The Revolving Door Between Government and Corporate America

The chief prosecutor for the US Justice Department polished his resume at Justice by not prosecuting anyone in the financial sector for fraud.  He is returning to his old law firm which defends corporations named in lawsuits.  He will earn $4 million staunchly defending corporations in law suits.  He is clearly an expert on how to avoid criminal prosecution by the Justice Department.  (Tip of the hat to Manan Shukla for the link)

Which States In The US Enjoy The Most Freedom?

The Mercatus Center at George Mason University is funded by the Koch brothers who worship economic freedom.  It is funded by the Koch brothers to produce libertarian propaganda.  Their latest effort to increase our freedom is a report card that measures the degree of freedom in each state.  They probably got this idea from another conservative think tank that ranks nations on their degree of freedom.  This provides conservative funded "educational" institutions with an opportunity to define the meaning of freedom.  We all value freedom in the abstract.  It is a powerful propaganda weapon to define its meaning in terms that satisfy libertarians. 

What Are Corporations Doing With Their Profits?

This graph shows that corporations have been returning a lot of their profits to shareholders.  Growth in buybacks by corporations rose dramatically during the real estate bubble, and it has picked up during our recovery.  Stock buybacks remove shares from the market.  This increases the value of shares outstanding in the market.  This is what shareholder capitalism is all about.  Executive compensation is heavily weighted with stock options.  They have a powerful incentive to increase the value of their stock options.  Stock buybacks serve that purpose very well.

Paying The Bill For War's of Choice

Dick Cheney was not concerned about the cost of his administration's war in Iraq.  He argued that it would pay for itself by providing access to oil.  Since then, a lot of research has been done to determine the cost of our military operations in the mid-east.  This study claims that we have spent around $2 trillion already.  That amounts to 20% of the debt incurred by government since 2001.  This was a war that was funded by debt. Taxes were actually cut during the Iraq war. However, That is only the tip of the iceberg.  The cost of providing medical care and other benefits to veterans will range between $2-4 trillion over time.  From a pure financial perspective we got a very poor return on our investment.  One can only imagine how that money might have been invested in areas that could have had a major impact on our well-being.  We don't even want to consider the human costs of our government's decision to invade a country that was not connected to the terrorist attacks on the US.

The Sunset Of America

Dick Cheney's daughter Liz was given a platform by the Wall Street Journal to tell the world that President Obama is destroying America.  This article highlights her references to the ways in which our president is taking away our freedom and weakening our military.  Her op-ed provides valuable insights into right-wing paranoia.  It is an illness that should not be taken lightly.  Her op-ed will stoke the same kind of paranoia into Rupert Murdoch's target market.  We have to destroy our president before he destroys America.

French President Has Lots Of Problems

This article (via Manan Shukla) describes the problems faced by France's president.  He announced a 75% tax on wages over one million euros on firms.  He lost face when his 75% tax on individual incomes over one million euros was declared unconstitutional.  The new tax is intended to win back his base which has not been pleased with the pro-business policies that he has adopted to encourage business investment.  He is caught in difficult situation.  The economy is not growing and unemployment is high.  Government debt in relation to GDP has been rising.  The actions that he takes to deal with slow growth and government debt displease his base,  and his tax policies anger the wealthy.  Its no wonder his popularity has been falling.  To make matters worse his private life is under attack. 

Median Household Income Has Declined Over Decade

Median household income is 7.3% lower than in was in 2007 at the start of the Great Recession and it is 8.4% lower than it was in 2000.  This is in sharp contrast with median household income growth per decade since the end of WW ll.  Median household income growth averaged 11% per decade prior to 2000.  Curiously, corporate profits have grown rapidly since the end of the recession.  Their profits have grown faster in international markets than they have in the US.  Globalization has been good for many multinational corporations but it has not been good for wages in most industrialized nations.  Much of the growth in income has gone to households which benefit from the growth in corporate income.  That is why income inequality has been increasing since 2000.

Declining household income is not good for households during a period in which healthcare costs and the cost of higher education has been growing rapidly.  It also explains why aggregate demand has been weak.  Households have less income to spend and they can no longer compensate for declining income by borrowing.  Globalization, however has made domestic demand less important for growth in profits.  The growth opportunities have moved to emerging markets for multinational corporations.

What Will We Leave To Our Children?

If a business cut back on research and development; failed to maintain its plant and equipment, and did not invest in employee development,  we would be concerned about its future.  It certainly would not be leaving a legacy to future generations.  We would also be concerned about the environment that we would be leaving to future generations if businesses continued to emit more pollutants into the environment than can be safely absorbed.  Paul Krugman argues that our nation may be making the same mistake.  The deficit scolds have had the same impact on future generations by forcing cutbacks on government investment in the future.  Ironically, they claim that it is necessary to curtail investments in the future in order to leave a better economy to our children.  Most of the scolds care little about the legacy that we will leave to our children.  They are more concerned about cutting taxes and government spending so that they can spend more today.

The Unnatural Rate Of Interest

Economists believe that there is a "natural" rate of interest.  When interest rates are held below the natural rate, the economy will expand and produce inflation.  (Milton Freidman expanded this notion to the natural rate of unemployment.  When unemployment is below the natural rate it will produce inflation).  The Fed has been using monetary policy to keep interest rates below the "natural" rate but we have not had inflation.  That is most likely explained by the fact that we seldom get inflation when we have high levels of unemployment. The Fed is using monetary policy, in part, to bring the unemployment rate down.

Conventional wisdom suggests that we need to balance the federal budget or we will be faced with higher interest rates.  That has not happened.  The explanation by those who have absorbed the conventional wisdom is that the Fed is keeping interest rates low through monetary policy.  Somehow the Fed has the power to alter the natural rate of interest.  Other governments have also been using monetary policy to keep interest rates low without producing inflation. Interest rates are also low in many other countries in which monetary policy is not being used to keep interest rates low.  There must be another explanation for the low cost of borrowing by governments that are creditworthy.  Conventional wisdom will not accept another reason.  The specter of higher interest rates is necessary to keep the pressure on governments to balance short term budgets.

US Attorney General Explains Why He Can't Bring Criminal Charges Against Wall Street Banks

We bailed out our largest banks because they are too big to fail.  If we let them fail the fallout to the global economy would hard to predict.  America's chief lawyer explains why he has not brought criminal charges against major banks.  According to Eric Holder, they are too big to prosecute.  In other words, they are protected by their size, and the consequences of economic fallout, from criminal prosecution.  That is why some argue that 21st century capitalism is based upon control fraud.  The financial rewards for fraud are very high since it can produce huge profits and bonuses to management.  Since it is unlikely that fraud will be prosecuted, the risk-reward ratio encourages even more fraud.  Its a no-brainer for many executives.

One of the unintended consequences of the reward system used by our large banks is that it justifies the huge increases that we have seen in the compensation of non-financial CEO's.  One of the presentations at the National Bureau of Economic Research,  in honor of Martin Feldstein, the conservative economist who had been the head of the NBER, compared CEO compensation to that of Wall Street bankers and hedge fund managers.  It was assumed that financial executives compete in the same labor market as non-financial CEO's.  Therefore, it is wrong to argue that high CEO compensation is the result of poor corporate governance.  CEO compensation is determined by the law of supply and demand in the CEO labor market.  If you believe that, I have a bridge that I would like to sell to you.

Foreign Tax Shelters Used by The BRIC's

This article (via Manan Shukla) shows how BRIC multinationals use their favorite tax havens to avoid taxes.  Their profits flow to a tax haven and they return to their home country as foreign direct investment (FDI).  This is called a "round trip".  The "Dutch Sandwich" is also described in this article.

All of these tax havens, and the techniques used to exploit them, are well known.  The implication is that governments in high tax states prefer to look the other way when they are used by their large corporations.  Every time one of the tax avoidance schemes is publicized in the press, the corporation claims, correctly, that they have done nothing illegal.

US Multinationals Pay Far Less In US Taxes

US multinationals use a variety of legal devices to avoid payment of US taxes.  One of the more popular methods is to take their profits in tax havens.  In 2008 43% of corporate profits were taken in tax havens in which they do little business.  (Bermuda, Ireland, Luxembourg, Netherlands, Switzerland).   For example, Microsoft has moved its patents to a tax haven.  This enables them to take profits on the patents in the tax haven.  Another tactic to manufacture a product in a tax haven, like Ireland, and use high transfer prices to international subsidiaries.  The profits are taken in Ireland instead of the subsidiary.  The bottom line is that many US corporations have dramatically reduced their US tax bills. 

This problem is not unique in the US.  The rapid growth in globalization has made the tax policies of most nation states obsolete.  Multinational corporations in most countries take advantage of obsolete tax policies and make extensive use of tax havens.  At the same time they campaign for lower taxes.  The ability of MNC's to avoid taxes has consequences for everyone else.  The tax burden must be shifted to other taxpayers, or government's must cut spending.  Its not surprising that there is pressure on governments to cut spending on popular programs that primarily benefit citizens who don't have lobbyists representing their interests in government.

Ben Bernanke On The Global Economy And Monetary Policy

The Chairman of Federal Reserve presents his views on how monetary policy is being used to deal with domestic demand problems.  He contrasts his use of monetary policy with trade policies during the Great Depression that attempted to stimulate domestic demand by tariffs and currency depreciation.  He does not believe that the Fed's  easy money policies has had a negative impact on emerging market economies that are dependent upon exports and stable exchange rates.

Conservative Economists Want To Soak The Poor To Fix The Economy

The WSJ found a group of conservative economists to develop a plan to stimulate the economy.  Their plan ignores the factors that caused the Great Recession, and those that are responsible for weak demand by consumers.  They believe that our economic problem is over-generous entitlement programs.  The bedrock idea among conservatives is that we need to reduce taxes on the rich, and on corporations.  If we reduce taxes, we must cut government spending.  The spending cuts that are most attractive to them are those that ordinary Americans depend upon.  Somehow they believe that cuts to government spending will fix an economy that was badly damaged by predatory bankers and suffers from high unemployment.  We should give their plan another title.  We should call it a plan to justify tax cuts and produce a smaller government.  That is what every conservative plan is about.

NY Times Editorial On Cyprus Bank Deal

This editorial provides more detail on the 10 billion euro bank bailout.  Depositors in Cyprus's two largest banks will lose part of their deposits above 100,000 euros.  Creditors and stockholders will lose money as well.  Cyprus will be left with a huge debt burden that will limit the ability of government to deal with a shrinking economy.  There is a risk of contagion that might affect depositors in Italy and Spain who are worried about their deposits.  Depositors may move their money to a safer location.  The EU seems to be moving from one problem to the next, as it responds to problems in one place, another problem seems to emerge.

Civilizing Capitalism

This is a lengthy (16 pages) article that is well worth the time that it will take to read it.  It provides an interesting historical perspective on many of the economic problems that we are currently experiencing.  It is highly critical of the Manchester School of economics which provides the foundation for what we call neo-liberalism today.  David Ricardo's formalist approach to economics is also criticized.  It provided a morally defensible argument for free trade that justified colonialism.  It also failed to make a distinction between the financial sector and the real economy that provides goods and services.  It is impossible to describe an economy with a parasitic financial sector that is bad for the real economy in his theory.

Manchester liberalism, and communism are described as irrational twins.  Both of these systems are derived from models that make assumptions about how humans behave.  The are idealized systems that fail to describe how economic systems really operate.  Since the fall of communism, the other irrational twin has survived and prospered.  It cannot distinguish between good greed and bad greed.  When self interest coincides with the public interest we have good greed.  Finance and the real economy work in harmony to expand the economic pie and serve the public interest.  Our current problems are the product of bad greed.  The financial sector has turned to speculation on price changes in assets that have already been produced. It extracts wealth from the real economy.  Under Margaret Thatcher, there is no such thing as society, or the public interest. It is impossible to distinguish between good greed and bad greed.  All greed is good.  We have a crisis of excessive economic freedom that serves the interest of predatory wealth extraction.

There are parallels to our current financial crisis.  The financial crisis of the 1890's in the US led to calls for economic reforms that are similar to those that we need today.  The Great Depression led to regulated capitalism and efforts to assure a more equal distribution of economic output.  It also stabilized the financial system.  Over time the regulatory system has been weakened and we no longer distinguish between good greed and bad greed.  We have a new system of feudalism.  The old system was based upon the ownership of land.  Our current system is based upon the control of finance.  We need to have a financial system that is more in harmony with the real economy and less centered on speculation that does not increase the economic pie.

The real economy is not run by angels either.  Enron was a classic example of a firm that made money by using political clout to deregulate the energy system so that it could make money by manipulating energy prices in California and speculating on price changes.  The Koch brothers spend millions to raise questions about the science behind climate change and the need for investment in renewable energy.  These are examples of bad greed in the real economy. We need to civilize capitalism so that it better serves the public interest.  We have done it before and we can do it again.

Cyprus Reachs Deal On Banking Crisis

It looks like a deal, that scraps the plan to tax bank deposits, has been reached between Cyprus and the EU.  One of Cyprus's large banks (Laiki) would be wound down.  Senior bondholders will take a loss and depositors with over 100,000 thousand euros would take a loss.

Cyprus banks have been used to evade taxes, and to provide secrecy for many wealthy members of the former Soviet Union.  It looks like they will have to find a less convenient place to hide their money.  

Paul Krugman argues that the crisis in Cyprus may lead other nations to place limits on the free flow of capital that has been responsible for most of the financial crises that we have experienced in recent years.

Europe's Plan To Cap Bonuses Is Not Enough

Europe plans to cut bonuses to bankers in order to discourage the kind of behavior that led to the financial crisis.  Bonuses cannot exceed the annual salary under the plan.  Bankers are already getting around the bonus cap by raising salaries.  This editorial suggests that it would be more effective to link bonuses to longer term performance and to clawback bonuses dependent upon longer term performance.

The Dodd-Frank bill gives government the power to deal with compensation plans that encourage excessive risk.  Like many other concepts in the bill,  government agencies must define inappropriate compensation.  As one might imagine,  the banking lobby will work hard to define inappropriate compensation so that it is relatively toothless.  Some banks have taken steps to implement clawbacks for self protection.  Most have not.

Proof That The Average Investor Is Irrational

The average investor knows that she can't beat the stock index but that does not effect investment behavior.  This graph shows assets appreciated between 1992 and 2011 and how the average investor has made out.  The average investor underperforms the market by acting irrationally.  The basic mistakes are attempts to pick stocks that will outperform the market and to time the market.  They invest during market peaks and they sell during market lows.

This result also says something about the fundamental assumption of economic theory.  That is, that we all make rational decisions,  and that the sum of our decisions is the best possible result that we can hope for in any market.  Asset prices have increased substantially but the average investor has not beaten the inflation rate.  The average investor is irrational to a fault.

The Polls Confirm What Many Know About The Transformation Of The GOP

This article, by a professional who has headed the Gallop poll and the Pew poll,  describes what many of us sense about changes that have occurred in the Republican Party, and why they were not able to win a presidential election during a period of high unemployment.  The core of the GOP base is made of an alignment between social conservatives and the pro business wing of the party.  That wing represents 45% of the base.  It is 92% white, mostly male, and mostly protestants at least 50 years old.  Moreover the base has been hardened as result of three important factors. The GOP has been uncomfortable with changing demographics in America.  It is worried about the increasing number of Hispanics and it is less comfortable with racial integration than most Americans.  The election of President Obama increased the ideological resistance of this base to the presidency and to Washington.  The emergence of a conservative media, which caters to the concerns of the base, has also reinforced the fears and concerns of the GOP core.  Only 30% of the base regularly watches network news.  The majority of this base (54%) regularly watches Fox News which is always critical of President Obama and consistently reinforces conservative ideology.  There is nothing like this on the left. The left leaning cable news shows are not regularly watched by an audience that has a common ideological perspective.  Their audience gets its news from a variety of sources.  It is more open to a variety of viewpoints.  The article concludes by arguing that the GOP will not be able win general elections in the US as long as the party is dominated by its core constituency.  The implication is that it will be a minority party that has the power to maintain the gridlock that we see in Washington today.  The risk is that Americans will continue to lose faith in the ability of government to address the problems that we face.  We will not be able to deal with global warming, or with our economic and budget problems as long as this ideological core dominates the GOP

The Senate Passes A Budget Bill That Will Go Nowhere

The senate passed a budget bill that four democrats from red states voted against.  The senate bill is far to the right of a bill proposed by the progressive caucus in the democratic party.  It is to the left of the Ryan budget only because the Ryan budget is further to the right of any budget that has been proposed in recent history.  (The Ryan budget is also flawed for other reasons.  It promises to balance the budget but it does not provide the details about how that will happen).

The senate budget has no chance of winning support in the GOP controlled House.  Any compromise that comes out of the reconciliation process between the House and the Senate, will produce a budget that is only bit less radical that the far right Ryan budget.  That is because of the way the senate is constituted.  Democrats manage to win senate seats in small states that are typically conservative but the senators from those seats do not always support democratic bills.  All of the republicans in the senate voted against the senate budget.  Many of them also come from small states that are typically conservative.  In other words, the senate is biased in a conservative direction.  Small conservative states like Wyoming have the same number of senators as large liberal states like California.  Consequently, the democrats which have a majority in the senate, and which also won the presidential election, are unable to pass liberal bills.  Even when the democrats controlled the House and the senate, President Obama could not get liberal bills passed.  Conservative democratic senators from small states joined with republicans in supporting filibusters in the senate.  It was necessary to win 60 votes in order to overcome the filibuster.  The primary advantage that liberals get when democrats  hold the White House, and have a majority in the senate, is that they can prevent an even more dramatic movement to the far right in America.  American politics will remain conservative as long as a super-majority is required to overcome filibusters in the senate.

The Leaderless Global Economy

This article describes the global economic problem quite well.  We know how we got into trouble but we are focused on the wrong way to get out of trouble.  We have a huge debt problem that we have to solve but we can't fix the debt problem as long as we have a large unemployment problem.  Austerity policies only make the debt burden worse because tax revenues fall as a result of high unemployment.

Since we have a highly interdependent global economy, we need global leadership to resolve our problems.  There were periods in which Britain, the US and Germany could provide the necessary leadership.  The US certainly provided leadership following WW ll.  Most nations, including the US, were burdened with debt but we grew our way out of debt.  The necessary leadership is not present today.  Domestic politics have transformed the agenda.  We don't have leaders in any of our largest economies that have the will to lead us in the right direction.  They appear to be prisoners of domestic politics that exaggerate the problem of national debt and minimize the problem of high unemployment.

How Should We Explain The Post Industrial Society?

Manufacturing jobs as a percent of employment have been in a steady decline.  That suggests that the decline is an inevitable trend that is part of our transition to the "Post Industrial Economy".  However, if we look at level of jobs in manufacturing, the level was steady for the 35 years preceding 2000.  Over 5 million manufacturing jobs have been lost in the last 12 years.  The typical explanation for the loss of manufacturing jobs is to attribute it to rising productivity.  That explanation implies that productivity was not a factor for the 35 years prior to the great decline beginning in 2000 when manufacturing unemployment was stable.  All of the increase in manufacturing productivity must have occurred during the last 12 years according to that hypothesis. 

It makes sense that manufacturing jobs have been falling as a percent of employment because the number of service jobs has been accelerating relative to the steady state in manufacturing employment.  There are lots of explanations for the rapid increase in service sector employment.  For example, healthcare spending has been rising rapidly as a percent of GDP.  Productivity in services also grows more slowly than manufacturing productivity. Moreover, we are all spending more on new services that did not previously exist.  Cell phone bills, and payments to internet and TV service providers have become a growing part of household budgets.  Manufacturers have also been outsourcing some of their work to third party service organizations.  For example, security services, information services and janitorial services have been outsourced from manufacturing companies to third party service organizations.  Those jobs are reclassified as service sector jobs.

The loss of manufacturing jobs must also be due to factors in addition to rising productivity.  The US trade balance has been negative.  That means that we are importing more tradable goods than we are exporting.  It is estimated that intra-company trade is a large percent of our total imports.  US manufacturers are offshoring production and importing products back to the US for sale.  That must account for a large share of the loss in US manufacturing employment.  The "Post Industrial Society" is not an inevitable trend.  It is not totally the result of increases in manufacturing productivity.  Its part of the way that nation states have managed globalization.  They have turned the job over to multinational corporations.  The assumption is that what is good for our large corporations is good for the country.

US Natural Gas Price Versus Europe

Natural gas prices in the US and Europe have generally tracked rather close to each other.  This graph shows that natural gas prices in Europe, using UK prices as a proxy for Europe, have risen while US prices have declined.  The price difference is around a factor of three.  This has been the result of technology in the US that provide access to natural gas deposits that were not accessible with older technologies.  There are still many questions about the environmental impacts from the use of these technologies.  In particular, there are concerns about their impact on fresh water supplies.  The use of natural gas, however, is much better than the use of coal for carbon emissions. 

Free Market Policies Rarely Make Poor Countries Rich

Rich countries in Europe, and the US are major proponents of free trade in poor countries.  The IMF and World Bank, which are dominated by Europe and the US, force poor countries to adopt free market policies in order to receive aid.  What they don't tell the poor countries is that this is not what they did to become rich countries.  The US protected it fledgling manufacturing industries from competition by placing tariffs on imported manufacturing products.  Britain made extensive use of tariffs to protect its wool industry competition with firms in Belgium and The Netherlands. After they established dominance in an industry they opened up their markets to trade.  The colonial system in Europe was predicated on importing raw materials from its colonies and selling high value added manufactured products to them.  Guess who wins in that trade.  They like poor countries to do as they say and they won't permit them to do what they did.

Ha-Joon Chang's book that I have been reviewing provides several examples of the hypocrisy.  Its a good thing that our dead presidents don't talk because they would tell you a very different story about US trade policy.  Alexander Hamilton was appointed as Treasury Secretary by George Washington.  They were the architects of US economic policy.  Hamilton used the "infant industry" argument to protect US manufacturing from competition with high tariffs.  He also promoted government investment in infrastructure and in the banking system.  If Hamilton were the finance minister of a developing country he would be heavily criticized by the US Treasury of today.

Benjamin Franklin was not an advocate of the infant industry defense but he had another reason for protecting manufacturers from foreign competition.  Land was available for almost no cost to immigrants and most of them were farmers.  In order to recruit labor for jobs in factories, it was necessary to pay wages that were four times what labor was paid in Europe.  He believed that tariffs were needed to protect US business from low wage competition from Europe.

Thomas Jefferson did not agree with Hamilton on protectionism but unlike Hamilton he opposed the granting of patents.  He argued that ideas were like air and that they should be free.  Patents and other intellectual property tools are major impediments to free markets.  They provide monopolies which restrict free markets and free trade.  Many firms in the US today turn out more patents and other forms of intellectual property than products.

If we look at the performance of developing countries today we find that most of the successful countries have done what rich countries did in order to grow.  Those that followed the advice and restrictions imposed by rich countries have done less well.  Rich countries are advocates of free markets and free trade when it serves their interests.  In their current state of development they benefit from free trade.  Developing countries are rarely helped by opening up their markets to foreign competition until they have established a foothold in an industry.  Moreover, governments have to take a larger role in developing countries in order to build the required infrastructure.  They have also played a major role in developing markets in countries that have been successful.

State By State History Of Funding Cuts To Higher Education

This graph shows the huge cuts that have been made in higher education at the state level.  State universities produce the majority of our college graduates.  Spending cuts make it harder for those with low incomes to earn a degree.  This has a big impact on inequality of opportunity.  Those without college degrees are excluded from most higher paying jobs.  It also limits the ability of talented people to achieve their potential in other areas.  Education improves one's life in many ways and it is has become increasingly essential for citizenship in an increasingly complex society.

The SEC Can Mitigate The Impact Of The Citizen's United Decision By The Supreme Court

Since the Citizen's United decision corporations have been able to contribute unlimited funds to political campaigns.  Mary Jo White's nomination to be head of the SEC has been approved by the Senate Banking Committee.  A campaign has been formed to encourage her to require corporations to make their contributions visible to shareholders.  Corporate managers often make contributions that serve their short-term interests.  They may not be in the interest of other stakeholders, including pension funds that cannot sell their large holdings without causing the value of their holdings to fall.  She has the votes necessary to make a decision to reduce the harm of the Citizen's United decision that has made a mockery out of the electoral process.  Over $6 billion was funneled into campaign's to fund the last election cycle.  We have a system of one dollar per vote as opposed to one vote per person.

The Republican Autopsy Report

The Republican National Committee commissioned a study to determine why it lost the presidential election and did not become the majority party in the senate.  It is hard to determine whether the study is a diagnosis of a sick patient or an autopsy of a corpse.  The study was quite frank about the problems that the party has outside of its regional strongholds.  The frankness of the report has led to denials by the conservative wing in the party.  The conservative wing is based primarily on social issues that appeal to a shrinking number of voters.  The GOP establishment is more oriented to economic issues.  It believes that the economic messages can be massaged without departing from core economic ideology.

Why Shareholder Value Maximization Is The Dumbest Idea In The World

This article summarizes the second point that is made in Ha-Joon Chang's book that I am reviewing.  We are told that corporations should be run to maximize shareholder value.  Jack Welch, the legendary CEO of GE applauded that idea in 1981.  He later called it "the dumbest idea in the world".  Which follows are some of the reasons why it is a dumb idea.

The major problem with running corporations to maximize shareholder value is that it is not good for long term stakeholders.  Unlike other stakeholders in a corporation, shareholders prefer strategies that maximize short term profits. They encourage management to return the profits to them by paying out dividends or by using stock repurchases to increase the share price.  This is often done at the expense of long term investments that reduce the growth potential of the firm.  Most shareholders don't care about the long term since they have an easier exit strategy than employees, suppliers, customers and the community.  They can simply sell their stock when they no longer expect profits to grow.  This further encouraged managers to take excessive risks or to focus on cutting costs and paying out dividends are repurchasing stock instead of investing in the future.

The alliance between shareholders and management worked out well.  The dividends and capital gains were financed at the expense of other stakeholders. Jobs were cut, many workers were fired and rehired as non-union labor or as temporary workers.  Their suppliers were squeezed by continuous cuts in procurement prices,  or by outsourcing from low wage countries.  Governments were pressured to cut corporate taxes and to increase subsidies by the threat to relocate to other countries.  As a result there was boom in corporate profits, which were funneled to management and stockholders, inequality soared.  Moreover, since the 1980's business investment as a share of national output declined from 20.5% in the 1980's to 18.7% between 1990 and 2007.  The growth rate in per capita income also fell from 2.6% in the 1960's and 1970's to 1.6% during 1990-2009.

General Motors provide a prime example of the problems in the focus on the maximization of shareholder value.  It squandered its dominance in the auto industry and was forced in bankruptcy in 2009 by its focus on shareholder value.  It paid more attention to cost cutting and less attention to investment in new products and technologies. It also increased dividends and stock repurchases to reward shareholder.  It was overtaken by foreign competitors who developed superior products, and longer term shareholders lost their equity.

Countries outside of the US and Britain have tried to reduce the influence of short term shareholders.  In some countries governments have held a share of ownership in key companies, either directly, or indirectly through ownership by state run banks.  Sweden has a system of differential voting rights for different classes of stocks that enables long term shareholders to have more significant control over the corporation.  In Germany workers have formal representation on supervisory boards.  Japan also minimizes the control of floating shareholders by cross-shareholding among friendly companies.  What we do in the US and Britain may not be in the best interest of our corporations or the country.

David Brooks On The Invasion Of Iraq 10 Years Ago

One of the problems with predicting the future is that you will most likely be wrong.  David Brooks wrote an article 10 years ago in support of George Bush's intent to invade Iraq.  He put his writing talent on full display.  George Bush is described as our fearless leader.  Those who are against the invasion are described as wishy washy Hamlets who can't come to a decision.  Unfortunately, for David Brooks, the Hamlets were correct and George Bush committed the most foolish foreign policy mistake in American history.  The article that Brooks wrote 10 years ago to this date, has been published to celebrate its anniversary. Tom Friedman was also an advocate for the invasion.  Both of them are now op-ed writers for the NYT.  Its OK to be completely wrong about important policy decisions as long as you are clever and can write well. 

What Is Free Market Capitalism?

I have been reading an excellent book written by Ha-Joon Chang who teaches economics at Cambridge.  Chang was awarded the Leontief Prize for Advancing the Frontiers of Economic Thought in 2005.  The book that I intend to review in this post, and in future posts, is entitled Things They Don't Tell You About Capitalism.  It was published in 2010.  It contains 23 ideas that are not very well explained in most treatments of economics.  The first idea that Chang analyzes is the concept of the free market.  I will summarize his analysis of the free market in this post.

Chang argues that there is no such thing as an objectively defined free market.  The first step in understanding capitalism is to understand that point.  For example, in 2008 President George W. Bush announced a plan to use $700 billion of taxpayer money to purchase toxic financial assets that were choking up the financial system.  Bush did not see this as a departure from the American system of free enterprise.  Nationalizing a huge part of the financial system is just something that government does when it is necessary.  In other words, one of the largest interventions in the free market economy by government is simply an extension of free market capitalism.  It is apparent that there is no scientifically defined boundary for a free market. It is simply a matter of opinion.

One of the basic ideas of free market capitalism is that labor markets should be free.  In 1819 a bill was tabled by the British Parliament that would have banned children under the age of 9 from working in cotton factories.  Older children between ages 10 and 16 would be permitted to work but their hours would be restricted to 12 per day.  The House of Lords objected to bill on the grounds that labor ought to be free.  The children want to work and factory owners want to employ them; what is the problem?

Today even ardent free market proponents would not think of bringing child labor back as part of the market liberalization program that they advocate.  They would not argue that such a law would interfere with a child's right to work.  On the other hand, they support laws which make it more difficult for workers to form labor unions.  Such laws are referred to as "right to work" laws which are essential in the operation of free labor markets.  Again the freedom of a market changes over time and, like beauty, it is in the eyes of the beholder.  There is no way of objectively defining a free market.  Today we accept many government regulations that are accepted as natural.  If markets look free, it only because we so totally accept the regulations that prop them up that they become invisible.

Wages in rich countries are determined more by immigration policies than by anything else.  If rich countries opened their doors to unrestricted immigration, a large percentage of workers would be replaced with cheaper workers.  Government policies on immigration, therefore are a major determinant of wages.  There is no free market for many forms of labor.  Licenses are required by many professions;  many countries have laws which determine the requirements for starting up a bank; the stock market regulates who can sell shares on stock exchanges, and the trading of shares can only be conducted by licensed brokers.  The price of money, which we call the interest rate, is also determined by the policies of the Federal Reserve.  If wages and the price of money are politically determined, then all the other prices are largely determined by political decisions because the cost of labor and interest rates affect most other prices.

The process of drawing the boundaries of a free market are often accompanied by conflict.  The US civil war was such a struggle.  Slaves were bought and sold in the market and they were a large component of the capital owned by cotton growers.  The decision to change that market relationship, along, with the decision to put tariffs on manufactured imports from England, in order to protect manufacturers in the North East, interfered with the free market as it was perceived in the South.  England retaliated by putting tariffs on cotton imported from the US.  Similarly, England fought a war with China in order to protect free trade in opium in the Chinese market.

Since the boundaries of a free market cannot be objectively determined, it is not possible to have a science that is based upon the assumption of free markets.  When free market economists oppose certain regulations on the grounds that they interfere in operation of a certain market, they are merely expressing a political opinion.  They use the ideological cloak of free markets to pretend that their opposition is based upon objective science, and not politically motivated.  "Stepping away from the illusion of market objectivity is the first step towards understanding capitalism"

Britain's East India Company

This article (via Manan Shukla) provides a brief history of the company that may have been one of the first multinational corporations.  It was also one of the first corporations that was too big to fail.  It had to be bailed out by the government. 

On one of my visits to London I spent an entire day at Westminster Abbey where many of Britain's royalty and leaders have been memorialized.  Many of the names were familiar to me because of their role in the Britain's historical and cultural development.  I was really surprised by the large number memorials to the leaders of the East India Company.  I knew that the company played a large role in the colonization of India, but I did not realize the importance of the company, and it leaders, in British history.  I am not aware of examples in the US where business leaders are memorialized together in a facility as important as Westminster Abbey. 

Some Surprising Conclusions From A Conservative Economist

Herman Daly, who has been an advocate for a steady state economy, reviews a book by a prominent conservative who shares his view.  The conclusions from the book are quoted below as they were in Daly's review.

“This book demonstrates that empty-world economic theory has failed on its own terms and that its application by policymakers has resulted in the failure of capitalism itself. Pursuing absolute advantage in cheap labor abroad, First World corporations have wrecked the prospects for First World labor, especially in the US, while concentrating income and wealth in a few hands. Financial deregulation has resulted in lost private pensions and homelessness. The cost to the US Treasury of gratuitous wars and bank bailouts threatens the social safety net, Social Security and Medicare. Western democracy and civil liberties are endangered by authoritarian responses to protests against the austerity that is being imposed on citizens in order to fund the wars and financial bailouts. Third World countries have had their economic development blocked by Western economic theories that do not reflect reality.
All of this is bad enough. But when we leave the empty-world economics and enter the economics of a full world, where nature’s capital (natural resources) and ability to absorb wastes are being exhausted, we find ourselves in a worse situation. Even if countries are able to produce empty-world economic growth, economists cannot tell if the value of the increase in GDP is greater than its cost, because the cost of nature’s capital is not included in the computation. What does it mean to say that the world GDP has increased four percent when the cost of nature’s resources are not in the calculation?
Economist Herman Daly put it well when he wrote that the elites who make the decisions “have figured out how to keep the benefits for themselves while ‘sharing’ the cost with the poor, the future, and other species (Ecological Economics, vol. 72, p. 8).
Empty-world economics with its emphasis on spurring economic growth by the accumulation of man-made capital has run its course. Full-world economics is steady-state economics, and it is past time for economists to get to work on a new economics for a full world.”

These conclusions reflect my views both on how the "empty world" economic system is working, and the need for the development of a "full world" economic system that is responsive to the threat of global warming.  I have focused primarily on the problems of the empty world economic system because that is the system that we have.  The changes required to implement a full world economic system are so enormous that politicians won't go there.  Its easier to solve the unemployment problem by growing the economy than it is to figure out how keep people employed in a steady state economy.

Greece Today Compared To US In Great Depression

These graphs show that Greece looks worse today than the US did in the Great Depression.  The major difference in the two economies was government spending.  The Greek government is unable to increase spending because of its financial position. It has been forced to cut spending. The US government did not have the same constraint.  Government spending on the military was increasing even during the Hoover administration.  Hoover did not like budget deficits but government was the only sector of the economy that was not shrinking during the Great Depression.

Why Does An MRI Cost More In The US Than In France?

This article provides some information about relative prices for healthcare products and services in the industrialized world.  Prices are much higher in the US.  If we paid the same prices as other countries, we would eliminate our budget deficit.  The article explains some of the reasons why prices are higher in the US.  One reason is that insurers have a weak bargaining position with suppliers.  Governments either help to set prices in most countries. They set prices in the UK and in Canada they have a national insurer (Medicare) that negotiates prices from a position of strength.

A conservative economist from George Mason University offers an opinion that shifts the focus from prices to waste.  He argues that there is a lot of waste in system and that we should eliminate the waste instead of meddling with prices.  He provides a good example of why it is so difficult to address the real problems in our healthcare system.  Conservatives believe that healthcare is no different from other things that consumer's purchase.  If we let the market determine prices, and the level of consumption, like it does for other commodities,  we would not have any problems.  Conservative economists at places like George Mason, and other conservative think tanks, provide the economic rationale for Republican positions on healthcare.  They tell the public that we need a market based solution and that waste in government provided programs is our biggest problem.

The European Union Is Adjusting To New Demands

The former president of the ECB, and the chairman of the Trilateral Commission that is meeting in Berlin, provides a history of the global financial crisis that began in the US, and the steps that are underway to strengthen the eurozone.  He believes that the crisis has paved the way for more integration.  Europe is still under development but progress is well underway.

Eurozone Fiscal Policy Contributes To Eurozone Recession

The eurozone in in recession and Paul Krugman argues that eurozone fiscal policy is partly responsible for the recession.  The eurozone as a whole should be stimulating the economy with fiscal policy.  Some countries have fiscal austerity imposed on them, but other countries like France and Germany, do have an opportunity to expand their economies.  France has a contractionary fiscal policy and Germany has a neutral fiscal policy.  As a result the cyclically adjusted primary balance in the eurozone is contractionary.

Conservatism And Sewers

Paul Krugman found a great quote from The Economist which was written in response to a proposal to build a sewer system in London.  The Economist opposed the proposal using a traditional conservative rationale.  The beneficent intentions of government lead to great harm.  It is a mistake for governments to attempt to change the world before the public is ready for change.  David Brooks could have written that opinion if he had been around in the good old days of Edmund Burke and others who thought like him. 

The opposition of Republicans to beneficent intentions, like reducing carbon emissions, contains and element of conservative opposition to government directed change.  In our modern world, however, politics are not based on philosophy.  Lobbyists are more effective than philosophers in the legislative process.  They are able to fund campaigns.  The role of conservative philosophy is to provide a superior rationale for greed.  Republicans need a higher order principle to justify their support for blocking government from doing things that are in the public interest.

The Senate Budget Plan

The NYT editors like the Senate budget plan better than the Ryan plan. Of course the Ryan plan did not set a high bar for comparison, but there are many important differences.  The editorial describes some of the things that it likes about the plan, and some of the things that might have been included, but were left out. A compromise between the Ryan plan and the Senate plan would move the budget even further to the right. There is a link to the Progressive Caucus Plan for those who want to review a budget plan that would be a better plan from which to negotiate.  A compromise from that plan would produce a budget closer to the center.

Stealing From Our Children Who Inherit The National Debt

Conservatives tell us that we are stealing from our children by passing our national debt on to them.  Now we are getting the same warning from a liberal who has been an economic adviser to the Democratic Party.  Dean Baker argues that this is a specious argument.  He claims that if we share the future gains in productivity with our children they will do just fine.  Their incomes will be much higher and the cost of providing for entitlements, relative to their future income, will not be a problem.  He also points out that we pay medical providers 2-3 times what they are paid in other rich countries.  Fixing that problem would do more to reduce budget deficits than anything else that we might do.

What Does A Progessive Budget Look Like?

A budget has been proposed by the progressive caucus within the Democratic Party.  It has not received much attention because most of the attention has been given to the Ryan budget.  It shows that there are more ways to cut budget deficits than those that have been proposed by Ryan and by the Democrats in the Senate.  Each of them share common characteristics.  They keep military spending high; they keep taxes low; they keep payments to medical providers high.  Cuts to Medicare and Social Security are used to reduce the deficit.  In a sense the Ryan budget and the Senate budget are similar.  Ryan's budget is a far right budget and the Senate budget is a center right budget. Since  the debate is between the far right and the center right, any compromise would be right of center.

The progressive budget cuts military spending; it makes the tax system more progressive; it cuts payments to medical providers, and it reduces the budget deficit without cutting Medicare and Social Security.  Most Americans would favor a budget  that looks more like the progressive budget proposal than either the Ryan budget or the budget proposed by Senate Democrats.  Unfortunately, few will even know that it exists.  The media focuses public attention only on the Ryan budget and the center right Democratic budget.  Any compromise between them will cut entitlements in order to keep military spending high, taxes low, and payments to medical providers more than twice as high as the rest of the world pays to medical providers.

The Second British Empire Provides A Home To Oligarchs

This is a long article (via Manan Shukla) that describes The City Of London as a very special place.  It has its own government, separate from the government of London, and it is where many of the richest oligarchs have established residency.  They do so for many reasons.  London is a nice place to live, when you are not in one of your other homes, but The City Of London is also a tax haven which provides many benefits to those who relish secrecy, and protection from legal authorities elsewhere in the world.

The article also provides some insights into the new global community plutocracy.  Most of them have not made their fortunes by building a productive enterprise.  They have acquired interests in commodities like oil, gas and other minerals through political intrigue and by exploiting weaknesses in the rule of law.  It is estimated that 16% come from Malaysia whose government has been under attack for corruption.  Of course, the oligarchs from the former Soviet Union,  as well as those from oil rich states in the Middle East and Nigeria are also well represented.  Most of the new plutocrats use a complex of tax havens to shield their holding from public view and to avoid taxes and criminal prosecution.  The City Of London is at the center of this complex.  It has become the second British Empire which has little connection to London proper or to the rest of England.  The City Of London has been established for this purpose, and it vigorously defends the system that has made it attractive to the global plutocracy and the financial center from much of the world.

Everything You Need To Know About Designing A Carbon Tax

Congress is looking for ideas on proposing a carbon tax.  This article explores many of the decisions that have to be considered.  The government has currently set the price at $20 per ton for carbon emissions.  That price seems to be too low in relation to long term emission reduction goals.  Congress will have to consider the relationship between pricing and emission targets.  There are also questions about how the tax affects different income groups that need to be considered.  Lastly, some states have already taken steps towards implementing a carbon tax.  How should national policy complement state initiatives? 

How Ryan's Budget Redistributes Income To The Rich

Robert Reich analyzes the Ryan budget and he explains how it makes the rich even richer and how it hurts the middle class.  Ironically, the GOP is arguing that the Ryan plan defends the middle class against the rich corporations who they claim are the real beneficiaries of Obamacare.  What the GOP really dislikes about Obamacare is that it increases Medicare taxes for the top 1%.  Fox News, of course provided a platform for the GOP to tell its story to its base which has it has been systematically misinformed about Obamacare.  They hate Obamacare because they believe that it provides benefits to the wrong kind of people. 

The Financial Times Gives Cameron's Defense Of Austerity In The UK A Failing Grade

Martin Wolf reports on Cameron's defense of his fiscal policies and explains the fallacies in each of his major points.  Wolf wins the debate but Cameron is still in charge of policies that were the foundation of his election campaign.  He cannot admit that they have been a disaster.  Moreover, those who voted for him probably can't admit that they made a mistake either.  The fiscal punishment is likely to continue.

Why We Need A Free Press

The trial of Bradley Manning has not received the media attention that it deserves.  He is being tried for his release of documents which shed important information about the behavior of our military in Iraq.  Moreover, the proceeding of the trial and his testimony have not been available to the public.  Fortunately, audios of his testimony and transcripts have been made public.  They show that he was careful not to release to secret documents and that he only released documents that would help the public to understand what was really happening in Iraq.  The documents that he released may be embarrassing to the military but they were not harmful to the war effort.

Daniel Ellsberg released the Pentagon Papers in 1969 which were published by the NYT.  They embarrassed the government and helped to end the Vietnam war.  He was punished for releasing the Pentagon Papers.  The NYT did what the press is entitled to do under the US Constitution.  If anything their decision to release the papers added to the prestige of the NYT and to the image of the US as a nation with a free press.  Links to Manning's testimony are available in this article by Daniel Ellsberg who explains the similarities to the ordeal that he experienced in 1969.  The Guardian has also published a report on the Manning trial and it has links to audios of his testimony. 

The Financial Times Believes That High Taxes On The Rich Will Cause Them To Emigrate

The Financial Times reported that increasing taxes on the rich is causing them to flee to lower tax countries.  It cites one example of a rich family moving to London in order to escape higher taxes in France.  The evidence for the claim that high taxes cause rich families to emigrate is rather weak.  The evidence is reviewed in this article.  A lot of the evidence comes from research in the US.  States that increased their taxes on the rich have not experienced the huge emigrations to tax friendly states that are commonly reported in the press.  Moreover, US citizens can change their residence to to tax friendly states without giving up their citizenship. 

The Financial Times seems to share the Ayn Rand fantasy that she published in Atlas Shrugged.  Her novel was about the rebellion of the "job creators" who decided to go on strike against state policies which encroached upon their freedom.  The strike was intended to show the "moochers" how much they depended upon the "job creators".  John Galt was the leader of the strike.  He has become a hero to many libertarians.

German Central Bank Increases Reserves

The German central bank set aside more reserves to cover potential losses that it might incur due to actions taken by the ECB to stabilize interest rates on sovereign debt.  The ECB is keeping sovereign interest rates low by purchasing sovereign bonds, and by loaning money to commercial banks backed by more risky collateral.  The ECB has taken these steps to keep the eurozone intact.  Losses that might be taken by the ECB are covered by the central banks in each eurozone nation.  Germany stands to lose the most if that happens.

The German central banks has never been happy with the policies of the ECB.  It believes that the financially troubled nations should take the steps necessary to improve the performance of their economies so that they do not need to borrow money.  However, the actions taken by the German central bank are a sign of continuing concern about the health of the eurozone.

NYT Editorial On Ryan's Budget

The NYT does not like the Ryan budget.  The GOP House loves it, and it will play well with the Tea Party and with a segment of the plutocrats.  It has no chance of passing in the Senate but it enables the GOP sing the song to its base that it has been taught to sing.  Ryan remains a hero to his base and he gets a chance to sing his song to a national TV audience.  Its good for Ryan but bad for country and it does little to enhance the image of his party which is locked into a vision of the 19th century.

Paul Ryan's Ayn Rand Budget In Three Sentences

This article provides all that you need to know about the Ryan budget.  It describes the cuts that might  balance the budget by 2023 as long as they do not curtail economic growth.  Ostensibly, it is about the federal budget, but it is really his view about the kind of country that we should be.  We need to slay the federal dragon that is destroying our communities (his way of advocating state's rights) by turning federal programs over to the states to implement with fewer dollars from the federal government.  That makes life worse for most Americans, but it will be better for corporations and the military.  Corporate taxes will be substantially cut, but defense spending will not be cut. Apparently, we need to spend about as much as the rest of the world combined on the military to defend ourselves from terrorists who hijack airplanes by using box cutters as weapons.  We can pay for that by cutting healthcare benefits for most Americans.

The Great Portugal Hollowing Out

Portugal has lots of economic problems and this article describes them well.  The demographic problems are not easy to fix.  The birth rate is below the replacement rate and young people are emigrating to find work.  The emigration improves Portugal's unemployment rate since many of the unemployed are leaving the country.  Like many other countries, Portugal will have hard time funding its programs for the elderly.  There will be fewer working people to pay for an aging population.

CBO Projects Over $700 In Healthcare Savings Over The Decade

Government spending on Medicare and Medicaid is projected to be lower by over $700 billion through 2020.  This is good news but it is not reflected in current budgets developed by Paul Ryan and the GOP House.  Ryan's plan calls for giving block grants to the states in order cut budget deficits.

Paul Krugman As Sisyphus

In Greek mythology Sisyphus had an affair with the wife of a God.  His punishment doomed him to roll a rock up a hill until he got close to the top.  The rock would then roll down the hill and he would have to start all over again with a task that could never be completed.  Paul Krugman feels like Sisyphus.  He is forced to keep destroying zombie ideas that never die.  He wishes that he could spend his time developing new ideas, but the zombie ideas won't go away. 

I have been reading some books on economic history.  It is full of zombie ideas that have been kept alive by diligent economists.  In 19th century England there was no such as involuntary unemployment.  People were unemployed because they refused to work for the wages that were determined by the labor market.  Moreover, many were provided with relief that made them less likely to look for jobs. They also believed that the market was self correcting.  If the market did not correct, it was because the market was not allowed to operate as it was intended to operate by nature.  Government, unions, and monopolists all conspired to prevent the market from performing its self correcting duty.  Governments were also supposed to run a balanced budget.  Bad things would happen if governments used debt to finance their activities.  I found very few economic ideas in 19th century England that are not commonly held today.  They were much better in physical sciences.  They provided much of the foundation for modern science.  Unfortunately, they also provided the foundation for numerous zombie ideas in economics.

David Brooks Has A New Love

David Brooks makes confession in this article.  He has a tough job.  Its hard to produce two op-ed's per week for the NYT.  In order to come up with ideas he hits the lecture circuit where he listens to a lot of flashy people whose ideas sound good but seldom pan out.  He has rejected the flashy folks with the brilliant ideas in favor of plain folks who produce commodities like food and energy products.  They don't get a lot of attention but they produce jobs and they may have found the key to our economic future.  The US will become the leading energy producer in the world. 

Unfortunately, Brooks got a lot of his new insights by attending a conference at the conservative Manhattan Institute.  He did not spend a lot of his valuable time in North Dakota to get his new ideas. The comments that follow his op-ed are very good.  They save me the job of making my own comments.

The Mean States In The US Are Also The Red States

If you are are poor, and you live in one of the mean states, you will pay more in taxes and you get fewer public services than the poor in the kinder states.  That is because the mean states make greater use of regressive taxes that take a higher share of the income from the poor than they do from those with higher incomes.  The sales tax is the tax of choice in the mean states.  Corporate taxes are low, and there are few states with a progressive income tax. Not surprisingly, the mean states are concentrated in the South and increasingly in the Western states.  They are also the red states that support politicians that are intent upon maintaining that system.  They are also the states with that don't spend a lot of money on public education.  The system works best when you don't have a well educated public.  Things would be even worse in the mean states if the poor did not get assistance from the federal government.  States in the Northeast and the Midwest provide more in federal taxes than they get back in benefits.  The citizens in these states help to pay for the low taxes on corporations and high income earners.  The mean states are the "moocher" states.  They receive more in federal benefits that they pay in federal taxes.  The mean states are also the primary beneficiaries of military spending.  The bulk of our military bases are located in the mean states.

Paul Ryan Lost The Election But He Insists On Running Fiscal Policy

Mitt Romney's running mate has a one track mind.  Paul Ryan's budget policies were rejected in the 2012 election but that has not deterred him from imposing them on the country that rejected them.  The budget that he pushed through the GOP House is even worse than the one on which he ran.  It includes tax cuts for the rich, and substantial cuts on programs that benefit ordinary Americans. The plutocrats that supported him in the election are encouraging him to push their agenda.  He has been a constant guest on the Sunday TV talk shows.  They never seem to tire of his fear mongering about the deficit and the need to cut government spending and cut taxes for the plutocrats.  I guess it helps to own the media that inform the public on government policy.

The Sequester May Make It Possible To Reduce The Defense Budget

The sequester mandates cuts in defense spending.  This article suggests that it has set the stage for further cuts in defense spending.  The defense budget is no longer immune from attack.  It won't be easy, but it may be easier to contain defense spending than it has been in the past.

How Investment Banks Make Money On IPO's

Investment banks charge a 7% fee when they take a company public.  This article (via Manan Shukla) shows that the 7% fee is only a minor portion of the value that investment banks derive from an IPO.  They make much more by providing shares to their customers prior to the public offer.  The shares typically increase in value when they market opens for public purchase.  Their client then sells the shares at a big profit.  In return for this favor, the investment bank requires that their client give them "soft money" in return.  That can come in different forms, but it frequently involves commissions that the bank earns on trades made by their client. 

This was a great way for the banks to make money during the dot com boom.  IPO's were more frequent and the payoffs to the banks and their clients were substantial.  It also shows the power that the banks hold over the firms that employ them to raise money.  The banks can make it difficult for complainers to raise money.  They control the fund raising process.   It also helps me to understand why the banks can sell toxic securities to their clients during the real estate boom and not lose them as customers.  The banks control the carrot and the stick.  They can provide favors, like when they issue IPO's, and they can also punish by control over the credit markets.

Let Keynes Speak For Himself

I have downloaded Chapter 24 of Keynes's General Theory.  Most of his critics have never read his book. This gives you an opportunity to be an informed critic.  One of the reasons why few, including many economists, have not read Keynes is because his writing style is rather difficult for a modern audience.  His sentences are long and complex, and his vocabulary includes terms like "the propensity to consume" which he had developed for his theory.  In any case, it worth the effort.

He wrote his book in response to the Great Depression which had raised many questions about the viability of capitalism.  In particular, Keynes was concerned about the high rate of unemployment.  He argued that the state should intervene in the economy in order to maintain a full-employment economy.  He believed that the state should take steps that would encourage the investment that was needed to reduce the unemployment rate.  That could be done while retaining the benefits of the market system.  He advocated a progressive tax system which dealt with the maldistribution of market income.  The maldistribution of income contributed to unemployment because the rich saved a larger portion of their income than the average person who spent a large share her income.  He also argued that the savings of the rich were not needed to fund business investment. That had been one of the main arguments for maintaining a system with high income inequality.

While Keynes was trying to preserve capitalism, by increasing the role of the state in the economy, his critics were numerous.  The doctrine of a self regulating market system has been difficult to dislodge. 

Mark Thoma Defends Krugman From Jeff Sachs

I posted Jeff Sach's critique of Paul Krugman's version of Keynesian stimulus, and the consequent budget deficits below.  Mark Thoma offers his defense of Krugman's fiscal policy in this article.  You can be the judge.

Crude Keynesianism Versus Subtle Keynesianism

Jeff Sachs summarizes his ongoing debate with Paul Krugman.  Sachs does not believe that the Great Recession was just another business cycle triggered by a collapse in aggregate demand.  He argues that structural changes in the economy led to the decline in aggregate demand, and that we should have focused attention on fixing the structural problems.  The Fed did what it needed to do.  It provided liquidity to the banking system.  That was necessary to revive the frozen credit system.  The stimulus package, however, failed to resolve the underlying structural problems in the economy. He describes some of the structural problems that should have been addressed by fiscal policy.  They were not addressed, and it is too late now to get them through Congress.  Obama should have taken advantage of the recession to invest in our future.  Instead he took a "crude" Keynesian approach to increasing aggregate demand.  Consequently, we have more debt and we have nothing to show for it.  The debt is not a burden today because of exceptionally low interest rates.  It will become a problem when interest rates return to normal and the cost of debt service squeezes out government spending on necessary investments in our future.  Sachs concludes his debate by citing Keynes who advocated more targeted spending during Britain's recovery from the Great Depression.

If The Medicine Is Killing The Patient We Should Use More Of The Medicine

The Financial Times provides Martin Wolf with a platform to review David Cameron's defense of his economic policies.  He reviews the data, which shows that the patient is not responding to Cameron's policies, and borrowing a phrase from Margaret Thatcher, he concludes that "Cameron is not for turning".  His policies are correct because he believes them to be correct.  Frankly, Cameron is stuck with the weak defense of a policy that is not working.  Politicians are not permitted to admit to mistakes.  Especially when the policy is based upon a zombie ideology that is the edifice of his party's platform.

In Search Of A "Robust" Defense Of Austerity In The UK

The Cameron administration is defending its decision to implement austerity by labeling its arguments as "robust".  This inspired one of Britain's leading economists to have some fun with  Cameron's overuse of the  robustness defense.  He analyzes the robustness defense and gives it a failing grade.  Paul Krugman has coined a couple of new concepts that have become part of the debate over austerity as well.  He frequently refers to zombie ideas.  They are ideas that never die despite the evidence against them.  He has also introduced the notion of the confidence fairy into the lexicon of economics.  The confidence fairy is supposed to respond to austerity measures by stimulating the economy.  We are still awaiting the appearance of the confidence fairy.  Economists in Britain have made a good case for introducing the robustness defense into the macro hall of infamy.

Everything You Need To Know About Social Security

This article provides a lot of information about SS, and a number of viewpoints about how to fund it.  The least favorite solution among pundits and politicians is to eliminate the cap on payroll tax.  The cap is currently around $113,000.  It increases annually at the rate of inflation.  That means that higher income people have lower tax rate than those with incomes below the cap.  If the cap were eliminated SS would be fully funded for the next 75 years.  Its pretty obvious why high income earners, which includes most of the pundits and politicians,  favor other funding solutions.

The federal income tax is a progressive tax.  The tax rate increases with income.  Those with high incomes prefer regressive taxes like the payroll tax.  Ronald Reagan cut the top tax rate from 70% to 28%.  He also raised the payroll tax rate.  Since the tax revenues from the payroll tax have exceeded payments to beneficiaries, the surplus from the payroll tax has helped to pay for cutting the tax rate for those with high incomes.  That is, we have substituted a regressive tax for a progressive tax.  The money is not segregated as it is collected.  The government does not distinguish between the revenue that comes from the payroll tax and the income tax.  Without the increase in the payroll tax Reagan would not have been able make the income tax less progressive.  The budget deficits from the tax cuts would have it politically impossible.

US Trade Deficit Is $44.3 Billion In January

The US trade deficit in January is on a path to an annual trade deficit of over $500 billion.  Trade deficits are subtracted from GDP so they reduce the economic growth rate.  They also contribute to US budget deficits.  Employment and tax revenues would be higher if we produced the $500 billion of goods in the US.

There are two details in the report that aroused my curiosity.  Our trade deficit with China accounted for more than half of the trade deficit in January.  The report suggests that this is due to China's manipulation of its currency.  There is a better explanation for the trade deficit with China.  US firms have decided to manufacture their products in China because it is cheaper to do so in China.  They also hope to gain access to the huge market in China by locating production in China.  Oil imports also made a substantial contribution to our trade deficit.  That is not news.  Oil prices in the US have declined in the US because of new extraction technologies.  US refiners are taking advantage of lower costs by shipping refined products to international markets.  We seem to be importing more expensive oil while we are shipping cheaper refined products to international markets.  Gasoline prices are rising in the US as a result of this policy.

A Paper By A Harvard Economist Influenced US Fiscal Policy

This article suggests that US fiscal policy has been influenced by a paper written by a Harvard economist.  The paper suggested that the "right kind of austerity" could be expansionary.  Austerity measures that included 85% in spending cuts and a 15% increase in tax revenues would reduce budget deficits and expand the economy.  The economist argued that the success of austerity in Europe, which used the right mix of austerity,  supported that prediction in a lecture that he made at the conservative Mercatus Center in 2010.  The Tea Partier's elected to the House adopted this policy and current US budget policy in the Obama administration has adhered to the recommended mix in spending cuts and tax increases.

The following graph shows how this policy has worked in Europe.  There is a very strong correlation between the degree of fiscal austerity and debt to GDP ratios.  Austerity increased the debt to GDP ratio the most in countries that imposed the most austerity.  We are still waiting for economic expansion.

This Is How Mexico Will Overtake China And India?

Tom Friedman made one of his flat earth visits to Mexico.  After visiting a technology center in Mexico, he concluded that Mexico would surpass China and India in the 21st century.  He was impressed by their use of twitter and cellphones.  He might have come to a different conclusion if he had learned that they are not learning how to read books.  Perhaps that is what the government wants.  Its easier to manage a country whose citizens are uniformed.  I don't think that China and India will have to worry about Mexico.

How The Distribution of Wealth In US Compares With What People Believe Or Desire

This video (via Manan Shukla) describes the distribution of wealth in the US.  It compares the actual distribution with two other distributions.  The real distribution is not even close to what the public believes, or what it thinks is the ideal distribution.  Ignorance is bliss.  The public has no idea how the distribution has changed since the 1980's.  They are told that inequality is built into capitalism and that it serves a good purpose.  That is true, but its hard to explain how the distribution of wealth has changed so much over a few decades in our country.  The world is not that much different, but our politics, and our culture have changed dramatically.  This is a story of two very different capitalist systems in the same country. 

TED Talk On The Relationship Between Financial Rewards And Perfomance

This is a link to a video which describes the research on the performance of individuals on brain intensive tasks and financial rewards.  Performance deteriorated as the rewards were increased.  This is what we observed in the financial crisis.  Huge financial incentives caused a lot of people to ruin their firms.

Referendum On Executive Compensation Stirs Boardrooms

The Economist describes the referendum in Switzerland, and refers to it as populist resentment.  Some of the commentators go further and call it communism.  Its hard to imagine that giving shareholders more control over executive compensation can be called populism or communism.  The shareholders are supposed to own the company.  They want to do what the Boards, that are theoretically elected by the shareholders, refuse to do. Shareholder capitalism has not been able to keep Boards from doing the bidding of the CEO because money managers hold most of the shares.  They have not been interested in containing executive compensation because they have conflicts of interest.  For example, many mutual funds are in the business of providing services to the firms whose stock they own. 

The Economist has been a defender of exorbitant executive compensation.  They do not question the classical assumption that compensation is determined by the marginal productivity of labor.  Executive compensation reflects the productivity of the CEO.  Its not really possible to measure the productivity of the CEO, but its hard to believe that CEO's today are 10 times more productive than the CEO's of major corporations a few decades ago.  CEO used to earn around 40 times the salary of their average employee.  They earn around 400 times the average salary today.  The system has been rigged in their favor by compliant Boards.  Its like having one's family determine one's compensation.

Europe Is Moving Foward On Executive Compensation

The Financial Times reports (via Doug Hendren) on the referendum in Switzerland to limit executive compensation, and to make it easier for shareholders to participate in compensation decisions.  It also reports on the bonus cap on bankers that has been proposed in the UK. The conservative government in the UK is arguing against the plan to limit banker bonuses.  They argue that the bankers will move to a more banker friendly country like the US.  The more likely event is that they will look for jobs in hedge funds.  They are not regulated by government, and most of them have already established offshore accounts to avoid taxes. Perhaps banks will go back to the old fashioned way of making money by taking in deposits and making sound loans.

In any case Europe is responding to public sentiment against executive compensation excesses.  Public anger has been growing even faster that executive compensation. 

What To Do About Income Inequality: A Progessive View

This link is to a lecture given by Emmanuel Saez at Stanford.  Saez has won several economic awards for his data on income inequality.  The lecture is fairly data intensive but it leads to a different set of conclusions about the growth in income inequality, and its causes, than the conservative explanation offered by Jerry Muller that I posted yesterday.

Many of the explanations for the growth in income inequality center around broad changes in the global economy.  Muller claims that it is due to the dynamic quality of capitalism which invariably leads to income inequality.  It would be mistake to alter that pattern because there is little that can be done about it, and because efforts to modify our economic system might decrease its dynamism.

Others argue that our economy has become more technical and that rising inequality is due to the premium that we pay for technical talent.  Globalization has also increased inequality, but there is nothing that can be done about how the effects of globalization might be modified by governments.  The financialization of the economy has contributed to inequality but there is nothing that can be done about that either.  Emmanuel Saez reviews the data on income inequality and reaches a very different conclusion.  I have summarized some his key points below.

The first point that I would like to make is that there is no such thing as capitalism.  Every nation has a mixed economy in which government and the private sector operate under slightly different rules that determine the economic outcomes, and the well being of the public.  Every nation has been subject to the same forces of technology, globalization and the financialization of their economies.  Saez shows that the pattern of growth in inequality in the US, Canada and the UK follows a similar pattern.  He is very polite, and he is also French, so he did not call it the Anglo American disease.  In each of these countries there are has been a dramatic increase in income inequality that exceeds that of most other OECD nations.  The pattern also reflects a basic difference in governance.  There is a strong correlation between the changes in the top marginal tax rate and the growth in inequality.  Lowering the top tax rate seems to have encouraged rent seeking.  That is, lower tax rates increased the incentives of those in positions of power to take actions that increased their share of the income.  The tax rate on incomes over $1 million was reduced from 70% in the Reagan administration to 28%.  The growth in income was equally shared by all segments of the population prior the Reagan tax cuts. The top 10% received only 33% of national income between 1960 and 1980.  The top 10% captured 46% of the growth in the nation's income in 2010.

One of the arguments for the Reagan tax cuts was that they would encourage people to work harder and stimulate economic growth.  The growth in the US economy since the Reagan tax cuts has been lower than it was in the decades with higher tax rates on high incomes.  That does not mean the high marginal tax rates encourage economic growth.  It shows, however, that low marginal tax rates are not necessary for economic growth.  The tax cuts influence the distribution of income more than they do the growth in income.

Some other comparisons between countries show that institutions have a huge effect on the growth in income income inequality.  Capitalism is not a thing of nature.  It is shaped by government,  and government can influence the distribution of income without destroying the dynamic capacity of capitalism.  In fact, the maldistribution of income has a negative impact on aggregate demand.  That is because the top 1% saves about 51% of its income.  Middle income households spend around 90% of their income.

Other capitalist countries have done a better job of dealing with income inequality.  Switzerland just passed a bill that severely restricts executive compensation.  It was passed with a 68% majority.  Capitalism is not a natural phenomenon.  It is shaped by government and some governments do a better job of spreading the benefits than others.  Its hard to imagine America or other Anglo nations taking the action just taken by Switzerland. The corporate executives would fire the politicians.  Perhaps Donald Trump would supervise the firing. 

Saez makes a final point about how to change tax policies which favor the rich and encourage growth in income inequality.  The bottom 99% have to understand how they are affected by cutting taxes for the rich. They are affected in several ways.  More of the tax burden is shifted to them; government programs that benefit them are at risk, and the rich have greater influence on government.  Many Americans would like to have a democratic system that is not controlled by the super rich.