Writing on the recession for the Foreign Policy Association’s recent series on “Great Decisions,” Daniel Drezner observed: “If nothing else, the Great Recession threatens the key ideas that underlie the global economic order in the past generation.”
I don’t understand the word “threatens.” The current financial calamity does not “threaten the key ideas” that have dominated economic policy in the United States and abroad for the past 35 years or so. By all empirical evidence it absolutely shreds the economic theology that prevailed and unhappily still underlies the effectiveness of the resistance to any meaningful remedial action by bankers, by other purveyors of financial services, and by their congressional and media agents.
Relieve the giant banks and all the other too-big-to-fail corporations of all their worthless paper, but don’t dare regulate them because that would upset the “efficient workings of the free market.” And that would be socialism. We don’t want the government in the banking business, do we? Or in the insurance business, do we? (Forget about the FDIC; forget about the federal guarantees for private lenders against defaults on student loans; forget about the Federal Private Investment Corporation that provides loan guarantees to private businesses that invest in “politically risky” countries.) We don’t want the government in the health care business, do we? (Forget about Medicare; forget about the Veterans Administration’s enormous integrated health care system with more than 1400 sites; forget about … well, just forget it.) Regulating the too-big-to-fail, for-profit service corporations would interfere with the free market – “distort” is usually the chosen word – and that would be bad. By definition.
Every time I see or hear the phrase “free market,” I have mixed feelings – a mix of anger and exasperation. Why? Because there is no such thing as a “free market;” there has never been any such thing, and never will be. What’s more: it is hard to believe that those otherwise intelligent people who prattle about “the free market” don’t know that. So it is easy to conclude that those who do use the phrase are simply monumental cynics or are suffering from an acute case of cognitive dissonance.
In a liberal society such as ours, there IS such a thing as a price-and-market system that governs the allocation of most goods and economic rewards. And that is a good thing. But the market system operates within the boundaries set by law, and to some extent by custom. Those constricting boundaries can be broad or narrow. They can include broadly different areas of permissible economic action, or they can constrict the areas of permissible economic action. However they are drawn, they determine the advantages and disadvantages among actors competing for the goods and rewards that the society has to offer. As laws change, the boundaries change, and there are new winners and new losers. That’s what law does and is intended to do.
But – and here is our problem – changes in the private sector alters who wins and who loses at least as much as changes in law does. And as national and international circumstances have changed, the power of the “free market” mythology/theology among inattentive voters has served entrenched, predominant interests while hamstringing legitimate efforts to reorder the distribution of advantages in response to the changed circumstances.
A little History: For a relatively short span of years in our country’s history, mostly in the middle third of the 19th century, governmental policy withdrew from large areas of economic activity that traditionally had been regulated, leaving it increasingly to the price-and-market system to control the distribution of most resources and rewards. That is, traditionally in the U.S., going back to the start of the nation and continuing well into the 19th century, government – especially at the state and local levels – closely regulated much economic behavior, including of course labor relations, employer liability, and even the price and quality of goods for sale. By the second quarter of the 19th century, government began pulling back, reducing its mediating role between buyers and sellers, and between employers and employees, and yielding to private contract as the main governor of such economic relationships. By mid-century, the American economy did in fact closely resemble the model of “free,” competitive enterprise; i.e., competitive capitalism did work relatively well in regulating most markets and producing something close to a fair and level field among buyers and sellers and other competing interests (but not labor).
But along came the Industrial and Corporation Revolutions. More than a century ago, that is by the last quarter of the 19th century, the transformative growth and mergers of large corporations sharply limited private-sector competition as an effective and fair regulator of markets. As the late dean of American legal historians (James Willard Hurst) put it: “The corporation was the most potent single instrument which the law put at the disposal of private decision makers. In making it available, the law lent its weight to the thrust of ambitions which reshaped not only the business of the country but also its whole structure of power.”
The populist and progressive movements of the late 19th and early 20th century rose in response to the changed structure of power in the country. That is, various commercial and producer interests called on government to intervene, to regulate, to redress the disadvantages that the transformation of the economic scene had brought upon them.
Still, it took almost another half-century before some of the more important economists came to acknowledge that oligopolistic rather than free competition had corrupted their models of the so-called free market system. One such belated acknowledgment came in 1936. That was when economist Arthur Burns, who would later become chairman of the Council of Economic Advisors for President Dwight Eisenhower and then chair of the Federal Reserve Board during the Nixon Administration, made the remarkable discovery that, as he put it: “The widening use of the corporate forms of business organization are bringing, if they have not already brought, the era of competitive capitalism to a close.” That was half a century after the Corporation Revolution had occurred. (It would seem that economists are slow learners.) WE, of course, having experienced the arrival of the megacorporation, and of the conglomerate and multinational corporation revolutions of the past 50 years – WE could have said to Mr. Burns, hey! you ain’t seen nuthin’ yet!
Remarkably, the dominant economic theorists of the past 35 years have continued promoting public policies as if “competitive capitalism” remains vigorously functional. As one dissenting economist (John Munkirs) wrote several years ago, “The enduring belief in the existence of competitive market-structure capitalism is partially explained by the fact that basic economic beliefs are religious in nature, and being so, are difficult to modify.” “Partially explained.” The rest of the explanation has to do with how well the theology serves powerful entrenched interests with privileged access to the media and to politicians. And that privilege has grown all the greater with the recent Supreme Court’s decision overruling more than 100 years of congressional and state legislation designed to limit the power of large corporations to influence elections, and awarding corporations nearly full First and Fourth Amendment rights as “persons.”
In the meantime, we are stuck in a rut as we face the current economic crisis. There seems to be a long lag time for economists’ ideas to catch up with changing economic reality. And ideas are powerful. John Drezner quotes John Maynard Keynes’remark 75 years ago, “The ideas of economists and political philosophers … are more powerful than is commonly understood.” A casual glimpse at history shows that financial policy during at least the past century has been influenced by leaders who are “usually the slaves of some defunct economist.“ In our current troubles, the most important such economist has been the late Milton Friedman.
Friedman and his predecessors at Chicago, such as his mentor, Friedrich Hayek, and his successors, such as Alan Greenspan (and Greenspan’s guru, the eccentric novelist Ayn Rand), stubbornly promoted a theology founded in their distortion of Adam Smith’s argument about the superiority of a price-and-market system that is governed by Providence’s “Invisible Hand.” Adams argued that if 18th century policymakers sought to maximize their country’s wealth, they should free most private transactions from governmental controls, because the self-interest of individual entrepreneurs would produce incentives for them to maximize their own private wealth; and that in turn would lead to a larger aggregate national wealth.
I say “distortion,” because if anyone should trouble actually to read Smith’s The Wealth of Nations, s/he would discover that not only did he write from a long-outdated anti-monarchial, anti-mercantilist 18th century perspective that led him to dwell on the overall economic virtues of a price-and-market system, but he laid out such a comprehensive list of when government must intervene in the economy that if it were compared to the interventions of FDR’s New Deal and LBJ’s Great Society, it would appear positively “socialistic.” (Of course, that label would not have troubled Adam Smith nearly as much as it does so many Americans. Smith, after all, held the chair in Moral Philosophy at Edinburgh U, and like almost everyone else at the time he regarded economic transactions within the context of a moral universe.) Among other things, Smith warned against chartering joint stock companies and corporations because they blurred the lines of accountability. He specifically urged government to take ownership control of banks, and of other industries that he considered to be parts of a country’s infrastructure. Had he written later, he would probably have included railroads, airlines, and telecommunications. He also specifically argued for government assistance to those who for various reasons cannot survive well competing for goods in a more permissive market environment; in other words, he favored a social welfare system. And he also saw the need for government intervention when the personal, private pursuit of gain created external or long term social as well as economic costs. In other words, Smith understood that the imperatives of “self-interest” that worked to make individuals wealthy did NOT always work to contribute to the nation’s general wealth or welfare.
Milton Friedman, his predecessors and his disciples, have argued that government should do nothing beyond providing for law, order, and national security, along with some manipulation of the monetary system. They would privatize everything else including schools, medical care, pensions, prisons, roadways and all other transportation facilities. (Of course, King Bush the Second went a long way toward privatizing the military, too. In Iraq, there are more employees of private so-called security companies – e.g.,Blackwater – than there are official members of the quasi-mercenary U.S. military there. The privateers have been doing everything from moving supplies to interrogating military captives and terrorist suspects, and even actively assisting the military and the CIA in military operations.)
Until the 1970s, Friedman and his “Chicago School” disciples enjoyed little support among public policymakers. The experience of the Great Depression had educated even conservative businessmen and economists (e.g. Burns) about the inadequacy of a non-intervening government for sustaining a prosperous economy. Friedmanesque critics of FDR claimed, and some newly minted and briefly best-selling pseudo-history books still insist that the New Deal delayed recovery and worsened the economy. (But how much of a billionaire’s fortune need be spent to make a “best seller” of any book? Like Amity Schlae’s The Forgotten Man?) But after huge government expenditures for war mobilization had finally pulled the country out of the Great Depression, it became clear that the New Deal had not spent enough. After that most economists took their cues from John Maynard Keynes who clearly saw the necessity of using government resources to bolster the economy at times and in areas (e.g., employment) that the private sector failed.
Then came the ‘70s and OPEC and Stagflation. Along with Affirmative Action, School Busing, Roe v Wade, the sexual and gender revolutions, Watergate, and the scandals associated with the brutality of the American effort in Vietnam. An anti-government reaction set in. “Privatization” and “deregulation” became the shibboleths of the decade, along with Looking Out for Number One. And Milton Friedman and his disciples finally had their day. After 30 years of unprecedented economic growth, job creation, and soaring standards of living, from 1940 through 1970, American voters were in the mood to believe the Friedman & Co. claim that Keynesian principles of government activism and regulation were all wrong. But then, memory is not one of the attributes of a democracy.
The fact is, even today, although they all are not entirely in thrall to St. Milton, the country’s principal economic advisors remain mostly committed to the “free market” model of modern capitalism. The influence of St. Milton remains strong. That includes most of President Clinton’s economic advisors such as Robert Rubin and Lawrence Summers, George W.’s advisors Henry Paulson and Bernard Bernanke, and now with President Obama, we have Summers and Bernanke again along with Tim Geithner (not to mention the unofficial influence of Goldman Sachs’ Lloyd Blankfein). These savants have extended the theology of “free markets” to the financial sector, where it never had been considered wise for governments to yield regulatory oversight.
Somehow, in choosing his chief economic advisors, Obama skipped over Nobel Prize winners Paul Krugman and Joseph Stiglitz, as well as former Federal Reserve Bank chairman, Paul Volker, and former vice-chairman Alan Blinder. (Volker does formally hold a position as an advisor to the President, but it seems clear that he has been relegated to some backroom.) Those economists have recognized that economic revival depends on the revival of consumer spending. And consumer spending cannot be revived if companies – and state governments – respond to Recession by firing millions of workers – 8 million since 2001. Krugman, Stiglitz, and Volker would have given priority to measures to counter rising unemployment, and to create jobs to bolster consumer demand. They could have used substantially more of TARP money to pay companies to keep employees, as some European governments have done, and to relieve states struggling to meet constitutional budget balancing requirements. It is telling that during the Great Depression, state and local government retrenchment exceeded the New Deal’s spending in most sectors, so that there was effectively a net loss in total government spending during the 1933-39 period – another reason that it took the outbreak of war to finally break the cycle of economic disasters during the ‘30s.
Stiglitz, et al, also would have attached governmental strings to the hundreds of billions of dollars doled out to the great banks and insurance companies, bail-outs that in fact made American taxpayers major owners of the rescued corporations but without ownership voting rights and in most cases without membership on boards of directors. Participation by the government in governing the rescued corporations could have included requiring the banks to use more of the bail-outs to make loans rather than simply to engage in profit-generating trades of obscure derivatives and to hand out obscene bonuses to major executives. That in fact is exactly what many of the European countries have done.
Can there be anything more revealing about the insider, banker/trader outlook of Paulson, Geithner, Bernanke, & Summers, Inc., than the massive bailout with taxpayer money to AIG which then promptly paid off at 100 percent on the dollar its $12 billion debt to Goldman, Sachs. Which in turn reported record profits the next quarter, an achievement that owed not to its role as a newly-chartered bank that generates loans but to its extensive and murky trading business. (How murky? We now know that Goldman, Sachs was/is among the conspirators that concealed the true fragility of the Greek government while encouraging investors to buy Greek government bonds; and at the same time, speculating in Credit-Default Swaps that will greatly profit G,S when/if the Greek Government defaults. Similarly, the federal government bought at 100 cents on the dollar Bank of America’s worthless loans so that B of A could buy the foundering Merrill, Lynch, another high roller in the financial casinos of the globe, at the same time concealing from its own shareholders (1) just how loaded with debt Merrill Lynch was, and (2) that M,L was about to award its top executives more than a billion dollars in bonuses!
Have the great economists as yet Got It? The current Great Recession has in fact shaken up a few eminent economists, including – marvels of all marvels – the Great Greenspan himself. In October 2008, the Great Greenspan confessed to a congressional panel: “I made a mistake in presuming that the self-interests of organizations, specifically banks and others, were such as that they were best capable of protecting their own shareholders and their equity in the firms.” When asked by Congressman Henry Waxman, if “in other words, you found that your view of the world, your ideology was not working,” Greenspan responded without hesitation: “Absolutely, precisely. I was shocked because I have been going for 40 years or more with very considerable evidence that it was working exceptionally well.”
Well, thanks Mr. Greenspan for the confession, but actually the evidence shows that it really was NOT working very well. But you wouldn’t know that because your attention was fixed on the banks and the stock and commodity exchanges, that did seem to be prospering extremely well – at least through the end of the 20th century.
The fact is, during the 40 years before 2008 when Greenspan had his epiphany, real economic growth in the United States slowed to a crawl, a fact not reflected in the soaring stock market. Part of the slowdown owed to what some economists are calling “the financialization” of the American economy. Just a couple of figures illustrate what was happening. Until 1950, manufactures constituted about 30 percent of GDP, while finance produced about 10 percent. By the 1980s, those figures were reversed, with financial activities amounting to three times the value of manufactures. During the last quarter of the 20th century more than half of all new investment went into financial deals – mergers and acquisitions and the like — compared to less than 10 percent around mid-century. That included the invention all kinds of complex holding companies and reshuffling of corporate entities within and outside of the master companies. By the ‘90s, 44 percent of all corporate profits came from these deals and dealings within the financial sector compared with only 10 percent from manufacturing.
Please understand that by financial profits, we are not referring to profits from underwriting production and consumer services. Rather, overwhelmingly those profits came from engineering corporate reorganizations, and by trading paper – that is, an increasingly obscure and complicated variety of “financial instruments,” sometimes referred to generally as “derivatives“ (including arcane devices like “credit-default swaps”). Many if not most of the new gimmicks were plainly designed (in Joseph Stiglitz’s words) for “circumventing regulations, accounting standards and taxation.”
Of the swift rise of the conglomerate corporation movement beginning in the late 1950s, one economist (Robert Lekachman) concluded in 1983, “Conglomerates are little more than mutual funds perpetually shuffling resources out of some subsidiaries and into others with scant heed to the production of anything more useful than paper claims.” And of the mergers themselves, the conservative British journal, The Economist, concluded in 1999, “over half of them had destroyed shareholder value, and a further third had made no discernible difference” for shareholders, while the American economy suffered mounting job losses. Research three years later by Business Week concluded that 61 percent of all the mergers studied “destroyed shareholder value.” Not to say destroying millions of jobs. As The Economist’s editors noted, each merger or consolidation led to substantial job cuts.
In fact, during many of those 40 years after 1970 that so pleased the Great Greenspan, unemployment rates rose to record post-Second World War heights. For those who managed to hold onto or win new jobs, median family income barely rose at all in that 40 year period – although family income for those in the top two percent of families rose spectacularly. Moreover, what modest rises families in the middle ranges of income did enjoy owed to the dramatic increase in two-earners in each family. In other words, earnings per worker in the great majority of American families dropped precipitously during those 40 years. (Do the arithmetic.)
But like the other economists who mistook the dramatic rise in the Dow Jones Averages along with NASDQ and the Standard & Poor Index as evidence of a healthy economy, Greenspan could not have paid attention to what was happening at the same time to most Americans. Besides, by lowering interest rates, Greenspan encouraged too many Americans to use debt to gain a high standard of living despite barely improving earnings. Meanwhile, banks and other mortgage lenders encouraged Americans to buy into mortgages with variable interest rates that would ultimately rise beyond homeowners and small business people’s ability to pay.
That was predictable. But lenders did not need to worry. Why? Because the lenders quickly liquidated their pile of dubious mortgages by “securitizing” the loans, and then selling them to other “securitizers” who repackaged the paper representations of property values and sold them to still other high rolling speculators who planned on selling the packages to still others who were attracted to the potentially high profits in the game. Each transaction, moreover, brought in substantial fees and commissions. At the same time, credit card companies drew in new high risk customers by offering very low interest rates for three or six months, after which the rates would climb by three or four fold. It isn’t that they didn’t anticipate defaults, but counted on the exorbitant interest rates on over-drawn accounts and high late-payment fees.
Greenspan is not alone in confessing his 40 years of obtuseness. Recently, in many articles, blogs, talking-head TV interviews, and a book, the prolific polymath and judge, Richard Posner, a long time libertarian advocate of minimal government and of deregulation, confessed that the Great Recession has opened his eyes as he never imagined before. For years, he admitted, he had declined to read any of the works of John Maynard Keynes. He said that, after all, fellow Chicagoan Milton Friedman had “refuted” Keynes. And another friend, Harvard economist Gregory Mankiw, had told him that “after fifty years of additional progress in economic science, Keynes’ General Theory is an outdated book. . . . We are,” Mankiw insisted, “in a much better position than Keynes was to figure out how the economy works.” So Posner said he saw no reason to waste his time reading Keynes. Now he confesses that by 2008 it had become clear that “the present generation of economists has NOT figured out how the economy works.” Both Friedman and Mankiw were wrong. So Posner sat down and read Keynes. And when he finished, he concluded that (pace Uncle Milty) Keynes was probably the greatest economist of the 20th century. It is Keynes’ work, he said, that provides the best guide for dealing with the current Great Recession.
We have seen how Larry Summers, who as Treasury Secretary for Bill Clinton, worked diligently to deregulate and keep unregulated the novel profit-generating financial gimmicks. In fact, Summers went so far as to brag that one of his greatest achievements as Treasury Secretary was ensuring that derivatives would remain unregulated. More recently, even before his current stint in the White House, he wrote articles supporting greater regulation of the financial industry. But the damage had long been done.
The ideologues’ triumphed politically 30 years ago with the election of Margaret Thatcher and Ronald Reagan. (Carter had already started the deregulation ball rolling.) Globalization had a role: Competition for international profit opportunities energized the financial giants in the separate countries to repeal or override whatever regulations there remained, including capital requirements for lending (the “Net Capital Rule”). The Rule was designed to limit the banks’ and brokerages’ leverage and risk exposure, and thus their eagerness to gamble for high stakes. But the banks had also run into competition from new financial service competition, as insurance companies and unregulated brokerages began offering checking, savings, mortgages, and other services usually provided by banks. Such changes were accompanied by dismantling government monitoring agencies, abolition of withholding tax requirements on foreign profits; anything in fact to gain “market share” in the international competition for money. In short, a race to the bottom. The forced separation of commercial and deposit banking from investment banking imposed by the Glass-Steagle Act of 1933 ended without legislation; the bankers just went ahead and did it. (G-S was not formally ended until 1999.) Laws against branch banking across state lines (and in NYC, outside the city) were similarly discarded without formal action.
As deregulation progressed, the Great Greenspan exulted: “Recent regulatory reform [i.e., deregulation] coupled with innovative technologies has spawned rapidly growing markets for, among other products, asset-backed securities [e.g. mortgages], collateral loan obligations [derivatives], and credit derivative default swaps. These increasingly complex financial instruments have contributed especially over the recent stressful period, to the development of a far more flexible, efficient, and hence resilient financial system than existed just a quarter of a century ago.” So much for Alan Nostrodamus.
Many observers have noted that the unwillingness of the Obama Administration to concentrate on the failure of the market to produce jobs has owed to the banking perspectives of the chief economic gurus. Indeed, it should be shocking that it took the Democrats’ defeat in Massachusetts to refocus economic policy. Still, it remains to be seen if anything substantial will be done. After all, nothing – literally nothing – was done after the Enron scandals ten years ago. Lock-step opposition to action in Congress indicates that no significant changes will happen soon. Probably it is already too late anyway.
As Joseph Stiglitz has written: “Because of the choices that have already been made, not only will the downturn be far longer and deeper than necessary but also we will emerge from the crisis with a much larger legacy of debt, with a financial system that is less competitive, less efficient, and more vulnerable to another crisis.”