I am hosting a discussion of Robert Frank's The Darwin Economy at FDL (2-4 PST). The introductory post is here, and you are, of course, welcome to join in.
One theme in the book is that the debate between libertarians and progressives over government intervention in the economy is a false one. Robert Frank argues that libertarians ought to support government intervention to stop the "arms race" for positional goods since the race wastes resources without providing any benefit to those engaged in the contest. But the ideas are presented as correcting both libertarian and progressive views. One thing I want to ask is why he sees his ideas as standing in opposition to traditional ideas about market failure that many progressives use to justify government intervention rather than enhancing and complementing them.
I wonder if the puppeteers in the Republican Party regret what they have created now that they have lost control of the strings controling the actions of the groups they needed to win elections:
For Senate Tax Cut Stopgap, Odds in House Are Uncertain, NY Times: ...the Senate voted overwhelmingly on Saturday to extend a payroll tax cut for only two months, with the chamber’s leaders and the White House proclaiming victory, even as they punted into the new year the issue of how to further extend the tax cut and unemployment benefits.
In an unusual Saturday vote, the Senate approved by an 89-to-10 vote a $33 billion package that would extend a payroll-tax holiday for millions of American workers, extend unemployment benefits and avoid cuts in payments to doctors who accept Medicare. ...
But House passage next week was thrown into serious doubt on Saturday afternoon, when a number of rank-and-file Republicans objected in a conference call with Speaker John A. Boehner, who tried to persuade them that it was good for their party, particularly the provision that would speed the decision process for construction of an oil pipeline from Canada to the Gulf Coast known as Keystone XL. ...
Republican leaders — but not necessarily their rank and file — had wanted a full-year payroll tax cut deal to try to inoculate themselves against accusations by Democrats, as they head into an election year, that they are against tax cuts for low- and middle-income workers. It will be up to Mr. Boehner to convince his members that extending the cut — and at least appearing to work with Democrats even as they labor to unseat Mr. Obama and the Democrats who still control the Senate — will ultimately work in their political favor. ...
Obama and House Republicans seem to be in some kind of contest to see who can give the biggest political gift to the other side.
But while there are strong patterns in the authors’ mountains of data, this simple summary misses an important fact: There’s dramatic variation in the aftermaths of crises, and much of it is caused by how policy makers respond. ......
The ... importance of the policy response in determining the effects of crises argues strongly against complacency here at home. A country as creditworthy as the United States can continue to use fiscal stimulus to help return the economy to full employment. And, as I argued in a previous column, there’s much more the Fed could be doing. Whether we continue to fester or finally embark on a robust recovery depends on whether we choose to use the tools available. ...
A work ethic doesn’t help much when there is no work to be had.
Policymakers need to get off their fat, lazy, pampered butts and do something to help to create the needed jobs. If Congress worked as hard on the unemployment problem as the poor do in their jobs, maybe we'd make some progress.
This annoyed Democrats during the health-care reform debate... It’s annoying Republicans now, as it means their Medicare-reform plans need to impose blunt spending caps if the CBO to certify them as deficit reducing.
But the CBO is in the right here: No matter how much sense competition makes in theory, no matter how obvious it is that it will drive down the price of health care, the fact is that it keeps failing when we put it into practice.
When I asked Sen. Ron Wyden to give me examples of programs that made him confident that competition could work, he mentioned the Federal Employee Health Benefits Program (FEHBP) and the California Public Employees Retirement System (CalPERS). Rep. Paul Ryan has also pointed towards the FEHBP... The only problem? Neither system controls costs...
That leaves us without a clear example of a competition-based program substantially cutting costs. As I wrote yesterday, I hope that’s simply because we haven’t yet cracked the code on competition. Cutting costs through competition comes with far fewer downsides than cutting costs through government price controls. But cutting costs through competition has not yet worked. Cutting costs through price controls, conversely, has worked, as even the most cursory analysis of international health-care systems proves:
(Kaiser Family Foundation)
The reality of our health-care debate right now is that both parties keep trying different versions of a cost control strategy that hasn’t worked because they’re uncomfortable with the cost control strategy that has.
Obama's New Populist Tone Gets Its First Test, by David A. Graham: Coming hot on the heels of the White House's decision not to veto controversial new measures on terror detainees, Democrats are poised for another defeat in Congress after Senate Democrats dropped their demand for a new surtax on millionaires as a means of paying for extending the payroll tax cut...
That's two major concessions in just a couple of days. ... It's a Washington truism that the current crop of Democrats are terrible negotiators. But this time, they really seemed to have it in the bag. They were calling for a tax cut, after all, and they had Republicans tying themselves in knots explaining why the party of Reagan and Tea didn't want lower taxes. All the Democrats wanted in exchange for extending the reduction was a small increase in how much the wealthy paid -- a position that was widely popular among voters. Even RedState's Erick Erickson was grudgingly impressed. "I never thought I would see the day, but Democrats are outmaneuvering Republicans on a tax cut," he wrote.
But Obama's Democratic allies in the Senate say they have now abandoned the millionaires' tax... And the White House does not appear to be pressing the case. ...
There isn't much point in asking, for the umpteenth time, why Republicans are so much better at this than Democrats. What's interesting here is the timing. Last week, Obama went to Osawatomie, Kansas, and delivered a stemwinder of a speech on inequality. The reaction was swift: left and right alike announced that the president was taking his cue from Occupy Wall Street and was adopting a stridently populist message focused on income inequality. More broadly, the speech seemed to be an indication that he was ready to shed the quiet, conciliatory demeanor and adopt a more pugilistic stance.
But the Democrats' two caves suggest Obama's new rhetoric isn't likely, for the foreseeable future, to be much more than posturing.
I really don't like that my choices in the upcoming election will be between one candidate who will betray the things I believe in, civil liberties, progressive taxation, etc., etc., etc., and a crazy person from the other side (take your pick) who will be even worse.
Mr. Paul identifies himself as a believer in “Austrian” economics... Austrians see “fiat money,” money that is just printed without being backed by gold, as the root of all economic evil, which means that they fiercely oppose the kind of monetary expansion Friedman claimed could have prevented the Great Depression — and which was actually carried out by Ben Bernanke this time around. ...
After Lehman Brothers fell, the Fed began lending large sums to banks as well as buying a wide range of other assets, in a (successful) attempt to stabilize financial markets... In the fall of 2010, the Fed began another round of purchases, in a less successful attempt to boost economic growth. The combined effect of these actions was that the monetary base more than tripled in size.
Austrians, and for that matter many right-leaning economists, were sure about what would happen as a result: There would be devastating inflation. One popular Austrian commentator who has advised Mr. Paul, Peter Schiff, even warned (on Glenn Beck’s TV show) of the possibility of Zimbabwe-style hyperinflation in the near future.
So here we are, three years later. How’s it going? Inflation has ... risen ... an average annual ... rate of only 1.5 percent. Who could have predicted that printing so much money would cause so little inflation? Well, I could. And did. And so did others who understood the Keynesian economics Mr. Paul reviles. But Mr. Paul’s supporters continue to claim, somehow, that he has been right about everything.
Still, while the original proponents of the doctrine won’t ever admit that they were wrong ... you might think that having been so completely off-base about something so central to their belief system would have caused the Austrians to lose popularity, even within the G.O.P. ...
What has happened instead, however, is that hard-money doctrine and paranoia about inflation have taken over the party, even as the predicted inflation keeps failing to materialize. ...
Now, it’s still very unlikely that Ron Paul will become president. But ... his economic doctrine has, in effect, become the official G.O.P. line, despite having been proved utterly wrong by events. And what will happen if that doctrine actually ends up being put into action? Great Depression, here we come.
The ECB's purchases of government bonds are "neither eternal, nor infinite," Mr. Draghi said in a speech in Berlin, stressing it would take "a lot" more than monetary-policy measures to restore market confidence in the euro zone.
Asked whether the ECB should copy the U.K. and U.S. in printing money to buy government bonds, a policy known as quantitative easing, Mr. Draghi said: "I don't see any evidence that quantitative easing leads to stellar economic performance" in those economies. EU treaties forbid monetary financing of government debt, he added.
This suggests Draghi believes quantitative easing should only be used if it delivers "stellar" economic performance. This is depressing, not to mention severely misguided. The appropriate metric should not be achieving a "stellar" economy, but what would have occurred in the absence of QE. Hopefully, he will recognize this distinction should (when) the situation deteriorate further.
The combination of fiscal consolidation and ECB intransigence promises to keep the European crisis in the headlines for a long, long time.
Fragile and Unbalanced in 2012, by Nouriel Roubini, Commentary, Project Syndicate: The outlook for the global economy in 2012 is clear, but it isn’t pretty: recession in Europe, anemic growth at best in the United States, and a sharp slowdown in China and in most emerging-market economies. Asian economies are exposed to China. Latin America is exposed to lower commodity prices (as both China and the advanced economies slow). Central and Eastern Europe are exposed to the eurozone. And turmoil in the Middle East is causing serious economic risks – both there and elsewhere – as geopolitical risk remains high and thus high oil prices will constrain global growth. ...
Restoring robust growth is difficult enough without the ever-present specter of deleveraging and a severe shortage of policy ammunition. But that is the challenge that a fragile and unbalanced global economy faces in 2012. To paraphrase Bette Davis in All About Eve, "Fasten your seatbelts, it’s going to be a bumpy year!"
Just bumps, or crashes too? That depends critically on whether the Europeans resolve the crisis they face, and how they go about it if they do.
With today's decent number for unemployment claims -- claims fell to 366,000 and are finally below the breakeven point for job creation -- it's worth thinking about how long it might take for employment to recover. Calculated Risk calculates how long it will take to reach 8% by November 2012 under various scenarios:
I think the participation rate will be in the 64.0% to 64.5% range next November. That would mean the economy would need to add somewhere between 167,000 and 260,000 jobs per month. The bottom end of that range seems possible with sluggish growth, but the top end is less likely.
This is very sensitive to the participation rate. If the economy adds 167,000 jobs per month next year, and the participation rate increases to 64.5%, the unemployment rate would be at 8.7%. So 8% is possible, but it seems unlikely unless growth picks up.
And even at the optimistic rate of job creation, we'd only be at 8% a year from now.
Note also that the claims number is clouded by uncertainty over seasonal adjustment procedures, so it's not certain that we are getting an accurate read on progress on employment. But even if it is accurate, even if we are finally headed back up the hill, as these graphs show there's still a long, long climb ahead of us:
Europe Still Heading For Collapse, by Tim Duy: The half-life of the effectiveness of European summits is growing increasingly shorter. While I have been a long-term Europessimist, market participants are more willing to trade on whatever appears to be positive news, thus markets jump whenever it appears the Europeans are taking action. But eventually the game will wear thin as market participants increasingly realize European "solutions" are never more than half-measures intended to kick the can down the road another few months.
And the last summit was no exception. The reality is quickly sinking in that, relative to the dimensions of the challenge, very little was really accomplished two weeks ago. And very little will be accomplished until European leaders come to the realization that they continue to treat the symptoms of the disease, not the cause of the disease. They need to find a mechanism to address Europe's internal imbalances that does not rely exclusively on deflation as a cure. Alan Blinder provided the background in the Wall Street Journal:
All financial eyes are fixed on the euro. Europe's common currency actually has two gigantic problems. The debt and banking crisis hogs all the attention because of its immediacy, plus the high drama of all those summit meetings. But the other, slower-acting problem—lopsided competitiveness within the euro zone—is far more intractable.
Blinder sees three paths out of the resultant mess:
There are three ways for the other countries to close the gap with Germany—and remember, the gap is large. First, Germany can volunteer for higher inflation than its euro partners by, for example, implementing a large fiscal stimulus or ending its wage restraint. How do you say "ain't gonna happen" in German?
Second, the other countries can engineer German-like productivity miracles through structural reforms while Germany, relatively speaking, stands still. Good luck with that. And even if it somehow happens, the timing is all wrong. Reforms take years to bear fruit while financial markets count time in seconds.
Third, the other countries can experience deflation, meaning a prolonged decline in both wages and prices, which is incredibly difficult and painful—and generally happens only in protracted recessions. Sadly, this may be the most likely way out.
The reality of Blinder's view - that option two will not work and option three is excessively painful - is revealed by the most recent IMF update on Greece. From the report:
Meanwhile, since the fourth review, the economic situation in Greece has taken a turn for the worse, with the economy increasingly adjusting through recession and related wage-price channels, rather than through structural reform-driven increases in productivity.
Really, this is a surprise to IMF economists? Yet apparently, the IMF still believes that structural change is an immediate cure:
We recognize the need to reach a critical mass of reforms and reform synergies to jump-start growth.
I like this - the IMF does not believe in "confidence" fairies; they believe in "synergy" fairies. I keep kicking myself for missing the "synergy" fairy lecture in graduate school. Apparently all the IMF economists made it to that lecture.
Of course, it is not their fault. The IMF attempts to shift some of the blame onto the Greeks:
Structural reforms have not yet delivered expected results, in part due to a disconnect between legislation and implementation.
While likely true, this is something of a red herring. The long-term nature of reforms was no match for the pace of financial market developments, while the willingness of the population to accept externally-driven reforms is understandably lacking given the desire of the external agents to support ongoing recession. Without more direct transfers and debt relief, the IMF, ECB, and EU continue to use more stick than carrort.
Arguably, European policymakers might see the fundamental problem, but also recognize a real solution in years away. Via the Financial Times:
Member states of the eurozone have set themselves on an “irreversible course towards a fiscal union” to underpin their common currency, even if it may take years to reach that goal, Angela Merkel, the German chancellor, told her parliament on Wednesday.
Europe doesn't have years. The vice of austerity packages will eventually crush to hard, and the cost of staying within the Euro will exceed the costs of exit.
Meanwhile, the ECB is at best having mixed results. On one hand, recent actions appear to have stabilized government debt markets in Spain, Belgium, and France. On the other, Italian yields have retraced much of their collapse. Probably more importantly, however, stabilization of the banking crisis remains elusive. From the Financial Times:
But, despite the central bank facilities, the cost of obtaining dollar funding in the private market continues to soar, pointing to a dollar funding squeeze as Europe’s banks head into their all-important year-end reporting period.
The three-month euro-US dollar basis swap dropped to as low as -150 basis points on Wednesday, meaning banks would have to pay an extra 1.5 per cent premium to swap their euros into dollars for a three-month period. The premium has not been persistently below the -140bps region since late 2008, during the depths of the financial crisis.
Not good, not good at all. Also, the hopes that the ECB will provide an unlimited backstop for soveriegn debt now look to be premature at best. Via the Wall Street Journal:
With many in Europe still hoping against hope that the European Central Bank will step in more aggressively to buy bonds and bring down borrowing costs for struggling governments, Jens Weidmann, the president of Germany's Bundesbank and member of the ECB governing council, indicated his opposition to that hadn't softened.
The idea that the ECB should turn on the printing presses to help finance some debt-ridden euro-zone states should be put to rest for good, Mr. Weidmann said. Central bank "independence is lost when monetary policy is tied to the wagon of fiscal policy and then loses control over prices," he said.
Some argue the ECB is just jawboning to drive a hard bargain when it comes to fiscal and structural reforms. I am not so sure - these guys sound pretty serious to me.
And perhaps you thought the Fed would ride to the rescue. Think again. From Bloomberg:
Simply put, the Fed is politically limited in what it can do for Europe. I don't see the hopes that the Fed could step in for the ECB being realized. Moreover, US lawmakers will resist efforts to contribute more to the IMF to help Europe, especially if this is the general attitude:
The belief in fiscal austerity runs deep. We need to teach those Europeans a lesson even if it means shooting ourselves in the foot. Now, in all honesty, you really can't expect US taxpayers to offer much support to Europe when German taxpayers themselves are resistant. Because I think that fundamentally Blinder is right on the appropriate cure to save the Euro. Germany needs to issue a massive amount of debt to support demand in Europe, even at the cost of higher relative inflation. And, better yet, to support debt writedowns in the periphery. The response from Germany: Nein.
Bottom Line: I still don't see where this ends well. Play the news cycle if you are so inclined, but keep one eye on the key issue. Is Europe working to resolve their fundamental internal imbalances with anything other than deflation? As long as the answer continues to be "no," be afraid. Be very afraid.
Japanese business mood turned pessimistic in the three months to December, the central bank's tankan survey showed, a sign the stubbornly strong yen, Europe's debt crisis and slowing global growth were taking their toll on the export-reliant economy.
In contrast to much of the globe, and despite Cargill's assertions, the United States is seen as weathering the storm, at least so far. From the FOMC statement:
Information received since the Federal Open Market Committee met in November suggests that the economy has been expanding moderately, notwithstanding some apparent slowing in global growth.
The expectation is that the Fed's next move will be to alter its communication strategy at the January meeting. Whether or not they gear up for another round of QE, this time via mortgage assets, remains dependent on the economy. Since I tend to be cautious that the US can forever resist the global drag now firmly in place, I expect additional easing. That said, I also believe the Fed will delay until the strains become more obvious, which may not be until deep into the first or second quarters of next year. In other words, hopes that the Federal Reserve would jump in with QE3 to save financial markets from the European disastor were simply premature. They should get ahead of this curve, in my opinion, but they won't.
For those that believe the Fed has the tools to stop another crisis in its tracks, FT Alphaville has some sobering news. Covering a report by Lewis Alexander, formerly of the US Treasury and Federal Reserve, currenty Nomura Chief US economist, they spot a particularly disconcerting element of Frank-Dodd:
DFA expressly prohibits the Federal Reserve from using 13(3) to support individual institutions. The legislative record on this provision indicates that Congress’ intent was to rule out the sorts of interventions that the Federal Reserve implemented to support the sale of Bear Stearns to JP Morgan and the backstop that was provided to AIG...
...In particular, the Federal Reserve could not have supported the Bear Stearns transaction, the backstop for AIG would not have been possible, the guarantees provided by the TLGP program would have required Congressional approval, and the ring fences provided for assets owned by Citi and the Bank of America would not have been possible.
It is not inconceivable that another US institution gets pulled in the European economic vortex. It would be unfortunate if, should that institution be in fact too big or connected to fail, the Fed could not be a backstop to hold the system together. While I think many of us were initially shocked by some of the Fed's actions, particularly salvaging AIG, in retrospect we realize it would have been a bad time to start playing moral hazrd games. Note also the process of winding down a too big to fail firm is untested. I have to admit that an orderly wind down during a crisis is something of a contradiction. Immovable object meet irresistable force.
Read the whole piece, and part I as well. They are worth the time, although they leave me feeling despite the lessons of the past few years, we are less prepare than we think we are.
Bottom Line: The global economy is hitting turbulence, just as the US data turns more sanguine. Can this decoupling be sustained as Europe sinks deeper into recession? I would like to think so, but remain very cautious that the US can escape without some significant cuts and bruises. So far, the Fed remains in a holding position. I expect them to stay there until more significant signs of economic distress emerge.
The Impact of Immigration on Native Poverty through Labor Market Competition, by Giovanni Peri, NBER Working Paper No. 17570, November 2011: In this paper I first analyze the wage effects of immigrants on native workers in the US economy and its top immigrant-receiving states and metropolitan areas. Then I quantify the consequences of these wage effects on the poverty rates of native families. The goal is to establish whether the labor market effects of immigrants have significantly affected the percentage of "poor" families among U.S.-born individuals. I consider the decade 2000-2009 during which poverty rates increased significantly in the U.S. As a reference, I also analyze the decade 1990-2000. To calculate the wage impact of immigrants I adopt a simple general equilibrium model of productive interactions, regulated by the elasticity of substitution across schooling groups, age groups and between US and foreign-born workers. Considering the inflow of immigrants by age, schooling and location I evaluate their impact in local markets (cities and states) assuming no mobility of natives and on the US market as a whole allowing for native internal mobility. Our findings show that for all plausible parameter values there is essentially no effect of immigration on native poverty at the national level. At the local level, only considering the most extreme estimates and only in some localities, we find non-trivial effects of immigration on poverty. In general, however, even the local effects of immigration bear very little correlation with the observed changes in poverty rates and they explain a negligible fraction of them.
Assessing the Climate Talks — Did Durban Succeed?, by Robert Stavins: The 17th Conference of the Parties (COP-17) of the United Nations Framework Convention on Climate Change (UNFCCC) adjourned on Sunday, a day and a half after its scheduled close, and in the process once again pulled a rabbit out of the hat by saving the talks from complete collapse (which appeared possible just a few days earlier). But was this a success?
The Durban Outcome in a Nutshell
The outcome of COP-17 includes three major elements: some potentially important elaborations on various components of the Cancun Agreements; a second five-year commitment period for the Kyoto Protocol; and (read this carefully) a non-binding agreement to reach an agreement by 2015 that will bring all countries under the same legal regime by 2020.
Is This a Success?
If by “success” in Durban, one means solving the climate problem, the answer is obviously “not close.”
Indeed, if by “success” one meant just putting the world on a path to solve the climate problem, the answer would still have to be “no.”
But, I’ve argued previously – including in my pre-Durban essay last month – that such definitions of success are fundamentally inappropriate for judging the international negotiations on the exceptionally challenging, long-term problem of global climate change.
The key question, at this point, is whether the Durban outcome has put the world in a place and on a trajectory whereby it is more likely than it was previously to establish a sound foundation for meaningful long-term action.
I don’t think the answer to that question is at all obvious, but having read carefully the agreements that were reached in Durban, and having reflected on their collective implications for meaningful long-term action, I am inclined to focus on “the half-full glass of water.” My conclusion is that the talks – as a result of last-minute negotiations – advanced international discussions in a positive direction and have increased the likelihood of meaningful long-term action. Why do I say this? ...[continue]...
Climate change legislation has all but dropped of the radar in the US political arena.
If you are going to read this, be sure to read this first so you can properly evaluate the credibility of the author -- an author who insists, despite mountains of evidence to the contrary, that ACORN caused the crisis:
...Congressman Frank was one of the leaders of the effort in Congress to meet the demands of activists like ACORN for an easing of underwriting standards in order to make home ownership more accessible to more people. It was perhaps a worthwhile goal, but it caused the financial crisis...
That's nuts to put it mildly. See here, or any of the other many, many debunkings of this attempt to push the blame for the housing crisis on programs that tried to help the poor. The hope, of course, is that this will undermine support for social programs intended to help the disadvantaged -- that's the underlying agenda as the post below this one points out. For that reason, it's important not to let the "big lie" go unchallenged as it is repeated again and again by those supporting the right's political agenda.
I've made this point many, many times as well, but it's worth emphasizing once again. As Krugman notes:
...the GOP is not now, and never has been (at least not since the 1970s) concerned about the deficit. All the fiscal posturing of the last couple of years has been about using the deficit as a club to smash the welfare state, with the secondary goal of frustrating any efforts on the part of the Obama administration to help the struggling economy.
The entire debate has been fake. If you don’t understand that, or can’t bring yourself to admit it, you’re missing the whole story.
European countries agreed to limit their government deficits and government debt (to 3% and 60% respectively) as part of the Maastricht Treaty that led to the creation of the Euro. The limits were not strictly enforced...
The constraints on fiscal policy were made more explicit through the Stability and Growth Pact that ... developed ... more specific interpretations of the limits as well as a process to deal with deviations from the rule. The Pact was a failure with many countries (including Germany) going above the deficit and debt limits. The rules were then rewritten once and just last weekend, during the European summit, there has been a proposal to rewrite them once again. This is what some have referred to as a proposal to create a fiscal union, which is clearly not the case. The proposal is simply about changing the enforcement rules of the Pact.
Academics have written extensively on how the Stability and Growth Pact was poorly designed and could not work (my own work can be found here, here or here. The criticisms can be summarized by the following three points:
- simple numerical limits are "too simple" to deal with fiscal policy. Applying the same rules to every country and every year makes no sense. And the moment you open the door for exceptions then the rules lose their meaning. - enforcement of the Stability and Growth Pact does not work because the enforcers is the same group as the sinners. ... - ...even if fines are applied, what would happen to a country in trouble (Italy today) if the other European countries imposed a fine on the Italian government? That their deficit would be even larger and it would simply make things worse.
The decision over the weekend was to improve the enforcement of the Stability and Growth Pact and it tries to address the second issue while it ignores the other two. What is worse is that it might not even addressed that issue. The proposal (to be approved) makes the fines automatic. They can only be overturned if a qualified majority of countries agree to it. This is a marginal change that is unlikely to work if many (more so the large) countries are the ones violating the rules. And the proposal ignores the fundamental problems of the Pact.
What is more concerning is that there is still no clarity on the goals of the Pact. The Pact and more so its implementation has always mixed goals such as sustainability with other goals such as coordination of fiscal policy and growth-oriented reforms. But there is no clarity on how these things mix together, and some times they do not. Long-term sustainability is a valid goal... But this does not imply that all countries should have the same fiscal policy all the time. In fact, we want fiscal policy in the short run to be different across countries. Coordination of fiscal policy (understood as one policy stance for all all the time) makes no sense in a monetary union.
And here is where we are today: starting with the concern about long-term sustainability we conclude that short-term austerity is the right policy for all European countries. But imposing coordination combined with a short-term focus on what should be a long-term goal will not deliver stability or growth. It will lead to stagnation in the region and instability in some countries as fiscal policy is not allowed to play a proper countercyclical role.
Severe recessions -- depressions -- have effects that go beyond economics:
Depression and Democracy, by Paul Krugman, Commentary, NY Times: It’s time to start calling the current situation what it is: a depression. True, it’s not a full replay of the Great Depression, but that’s cold comfort. Unemployment in both America and Europe remains disastrously high. Leaders and institutions are increasingly discredited. And democratic values are under siege.
On that last point, I am not being alarmist. ... Let’s talk, in particular, about what’s happening in Europe... First of all, the crisis of the euro is killing the European dream. The shared currency, which was supposed to bind nations together, has instead created an atmosphere of bitter acrimony.
Specifically, demands for ever-harsher austerity, with no offsetting effort to foster growth, have ... failed as economic policy...; a Europe-wide recession now looks likely even if the immediate threat of financial crisis is contained. And they have created immense anger, with many Europeans furious at what is perceived, fairly or unfairly (or actually a bit of both), as a heavy-handed exercise of German power.
Nobody familiar with Europe’s history can look at this resurgence of hostility without feeling a shiver. Yet there may be worse things happening.
Right-wing populists are on the rise from Austria, where the Freedom Party (whose leader used to have neo-Nazi connections) runs neck-and-neck in the polls with established parties, to Finland, where the anti-immigrant True Finns party had a strong electoral showing last April. ...
Last month the European Bank for Reconstruction and Development documented a sharp drop in public support for democracy in the ... nations that joined the European Union after the fall of the Berlin Wall. Not surprisingly, the loss of faith in democracy has been greatest in the countries that suffered the deepest economic slumps.
And in at least one nation, Hungary, democratic institutions are being undermined as we speak. One of Hungary’s major parties, Jobbik, is a nightmare out of the 1930s: it’s anti-Roma (Gypsy), it’s anti-Semitic, and it even had a paramilitary arm. But the immediate threat comes from Fidesz, the governing center-right party.
Fidesz won an overwhelming Parliamentary majority last year, at least partly for economic reasons... Now Fidesz ... seems bent on establishing a permanent hold on power. ...
Taken together, all this amounts to the re-establishment of authoritarian rule, under a paper-thin veneer of democracy, in the heart of Europe. And it’s a sample of what may happen much more widely if this depression continues. ...
The European Union missed the chance to head off the power grab at the start... It will be much harder to reverse the slide now. Yet Europe’s leaders had better try, or risk losing everything they stand for.
And they also need to rethink their failing economic policies. If they don’t, there will be more backsliding on democracy — and the breakup of the euro may be the least of their worries.
Comparisons involving infinitely large numbers are notoriously tricky. ... To grasp the mathematical challenge, imagine that you’re a contestant on Let’s Make a Deal and you’ve won an unusual prize: an infinite collection of envelopes, the first containing $1, the second $2, the third $3, and so on. As the crowd cheers, Monty chimes in to make you an offer. Either keep your prize as is, or elect to have him double the contents of each envelope. At first it seems obvious that you should take the deal. “Each envelope will contain more money than it previously did,” you think, “so this has to be the right move.” And if you had only a finite number of envelopes, it would be the right move. To exchange five envelopes containing $1, $2, $3, $4, and $5 for envelopes with $2, $4, $6, $8, and $10 makes unassailable sense. But after another moment’s thought, you start to waver, because you realize that the infinite case is less clear-cut. “If I take the deal,” you think, “I’ll wind up with envelopes containing $2, $4, $6, and so on, running through all the even numbers. But as things currently stand, my envelopes run through all whole numbers, the evens as well as the odds. So it seems that by taking the deal I’ll be removing the odd dollar amounts from my total tally. That doesn’t sound like a smart thing to do.” Your head starts to spin. Compared envelope by envelope, the deal looks good. Compared collection to collection, the deal looks bad.
Your dilemma illustrates the kind of mathematical pitfall that makes it so hard to compare infinite collections. The crowd is growing antsy, you have to make a decision, but your assessment of the deal depends on the way you compare the two outcomes.
A similar ambiguity afflicts comparisons of a yet more basic characteristic of such collections: the number of members each contains. ... Which are more plentiful, whole numbers or even numbers? Most people would say whole numbers, since only half of the whole numbers are even. But your experience with Monty gives you sharper insight. Imagine that you take Monty’s deal and wind up with all even dollar amounts. In doing so, you wouldn’t return any envelopes nor would you require any new ones... You conclude, therefore, that the number of envelopes required to accommodate all whole numbers is the same as the number of envelopes required to accommodate all even numbers—which suggests that the populations of each category are equal (Table 7.1). And that’s weird. By one method of comparison—considering the even numbers as a subset of the whole numbers—you conclude that there are more whole numbers. By a different method of comparison—considering how many envelopes are needed to contain the members of each group—you conclude that the set of whole numbers and the set of even numbers have equal populations.
Table 7.1 Every whole number is paired with an even number, and vice versa, suggesting that the quantity of each is the same.
You can even convince yourself that there are more even numbers than there are whole numbers. Imagine that Monty offered to quadruple the money in each of the envelopes you initially had, so there would be $4 in the first, $8 in the second, $12 in the third, and so on. Since, again, the number of envelopes involved in the deal stays the same, this suggests that the quantity of whole numbers, where the deal began, is equal to that of numbers divisible by four (Table 7.2), where the deal wound up. But such a pairing, marrying off each whole number to a number that’s divisible by 4, leaves an infinite set of even bachelors—the numbers 2, 6, 10, and so on—and thus seems to imply that the evens are more plentiful than the wholes.
Table 7.2 Every whole number is paired with every other even number, leaving an infinite set of even bachelors, suggesting that there are more evens than wholes.
From one perspective, the population of even numbers is less than that of whole numbers. From another, the populations are equal. From another still, the population of even numbers is greater than that of the whole numbers. And it’s not that one conclusion is right and the others wrong. There simply is no absolute answer to the question of which of these kinds of infinite collections are larger. The result you find depends on the manner in which you do the comparison. ...
Physicists call this the measure problem, a mathematical term whose meaning is well suggested by its name. ... Solving the measure problem is imperative.
[From Greene, Brian (2011). The Hidden Reality: Parallel Universes and the Deep Laws of the Cosmos (Kindle Locations 3609-3624). Random House, Inc.. Kindle Edition.]
Structural adjustment for the middle class?, by Dan Little: Working people in the US have suffered big economic losses in the past four years. Losses of jobs in the economy have pushed many working people from high-wage to low-wage jobs, and as we all know, many people have been pushed out of jobs altogether. The national unemployment rate was 8.6% in November, and very much higher in urban areas and African-American and Latino communities. Michigan's rate was 10.6% in October 2011 (link). White non-Hispanic households fell from $55,360 in 2009 to $54,620 (-1.3%), while black households fell from $33,122 to $32,068 (-3.2%) (Table 1). These differences in household income across race are stunning: black households started out at only 63% the level of white households in 2009, and they fell by more than double the percentage rate of loss from 2009 to 2010.
Here is a report from the US Census Bureau, Income, Poverty, and Health Insurance Coverage in the United States: 2010, that sheds some light on the changes of the past several years. Here are a few important summary findings:
Real median household income was $49,445 in 2010, a 2.3 percent decline from 2009 (Figure 1 and Table 1).
Since 2007, the year before the most recent recession, real median household income has declined 6.4 percent and is 7.1 percent below the median household income peak that occurred in 1999 (Figure 1 and Tables A-1 and A-2).3
Both family and nonfamily households had declines in real median income between 2009 and 2010. The income of family households declined by 1.2 percent to $61,544; the income of nonfamily households declined by 3.9 percent to $29,730 (Table 1).
Real median income declined for White and Black households between 2009 and 2010, while the changes for Asian and Hispanic-origin households were not statistically significant (Table 1).
Real median household income for each race and Hispanic-origin group has not yet recovered to the pre-2001 recession all-time highs (Table A-1). (5)
Here is what real median income looks like, broken down by racial group, since 1967.
Now consider the poverty statistics the report contains. Here is a summary graph:
The national poverty rate reached a forty-year low in 2000, at about 12%. Through the decade, however, the national rate has grown to 15.1% in 2010, representing 46.2 million people. Here again there is a stunningly wide gap between white and black populations. The poverty rate in 2010 for white non-Hispanic households is 9.9%, while the rate for black households in 2010 is 27.4% (Table 4).
We've tended to think of this period as a difficult economic time that will eventually come to an end. But perhaps that's too optimistic. Perhaps what we are witnessing is a structural adjustment of the US labor market, with a permanent downward shift in income for middle and low income people. And perhaps these shifts will be most extreme for African-American households. (The past decade seems to bear this out. From 2000 to 2010 white non-Hispanic households had declined 5.5%, while black households declined 14.6% during that same period (8).)
Here the concern is that maybe Bruce Springsteen was right -- "these jobs are going, boys, and they ain't coming back to your hometown." Jobs with decent wages -- manufacturing jobs, union jobs, professional service jobs -- have declined precipitously in the past twenty years (not just since the recession). And that means that the opportunities for many workers to have "middle-class" incomes have become much more restricted. Here is a sober report from Chemical and Engineering News --
The severe national recession of the past several years is having a negative impact on the employment and the starting salaries of chemists and chemical engineers. The latest data from the American Chemical Society on graduates from 2009 found that median starting salaries fell about 5% for those receiving bachelor’s and doctoral degrees compared with the previous year. New graduates with master’s degrees appeared to have gotten a jump in pay.
Even the banking and financial sector has contracted (link):
The financial services industry, hammered by job cuts and record losses, is in for an even bigger contraction as the global recession deepens, said Marc Faber, publisher of the Gloom, Boom & Doom Report.
“The financial sector will contract and it will contract much more than we’ve seen so far,” said Faber, who was in Tokyo to speak at an event hosted by CLSA Ltd. Financial professionals have “been in paradise for the past 25 years.”
More than 275,000 jobs in the financial industry have been lost in the last two years, according to Bloomberg data, while losses and writedowns at global companies exceeded $1 trillion in the past year. Faber said the contraction could rival declines seen in the 1970s following the collapse of Bernard Cornfeld’s Investors Overseas Services that shook confidence in the industry for a decade.
So the financial industry isn't providing ready opportunities for young MBAs; many of them too will need to find other, less well-paying jobs.
Does this mean that everyone in the US economy is facing downward pressure on wages and salary? Not exactly. There is a segment of the American economy that is doing very well indeed. Here is a graph provided by Lane Kenworthy demonstrating the growth in income of the top 1% (link). (Kenworthy's discussion is very good.) The top line is the median household income of the top 1%. The lower lines, showing virtually no growth, represent the median of the middle three quintiles and the median of the bottom quintile of households.
So here are two important questions. Is the US economy on a path towards a shift to lower-paid jobs for a large segment of its working population? And are there policies that could be chosen that would result in an outcome that looks more fair than this graph of the recent past, with reasonable growth of income for all American workers and less extreme growth at the very top?
My answer (from a column in January) starts from the same question. Is the change we are seeing a permanent structural shift, and if so what should we do it?:
...I’ve never favored redistributive policies, except to correct distortions in the distribution of income resulting from market failure, political power, bequests and other impediments to fair competition and equal opportunity. I’ve always believed that the best approach is to level the playing field so that everyone has an equal chance. If we can do that – an ideal we are far from presently – then we should accept the outcome as fair. Furthermore, under this approach, people are rewarded according to their contributions, and economic growth is likely to be highest.
But increasingly I am of the view that even if we could level the domestic playing field, it still won’t solve our wage stagnation and inequality problems. Redistribution of income appears to be the only answer. ...
I'd prefer for the economy to solve this problem on its own, but this may not be a problem that self-corrects. In addition, I don't think that the idea that increasing income inequality in recent years is attributable to merit, i.e. people getting rewarded purely for their contributions, is defensible. Wages for the working class have not increased with their productivity, but that income went somewhere and it's not hard to figure out where. One argument is that it would be unfair to redistribute income. However, to the extent that redistribution simply claws back the income that should have gone to the working class, it is not unfair at all. In fact, it would be unfair not to do this. Another argument is this would harm economic growth. There's little evidence that redistributing income affects economic growth in any case, but if the existing rewards are mal-distributed, as I think they are, then the distribution is not growth maximizing to begin with. Redistributing rewards so that the distributuion of income better reflects the contribution to production should enhance growth, not harm it.
[Note: Video starts just after the 10 minute mark, lectures start just after the 16:30 mark. Video link from Steven Kinsella who says "Tom Sargent’s Nobel lecture compares the formation of the US fiscal and monetary union by Alexander Hamilton to the current experience in Europe. Well worth watching..."]
Many people think that 2012 will be the make-or-break year for Europe – either a quantum leap in European integration,... or the eurozone’s disintegration, igniting the mother of all financial crises.
In fact, neither scenario is plausible. The collapse of the eurozone would, of course, be an economic and financial calamity. But that is precisely why the European Central Bank will overcome its reluctance and intervene in the Italian and Spanish bond markets, and why the Italian and Spanish governments will, in the end, use that breathing space to complete the reforms that the ECB requires as a quid pro quo. ...
While the eurozone is unlikely to collapse in 2012, there will be no definitive answer to the question of whether the euro will survive, because there will be no quantum leap in European integration. Treaty revisions take time to draft – and more time to ratify. ...
It is a sad state of affairs when a recession qualifies as muddling through. But such is the European condition. ... But muddling through cannot continue forever. Europe needs to draw a line under its crisis and figure out how to grow. The US needs to overcome its political polarization and policy gridlock. And China needs to rebalance its economy – shifting from construction and exports to household consumption as the main engine of growth – while it still has time.
Of course, if none of this happens – or if not enough of it does – 2013 could turn out to be the annus horribilis of the perma-bears’ dreams.
A Mixed Bag From Europe, by Tim Duy: I find it somewhat hard to judge the merits of this week's developments in Europe. Some positives, some negatives. On net, though, I remain a Europessimist. In my opinion, the issues of internal rebalancing remain completely ignored, and this will eventually doom the Euro if not addressed.
The European Central Bank moved forward with additional easing specifically intended to alleviate pressures in the banking system. The breakdown in the interbank lending market threatened to create a Lehman-type event sooner than later, and that threat was receded with the ECB's extension of liquidity facilities and cutting in half reserve requirements for commercial banks. The ECB also cut interest rates to 1%, with more cuts expected.
That said, the European financial system remains under pressure with continuing deleveraging and eventually more bank recapitalizations efforts needed. The result will be a worsening of the European recession, an event that is only in its infancy. And, as has been widely reported, ECB President Mario Draghi did not offer unlimited support for Eurozone sovereign debt, which was greeted with disappointment yesterday. I think it is premature to expect such a commitment; they will only play that card as a very last measure.
Overall, somewhat more aggressive than than I expected, and a clear indication that the ECB now realizes the depth of the Eurozone's financial problems. So far, so good. Yes, I would be happier with a clear statement that the ECB is the lender of last resort for European sovereign debt, but I just don't expect to hear this yet anyway.
In contrast, the Eurozone summit predictably failed to meet expectations. The UK bowed out of the agreement, guaranteeing a lack of EU wide commitment. At best you get the 17 Eurozone nations plus a few others to sign up. This opens up the possibility of more EU ruptures in the future. The seal has been broken. Second, as Felix Salmon points out, we have an agreement in principle, but ratification battles lie ahead:
It seems that German chancellor Angela Merkel is insisting on a fully-fledged treaty change — something there simply isn’t time for, and which the electorates of nearly all European countries would dismiss out of hand. Europe, whatever its other faults, is still a democracy, and it’s clear that any deal is going to be hugely unpopular among most of Europe’s population. There’s simply no chance that a new treaty will get the unanimous ratification it needs, and in the mean time the EU’s crisis-management tools are just not up to dealing with the magnitude of the current crisis.
Many opportunities for national politics to blow this agreement apart in the weeks ahead.
As far as Eurozone crisis-management tools are concerned, we are simply still where we have always been - the wealthier nations of the Eurozone - largely Germany - continue to resist putting in the necessary capital to create effective crisis funds. Moreover, the ECB appears to remain unwilling to lend the necessary money to rescue funds. In the absence of internal support, Europe continues to look toward international support. I still think this is ludicrous. How much help should Europe really expect knowing that Germany is not willing to go all-in financially to save the Euro, and now that we know the UK is making a calculated bet that the Euro is already a doomed experiment?
Let's put aside the above concerns for a minute. When all is said and done, I am still amazed that the outcome of this summit is being described as a move toward fiscal union. It is not that - it is commitment to unified fiscal austerity, nothing more. Consider just a strict enforcement of the 3% deficit ceiling in light of actual deficits in the EU. Via NPR:
Just on the surface, it is tough to see any commitment to fiscal austerity as credible. Germany itself exceeded the targets in 7 out of the past 11 years. Talk about the pot calling the kettle black. France missed 6 in the past 11 years. And Italy 8 times. Thus, in addition to the periphery nations, the biggest economies in the Eurozone will all need to increase government saving to meet these targets.
Such saving will be attempted in the context of a recession in which the private sector also will be increasing savings as well. In other words, the public sector will be engaging in massive pro-cyclical fiscal policy as the recession intensifies. You have to imagine the end result is a substantial deflationary environment.
In short, I think Europe is rushing full speed to a Japanese outcome, with slow growth coupled with an appreciating currency. And it is that promise of slow growth and a strong currency will be what eventually tears the Eurozone apart. And this is truly sad given that deficits are not really the problem to begin with.
Why will the Eurozone fail? Because we still see nothing that addresses the internal imbalances between the core (largely Germany), and the periphery. That is the result of failing to commit to a real fiscal union. Such a union would include automatic internal fiscal transfers that are essential to maintaining regional economic stability. For example, economic distress in a US state results in an automatic relative transfer of resources via decreased tax revenue from and increased transfer payments to that state. Lacking such a mechanism, a slow growth, hard money regime will increasingly ratchet up the levels of economic distress in the periphery. And eventually the costs of staying in the Euro will exceed the costs of exit.
If Europe was serious about saving the Euro, they would commit to issuing more safe assets (more sovereign debt), using the ECB backstop to create such assets, and engage in direct fiscal transfers to reduce economic pain in the periphery while encouraging continuing structural and budget reforms in recipient economies. I don't think we are anywhere near such a plan - and are arguably moving in the opposite direction.
Bottom Line: I remain a Europessimist. The ECB is moving aggressively to preventing an imminent financial collapse. That should be seen as good news. But there remain unresolved deeper issues. At the core of those issues is the inability to see Europe as one large, fiscal unified economy rather than a combination of separate, fiscally austere economies. And in that remains the long-term vulnerability of the Euro experiment.
Update: That will teach me to write a post on an airplane without an internet connection, get stranded at the airport due to mechanical problems, and then stuck in a hotel with crappy internet service -- I could hardly do links last night. In the meantime, this post has been a bit dated by events. I'm still not able to do much (finally made it to the conference), so I'll leave it to you to update events in comments.
Now that I have a few more minutes, here's the post itself:
The outcome of the European summit is important not just for the future of Europe and the European Union, but also for the U.S. If Europe doesn't get its problems under control and conditions deteriorate further, that will affect the ability of the U.S. economy to recover.
So far the recovery in the U.S. has been tepid at best. Though there are signs that things are improving, presently we are simply treading water. There is just enough growth to absorb new workers entering the labor force due to population growth, but not enough to allow all the workers that lost jobs during the recession to be reemployed. We need an acceleration in the recovery at some point, and the sooner the better. If things don't pick up, we are looking at years before we get back to a more normal economy.
But an acceleration in the recovery is not going to happen if the troubles in Europe get worse. It may not happen in any case, but as I pointed out in a previous article, the U.S. and European economies are highly correlated, and trouble in Europe will also cause trouble here.
What problems must be resolved in order for the European outlook to improve? First and foremost, the EU must solve the sovereign debt problems that many countries in Europe face. The reasons for the problems vary by country. In some cases, such as Greece, it was excessive spending on social programs. Other countries, such as Ireland, had budgets that were in fairly good shape prior to the recession, but the fall in tax revenue from the recession has made it difficult for them to meet their obligations. But whatever the source, many countries in Europe are now facing debt troubles that must be resolved to calm financial markets.
The plan at this point is to alter the EU to impose debt limits, and, importantly, to add sanctions for failing to meet the debt limits (3 percent of GDP per year and no more than a 60 percent debt to GDP level overall are tentative guidelines). That's not a process that can happen quickly. It will take time to get a new treaty ratified -- if it can be ratified at all -- and the initial reaction of markets was negative. Thus, if that were all there was to the proposal, then the considerable time and uncertainty inherent in writing and approving a new treaty would leave financial markets just as nervous as before.
There is a mechanism in place to deal with this called the European Financial Stability Fund. The ESFS is a 440 billion euro fund backed by European countries empowered to make loans to troubled nations. However, doubts that the size of the fund is sufficient and the fact that it is temporary (it ends in June 2013) make it less than a fully satisfactory solution, as evidenced by the fact that the troubles persist. There is also a plan for a similar fund called the European Stability Mecanism to be established in 2013 to replace the EFSF, but the details of how the ESM will be funded are still unclear, and it is too far away to calm financial markets.
So what can be done? This is where support of the debt by the ECB comes into play. So far the ECB has been reluctant to support the debt of troubled countries through purchases of sovereign debt. However, a solid commitment to alter the EU treaty may give the ECB the political cover it needs to take a more active role in its capacity as lender of last resort. In this regard, market participants were disappointed that the ECB did not announce an asset purchase program at the end of its rate setting meeting on Thursday. It did cut the target interest rate by one percent, but that wasn't enough to calm market participants looking for a signal that the ECB will take a more active role once commitments to a treaty or some other mechanism to force debt reduction are in place.
If the summit fails, and if ECB refuses to act, there is another route that might work: the IMF. If the IMF can secure the necessary funding, then it could make loans to troubled countries. Failing this, there have also been discussions for the creation of Eurobonds, another way for European countries to jointly support the debt of troubled countries. But all of these programs hinge critically upon a credible debt-management program for the future. With a credible plan, there are several ways to proceed. Without a plan, the options are far more limited.
The second important problem the European leaders must resolve at their two-day meeting is how to divide up the losses. Somebody has to pay for the bad debts, but who? This is not an easy problem. For example, one key issue is the degree to which bondholders will be protected in a bailout. If bondholders are forced to take haircuts on their asset holdings, the fear is that they will stop lending and produce a Lehman like event -- and that is to be avoided. But if they aren't held at least partly responsible, then someone has to pay, and that someone is likely to be taxpayers. But why should taxpayers who had nothing to do with causing the problems be responsible for covering the losses?
Much of the fighting among EU countries is over who, in the end, will be forced to absorb the losses. Countries like Germany, who feel they made the hard choices necessary to keep their personal and national budgets under control (and thus had a surplus to lend to other countries), do not believe they should have to pay losses. Exactly how this is resolved is important. As we have seen in the U.S., if policymakers do not pay attention to who benefits from bailouts -- if the perception and reality is that bad behavior got rewarded when the financial system was saved -- the political fallout down the road could be significant. In addition, when bailouts are carried out in a way that is politically objectionable, it makes it all that much harder to help the system the next time it gets into trouble, since people will resist repeating the same set of policies.
I am more confident than I was a week or so ago that Europe will finally find a way out of this mess, but it is by no means certain that this summit will produce the needed changes, or that the ECB will respond as needed and finally fulfill its role of lender of last resort. For an economist, these are incredibly interesting times, but for everyone else, it's a time of great uncertainty. It seems as though a new problem pops up the minute the last one appears under control, and there is no end in sight. I'm hoping the summit in Brussels reduces that uncertainty, and there's a chance that it will. But there's no guarantee that the summit will produce the necessary agreements among European countries. This isn't over yet.
All the G.O.P.’s Gekkos, by Paul Krugman, Commentary, NY Times: Almost a quarter of a century has passed since the release of the movie “Wall Street,” and the film seems more relevant than ever. The self-righteous screeds of financial tycoons denouncing President Obama all read like variations on Gordon Gekko’s famous “greed is good” speech, while the complaints of Occupy Wall Street sound just like what Gekko says in private:... “Now you’re not naïve enough to think we’re living in a democracy, are you, buddy?” ...
And, according to ... Intrade, there’s a 45 percent chance that a real-life Gordon Gekko will be the next Republican presidential nominee. I am not, of course, the first person to notice the similarity between Mitt Romney’s business career and the fictional exploits of Oliver Stone’s antihero. ... But there’s an issue here that runs deeper than potshots against Mr. Romney.
For the current orthodoxy among Republicans is that we mustn’t even criticize the wealthy, let alone demand that they pay higher taxes, because they’re “job creators.” Yet the fact is that quite a few of today’s wealthy got that way by destroying jobs rather than creating them. And Mr. Romney’s business history offers a very good illustration of that fact. ...
Bain Capital, the private equity firm that Mr. Romney ran from 1984 to 1999 ... specialized in leveraged buyouts... The idea was to increase the acquired companies’ profits, then resell them.
But how were profits to be increased? The popular image — shaped in part by Oliver Stone — is that buyouts were followed by ruthless cost-cutting, largely at the expense of workers who either lost their jobs or found their wages and benefits cut. And while reality is more complex..., it contains more than a grain of truth. ...
So Mr. Romney made his fortune in a business that is, on balance, about job destruction... And because job destruction hurts workers even as it increases profits and the incomes of top executives, leveraged buyout firms have contributed to the combination of stagnant wages and soaring incomes at the top that has characterized America since 1980. ...
Contrary to conservative claims, liberals aren’t out to demonize or punish the rich. But they do object to the attempts of the right to do the opposite, to canonize the wealthy and exempt them from the sacrifices everyone else is expected to make because of the wonderful things they supposedly do for the rest of us.
The truth is that what’s good for the 1 percent, or even better the 0.1 percent, isn’t necessarily good for the rest of America — and Mr. Romney’s career illustrates that point perfectly. There’s no need, and no reason, to hate Mr. Romney and others like him. We do, however, need to get such people paying more in taxes — and we shouldn’t let myths about “job creators” get in the way.
Bruce Judson: I started discussing the book with Harper Collins in 2007. At that time, a number of prominent people were also very concerned about it, including Paul Krugman, Robert Reich, Elizabeth Warren, and Roosevelt Institute Chief Economist Joseph Stiglitz. They all said it was dangerous for our democracy. But I kept wondering why. What happens next? So I started my own research.
In the book, I took a historic perspective on what happens when extreme inequality arises in a society. It describes a series of steps, or a narrative, for how growing economic inequality can ultimately lead a democracy to implode. The book argued that if economic inequality in America continued unchecked, it would lead to a dysfunctional economy, even greater political polarization, ultimately political paralysis, anger and mistrust throughout the society, protests, and eventually reform or some type of political instability.
Sadly, each of the stages of misery seems to be happening like dominoes falling. And I am convinced the Occupy movement reflects the coalescing of the deep and unfortunate anger that pervades our society as a result.
BC: What historical trends stood out as most similar to our situation?
BJ: I was terrified by the similarities between our society and the era of the Great Depression. As a nation, we were moving toward levels of economic inequality we had not seen since the financial crash of the late 1920s. My reading of history, of events surrounding the New Deal era and the Depression, is that excess inequality tended to be associated with high speculation and a lack of appropriate constraints on the financial industry.
In essence, I came to believe growing economic inequality was intimately linked to economic catastrophe, which would be so great that it would tear our social fabric. ...[continue reading]...
The labor market seems to be improving, but the pace of change is far, far too slow. I've been hoping for an acceleration in job creation at some point, but it's hard to see that happen any time soon with so much uncertainty hanging over Europe.
Gorton’s story is that this was a bank run, not substantially different from the bank runs that have always plagued capitalist economies. In this case, the run took place in the repo market, which is an unregulated (and largely unmonitored)... The repo market serves large institutions (e.g. Fidelity Investments or state governments) with a lot of cash on hand that they want to stash in an interest-bearing account for a day or two. So Fidelity deposits, say, a half-billion dollars at, say, Bear Stearns, just as you might deposit five hundred dollars at your local bank. One difference, though, is that your account at your local bank is insured, whereas Fidelity’s account at Bear Stearns is not — so Fidelity, unlike you, demands collateral for its deposit. Bear Stearns complies by handing over a half-billion dollars worth of bonds, of which Fidelity takes physical possession. The next morning, Fidelity withdraws its money and returns the bonds.
The problem comes in when rumors begin to spread that some bonds might be riskier than they appear, and Fidelity starts to worry that maybe Bear Stearns is picking particularly risky bonds to hand over. Therefore Fidelity demands more than a half-billion in bonds to guarantee its half-billion dollar deposit. If there’s, say, a 10% discrepancy between the deposit and the collateral, we say that Bear Stearns has taken a half-billion dollar haircut.
Because Bear Stearns has a fixed quantity of bonds on hand, and because all of its depositors are demanding haircuts, Bear Stearns can now accept fewer deposits than before. This means that Bear Stearns has less cash on hand. This makes depositors even more worried about the security of their deposits, which means they demand larger haircuts. The effects snowball until Bear Stearns collapses. ...
So what should we do about all this? Gorton, along with his colleague Andrew Metrick, argues that the repo market, like any banking market, is inherently susceptible to runs and therefore ought to be regulated. In this case, the regulations should focus on insuring the availability of sufficient high-quality collateral to keep depositors calm. Gorton observes that the existing policy responses to the crisis (e.g. the Dodd-Frank bill) do pretty much nothing to address this fundamental need. The Gordon/Metrick paper contains some specific proposals, which unfortunately Gorton never got to in yesterday’s talk. ...
Insuring the availability of high-quality collateral is not the only solution. For example, the shadow banking system could also be regulated much like the traditional banking system where limits on risk taking behavior and insurance fees are traded for deposit insurance (see here for an email from Metrick on this, the limits on risk-taking and the fees are intended to counter the moral hazard that arises with the deposit insurance). Regulators are supposedly working on this, and a solution involving collateral restrictions is the likely outcome, but so far the vulnerability persists.
The Grapes of Wrath was published by its author, John Steinbeck, in 1939, during the worst economic crisis in American and world history. Set in and written during the Great Depression, The Grapes of Wrath is a bluesy road-novel with a lot of social and economic theory and analysis. It follows a family of homeless and landless tenant farmers from Oklahoma—the Joads—who’ve been forced on account of foreclosure to leave the farm and land which they labored and lived on for several generations.
Forced by a large bank and absentee owners to leave their home, the Midwestern farmers with little education and no income join other displaced workers on the road to California, in search of jobs, food, and housing—a piece of the American Dream.
Steinbeck’s Pulitzer Prize-winning novel was for many years censored and banned by governments and school boards made uncomfortable by the novel’s detailed portrayal of economic inequality, hardship, and oppression.
We asked Stephen Ziliak to share his experience teaching The Grapes of Wrath, which he has used since 1996 to form the basis of his intro economics course.
Q: Why, Professor Ziliak, way back in 1996, did you begin to teach to introductory economics students The Grapes of Wrath?
A: I guess my first response is that I eschewed in my own research the one-voiced, monological approach of conventional neoclassical economics. Trained as an economic historian, I’m an amateur poet who had also worked as a welfare and food stamp caseworker in the county welfare department, going door-to-door in the poorest neighborhoods of Indianapolis. When I became an Assistant Professor of Economics, in 1996, I was searching for a teaching method that would open up the conversation to a wider, more realistic set of issues. It only seemed fair to me: given that I myself had philosophical objections to the conventional approach to teaching utilitarian economics, it hardly seemed right to force-feed my students. Plus, many of my students came from working class families but they’d never experienced a recession. I wanted them to know that growth and bubbles do not last forever.
Q: Why teach The Grapes of Wrath and not some other novel?
A: Good question. First and foremost, it’s an incredibly moving novel that—I openly admit—continues to make me laugh and cry. Now laughing and crying are not necessary for good pedagogy. But it seems to me that if a fact-based story about economic history can make a grown man and professor of economics cry, it must have something important to say. The visible hand of class conflict needs to be aired and this novel does it.
Q: You said fact-based. What do you mean—it’s a novel, it’s fiction, yes?
A: Yes, but it’s historical fiction—meaning that Steinbeck, like Hugo, Zola, and others before him, was deliberately depicting real and felt experiences. There are exaggerations and omissions of fact, true—as economic historians and English professors know full well. But in fact, Steinbeck himself spent a year or more working and studying inside of the same temporary labor camps that the fictional Joad family experienced in California.
Q: How do students react? Can you share some insights from the teacher perspective?
A: Really well, eventually. Some are defensive at first, being trained to believe that stories are for novelists and theory for scientists. Still others have been so deeply entrenched with what I call the banking approach to learning—regurgitating facts and equations—they’re afraid of dialogue and a plurality of voices and interpretation. But students tell me it’s one of those life-changing courses.
Q: What about the “quants”? Do quants survive the course?
A: Again, it’s not for everyone. But yes, absolutely. An example is a student who studied with me at Roosevelt University. He came to Roosevelt as a freshman from Puerto Rico on a violin scholarship. He was preparing for a career in violin at our conservatory and, at the same time, he had a passion for advanced mathematics. On a lark he enrolled in my Grapes of Wrath course. Half-way through the term he told me that something was happening to him. The evolution of the protagonist, Tom Joad, from self-interested ex-con to benevolent labor leader, he found fascinating. He thought that he might have to switch from violin and math to economics. I told him no, if he really wanted to switch he could study math and economics—he wouldn’t have to give up the math. By the time he was a junior (a third year student) he landed a job with the Federal Reserve Bank of Chicago. At graduation he was promoted to Associate Research Economist. Now he’s a master’s student in economics and statistics at Duke University but he is not at all bamboozled by the utility maximization-only school.
Q: Do you supplement the novel with other literature or media?
A: Yeah. For example, a particularly fun day of class is when we play music by Woody Guthrie, Bruce Springsteen, and Rage Against the Machine—who’ve recorded songs about Tom Joad. Springsteen himself recorded an entire CD on the central themes.
From the syllabus linked above:
In 1776 three astonishing works of genius were given to the world. One was the Declaration of Independence. A second was Edward Gibbon’s Decline and Fall of the Roman Empire. For many students these two great works of 1776 require little or no introduction. The third work does. Yet some say it is the most important and influential of all. I am speaking of The Wealth of Nations, a lengthy and learned book written by a humble professor of philosophy living in Scotland. Adam Smith’s The Wealth of Nations supplied an intellectual justification for a free and commercial society. It gave new life to a field of inquiry called "economics" and it continues to challenge and to shape the values of economists, presidents, and ministers of finance all over the world.
Smith’s book is central to the economic conversation, true, but it is not the end-all, be-all of economic truth. It would not be wrong to think of our course as a conversation about "How the economists Adam Smith, Karl Marx, John Maynard Keynes, Joan Robinson, Milton Friedman, and others have responded to Mercantilism, Romanticism, and the rise and fall of Communism and Fascism."
Mostly, however, the course is an introduction to microeconomic ways of thinking. Our course introduces a new grammar, if you will – an economic grammar of scarcity, competition, relative price, opportunity cost, supply and demand, efficiency, and equilibrium, to name a few. At minimum our course will help you to become an informed voter and a sophisticated reader of The Wall Street Journal. It will certainly invite you to engage in a lifetime of learning.
But microeconomics cannot be learned just by reading The Wall Street Journal or Atlas Shrugged, nor by listening to Green Day or Rage Against the Machine. These will help you care about economics. But to learn how to speak economics you’ll have to solve homework problems, read the books, and participate in class.
Still, the economic conversation is shaped by many different texts and experiences, from novels to music and media. It’s important for economists to learn how to speak to the humanistic sides of the conversation, and, likewise, it’s crucial that humanists speak intelligently about economic theory and facts, and not be bamboozed. To this end and others, we’ll read and analyze the most famous protest novel in American literature, John Steinbeck’s The Grapes of Wrath. Set in and written during the Great Depression, The Grapes of Wrath is a bluesy road-novel with a lot of economic theory and analysis. It follows homeless and landless tenant farmers from Oklahoma, who’ve been pushed off of foreclosed farms. Forced by large and foreign banks to leave their rented shacks and lean-tos, the Midwestern farmers with little education and no income join other displaced on the road to California, in search of jobs, food, and housing—a piece of the American Dream.
We’ll read this highly relevant novel using in part the lens of economic theory and facts, and likewise we’ll critically analyze economic theory and facts, using concepts and insights we discover in The Grapes of Wrath. Attached to the back of this syllabus is an example of a homework assignment from a previous semester, indicating how we’ll put Steinbeck’s Depression-era novel together with supply and demand.
Finally, throughout the semester, we’ll occasionally read and discuss parts of Tim Harford’s popular book, The Undercover Economist, which supplies many useful, real-world applications of the microeconomic way of thinking. Harford’s book is a great help, especially to those who do not naturally think of price and incentive when analyzing the human condition. ...
Required Texts: Microeconomics, by David Colander, 7th edition...; The Grapes of Wrath, by John Steinbeck; The Undercover Economist, by Tim Harford. ...
The Futility Of Bipartisan Outreach, by Paul Krugman: President Obama has tried — desperately, and far beyond the point at which it made any kind of sense — to reach out across the partisan divide. He has bent over backwards to be nice to bankers. He has clearly been uncomfortable with any kind of populist rhetoric, although that may finally be changing.
[Obama] seeks to replace our merit-based society with an entitlement society. In an entitlement society, everyone receives the same or similar rewards, regardless of education, effort and willingness to take risk. That which is earned by some is redistributed to the others. And the only people to enjoy truly disproportionate rewards are the people who do the redistributing — the government.
Reality just doesn’t matter here — which is why Obama might as well reach out to his base instead of the unreachable right.
Lucy and the football. The fake handshake trick. True colors shining through. Whatever. Ken Houghton has had it:
...the Obama Administration has been making it Really Effing Easy for Its Base to Mobilize since around the time Tim Geithner was appointed. That mobilization is just away from the voting booth and onto the streets. ...
There are two ways to get votes. You can take votes from the other side by appealing to the middle, or you can increase the turnout on your side by mobilizing the base or bringing in new voters (many policies involve a tradeoff between these margins, but the best policies appeal to both groups). It seems to me that Obama is losing far more in terms of enthusiasm and turnout than he is gaining by moving the middle (though it may be incorrect to describe him as having to move to the middle, unless it's from the right).
Who would pay a 73 percent income tax? Not necessarily the rich., by Richard Green: A paper which is receiving considerable attention (see here, here and here) is Diamond and Saez's Journal of Economic Perspectives piece on optimal marginal tax rates. They put the rate at 73 percent, and declare it an optimum because it would maximize revenue that could then be used for other things. In particular, they argue that the utility lost to the rich would be much less than the utility gained by lower income people via government programs. I do believe that many government programs leave people better off, but I am skeptical about whether the optimal size of government is that which is supported by a revenue maximizing income tax.
In any event, one aspect of the paper bothers me: if one searches for the word "incidence," it is not found. Incidence reflects who really bears the burden of a tax. If one taxes a person or a business, they might absorb it, or they might pass it on to someone else.
The formula for the incidence of a tax on those who demand a taxed good is (Supply Elasticity)/(Supply Elasticity - Demand Elasticity). (I apologize for having elegant formulas--I don't know how to paste them into Blogger). Because demand curves are generally downward sloping, demand elasticity has a negative sign, so in a sense, the incidence reflects how relatively elastic supply is relative to the sum of the absolute values of the elasticities of demand and supply.
Now let's think about supply elasticity at the revenue maximizing point. It is exactly one, in that the reduction in labor offered exactly offsets any increase in the rate. To illustrate, let us just assume for a moment that demand elasticity is -1. Then half the incidence of the tax is on the supplier of labor or capital (a.k.a. the rich) and half the incidence is on the demander. This means that the burden on the rich person is 36.5 percent, not 73 percent.
What we do know is that as tax rates fall, the supply elasticity of the wealthy falls. Why? Because we know at lower tax rates, raising rates raises revenue-the supply response to an increase in taxes is smaller. Let's assume that at a 50 percent marginal tax rate, the elasticity of labor supply for the rich is .25. Now the incidence on demanders is .25/1.25, or 20 percent of the tax burden; it is 80 percent on the rich. hence with a 50 percent tax rate, the effective tax on the rich is 40 percent, or higher than it would be with a 73 percent rate!
These arguments all depend on assumed elasticity parameters, and so it is important to estimate them as best as possible. I should also note that I am all for raising taxes, including on myself, to pay for the many government services that I do support. Somedays I think that if I could change the tax code, I would just raise my own taxes by ten percent and then have policy that assured that everyone with income greater than mine would pay an effective tax rate no lower than mine.
The drop in U.S. unemployment so far this year may be an early glimpse of what’s to come as the workforce ages...
...At play is a decline in the share of the working-age population, known as the participation rate, meaning that the economy needs to create fewer jobs to bring down unemployment. While some of the decrease has been caused by discouraged workers dropping out of the labor force, another driver is that the baby-boom generation is starting to move into retirement, according to economist Dean Maki.
“Demographic forces are the single biggest factor pushing the participation rate down,” said Maki, chief U.S. economist at Barclays Capital Inc. in New York and a former economist at the Federal Reserve. “This is a bit of a slow-moving drama but it’s likely to become more important in coming years.”
I think it is important to focus on the "slow-moving drama" part, otherwise the problem with this story is the facts. Labor force participation rates of the 65 and older group:
Note that labor force participation rates begin to rise at the end of the last decade, after the collapse of the internet bubble. It seems that this event, not to mention the subsequent rise and fall of housing markets, played havoc with retirement plans. Many who thought they could retire suddenly realized they couldn't afford retirement, and were stuck working longer than anticipated.
A little more support for Maki's case can be found in near-retirees:
I looks like labor force participation rates in this group might be topping out, but not enough to be the "single biggest factor" pushing rate down. To get to that story, you need to go lower on the demographic ladder:
That looks like a pretty dramatic shift to me - 23 percentage points or so. Too be sure, the intermediate group has also declined:
Given the wide range of ages in this group, it is difficult to apply all of the deterioration to the baby-boomers. Looking across the data, we very much see young people fleeing the labor market. To where? Given the weak labor market this decade, the opportunity cost of education is low, and thus many are continuing their education. Interestingly, Karl Smith looks at the data and concludes:
The United States is becoming more educated faster than the economy would absorb educated workers.
Presumably, this is good in the lon-run, as eventually those more educated workers will be absorbed by the labor market. Here I would caution, however, that defining educated or high-skilled workers as those with college degrees may be too-broad a classification. I sense the college-educated population is much more heterogeneous than commonly believed, and in reality contains a mix of high- and low-skilled workers. In other words, just because we are pushing people through the hoops that lead to a college education does not guarantee that those students have gathered skills marketable in the real world. Which means that we don't really know if we are creating "educated" workers faster than the economy can absorb. We could simply be overestimating the number of "educated" workers.
I think the article would have felt better if it began not with the impression that baby boomers are the driving force behind recent declines in the participation rate, but could be more of an influence in over time. This, I sense, is what Maki really wants to say:
The effect of the baby-boomer exit from the labor force will become more evident in the coming decade, Maki said. The policy implications may be more pressing, as Fed officials keep interest rates near record low levels for longer than may be required given the likely drop in the jobless rate. That may fuel price pressures in the economy, he said.
Then again, maybe not:
“It means there is less slack in the economy than is commonly perceived, and the slack will diminish more quickly than people think,” Maki said. As a result, “there are more inflationary risks with the very accommodative monetary policy we have now than one might believe.”
I think the near-term reality is a little less dire. And the article eventually gets there:
To be sure, the outlook for jobs may brighten as the economic expansion develops, drawing more people back into the workforce and limiting declines in unemployment. In addition, some economists argue that retiring baby boomers may not be the best explanation for the decrease already in train in the participation rate.
“Demographic trends are pushing down, over time, the normal labor force participation rate,” said Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. in New York. Nonetheless, he said, “the speed of the decline seen this year is in excess of what one would expect just given the demographic trend.”
A much more measured analysis, one I think consistent with the data. Too bad it wasn't the central point of the story. Yes, demographic shifts are likely to put downward pressure on labor force participation rates. But the tendency for those 65 and older to work longer than expected pushes in the other direction. Moreover, an improving economy would also increase labor force participation, especially among younger workers. Simply put, the aging of the baby boomers is just one of many factors currently influencing labor force participation rates and, by extension, the amount of slack in the labor markets.