Category Archives: Economics 101

THE EU IS A NEOLIBERAL, CORPORATIST PROJECT – Bill Mitchell * The Left Case Against the EU – Costas Lapavitsas.

“A cabal of elites who are unelected and largely unaccountable.”

Under current EU trade agreements being negotiated profit becomes prioritised over the independence of a legislature and the latter cannot compromise the former.

There is never a case to be made that a corporation should have institutional structures available that allow it to use ‘commercial’ arguments to subvert national legal positions.

The EU is not an institution or structure than anyone on the progressive Left should support or think is capable of reform any time soon. It has become a neoliberal, corporatist state and hierarchical in operation, with Germany at the apex, bullying the weaker states into submission. Divergence in outcomes across the geographic spread is the norm. It is also the anathema of our concepts of democracy, both in concept and operation. It is more like a cabal of elites who are unelected and, largely unaccountable. By giving their support to this monstrosity, the traditional Left political parties (social democrats, socialists etc) have been increasingly wiped out, such is the anger of voters to what has become a massive coup by capital against labour.

One of the the hallmarks of the neoliberal era has been the way it has pushed the concept of ‘society’ to the background. People live in societies not economies. Economies are meant to serve those societies (and us) not the other way around.

Over the past three decades, financial globalization has produced a highly interconnected but deeply unstable financial system. Almost all of the transactions that this sector is engaged in are unproductive, wealth shuffling.

The problem is that when the players get ahead of themselves the folly they create spills over into the real economy and starts damaging the well-being of all of us. What we have now is a financial sector that is way too large and which uses its financial clout to manipulate political systems to ensure policies structures allow it to get even larger.

“The framework of financial market liberalization may restrict the ability of governments to change the regulatory structure in ways which support financial stability, economic growth, and the welfare of vulnerable consumers and investors.” IMF

Under current EU trade agreements being negotiated profit becomes prioritised over the independence of a legislature and the latter cannot compromise the former.

In other words, a democratically-elected government is unable to regulate the economy to advance the well-being of the people who elect it, if some corporation or another considers that regulation impinges on their profitability. Corporation rule becomes dominant under these agreements.

The agreements create what are known as ‘supra-national tribunals’ which are outside any nation’s judicial system but which governments are bound to obey. The make-up of the tribunals is beyond the discretion of a nation’s population, and are typically dominated by corporate lawyers and other nominees. The notion of accountability disappears.

These tribunals can declare a law enacted by a democratically elected government to be illegal and impose fines on the state for breaches. With heavy fines looming, states will bow to the will of the corporations. Corporation rule!

There is never a case that can be made where a corporation has primacy over the elected government. So there is never a case for so-called ‘Investor State Dispute Mechanisms’ in bi-lateral agreements between nations.

A nation state is defined by its legislature and that institutions set the legal framework in which all activity within the sovereign borders engages. Corporations have rights under that framework as do citizens. But the assumption is that the legislative framework should reflect the goals of national well-being.

There is never a case that a corporation should have institutional structures available that allow it to use ‘commercial’ arguments to subvert national legal positions.

The EU technocrats work away every day on strategies and rule designs and negotiations which explicitly undermine the capacity of elected governments to represent the best interests of their nation. Their trade agreement negotiations are just one aspect of that behaviour.

This is core EU. If you were to eliminate it the ‘European Project’ as it has become would be terminated.

Prof. Bill Mitchell

Book review

The Left Case against the EU

Costas Lapavitsas

A new book advancing the case against the EU is of crucial importance in arguing that its neoliberal structures are irreformable and incompatible with left advance.

COSTAS LAPAVITSAS’S detailed critique of the EU is of immediate importance to all on the left. A renowned expert on the dynamics of contemporary capitalism and professor of economics at London University (SOAS), Lapavitsas was elected as a Syriza MP in 2015.

He resigned from the party in protest at the Syriza government’s capitulation to unending EU demands for austerity and its attacks on the labour movement.

The book contains a penetrating analysis of EU economics. However, its strongest recommendation is the author’s own political experience.

Lapavitsas’s conclusion is that the left can never win if it argues within the terms set by the EU, that the EU cannot be reformed and that its structures, including the single market, are fatally prejudicial to any attempt to implement left policies or indeed simply measures that promote industrial regeneration and defend employment of a left Keynesian character.

He warns the Labour Party that the single market ”is not compatible with the aim of beating neoliberalism, restructuring the British economy and reducing the power of the City in favour of workers and the poor through a far reaching industrial strategy.”

Why has the EU taken on this neoliberal character? Lapavitsas argues that it was always present.

Long before the Treaty of Rome, Margaret Thatcher’s favourite economist Frederick Hayek had advocated a Federalist Free trade association in Europe as offering the ultimate protection against socialism.

Supranational structures would make it possible to bypass popular pressure on national governments for democratic control over capital.

The same supranational institutions would give legal sanction to the myth that economic well-being demands that markets remain free and supreme even if, in reality, such markets are monopolised and also reflect the monopoly power of some states over others.

Lapavitsas argues that this antidemocratic potential became fully explicit with the Maastricht Treaty of 1992 and the introduction of a single currency. At that time, massive differences in economic power existed across the EU between the great industrial combines of Germany and to a lesser extent the Benelux countries and Sweden and the rest, Greece, Portugal, Spain and even Italy.

Trapped within the single currency, deficit countries could no longer devalue to compete. Nor could their governments use any form of state aid to stimulate industrial redevelopment.

As a result, inequality increased and trade imbalances, financed by German, French and British banks, grew to massive proportions.

The outcome, in 2008-2010, was financial crisis, but it is a crisis that is not resolved. Big capital in Germany and its allies elsewhere remain opposed to any fiscal union that would internationalise these debts across the EU. Why? Because this would rob them of the power to secure further institutional and economic change across the EU.

Here Lapavitsas exposes another and less well-known aspect of German industrial dominance, its reliance on driving down labour costs.

German capital investment in industry has in fact been quite low and the country’s high productivity has depended on a series of strategic reductions in labour costs.

In the 1990s, German industry was able to do this by driving industrial supply chains into Eastern Europe to exploit highly qualified but much cheaper labour. Once this potential was largely exhausted, there was an assault on the domestic labour market.

From 2002 the Hartz reforms ensured, says Lapavitsas, that “the protection of German workers in the labour market was profoundly weakened and wage pressures intensified.”

Where did German capital investment go ? Lapavitsas documents the capital flows and demonstrates that it was used to consolidate monopoly control elsewhere within EU economies. And the same pattern continues today. The drive to reduce labour costs continues in Germany and across the EU as competition intensifies with the US.

This is why German capital and its allies need the bargaining lever of debt and austerity to compel further institutional change and, like all processes that involve monopoly power and exploitation, it is unlikely to have a happy ending.

Lapavitsas urges the left, and especially Britain’s Labour Party, to look this reality in the face and seek instead “a radical internationalism that would draw on domestic strength and reject the dysfunctional and hegemonic structures of the EU giving, fresh content to popular sovereignty and democratic rights.”

The Left Case Against the EU

Get it at Amazon.com

“Out-Thatchering Mrs.Thatcher”. USER PAYS, NEW ZEALAND’S NEOLIBERAL CONVERSION, Rogerpolitics – Chris Trotter * An analysis of ‘The New Zealand Way’ – Georg Menz.

How did a country known for its progressive policies, its welfare state and its anti nuclear and environmental policies so quickly and emphatically embrace the tenets of Neoliberalism and the New Right?

New Zealand, in the 1980s, went from being one of the most regulated countries in the OECD to being one of the most deregulated. It underwent a very painful period of transition and adjustment during the reforms. Even now the beneficial effects are far from obvious. Market liberalisation has come at a very high social cost. Poverty and social inequality are rising. New Zealand presents a paradigmatic case of complete market liberalisation and the embrace of neoliberal doctrines.

With remarkable alacrity, the ideological and practical political infrastructure required to support the new economic regime was cemented into place. In the nation’s schools and universities; in it’s publicly and privately owned news media; in its local and national institutions, Rogerpolitics became the new orthodoxy. For the next thirty years it would not only inspire the design of the mechanisms by which political power is exercised, but also the moral justifications for their use.

Those New Zealanders born after 1984, New Zealand neoliberalism’s “Year Zero”, have absorbed the “free market” catechism practically without thinking.

Rogerpolitics does not believe that democracy is a market friendly form of government, and all Rogerpoliticians are expected to act accordingly.

New Zealand is a case study of a small country moving from strong isolationism to full fledged market liberalism. New Zealand policy makers concluded in the mid 1980s that isolationism was no longer a viable policy option. Instead, they turned their country into a laboratory of free trade and Chicago style Neoliberalism. Does this model have insights to offer to other small states?

Chris Trotter

“ROGERNOMICS” is political shorthand for the neoliberal economic policies introduced by Labour’s finance minister, Roger Douglas between 1984 and 1988. While most New Zealanders have heard of Rogernomics, nowhere near as many have heard of its inseparable companion, “Rogerpolitics”.

The term was coined by the New Zealand political scientist, Richard Mulgan, to describe the form of politics required to make sure that Rogernomics “took” in a country which, on the face of it, should have rejected neoliberalism out of hand. Had Rogerpolitics not been so successfully embedded in the key organs of the New Zealand state, then Rogernomics would not have lasted.

Critical to the success of Rogerpolitics was the widespread public disillusionment with the style of politics that preceded it. In New Zealand’s case, the principal target of the public’s hostility was the National Party Prime Minister, Rob Muldoon, and his highly interventionist economic policies – “Muldoonism”.

An additional factor in the public’s antipathy towards Muldoon was his facilitation of the extremely divisive Springbok Tour of 1981. In the eyes of younger New Zealanders, “The Tour” was proof of their elders’ unfitness to rule. The people referred to by the then prominent political journalist, Colin James, as the “RSA Generation” had, in the eyes of the “Vietnam Generation”, been confronted with a straightforward moral test, and they had failed.

Without Muldoon and Muldoonism; without the Springbok Tour; the hunger for a new way of managing the economy and running the country would not have been so acute. The proponents of neoliberalism, or “free market forces” (as the ideology was more commonly referred to thirty-five years ago) were pushing against an open door.

It was the same all over the advanced capitalist world. The interventionist economic policies that had played such a crucial role in generating the unparalleled prosperity of the post-war period had finally run up against the buffers of the capitalist system. Every attempt to reduce the rising levels of unemployment and inflation that were the primary manifestations of the system’s failure only ended up pushing them higher. Margaret Thatcher’s Conservative Party captured the growing sense of unease with its 1979 slogan: “Labour isn’t working.” The following year, in the USA, the Republican candidate for President, Ronald Reagan, summed-up the popular mood when he declared: “In this present crisis, government is not the solution to our problem, government IS the problem.”

In its essence, this is what Rogerpolitics is all about: getting government out of the way. If politicians, by interfering in the economy, only made things worse, then the obvious solution is simply to prevent them from interfering.

. . . Bowalley Road

A Model Strategy for Small States to Cope and Survive in a Globalised World Economy? An Analysis of the “New Zealand Way”.

Georg Menz, Department of Political Science, University of Pittsburgh

Can New Zealand indeed serve as a model for other small states?

1. Introduction

A major issue of concern to contemporary social scientists is the relative decline of the autonomy of the nation state. Traditionally, the nation state served as a useful unit of analysis for scholars in international political economy. It may no longer be a useful starting point. Advocates of the globalisation thesis argue that the nation state is losing much of its room for maneuver in public policy decision making. This is a result of trade liberalisation and deregulation, particularly of the financial sector; rapid technological advances in telecommunications and data processing, and the exponential growth of international trade and foreign direct investment (FDI).

As I will argue below, two opposite arguments about the impact of globalisation on small states might be put forward.

First, it would appear that small states are particularly affected by a loss of autonomy as a result of globalisation. Smaller states face a constrained choice of responses to the impact of the world economy on their own national markets. By virtue of their economic and political power, size and strength, smaller states dispose of a relatively smaller array of policy responses than larger states. They cannot hope to set the parameters of the global economy given their relatively small economies and limited political and military clout.

Small states are usually host to only a small number of transnational corporations and, owing to the size of their own domestic market, they are commonly not only dependent on exporting their own products, but also on importing raw materials from abroad.

Alternatively, the opposite argument might be made. Small states are particularly well prepared to deal with open markets because of their economic structure. For many European small states, a protectionist trade policy was never a viable option.

Katzenstein (1985), who is often credited for his pioneering work on “small states”, points out that these states, due to their dependence on both imports and exports, are committed to the cause of international free trade. Foreign trade typically makes up a large proportion of small state Gross Domestic Product (GDP). Small states also depend on occupying market niches with relatively highly developed technology in sections of the economy where they enjoy a comparative advantage in production or a technological lead over their competitors.

In this study, I seek to analyse how one small state has responded to the challenges of globalisation. Using New Zealand (NZ) as a case study, I will examine New Zealand’s remarkable reform process as one possible policy response to dealing with a globalised world economy. “Model New Zealand” has been heralded as a successful model of structural adjustment by international observers. Regardless of whether one accepts the normative component of this judgement, New Zealand presents a paradigmatic case of complete market liberalisation and the embrace of neoliberal doctrines.

Can New Zealand indeed serve as a model for other small states? I seek to critically examine the reform process and shed light on its intellectual sources, employing some of the insights generated by the constructivist approach in international relations. Can New Zealand be properly considered a success story from which other small states can learn? The country went from being one of the most regulated countries in the OECD to being one of the most deregulated.

I argue that it underwent a very painful period of transition and adjustment during the reforms. Even now the beneficial effects are far from obvious. Market liberalisation has come at a very high social cost. Poverty and social inequality are rising.

The economic data reveals an equally mixed picture. In 1995, commentators admired the “turn around economy” and observed that the initial hardship seemed to be finally paying off. After the devastating impact of the Asian crisis in New Zealand, this assessment seems questionable and premature. New Zealand has been able to successfully fill some market niches in cutting edge agricultural engineering. At the same time, however, extreme liberalisation also means strong dependency on foreign capital, as is especially true for New Zealand with its large current account deficit and high level of foreign direct investment. Dependency on highly volatile foreign capital can become problematic rather quickly, as New Zealand’s recession in the wake of the Asian crisis vividly demonstrates.

2. Small States and Globalisation

How should we conceptualise globalisation? And how is it affecting the policy choices of small states? The purpose of this section is to arive at a working definition of globalisation and to analyse its impact on small states.

Since academic discourse on this subject is of a relatively recent nature, it is perhaps unsurprising that no single coherent definition of the phenomenon has yet emerged. However, from the writings of those authors who are willing to acknowledge globalisation as a genuinely new phenomenon a common thread can be extracted. These authors argue that the nation state is losing its autonomy, or posit, as Susan Strange has done “the retreat of the state”. The state’s sphere of control is decreasing, as an array of new actors moves in to undermine the state’s formerly comfortable command of territorially based authoritys. Among those actors are international institutions, networks and, most importantly, private transnational and multinational corporations.

While the nation-state no longer seems able to command the same array of macroeconomic tools, obvious winners are international markets. Global financial flows of gigantic proportions play an important role in shaping and curtailing governments’ choices.

Following the wave of deregulation and market liberalisation, which commenced in the late 1970s, particularly in the financial sector, the state’s macroeconomic weaponry chest looks considerably less well-stocked today. No longer can a government simply rely on monetary policy to set its economy’s parameters: If it tries to increase the interest rate so as to curtail inflationary growth, this move will simply attract mobile foreign capital.

National fiscal policy is also affected by the increased mobility of global capital. Nation states cannot freely determine corporate tax levels, because what the market deems to be an excessive rate will only cause companies to invest in regions or state more amiable to their interests. Some analysts have gone as far as positing a global “race to the bottom” in which regions and indeed nations have to compete for corporate investment by lowering their environmental, safety, health and social standards and offering tax breaks and other incentives”. Regardless of state incentives, due to the decrease in strict regulation of the financial sector, global capital is much more uninhibited to move into and out of new locales at relative ease. Large volumes of money are on the move, “free to roam the globe looking for the brightest investment opportunities”.

There are two factors contributing to the relative ease with which large scale global financial flows are occurring today at an unprecedented rate.

Firstly, deregulation of the financial markets made short term foreign investment and portfolio investment much easier than before. Secondly, technological innovation, another important factor mentioned by Strange and Drachels, has meant that such transfers of financial capital can take place at an ever accelerating pace. Rapid advances in modern computer based technology allow for rapid and easy data processing and manipulation. The progress of telecommunications technology enables global dissemination of information at unprecedented levels of speed. In fact, I would argue that innovations in technology as such undermine the feasibility of the nation state’s regulatory capacity.

The dramatic increase in foreign direct investment (FDI) should also be mentioned, which is a relatively recent development as well. Investment of a given company abroad in means of production (factories, plants, refineries, etc.) is a phenomenon unparalleled in previous economic history and ought to be distinguished from colonial patterns of raw material extraction through subsidiary companies within colonies. Foreign direct investment in production facilities either seeks to elude protectionist measures by the host country or endeavours to exploit different levels of wages or social standards for production.

Thus, global trade is to some extent no longer the exchange of goods among companies from different nation states (taking advantage of Adam Smith’s comparative advantage in the production of goods), but instead has to be re-conceptualised as the intra company exchange of goods in various stages of the production cycle”.

Closely related to the issue of establishing a concisely specified definition of globalisation are questions of distinctiveness and uniqueness. Is the current degree of global economic interdependence and growth of trade dependency indeed a genuinely new phenomenon? Is there something that distinguishes the global exchange of money, goods and services today from exchange routes and networks in the age of Cecil Rhodes’ Imperialism, Marco Polo’s Asian expeditions, trans Saharan trade routes, or Roman trade with its neighbours? Perhaps so, some authors might concede, but they are less convinced that the level of current global interdependence and international trade is more than just a return to the pre 1914 levels of global interchange.

Different scholars emphasize different policy areas, which vary in the degree to which they are affected by a globalised world economy. Obviously, there are also different normative points of view arguing about whether or not globalisation is a phenomenon worthy of appraisal or condemnation, usually depending on the author’s political persuasion .

Based on this discussion, I propose to define and conceptualise globalisation in terms of the speed and regulatory ease of worldwide flow of capital. While it is important to consider the rapid growth of international trade in recent years as well, the latter component does not constitute a genuinely new phenomenon and therefore does not really deserve a new label.

At this juncture, it is important to distinguish between globalisation as defined above and internationalisation, that is, the increasing global interdependence based on growth of international trade.

How and in what way is globalisation affecting small states? While Katzenstein contributed significantly to research on small states, his work and that of others exploring small states in the literature dates back to the mid 1980s or earlier. At that point, the imminent pressures of globalisation had not yet received the same amount of scholarly attention as is true of today, since they were not as readily apparent.

As briefly alluded to in the beginning, two arguments could be advanced here.

Based on Katzenstein’s research, one might argue that small states are actually particularly well prepared for a world of deregulated financial and trade flow. Since they have always been dependent on the international market place for the raw materials they imported and the export of the manufactured goods they exported, they had to be able to navigate the treacherous tides of the international marketplace from very early on. In fact, because of their status they had no choice other than to open up their economy. At the same time, they found ways to specialise in niche products.

On the other hand, the argument could be made that small states are but pawns in a game they cannot control nor even manipulate. The globalised economy finds small states in a particularly vulnerable position.

If we accept the premise that nation state lose some of their ability to manipulate their macroeconomic parameters, this must apply with particular vengeance to small states. They are even more vulnerable to the consequences of the rapid inflow and outflow of foreign short term investment. If governments of large countries can no longer counteract the speculative movement of the markets, this must be an even more unsurpassable challenge for small states.

Companies from small states cannot enjoy the advantages of the economies of scale, which a large domestic market offers. Small states are typically host to only a small number of transnational companies (TNCs), which are in a position to take advantage of deregulated international trade and investment opportunities. Their economies are made up by small and medium sized businesses, which run the risk of being taken over or run off the road by large foreign TNCs. The best these small and medium sized businesses can hope for is to diversify their customer base by gaining new markets abroad. However, they will cenainly be hard pressed to find products they can effectively and competitively market abroad owing to their limited resource basis for international advertising, marketing, and distribution.

New Zealand is a case study of small country moving from strong isolationism to full fledged market liberalism. New Zealand policy makers concluded in the mid 1980s that isolationism was no longer a viable policy option. Instead, they turned their country into a laboratory of free trade and Chicago style neoliberalism. Does this model have insights to offer to other small states?

3. Introducing the ‘New Zealand Way’

In 1984, the small South Pacific island nation of New Zealand gained worldwide attention by implementing the most comprehensive economic reform program of any OECD country to date. Within only a few years, New Zealand experienced a paradigmatic shift from neo Keynesiasism to New Right monetarism. It went from being one of the most regulated countries in the OECD to being the most liberalised and deregulated. In fact, neo liberalism found a much more zealous disciple in New Zealand’s Labour Party than is true for any other New Right leader. New Zealand “out Thatchered Mrs. Thatcher”.

A small remote island nation, over a thousand miles from its nearest neighbour Australia, it had previously been known for pre-empting its European cousins with progressive policies such as female suffrage in 1893, a comprehensive welfare system and a fervent environmental and anti nuclear policy. Now New Zealand stood at the forefront once again. This time, though, it overtook Western Europe on the right. It made headlines for a radical move away from Keynesian economics and the welfare state. Perhaps surprisingly, it was a Labour government, which under the stewardship of Prime Minister Lange and Minister of Treasury Roger Douglas jump started a radical programme of deregulation, market liberalisation and privatisation of state owned enterprises.

The OECD, The Economist, and other like minded apostles of the neo liberal New Right outdid themselves in praises for the blitzkrieg style economic reform programme which radically redefined the role and scope of government in New Zealand within a few years.

The reform programme included the deregulation of the financial sector, the removal of subsidies to producers, both in the manufacturing and the agricultural sector; the removal of tariffs on imports, a fundamental tax reform, a comprehensive restructuring of the public sector, a radical cut in the generous system of welfare provisions, a total remodelling of labour relations, and the corporatisation and privatisation of formerly government owned enterprises. The following table provides an outline of the reform program enacted in New Zealand between 1984 and 1994.

As can be seen above, the liberalisation programme occurred in two major waves. Under Labour Party guidance, from 1984 to 1990. the first wave of reforms was implemented. As Minister of Finance Roger Douglas played such a pivotal role in the process, the label “Rogermomics” is often applied to the reforms. These included industry deregulation, trade reform and capital market reform. Startling to many voters and academic observers, the National Party continued the reform programme, after it took over power from Labour in 1990. The second wave of reforms entailed macroeconomic stabilisation, corporatisation of state owned enterprises (SOEs), privatisation of SOEs, a comprehensive labour reform, and a fundamental restructuring of the welfare state.

As can be seen, the reform programme bears a striking resemblance with structural adjustment programmes commonly recommended for Third World countries.

The first steps of deregulation affected the financial sector. and included the removal of exchange rates and a floating of the New Zealand dollar. The government committed itself to a monetarist anti inflationary regime, by means of sustaining high interest rates and exchange rates. Price stability was enshrined as the overarching goal in the Reserve Bank Act of 1989, leading to what can be described as the “Bundesbank-sation” of the institution. Labour drastically cut down subsidies, abolished import licences, and began to phase out tariffs. It also opened up the economy to foreign direct investment. In fiscal policy, personal income tax for top earners was reduced significantly and a goods and services tax was introduced.

Government activity and the public sector as a whole were fundamentally restructured. Government departments were re-organised along corporate lines. In many cases, this meant transformation into SOEs and subsequent privatisation, in most cases to Australian or American companies. This corporatisation included government research facilities, hospitals, public housing, and universities.

As part of the second wave, the labour market was liberalised and the welfare state underwent severe cutbacks in scope and size. This translated into a full blown attack on the structural power of unions with the abandonment of collective bargaining imbedded in the 1991 Employment Contracts Act. At the same time, welfare benefits and eligibility were drastically curtailed.

This “big bang” reform program marked a revolutionary departure from the past. New Zealand has a long history of heavy state interventionism and government regulation. Barry Gustafson notes that:

“Manufacturers and wage earners were protected by import controls, and farmers were encouraged to produce and were protected from fluctuations in overseas markets by subsidies, tax incentives, and producer boards, responsible for the coordination of marketing of products. The banking system and value of the currency were tightly controlled.”

In fact, some of the economic measures pursued by its government were commonly associated with the State Socialist countries of the former Warsaw Pact such as tight controls on the circulation of currency, high tariffs, import quotas, and a central government agency co ordinating export policy. Government intervention has traditionally been regarded as beneficial and a cautiously modernising force.

Due to almost unlimited access for its agricultural products to its former motherland Britain, “England’s Garden” prospered throughout the 1950s and 1960s, boasting the third highest standard of living in the 1950s. New Zealand was able to provide its citizens a generous set of cradle to grave welfare provisions, universal health care and free access to education. Until the mid 1970s, unemployment was virtually unheard of.

Wage levels were set so as to guarantee a living wage “for a man, his wife and three children”.

The National Party government provided generous agricultural subsidies and managed the worldwide marketing of New Zealand’s agricultural products. Meanwhile, domestic manufacturing was protected from competition from abroad through high tariff barriers. The government willingly underwrote New Zealand’s continuing current account deficit by accumulating foreign debt. As delightful as life at the other end of the planet seemed, some troubling structural problems were already evident, such as the excessive dependence on the export of commodities.

In the 1970s these problems were brought to light as the global economy experienced meagre growth and high inflation. New Zealand was hard hit, exhibiting one of the lowest growth rates of any country within the OECD during the 1960s and 70s. There were a number of external shocks which New Zealand faced.

Firstly, main customer Great Britain joined the European Community, thereby becoming part of the Common Market for agricultural products. Though exceptional provisions were made to buffer some of the shocks for the New Zealand economy, this meant a sudden loss of New Zealand’s main market.

Secondly, in the wake of the oil crises of 1973 and 1979, New Zealand’s terms of trade deteriorated dramatically. Not only did oil prices rise exponentially, demand for commodities slipped. This hurt New Zealand’s economy badly, since its exports were still largely composed of wool, meat and dairy products. Notwithstanding a temporary boom in commodity prices between 1971 and 74, terms of trade deteriorated further throughout the 1970s and early 1980s. New Zealand’s unsophisticated reliance on agricultural products and its failure to diversify its export basis in time was beginning to backfire.

Thirdly, and related to this, in the wake of global stagflation, the Europeans were not alone in their hesitance to accept agricultural imports. A worldwide shift towards more protectionism occurred in the agricultural sector. This development continued to bedevil the New Zealand economy and only gradually came to an end.

Robert Muldoon, Prime Minister and Finance Minister between 1975 and 1984, attempted to address the economy’s sour performance by pseudo Keynesian methods. As part of the so called “Think Big projects”, he led an ambitious campaign to reduce New Zealand’s dependence on foreign oil imports and increase the domestic heavy manufacturing industry such as the steel industry in Northland. His macroeconomic policy was unfortunately poorly designed and inconsistent.

Though Keynes had called for state intervention to stimulate demand, this did not imply gross misallocation of funds to poorly planned projects.

Muldoon’s short sighted and ill advised course maneuvered unsteadily between heavy state interventionism, including the 1982 wage and price freeze, and cautious flirts with reforms. Essentially, this misguided lingering highlighted his lack of any real vision.

In 1984, the country underwent a severe economic crisis. Muldoon and his National Party had failed to offer anything more sophisticated than a simple wage and price freeze, while clinging on to an overvalued New Zealand dollar. Foreign debt had accumulated to a level of 40 percent of Gross Domestic Product (GDP), well in excess of what crisis ridden countries such as Mexico and Argentina had taken. In this situation, the National Party called a snap election on 14 July. Labour scored an overwhelming victory.

4. Why did it happen and why in New Zealand? Analysing the intellectual sources

“Government bad! Market good!”

Notwithstanding the economic malaise the country faced in 1983 and 1984, the dogmatic zealousness with which economic reforms were implemented by Labour Minister of Finance Roger Douglas and his small group of cohorts in the Treasury Department presents somewhat of a puzzle to the outside observer.

How did a country known for its progressive policies, its welfare state and its anti nuclear and environmental policies so quickly and emphatically embrace the tenets of neoliberalism and the New Right?

The simplest answer is usually provided by the defenders of New Zealand’s neo liberal experience. They are quick to point out that New Zealand faced with tremendous economic structural problems and facing a severe crisis and government bankruptcy had little choice. A small country cannot continue down a path of isolationism, but must accept to navigate the tides and the ups and downs of the global market.

This is, of course, hardly a satisfactory answer. The country still had other policy options, such as moving towards a more neo corporatist direction, as in Western Europe, or a much more gradual and cautious reform programme such as that in Australia.

A more satisfactory answer can be provided if we follow some of the insights generated by the constructivist literature in international relations. Scholars in this tradition have questioned the static structure-agent relation embedded in the neo realist paradigm and posit a more dynamic interrelation between the two. Since our environment is socially constructed and interpreted, actors respond to their perception of the environment. Constructivist scholars emphasise the importance of what states make of their situation. In this process of forming one’s perception, it is of obvious importance what types of intellectual frameworks inform the actor and to what extent these parameters can be manipulated as a result of the inflow and acceptance of ideas. There is now a burgeoning body of literature on the influence of ideas on policy makers. Scholars basing their work on these premises emphasise the diffusion of ideas through network channels. The results of a “cognitive evolution“ might thus disseminate worldwide.

Especially interesting is the suggestion that while ideas might be out in the open, they have to find channels of access to policy makers and are then usually adapted to circumstances and institutional configuration of individual countries.

However, we should remind ourselves, that the influence of ideas on actual policy makers, particularly those originated by academics, has been pointed out quite some time ago.

Keynes himself asserted in 1936:

“Indeed the world is ruled by little else than ideas. Practical men, who believe themselves quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.“

In the case of New Zealand, it seems fairly evident that the type of ideas and intellectual constructs embraced by Douglas and his associates at Treasury were imported from abroad, seeing that they constituted a revolutionary break with New Zealand’s state interventionist and later Keynesian tradition. Since the ideas behind the reform programmes were so alien to the New Zealand context, how can we account for this policy turn? Where, then, did these ideas originate?

In this context, the two major documents released by Treasury following the 1984 elections, Economic Management, and the 1987 elections, Government Management are informative to study. Economic Management was prepared by Treasury in a mere six weeks and provided the outline for the economic policies for the following six years. The spirit and at times even the letter of these documents betray their heavy indebtedness to the ideology of the New Right.

Most centrally, the neoclassical ideology of the Chicago School, the Public Choice writings and Austrian economics left their heavy imprints on the guidelines which were to dominate the New Zealand reform process.

A thorough summary of these intellectual sources would be well beyond the scope of this paper. However, one can adequately summarise these intellectual sources by pointing out the common themes stressed by these writers, namely a fundamental distrust in the state and a reliance on the market for the efficient allocation of resources and the greater good.

Or, to put it into slightly more acerbic terms, just as George Orwell’s pigs had chanted “Four legs good! Two legs bad!’ , so Friedman, von Hayek, Buchanan and their cohorts were chanting “Government bad! Market good!”

While New Zealanders profited over the decades from a benevolent state interventionism, Friedrich von Hayek, epitomising the Austrian school, portrayed the state as an inevitably power maximising leviathan, eager to clutch its paws around individual citizen’s liberties. Thus, the state was virtually guaranteed to intervene into an ever increasing array of individual liberties, thereby perpetuating a journey down a “road to serfdom”. The market, on the other hand, provides innovation and allows for creative discovery.

Chicago School economist Milton Friedman also strongly criticised government’s tendency to curtail an individual’s liberty. He postulated a minimalist role for the state. Only the unregulated market would provide for the most efficient price setting, send out the “right” signals, and thereby foster and encourage the activities of the utility maximising individual. Consequently, Friedman rallied against the welfare state and against any state intervention beyond a closely circumscribed array of public goods.

The sum of actions of rational, utility maximising individuals, on the other hand, would provide benefits for evelyone as the economy would move towards an equilibrium.

This semi religious belief in the invisible hand of the market in efficiently allocating resources and a general distrust in government was complimented by some of the Public Choice theorists, also originating at the University of Chicago as well as Virginia. Public choice applies some of the basic tenets of economics to political activity, arguing that bureaucrats, far from being benevolent altruistic and high spirited individuals, working in the interest of the greater public good, are really just as pettily minded profit maximising as anybody else. Thus, they attempt to maximise their department’s budget, size and scope.

How did Chicago influence New Zealand? What were the channels of influence along which these ideas travelled? And what characteristics of the domestic structure, emphasised by constructivists like Risse Kappen, nourished the implementation of the reform programme?

In this context, it is important to recognise the importance of channels of intellectual exchange with the United States. A number of Treasury officials had received their graduate training in the United States. To some extent, this mirrored the development in Latin American countries, particularly Chile and Mexico, where students trained in the US (the “Chicago Boys” in the Chilean example), applied with almost religious zealot the theories they had been indoctrinated with to restructuring the domestic structures of their home countries.

Similarly, many NZ Treasury officials had spent time at academic institutions in the US or had previous experience at such free market bastions as the World Bank or the International Monetary Fund (IMF).

We should mention in passing that many New Zealanders began to develop a negative self image of their own country as a sleepy backwater prone to old fashioned ‘boring’ Keynesian state interventionism. They were fed up with Muldoon’s heavy handed and fairly authoritarian paternalism.

In addition, we can point to at least two other intellectual sources.

First, there is the IMF. Schwartz points out that New Zealand’s reform programme bears striking similarity to the recommendations of the IMF for structural adjustment. New Zealand removed its wage, price and interest controls. deregulated financial transactions and phased out subsidies for manufacturing and agriculture. As mentioned previously, some NZ Treasury officials had professional experience at the IMF.

Secondly, it is certainly no coincidence that New Zealand launched its reform programme a mere five years after a similarly minded individual had ascended to power at 10 Downing Street. The former colonial power Great Britain still exerted an intellectual hegemony over New Zealand. Thatcher exhibited distrust towards the state and its role in the economy, initiating an expansive programme of privatisation and an extensive restructuring of the public sector. She also significantly curtailed the role of unions.

Meanwhile, in the United States, supply side economics and market liberalisation also carried the day after the election of Ronald Reagan in 1980. Reagan’s policies included measures such as deregulation, prominently in the field of telecommunications and airlines, “rolling back the state”, cutting down welfare expenditures, and enacting tax cuts, particularly at the top end of the income scale.

Following the constructivist research agenda, the particular domestic structures of a host nation also ought to deserve attention in an analysis of the impact of ideas on a given polity. In the case of New Zealand there are indeed particularities, in fact peculiarities which fostered the swift and rapid enactment of a comprehensive package of economic reforms. Two central factors merit our attention here.

First, as part of its colonial heritage, New Zealand had up until 1993 a Westminster style “first past the post” system and only two major political parties. In fact, New Zealand constituted a more perfect example of the Westminster model than the British motherland. Thus, once Labour had got hold of power in 1984, it commanded a comfortable absolute majority of seats. Political opposition thus had practically no way of manipulating the course of events. The same applies for the situation of the National Party after 1990. Because of the amount of power the executive could wield in this system, no checks and balances were in place to act as a dam against the blitzkrieg style policy making approach of Mr Douglas. Thus he and his intellectual companion in the Treasury Department were able to quickly enact their programme.

There was no second chamber of parliament, no effective opposition and no presidential veto to impede the onslaught of reforms.

Secondly, Treasury played a central role in the reform processs. In fact, it “became the principal initiator” and formed a “consistent, cohesive, intellectually convicted group” as Prime Minister Lange later recalled. It was able to do so owing to its “near monopoly position with respect to economic policy advice” within the “unitary, centralized structure” of the political system in New Zealand.

Because the reforms constituted such a radical break with the intellectual tradition hitherto pursued we must look abroad for some of the intellectual sources of the New Zealand sources. In this context it is enlightening to accept the premise of the constructivist turn in international relations and consider how ideas and norms can influence policy makers. The Treasury documents outlining the economic reform programme bear the heavy imprint of the Chicago school, the Austrian school and to some extent the insights of Public Choice. Based on the premise of a distrust of the state and placing faith in the invisible hand of the market, these theories shared in common their advocacy of relying on an unregulated market and a minimised state.

They made their way to New Zealand by way of intellectual interchange with the United States. A feeling of disdain towards Muldoon’s heavy handed authoritarianism, commonly yet falsely associated with Keynesianism helped usher in a paradigmatic intellectual change in New Zealand and a shift towards the free market ideas of Chicago. Domestic structures, such as a Westminster style political system, ensuring an absolute majority for one party, and the strong influence, which Treasury could exert, both contributed to the implementation of these ides in to practice.

5. A Model Strategy? Analysing the implementation of the “New Zealand Way”

In 1984, economic crisis mandated immediate action. Defenders of the reform programme argued that there was little choice to a comprehensive restructuring in light of the apparent failures of Muldoon’s pseudo Keynesianism. In any case, in the early 1990s “Model New Zealand” was touted in the international press as a success story and not only by the OECD. A never ending stream of international journalists, academics, and politicians descended perennially upon Wellington to explore what it was that had turned this small South Pacific nation into a “job creation machine”.

Commonly, New Zealand’s relatively low unemployment rate was mentioned along with its economic growth rate as measured by GDP. In 1993, GDP grew by 4.8 per cent, by 6.1 per cent in 1994 and by 3.3 per cent in 1995. Employment grew by 2 per cent in 1993, 4.3 per cent in 1994, and 4.7 per cent in 1995. Meanwhile, unemployment declined from 9.5 per cent in 1993 to 8.2 per cent in 1994 and again to 6.3 per cent in 1995 (see also appendix).

Government was able to record a surplus in its budget balance, allowing it to enact a tax cut in 1997. The implication was, of course, that both developing countries and the advanced industrial countries could stand to learn a lesson or two from this powerhouse in the South Pacific. Slavish adoption of an IMF style structural adjustment programme seemed to have paid off for the Kiwis. An economy, which up until the 1980s had exhibited sluggish growth and still bore uncanny resemblance to a developing country owing to its heavy reliance on a large commodity sector, was now showing signs of remarkable growth.

Meanwhile, the advanced industrial countries of Europe were suffering no or slow growth while facing a pressing structural unemployment problem. There was considerable debate about liberalising the labour market and restructuring the public sector in order to be able to successfully compete in a global economy. New Zealand had enacted all these changes and seemed to be harvesting the fruits the reform programme bore. It had gone from being extremely regulated and protectionist to being the most ardent supporter of an unregulated market environment. New Zealand’s remarkable reform programme seemed to translate into impressive economic benefits. Thus, the country seemed well suited to serve as a model for coping with the challenges of globalisation.

However, a closer look reveals a much more mixed record. Upon closer inspection, it becomes evident rather quickly that the 1993-95 economic boom constituted little more than a temporary recovery from almost a decade of recession. Throughout the 1980s, the payoffs from the reforms appeared far from evident. New Zealand went through a drawn out period of extremely painful adjustments. On many indicators, such as employment, the economy is returned to pre 1984 levels only in the late 1990s. In the following section we shall examine the economic performance in more detail.

As I will point out, the country paid a very high price for its “success”. Both the social cost is chilling and the issue of loss of national autonomy is far from a purely academic concern for many Kiwis. Privatisation and economic liberalisation has meant that many economic decisions are no longer being made in Wellington, but in corporate headquarters in Australia, Britain and the US.

Due to its reliance on foreign capital both in the form of portfolio investment and FDI the country has made itself vulnerable to the whims of the international financial markets, as became painfully obvious during the Asian crisis. A genuine success is New Zealand’s cutting edge technology in the field of agricultural engineering. But overall, a sober analysis of the costs and benefits of the reform programme cannot lead to the sameenthusiastic conclusions of the international financial media.

Let us consider the economic side flrst. Throughout the 1980s, New Zealand’s macroeconomic indicators were anything but impressive. In fact, between 1985 and 1992 total growth across OECD economies averaged 20 percent, while New Zealand’s economy shrank by one percent. In both 1989 and 1991 GDP growth was negative. Between 1987 and 1991, the unemployment rate more than doubled from 4.1 to 10.7 percent, reaching unprecedented levels and exceeding the OECD small member countries’ average (see appendix 2 for further details). While labour productivity did begin to increase in 1986, this was mainly due to massive labour cutbacks and not even a consistent trend. In fact, between 1984 and 1993 productivity growth averaged only 0.9 percent.

While Muldoon’s practice of heavy borrowing from overseas was severely criticised, Labour actually continued this practice without passing down the benefits to NZ citizens. Both total public debt and public overseas debt continued to increase, the former reaching a record 80 per cent of GDP in 1987. Inflation continued to vex the economy until 1993, averaging 9 per cent.

In the short to medium term the reforms brought about the worst recession in New Zealand since the 1930s. The “reinvention” of government and the public sector translated into a massive rise of unemployment. A country in which unemployment was virtually unheard of now saw workers laid off by the thousands. Unemployment peaked up to record levels.

Yet after eight painful years of transition, the reforms finally seemed to pay off. In December 1991, inflation dropped to below two per cent. In 1993, the balance of payment deficit moved below two per cent of GDP and the government budget showed a surplus for the first time in fiscal year 1993/94. Real GDP began to grow again in 1992 and unemployment began to sink in 1994-95. However, unemployment was still well above pre 1984 levels and so was public debt. According to the OECD, real GDP in 1992 was still 5 per cent below the 1985-86 level. The GDP growth in 1993 seemed to have brought NZ merely back into a general trend of worldwide economic recovery.

In the meantime, New Zealand had become a dramatically different society. Before analysing the more recent development and the impact of the Asian crisis, it is worth shedding some light on the social costs of “Model New Zealand”.

New Zealand has always been proud of its social cohesion. A quasi social democratic commitment to social equality, equal wages and a welfare state had meant a stable, peaceful and socially cohesive society.

Now, as the commitment to “sleepy backward” Keynesianism went flying out of the window, so too, did the commitment to social equality. The income gap rose and as unemployment grew, so did social inequality. Despite a slight increase in productivity, real wages by 1999 had slightly decreased since 1985/86.

A lot of the growth in employment can actually be traced back to the growth of part time jobs which doubled from 200,000 to 400,000 between 1984 and 1995, while the number of full time positions decreased. These part time positions typically do not entail the same amount of benefits as full time jobs.

Following the first wave of corporatisation and privatisation, which lead to massive growth in unemployment, the National party, adding insult to injury, enacted a combined programme of welfare cuts and labour market deregulation in 1990/91.

Subsequently, poverty increased markedly. By 1991, 17.8 per cent of all New Zealanders lived below the poverty line, while the median income had declined by 19.2 per cent between 1982 and 1991.

Perhaps unsurprisingly, crime rates rocketed, violent crime increasing by 50 percent between 1982 and 1991, endowing New Zealand with the dubious distinction of having the third highest violent crime rate in the world.

New Zealand today has the highest youth suicide rate in the western world. For a country which is trying to portray itself as one of the few success stories in creating a bicultural society, Aotearoa New Zealand, the disproportionate rise in poverty and unemployment among its Maori and Pacific Island population presents at the very least a severe embarrassment.

Of serious concern is the emergence a two tier social stratification of society, which parallels racial lines and mirrors the unfortunate American experience. Symptoms of this development are the growth of urban ghettos in South Auckland and the growth of criminal youth gangs among Maori and Pacific Island youths.

Following the cuts in the welfare system enacted by National in 1990, real poverty emerged in New Zealand to a degree previously unprecedented. There was a rapid growth in the number of people reliant on soup kitchens and private welfare organisations. Furthermore, corporatisation and privatisation of the Housing Corporation has obliged this former component of the welfare state to raise profits. A logical result has been the steady increase in rents and sales of a number of flats. This policy accepted the eviction of the most needy, precisely those for whose purpose the system was created. This lead to the emergence of homelessness for the first time in the history of the country.

At the same time, the corporatisation of higher education has meant the introduction of steep fees for tertiary education. Government drastically cut its spending on the education sector. While New Zealand students previously were obliged to a nominal fee of approximately NZ$100 per academic year, rates increased to between NZ$3000 and NZ$20,000 by 1999. Student loans are available, but at market level interest rates only. At the same time, student allowances were cut both in size and scope. This has contributed further to social stratification and inequality. Meanwhile, the policy of privatisation and corporatisation was extended to cover the health sector with the better off being offered the option of buying into private health insurance schemes. Meanwhile. the quality and scope of public health provision is deteriorating.

In the medium to long term, the radical privatisation programme and liberalisation of the economy has made New Zealand extremely dependent on volatile international financial markets. Such dependency became readily apparent during the Asian crisis.

As speculators withdrew their money from the overvalued Asian currencies they did not stop and discriminate, thereby excluding New Zealand. The Asian flu rapidly spread to the country, plunging it into recession and causing a fall of the NZ dollar to below 50 US cents for the first time in eleven years. New Zealand’s Top40 share index followed the dramatic decline of its Asian cousins in late 1997 and again in June 1998. In a sense this was not surprising. seeing that New Zealand suffered from similar problems as Thailand did, namely a large current account deficit, caused by the large inflow of foreign capital. While superficially speaking, the situation might be seen as different from Thailand because a large proportion of the deficit was due to large sale FDI, foreign investors in East Asia had thought exactly that to be true of countries there.

It is clear that the negative impact of the Asian crisis also had to do with the extent to which Asian countries, such as Japan and Korea, had begun to replace Britain and Europe as main outlets for New Zealand products. Owing to the persistence of trade barriers to agricultural sectors, New Zealand farmers were glad to find customers in resource poor commodity importers such as Hong Kong, Singapore and Taiwan. The rise of the New Zealand dollar versus the currencies of most of its Asian trade partners inevitably made its products more expensive and thus less attractive. This also translated into losses in revenues from the tourism sector. Furthermore, since Australia toik 20.3 percent of NZ exports, some indirect effects also came to play a role.

The exposure of New Zealand’s economy to the international financial markets is so high because of a perpetual current account deficit. The external deficit to GDP ratio hovers between 6 and 7 percent, while the foreign liabilities amounted to 80 percent of GDP in 1998. This level of foreign debt was a record high for any OECD country. It makes New Zealand dependent on the volatility of the market. To some degree, this is a result of the policy of the private sector to accrue high levels of foreign debt, in order to finance investment so as to stay internationally competitive. Another large causal factor of the problem of a current account deficit is New Zealand’s radical privatisation programme, enticing overseas investors to invest in a country with a very business friendly environment and causing profits to be repatriated. The stock of foreign direct investment more than tripled between 1989 and 1994, now making up one quarter of the GDP. Whether this level of foreign direct investment can be sustained over a long term period now that key assets of the New Zealand economy have been sold off into private hands is, however, far from certain.

Regardless of whether or not one accepts the neoliberal premise that privatisation of public enterprises results in overall efficiency gains for the economy, for a small country such policy raises the non-trivial concern over real loss of sovereignty. Foreign control over New Zealand is anything but a purely academic subject. In 1995, foreign investors owned half the stock market, 40 per cent of government bonds, while foreign ownership of companies amounted to 33.6 NZ$ billion as compared to government assets of 30 NZ$ billion. Around 90 percent of the banking sector is foreign owned, primarily by Australian companies.

US, British and Australian companies profited from the wave of privatisations, buying up companies at relatively low prices, though NZ taxpayers’ money helped create the bulk of the infrastructure of these companies in the first place.

Major examples of privatisation include the sale of Telecom, Air New Zealand, Bank of New Zealand, New Zealand Rail, and the cutting rights for the states’ forests. At the same time, Asian investors bought up large shares of NZ real estate, both commercial property and forestry land. These developments led one NZ politician to comment that “we risk being transformed into sharecroppers on our land”.

With telecommunication, transportation, the financial sector, the energy sector and increasingly the natural resource base and urban real estate being turned over to foreign owners, constraints on the array of policy measures a NZ government can undertake are quite severe. In a small country, privatisation programmes run the risk of attracting predominantly foreign investors due to the small domestic capital basis. As the case of New Zealand demonstrates this can leave the “independence as a nation substantially undermined”, with decisions affecting the economic and political life of the polity being made in boardrooms in New York, London and Sydney and no longer in Wellington.

This also implies that for the sake of marginally reducing its debt levels, the NZ government has terminally abandoned its control levers over a large section of the economy, now no longer controlled by a democratically elected government, but rather by purely profit oriented private businesses. It has also given away valuable sources of revenue which are now used to maximise private sector profits. These profits, in turn, are being quickly repatriated to overseas locales. For a small country, following the ‘New Zealand Way’ there is a very real danger of turning into a banana republic.

However, while large scale enterprises where sold off to foreign buyers, New Zealand has been fairly successful in developing cutting edge products in a number of agriculture related technologies, thereby occupying specialised market niches. Companies specialise in high tech agricultural products and services, particularly geared towards the dairy and sheep farm industries. These range from technical equipment for livestock feeding to livestock genetics services. Companies have the advantage of profiting from high quality research and development conducted at the Department of Technology at Waikato University in Hamilton and the Department of Agricultural Engineering at Massey University in Palmerston North. High quality research in agricultural sciences is also being carried out on the South Island at the Animal Division and Food Sciences Department at Lincoln University in Christchurch. There are early signs of the development of a “cluster economy” in Hamilton where the university promotes the co operation with the regional Crown Research Institute (CRI) and the emergence of spin off companies commercialising in some of the fruits of the research activity. These are encouraging signs and indicators of New Zealand taking advantage of its experience, expertise, and technical know how to develop unique globally competitive leading products.

This is an indication of acknowledging and profiting from niche markets which other, larger countries are either unaware of or incapable of penetrating. However, we might voice some concern about the fact that these products are still related to agriculture. Thus, the economy’s reliance on this sector is sustained.

6. Conclusion: A Mixed Picture

New Zealand has launched an ambitious and comprehensive series of reforms, commencing in 1984. The country chose to respond to the challenges implied by a globalising world economy in a fairly radical fashion, moving from being one of the most regulated economies in the OECD to the opposite extreme.

This paper has analysed the New Zealand reform programme in a quest to explore its feasibility as a model for other small states in coping with the pressures of globalisation. It is commonly argued that increasing interdependence, exponentially growing trade flows and expanding foreign direct investment are undermining the nation state’s level of autonomy. More precisely, the nation state loses its capability to manipulate key macroeconomic tools and thereby effectively to control key parameters of public policy making. As my analysis has shown, the ‘New Zealand way’ presents a mixed track record. The fairly limited successes of the much heralded “Model New Zealand” have come at a significant cost. Unemployment, poverty, and social inequality all stand at unprecedented levels today in New Zealand. While some macroeconomic indicators have been stabilised, the short to medium term impact of the reforms has been devastating. The short term recovery of the mid 1990s faded in the wake of the Asian crisis.

New Zealand’s high level of foreign debt combined with an extraordinary level of foreign direct investment means that the country is highly exposed to the whims of the international financial market.

Owing to large scale privatisations, initiated in the mid 1980s as a measure to reduce foreign debt and in line with the neoliberal antistatist dogma, substantial sections of the New Zealand economy are now controlled by Australian, American and British companies. This leads to the repatriation of profits from NZ operations and a huge current account deficit. It also means that the NZ government has voluntarily abandoned its capability of controlling large sectors of the economy and has given away revenue generating resources.

The NZ government thus finds the range and effectiveness of its public policy options severely curtailed, not least due to the Fiscal Responsibility Act, the Public Finance Act and the Reserve Bank Act, all of which constrain the role of government in the economy.

It will be interesting to follow the further developments of the New Zealand economy. A current assessment of the reforms, however, cannot lead to an endorsement of any such package of measures for other small states. The costs are quite considerable, while the benefits of a policy of effective capitulation to the market seem fairly limited.

Journalists, policy makers, and academics will probably continue to flock to Wellington to study this most ambitious of all public sector reform programmes.

Yet a comprehensive candid assessment about the overall results of this programme leads to the conclusion that New Zealand in liberalising its economy has overdone it.

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The New Zealand Way. European Consortium for Political Research

HOW SHALL WE LIVE? How Universal Basic Income Solves Widespread Insecurity and Radical Inequality – Daniel Nettle.

Answering the four big objections from critics of UBI.

“A host of positive psychological changes inevitably will result from widespread economic security.” Martin Luther King Jr.

Security is one of the most basic human emotional needs.

Contrary to the predictions of mid-twentieth century economists, the age of universal wellbeing has not materialised.

We are washed up on the end of one big idea, failed Neoliberalism, waiting for something else to come along. At best we are dealing with one symptom at a time. Each piecemeal intervention increases the complexity of the state; divides citizens down into finer and finer ad hoc groups each eligible for different transactions; requires more bureaucratic monitoring; and often has unintended and perverse knock-on effects.

Each conditional government welfare scheme generates a bureaucracy of assessment and the need for constant eligibility monitoring, at vast expense.

Something more systemic is needed; an idea with bigger and bolder scope. That big, bold idea just might be the Universal Basic Income.

For UBI to go mainstream, a positive case will need to be made that also draws on easily available simple social heuristics. If we can’t make it make intuitive sense, it will be confined forever to the world of policy nerds.

The health and wellbeing benefits observed in trials of UBI and minimum income guarantees, even over quite short periods, have been so massive that it is hard not to conclude that security does something interesting to human beings, out of all proportion to the monetary value of the transfer, just as Martin Luther King predicted.

Daniel Nettle is Professor of Behavioural Science at Newcastle University. His varied research career has spanned a number of topics, from the behaviour of starlings to the origins of social inequality in human societies. His research is highly interdisciplinary and sits at the boundaries of the social, psychological and biological sciences.

“Can we not find a method of combining the advantages of anarchism and socialism? It seems to me that we can. The plan we are advocating amounts essentially to this: that a certain small income, sufficient for necessaries, should be secured to all, whether they work or not.” Bertrand Russell

Today should be the best time ever to be alive. Thanks to many decades of increasing productive efficiency, the real resources available to enable us to do the things we value, the avocados, the bicycles, the musical instruments, the bricks and glass are more abundant and of better quality than ever. Thus, at least in the industrialised world, we should be living in the Age of Aquarius, the age where the most urgent problem is self-actualisation, not mere subsistence: not ‘How can we live?’, but ‘How shall we live?’.

Why then, does it not feel like the best time ever? Contrary to the predictions of mid-twentieth-century economists, the age of universal wellbeing has not really materialised. Working hours are as high as they were for our parents, if not higher, and the quality of work is no better for most people. Many people work several jobs they do not enjoy, just to keep a roof over their heads, food on the table, and the lights on. In fact, many people are unable to satisfy these basic wants despite being in work: the greater part of the UK welfare bill, leaving aside retirement pensions, is spent on supporting people who have jobs, not the unemployed. Thousands of people sleep on the streets of Britain every night. Personal debt is at unprecedented levels. Many people feel too harried to even think about self-actualisation.

Twin spectres stalk the land, and help explain the gap between what our grandparents hoped for and what has materialised. These are the spectres of inequality and insecurity. Insecurity, in this context, means not being able to be sure that one will be able to meet one’s basic needs at some point in the future, either because cost may go up, or income may fluctuate. Insecurity is psychologically damaging: most typologies put security as one of the most basic human emotional needs. Insecurity dampens entrepreneurial activity: one of the big reasons that people don’t follow up their innovative ideas is that these are by definition risky, and they worry about keeping bread on the table whilst they try them out. Insecurity deters people from investing in increasing their skills: what if they cannot eat before the investment starts to pay off? It encourages rational short-termism: who would improve a house or a neighbourhood that might be taken away from them in a few months’ time for reasons beyond their control? It also increases the likelihood of anti-social behaviour: I would not steal a loaf of bread if I knew there was no danger of going hungry anyway, but faced with the danger of starvation tomorrow, I would seriously consider it. Insecurity is a problem that affects those who have little to start with especially acutely: hence the link between insecurity and inequality.

Big problems require big ideas. Our current generation of politicians don’t really have ideas big enough to deal with the problems of widespread insecurity and marked inequality. Big ideas come along every few decades. The last one was about forty years ago: neoliberalism, the idea that market competition between private-sector corporations would deliver the social outcomes we all wanted, as long as government got out of the way as far as possible. Interestingly, neoliberalism was not such an obviously good idea that politicians of all stripes ‘just got it’. It took several decades of carefully orchestrated deliberate communication and advocacy, which was not at all successful at first, to eventually make it seem, across the political spectrum, that the idea was so commonsensical as to be obvious. I don’t think any of the early advocates of neoliberalism could possibly have dreamed that after thirty years of implementation of their big idea, available incomes would have stagnated or declined for the median family; public faith in corporate capitalism would have seeped away; even the UK Conservative party would have to concede that market mechanisms did not really work as envisaged; or that the major UK political parties would both be advocating government-imposed pricecaps in an area, the supply of energy, where the neoliberal market model had been followed to its logical conclusion. It feels like we are washed up on the end of one big idea, waiting for something else to come along.

Our current politicians propose to deal with symptoms piecemeal, a minimum-wage increase here, a price cap there, rent-control in the other place; tax credits for those people; financial aid to buy a house for those others. At best we are dealing with one symptom at a time. Each piecemeal intervention increases the complexity of the state; divides citizens down into finer and finer ad hoc groups each eligible for different transactions; requires more bureaucratic monitoring; and often has unintended and perverse knock-on effects. For example, helping young people to buy a house with government financial aid only maintains the high levels of house prices. Vendors can simply factor into the price the transfer from government that they will receive. The policy would be much less popular if millions of pounds of taxpayer money were just given directly to large property development corporations, but that might as well be what the policy did. No, something more systemic is needed; an idea with bigger and bolder scope. That big, bold idea just might be the Universal Basic Income.

A Universal Basic Income (UB1) is a regular financial payment made to all eligible adults, whether they work or not, regardless of their other income. People can know that it will always be there, now and in the future. It should not be a fortune, but it should ideally be enough that no-one ever needs to be hungry or cold.

All developed societies agree on the need to protect citizens from desperate want that may befall them, usually for reasons beyond their control. However, the ways we currently make these transfers are incredibly complex. Guy Standing reports that in the USA, there are at least 126 different federal assistance schemes, not to mention state-level ones. In the UK, individuals have had until recently to be separately assessed for unemployment support, ill-health support, carer support, working tax credits (which amount to low-income support), and so on. The new Universal Credit system only partly simplifies this thicket. Each conditional scheme generates a bureaucracy of assessment and the need for constant eligibility monitoring, at vast expense.

Moreover, conditional transfers always generate incentive problems. If you go back into work after being unemployed, you lose benefits. If you are a carer and the person you care for recovers, you are financially penalised: you do better by keeping them ill. If your wages or hours go up, you lose out in benefit reductions. Under the UK’s new Universal Credit system, the marginal tax rate (the amount you lose of every extra pound you earn in the job market if you are a recipient) is around 80%, and that scheme was a reform designed to increase the incentive to work! Moreover, the 80% figure does not factor in the fact that if you move briefly out of eligibility, for example for some seasonal work, you are uncertain about when and whether you would be able to get back in afterwards, should you need to. This is a disincentive for taking the work.

It is very hard to eliminate these perversities within any system of conditional, circumstance-specific transfers.

The UBI, then, seems like a good idea. It is far from a new one. It has fragmentary roots in the eighteenth and nineteenth centuries. In the twentieth century, there was one wave of enthusiasm in the 1920s, and another in the late 1960s and 1970s. The second wave generated a positive consensus, specific policy proposals, and a certain amount of pilot activity, but other paths ended up being taken. The idea has never quite died, though. It is now back in political consciousness in a very big way.

Why, when the UBI seems such a good idea, when it has been cognitively available to us for so long, when so many very clever people have modelled it and found it desirable, is there no developed society on earth in which it has been fully implemented? Partly this is because democratic governments, indeed societies in general, are poor at farreaching systemic reform, instead finding it easier to tinker with and tune existing systems. It’s only the political outsiders who dare propose massive change, they have less to lose. But it is also because human psychology is an obstacle to the UBI, and this is what interests me in this essay. As Pascal Boyer and Michael Bang Petersen have recently argued, when we (non-specialists) think about how the economy ought to be organized, we don’t derive our conclusions from formal theory, simulations, or systematic research evidence. No, we generally fall back on simple social heuristics, like ‘if someone takes a benefit, they ought to pay a commensurate cost’; ‘more for you is less for me’; or ‘people should only get help when they are in need’. These simple social heuristics are all well and good for the problems they developed to solve, basically, regulating everyday dyadic or small-group social interactions. But they don’t automatically lead us to the right conclusions when trying to design optimal institutions for a complex system like a modern capitalist economy.

Certain aspects of the UBI idea violate one of these simple social heuristics. In fact, the UBI sometimes manages to violate two different and contradictory simple social heuristics simultaneously, as we shall see. These violations are like notes played slightly out of tune: they just seem wrong, before one has had to think much about it. Politicians are afraid of these reactions; they don’t like going out to campaign and meeting the same immediate objections all the time. If you want to build a consensus for the UBI, you have to analyse these jarring notes with some care, and develop a counter-strategy. For UBI to go mainstream, a positive case will need to be made that also draws on easily available simple social heuristics. If we can’t make it make intuitive sense, it will be confined forever to the world of policy nerds.

Fortunately, the challenge can be met. Our simple social heuristics do not constitute a formally consistent system, like arithmetic (why would they?). Instead, they are a diverse bunch of often contradictory gut feelings and moral reactions each triggered by particular contextual cues. For example, we do have strong intuitions that people should not take a benefit without paying a commensurate cost, but these intuitions only get triggered when certain sets of features are present in the situation. These features include: the resource is scarce enough every additional unit of it is valuable to me; the resource was created by deliberate individual effort; the person taking the benefit is somehow dissimilar to me, so their interests are not closely tied in to mine; and it is feasible to monitor who is getting what at reasonable cost.

The features do not always obtain: the resource might be more plentiful than anyone really needs; its acquisition might be mainly due to luck; the other people might be fundamentally similar to me, or their interests closely bound up with mine; or the cost of monitoring who got what might be prohibitive. In such situations, humans everywhere merrily and intuitively sign up to the proposition: the resource should be shared out somehow. There are a number of ways this can happen: pure communal sharing, where each qualifying individual just takes what they like, or equality matching, where every qualifying individual is allotted an equal share as of right. Every society has domains in which communal sharing or equality matching is deployed in preference to market pricing (the rule ‘you should only take a benefit if you pay a commensurate cost’).

Hunter-gatherers deal with large game, chancy and producing a huge surfeit when it comes, by communal sharing. Even in the more private property focussed Western societies, communal sharing is ubiquitous. Households, for example. If I buy a litre of milk, I don’t give my wife a bill at the end of the week for whatever she uses. Su casa es mi casa. Communal sharing or equality matching happens beyond households too. It is anathema to suggest that the residents of Summerhill Square might charge passersby for the air they breathe whilst walking through. Very few people think that those who pay more taxes should get more votes. When proposals are made to move a resource from the domain of the communally shared or equality matched to the priced, there is outcry: witness the response that greets proposals for road tolls in places where use of the roads is currently free; or to charge money at the gates of the town park. The case for the UBI is the case for moving part, no means all, of our money the other way, out of conditionality and into the domain of the equality-matched. Getting your head around it involves framing your understanding of our current economic situation in such a way as to trigger the appropriate equality-matching intuitions. Here as in many other political domains, those who determine the framing of the problem get to have a big influence on the outcome.

Whenever one talks about the UBI, one hears the same objections, including:

– How can we afford such a scheme?

– Why should I give my money to people for them to do nothing in return?

– Why would anyone work if they were given money for free?

– Why should we give money to the rich, who don’t need it?

The first of these objections is the easiest to dispose of. There have been detailed recent costings for the UK, which vary in their assumptions, but the consensus is that introduction of a modest initial UBI scheme would require surprisingly little disruption to our current tax and expenditure system; perhaps modest tax rises, perhaps no change, perhaps tax cuts. If this surprises you, let me give you the following back-of-an-envelope calculations. There are around 65 million people in the UK, of whom 63% are aged between 16 and 64. Assuming that the over 65s will continue with their current pension arrangements instead of the UBI, that gives us at most 41 million adults to cater for, plus about 12 million under-16s. Let’s say we want to give £80 per week to each of the adults. This would cost £171 billion per annum. And let’s further say that we want to give £40 per week, to the mother or other caregiver, for each child under 16. That’s another £25 billion, giving a nice round £200 billion in total.

Of course, £200 billion a year is an eye-watering sum. But UK government expenditure in 2017 was £814 billion, so we are only talking about one quarter of what the government spends anyway. Increasing government expenditure by one quarter might be a rather rash move, but this would not be the net increase, because the UBI would produce savings elsewhere. The welfare bill for 2017, less retirement pensions, was £153 billion. It’s unrealistic to expect a UBI scheme to reduce this to zero: most UBI advocates argue for retaining some extra provision for the disabled, and also retaining, for the time being, means-tested benefits to pay housing rental in some cases (the cost of housing is so high in parts of the UK that many people would become homeless if this disappeared overnight). But certainly, we might hope to eliminate up to £100 billion, or 2/3, of the non-pensions welfare bill, including a very large part of the administrative cost. So we are already half-way there.

At present, most UK adults are taxed at a zero rate on the Iirst £8,164 of earned income, 12% from £8,164 to £11,500, and 32% above £11,500. What this means, in effect, is that anyone earning £11,500 or more is effectively being given a freebie from the state of £3680, compared to being standardly taxed at 32% from the first pound. This figure, £3680 per year is, you will note, not so very far off my proposed initial UBI of £4160 anyway. Personal tax allowances cost the government around £100 billion per annum in foregone revenue. If my proposed UBI were to be introduced, it would be reasonable to ask people to pay their taxes from the first pound. For people like me who earn more than £11,500 per annum, the introduction of the UBI would then be largely neutral, my tax bill going up by around £4000, offset by £4000 coming separately into my bank account as UBI.

So, if you will allow me very broad approximations, moving to a modest UBI would cost about £200 billion per annum, to be funded by about £100 billion of welfare savings, and about £100 billion from abolishing personal tax allowances, so pretty much fiscally neutral.

And this is just a business-as-usual analysis of the likely financial consequences. What advocates believe is that there will be positive knock-on effects: people will be able to move to more productive and enjoyable jobs, or start entrepreneurial activities; people have no financial disincentives to take casual work or increase their hours; the expensive negative psychological consequences of insecurity (anxiety, depression, addiction, maybe even crime) will improve. Thus, what you end up with will be a net saving for the government, not a net cost.

The initial scheme discussed above, and other proposals like it, are not immediately very redistributive. Those currently receiving full Universal Credit would only end up with about the same as their current entitlement; and, as I mentioned above, for well-off people like me, the UBI would be almost exactly offset by the increase in my tax bill. So what is the point of such a reform? The answer has to do with security. I see UBI not so much as an immediate solution to inequality (you would have to set it very high to have a big direct effect on the inequality figures), but as a prophylactic against insecurity. For a wealthy person such as myself, there’s not much financial difference between getting a personal tax allowance and receiving a UBI, until my life is hit with a shock. I am well-off now, but I might not always be. Say I suddenly lose my job, or need to care for my wife. I know the UBI will continue to be there, every week, without any action required of my part. I can factor it into my worst expectations. The same is not true of the transfer effected by my personal tax allowance. And this, briefly, is the best response to objection 4, ‘Why should we give money to the rich, who don’t need it?’ Well, as long as they remain rich, then they are net payers into the system, since their tax bill exceeds their UBI, so we are giving them money only in an accounting sense. But it is still better to have them make a large tax payment in and concurrently take a small UBI payment out, rather than just make their tax rate a bit lower, because they might suddenly become non-rich at any moment. The UBI is ready for that moment should it come. To counter objection 4, we need to activate the social heuristics: ‘anyone could have bad luck’ and ‘everyone is potentially in the same boat’.

There is a large difference between the knowledge that £80 a week will always come into my bank account, this week, next month, and for the rest of my life; and the knowledge that, if things go badly for me, I can do a complex application process, be subjected to a humiliating and lengthy bureaucratic examination, following which, after a delay of up to six weeks during which I will receive nothing, about £80 per week may or may not start to appear in my bank account, and could be withdrawn at any moment if I am ten minutes late for an interview, or am deemed to not be sick enough or not be trying hard enough to look for work.

It is ironic that the system we often refer to as ‘social security’ provides the exact opposite of that: it provides continual, unplannable for uncertainty akin to a sword of Damacles.

The insecure, such as those waiting for benefits decisions or enduring benefits sanctions, have short term problems of liquidity. They lose their homes and possessions, or end up having to borrow money at very high interest rates. This is expensive and spirals them into abject poverty. Reducing insecurity could have an indirect effect on inequality, by stopping this spiral. And the health and wellbeing benefits observed in trials of UBI and minimum income guarantees, even over quite short periods, have been so massive that it is hard not to conclude that security does something interesting to human beings, out of all proportion to the monetary value of the transfer, just as Martin Luther King predicted.

What about objection 2 (‘Why should I give my money to people for them to do nothing in return?’). The objection has two parts: there’s a part about my money being my money, and a part about giving to other people without them doing anything in return. Both parts are important.

First, the my money part. All societies distinguish between individually owned resources and communal resources, though they draw the line in different places. Across societies, alienating an individually-owned resource from someone is morally wrong; but depriving people of a communal resource is equally so. The kinds of cues that trigger intuitions of individual ownership are: my having transformed the material extensively through deliberate action; the resource having been given to me by someone in return for something specific; or the resource having been in my sole possession and use for some time. The kinds of cues that trigger intuitions of communal ownership are: the resource being very abundant; its use being hard to monitor and police; a little of it being essential for everyone’s survival; and the having of it being mainly due to luck. So I think a first move you need to make in making the UBI make sense is to loosen the hold of the individual ownership schema on the money in your wage packet.

The money in my wage packet certainly feels like a good candidate for individual ownership. I have worked hard to get where I have, and this leads to the intuition that every penny in my wage packet is mine, should not be given away to other people without a specific reciprocal service rendered. I supposed I should grudgingly admit that I have got some help from others in earning my salary as an academic, I mean it’s not quite all my own sweat. Following the logic of individual ownership, I should really have paid for all these inputs at point of use, but somehow I didn’t always do so. There’s the statistical computing language R, the backbone of all my research; developed by people I didn’t know and made freely available without me lifting a finger. Maybe 1p in every pound I earn is really owable to the R Foundation for Statistical Computing.

Then come to think of it there is the computer itself, developed by a mixture of public and private investment mainly before I was born. It’s unthinkable that I could be a productive modern professor without this input available. So really I should attribute 2p of each pound I earn to having had that available. Come to think of it, I could not really earn anything as a professor without the existence of an affluent society in which enough people are freed from daily subsistence activities as to want to spend their time studying behavioural science. So I guess I owe the Industrial Revolution say 5p; and then another 3p to those Europeans who invented a rather good system of universities for students to come and study at. Oh, and I do use the scientific method rather a lot (say 4p distributed across a wide range of people in many countries over the last couple of hundred years, and another 2p specifically for the intellectual work of creating my discipline). And a couple of pence in the pound for the philosophers of the enlightenment; without them to make the world safe for my kind I would at best be a priest with low wages. And then there’s the Romans. What did the Romans ever do for me? Well, there’s the sanitation. And the roads…

As soon as we complete this exercise, we are forced to concede that what seems like my money only partly meets all the triggers for individual ownership (my individual labour produced it). In large part, it is a windfall of cumulative cultural evolution. I just got lucky to be born into a shared cultural and technological heritage. I can’t pay back to all those parties whose cultural activities contributed to my luck, since many of them are long gone (and besides, they are innumerable and diverse). But accepting that what I earn is partly due to an abundant social windfall created by a whole society over time, whose use and scope is hard to monitor, and I acquired by sheer luck, loosens the hold of the intuition that all my money all belongs exclusively to me. It’s a short step from ‘a part of what I receive from society is due to our common, difficult to monitor, abundant social luck’ to ‘a part of what I receive should be shared out’.

So now we turn to the part about why I should give anything to strangers without requiring them to pay any particular cost in return. A popular pro-UBI argument here, which goes back to Thomas Paine, is that people should be recompensed for the natural heritage that has been alienated from them. The land has been enclosed and privatised; the water has been bottled and sold; you can’t just chop down the trees, hunt game or build a house where you want, as you would have been able to do at the dawn of society. The UBI is this recompense, the royalty, if you will, on an inheritance that was once socially shared but has been taken away by civilization. This reasoning is fine, but a bit lofty and philosophical. I prefer a quiverful of different, more forward looking arguments.

First, social transfers of some kind are necessary, and monitoring them under the current system is really costly. The UK government recently announced that it needed to review whether its rules on disability benefit claims had been applied correctly to recent claimants. This review is estimated to cost £3.7 billion. That’s enough to give my proposed UBI to everyone in the town of Hexham for over 8 years. Not the cost of the benefit, not the cost of administering the benefit, just the cost of one review of whether the benefit has in fact been correctly administered, for a benefit that only a small fraction of the UK population claims anyway. Scale that up and you appreciate the madness of how we currently administer social transfers.

Second, I do derive all kinds of payoffs from the welfare of others, even strangers. What are they? Well, I enjoy strolling around my city. I enjoy living in a nice orderly street. I enjoy going to the theatre. If my cocitizens were so hungry and desperate that they turned to assaulting their fellows, smashing property, not tending their yards, and abandoning the arts, my personal wellbeing would be directly reduced. I like writing books and giving lectures. It’s therefore in my direct interest that as many people as possible have the resources to read or attend these. Businesses can only flourish if there are people well enough off to be customers. This was the great insight of Henry T. Ford: he realised he could really make a lot more money once he paid his workers enough that they would be able to buy his cars. It’s the kind of reverse Ponzi scheme trick, or perpetual motion machine, of modern consumer capitalism: those at the top of the pyramid need enough money to get down to those at the bottom of the pyramid that those people can buy goods and services, which means that the money comes back up to them again. Otherwise the whole thing grinds to a nasty halt.

One way of thinking about this is to say that, in a community, because of the fundamentally social character of human life, the wellbeing of each individual creates a spill-over benefit for the others. It’s what economists call a positive externality. Because of the changes in behaviour that will follow from my neighbour not being in completely dire straits, my life improves a tiny little bit as theirs does. This improvement is very real and substantial, but hard to tie to any one act my neighbour does, and hence hard to monitor or account for in a ledger.

Third, the marginal wellbeing returns to keeping all of my money are diminishing. Diminishing marginal returns mean that if the first few hundred pounds of income massively improve my well-being, then the next few hundred improve it slightly less, and so on. A few years ago, Karthik Panchanathan, Tage Rai, Alan Fiske and I produced a simple model of what resource distribution a selfish actor should prefer when there are positive social externalities, and diminishing wellbeing returns. We imagined a simple world where there are two actors, me and someone else. We put a value 5 on the positive externality that flows to me as the other person’s well-being increases by one unit. Now we ask: if I can decide how all the available resources get divided up, what allocation should I prefer? The exact numerical answer depends on the value of s and the degree to which marginal returns diminish, but generally, the result is the following. I should want to keep everything up until the point where I myself have got off the steepest part of the increasing wellbeing curve. Above that, it becomes rational for me to want the other actor to have the next chunk of resource, since the positive social externality coming to me from their large increase in wellbeing (they are still on the steep bit of the curve, remember) outweighs the rather small increase in my wellbeing I get from keeping it (since I am on the flatter bit of the curve). There is no ‘problem of cheating’ in this model, since we assume that the positive externalities arise from behavioural changes that the other party will simply want to make anyway as their state improves. It’s a model of mutual benefit, or interdependence, rather than tit-for-tat.

This is the reasoning I would use with a well-off person to advocate funding a UBI from their taxes. The money you put into other people’s UBIs will directly increase your individual wellbeing, because in a society where no-one is desperate, it’s easier for the things you really value and derive benefit from to flourish. Furthermore, as already discussed, UBI offers security to you too. You may not need it right now, but you could do in the future. Both of these are self-interest arguments, where selfinterest is construed sufficiently broadly. You have to be careful about basing all policy arguments on self-interest: it can end up signalling that self-interest is the only normal reason for action, which could become a self-fulfilling prophecy. Nonetheless, perhaps here having self-interest on side helps buttress nobler motives. Experience shows that the long-term success of social policies is tied to the relatively well-off seeing themselves as getting something from them. Where schemes are perceived to benefit only an ‘underclass’, different in kind from the people footing the bill, support is easily driven away in the next downturn.

Objection 3 (‘Why would anyone work if they were given money for free?’) is based on the reasonable intuition that conditionality is important in motivating others to do something. One does not generally say to the plumber: ‘Here’s £100. I’m hoping that at some point you will fix my tap’. However nice the plumber might be, the incentives are a bit wrong here. And if people withdrew their supply of labour, the very affluence that can fund the UBI would be undermined.

The best way to loosen this objection is to remind one’s interlocutor of two things. First, the UBI is only ever going to be basic, and people want more than basic out of life. If people’s life ambitions were limited to gaining some modest level of income of £5000 or £10000 per annum a year and then stopping, then frankly, the behaviour of the vast majority of people in western societies for the last century would be completely incomprehensible. Lottery winners almost universally continue to work, though often not in their previous jobs. Academics don’t work less when they become full professors: they work harder. The very same critics who say that people won’t do anything if given money for free also often advocate the awarding of huge salaries, millions of pounds per annum, to CEOs and other leaders. Admittedly, those huge salaries are conditional on working, whereas the UBI is not. But the fact that the salary allegedly needs to be so huge to attract candidates implies that people are motivated not just by getting a little bit of money, but by getting a lot. So those who advocate large salaries must believe that the motivation for more money holds up at levels of income way above the basic (at least for the right sort of people, but hey, maybe all people are the right sort).

Second, more important than the amount of labour people supply is the productivity of that labour. By this, I mean people choosing to do activities that are socially useful, in which they are happy, and that they are good at. That has to be key to maximising social wellbeing as well as economic stability in future. There is plenty of evidence from pilot schemes of the effect of the UBI (or similar policies) on labour supply. In the 1970s North American schemes, reductions in work hours were real but very modest. No-one stopped working altogether (and these were minimum income guarantee schemes, which provide stronger disincentives for work than a fully unconditional UBI). The slight reductions in labour supply overall were mainly explained by the behaviour of specific groups: parents took more time out of the labour market to look after their children; and young people were more likely to stay on in education, to improve their skills. Need I point out that these are all things that the state currently subsidizes people to do, at considerable cost, because they are felt to be socially desirable? In short, as Michael Howard has put it: ‘In the pilot schemes people withdrew from the labour market, but the kind of labour market withdrawal you got was the kind you would welcome’.In more recent trials of a full UBI in India and Namibia, overall economic activity actually went up, as more people were able to afford to access job markets, or began entrepreneurial activities on their own accounts. I believe that under a UBI scheme, work would continue, and become better: innovation, worthwhile work, scholarship, and the arts would flourish, whilst degrading or miserable jobs would have to pay people more or treat them better. Hardly the end of civilization as we know it then.

If people persist with their intuition that UBI incentivizes people to do nothing, then the argument of last resort is the following: If you think it is stupid to give money to people even if they do nothing (UBI), then you ought to think it really stupid to give people money only on condition that they do nothing (the current means-tested benefits system). How much sense does that make?

There is one other great obstacle to acceptance of the UBI. People can’t figure out whether it is a left-wing idea, or a right-wing one, so neither side takes it fully to its heart. At first it seems left-wing: making the welfare system more humane and less conditional, transferring money from those with most income to those with less, is the latest tool to further a long-standing socialist or social-democratic concern with inequality and social justice. The neoliberal big idea has failed. A big idea based on collective action must replace it, and the UBI is part of that idea.

But good UBI arguments have come from the right, too. Freemarket economist Milton Friedman flirted with the idea, and the most serious Federal-level US policy initiative, the Family Assistance Plan (born about 1968, died about 1973) was proposed by a Republican president (Nixon) and largely killed off by the Democratic party. The right-wing (or libertarian) argument is that UBI massively simplifies the state, and could facilitate it relinquishing a lot of its micro-control over our lives. For example, if a UBI is there providing a protective floor for everyone, does the state also need to regulate minimum wages so closely? Couldn’t people protected from dire exploitation by the UBI make their own minds up about what paid labour they wish to do under what conditions? Perhaps, going further down this line, the UBI plus control of law and order, is pretty much all the state needs to do, internally at any rate. We’ve given everyone enough to avoid starvation and be able to participate in economic life in a minimally sufficient way. After that, they are on their own: they can contract for the goods and services they choose in the market. This argument makes UBI the missing piece that completes, not replaces, the neoliberal vision.

In another essay, I have written about the difficulty of inter-disciplinarity. Valuable integrative ideas can languish in the academic uncanny valley, not obviously owned by one discipline or another, and thus fail to have their potential recognized by anyone. Ideas that are quite good from two points of view, perversely, end up being championed by neither side, and thus have less immediate success than ideas that only appeal to one camp or the other. But what happens to the best of these ideas, in the end, is interesting: They go quite abruptly from all parties saying ‘that makes no sense’, to all parties saying ‘well, everyone knows that!’. There’s a similar adage in public policy: Important policy reforms are politically impossible, until just about the point where they are politically inevitable. We’ve seen plenty of examples of this in the slow and halting march of progress. Perhaps that is what will happen with UBI. We will look back and wonder what took us quite so long. Until then, and this is what scholars are uniquely placed to do, we have to keep the idea alive.

Excerpt from Hanging On To The Edges by Daniel Nettle (2018).

Evonomics

SOFT CURRENCY ECONOMICS. MMT, The Final Analysis – Warren Mosler.

Modern Monetary Theory, MMT, in a Nutshell – Johnsville * MMT, a quick start guide * Modern Money Theory: Deadly Innocent Fraud #1. Government Must Tax To Spend. – Warren Mosler.

“It is the neoclassical orthodoxy and others who try to make out that we can’t use resources, even if they are available, because of some magical, mysterious monetary or financial constraint. Just who is it that believes in magic here?

Operationally, federal spending is not revenue constrained. All constraints are necessarily self imposed and political. And everyone in Fed operations knows it.

The foundation of MMT is its recognition of the importance of the government’s power to tax, thereby creating a demand for its money, and its monopoly power to print money.

MMT’s full potential and its massive monetary fire power were not locked and loaded until President Nixon took the U.S. off the gold standard on August 15, 1971.”

A rampaging mutant macroeconomic theory called Modern Monetary Theory, or MMT for short, is kicking keisters and smacking down conventional wisdom in economic circles these days. This is because an energized group of MMT economists, bloggers, and their loyal foot soldiers, lead by economists Warren Mosler, Bill Michell, and L. Randall Wray are swarming on the internet.

New MMT disciples are hatching out everywhere. They are like a school of fresh-faced paramedics surrounding a gasping heart attack victim. They seek to present their economic worldview as the definitive first aid for understanding and dealing with the critical issues of growth, unemployment, inflation, budget deficits, and national debt.

MMT is a reformulated blend of some older macroeconomic theories called Chartalism and Functional finance. But, it also adds a fresh dose of monetary accounting for intellectual muscle mass. Chartalism is a school of economic thought that was developed between 1901 and 1905 by German economist Georg F. Knapp with important contributions (1913-1914) from Alfred Mitchell-Innes. Functional finance is an extension of Chartalism, which was developed by economist Abba Lerner in the 1940’s.

However, Chartalism and Functional finance did not directly spawn this new mutant monetary theory. Rather, Modern Monetary Theory had a hot, steamy, Rummy induced, immaculate conception as its creator, Warren Mosler, has stated:

“The origin of MMT is ‘Soft Currency Economics‘ [1993] at http://www.moslereconomics.com which I wrote after spending an hour in the steam room with Don Rumsfeld at the Racquet Club in Chicago, who sent me to Art LajTer, who assigned Mark McNary to work with me to write it. The story is in ‘The 7 Deadly Innocent Frauds of Economic Policy’ [pg 98].

I had never read or even heard of Lerner, Knapp, Inness, Chartalism, and only knew Keynes by reading his quotes published by others. I ‘created’ what became know as ‘MMT’ entirely independently of prior economic thought. It came from my direct experience in actual monetary operations, much of which is also described in the book.

The main takeaways are simply that with the $US and our current monetary arrangements, federal taxes function to regulate demand, and federal borrowing functions to support interest rates, with neither functioning to raise revenue per se. In other words, operationally, federal spending is not revenue constrained. All constraints are necessarily self imposed and political. And everyone in Fed operations knows it.”

The name Modern Monetary Theory was reportedly coined (pun unintended) by Australian economist Bill Mitchell. Mitchell has an MMT blog that gives tough weekly tests in order to make sure that the faithful are paying attention and learning their MMT ABC’s. MMT is not easy to fully comprehend unless you spend some time studying it.

MMT is a broad combination of fiscal, monetary and accounting principles that describe an economy with a floating rate fiat currency administered by a sovereign government.

The foundation of MMT is its recognition of the importance of the government’s power to tax, thereby creating a demand for its money, and its monopoly power to print money.

MMT’s full potential and its massive monetary fire power were not locked and loaded until President Nixon took the U.S. off the gold standard on August 15, 1971.

There is really not that much “theory” in Modern Monetary Theory. MMT is more concerned with explaining the operational realities of modern fiat money. It is the financial X’s and 0’s, the ledger or playbook, of how a sovereign government’s fiscal policies and financial relationships drive an economy. It clarifies the options and outcomes that policy makers face when they are running a tax-driven money monopoly.

Proponents of MMT say that its greatest strength is that it is apolitical.

The lifeblood of MMT doctrine is a government’s fiscal policy (taxing and spending). Taxes are only needed to regulate consumer demand and control inflation, not for revenue. A sovereign government that issues its own floating rate fiat currency is not revenue constrained. In other words, taxes are not needed to fund the government. This point is graphically described by Warren Mosler as follows:

“What happens if you were to go to your local IRS office to pay your taxes with actual cash? First, you would hand over your pile of currency to the person on duty as payment. Next, he’d count it, give you a receipt and, hopefully, a thank you for helping to pay for social security, interest on the national debt, and the Iraq war. Then, after you, the tax payer, left the room he’d take that hard-earned cash you just forked over and throw it in a shredder.

Yes, it gets thrown away [sic]. Destroyed!”

The 7 Deadly Frauds of Economic Policy, page 14, Warren Mosler

Gadzooks!

The delinking of tax revenue from the budget is a critical element that allows MMT to go off the “balanced budget” reservation.

In a fiat money world, a sovereign government’s budget should never be confused with a household budget, or a state budget. Households and U.S. states must live within their means and their budgets must ultimately be balanced. A sovereign government with its own fiat money can never go broke. There is no solvency risk and the United States, for example, will never run out of money.

The monopoly power to print money makes all the difference, as long as it is used wisely.

MMT also asserts that the federal government should net spend, again usually in deficit, to the point where it meets the aggregate savings desire of its population. This is because government budget deficits add to savings. This is a straightforward accounting identity in MMT, not a theory. Warren Mosler put it this way:

“So here’s how it really works, and it could not be simpler: Any $U.S. government deficit exactly EQUALS the total net increase in the holdings ($U.S. financial assets) of the rest of us businesses and households, residents and non-residents what is called the “non-government” sector. In other words, government deficits equal increased “monetary savings” for the rest of us, to the penny. Simply put, government deficits ADD to our savings (to the penny).”

The 7 Deadly Frauds of Economic Policy, page 42, Warren Mosler

Therefore, Treasury bonds, bills and notes are not needed to support fiscal policy (pay for government). The U.S. government bond market is just a relic of the pre-1971 gold standard days. Treasury securities are primarily used by the Fed to regulate interest rates. Mosler simply calls U.S. Treasury securities a “savings account” at the Federal Reserve.

In the U.S., MMTers see the contentious issue of a mounting national debt and continuing budget deficits as a pseudo-problem, or an “accounting mirage.” The quaint notion of the need for a balanced budget is another ancient relic from the old gold standard days, when the supply of money was actually limited. In fact, under MMT, running a federal budget surplus is usually a bad thing and will often lead to a recession.

Under MMT the real problems for a government to address are ensuring growth, reducing unemployment, and controlling inflation. Bill Mitchell noted that, “Full employment and price stability is at the heart of MMT.” A Job Guarantee (JG) model, which is central to MMT, is a key policy tool to help control both inflation and unemployment. Therefore, given the right level of government spending and taxes, combined with a Job Guarantee program; MMTers state emphatically that a nation can achieve full employment along with price stability.

As some background to understand Modern Monetary Theory it is helpful to know a little about its predecessors: Chartalism and Functional Finance.

German economist and statistician Georg Friedrich Knapp published The State Theory of Money in 1905. It was translated into English in 1924. He proposed that we think of money as tokens of the state, and wrote:

“Money is a creature of law. A theory of money must therefore deal with legal history… Perhaps the Latin word “Charta” can bear the sense of ticket or token, and we can form a new but intelligible adjective “Chartal.” Our means of payment have this token, or Chartalform. Among civilized peoples in our day, payments can only be made with pay-tickets or Chartal pieces.”

Alfred Mitchell-Innes only published two articles in the The Banking Law journal. However, MMT economist L. Randall Wray called them the ”best pair of articles on the nature of money written in the twentieth century”. The first, What is Money?, was published in May 1913, and the follow-up, Credit Theory of Money, in December 1914. Mitchell-Innes was published eight years after Knapp’s book, but there is no indication that he was familiar with the German’s work. In the 1913 article Mitchell-Innes wrote:

“One of the popular fallacies in connection with commerce is that in modern days a money-saving device has been introduced called credit and that, before this device was known, all, purchases were paid for in cash, in other words in coins. A careful investigation shows that the precise reverse is true…

Credit is the purchasing power so often mentioned in economic works as being one of the principal attributes of money, and, as I shall try to show, credit and credit alone is money. Credit and not gold or silver is the one property which all men seek, the acquisition of which is the aim and object of all commerce…

There is no question but that credit is far older than cash.”

L. Randall Wray, in his 1998 book, Understanding Modern Money, was the first to link the state money approach of Knapp with the credit money approach of Mitchell-Innes. Modern money is a state token that represents a debt or IOU. The book is an introduction to MMT.

Finally, to finish the historical tour, here is how Abba Lerner’s Functional finance is described by professor Wray:

“Functional Finance rejects completely the traditional doctrines of ‘sound finance’ and the principle of trying to balance the budget over a solar year or any other arbitrary period. In their place it prescribes: first, the adjustment of total spending (by everybody in the economy, including the government) in order to eliminate both unemployment and inflation, using government spending when total spending is too low and taxation when total spending is too high.”

Given its mixed history it is not surprising that MMT has been given different labels. Some economists refer to MMT as a “post-Keynesian” economic theory. L. Randall Wray has used the term “neo-Chartalist”. Warren Mosler stated, “MMT might be more accurately called pre-Keynesian.” Given that Georg Knapp’s work was cited by John Maynard Keynes, the use of “pre-Keynesian” does seem more appropriate than “post-Keynesian”.

But under any category, MMT has been considered fringe or heterodox economics by most mainstream economists. It therefore has been relegated to the equivalent of the economic minor leagues, somewhere below triple-A level. However, that perception is changing.

MMT is slowly seeping into the public policy debate. These days Warren Mosler and others with an MMT viewpoint are frequently being interviewed on business news channels. MMT articles are being published. Recently, Steve Liesman, CNBC’s senior economics reporter, used a Warren Mosler quote to make a point. Liesman said: “As Warren Mosler has said: ‘Because we think we may be the next Greece, we are turning ourselves into the next Japan .

MMT is not easy for many people, including trained economists, to understand. This is probably because of its heavy reliance on accounting principles (debts and credits). Some critics consider MMT nothing more than a twisted Ponzi scheme that is simply “printing prosperity.” Calling MMT a “printing prosperity” scheme, by the way, is the quickest way to send MMTers into spasms of outrage. MMT does not “print prosperty” according to its proponents. The MMT counter argument is:

“It is a perverse injustice that, in online discussions, MMT sympathizers are frequently reproached for imagining that “we can print prosperity” when in fact it is us who constantly stress as a fundamental point that the only true constraints are resource based, not financial or monetary in nature. We are the ones insisting that if we have the resources, we can put them to use. It is the neoclassical orthodoxy and others who try to make out that we can’t use resources, even if they are available, because of some magical, mysterious monetary or financial constraint. Just who is it that believes in magic here?”

Emotions run hot in the current economic environment, especially on the internet. In some cases the energetic online promoting of MMT has turned into passive aggressive hectoring, hazing, name calling, badgering, and belittling. So be warned, if you write some economic analysis online that disagrees with MMT doctrine you might find yourself attacked and stung by a swarm of MMTers. If you are an economic “expert” and you do not understand monetary basics you may also get mounted on an MMT wall of shame.

A heavyweight Keynesian economist, like Nobel Prize winner Paul Krugman, has felt the sting of MMT. But the quantity and quality of his criticism of MMT, so far, has been featherweight. He could not land a solid glove on the contender, Kid MMT. Krugman only proved that he does not understand MMT, so his criticism was weak (see MMT comments) and his follow-up even weaker. MMT economist James Galbraith did a succinct breakdown of Krugman’s major errors.

Another school of economics feeling the heat from MMT are the Austrians. Austrian economist Robert Murphy recently wrote an article critical of MMT, calling it an “Upside Down World”. MMTers lined up to disassemble and refute Murphy’s essay. Cullen Roach at the Pragmatic Capitalist blog shot back this broadside:

“We now live in a purely fiat world and not the gold standard model in which Mises and many of the great Austrian economists generated their finest work. Therein lies the weakness of the Austrian model. It is based on a monetary system that is no longer applicable to modern fiat monetary systems such as the one that the USA exists in.”

Does MMT really offer a path to prosperty? Or did the ancient Roman, Marcus Cicero (106BC-43BC), have it right when he said: “Endless money forms the sinews of war.”? The debate will only intensify. If you value those green, money-thing, government IOU tokens in your wallet then it pays to learn what all the commotion is about.

MMT, a quick start guide

Because of MMT’s growing popularity it might be helpful to present a quick start guide so beginners can get up to speed and understand some of its fundamental elements. As a starting point here are some basics of Modern Monetary Theory (MMT) compared to some other principles of money and economics that might be considered conventional wisdom or old school wisdom.

1. What is money?

Modern Monetary Theory: Money is a debt or IOU of the state.

“The history of money makes several important points. First, the monetary system did not start with some commodities used as media of exchange, evolving progressively toward precious metals, coins, paper money, and finally credits on books and computers. Credit came first and coins, late comers in the list of monetary instruments, are never pure assets but are always debt instruments IOUs that happen to be stamped on metal...

Monetary instruments are never commodities, rather they are always debts, IOUs, denominated in the socially recognized unit of account. Some of these monetary instruments circulate as “money things” among third parties, but even “money things” are always debts whether they happen to take a physical form such as a gold coin or green paper note.”

Money: An Alternate Story by Eric Lymoigne and L. Randall Wray

“Money is a creature of law”, and, because the state is “guardian of the law”, money is a creature of the state. As Keynes stated:

“The Age of Chartalist or State Money was reached when the State claimed the right to declare what thing should answer as money to the current money-of-account… (Keynes 1930)…”

Chartalism, Stage of Banking, and Liquidity Preference by Eric Tymoigne

John Maynard Keynes in his 1930 Treatise on Money, also stated: “Today all civilized money is, beyond the possibility of dispute, Chartalist.”

Old School Wisdom:

“Money is essentially a device for carrying on business transactions, a mere satellite of commodities, a servant of the processes in the world of goods.”

Joseph Schumpeter, Schumpeter on money, banking and finance… by A. Festre and E. Nasica

Conventional Wisdom:

“Money is any object or record, that is generally accepted as payment for goods and services and repayment of debts in a given country or socio-economic context.”

Wikipedia


2. Why is money needed?

MMT: Money is needed in order to pay taxes.

“Money is created by government spending (or by bank loans, which create deposits). Taxes serve to make us want that money we need it in order to pay taxes.”

The 7 Deadly Frauds of Economic Policy, Warren Mosler

“The inordinate focus of other economists on coins (and especially on government issued coins), market exchange and precious metals, then appears to be misplaced.

The key is debt, and specifically, the ability of the state to impose a tax debt on its subjects; once it has done this, it can choose the form in which subjects can ‘pay’ the tax. While governments could in theory require payment in the form of all the goods and services it requires, this would be quite cumbersome. Thus it becomes instead a debtor to obtain what it requires, and issues a token (hazelwood tally or coin) to indicated the amount of its indebtedness; it then accepts its own token in payment to retire tax liabilities.

Certainly its tokens can also be used as a medium of exchange (and means of debt settlement among private individuals), but this derives from its ability to impose taxes and its willingness to accept its tokens, and indeed is necessitated by imposition of the tax (if one has a tax liability but is not a creditor of the Crown, one must offer things for sale to obtain the Crown’s tokens).”

Money: An Alternate Story by Eric Iymoigne and L. Randall Wray

“Money, in the Chartalist view, derives from obligations (fines, fees, tribute, taxes) imposed by authority; this authority then “spends” by issuing physical representations of its own debts (tallies, notes) demanded by those who are obligated to pay “taxes” to the authority. Once one is indebted to the crown, one must obtain the means of payment accepted by the crown. One can go directly to the crown, offering goods or services to obtain the crown’s tallies, or one can turn to others who have obtained the crown’s tallies, by engaging in “market activity” or by becoming indebted to them. Indeed, “market activity” follows (and follows from) imposition of obligations to pay fees, fines, and taxes in money form.”

A Chartalist Critique of john Locke’s Theory of Property, Accumulation and Money… by Bell, Henry, and Wray

Conventional Wisdom:

Money is needed as a medium of exchange, a unit of account, and a store of value.

Old School Wisdom:

Money is needed because it could “excite the industry of mankind. ”

Thomas Hume, Hume, Money and Civilization… by C. George CajTettzis

Old School Tony Montoya, aka Scarface, Wisdom: money is needed for doing business, settling debts, and emergency situations…

Hector the Toad: So, you got the money? Tony Montana: Yep. You got the stuff? Hector the Toad: Sure I have the stuff. I don’t have it with me here right now. I have it close by.

Tony Montana: Oh… well I don’t have the money either. I have it close by too.

Hector the Toad: Where? Down in your car?

Tony Montana: [lying] Uh… no. Not in the car.

Hector the Toad: No?

Tony Montana: What about you? Where do you keep your stuff‘?

Hector the Toad: Not far.

Tony Montana: I ain’t getting the money unless I see the stuff first.

Hector the Toad: No, no. First the money, then the stuff.

Tony Montana: [after a long tense pause] Okay. You want me to come in, and we start over again?

Hector the Toad: [changing the subject] Where are you from, Tony?

Tony Montana: [getting angry and supicious] What the f **k difference does that make on where I ’m from?

Hector the Toad: Cona, Tony. I ’m just asking just so I know who I ’m doing business with.

Tony Montana: Well, you can know about me when you stop f **king around and start doing business with me, Hector! […]

Hector the Toad: You want to give me the cash, or do I kill your brother first, before I kill you?

Tony Montana: Why don’t you try sticking your head up your ass? See if it fits. […J

Frank Lopez: [pleading] Please Tony, don’t kill me. Please, give me one more chance. I give you $10 million. $10 million! All of it, you can have the whole $10 million. I give you $10 million. I give you all $10 million just to let me go. Come on, Tony, $10 million. It’s in a vault in Spain, we get on a plane and it’s all yours. That’s $10 million just to spare me.

Dialog from Scarface, the movie.

Note: The comment about the $10 million stashed in a Spanish vault highlights a small chink in MMT’s armor. If the taxing power of the sovereign state is sabotaged, or there is widespread tax evasion, then MMT falls apart.


3. Where does money come from?

MMT: The government just credits accounts.

Modern money comes from “nowhere.” Bill Mitchell

Conventional Wisdom: Money comes from the government printing currency and making it legal tender.


4. Government Spending: any limits?

MMT: government spending is not constrained.

“A sovereign government can always spend what it wants. The japanese government, with the highest debt ratio by far (190 per cent or so) has exactly the same capacity to spend as the Australian government which has a public debt ratio around 18 per cent (last time I looked). Both have an unlimited financial capacity to spend.

That is not the same thing as saying they should spend in an unlimited fashion. Clearly they should run deficits sufficiently to close the non-government spending gap. That should be the only fiscal rule they obey.” Bill Mitchell

Conventional Wisdom: government spending should be constrained.

“One option to ensure that we begin to get our fiscal house in order is a balanced budget amendment to the Constitution. I have no doubt that my Republican colleagues will overwhelmingly support this common sense measure and I urge Democrats to as well in order to get our fiscal house in order.”

House Majority Leader Eric Cantor (RVA), June 23th, 2010

5. What is Quantitative Easing?

MMT: It is an asset swap. It is not “printing money” and it is not a very good anti-recession strategy.

“Quantitative easing merely involves the central bank buying bonds (or other bank assets) in exchange for deposits made by the central bank in the commercial banking system that is, crediting their reserve accounts… So quantitative easing is really just an accounting adjustment in the various accounts to reflect the asset exchange. The commercial banks get a new deposit (central bank funds) and they reduce their holdings of the asset they sell…

Invoking the “evil-sounding” printing money terminology to describe this practice is thus very misleading and probably deliberately so.

All transactions between the Government sector (Treasury and Central Bank) and the non-government sector involve the creation and destruction of net financial assets denominated in the currency of issue. Typically, when the Government buys something from the non-government sector they just credit a bank account somewhere that is, numbers denoting the size of the transaction appear electronically in the banking system.

It is inappropriate to call this process “printing money”. Commentators who use this nomenclature do so because they know it sounds bad! The orthodox (neoliberal) economics approach uses the “printing money” term as equivalent to “inflationary expansion”. If they understood how the modern monetary system actually worked they would never be so crass…

So I don’t think quantitative easing is a sensible anti-recession strategy. The fact that governments are using it now just reflects the Neoliberal bias towards monetary policy over fiscal policy…” Bill Mitchell

Conventional Wisdom: Quantitative Easing is “money printing”

James Grant, editor of Grant’s Interest Rate Observer, says Quantitative Easing is just Money Printing.


6. What is the view on personal debt?

MMT: personal debt is not dangerous.

“Americans today have too much personal debt. False. Private debt adds money to our economy. Though bankruptcies have increased lately, that is due more to the liberalization of bankruptcy laws, rather than to economics. Despite rising debt and bankruptcies, our economy has continued to grow. The evidence is that high private debt has had no negative effect on our economy as a whole, though it can be a problem for any individual.”

Free Money: Plan for Prosperity ©2005 (pg 154), by Rodger Malcolm Mitchell

.
Note: Rodger Mitchell is an MMT extremist. He calls his brand of MMT, “Monetary Sovereignty”. Not all of his views may be in sync with mainstream MMT doctrine.


Conventional Wisdom: too much debt is dangerous.

“The core of our economic problem is, instead, the debt, mainly mortgage debt that households ran up during the bubbleyears of the last decade. Now that the bubble has burst, that debt is acting as a persistent drag on the economy, preventing any real recovery in employment.” Paul Krugman

Old School Wisdom: debt is always dangerous.

“Neither a borrower, nor a lender be”

Polonius speaking in Hamlet, by William Shakespeare

7. What is the view on foreign trade?

MMT: Exporters please just take some more fiat money and everyone will be fat and happy!

“Think of all those cars japan sold to us for under $2,000 years ago. They’ve been holding those dollars in their savings accounts at the Fed (they own US. Treasury securities), and if they now would want to spend those dollars, they would probably have to pay in excess of $20,000 per car to buy cars from us. What can they do about the higher prices? Call the manager and complain? They’ve traded millions of perfectly good cars to us in exchange for credit balances on the Fed’s books that can buy only what we allow them to buy…

We are not dependent on China to buy our securities or in any way fund our spending. Here’s what’s really going on:

Domestic credit creation is funding foreign savings…

Assume you live in the US. and decide to buy a car made in China. You go to a US. bank, get accepted for a loan and spend the funds on the car. You exchanged the borrowed funds for the car, the Chinese car company has a deposit in the bank and the bank has a loan to you and a deposit belonging to the Chinese car company on their books. First, all parties are “happy.” You would rather have the car than the funds, or you would not have bought it, so you are happy. The Chinese car company would rather have the funds than the car, or they would not have sold it, so they are happy. The bank wants loans and deposits, or it wouldn’t have made the loan, so it’s happy.

There is no “imbalance.” Everyone is sitting fat and happy…”

Warren Mosler, The 7 Deadly Frauds of Economic Policy

Old School Wisdom: Trade arrangements will break down if a currency is debased.

“Sorry paleface, Chief say your wampum is no good. We want steel knives and firewater for our beaver pelts.” American Indian reaction after Dutch colonists debase wampum in the 1600’s


See also:

Modern Money Theory: Deadly Innocent Fraud #1. Government Must Tax To Spend. – Warren Mosler

Why UNIVERSAL BASIC INCOME is Our Future. The War on Normal People – Andrew Yang.

The Truth About America’s Dissappearing Jobs.

This is the most pressing economic and social issue of our time; our economy is evolving in ways that will make it more and more difficult for people with lower levels of education to find jobs and support themselves.

Soon, these difficulties will afflict the white-collar world. it’s a boiling pot getting hotter one degree at a time. And we’re the frog.

In order for society to continue to function and thrive when tens of millions of people don’t have jobs, we will need to rethink the relationship between work and being able to pay for basic needs.

And then, we will have to determine ways to convey the psychic and social benefits of work in other ways.

Little effort is being made to distribute the gains from automation and reverse the decline in opportunities. To do so would require an active, stable, invigorated, unified federal government willing to make large bets. This, unfortunately, is not what we have.

We need a revitalized, dynamic government to rise to the challenge posed by the largest economic transformation in the history of mankind.

“We are at the most dangerous moment in the development of humanity. .. the rise of artificial intelligence is likely to extend job destruction deep into the middle classes, with only the most caring, creative or supervisory roles remaining.” Stephen Hawking

“Human beings are also animals, to manage one million animals gives me a headache.” Terry Gou, founder of Foxconn

THE GREAT DISPLACEMENT

I am writing from inside the tech bubble to let you know that we are coming for your jobs.

I recently met a pair of old friends for drinks in Manhattan. One is an executive who works at a software company in New York. They replace call center workers with artificial intelligence software. I asked her whether she believed her work would result in job losses. She responded matter-of-factly, “We are getting better and better at things that will make large numbers of workers extraneous. And we will succeed. There needs to be a dramatic reskilling of the workforce, but that’s not going to be practical for a lot of people. It’s impossible to avoid a lost generation of workers.” Her confidence in this assessment was total. The conversation then quickly shifted to more pleasant topics.

I later met with a friend who’s a Boston based venture capitalist. He told me he felt “a little uneasy” about investing in software and robotics companies that, if successful, would eliminate large numbers of jobs. “But they’re good opportunities,” he noted, estimating that 70 percent of the startups he’s seeing will contribute to job losses in other parts of the economy.

In San Francisco, I had breakfast with an operations manager for a large tech company. He told me, “I just helped set up a factory that had 70 percent fewer workers than one even a few years ago would have had, and most of them are high-end technicians on laptops. I have no idea what normal people are going to do in a few years.”

Normal people. Seventy percent of Americans consider themselves part of the middle class. Chances are, you do, too. Right now some of the smartest people in the country are trying to figure out how to replace you with an overseas worker, a cheaper version of you, or, increasingly, a widget, software program, or robot. There’s no malice in it. The market rewards business leaders for making things more efficient. Efficiency doesn’t love normal people. It loves getting things done in the most cost-effective way possible.

A wave of automation and job loss is no longer a dystopian vision of the future, it’s well under way. The numbers have been telling a story for a while now that we have been ignoring. More and more people of prime working age have been dropping out of the workforce. There’s a growing mass of the permanently displaced. Automation is accelerating to a point where it will soon threaten our social fabric and way of life.

Experts and researchers project an unprecedented wave of job destruction coming with the development of artificial intelligence, robotics, software, and automation. The Obama White House published a report in December 2016 that predicted 83 percent of jobs where people make less than $20 per hour will be subject to automation or replacement. Between 2.2 and 3.1 million car, bus, and truck driving jobs in the United States will be eliminated by the advent of self-driving vehicles.

Read that last sentence again: we are confident that between 2 and 3 million Americans who drive vehicles for a living will lose their jobs in the next 10 to 15 years. Driving a truck is the most common occupation in 29 states. Self-driving vehicles are one of the most obvious job-destroying technologies, but there are similar innovations ahead that will displace cashiers, fast food workers, customer service representatives, administrative assistants, and even well-paid whitecollar jobs like wealth managers, lawyers, and insurance agents, all within the span of a few short years. Suddenly out of work, millions will struggle to find a new job, particularly those at the lower end of the skill ladder.

Automation has already eliminated about 4 million manufacturing jobs in the United States since 2000. Instead of finding new jobs, a lot of those people left the workforce and didn’t come back. The U.S. labor force participation rate is now at only 62.9 percent, a rate below that of nearly all other industrialized economies and about the same as that of El Salvador and the Ukraine. Some of this is driven by an aging population, which presents its own set of problems, but much of it is driven by automation and a lower demand for labor.

Each 1 percent decline in the labor participation rate equates to approximately 2.5 million Americans dropping out. The number of working-age Americans who aren’t in the workforce has surged to a record 95 million. Ten years into the nation’s recovery from the financial crisis and 95 million working-age Americans not in the workforce, I’ve taken to calling this phenomenon the Great Displacement.

The lack of mobility and growth has created a breeding ground for political hostility and social ills. High rates of unemployment and underemployment are linked to an array of social problems, including substance abuse, domestic violence, child abuse, and depression. Today 40 percent of American children are born outside of married households, due in large part to the crumbling marriage rate among working-class adults, and overdoses and suicides have overtaken auto accidents as leading causes of death. More than half of American households already rely on the government for direct income in some form. In some parts of the United States, 20 percent of working-age adults are now on disability, with increasing numbers citing mood disorders. What Americans who cannot find jobs find instead is despair. If you care about communities and our way of life, you care about people having jobs.

This is the most pressing economic and social issue of our time; our economy is evolving in ways that will make it more and more difficult for people with lower levels of education to find jobs and support themselves. Soon, these difficulties will afflict the white-collar world. it’s a boiling pot getting hotter one degree at a time. And we’re the frog.

In my role as founder of Venture for America, I spent the past six years working with hundreds of startups across the country in cities like Detroit, New Orleans, Cincinnati, Providence, Cleveland, Baltimore, Philadelphia, St. Louis, Birmingham, Columbus, Pittsburgh, San Antonio, Charlotte, Miami, Nashville, Atlanta, and Denver. Some of these places were bustling industrial centers in the late 19th and 20th centuries, only to find themselves faced with population loss and economic transition as the 20th century wound down. Venture for America trains young aspiring entrepreneurs to work at startups in cities like these to generate job growth. We’ve had many successes. But the kinds of jobs created tend to be very specific; every business I worked with will hire the very best people it can find, particularly startups. When entrepreneurs start companies and expand, they generally aren’t hiring a down-on-his-or-her-luck worker in need of a break. They are hiring the strongest contributors with the right mix of qualities to help an early-stage company succeed. Most jobs in a startup essentially require a college degree. That excludes 68 percent of the population right there. And some of these companies are lifting further inefficiencies out of the system, reducing jobs in other places even while hiring their own new workers.

There’s a scene in Ben Horowitz’s book The Hard Things about Hard Things in which he depicts the CEO of a company meeting with his two lieutenants. The CEO says to one of them, “You’re going to do everything in your power to make this deal work.” Then he turns to the other and says, “Even if he does everything right, it’s probably not going to work. Your job is to fix it.” That’s where we’re at with the American economy. Unprecedented advances are accelerating in real time and wreaking havoc on lives and communities around the country, particularly on those least able to adapt and adjust.

We must do all we can to reduce the worst effects of the Great Displacement, it should be the driving priority of corporations, government, and nonprofits for the foreseeable future. We should invest in education, job training and placement, apprenticeships, relocation, entrepreneurship, and tax incentives, anything to help make hiring and retaining workers appealing. And then we should acknowledge that, for millions of people, it’s not going to work.

In the United States we want to believe that the market will resolve most situations. In this case, the market will not solve the problem, quite the opposite. The market is driven to reduce costs. It will look to find the cheapest way to perform tasks. The market doesn’t want to provide for unemployed truck drivers or cashiers. Uber is going to get rid of its drivers as soon as it can. Its job isn’t to hire lots of people, its job is to move customers around as efficiently as possible. The market will continue to throw millions of people out of the labor force as automation and technology improve. In order for society to continue to function and thrive when tens of millions of Americans don’t have jobs, we will need to rethink the relationship between work and being able to pay for basic needs. And then, we will have to determine ways to convey the psychic and social benefits of work in other ways.

There is really only one entity, the federal government, that can realistically reformat society in ways that will prevent large swaths of the country from becoming jobless zones of derelict buildings and broken people. Nonprofits will be at the front lines of fighting the decline, but most of their activities will be like bandages on top of an infected wound. State governments are generally hamstrung with balanced budget requirements and limited resources.

Even if they don’t talk about it in public, many technologists themselves fear a backlash. My friends in Silicon Valley want to be positive, but many are buying bunkers and escape hatches just in case. One reason that solutions are daunting to even my most optimistic friends is that, while their part of the American economy is flourishing, little effort is being made to distribute the gains from automation and reverse the decline in opportunities. To do so would require an active, stable, invigorated, unified federal government willing to make large bets. This, unfortunately, is not what we have. We have an indebted state rife with infighting, dysfunction, and outdated ideas and bureaucracies from bygone eras, along with a populace that cannot agree on basic facts like vote totals or climate change. Our politicians offer half-hearted solutions that will at best nibble at the edges of the problem. The budget for research and development in the Department of Labor is only $4 million. We have a 1960s-era government that has few solutions to the problems of 2018.

This must change if our way of life is to continue. We need a revitalized, dynamic government to rise to the challenge posed by the largest economic transformation in the history of mankind.

The above may sound like science fiction to you. But you’re reading this with a supercomputer in your pocket (or reading it on the supercomputer itself) and Donald Trump was elected president. Doctors can fix your eyes with lasers, but your local mall just closed. We are living in unprecedented times. The future without jobs will come to resemble either the cultivated benevolence of Star Trek or the desperate scramble for resources of Mad Max. Unless there is a dramatic course correction, I fear we are heading toward the latter.

As Bismarck said, “If revolution there is to be, let us rather undertake it not undergo it.” Society will change either before or after the revolution. I choose before.

I’m a serial entrepreneur who started out as a lawyer. Before launching Venture for America, I co-founded an Internet company, worked at a health care software startup, and ran a national education company that was acquired in 2009. I’ve worked in startups and economic development for 17 years. I know how companies operate and how jobs are created and reduced. I’m also both an ardent capitalist and completely certain that our system needs to change in order to continue our way of life.

Our society has already been shaped by large-scale changes in the economy due to technological advances. it turns out that Americans have been dealing with the lack of meaningful opportunities by getting married less and becoming less and less functional. The fundamental message is that we are already on the edge of dystopia with hundreds of thousands of families and communities being pushed into oblivion.

Education and retraining won’t address the gaps; the goalposts are now moving and many affected workers are well past their prime. We need to establish an updated form of capitalism, I call it Human Centered Capitalism, or Human Capitalism for short, to amend our current version of institutional capitalism that will lead us toward ever increasing automation accompanied by social ruin. We must make the market serve humanity rather than have humanity continue to serve the market. We must simultaneously become more dynamic and more empathetic as a society. We must change and grow faster than most think possible.

When the next downturn hits, hundreds of thousands of people will wake up to do their jobs only to be told that they’re no longer needed. Their factory or retail store or office or mall or business or truck stop or agency will close. They will look for another job and, this time, they will not find one. They will try to keep up a brave face, but the days and weeks will pass and they will become more and more defeated. They will almost always blame themselves for their lot. They will say things like, “I wish I’d applied myself more in school,” or “I should have picked another job.” They’ll burn through their meager savings. Their family lives and communities will suffer. Some will turn to substance abuse or watch too much TV. Their health will slip, the ailments they’ve been working through will seem twice as painful. Their marriages will fail. They will lose their sense of self-worth. Their physical environments will decay around them and their loved ones will become reminders of their failure.

For every displaced worker, there will be two or three others who have their shifts and hours reduced, their benefits cut, and their already precarious financial lives pushed to the brink. They will try to consider themselves lucky even as their hopes for the future dim.

Meanwhile, in Manhattan and Silicon Valley and Washington, DC, my friends and I will be busier than ever fighting to stay current and climb within our own hypercompetitive environments. We will read articles with concern about the future and think about how to redirect our children to more fertile professions and livelihoods. We will retweet something and contribute here and there. We will occasionally reflect on the fates of others and shake our heads, determined to be among the winners in whatever the new economy brings.

The logic of the meritocracy is leading us to ruin, because we are collectively primed to ignore the voices of the millions getting pushed into economic distress by the grinding wheels of automation and innovation. We figure they’re complaining or suffering because they’re losers.

We need to break free of this logic of the marketplace before it’s too late.

We must reshape and accelerate society to bring us all to higher ground. We must find new ways to organize ourselves independent of the values that the marketplace assigns to each and every one of us.

We are more than the numbers on our paychecks and we are going to have to prove it very quickly.

PART ONE

WHAT’S HAPPENING TO JOBS

1. MY JOURNEY

I grew up a skinny Asian kid in upstate New York who was often ignored or picked on, like one of the kids from Stranger Things but nerdier and with fewer friends. It stuck with me. I’ve never forgotten what it felt like to be young. To be gnawed at by doubts and fears so deep that they inflict physical pain, a sense of nausea deep in your stomach. To feel like an alien, to be ignored or ridiculed. I didn’t think it was possible to forget all that. But it turns out that most of us do. In movies, they show children going through formative experiences at home. The protagonists go back where they came from later to make it better. In real life, none of us goes back.

My parents valued education deeply. My father, who immigrated from Taiwan, worked in the research labs of GE and IBM. He got his PhD in physics from Berkeley and generated 69 patents over his career. He met my mom, also from Taiwan, while in grad school. She has a master’s in statistics and worked as a computer services administrator at our local university before becoming an artist. My brother became a professor, which is kind of the family business. Being the first generation born in this country gave me both a fierce love for the United States and a deep sense of what it means to struggle to fit in.

I was one of the only Asians in my local public school. That didn’t go unnoticed. Classmates offered frequent reminders as to my identity:

“What’s up, Chink.” “Hey… you… wanna fight?” said with mouth moving but no sound coming out, to imitate a kung fu movie with bad dubbing.

“Ching chong ching chong.”

“Hey, you know what Chinese use for blindfolds?

Dental floss!”

“You see that?” Demonstrates a blank face. “That’s the way the gook laughs.”

“Hey, Yang, you hungry? You want a gook-ie?”

“Hey, Yang. I see where you’re looking. No interracial dating.”

“Hey, Yang, what’s it like having such a small dick? Everyone knows Chinese guys have small dicks. Do you need tweezers to masturbate?”

Most of this was in middle school. I had a few natural responses: I became quite self-conscious. I started wondering if I did indeed have a small dick. Last, I became very, very angry.

Perhaps as a result, I’ve always taken pride in relating to the underdog or little guy or gal. As I grew up, I tried to stick up for whoever seemed excluded or marginalized. I became a Mets fan. I’d go to a party and find the person who seemed the most alone or uncomfortable and strike up a conversation. I worked out a little too much in college.

I grew up and found that my zeal extended into my professional life. I love small companies and helping them grow. After five months as a corporate lawyer, I co-founded an Internet company when I was 25, back in 2000. After it went bust, I worked at a medical records software company, and then helped a friend, Zeke Vanderhoek, with his GMAT prep company when he was starting out as a solo tutor in a Starbucks. He eventually asked me to take over as CEO. Between the two of us and our team, we grew the company to become number one in the country.

By 2010 I was riding high. Our company, Manhattan Prep, had been acquired by the Washington Post Company’s Kapian division for millions of dollars. I was 35 years old, the head of a national education company that I loved, living in New York City among family and friends, and engaged to marry my fiancée the following year. I was on top of the world.

And yet, something bothered me that I couldn’t let go. I’d trained hundreds of young people, as CEO of Manhattan Prep I’d taught the analyst classes at Goldman Sachs, McKinsey, JP. Morgan, Morgan Stanley, and many other companies. These college graduates often seemed disenchanted with their careers; they were looking to go to business school to take a break and find the next step. Many of them hailed from other parts of the country, Michigan, Ohio, Georgia, and had come to Wall Street for better opportunities. When I talked to them after class, they seemed to be searching for some higher purpose that had eluded them. They reminded me of myself a decade earlier, when I had started my career as an unhappy corporate lawyer.

. . .

from

The War on Normal People. The Truth About America’s Dissappearing Jobs and Why Universal Basic Income is Our Future

by Andrew Yang

get it at Amazon.com

The Suffocation of Democracy – Christopher R. Browning.

Trump, History Repeats.


In the 1920s, the US pursued isolationism in foreign policy and rejected participation in international organizations like the League of Nations. America First was America alone, except for financial agreements like the Dawes and Young Plans aimed at ensuring that our “free-loading” former allies could pay back their war loans. At the same time, high tariffs crippled international trade, making the repayment of those loans especially difficult. The country witnessed an increase in income disparity and a concentration of wealth at the top, and both Congress and the courts eschewed regulations to protect against the self-inflicted calamities of free enterprise run amok. The government also adopted a highly restrictionist immigration policy aimed at preserving the hegemony of white Anglo-Saxon Protestants against an influx of Catholic and Jewish immigrants. (Various measures barring Asian immigration had already been implemented between 1882 and 1917.) These policies left the country unable to respond constructively to either the Great Depression or the rise of fascism, the growing threat to peace, and the refugee crisis of the 1930s.

New York Review of Books

How shareholder profits conquered capitalism, and how workers can win back its benefits for themselves – Louis Brennan, Trinity College Dublin.

It is past the time that business schools should smarten up, jettison this “dumb” shareholder value dogma, and start teaching a version of capitalism less damaging to the interests of society.

The Conversation

Mike Taylor: Another financial crisis is coming… but when and where? – NZ Herald

The next crisis is lurking just below the surface and it might not take much to set it off.
As humans we have managed to solve just about every problem thrown our way, like communication, transportation, human rights, famine, plagues, and global wars.
But we are yet to solve the economic cycle.
We remain in an environment of boom and bust, misallocated capital, unintended consequences and are left always with the failings of capitalism.

NZ Herald

Money. The Unauthorised Biography – Felix Martin.

Simple and intuitive though it may be, there is a drawback to the conventional theory of money. It is entirely false.

Not a single researcher has been able to find a society, historical or contemporary, that regularly conducted its trade by barter.

‘For a century or more, the “civilized” world regarded as a manifestation of its wealth, metal dug from deep in the ground, refined at great labor, and transported great distances to be buried again in elaborate vaults deep under the ground. Is the one practice really more rational than the other?’ Milton Friedman

So if it is so obvious that the conventional theory of money is wrong, why has such a distinguished canon of economists and philosophers believed it? And why does today’s economics profession by and large persist in using the fundamental ideas of this tradition as the building blocks of modern economic thinking?

What is money, and how does it work?

The conventional answer is that people once used sugar in the West Indies, tobacco in Virginia, and dried cod in Newfoundland, and that today’s financial universe evolved from barter.

Unfortunately, there is a problem with this story. It’s wrong. And not just wrong, but dangerous. Money: the Unauthorised Biography unfolds a panoramic secret history and explains the truth about money: what it is, where it comes from, and how it works.

Drawing on stories from throughout human history and around the globe, Money will radically rearrange your understanding of the world and shows how money can once again become the most powerful force for freedom we have ever known.

About the author

Felix Martin was educated in the UK, Italy and the US, and holds degrees in Classics, International Relations and Economics, including a D.Phil. in Economics from Oxford University. He worked for the World Bank and for the European Stability Initiative think tank, and is currently a partner in the fixed income division at Liontrust Asset Management plc.

1 What is Money?

“Everyone, except an economist, knows what ‘money’ means, and even an economist can describe it in the course of a chapter or so . . .” A.H. Quiggin, A Survey of Primitive Money: the Beginnings of Currency

THE ISLAND OF STONE MONEY

THE PACIFIC ISLAND of Yap was, at the beginning of the twentieth century, one of the most remote and inaccessible inhabited places on earth. An idyllic, subtropical paradise, nestled in a tiny archipelago nine degrees north of the equator and more than 300 miles from Palau, its closest neighbour, Yap had remained almost innocent of the world beyond Micronesia right up until the final decades of the nineteenth century. There had, it is true, been a brief moment of Western contact in 1731 when a group of intrepid Catholic missionaries had established a small base on the island. When their supply ship returned the following year, however, it discovered that the balmy, palm-scattered islands of Yap had not proved fertile ground for the Christian gospel. The entire mission had been massacred several months previously by local witch doctors aggrieved at the competition presented by the Good News. Yap was left to its own devices for another one hundred and forty years.

It was not until 1869 that the first European trading post run by the German merchant firm of Godeffroy and sons was established in the Yap archipelago. Once a few years had passed, with Godeffroy not only avoiding summary execution but prospering, Yap’s presence came to the attention of the Spanish, who by virtue of their colonial possessions in the Philippines a mere 800 miles to the west considered themselves the natural overlords of this part of Micronesia. The Spanish laid claim to the islands, and believed that they had achieved a fait accompli when in the summer of 1885 they erected a house and installed a Governor in it. They had not counted, however, on the tenacity of Bismarck’s Germany in matters of foreign policy. No island was so small, or so remote, as to be unworthy of the Imperial Foreign Ministry’s attention if it meant a potential addition to German power. The ownership of Yap became the subject of an international dispute. Eventually, the matter was referred somewhat ironically, given the island’s track record to arbitration by the Pope, who granted political control to Spain, but full commercial rights to Germany. But the Iron Chancellor had the last laugh. Within a decade and a half, Spain had lost a damaging war with America for control of the Philippines, and its ambitions in the Pacific had disintegrated. In 1899, Spain sold Yap to Germany for the sum of $3.3 million.

The absorption of Yap into the German Empire had one great benefit. It brought one of the more interesting and unusual monetary systems in history to the attention of the world. More specifically, it proved the catalyst for a visit by a brilliant and eccentric young American adventurer, William Henry Furness III. The scion of a prominent New England family, Furness had trained as a doctor before converting to anthropology and making his name with a popular account of his travels in Borneo. In 1903 he made a two-month visit to Yap, and published a broad survey of its physical and social make-up a few years later. He was immediately impressed by how much more remote and untouched it was than Borneo. Yet despite being a tiny island with only a few thousand inhabitants ‘whose whole length and breadth is but a day’s walk’, as Furness described it Yap turned out to have a remarkably complex society. There was a caste system, with a tribe of slaves, and special Clubhouses lived in by fishing and fighting fraternities. There was a rich tradition of dancing and songs, which Furness took particular delight in recording for posterity. There was a vibrant native religion as the missionaries had previously discovered to their cost complete with an elaborate genesis myth locating the origins of the Yapese in a giant barnacle attached to some floating driftwood. But undoubtedly the most striking thing that Furness discovered on Yap was its monetary system.

The economy of Yap, such as it was, could hardly be called developed. The market extended to a bare three products fish, coconuts, and Yap’s one and only luxury, sea cucumber. There was no other exchangeable commodity to speak of; no agriculture; few arts and crafts; the only domesticated animals were pigs and, since the Germans had arrived, a few cats; and there had been little contact or trade with outsiders. It was as simple and as isolated an economy as one could hope to find. Given these antediluvian conditions, Furness expected to find nothing more advanced than simple barter. Indeed, as he observed, ‘in a land where food and drink and ready-made clothes grow on trees and may be had for the gathering’ it seemed possible that even barter itself would be an unnecessary sophistication.

The very opposite turned out to be true. Yap had a highly developed system of money. It was impossible for Furness not to notice it the moment that he set foot on the island, because its coinage was extremely unusual. It consisted of fei, large, solid, thick stone wheels ranging in diameter from a foot to twelve feet, having in the centre a hole varying in size with the diameter of the stone, wherein a pole may be inserted sufficiently large and strong to bear the weight and facilitate transportation’. This stone money was originally quarried on Babelthuap, an island some 300 miles away in Palau, and had mostly been brought to Yap, so it was said, long ago. The value of the coins depended principally on their size, but also on the fineness of the grain and the whiteness of the limestone.

At first, Furness believed that this bizarre form of currency might have been chosen because, rather than in spite of, its extraordinary unwieldiness: ‘when it takes four strong men to steal the price of a pig, burglary cannot but prove a somewhat disheartening occupation’, he ventured. ‘As may be supposed, thefts of fei are almost unknown.’ But as time went on, he observed that physical transportation of fei from one house to another was in fact rare. Numerous transactions took place but the debts incurred were typically just offset against each other, with any outstanding balance carried forward in expectation of some future exchange. Even when open balances were felt to require settlement, it was not usual for fei to be physically exchanged.

‘The noteworthy feature of this stone currency,’ wrote Furness, ‘is that it is not necessary for its owner to reduce it to possession. After concluding a bargain which involves the price of a fei too large to be conveniently moved, its new owner is quite content to accept the bare acknowledgement of ownership and without so much as a mark to indicate the exchange, the coin remains undisturbed on the former owner’s premises.’

The stone currency of Yap as photographed by William Henry Furness III in 1903, with people and palm trees for scale.

When Furness expressed amazement at this aspect of the Yap monetary system, his guide told him an even more surprising story:

“There was in the village nearby a family whose wealth was unquestioned, acknowledged by everyone and yet no one, not even the family itself, had ever laid eye or hand on this wealth; it consisted of an enormous fei, whereof the size is known only by tradition; for the past two or three generations it had been and was at that time lying at the bottom of the sea!”

This fei, it transpired, had been shipwrecked during a storm while in transit from Babelthuap many years ago. Nevertheless:

“It was universally conceded . . . that the mere accident of its loss overboard was too trifling to mention, and that a few hundred feet of water offshore ought not to affect its marketable value . . . The purchasing power of that stone remains, therefore, as valid as if it were leaning visibly against the side of the owner’s house, and represents wealth as potentially as the hoarded inactive gold of a miser in the Middle Ages, or as our silver dollars stacked in the Treasury in Washington, which we never see or touch, but trade with on the strength of a printed certificate that they are there.”

When it was published in 1910, it seemed unlikely that Furness’ eccentric travelogue would ever reach the notice of the economics profession. But eventually a copy happened to find its way to the editors of the Royal Economic Society’s Economic Journal, who assigned the book to a young Cambridge economist, recently seconded to the British Treasury on war duty: a certain John Maynard Keynes. The man who over the next twenty years was to revolutionise the world’s understanding of money and finance was astonished. Furness’ book, he wrote, ‘has brought us into contact with a people whose ideas on currency are probably more truly philosophical than those of any other country. Modern practice in regard to gold reserves has a good deal to learn from the more logical practices of the island of Yap.’ Why it was that the greatest economist of the twentieth century believed the monetary system of Yap to hold such important and universal lessons is the subject of this book.

GREAT MINDS THINK ALIKE

What is money, and where does it come from?

A few years ago, over a drink, I posed these two questions to an old friend, a successful entrepreneur with a prospering business in the financial services industry. He responded with a familiar story. In primitive times, there was no money just barter. When people needed something that they didn’t produce themselves, they had to find someone who had it and was willing to swap it for whatever they did produce. Of course, the problem with this system of barter exchange is that it was very inefficient. You had to find another person who had exactly what you wanted, and who in turn wanted exactly what you had got, and what is more, both at exactly the same time.

So at a certain point, the idea emerged of choosing one thing to serve as a ‘medium of exchange’. This thing could in principle be anything so long as, by general agreement, it was universally acceptable as payment. In practice, however, gold and silver have always been the most common choices, because they are durable, malleable, portable, and rare. In any case, whatever it was, this thing was from then on desirable not only for its own sake, but because it could be used to buy other things and to store up wealth for the future. This thing, in short, was money and this is where money came from. it’s a simple and powerful story. And as I explained to my friend, it is a theory of money’s nature and origins with a very ancient and distinguished pedigree. A version of it can be found in Aristotle’s Politics, the earliest treatment of the subject in the entire Western canon. It is the theory developed by John Locke, the father of classical political Liberalism, in his Second Treatise of Government. To cap it all, it is the very theory almost to the letter advocated by none other than Adam Smith in his chapter ‘Of the Origin and Use of Money’ in the foundation text of modern economics, An Inquiry into the Nature and Causes of the Wealth of Nations:

“But when the division of labour first began to take place, this power of exchanging must frequently have been very much clogged and embarrassed in its operations . . . The butcher has more meat in his shop than he himself can consume, and the brewer and the baker would each of them be willing to purchase a part of it. But they have nothing to offer in exchange, except the productions of their respective trades, and the butcher is already provided with all the bread and beer which he has immediate occasion for . . . In order to avoid such situations, every prudent man in every period of society, after the first establishment of the division of labour, must naturally have endeavoured to manage his affairs in such a manner, as to have at all times by him, besides the peculiar produce of his own industry, a certain quantity of some one commodity or other, such as he imagined few other people would be likely to refuse in exchange for the produce of their industry.”

Smith even shared my friend’s agnosticism as to which commodity would be chosen to serve as money:

“Many different commodities, it is probable, were successively both thought of and employed for this purpose. In the rude ages of society, cattle are said to have been the most common instrument of commerce . . . Salt is said to be the common instrument of commerce and exchange in Abyssinia; a species of shells in some parts of the coast of India; dried cod in Newfoundland; tobacco in Virginia; sugar in some of our West India colonies; hides or dressed leather in some other countries; and there is to this day a village in Scotland where it is not uncommon, I am told, for a workman to carry nails instead of money to the baker’s shop or the alehouse.”

And like my friend, Smith also believed that in general, gold, silver, and other metals were the most logical choices:

“In all countries, however, men seem at last to have been determined by irresistible reasons to give the preference, for this employment, to metals above every other commodity. Metals can not only be kept with as little loss as any other commodity, scarce any thing being less perishable than they are, but they can likewise, without any loss, be divided into any number of parts, as by fusion of those parts can easily be re-united again; a quality which no other equally durable commodities possess, and which more than any other quality renders them fit to be the instruments of commerce and circulation.”

So I told my friend he could congratulate himself. Without having studied economics at all, he had arrived at the same theory as the great Adam Smith. But that’s not all, I explained. This theory of money’s origins and nature is not just a historical curiosity like Ptolemy’s geocentric astronomy, a set of obsolete hypotheses long since superseded by more modern theories. On the contrary, it is found today in virtually all mainstream textbooks of economics. What’s more, its fundamental ideas have formed the bedrock of an immense body of detailed theoretical and empirical research on monetary questions over the last sixty years. Based on its assumptions, economists have designed sophisticated mathematical models to explore exactly why one commodity is chosen as money over all others and how much of it people will want to hold, and have constructed a vast analytical apparatus designed to explain every aspect of money’s value and use. It has provided the basis for the branch of economics, ‘macroeconomics’ as it is known, which seeks to explain economic booms and busts, and to recommend how we can moderate these so-called business cycles by managing interest rates and government spending. In short, my friend’s ideas not only had history behind them. They remain today, amongst amateurs and experts alike, very much the conventional theory of money.

By now, my friend was positively brimming with self-congratulation. ‘I know that I’m brilliant,’ he said with his usual modesty, ‘but it does still amaze me that I, a rank amateur, can match the greatest minds in the economic canon without ever having given it a second thought before today. Doesn’t it make you think you might have been wasting your time all those years you were studying for your degrees?’ I agreed that there was certainly something a bit troubling about it all. But not because he had hit upon the theory without any training in economics. It was quite the opposite. It was that those of us who have had years of training regurgitate this theory. Because simple and intuitive though it may be, there is a drawback to the conventional theory of money. It is entirely false.

John Maynard Keynes

STONE AGE ECONOMICS?

John Maynard Keynes was right about Yap. William Henry Furness’ description of its curious stone currency may at first appear to be nothing more than a picturesque footnote to the history of money. But it poses some awkward questions of the conventional theory of money. Take, for example, the idea that money emerged out of barter. When Aristotle, Locke, and Smith were making this claim, they were doing so purely on the basis of deductive logic. None of them had ever actually seen an economy that operated entirely via barter exchange. But it seemed plausible that such an arrangement might once have existed; and if it had existed, then it also seemed plausible that it would have been so unsatisfactory that someone would have tried to invent a way to improve on it.

In this context, the monetary system of Yap came as something of a surprise. Here was an economy so simple that it should theoretically have been operating by barter. Yet it was not: it had a fully developed system of money and currency. Perhaps Yap was an exception to the rule. But if an economy this rudimentary already had money, then where and when would a barter economy be found?

This question continued to trouble researchers over the century after Furness’ account of Yap was published. As historical and ethnographic evidence accumulated, Yap came to look less and less of an anomaly. Seek as they might, not a single researcher was able to find a society, historical or contemporary, that regularly conducted its trade by barter.

By the 1980s, the leading anthropologists of money considered the verdict to be in. ‘Barter, in the strict sense of moneyless market exchange, has never been a quantitatively important or dominant mode of transaction in any past or present economic system about which we have hard information,’ wrote the American scholar George Dalton in 1982. ‘No example of a barter economy, pure and simple, has ever been described, let alone the emergence from it of money; all available ethnography suggests that there has never been such a thing,’ concluded the Cambridge anthropologist Caroline Humphrey.

The news even began filtering through to the more intellectually adventurous fringes of the economics profession. The great American economic historian Charles Kindleberger, for example, wrote in the second edition of his Financial History of Western Europe, published in 1993, that ‘Economic historians have occasionally maintained that evolution in economic intercourse has proceeded from a natural or barter economy to a money economy and ultimately to a credit economy. This view was put forward, for example, in 1864 by Bruno Hildebrand of the German historical school of economics; it happens to be wrong.’

By the beginning of the twenty-first century, a rare academic consensus had been reached amongst those with an interest in empirical evidence that the conventional idea that money emerged from barter was false. As the anthropologist David Graeber explained bluntly in 2011: ‘There’s no evidence that it ever happened, and an enormous amount of evidence suggesting that it did not.’

The story of Yap does not just present a challenge to the conventional theory’s account of money’s origins, however. It also raises serious doubts about its conception of what money actually is. The conventional theory holds that money is a ‘thing’ a commodity chosen from amongst the universe of commodities to serve as a medium of exchange and that the essence of monetary exchange is the swapping of goods and services for this commodity medium of exchange. But the stone money of Yap doesn’t fit this scheme. In the first place, it is difficult to believe that anyone could have chosen ‘large, solid, thick stone wheels ranging in diameter from a foot to twelve feet’ as a medium of exchange since in most cases, they would be a good deal harder to move than the things being traded. But more worryingly, it was clear that the fei were not a medium of exchange in the sense of a commodity that could be exchanged for any other since most of the time, they were not exchanged at all. Indeed, in the case of the infamous shipwrecked fei, no one had ever even seen the coin in question, let alone passed it around as a medium of exchange. No, there could be no doubt: the inhabitants of Yap were curiously indifferent to the fate of the fei themselves. The essence of their monetary system was not stone coins used as a medium of exchange, but something else.

Closer consideration of Adam Smith’s story of commodities chosen to serve as media of exchange suggests that the inhabitants of Yap were on to something. Smith claimed that at different times and in different places, numerous commodities had been chosen to serve as the money: dried cod in Newfoundland; tobacco in Virginia; sugar in the West Indies; and even nails in Scotland. Yet suspicions about the validity of some of these examples were already being raised within a generation or two of the publication of Smith’s Wealth of Nations.

The American financier Thomas Smith, for example, argued in his Essay on Currency and Banking in 1832 that whilst Smith thought that these stories were evidence of commodity media of exchange, they were in fact nothing of the sort. In every case, these were examples of trade that was accounted for in pounds, shillings, and pence, just as it was in modern England. Sellers would accumulate credit on their books, and buyers debts, all denominated in monetary units. The fact that any net balances that remained between them might then be discharged by payment of some commodity or other to the value of the debt did not mean that that commodity was ‘money’. To focus on the commodity payment rather than the system of credit and clearing behind it was to get things completely the wrong way round. And to take the view that it was the commodity itself that was money, as Smith did, might therefore start out seeming logical, but would end in nonsense. Alfred Mitchell Innes, the author of two neglected masterworks on the nature of money, summed up the problem with Smith’s report of cod-money in Newfoundland bluntly but accurately:

“A moment’s reflection shows that a staple commodity could not be used as money, because ex hypothesi the medium of exchange is equally receivable by all members of the community. Thus if the fishers paid for their supplies in cod, the traders would equally have to pay for their cod in cod, an obvious absurdity.”

If the fei of Yap were not a medium of exchange, then what were they? And more to the point, what, in fact, was Yap’s money if it wasn’t the fei? The answer to both questions is remarkably simple. Yap’s money was not the fei, but the underlying system of credit accounts and clearing of which they helped to keep track. The fei were just tokens by which these accounts were kept.

As in Newfoundland, the inhabitants of Yap would accumulate credits and debts in the course of their trading in fish, coconut, pigs, and sea cucumber. These would be offset against one another to settle payments. Any outstanding balances carried forward at the end of a single exchange, or a day, or a week, might, if the counterparties so wished, be settled by the exchange of currency, a fei to the appropriate value; this being a tangible and visible record of the outstanding credit that the seller enjoyed with the rest of Yap.

Coins and currency, in other words, are useful tokens to record the underlying system of credit accounts and to implement the underlying process of clearing. They may even be necessary in an economy larger than that of Yap, where coins could drop to the bottom of the sea and yet no one would think to question the wealth of their owner.

But currency is not itself money. Money is the system of credit accounts and their clearing that currency represents.

If all this sounds familiar to the modern reader, even obvious, it should. After all, thinking of money as a commodity and monetary exchange as the swapping of goods for a tangible medium of exchange may have been intuitive in the days when coins were minted from precious metals. It may even have made sense when the law entitled the holder of a Federal Reserve or Bank of England note to present it on Constitution Avenue or Threadneedle Street and expect its redemption for a specified quantity of gold.

But those days are long gone. In today’s modern monetary regimes, there is no gold that backs our dollars, pounds, or euros nor any legal right to redeem our banknotes for it.

Modern banknotes are quite transparently nothing but tokens. What is more, most of the currency in our contemporary economies does not enjoy even the precarious physical existence of a banknote. The vast majority of our national money around 90 per cent in the US, for example, and 97 per cent in the UK has no physical existence at all. It consists merely of our account balances at our banks. The only tangible apparatus employed in most monetary payments today is a plastic card and a keypad. It would be a brave theorist indeed who would try to maintain that a pair of microchips and a Wi-Fi connection are a commodity medium of exchange.

By a strange coincidence, John Maynard Keynes is not the only giant of twentieth-century economics to have saluted the inhabitants of Yap for their clear understanding of the nature of money. In 1991, seventy-nine-year-old Milton Friedman, hardly Keynes’ ideological bedfellow, also came across Furness’ obscure book. He too extolled the fact that Yap had escaped from the conventional but unhealthy obsession with commodity coinage, and that by its indifference to its physical currency it acknowledged so transparently that money is not a commodity, but a system of credit and clearing.

‘For a century or more, the “civilized” world regarded as a manifestation of its wealth metal dug from deep in the ground, refined at great labor, and transported great distances to be buried again in elaborate vaults deep under the ground,’ he wrote. ‘Is the one practice really more rational than the other?’

To win the praise of one of the two greatest monetary economists of the twentieth century may be regarded as chance; to win the praise of both deserves attention.

MONETARY VANDALISM: THE FATE OF THE EXCHEQUER TALLIES

The economic worldview of Yap, which both Keynes and Friedman applauded, of money as a special type of credit, of monetary exchange as the clearing of credit accounts, and of currency as merely tokens of an underlying credit relationship, has not been without its own forceful historical proponents. Amongst those who have had to deal with the practical business of managing money especially in extremis the view of money as credit, rather than a commodity, has always had a strong following. One famous example is provided by the siege of Valletta by the Turks in 1565. As the Ottoman embargo dragged on, the supply of gold and silver began to run short, and the Knights of Malta were forced to mint coins using copper. The motto that they stamped on them in order to remind the population of the source of their value would have seemed perfectly sensible to the inhabitants of Yap: Non Aes, sed Fides ‘Not the metal, but trust’.

Nevertheless, it is undoubtedly the conventional view of money as a commodity, of monetary exchange as swapping goods for a medium of exchange, and of credit as the lending out of the money commodity, that has enjoyed the lion’s share of support from theorists and philosophers over the centuries, and thereby dominated economic thought and, for much of the time, policy as well.

But if it is so obvious that the conventional theory of money is wrong, why has such a distinguished canon of economists and philosophers believed it? And why does today’s economics profession by and large persist in using the fundamental ideas of this tradition as the building blocks of modern economic thinking? Why, in short, is the conventional theory of money so resilient? There are two basic reasons, and they are worth dwelling on.

The first reason has to do with the historical evidence for money. The problem is not that so little of it survives from earlier ages, but that it is virtually all of a single type, coins. Museums around the world heave with coins, ancient and modern. Coins and their inscriptions are one of the main archaeological sources for the understanding of ancient culture, society, and history. Deciphered by ingenious scholars, their graven images and their abbreviated inscriptions give up vast libraries of knowledge about the chronologies of ancient kings, the hierarchy of classical deities, and the ideologies of ancient republics. An entire academic discipline, numismatics, is devoted to the study of coins; and far from being the scholarly equivalent of stamp collecting, as it might appear to the uninitiated, numismatics is amongst the most fruitful fields of historical research.

But of course the real reason why coins are so important in the study of ancient history, and why they have dominated in particular the study of the history of money, is that coins are what have survived. Coins are made of durable metals and very often of imperishable metals, such as gold or silver, which do not rust or corrode. As a result, they tend to survive the ravages of time better than most other things. What is more, coins are valuable. As a result, there has always been a tendency for them to be squirrelled away in buried or hidden hoards, the better to be discovered decades, centuries, or even millennia later by the enterprising historian or numismatist. The problem is that in no field so much as the history of money is an approach fixated upon what physically survives likely to lead us into error.

The unfortunate story of the wholesale destruction of one of the most important collections of source material for the history of money ever to have existed shows why.

For more than six hundred years, from the twelfth to the late eighteenth century, the operation of the public finances of England rested on a simple but ingenious piece of accounting technology: the Exchequer tally. A tally was a wooden stick usually harvested from the willows that grew along the Thames near the Palace of Westminster. On the stick were inscribed, always with notches in the wood and sometimes also in writing, details of payments made to or from the Exchequer. Some were receipts for tax payments made by landowners to the Crown. Others referred to transactions in the opposite direction, recording the sums due on loans by the sovereign to prominent subjects. ‘92 4s 4p from Fulk Basset for the farm of Wycombe’ reads one that has survived, for example relating a debt owed by Fulk Basset, a thirteenth-century Bishop of London, to Henry III. Even bribes seem to have been recorded on Exchequer tallies: one stick in a private collection bears the suspicious-sounding euphemism ‘135 4d from William de Tullewyk for the king’s good will’.

Once the details of the payment had been recorded on the tally stick, it was split down the middle from end to end so that each party to the transaction could keep a record. The creditor’s half was called the ‘stock’, and the debtor’s the ‘foil’: hence the English use of the term ‘stocks’ for Treasury bonds, which survives to this day. The unique grain of the willow wood meant that a convincing forgery was virtually impossible; while the record of the account in a portable format rather than just inscribed in the Treasury account books at Westminster, for example meant that Exchequer credits could be passed from their original holder to a third party in payment of some unrelated debt. Tallies were what are called ‘bearer securities’ in modern financial jargon: financial obligations such as bonds, share certificates, or banknotes, the beneficiary of which is whoever holds the physical record.

Historians agree that the vast majority of fiscal operations in medieval England must have been carried out using tally sticks; and they suppose that a great deal of monetary exchange was transacted using them as well. A credit with the Exchequer, as recorded on a tally stick, would after all have been welcomed in payment by anyone who had taxes of his own coming due. It is, however, impossible to know for certain. For although millions of tallies must have been manufactured over the centuries, and though we know for sure that many thousands survived in the Exchequer archives up until the early nineteenth century, only a handful of specimens exist today. The ultimate culprit for this unfortunate situation is the famous zeal of England’s nineteenthcentury advocates of administrative reform.

A collection of English Exchequer tallies: rare survivors of one of the great episodes of historical vandalism of the nineteenth century.

Despite the fact that the tally-stick system had proved itself remarkably efficient over the preceding five hundred years, by the late eighteenth century it was felt that it was time to dispense with it. Keeping accounts with notched sticks let alone using wooden splints as money alongside the elegant paper notes of the Bank of England was by then considered little short of barbaric, and certainly out of keeping with the enormous progress being made in commerce and technology. An Act of Parliament of 1782 officially abolished tally sticks as the main means of account-keeping at the Exchequer, though, because certain sinecures still operated on the old system, the Act had to wait almost another half-century, until 1826, to come into effect. But in 1834, the ancient institution of the Receipt of the Exchequer was finally abolished, and the last Exchequer tally replaced by a paper note.

Once the tally-stick system had finally been abolished, the question arose of what to do with the vast archive of tallies left in the Exchequer. Amongst the partisans of reform the general feeling was that they were nothing but embarrassing relics of the way in which the fiscal accounts of the British Empire had been kept, ‘much as Robinson Crusoe kept his calendar on the desert island’, and it was decided without hesitation to incinerate them. Twenty years later, Charles Dickens recounted the unfortunate consequences:

It came to pass that they were burnt in a stove in the House of Lords. The stove, overgorged with these preposterous sticks, set fire to the panelling; the panelling set fire to the House of Lords; the House of Lords set fire to the House of Commons; the two houses were reduced to ashes; architects were called in to build others; we are now in the second million of the cost thereof . . .

The Houses of Parliament could be rebuilt, of course and were, to leave the splendid Palace of Westminster that stands on the banks of the Thames today. What could not be resurrected from the inferno, however, was the priceless record of England’s fiscal and monetary history constituted by the tallies. Historians have had to rely on a handful of tallies that survived by chance in private collections, and we are fortunate that there are a few contemporary accounts of how they were used. But as for the immense wealth of knowledge that the Westminster archive embodied about the state of England’s money and finances throughout the Middle Ages, it is irretrievably lost.

If this is a problem for the history of money in medieval England, the situation is infinitely worse for the history of money more generally and especially in pre-literate societies. All too often, the only physical trace of money that remains is coins: yet as the example of the English tally-stick system shows, coinage may have been only the very tip of the monetary iceberg. Vast hinterlands of monetary and financial history lie beyond our grasp simply because no physical evidence of their existence and operation survives.

To appreciate the seriousness of the problem we have only to consider what hope the historians of the future would have of reconstructing our own monetary history if a natural disaster were to destroy the digital records of our contemporary financial system. We can only trust that reason would prevail, and that they would not build their understanding of modern economic life on the assumption that the pound and euro coins and nickels and dimes that survived were the sum total of our money.

THE BENEFIT OF BEING A FISH OUT OF WATER

The second reason why the conventional theory of money remains so resilient is directly related to a still more intrinsic difficulty. There is an old Chinese proverb: ‘The fish is the last to know water’. It is a concise explanation of why the ‘social’ or ‘human’ sciences anthropology, sociology, economics and so on are different from the natural sciences physics, chemistry, and biology. In the natural sciences, we study the physical world; and it is at least in principle possible to get an objective view. Things are not so simple in the social sciences. In these fields, we are studying ourselves, as individuals and in groups. Society and our selves have no independent existence apart from us and by contrast to the natural sciences, this makes it exceptionally difficult to get an objective view of things. The closer an institution is to the heart of our daily lives, the trickier it is to step outside of it in order to analyse it and the more controversial will be attempts to do so.

The second reason why the nature of money is so difficult to pin down, and why it has been and remains a subject of such controversy, is precisely because it is such an integral part of our economies. When we try to understand money, we are like the fish of the Chinese proverb, trying to know the very water in which it moves.

This doesn’t mean that all social science is a waste of time, however. It may not be possible to get an absolutely objective view of our own habits, customs, and traditions; but by studying them under different historical conditions we can get a more objective view than otherwise. Just as we can use two different perspectives on a point in the distance to triangulate its position when out hiking, we can learn a lot about a familiar social phenomenon by observing it in other times, in other places, and in other cultures. The only problem in the case of money is that it is such a basic element of the economy that finding opportunities for such triangulation is tricky. Most of the time money is just part of the furniture. It is only when the normal monetary order is disrupted that the veil is snatched from our eyes. When the monetary order dissolves, the water is temporarily tipped out of the fishbowl and we become for a critical moment a fish out of water.

. . .

*

from

Money. The Unauthorised Biography

by Felix Martin

get it at Amazon.com

Give People Money. How a Universal Basic Income would end poverty, revolutionise work, and remake the world – Annie Lowrey.

A UBI is an ethos as much as it is a technocratic policy proposal. It contains within it the principles of universality, unconditionality, inclusion, and simplicity, and it insists that every person is deserving of participation in the economy, freedom of choice, and a life without deprivation. Our governments can and should choose to provide those things.

Surely just giving people money couldn’t work. Or could it?

Imagine if every month the government deposited £1000 in your bank account, with no strings attached and nothing expected in return. It sounds crazy, but Universal Basic Income (UBI) has become one of the most influential policy ideas of our time, backed by thinkers on both the left and the right. The founder of Facebook, Obama’s chief economist, governments from Canada to Finland are all seriously debating some form of UBI.

In this sparkling and provocative book, economics writer Annie Lowrey looks at the global UBI movement. She travels to Kenya to see how UBI is lifting the poorest people on earth out of destitution, India to see how inefficient government programs are failing the poor, South Korea to interrogate UBI’s intellectual pedigree, and Silicon Valley to meet the tech titans financing UBI pilots in expectation of a world with advanced artificial intelligence and little need for human labour. She also examines the challenges the movement faces: contradictory aims, uncomfortable costs, and most powerfully, the entrenched belief that no one should get something for nothing.

The UBI movement is not just an economic policy, it also calls into question our deepest intuitions about what we owe each other and what activities we should reward and value as a society.

Annie Lowrey is a contributing editor for The Atlantic, where she covers economic policy. She is a frequent guest on CNN, MSNBC, and NPR. She is a former writer for the New York Times, the New York Times Magazine, and Slate, among other publications.

Wages for Breathing

ONE OPPRESSIVELY HOT and Muggy day in July, I stood at a military installation at the top of a mountain called Dorasan, overlooking the demilitarized zone between South Korea and North Korea. The central building was painted in camouflage and emblazoned with the hopeful phrase “End of Separation, Beginning of Unification.” On one side was a large, open observation deck with a number of telescopes aimed toward the Kaesong industrial area, a special pocket between the two countries where, up until recently, communist workers from the North would come and toil for capitalist companies from the South, earning $90 million in wages a year. A small gift shop sold soju liquor made by Northern workers and chocolate-covered soybeans grown in the demilitarized zone itself. (Don’t like them? Mail them back for a refund, the package said.)

On the other side was a theater whose seats faced not a movie screen but windows looking out toward North Korea. In front, there was a labeled diorama. Here is a flag. Here is a factory. Here is a juche-inspiring statue of Kim ll Sung. See it there? Can you make out his face, his hands? Chinese tourists pointed between the diorama and the landscape, viewed through the summer haze.

Across the four-kilometer-wide demilitarized zone, the North Koreans were blasting propaganda music so loudly that I could hear not just the tunes but the words. I asked my tour guide, Soo-jin, what the song said. “The usual,” she responded. “Stuff about how South Koreans are the tools of the Americans and the North Koreans will come to liberate us from our capitalist slavery.” Looking at the denuded landscape before us, this bit of pomposity seemed impossibly sad, as did the incomplete tunnel from North to South scratched out beneath us, as did the little Potemkin village the North Koreans had set up in sight of the observation deck. It was supposedly home to two hundred families, who Pyongyang insisted were working a collective farm, using a child care center, schools, a hospital. Yet Seoul had determined that nobody had ever lived there, and the buildings were empty shells. Comrades would come turn the lights on and off to give the impression of activity. The North Koreans called it “peace village”; Soo-jin called it “propaganda village.”

A few members of the group I was traveling with, including myself, teared up at the stark difference between what was in front of us and what was behind. There is perhaps no place on earth that better represents the profound life-and-death power of our choices when it comes to government policy. Less than a lifetime ago, the two countries were one, their people a polity, their economies a single fabric. But the Cold War’s ideological and political rivalry between capitalism and communism had ripped them apart, dividing families and scarring both nations. Soo-jin talked openly about the separation of North Korea from the South as “our national tragedy.”

The Republic of Korea, the South, rocketed from third-world to first-world status, becoming one of only a handful of countries to do so in the postwar era. In 1960, about fifteen years after the division of the peninsula, its people were about as wealthy as those in the Ivory Coast and Sierra Leone. In 2016, they were closer income-wise to those in Japan, its former colonial occupier, and a brutal one. Citigroup now expects South Korea to be among the most prosperous countries on earth by 2040, richer even than the United States by some measures.

Yet the Democratic People’s Republic of Korea, the North, has faltered and failed, particularly since the 1990s. It is a famine-scarred pariah state dominated by governmental graft and military buildup. Rare is it for a country to suffer such a miserable growth pattern without also suffering from the curse of natural disasters or the horrors of war. As of a few years ago, an estimated 40 percent of the population was living in extreme poverty,‘ more than double the share of people in Sudan. Were war to befall the country, that proportion would inevitably rise.

Even from the remove of the observation deck, enveloped in steam, hemmed in by barbed wire, patrolled by passive young men with assault rifles, the difference was obvious. You could see it. I could see it. The South Korean side of the border was lush with forest and riven with well built highways. Everywhere, there were power lines, trains, docks, high-rise buildings. An hour south sat Seoul, as cosmopolitan and culturally rich a city as Paris, with far better infrastructure than New York or Los Angeles. But the North Korean side of the border was stripped of trees. People had perhaps cut them down for firewood and basic building supplies, Soo-jin told me. The roads were empty and plain, the buildings low and smalI. So were the people: North Koreans are now measurably shorter than their South Korean relatives, in part due to the stunting effects of malnutrition.

South Korea and North Korea demonstrated, so powerfully demonstrated, that what we often think of as economic circumstance is largely a product of policy. The way things are is really the way we choose for them to be. There is always a counterfactual. Perhaps that counterfactual is not as stark as it is at the demilitarized zone. But it is always there.

Imagine that a check showed up in your mailbox or your bank account every month.

The money would be enough to live on, but just barely. It might cover a room in a shared apartment, food, and bus fare. It would save you from destitution if you had just gotten out of prison, needed to leave an abusive partner, or could not find work. But it would not be enough to live particularly well on. Let’s say that you could do anything you wanted with the money. It would come with no strings attached. You could use it to pay your bills. You could use it to go to college, or save it up for a down payment on a house. You could spend it on cigarettes and booze, or finance a life spent playing Candy Crush in your mom’s basement and noodling around on the Internet. Or you could use it to quit your job and make art, devote yourself to charitable works, or care for a sick child. Let’s also say that you did not have to do anything to get the money. It would just show up every month, month after month, for as long as you lived. You would not have to be a specific age, have a child, own a home, or maintain a clean criminal record to get it. You just would, as would every other person in your community.

This simple, radical, and elegant proposal is called a universal basic income, or UBI. It is universal, in the sense that every resident of a given community or country receives it. It is basic, in that it is just enough to live on and not more. And it is income.

The idea is a very old one, with its roots in Tudor England and the writings of Thomas Paine, a curious piece of intellectual flotsam that has washed ashore again and again over the last half millennium, often coming in with the tides of economic revolution. In the past few years, with the middle class being squeezed, trust in government eroding, technological change hastening, the economy getting Uberized, and a growing body of research on the power of cash as an antipoverty measure being produced, it has vaulted to a surprising prominence, even pitching from airy hypothetical to near-reality in some places. Mark Zuckerberg, Hillary Clinton, the Black Lives Matter movement, Bill Gates, Elon Musk, these are just a few of the policy proposal’s flirts, converts, and supporters. UBI pilots are starting or ongoing in Germany, the Netherlands, Finland, Canada, and Kenya, with India contemplating one as well. Some politicians are trying to get it adopted in California, and it has already been the subject of a Swiss referendum, where its reception exceeded activists’ expectations despite its defeat.

Why undertake such a drastic policy change, one that would fundamentally alter the social contract, the safety net, and the nature of work? UBI’s strange bedfellows put forward a dizzying kaleidoscope of arguments, drawing on everything from feminist theory to environmental policy to political philosophy to studies of work incentives to sociological work on racism.

Perhaps the most prominent argument for a UBI has to do with technological unemployment, the prospect that robots will soon take all of our jobs. Economists at Oxford University estimate that about half of American jobs, including millions and millions of white-collar ones, are susceptible to imminent elimination due to technological advances. Analysts are warning that Armageddon is coming for truck drivers, warehouse box packers, pharmacists, accountants, legal assistants, cashiers, translators, medical diagnosticians, stockbrokers, home appraisers, I could go on.

In a world with far less demand for human work, a UBI would be necessary to keep the masses afloat, the argument goes. “I’m not saying I know the future, and that this is exactly what’s going to happen,” Andy Stern, the former president of the two-million member Service Employees International Union and a UBI booster, told me. But if “a tsunami is coming, maybe someone should figure out if we have some storm shutters around.”

A second common line of reasoning is less speculative, more rooted in the problems of the present rather than the problems of tomorrow. It emphasizes UBl’s promise at ameliorating the yawning inequality and grating wage stagnation that the United States and other high-income countries are already facing. The middle class is shrinking. Economic growth is aiding the brokerage accounts of the rich but not the wallets of the working classes. A UBl would act as a straightforward income support for families outside of the top 20 percent, its proponents argue. It would also radically improve the bargaining power of workers, forcing employers to increase wages, add benefits, and improve conditions to retain their talent. Why take a crummy job for $7.25 an hour when you have a guaranteed $1,000 a month to fall back on? “In a time of immense wealth, no one should live in poverty, nor should the middle class be consigned to a future of permanent stagnation or anxiety,” argues the Economic Security Project, a new UBI think tank and advocacy group.

In addition, a UBI could be a powerful tool to eliminate deprivation, both around the world and in the United States. About 41 million Americans were living below the poverty line as of 2016. A $1,000-a-month grant would push many of them above it, and would ensure that no abusive partner, bout of sickness, natural disaster, or sudden job loss means destitution in the richest civilization that the planet has ever known. This case is yet stronger in lower income countries. Numerous governments have started providing cash transfers, if not universal and unconditional ones, to reduce their poverty rates, and some policymakers and political parties, pleased with the results, are toying with providing a true UBI. In Kenya, a U.S.-based charity called GiveDirectly is sending thousands of adults about $20 a month for more than a decade to demonstrate how a UBl could end deprivation, cheaply and at scale. “We could end extreme poverty right now, if we wanted to,” Michael Faye, GiveDirectly’s cofounder, told me.

A UBI would end poverty not just effectively, but also efficiently, some of its libertarian-leaning boosters argue. Replacing the current American welfare state with a UBI would eliminate huge swaths of the government’s bureaucracy and reduce state interference in its citizens’ lives: Hello UBI, good-bye to the Departments of Health and Human Services and Housing and Urban Development, the Social Security Administration, a whole lot of state and local offices, and much of the Department of Agriculture. “Just giving people money is a very natural solution,” says Charles Murray of the American Enterprise Institute, a right-of center think tank. “It’s a way of cutting the Gordian knot. You don’t need to be drafting ever more sophisticated solutions to our problems.”

Protecting against a robot apocalypse, providing workers with bargaining power, jump-starting the middle class, ending poverty, and reducing the complexity of government: It sounds pretty good, right? But a UBI means that the government would send every citizen a check every month, eternally and regardless of circumstance. That inevitably raises any number of questions about fairness, government spending, and the nature of work.

When I first heard the idea, I worried about UBl’s impact on jobs. A $1,000 check arriving every month might spur millions of workers to drop out of the labor force, leaving the United States relying on a smaller and smaller pool of workers for taxable income to be distributed to a bigger and bigger pool of people not participating in paid labor. This seems a particularly prevalent concern given how many men have dropped out of the labor force of late, pushed by stagnant wages and pulled, perhaps, by the low-cost marvels of gaming and streaming. With a UBI, the country would lose the ingenuity and productivity of a large share of its greatest asset: its people. More than that, a UBI implemented to fight technological unemployment might mean giving up on American workers, paying them off rather than figuring out how to integrate them into a vibrant, techfueled economy. Economists of all political persuasions have voiced similar concerns.

And a UBI would do all of this at extraordinary expense. Let’s say that we wanted to give every American $1,000 a month in cash. Back-of-the-envelope math suggests that this policy would cost roughly $3.9 trillion a year. Adding that kind of spending on top of everything else the government already funds would mean that total federal outlays would more than double, arguably requiring taxes to double as well. That might slow the economy down, and cause rich families and big corporations to flee offshore. Even if the government replaced Social Security and many of its other antipoverty programs with a UBI, its spending would still have to increase by a number in the hundreds of billions, each and every year.

Stepping back even further: Is a UBI really the best use of scarce resources? Does it make any sense to bump up taxes in order to give people like Mark Zuckerberg and Bill Gates $1,000 a month, along with all those working-class families, retirees, children, unemployed individuals, and so on? Would it not be more efficient to tax rich people and direct money to poor people through means-testing, as programs like Medicaid and the Supplemental Nutrition Assistance Program, better known as SNAP or food stamps, already do? Even in the socialist Nordic countries, state support is generally contingent on circumstance. Plus, many lower-income and middle-income families already receive far more than $1,000 a month per person from the government, in the United States and in other countries. If a UBI wiped out programs like food stamps and housing vouchers, is there any guarantee that a basic income would be more fair and effective than the current system?

There are more philosophical objections to a UBI too. In no country or community on earth do individuals automatically get a pension as a birthright, with the exception of some princes, princesses, and residents of petrostates like Alaska. Why should we give people money with no strings attached? Why not ask for community service in return, or require that people at least try to work? Isn’t America predicated on the idea of pulling yourself up by your bootstraps, not on coasting by on a handout?

As a reporter covering the economy and economic policy in Washington, I heard all of these arguments for and objections against, watching as an obscure, never before tried idea became a global phenomenon. Not once in my career had I seen a bit of social-policy arcana go viral. Search interest in UBI more than doubled between 2011 and 2016, according to Google data.“ UBl barely got any mention in news stories as of the mid 2000s, but since then the growth has been exponential. It came up in books, at conferences, in meetings with politicians, in discussions with progressives and libertarians, around the dinner table.

I covered it as it happened. I wrote about that failed Swiss referendum, and about a Canadian basic income experiment that has provided evidence for the contemporary debate. I talked with Silicon Valley investors terrified by the prospect of a jobless future and rode in a driverless car, wondering how long it would be before artificial intelligence started to threaten my job. I chatted with members of Congress on both sides of the aisle about the failing middle class and whether the country needed a new, big redistributive policy to strengthen it. I had beers with European intellectuals enthralled with the idea. I talked with Hill aides convinced that a UBI would be a part of a 2020 presidential platform. I spoke with advocates certain that in a decade, millions of people around the world would have a monthly check to fall back on, or else would make up a miserable new precariat. I heard from philosophers convinced that our understanding of work, our social contract, and the underpinnings of our economy were about to undergo an epochal transformation.

The more I learned about UBI, the more obsessed I became with it, because it raised such interesting questions about our economy and our politics. Could libertarians in the United States really want the same thing as Indian economists as the Black Lives Matter protesters as Silicon Valley tech pooh-bahs? Could one policy be right for both Kenyan villagers living on 60 cents a day and the citizens of Switzerland’s richest canton? Was UBI a magic bullet, or a policy hammer in search of a nail? My questions were also philosophical. Should we compensate uncompensated care workers? Why do we tolerate child poverty, given how rich the United States is? Is our safety net racist? What would a robot jobs apocalypse actually look like?

I set out to write this book less to describe a burgeoning international policy movement or to advocate for an idea, than to answer those questions for myself. The research for it brought me to villages in remote Kenya, to a wedding held amid monsoon rains in one of the poorest states in India, to homeless shelters, to senators’ offices. I interviewed economists, politicians, subsistence farmers, and philosophers. I traveled to a UBI conference in Korea to meet many of the idea’s leading proponents and deepest thinkers, and stood with them at the DMZ contemplating the terrifying, heartening, and profound effects of our policy choices.

What I came to believe is this:

A UBI is an ethos as much as it is a technocratic policy proposal. It contains within it the principles of universality, unconditionality, inclusion, and simplicity, and it insists that every person is deserving of participation in the economy, freedom of choice, and a life without deprivation. Our governments can and should choose to provide those things, whether through a $1,000-a-month stipend or not.

This book has three parts. First, we’ll look at the issues surrounding UBI and work, then UBI and poverty, and finally UBI and social inclusion. At the end, we’ll explore the promise, potential, and design of universal cash programs. I hope that you will come to see, as I have, that there is much to be gained from contemplating this complicated, transformative, and mind-bending policy.

Chapter One

The Ghost Trucks

THE NORTH AMERICAN International auto show is a gleaming, roaring affair. Once a year, in bleakest January, carmakers head to the Motor City to show off their newest models, technologies, and concept vehicles to industry figures, the press, and the public. Each automaker takes its corner of the dark, carpeted cavern of the Cobo Center and turns it into something resembling a game-show set: spotlights, catwalks, light displays, scantily clad women, and vehicle after vehicle, many rotating on giant lazy Susans. I spent hours at a recent show, ducking in and out of new models and talking with auto executives and sales representatives. I sat in an SUV as sleek as a shark, the buttons and gears and dials on its dash-board replaced with a virtual cockpit straight out of science fiction. A race car so aerodynamic and low that I had to crouch to get in it. And driverless car after driverless car after driverless car.

The displays ranged in degrees of technological spectacle from the cool to the oh-my-word. One massive Ford truck, for instance, offered a souped-up cruise control that would brake for pedestrians and take over stop-and-go driving in heavy traffic. “No need to keep ramming the pedals yourself,” a representative said as l gripped the oversize steering wheel.

Across the floor sat a Volkswagen concept car that looked like a hippie caravan for aliens. The minibus had no door latches, just sensors. There was a plug instead of a gas tank. On fully autonomous driving mode, the dash swallowed the steering wheel. A variety of lasers, sensors, radar, and cameras would then pilot the vehicle, and the driver and front-seat passenger could swing their seats around to the back, turning the bus into a snug, space-age living room. “The car of the future!” proclaimed Klaus Bischoff, the company’s head of design.

It was a phrase that I heard again and again in Detroit. We are developing the cars of the future. The cars of the future are coming. The cars of the future are here. The auto market, I came to understand, is rapidly moving from automated to autonomous to driverless. Many cars already offer numerous features to assist with driving, including fancy cruise controls, backup warnings, lanekeeping technology, emergency braking, automatic parking, and so on. Add in enough of those options, along with some advanced sensors and thousands of lines of code, and you end up with an autonomous car that can pilot itself from origin to destination. Soon enough, cars, trucks, and taxis might be able to do so without a driver in the vehicle at all.

This technology has gone from zero to sixty, forgive me, in only a decade and a half. Back in 2002, the Defense Advanced Research Projects Agency, part of the Department of Defense and better known as DARPA, announced a “grand challenge,” an invitation for teams to build autonomous vehicles and race one another on a 142-mile desert course from Barstow, California, to Primm, Nevada. The winner would take home a cool million. At the marquee event, none of the competitors made it through the course, or anywhere close. But the promise of prize money and the publicity around the event spurred a wave of investment and innovation. “That first competition created a community of innovators, engineers, students, programmers, offroad racers, backyard mechanics, inventors, and dreamers who came together to make history by trying to solve a tough technical problem,” said Lt. Col. Scott Wadle of DARPA. “The fresh thinking they brought was the spark that has triggered major advances in the development of autonomous robotic ground vehicle technology in the years since.”

As these systems become more reliable, safer, and cheaper, and as government regulations and the insurance markets come to accommodate them, mere mortals will get to experience them. At the auto show, I watched John Krafcik, the chief executive of Waymo, Google’s self-driving spin-off, show off a fully autonomous Chrysler Pacifica minivan. “Our latest innovations have brought us closer to scaling our technology to potentially millions of people every day,” he said, describing how the cost of the threedimensional light-detection radar that helps guide the car has fallen 90 percent from its original $75,000 price tag in just a few years. BMW and Ford, among others, have announced that their autonomous offerings will go to market soon. “The amount of technology in cars has been growing exponentially,” said Sandy Lobenstein, a Toyota executive, speaking in Detroit‘s “The vehicle as we know it is transforming into a means of getting around that futurists have dreamed about for a long time.” Taxis without a taxi driver, trucks without a truck driver, cars you can tell where to go and then take a nap in: they are coming to our roads, and threatening millions and millions of jobs as they do.

*

from

Give People Money. How a Universal Basic Income would end poverty, revolutionise work, and remake the world

by Annie Lowrey

get it at Amazon.com

Modern Monetary Theory. The government is not a household and imports are still a benefit – Bill Mitchell.

A government is not a household, is a core Modern Monetary Theory (MMT) proposition because it separates the currency issuer from the currency user and allows us to appreciate the constraints that each has on its spending capacities.

Another core MMT proposition is that imports are a benefit and exports are a cost.

In the case of a household, there are both real and financial resource constraints which limit its spending and necessitate strategies being put in place to facilitate that spending (getting income, running down savings, borrowing, selling assets).

In the case of a currency issuing government the only spending constraints beyond the political are the available real resources that are for sale in that currency.

Beyond that, the government sector thus assumes broad responsibilities as the currency issuer, which are not necessarily borne by individual consumers. Its objectives are different. Which brings trade into the picture.

Another core MMT proposition is that imports are a benefit and exports are a cost.

So why would I support Jeremy Corbyn’s Build it in Britain policy, which is really an import competing strategy? Simple, the government is not a household.

Household consumers are users of the currency and aim to use their disposable incomes to create well-being, primarily for themselves and their families.

We exhibit generosity by extending our spending capacities to others when we give gifts.

But our aims are to get the best deal we can in our transactions. That means we like goods and services that satisfy our quality standards at the best price possible.

Which means that we will be somewhat indifferent to geography. If local suppliers are expensive and imported goods and services are cheaper, then as long as quality considerations are broadly met, we will purchase the imported commodity and be better off in a material sense.

If other nations are willing to send more goods and services to us than they get back in return then the real terms of trade are in our favour.

Exports require we give up our use of those real resources while imports mean we deprive other nations of the use of their resources.

There are nuances obviously.

A nation with lots of minerals (Australia) may not feel it is too much of a ‘cost’ to send boatloads of primary commodities to Japan or China.

We also individually might ascribe to broader goals in our purchasing decisions, although the evidence for this is weak.

For example, some of us believe that imports are only a beneflt if they come from nations that treat their workers reasonably (no sweat shops, killing trade unionists etc) and do not ravage the natural environment in the process of producing the goods.

I would guess those concerns do not dominate our decision making generally because if they did China would not have huge export surpluses.

But there are nuances.

However, a government is not a household. It has a wider remit (objectives) than a household and must consider a broad range of concerns when it uses its currency issuing capacity to shift real resources (as goods and services) from the non-government sector to the government sector to fulfill its elected mandate.

In that sense, imports remain a benefit but the broader concerns make the net decision more complex than it is for the nongovernment sector.

The government must consider regional disparities. When a household is making a decision to purchase a good or service, what is happening elsewhere in the nation might not rank very high in the decision.

The government must consider how best to maintain full employment. A household is really only concerned with their own employment although that doesn’t preclude us being generally concerned with high unemployment rates.

But ’buy local’ campaigns typically do not work when they try to steer household consumption expenditure.

The government can always maintain full employment through its fiscal spending decisions. We know that because it can always purchase the services of all idle labour that wants to work and receive payment in the currency of issue.

So from that starting point, there is no question that mass unemployment is a policy choice, not some uncontrollable outcome of a ’market‘.

In that context, the challenge for government is to work out how to frame the spending capacity to get the best employment outcomes:

* Direct public employment, that is obvious.

* Subsidy of local non-government firms, that is, operate by lowering the unit costs for firms to render them profitable when they otherwise would not be.

* ‘Build it in Britain’ that is, use procurement policies to sustain sales for local firms rather than subsidise their costs.

None of these full employment strategies negate the insight that imports are a benefit to a nation.

But the government has to consider broader concerns than just getting a good or service at the cheapest ’market’ price.

There are more considerations, but that is how we can understand this issue.

The End of Alchemy: Money, Banking and the Future of the Global Economy – Mervyn King.

If the economy had grown after the global financial crisis at the same rate as the number of books written about it, then we would have been back at full employment some while ago.

Modern economics has encouraged ways of thinking that make crises more probable. Economists have brought the problem upon themselves by pretending that they can forecast. No one can easily predict an unknowable future, and economists are no exception.

The fragility of our financial system stems directly from the fact that banks are the main source of money creation. Banks are man made institutions, important sources of innovation, prosperity and material progress, but also of greed, corruption and crises. For better or worse, they materially affect human welfare.

Unless we go back to the underlying causes we will never understand what happened and will be unable to prevent a repetition and help our economies truly recover.

The financial crisis of 2007-9 was merely the latest manifestation of our collective failure to manage the relationship between finance, the structure of money and banking, and a capitalist system.”

The former governor of the Bank of England on reforming global finance.

Mervyn King was governor of the Bank of England in 2003-13. In “The End of Alchemy” there is no gossip and few revelations. Instead Lord King uses his experience of the crisis as a platform from which to present economic ideas to non-specialists.

He does a good job of putting complex concepts into plain English. The discussion of the evolution of money, from Roman times to 19th-century America to today, is a useful introduction for those not quite sure what currency really is.

He explains why economies need central banks: at best, they are independent managers of the money supply and rein in the banking system. Central bankers like giving the impression that they have played such roles since time immemorial, but as Lord King points out the reality is otherwise. The Fed was created only in 1913; believe it or not, until 1994 it would not reveal to the public its interest rate decisions until weeks after the event. Even the Bank of England, founded in 1694, got the exclusive right to print banknotes, in England and Wales, only in 1844.

At times, Lord King can be refreshingly frank. He is no fan of austerity policies, saying that they have imposed “enormous costs on citizens throughout Europe”. He also reserves plenty of criticism for the economics profession. Since forecasting is so hit and miss, he thinks, the practice of giving prizes to the best forecasters “makes as much sense as it would to award the Fields Medal in mathematics to the winner of the National Lottery”.

The problem leading up to the global financial crisis, as Lord King sees it, is that commercial banks had little incentive to hold large quantities of safe, liquid assets. They knew that in a panic, the central bank would provide liquidity, no matter the quality of their balance sheets; in response they loaded up on risky investments.

The Economist

‘It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity …’ Charles Dickens, A Tale of Two Cities

The End of Alchemy, Mervyn King

The past twenty years in the modern world were indeed the best of times and the worst of times. It was a tale of two epochs in the first growth and stability, followed in the second by the worst banking crisis the industrialised world has ever witnessed. Within the space of little more than a year, between August 2007 and October 2008, what had been viewed as the age of wisdom was now seen as the age of foolishness, and belief turned into incredulity. The largest banks in the biggest financial centres in the advanced world failed, triggering a worldwide collapse of confidence and bringing about the deepest recession since the 1930s.

How did this happen? Was it a failure of individuals, institutions or ideas? The events of 2007-8 have spawned an outpouring of articles and books, as well as plays and films, about the crisis. If the economy had grown after the crisis at the same rate as the number of books written about it, then we would have been back at full employment some while ago.

Most such accounts like the media coverage and the public debate at the time focus on the symptoms and not the underlying causes. After all, those events, vivid though they remain in the memories of both participants and spectators, comprised only the latest in a long series of financial crises since our present system of money and banking became the cornerstone of modern capitalism after the Industrial Revolution in the eighteenth century. The growth of indebtedness, the failure of banks, the recession that followed, were all signs of much deeper problems in our financial and economic system.

Unless we go back to the underlying causes we will never understand what happened and will be unable to prevent a repetition and help our economies truly recover. This book looks at the big questions raised by the depressing regularity of crises in our system of money and banking. Why do they occur? Why are they so costly in terms of lost jobs and production? And what can we do to prevent them? It also examines new ideas that suggest answers.

In the spring of 2011, I was in Beijing to meet a senior Chinese central banker. Over dinner in the Diaoyutai State Guesthouse, where we had earlier played tennis, we talked about the lessons from history for the challenges we faced, the most important of which was how to resuscitate the world economy after the collapse of the western banking system in 2008. Bearing in mind the apocryphal answer of Premier Chou Enlai to the question of what significance one should attach to the French Revolution (it was ‘too soon to tell’), I asked my Chinese colleague what importance he now attached to the Industrial Revolution in Britain in the second half of the eighteenth century.

He thought hard. Then he replied: ‘We in China have learned a great deal from the West about how competition and a market economy support industrialisation and create higher living standards. We want to emulate that.’ Then came the sting in the tail, as he continued: ‘But I don’t think you’ve quite got the hang of money and banking yet.’ His remark was the inspiration for this book.

Since the crisis, many have been tempted to play the game of deciding who was to blame for such a disastrous outcome. But blaming individuals is counterproductive, it leads you to think that if just a few, or indeed many, of those people were punished then we would never experience a crisis again. If only it were that simple. A generation of the brightest and best were lured into banking, and especially into trading, by the promise of immense financial rewards and by the intellectual challenge of the work that created such rich returns. They were badly misled. The crisis was a failure of a system, and the ideas that underpinned it, not of individual policy makers or bankers, incompetent and greedy though some of them undoubtedly were. There was a general misunderstanding of how the world economy worked. Given the size and political influence of the banking sector, is it too late to put the genie back in the bottle? No it is never too late to ask the right questions, and in this book I try to do so.

If we don’t blame the actors, then why not the playwright? Economists have been cast by many as the villain. An abstract and increasingly mathematical discipline, economics is seen as having failed to predict the crisis. This is rather like blaming science for the occasional occurrence of a natural disaster. Yet we would blame scientists if incorrect theories made disasters more likely or created a perception that they could never occur, and one of the arguments of this book is that economics has encouraged ways of thinking that made crises more probable. Economists have brought the problem upon themselves by pretending that they can forecast. No one can easily predict an unknowable future, and economists are no exception.

Despite the criticism, modern economics provides a distinctive and useful way of thinking about the world. But no subject can stand still, and economics must change, perhaps quite radically, as a result of the searing experience of the crisis. A theory adequate for today requires us to think for ourselves, standing on the shoulders of giants of the past, not kneeling in front of them.

Economies that are capable of sending men to the moon and producing goods and services of extraordinary complexity and innovation seem to struggle with the more mundane challenge of handling money and banking. The frequency, and certainly severity, of crises has, if anything, increased rather than decreased over time.

In the heat of the crisis in October 2008, nation states took over responsibility for all the obligations and debts of the global banking system. In terms of its balance sheet, the banking system had been virtually nationalised but without collective control over its operations. That government rescue cannot conveniently be forgotten. When push came to shove, the very sector that had espoused the merits of market discipline was allowed to carry on only by dint of taxpayer support. The creditworthiness of the state was put on the line, and in some cases, such as Iceland and Ireland, lost. God may have created the universe, but we mortals created paper money and risky banks. They are man made institutions, important sources of innovation, prosperity and material progress, but also of greed, corruption and crises. For better or worse, they materially affect human welfare.

For much of modern history, and for good reason, money and banking have been seen as the magical elements that liberated us from a stagnant feudal system and permitted the emergence of dynamic markets capable of making the long-term investments necessary to support a growing economy. The idea that paper money could replace intrinsically valuable gold and precious metals, and that banks could take secure short-term deposits and transform them into long-term risky investments, came into its own with the Industrial Revolution in the eighteenth century. It was both revolutionary and immensely seductive. It was in fact financial alchemy, the creation of extraordinary financial powers that defy reality and common sense. Pursuit of this monetary elixir has brought a series of economic disasters from hyperinflations to banking collapses.

Why have money and banking, the alchemists of a market economy, turned into its Achilles heel?

The purpose of this book is to answer that question. It sets out to explain why the economic failures of a modern capitalist economy stem from our system of money and banking, the consequences for the economy as a whole, and how we can end the alchemy. Our ideas about money and banking are just as much a product of our age as the way we conduct our politics and imagine our past.

The twentieth century experience of depression, hyperinflation and war changed both the world and the way economists thought about it. Before the Great Depression of the early 1930s, central banks and governments saw their role as stabilising the financial system and balancing the budget. After the Great Depression, attention turned to policies aimed at maintaining full employment. But post-war confidence that Keynesian ideas, the use of public spending to expand total demand in the economy, would prevent us from repeating the errors of the past was to prove touchingly naive. The use of expansionary policies during the 1960s, exacerbated by the Vietnam War, led to the Great Inflation of the 1970s, accompanied by slow growth and rising unemployment, the combination known as ‘stagflation’.

The direct consequence was that central banks were reborn as independent institutions committed to price stability. So successful was this that in the 1990s not only did inflation fall to levels unseen for a generation, but central banks and their governors were hailed for inaugurating an era of economic growth with low inflation, the Great Stability or Great Moderation. Politicians worshipped at the altar of finance, bringing gifts in the form of lax regulation and receiving support, and sometimes campaign contributions, in return. Then came the fall: the initial signs that some banks were losing access to markets for short-term borrowing in 2007, the collapse of the industrialised world’s banking system in 2008, the Great Recession that followed, and increasingly desperate attempts by policy-makers to engineer a recovery. Today the world economy remains in a depressed state. Enthusiasm for policy stimulus is back in fashion, and the wheel has turned full circle.

The recession is hurting people who were not responsible for our present predicament, and they are, naturally, angry. There is a need to channel that anger into a careful analysis of what went wrong and a determination to put things right. The economy is behaving in ways that we did not expect, and new ideas will be needed if we are to prevent a repetition of the Great Recession and restore prosperity.

Many accounts and memoirs of the crisis have already been published. Their titles are numerous, but they share the same invisible subtitle: ‘how I saved the world’. So although in the interests of transparency I should make clear that I was an actor in the drama, Governor of the Bank of England for ten years between 2003 and 2013, during both the Great Stability, the banking crisis itself, the Great Recession that followed, and the start of the recovery, this is not a memoir of the crisis with revelations about private conversations and behind the scenes clashes. Of course, those happened as in any walk of life. But who said what to whom and when can safely, and properly, be left to dispassionate and disinterested historians who can sift and weigh the evidence available to them after sufficient time has elapsed and all the relevant official and unofficial papers have been made available.

Instant memoirs, whether of politicians or officials, are usually partial and self-serving. I see little purpose in trying to set the record straight when any account that I gave would naturally also seem self-serving. My own record of events and the accompanying Bank papers will be made available to historians when the twenty-year rule permits their release.

This book is about economic ideas. My time at the Bank of England showed that ideas, for good or ill, do influence governments and their policies. The adoption of inflation targeting in the early 1990s and the granting of independence to the Bank of England in 1997 are prime examples. Economists brought intellectual rigour to economic policy and especially to central banking. But my experience at the Bank also revealed the inadequacies of the ‘models’, whether verbal descriptions or mathematical equations, used by economists to explain swings in total spending and production. In particular, such models say nothing about the importance of money and banks and the panoply of financial markets that feature prominently in newspapers and on our television screens.

Is there a fundamental weakness in the intellectual economic framework underpinning contemporary thinking?

An exploration of some of these basic issues does not require a technical exposition, and I have stayed away from one. Of course, economists use mathematical and statistical methods to understand a complex world, they would be remiss if they did not. Economics is an intellectual discipline that requires propositions to be not merely plausible but subject to the rigour of a logical proof. And yet there is no mathematics in this book. It is written in (I hope) plain English and draws on examples from real life. Although I would like my fellow economists to read the book in the hope that they will take forward some of the ideas presented here, it is aimed at the reader with no formal training in economics but an interest in the issues.

In the course of this book, I will explain the fundamental causes of the crisis and how the world economy lost its balance; how money emerged in earlier societies and the role it plays today; why the fragility of our financial system stems directly from the fact that banks are the main source of money creation; why central banks need to change the way they respond to crises; why politics and money go hand in hand; why the world will probably face another crisis unless nations pursue different policies; and, most important of all, how we can end the alchemy of our present system of money and banking.

By alchemy I mean the belief that all paper money can be turned into an intrinsically valuable commodity, such as gold, on demand and that money kept in banks can be taken out whenever depositors ask for it. The truth is that money, in all forms, depends on trust in its issuer. Confidence in paper money rests on the ability and willingness of governments not to abuse their power to print money. Bank deposits are backed by long-term risky loans that cannot quickly be converted into money. For centuries, alchemy has been the basis of our system of money and banking. As this book shows, we can end the alchemy without losing the enormous benefits that money and banking contribute to a capitalist economy.

Four concepts are used extensively in the book: disequilibrium, radical uncertainty, the prisoner’s dilemma and trust. These concepts will be familiar to many, although the context in which I use them may not. Their significance will become clear as the argument unfolds, but a brief definition and explanation may be helpful at the outset.

Disequilibrium is the absence of a state of balance between the forces acting on a system. As applied to economics, disequilibrium is a position that is unsustainable, meaning that at some point a large change in the pattern of spending and production will take place as the economy moves to a new equilibrium. The word accurately describes the evolution of the world economy since the fall of the Berlin Wall, which I discuss in Chapter 1.

Radical uncertainty refers to uncertainty so profound that it is impossible to represent the future in terms of a knowable and exhaustive list of outcomes to which we can attach probabilities. Economists conventionally assume that ‘rational’ people can construct such probabilities. But when businesses invest, they are not rolling dice with known and finite outcomes on the faces; rather they face a future in which the possibilities are both limitless and impossible to imagine. Almost all the things that define modern life, and which we now take for granted, such as cars, aeroplanes, computers and antibiotics, were once unimaginable. The essential challenge facing everyone living in a capitalist economy is the inability to conceive of what the future may hold. The failure to incorporate radical uncertainty into economic theories was one of the factors responsible for the misjudgements that led to the crisis.

The prisoner’s dilemma may be defined as the difficulty of achieving the best outcome when there are obstacles to cooperation. Imagine two prisoners who have been arrested and kept apart from each other. Both are offered the same deal: if they agree to incriminate the other they will receive a light sentence, but if they refuse to do so they will receive a severe sentence if the other incriminates them. If neither incriminates the other, then both are acquitted. Clearly, the best outcome is for both to remain silent. But if they cannot cooperate the choice is more difficult. The only way to guarantee the avoidance of a severe sentence is to incriminate the other. And if both do so, the outcome is that both receive a light sentence. But this non-cooperative outcome is inferior to the cooperative outcome. The difficulty of cooperating with each other creates a prisoner’s dilemma. Such problems are central to understanding how the economy behaves as a whole (the field known as macroeconomics) and to thinking through both how we got into the crisis and how we can now move towards a sustainable recovery. Many examples will appear in the following pages. Finding a resolution to the prisoner’s dilemma problem in a capitalist economy is central to understanding and improving our fortunes.

Trust is the ingredient that makes a market economy work. How could we drive, eat, or even buy and sell, unless we trusted other people? Everyday life would be impossible without trust: we give our credit card details to strangers and eat in restaurants that we have never visited before. Of course, trust is supplemented with regulation, fraud is a crime and there are controls of the conditions in restaurant kitchens but an economy works more efficiently with trust than without. Trust is part of the answer to the prisoner’s dilemma. It is central to the role of money and banks, and to the institutions that manage our economy. Long ago, Confucius emphasised the crucial role of trust in the authorities: ‘Three things are necessary for government: weapons, food and trust. If a ruler cannot hold on to all three, he should give up weapons first and food next. Trust should be guarded to the end: without trust we cannot stand.’

Those four ideas run through the book and help us to understand the origin of the alchemy of money and banking and how we can reduce or even eliminate that alchemy.

When I left the Bank of England in 2013, I decided to explore the flaws in both the theory and practice of money and banking, and how they relate to the economy as a whole. I was led deeper and deeper into basic questions about economics. I came to believe that fundamental changes are needed in the way we think about macroeconomics, as well as in the way central banks manage their economies.

A key role of a market economy is to link the present and the future, and to coordinate decisions about spending and production not only today but tomorrow and in the years thereafter. Families will save if the interest rate is high enough to overcome their natural impatience to spend today rather than tomorrow. Companies will invest in productive capital if the prospective rate of return exceeds the cost of attracting finance. And economic growth requires saving and investment to add to the stock of productive capital and so increase the potential output of the economy in the future. In a healthy growing economy all three rates, the interest rate on saving, the rate of return on investment, and the rate of growth are well above zero. Today, however, we are stuck with extraordinarily low interest rates, which discourage saving, the source of future demand and, if maintained indefinitely, will pull down rates of return on investment, diverting resources into unprofitable projects. Both effects will drag down future growth rates. We are already some way down that road. It seems that our market economy today is not providing an effective link between the present and the future.

I believe there are two reasons for this failure. First, there is an inherent problem in linking a known present with an unknowable future. Radical uncertainty presents a market economy with an impossible challenge how are we to create markets in goods and services that we cannot at present imagine? Money and banking are part of the response of a market economy to that challenge. Second, the conventional wisdom of economists about how governments and central banks should stabilise the economy gives insufficient weight to the importance of radical uncertainty in generating an occasional large disequilibrium. Crises do not come out of thin air but are the result of the unavoidable mistakes made by people struggling to cope with an unknowable future. Both issues have profound implications and will be explored at greater length in subsequent chapters.

Inevitably, my views reflect the two halves of my career. The first was as an academic, a student in Cambridge, England, and a Kennedy scholar at Harvard in the other Cambridge, followed by teaching positions on both sides of the Atlantic. I experienced at first hand the evolution of macroeconomics from literary exposition where propositions seemed plausible but never completely convincing, into a mathematical discipline where propositions were logically convincing but never completely plausible. Only during the crisis of 2007-9 did I look back and understand the nature of the tensions between the surviving disciples of John Maynard Keynes who taught me in the 1960s, primarily Richard Kahn and Joan Robinson, and the influx of mathematicians and scientists into the subject that fuelled the rapid expansion of university economics departments in the same period. The old school ‘Keynesians’ were mistaken in their view that all wisdom was to be found in the work of one great man, and as a result their influence waned. The new arrivals brought mathematical discipline to a subject that prided itself on its rigour. But the informal analysis of disequilibrium of economies, radical uncertainty, and trust as a solution to the prisoner’s dilemma was lost in the enthusiasm for the idea that rational individuals would lead the economy to an efficient equilibrium. It is time to take those concepts more seriously.

The second half of my career comprised twenty-two years at the Bank of England, the oldest continuously functioning central bank in the world, from 1991 to 2013, as Chief Economist, Deputy Governor and then Governor. That certainly gave me a chance to see how money could be managed. I learned, and argued publicly, that this is done best not by relying on gifted individuals to weave their magic, but by designing and building institutions that can be run by people who are merely professionally competent. Of course individuals matter and can make a difference, especially in a crisis. But the power of markets, the expression of hundreds of thousands of investors around the world is a match for any individual, central banker or politician, who fancies his ability to resist economic arithmetic. As one of President Clinton’s advisers remarked, ‘I used to think if there was reincarnation, I wanted to come back as the president or the Pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody.’ Nothing has diminished the force of that remark since it was made over twenty years ago.

In 2012, I gave the first radio broadcast in peacetime by a Governor of the Bank of England since Montagu Norman delivered a talk on the BBC in March 1939, only months before the outbreak of the Second World War. As Norman left Broadcasting House, he was mobbed by British Social Credits Party demonstrators carrying flags and slogan-boards bearing the words: CONSCRIPT THE BANKERS FIRST! Feelings also ran high in 2012. The consequences of the events of 2007-9 are still unfolding, and anger about their effects on ordinary citizens is not diminishing. That disaster was a long time in the making, and will be just as long in the resolving.

But the cost of lost output and employment from our continuing failure to manage money and banking and prevent crises is too high for us to wait for another crisis to occur before we act to protect future generations.

Charles Dickens’ novel A Tale of Two Cities has not only a very famous opening sentence but an equally famous closing sentence. As Sydney Carton sacrifices himself to the guillotine in the place of another, he reflects: ‘It is a far, far better thing that I do, than I have ever done …’ If we can find a way to end the alchemy of the system of money and banking we have inherited then, at least in the sphere of economics, it will indeed be a far, far better thing than we have ever done.

One

THE GOOD, THE BAD AND THE UGLY

‘I think that Capitalism, wisely managed, can probably be made more efficient for attaining economic ends than any alternative system yet in sight.’ John Maynard Keynes, The End of Laissez-faire (1926)

‘The experience of being disastrously wrong is salutary; no economist should be spared it, and few are.’ John Kenneth Galbraith, A Life in Our Times (1982)

History is what happened before you were born. That is why it is so hard to learn lessons from history: the mistakes were made by the previous generation. As a student in the 1960s, I knew why the 1930s were such a bad time. Outdated economic ideas guided the decisions of governments and central banks, while the key individuals were revealed in contemporary photographs as fuddy-duddies who wore whiskers and hats and were ignorant of modern economics. A younger generation, in academia and government, trained in modern economics, would ensure that the Great Depression of the 1930s would never be repeated.

In the 1960s, everything seemed possible. Old ideas and conventions were jettisoned, and a new world beckoned. In economics, an influx of mathematicians, engineers and physicists brought a new scientific approach to what the nineteenth-century philosopher and writer Thomas Carlyle christened the ‘dismal science’. It promised not just a better understanding of our economy, but an improved economic performance.

The subsequent fifty years were a mixed experience. Over that period, national income in the advanced world more than doubled, and in the so-called developing world hundreds of millions of people were lifted out of extreme poverty. And yet runaway inflation in the 1970s was followed in 2007-9 by the biggest financial crisis the world has ever seen. How do we make sense of it all? Was the post-war period a success or a failure?

The origins of economic growth

The history of capitalism is one of growth and rising living standards interrupted by financial crises, most of which have emanated from our mismanagement of money and banking. My Chinese colleague spoke an important, indeed profound, truth.

The financial crisis of 2007-9 (hereafter ‘the crisis’) was not the fault of particular individuals or economic policies. Rather, it was merely the latest manifestation of our collective failure to manage the relationship between finance, the structure of money and banking, and a capitalist system.

Failure to appreciate this explains why most accounts of the crisis focus on the symptoms and not the underlying causes of what went wrong. The fact that we have not yet got the hang of it does not mean that a capitalist economy is doomed to instability and failure. It means that we need to think harder about how to make it work.

Over many years, a capitalist economy has proved the most successful route to escape poverty and achieve prosperity.

Capitalism, as I use the term here, is an economic system in which private owners of capital hire wage earners to work in their businesses and pay for investment by raising finance from banks and financial markets.

The West has built the institutions to support a capitalist system, the rule of law to enforce private contracts and protect property rights, intellectual freedom to innovate and publish new ideas, anti-trust regulation to promote competition and break up monopolies, and collectively financed services and networks, such as education, water, electricity and telecommunications, which provide the infrastructure to support a thriving market economy. Those institutions create a balance between freedom and restraint, and between unfettered competition and regulation. It is a subtle balance that has emerged and evolved over time. And it has transformed our standard of living. Growth at a rate of 2.5 per cent a year, close to the average experienced in North America and Europe since the Second World War, raises real total national income twelvefold over one century, a truly revolutionary outcome.

Over the past two centuries, we have come to take economic growth for granted. Writing in the middle of that extraordinary period of economic change in the mid-eighteenth century, the Scottish philosopher and political economist, Adam Smith, identified the source of the breakout from relative economic stagnation, an era during which productivity (output per head) was broadly constant and any increase resulted from discoveries of new land or other natural resources, to a prolonged period of continuous growth of productivity: specialisation. It was possible for individuals to specialise in particular tasks, the division of labour, and by working with capital equipment to raise their productivity by many times the level achieved by a jack-of-all-trades. To illustrate his argument, Smith employed his now famous example of a pin factory:

A workman could scarce, perhaps, with his utmost industry, make one pin in a day, and certainly could not make twenty. But in the way in which this business is now carried on, not only the whole work is a peculiar trade, but it is divided into a number of branches. One man draws out the wire, another straights it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the head The important business of making a pin is, in this manner, divided into about eighteen distinct operations, which, in some manufactories, are all performed by distinct hands.

The factory Smith was describing employed ten men and made over 48,000 pins in a day.

The application of technical knowhow to more and more tasks increased specialisation and raised productivity. Specialisation went hand in hand with an even greater need for both a means to exchange the fruits of one’s labour for an ever wider variety of goods produced by other specialists, money, and a way to finance the purchase of the capital equipment that made specialisation possible, banks.

As each person in the workforce became more specialised, more machinery and capital investment was required to support them, and the role of money and banks increased. After a millennium of roughly constant output per person, from the middle of the eighteenth century productivity started, slowly but surely, to rise. Capitalism was, quite literally, producing the goods. Historians will continue to debate why the Industrial Revolution occurred in Britain, population growth, plentiful supplies of coal and iron, supportive institutions, religious beliefs and other factors all feature in recent accounts.

But the evolution of money and banking was a necessary condition for the Revolution to take off.

Almost a century later, with the experience of industrialisation and a massive shift of labour from the land to urban factories, socialist writers saw things differently. For Karl Marx and Friedrich Engels the future was clear. Capitalism was a temporary staging post along the journey from feudalism to socialism. In their Communist Manifesto of 1848, they put forward their idea of ‘scientific socialism’ with its deterministic view that capitalism would ultimately collapse and be replaced by socialism or communism. Later, in the first volume of Das Kapital (1867), Marx elaborated (at great length) on this thesis and predicted that the owners of capital would become ever richer while excessive capital accumulation would lead to a falling rate of profit, reducing the incentive to invest and leaving the working class immersed in misery. The British industrial working class in the nineteenth century did indeed suffer miserable working conditions, as graphically described by Charles Dickens in his novels. But no sooner had the ink dried on Marx’s famous work than the British economy entered a long period of rising real wages (money wages adjusted for the cost of living). Even the two world wars and the intervening Great Depression in the 1930s could not halt rising productivity and real wages, and broadly stable rates of profit. Economic growth and improving living standards became the norm.

But if capitalism did not collapse under the weight of its own internal contradictions, neither did it provide economic security. During the twentieth century, the extremes of hyperinflations and depressions eroded both living standards and the accumulated wealth of citizens in many capitalist economies, especially during the Great Depression in the 1930s, when mass unemployment sparked renewed interest in the possibilities of communism and central planning, especially in Europe. The British economist John Maynard Keynes promoted the idea that government intervention to bolster total spending in the economy could restore full employment, without the need to resort to fully fledged socialism.

After the Second World War, there was a widespread belief that government planning had won the war and could be the means to win the peace. In Britain, as late as 1964 the newly elected Labour government announced a ‘National Plan’. Inspired by a rather naive version of Keynesian ideas, it focused on policies to boost the demand for goods and services rather than the ability of the economy to produce them. As the former outstripped the latter, the result was inflation. On the other side of the Atlantic, the growing cost of the Vietnam War in the late 1960s also led to higher inflation.

Rising inflation put pressure on the internationally agreed framework within which countries had traded with each other since the Bretton Woods Agreement of 1944, named after the conference held in the New Hampshire town in July of that year. Designed to allow a war-damaged Europe slowly to rebuild its economy and reintegrate into the world trading system, the agreement created an international monetary system under which countries set their own interest rates but fixed their exchange rates among themselves. For this to be possible, movements of capital between countries had to be severely restricted otherwise capital would move to where interest rates were highest, making it impossible to maintain either differences in those rates or fixed exchange rates. Exchange controls were ubiquitous, and countries imposed limits on investments in foreign currency. As a student, I remember that no British traveller in the 1960s could take abroad with them more than £50 a year to spend.

The new international institutions, the International Monetary Fund (IMF) and the World Bank, would use funds provided by its members to finance temporary shortages of foreign currency and the investment needed to replace the factories and infrastructure destroyed during the Second World War. Implicit in this framework was the belief that countries would have similar and low rates of inflation. Any loss of competitiveness in one country, as a result of higher inflation than in its trading partners, was assumed to be temporary and would be met by a deflationary policy to restore competitiveness while borrowing from the IMF to finance a short-term trade deficit. But in the late 1960s differences in inflation across countries, especially between the United States and Germany, appeared to be more than temporary, and led to the breakdown of the Bretton Woods system in 1970-1. By the early 1970s, the major economies had moved to a system of ‘floating’ exchange rates, in which currency values are determined by private sector supply and demand in the markets for foreign exchange.

Inevitably, the early days of floating exchange rates reduced the discipline on countries to pursue low inflation. When the two oil shocks of the 1970s, in 1973, when an embargo by Arab countries led to a quadrupling of prices, and 1979, when prices doubled after disruption to supply following the Iranian Revolution hit the western world, the result was the Great Inflation, with annual inflation reaching 13 per cent in the United States and 27 per cent in the United Kingdom.

Economic experiments

From the late 1970s onwards, the western world then embarked on what we can now see were three bold experiments to manage money, exchange rates and the banking system better. The first was to give central banks much greater independence in order to bring down and stabilise inflation, subsequently enshrined in the policy of inflation targeting, the goal of national price stability. The second was to allow capital to move freely between countries and encourage a shift to fixed exchange rates both within Europe, culminating in the creation of a monetary union, and in a substantial proportion of the most rapidly growing part of the world economy, particularly China, which fixed its exchange rates against the US dollar, the goal of exchange rate stability. And the third experiment was to remove regulations limiting the activities of the banking and financial system to promote competition and allow banks both to diversify into new products and regions and to expand in size, with the aim of bringing stability to a banking system often threatened in the past by risks that were concentrated either geographically or by line of business, the goal of financial stability.

These three simultaneous experiments might now be best described as having three consequences the Good, the Bad and the Ugly. The Good was a period between about 1990 and 2007 of unprecedented stability of both output and inflation the Great Stability. Monetary policy around the world changed radically. Inflation targeting and central bank independence spread to more than thirty countries. And there were significant changes in the dynamics of inflation, which on average became markedly lower, less variable and less persistent.

The Bad was the rise in debt levels. Eliminating exchange rate flexibility in Europe and the emerging markets led to growing trade surpluses and deficits. Some countries saved a great deal while others had to borrow to finance their external deficit. The willingness of the former to save outweighed the willingness of the latter to spend, and so long-term interest rates in the integrated world capital market began to fall. The price of an asset, whether a house, shares in a company or any other claim on the future, is the value today of future expected returns (rents, the value of housing services from living in your own home, or dividends). To calculate that price one must convert future into current values by discounting them at an interest rate. The immediate effect of a fall in interest rates is to raise the prices of assets across the board. So as long-term interest rates in the world fell, the value of assets especially of houses rose. And as the values of assets increased, so did the amounts that had to be borrowed to enable people to buy them. Between 1986 and 2006, household debt rose from just under 70 per cent of total household income to almost 120 per cent in the United States and from 90 per cent to around 140 per cent in the United Kingdom.

The Ugly was the development of an extremely fragile banking system. In the USA, Federal banking regulators’ increasingly lax interpretation of the provisions to separate commercial and investment banking introduced in the 1933 Banking Act (often known as Glass-Steagall, the senator and representative respectively who led the passage of the legislation) reached its inevitable conclusion with the Gramm-Leach-Bliley Act of 1999, which swept away any remaining restrictions on the activities of banks. In the UK, the so-called Big Bang of 1986, which started as a measure to introduce competition into the Stock Exchange, led to takeovers of small stockbroking firms and mergers between commercial banks and securities houses. Banks diversified and expanded rapidly after deregulation. In continental Europe so-called universal banks had long been the norm. The assets of large international banks doubled in the five years before 2008. Trading of new and highly complex financial products among banks meant that they became so closely interconnected that a problem in one would spread rapidly to others, magnifying rather than spreading risk.

Banks relied less and less on their own resources to finance lending and became more and more dependent on borrowing. The equity capital of banks, the funds provided by the shareholders of the bank accounted for a declining proportion of overall funding. Leverage, the ratio of total assets (or liabilities) to the equity capital of a bank, rose to extraordinary levels. On the eve of the crisis, the leverage ratio for many banks was 30 or more, and for some investment banks it was between 40 and 50. A few banks had ratios even higher than that. With a leverage ratio of even 25 it would take a fall of only 4 per cent in the average value of a bank’s assets to wipe out the whole of the shareholders’ equity and leave it unable to service its debts.

By 2008, the Ugly led the Bad to overwhelm the Good. The crisis, one might say catastrophe of the events that began to unfold under the gaze of a disbelieving world in 2007, was the failure of all three experiments. Greater stability of output and inflation, although desirable in itself, concealed the build-up of a major disequilibrium in the composition of spending. Some countries were saving too little and borrowing too much to be able to sustain their path of spending in the future, while others saved and lent so much that their consumption was pushed below a sustainable path. Total saving in the world was so high that interest rates, after allowing for inflation, fell to levels incompatible in the long run with a profitable growing market economy. Falling interest rates led to rising asset values and increases in the debt taken out against those more valuable assets. Fixed exchange rates exacerbated the burden of the debts, and in Europe the creation of monetary union in 1999 sapped the strength of many of its economies, as they became increasingly uncompetitive. Large, highly leveraged banks proved unstable and were vulnerable to even a modest loss of confidence, resulting in contagion to other banks and the collapse of the system in 2008.

At their outset the ill-fated nature of the three experiments was not yet visible. On the contrary, during the 1990s the elimination of high and variable inflation, which had undermined market economies in the 1970s, led to a welcome period of macroeconomic stability. The Great Stability, or the Great Moderation as it was dubbed in the United States, was seen, as in many ways it was, as a success for monetary policy. But it was unsustainable. Policy-makers were conscious of problems inherent in the first two experiments, but seemed powerless to do anything about them. At international gatherings, such as those of the IMF, policy-makers would wring their hands about the ‘global imbalances’ but no one country had any incentive to do anything about it. If a country had, on its own, tried to swim against the tide of falling interest rates, it would have experienced an economic slowdown and rising unemployment without any material impact on either the global economy or the banking system. Even then the prisoner’s dilemma was beginning to rear its ugly head.

Nor was it obvious how the unsustainable position of the world economy would come to an end. I remember attending a seminar of economists and policy-makers at the IMF as early as 2002 where the consensus was that there would eventually be a sharp fall in the value of the US dollar, which would produce a change in spending patterns. But long before that could happen, the third experiment ended with the banking crisis of September and October 2008. The shock that some of the biggest and most successful commercial banks in North America and Europe either failed, or were seriously crippled, led to a collapse of confidence which produced the largest fall in world trade since the 1930s. Something had gone seriously wrong.

Opinions differ as to the cause of the crisis. Some see it as a financial panic in which fundamentally sound financial institutions were left short of cash as confidence in the credit-worthiness of banks suddenly changed and professional investors stopped lending to them, a liquidity crisis. Others see it as the inevitable outcome of bad lending decisions by banks, a solvency crisis, in which the true value of banks’ assets had fallen by enough to wipe out most of their equity capital, meaning that they might be unable to repay their debts. But almost all accounts of the recent crisis are about the symptoms, the rise and fall of housing markets, the explosion of debt and the excesses of the banking system rather than the underlying causes of the events that overwhelmed the economies of the industrialised world in 2008. Some even imagine that the crisis was solely an affair of the US financial sector. But unless the events of 2008 are seen in their global economic context, it is hard to make sense of what happened and of the deeper malaise in the world economy.

The story of what happened can be explained in little more than a few pages, everything you need to know but were afraid to ask about the causes of the recent crisis. So here goes.

The story of the crisis

By the start of the twenty-first century it seemed that economic prosperity and democracy went hand in hand. Modern capitalism spawned growing prosperity based on growing trade, free markets and competition, and global banks. In 2008 the system collapsed. To understand why the crisis was so big, and came as such a surprise, we should start at the key turning point, the fall of the Berlin Wall in 1989. At the time it was thought to represent the end of communism, indeed the end of the appeal of socialism and central planning.

For some it was the end of history. For most, it represented a victory for free market economics. Contrary to the prediction of Marx, capitalism had displaced communism. Yet who would have believed that the fall of the Wall was not just the end of communism but the beginning of the biggest crisis in capitalism since the Great Depression?

What has happened over the past quarter of a century to bring about this remarkable change of fortune in the position of capitalist economies?

After the demise of the socialist model of a planned economy, China, countries of the former Soviet Union and India embraced the international trading system, adding millions of workers each year to the pool of labour around the world producing tradeable, especially manufactured, goods. In China alone, over 70 million manufacturing jobs were created during the twenty-first century, far exceeding the 42 million working in manufacturing in 2012 in the United States and Europe combined. The pool of labour supplying the world trading system more than trebled in size. Advanced economies benefited from an influx of cheap consumer goods at the expense of employment in the manufacturing sector.

The aim of the emerging economies was to follow Japan and Korea in pursuing an export-led growth strategy. To stimulate exports, their exchange rates were held down by fixing them at a low level against the US dollar. The strategy worked, especially in the case of China. Its share in world exports rose from 2 per cent to 12 per cent between 1990 and 2013. China and other Asian economies ran large trade surpluses. In other words, they were producing more than they were spending and saving more than they were investing at home. The desire to save was very strong. In the absence of a social safety net, households in China chose to save large proportions of their income to provide self-insurance in the event of unemployment or ill-health, and to finance retirement consumption. Such a high level of saving was exacerbated by the policy from 1980 of limiting most families to one child, making it difficult for parents to rely on their children to provide for them in retirement.

Asian economies in general also saved more in order to accumulate large holdings of dollars as insurance in case their banking system ran short of foreign currency, as happened to Korea and other countries in the Asian financial crisis of the 1990s.

*

from

The End of Alchemy: Money, Banking and the Future of the Global Economy

by Mervyn King

get it at Amazon.com

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 . . .

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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 a