealand for only a year, feels New Zealand is sometimes overly cautious about Chinese sensitivities. “It’s not a traditional link like the UK or Australia, so maybe it is because it is new that we are so cautious.”

Jacobi believes the Chinese have a good understanding of our deep political and economic ties with the Western nations, and particularly the US. “In fact, one of the positive aspects they see in our relationship is that we are an interesting interlocutor because of our attachment to the West,” he says. “But they also know our trade and economic ties are towards China. So whether that will amount to cutting slack … I’m not sure.”

Both Sandaram and Jacobi believe we have more options than we did a generation ago. “We need to diversify,” says Sandaram. “China is decelerating. But we have Asian powers that are fast growing economies. India, Malaysia, Indonesia – with the emerging middle class there is going to be