“The free market is an impossible utopia”

Karl Polanyi’s The Great Transformation is probably the most influential book I’ve read on the framework I use to think about the economy. I had the privilege to read and discuss his book in a political philosophy seminar with Prof. Stephen Leonard junior year of college.

One of the world’s experts on Polanyi, I understand, is Prof. Fred Block, who recently released a new book (The Power of Market Fundamentalism: Karl Polanyi’s Critique). Henry Farrell, at WaPo’s Monkey Cage blog recently interviewed Block and co-author Somers. Their description of Polanyi’s work is too good not to block quote:

Polanyi’s core thesis is that there is no such thing as a free market; there never has been, nor can there ever be. Indeed he calls the very idea of an economy independent of government and political institutions a “stark utopia”—utopian because it is unrealizable, and the effort to bring it into being is doomed to fail and will inevitably produce dystopian consequences. While markets are necessary for any functioning economy, Polanyi argues that the attempt to create a market society is fundamentally threatening to human society and the common good In the first instance the market is simply one of many different social institutions; the second represents the effort to subject not just real commodities (computers and widgets) to market principles but virtually all of what makes social life possible, including clean air and water, education, health care, personal, legal, and social security, and the right to earn a livelihood. When these public goods and social necessities (what Polanyi calls “fictitious commodities”) are treated as if they are commodities produced for sale on the market, rather than protected rights, our social world is endangered and major crises will ensue.

Free market doctrine aims to liberate the economy from government “interference”, but Polanyi challenges the very idea that markets and governments are separate and autonomous entities. Government action is not some kind of “interference” in the autonomous sphere of economic activity; there simply is no economy without government rules and institutions. It is not just that society depends on roads, schools, a justice system, and other public goods that only government can provide. It is thatall of the key inputs into the economy—land, labor, and money—are only created and sustained through continuous government action. The employment system, the arrangements for buying and selling real estate, and the supplies of money and credit are organized and maintained through the exercise of government’s rules, regulations, and powers.

By claiming it is free-market advocates who are the true utopians, Polanyi helps explain the free market’s otherwise puzzlingly tenacious appeal: It embodies a perfectionist ideal of a world without “coercive” constraints on economic activities while it fiercely represses the fact that power and coercion are the unacknowledged features of all market participation.

This gives us a different framework for thinking about economic problems and policies. I’ve discussed it before, but again Block and Somers say it better:

By putting government and politics into the center of economic analysis, Polanyi makes it clear that today’s vexing economic problems are almost entirely political problems. This can effectively change the terms of modern political debate: Both left and right today focus on “deregulation”—for the right it is a rallying cry against the impediments of government; for the left it is the scourge behind our current economic inequities.  While they differ dramatically on its desirability, both positions assume the possibility of a “non-regulated” or “non-political” market.  Taking Polanyi seriously means rejecting the illusion of a “deregulated” economy. What happened in the name of “deregulation” has actually been “reregulation,” this time by rules and policies that are radically different from those of the New Deal and Great Society decades. Although compromised by racism, those older regulations laid the groundwork for greater equality and a flourishing middle class.  Government continues to regulate, but instead of acting to protect workers, consumers, and citizens, it devised new policies aimed to help giant corporate and financial institutions maximize their returns through revised anti-trust laws, seemingly bottomless bank bailouts, and increased impediments to unionization.

The implications for political discourse are critically important: If regulations are always necessary components of markets, we must not discuss regulation versus deregulation but rather what kinds of regulations we prefer: Those designed to benefit wealth and capital? Or those that benefit the public and common good? Similarly, since the rights or lack of rights that employees have at the workplace are always defined by the legal system, we must not ask whether the law should organize the labor market but rather what kinds of rules and rights should be entailed in these laws—those that recognize that it is the skills and talents of employees that make firms productive, or those that rig the game in favor of employers and private profits?

The interview also tied in importantly to some of Mattis’ thinking/blogging about European elections. Basically Polanyi’s framework for thinking about the economy provides us a mechanism or explanation for thinking about voting patterns and social movements (in that sense his work was really political-economic-historical-philosophy).

Polanyi argued that the devastating effects on society’s most vulnerable brought on by market crises (such as the Great Depression in the 1930s) tends to generate counter movements as people struggle to defend their livelihoods, their neighborhoods, and their cultures from the destructive forces of marketization.  The play of these opposing dynamics is the double movement, and it always involves the effort to remobilize political power to tame the apparent over-extension of market forces.  The great danger Polanyi alerts us to, however, is that mobilizing politics to protect against markets run wild is just as likely to be reactionary and conservative, as it is to be progressive and democratic. Whereas the American New Deal was Polanyi’s example of a democratic counter movement, fascism was the classic instance of a reactionary counter-movement; it provided protection to some while utterly destroying democratic institutions.

This helps us to understand the tea party as a response to the uncertainties and disruptions that free market globalization has brought to many white Americans, particularly in the South and Midwest. When people demonstrate against Obamacare with signs saying “Keep Your Government Hands off My Medicare,” they are trying to protect their own health care benefits from changes that they see as threatening what they have.  When they express deep hostility to immigrants and immigration reform, they are responding to a perceived  threat to their own resources—now considerably diminished from outsourcing and deindustrialization.  Polanyi teaches us that in the face of market failures and instabilities we must be relentlessly vigilant to the threats to democracy that are often not immediately apparent in the political mobilizations of the double movement.

HF – The European Union’s single currency creates many of the same tensions between international rules and domestic society as the gold standard did a century ago. What are the political consequences of these tensions?

FB & MS – We just saw in the European elections that right-wing, seemingly fringe parties, came in first in France and the U.K.  This is a response to the continuing austerity policies of the European Community that have kept unemployment rates high and blocked national efforts to stimulate stronger growth.  It might still be largely a protest vote—a signal to the major parties that they need to abandon austerity, create jobs, and reverse the cuts in public spending.   But unless there are some serious initiatives at the European Community and the global level to chart a new course, we can expect that the threat from the nationalist and xenophobic right will only grow stronger.

Having read and written this, I have to say that the implications for this way of thinking about political economy are unsettling. Polanyi theorized and wrote about the fictitious commodities and double movement, but, if I recall correctly, his work was weakest at coming up with solutions to the economic (and, really, political) problems of market society/capitalism.

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The Link Between Growth and Poverty is Broken

I really really like an article Neil Irwin published yesterday. Sometimes the tone and conclusions in economic reporting bother me, but this one gets it just right (one gripe is labeling EPI a “liberal-leaning group,” I mean they do more hard data and policy work than I could even dream of… why can’t you just call them “academics and wonks who care about things like poverty”).

Basically EPI just released a study on the link between economic growth and poverty that shows a strong link in the 1959-1973 period where there is substantial growth and falling poverty. Then the link breaks in the 1970s:

From 1959 to 1973, the nation’s economy per person grew 82 percent, and that was enough to drive the proportion of the poor population from 22 percent to 11 percent.

But over the last generation in the United States, that simply hasn’t happened. Growth has been pretty good, up 147 percent per capita. But rather than decline further, the poverty rate has bounced around in the 12 to 15 percent range — higher than it was even in the early 1970s. The mystery of why — and how to change that — is one of the most fundamental challenges in the nation’s fight against poverty.

From 1959 to 1973, a more robust United States economy and fewer people living below the poverty line went hand-in-hand. That relationship broke apart in the mid-1970s. If the old relationship between growth and poverty had held up, the E.P.I. researchers find, the poverty rate in the United States would have fallen to zero by 1986 and stayed there ever since.

Irwin is level-headed in his explanation and interpretation. I liked how he laid out the facts and asks U.S. policymakers for more than just meaningless platitudes in economic policy:

“The federal government,” Paul Ryan, the House Budget Committee chairman, wrote in The Wall Street Journal, “needs to remember that the best anti-poverty program is economic growth,” which is not so different from the argument put forth by John F. Kennedy (in a somewhat different context) that “a rising tide lifts all boats.”

In Kennedy’s era, that had the benefit of being true.


[T]he facts still cast doubt on the notion that growth alone will solve America’s poverty problem.

If you are committed to the idea that poor families need to work to earn a living, this has been a great three decades. For households in the bottom 20 percent of earnings in the United States — in 2012, that meant less than $14,687 a year — the share of income from wages, benefits and tax credits has risen from 57.5 percent of their total income in 1979 to 69.7 percent in 2010.

The percentage of their income from public benefits, including Medicaid, food stamps, Social Security and unemployment insurance, has fallen in that time.

The fact that more of poor families’ income is coming from wages doesn’t necessarily mean that they’re getting paid more, though. In fact, based on the E.P.I.’s analysis of data from the Census Bureau, it appears that what income gains they are seeing are coming from working more hours, not from higher hourly pay.

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EU Blues

First post in a while. Kudos to Sam for his amazing take down of austerity and other such economic illiteracy. The little Rogoff/Reinhardt spreadsheet error was responsible for major delusions about the “right” ratio of debt to GDP. Perceptions that had a real impact on thousands (millions?) of lives/jobs in Europe.

Austerity was a terrible idea for a sluggish EU economy (0.3% GDP growth in 2014) and it did little to heal emerging rifts in the European community. Fast forward to today, and we are seeing major gains made by eurosceptic, populist and right-wing political parties in local and European elections.

In France, the National Front, Marine Le Pen’s bigoted, anti-immigrant, nationalist party, won 26% in recent elections, far ahead of the conservative UMP and the Socialists. Similar results in Britain, where the UK Independence Party made huge gains. A party that claims it is not homophobic OR racist, which just had to suspend one of its worst offenders, a certain Councillor Dave Smalls, for posting on facebook that gay people are “perverts” and Malians are “scroungers.” Similar folks got elected in Denmark, Austria, the Netherlands and elsewhere.

The Financial Times summed up the results:

“Ukip is forecast to be the biggest winner in the UK’s European race seizing 30 per cent of the popular vote and securing 24 seats in the EU assembly, 11 more than in 2009.

Among other eurosceptic parties, the Danish People’s party was set to become the biggest in Denmark with about 25 per cent of the vote. Meanwhile, Austria’s populist party, the FPÖ, is set to finish third with 20 per cent of the vote – against 12.7 per cent in 2009.

The gains of the populists could be sufficient for Ms Le Pen to form an anti-EU group with other like-minded parties. That would give them extra funds and speaking rights to destroy the “Brussels monster”.

According to exit polls released by the European Parliament, the European People’s party centre-right grouping in the assembly is set to win the elections with 212 seats, followed by the Socialists with 185; the Liberals with 71; and the Greens 55. Eurosceptic and anti-establishment parties from both left and right won 228 seats.”

228 seats? Europe, you are seriously scaring me right now.

“Voter turnout across the continent was estimated at 43.11 per cent, practically unchanged from 2009.”

No change in voter turnout in five years, and at a percentage that rivals sham elections like the ones Egypt just held. I wish it was just a sad joke, but it’s just the state of EU politics. We had our little experiment with Europe, now its time to crawl back under our rocks.

But wait, just watch this video from the European Commission:



There, all better.


Full EP election results here: http://www.results-elections2014.eu/en/election-results-2014.html

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Lessons After Reinhart & Rogoff: Not Just Wrong, the Opposite of Right

(I want to apologize to the people to whom I tried to explain Vector Autoregressive (VAR) models at bars this weekend)

Carmen Reinhart and Ken Rogoff, two prominent and smart economists, are best known for their research on debt and financial crises. Their research “found” a link between debt and economic growth, so they postulated that higher debt causes lower growth, and that this effect particularly occurs at 90% public debt -to-GDP. They believed and argued strongly and convincingly that high levels of public debt hurt the economy, though they did provide the disclaimer that the causal relationship may partially run in the other direction (slow growth causes high growth). This provided cover for deficit hawks and conservatives to argue for cutting government spending in the U.S. and EU.

Turns out this work on debt and growth was wrong and the lessons and policies resulting from it had the opposite effect than was intended.

Last summer, a UMass graduate student, Thomas Herndon, tried to replicate R&R’s results for a class assignment, found mistakes (some small, some less small), and ended up publishing an awesome paper.

I’ve talked about this before, but there is fun new research to share.

I am fairly confident that the thorough debunking of a “90% threshold” or a “tipping point” for public debt is basically complete.

In addition to debunking the tipping point concept, evidence that the causal relationship learned from R&R’s research is incorrect is accumulating. Miles Kimball and Yichuan Wang put up a great argument in Quartz last year. Their conclusions?

Here is the bottom line. Based on economic theory, it would be surprising indeed if high levels of national debt didn’t have at least some slow, corrosive negative effect on economic growth. And we still worry about the effects of debt. But the two of us could not find even a shred of evidence in the Reinhart and Rogoff data for a negative effect of government debt on growth.

More recently, Professors Matthijs Lof and Tuomas Malinen wrote their own paper where they find that not only does high public debt not cause low growth, the relationship appears to run in the opposite direction! They use Vector Autoregressive (VAR) models to tease out the inherent problem of endogeneity in this type of question where the variables being studied may affect each other

Even if a negative correlation between debt and growth seems undisputed, this does not imply that debt is harmful for growth, since correlation does not always imply causation. In fact, Reinhart and Rogoff (2010b) have emphasised the possible bi-directional causality between debt and growth. They argue that high debt may lead to higher taxes and/or lower government expenditure, which is harmful for economic growth, while on the other hand periods of low growth may lead to high deficits and accumulation of debt. Nevertheless, these hypotheses are not backed by a quantitative analysis to establish the relative size and significance of each direction. To decompose the correlation into cause and effect, we apply Vector Autoregressive (VAR) models. Our main result is that debt does not seem to have any significant impact on growth.

Methods and results

We estimate a VAR for sovereign debt and GDP growth on panel data for 20 OECD countries over a period of 55 years, which we obtain from the dataset of Reinhart and Rogoff (2009). Detailed descriptions of the data and model can be found in our recent article (Lof and Malinen 2014). The application of VAR models has several advantages.

  • First, a VAR treats both debt and GDP as endogenous. Both are allowed to have an impact on each other, and these impacts can be separated.
  • Second, a VAR is a dynamic model, such that we can analyse and quantify intertemporal impacts. By computing so-called impulse response functions, we can visualise the long-run impact on both variables after a shock hits one of the variables.
  • Finally, a VAR is a fairly simple model, which is estimated by regressing both debt and GDP growth on both their own and each other’s past observations.

Eberhardt and Presbitero (2013b) emphasise the role of nonlinearities and cross-country heterogeneities, to show that there is no robust evidence for a significant effect of debt on growth. Our analysis shows that this holds even in this simple linear framework.

Awesome, right?

Based on a simple VAR analysis with panel data, we can conclude that there is little evidence for a negative long-run effect of sovereign debt on economic growth. Our findings are consistent with recent studies applying different methods, such as Panizza and Presbitero (2013), as well as Kimball and Wang (2013) who “could not find even a shred of evidence in the Reinhart and Rogoff data for a negative effect of government debt on growth”.

Using the negative correlation between debt and growth as a justification for austerity policies could be another example of confusing correlation with causation. While high levels of sovereign debt may surely be a burden for a country, the claim that debt is harmful for growth is not supported by our results.

So this is awkward, when the U.S. turned to austerity policies in 2010, with the leadership of Blue Dog Democrats, President Obama, and relentlessly hawkish Republicans, they claimed lower government spending was good and would cause lower public debt and higher growth. It turns out that cutting government spending when the economy is weak causes lower growth, and lower growth causes higher debt burden. We knew better and there were economists who told them not to do it, but the politicians didn’t listen. Why? Who knows, maybe Professor Wren-Lewis can figure it out.

This is why it annoys me when people say things like (sorry Chris, I know you said this today) “I think I’m socially liberal and economically/fiscally conservative.” What is “economically conservative”? Is it a code word for economically illiterate (or I guess macroeconomically illiterate)? Stop saying that and listen to me!! (or better yet do your own research (or get a PhD)!). I hope I didn’t get too mean here at the end and I’m sorry if I did. I think I’m naturally argumentative, this is stuff I care about, and the resulting policies affect millions of people’s lives.

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What I wish policy debates were like (on mortgage debt, financial crisis, and recession)

Jared Bernstein summarizes an awesome debate that is going on in the economics world and blogosphere right now:

There’s a very interesting, albeit down-in-the-weeds, analytic debate brewing around a confluence of recent publications.  Tim Geithner’s new book defends the interventions of the Treasury Department he led to reflate credit markets (and I worked with the team on this back then).   Mian and Sufi’s new book, reviewed here by Bin Appelbaum, argues that Treasury got it wrong by not recognizing the extent to which debt burdens were restricting growth and intervening in ways to write off more debt: “The fact that Secretary Geithner and the Obama administration did not push for debt write-downs more aggressively remains the biggest policy mistake of the Great Recession.”

Dean Baker has long argued the problem was not just the debt overhang but the wealth effect’s sharp shift into reverse when the housing bubble burst.  That’s similar to Main/Sufi except it implies that even had you forgiven the debt, consumption still would have tanked.  Brad DeLong articulates an “all-of-the-above” theory, suggesting each of these analyses gets at one part of the problem but you need all of them to understand what happened.

Here’s what I think.  It comes from a line Matt Yglesias once wrote, reflecting on the Reinhart/Rogoff view that balance-sheet recessions that result from a leveraged bubble bursting tend to be particularly hard to grow out of.  Matt said something to the effect of: “it’s like trying to drive out of a deep fog–you have to go very slowly or risk crashing.  However, if you have strong fog lights, you’re much less restricted.”

“Fog lights” in this context mean you have to do everything you can to get the system back up.  You have to reflate the credit system through both liquidity (as in the TARP) as well as Mian/Sufi-style principal reductions and cramdowns of mortgage debt that cannot realistically be serviced without sustained pain.  The administration did a lot of the former and little (not none) of the latter.

Why not?  From where I sat, and I didn’t see everything from my seat for sure, it was less about protecting creditors per se than the belief that breaking contracts was an interventionist step too far (though the fact that this principal was less active in the auto-bailout suggests a protection that extended more to white than blue collar industry).

It was also argued at the time that the administration tried to get Congress to write legislation allowing bankruptcy judges to allow cramdowns on primary residences but the members uniformly said no.  You ask me, I think we didn’t push hard enough, again, based on the perceived sanctity of debt contracts.

Dean’s point means that debt forgiveness and revived credit flows must be met with deep fiscal stimulus that lasts as long as needed (he also emphasizes the demand-zapping role of the US trade deficit).  No question that accelerating the deleveraging cycle will hasten the recovery, but as long as unemployment remains high, job growth slow, and real wages flat, demand will be seriously constrained by the negative wealth effect, even as debt forgiveness dampens that dynamic.

With the private sector still licking its wounds, absent committed stimulus there’s no reason to expect deleveraging, or even aggressive monetary policy, to trigger the growth needed to reach escape velocity.  In fact, you might expect to see a pattern as in the figure below, which plots households’ debt service as share of disposable income against real, year-over-year GDP growth.  Deleveraging would have surely been faster with more debt forgiveness, but without doing more to offset the crashing wealth effect, we may have still been in the slog you see there: basically, a return to trend growth before the output gaps were closed.

To be clear, the administration did, in fact, respond quickly and effectively with precisely this stimulative “fog light” but the headlights dimmed before the fog cleared.  Why?  Because of a precipitous pivot to deficit reduction.  And, of course, aggressive stimulus was not accompanied by aggressive debt reduction.

So I’m with Brad—all of the above.   And let’s keep it real: the problem was not only that we didn’t do all of the above.  It’s that even when we did the right things, we didn’t stick with them long enough.  The important thing now is to try to learn from our mistakes, and I for one am thankful to all of these authors for continuing to plumb these deep waters.


I was taken with Mian and Sufi’s argument until I read Professor Delong’s take:

But to the argument–to Amir and Atif, and Dean, and Ryan–what I want to do is to respond: “yes, but…” and “not really…”

As any monetarist will tell you (whether you want them to or not), an economic recession is an episode in which less money is supplied than the economy’s decision-makers wish to hold at full employment. In such a case, the consequence is a “general glut”: a critical mass attempt to cut their total spending below their incomes as they try to build up their money balances with no counterbalancing mass trying to spend more than their incomes, but such my spending is your income the result is depression. An excess demand for money accompanied, by virtue of Walras’s Law, by an excess supply of pretty much everything else. This process can be interrupted only if the system “prints” the extra money decision-makers want to hold. The banking system can print “inside” money–if it dares, and if decision-makers trust it enough to classify transferable banking-sector liabilities as means of payment. The central bank can print “outside” money. Or we can wait, mired in depression, until price levels fall enough to raise real balances supplied to a sufficient level.

The key to depression, in my view at least, is not a decline in any component of spending: it is the decline in one component of spending below its decision-makers’ incomes while the normal economic channels are blocked that would normally lead some other component of spending to rise above its decision-makers’ incomes.

We can see this from 2005-2007. Residential investment as a share of GDP collapses. But as residential investment collapses, does GDP shrink? No. The grey zone of GDP shrinkage starts only in early 2008, even though residential investment had already fallen from 6.2% to 3.7% of GDP beforehand. From 2005-2007 those who had financed residential investment did not decide to stop funding residential investment and start building up their cash balances. They decided to stop funding residential investment and use their money to fund something else–net exports, or additional government purchases, or business investment.

And then, from 2007-2009, collapsing home values significantly impact household wealth and lead them to cut their consumption spending back below their household incomes. But why is it that this reduction in money flow into the shopping malls as consumers cut spending below income to build up their cash balances is not properly compensated by an increase in money flow elsewhere as foreigners, governments, businesses draw down their gross cash balances, and as bankers draw down their net cash balances?

And to understand that we need to look at the banking system. We already know about the size of the negative shock to spending from the construction sector. Mian and Sufi do an excellent job of documenting the size of the negative shock to spending from the household sector via the housing equity-underwater mortgage-wealth channel–and in the process do, I think, successfully demolish Tim Geithner’s claims in his Stress Test that aggressively refinancing mortgages would not have materially helped the economy.

But to explain a deep, long, persistent downturn you need more than a big shock. You need: (a) a big shock, and (b) forces that make that shock persistent, and (c) an absence of damping mechanisms elsewhere in the system, and (d) an absence of recovery mechanisms elsewhere in the system. Mian and Sufi, I believe, do an excellent job of tracing the household wealth channel via (a) and (b)–how the overleverage followed by the collapse of the housing bubble delivered not juts a construction shock but a consumption shock, and how the failure to resolve underwater mortgages made the consumption shock persistent. (And I reflect that Chrysler and GM got resolved with their top executives fired and their shareholders and option holders zeroed out; the New York banks got fed huge amounts of money while their top executives kept their jobs and their shareholders and option holders got made large whole, and underwater homeowners got nothing.) But to explain (c) and (d) we need more than Mian and Sufi (and Baker) can give us: we need the banking, monetary, and fiscal policy stories as well.

Thus when Ryan Avent writes:

Shifting focus from banks to households, in turn, leads [Mian and Sufi] to very different remedies, the most radical of which is to replace many loans with equity-like contracts in which lenders share losses with borrowers…

Again I want to say: “yes, but…” As Larry Summers, Paul Krugman, Joe Stiglitz, and Laura Tyson all like to say: you don’t have to fill a tire through the leak. restoring consumer spending via successfully rewriting mortgage contracts to rebalance household balance sheets would have been a wonderful thing to do. It would still be a wonderful thing to do. But it was and is not the only thing to do to get us out of our current mess.

But let me endorse Ryan Avent’s endorsement of Mian and Sufi’s bottom line:

What is needed, they argue, is to make debt contracts more flexible, and where possible, replace them with equity. Courts should be able to write down the principal of mortgages as an alternative to foreclosure. They recommend “shared-responsibility mortgages” whose principal would decline along with local house prices. To compensate for the risk of loss, lenders, they reckon, would have to charge a fee equal to 1.4% of the mortgage, or receive 5% of any increase in the value of the property…

All I can say is that I thought that this was the system that we had. I thought–from the Great Depression era history of the HOLC and the RFC, from the 1980s history of the Latin American debt crisis, from the 1990s history of the RTC, from innumerable emerging-market crises, et cetera, that we understood very well that this is what we should do. Whenever the financial system got sufficiently wedged we resolved it–we turned debt into equity, and we crammed losses down onto debt holders whose investments were ex post judged to have been ex ante unwise.

And from my standpoint the true puzzle is why Bernanke, Geithner, and Obama were so uninterested in pulling out the Walter Bagehot-Hyman Minsky-Charlie Kindleberger playbook and following it in housing finance from 2009-2014. Did they read no history?

And let me qualify Ryan’s conclusion:

[But] while debt may be dangerous for the borrower, it is the opposite for the lender. Savers prefer the safety and predictability of a debt contract, which is why they accept lower returns on bonds over time than on equities. Many debt contracts exist primarily to satisfy this desire for safe assets—most notably bank deposits…

This is true only as long as the economy is not overleveraged. When it is overleveraged–when debt is underwater–the mismatch between cash-flow and control rights means that even lenders should prefer to “resolve” and transform debt into some more equity-like claim.

I wish that the politics/policy world had taken homeowner debt relief seriously. The proposed cram down legislation, in addition to dozens of other plans to help homeowners, could have improved millions of lives. Having the Delong historical perspective would have made the arguments for those policies that much stronger. With such a myopic and dysfunctional Congress, it seems to me that helping homeowners (not to mention housing finance reform) never stood much of a chance.

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One reason I might want to end up in Berkeley

Robert Reich is smart.

It would be nice to implement any policies to reduce inequality, but Professor Reich has 10 for us:

Some inequality of income and wealth is inevitable, if not necessary. If an economy is to function well, people need incentives to work hard and innovate.

The pertinent question is not whether income and wealth inequality is good or bad. It is at what point do these inequalities become so great as to pose a serious threat to our economy, our ideal of equal opportunity and our democracy.


This trend is now threatening the three foundation stones of our society: our economy, our ideal of equal opportunity and our democracy.

The economy. In the United States, consumer spending accounts for approximately 70 percent of economic activity. If consumers don’t have adequate purchasing power, businesses have no incentive to expand or hire additional workers. Because the rich spend a smaller proportion of their incomes than the middle class and the poor, it stands to reason that as a larger and larger share of the nation’s total income goes to the top, consumer demand is dampened. If the middle class is forced to borrow in order to maintain its standard of living, that dampening may come suddenly—when debt bubbles burst.


Equal opportunity. Widening inequality also challenges the nation’s core ideal of equal opportunity, because it hampers upward mobility. High inequality correlates with low upward mobility. Studies are not conclusive because the speed of upward mobility is difficult to measure.

But even under the unrealistic assumption that its velocity is no different today than it was thirty years ago—that someone born into a poor or lower-middle-class family today can move upward at the same rate as three decades ago—widening inequality still hampers upward mobility. That’s simply because the ladder is far longer now. The distance between its bottom and top rungs, and between every rung along the way, is far greater.


Democracy. The connection between widening inequality and the undermining of democracy has long been understood. As former Supreme Court Justice Louis Brandeis is famously alleged to have said in the early years of the last century, an era when robber barons dumped sacks of money on legislators’ desks, “We may have a democracy, or we may have great wealth concentrated in the hands of a few, but we cannot have both.

What We Must Do

There is no single solution for reversing widening inequality.


…[from Economist's View]

1) Make work pay. … [Min wage, EITC, etc.]
2) Unionize low-wage workers. …
3) Invest in education. …
4) Invest in infrastructure. …
5) Pay for these investments with higher taxes on the wealthy. …
6) Make the payroll tax progressive. …
7) Raise the estate tax and eliminate the “stepped-up basis” for determining capital gains at death. …
8) Constrain Wall Street. …
9) Give all Americans a share in future economic gains. … [Diversified index of stocks and bonds given to all at birth]
10) Get big money out of politics. …

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Piketty-Pessimistic Salmon

Felix Salmon points out that the World Economic Forum’s Global Risks Report called out inequality as a serious threat in 2012. Piketty’s big idea is that throughout history the return on capital (“r”) has been greater than growth (“g”), and that the Great Moderation when inequality consistently fell and g was greater than r, was an anomaly. It was an exceptional period that will not naturally return. This implies that our economic system, “capitalism,” is naturally prone to the great accumulation of wealth, even to develop into plutocracy.

In discussing the economy and these issues with my friends, I find two things particularly hard to contemplate: 1) How should we approach capitalism’s aristocratic/plutocratic tendency? What policies can I advocate and ideas can I come up with? (especially in society today, where finance occupies a huge and growing part of the U.S. economy and continues to build dominant influence on the political system); 2) How can I be optimistic about the future when I know that the chances of near all effective economic policies being enacted is close to nil?

Like Felix Salmon, I feel pretty Piketty-Pessimistic, but, at the same time, there are people out there making strides in the research and policy fields who successfully fight off the pessimism bug. Those people, like Thomas Piketty, Emmanuel Saez, Paul Krugman, Larry Summers, Elizabeth Warren, Christina and David Romer, George Akerlof and Janet Yellen (just to name a few I’ve read and listened to lately), are much smarter than me and have not succumbed to the pessimistic reading of the evidence in Capital in the 21st Century. My Dad got me the book for my birthday and I’m excited to see if I enjoy the book as much as Piketty-Saez’ papers.

Here is Salmon’s description of the pessimistic vs. optimistic view of the book:

Chrystia Freeland has a hopeful thesis. “Piketty’s work,” she says, “and the wider shift it surely portends, poses a new, powerful, existential threat to the plutocrats.” Her argument in a nutshell: politicians across the political spectrum, but especially on the left, have historically used the language of criminality to rail against the rich. (See, for instance, how the WEF said that “corruption” was the third-most-likely global risk in 2011.) In other words, capitalism itself is generally assumed to be a pretty good thing, which works well for everybody so long as everybody plays by the rules. But Piketty has challenged that assumption, by showing that even if everybody plays by the rules, inequality is very likely to increase to obscene levels. It’s not the corrupt and venal robber barons who are the problem, it’s rather that unless we make a concerted effort to impede capitalism’s natural tendencies, the entire middle class is likely to get hollowed out.

Freeland limns this debate well: on the one side are the likes of Matt Taibbi and Michael Lewis, always on the hunt for villains; on the other side are people looking at a broader historical sweep, and saying that if you go around blaming individuals you are always going to miss the bigger picture. Piketty, of course, is in the latter camp, but so are people like Erik Brynjolfsson and Andrew McAfee, who see success in the future accruing increasingly to a small group of high-level “ideators”, while the jobs of much of the present middle class become automated.

If the broad public stops being angry at individuals and starts understanding that the entire system is constructed so that it benefits the few at the expense of the many, then that system itself will start looking unsustainable and ripe for dismantling.

Freeland herself concedes that this is unlikely to happen any time soon: “The only thing worse than having plutocrats is not having them,” she writes. “San Franciscans may be rising up against their tech billionaires, even blockading the Google bus, but the rest of the world, from Moscow to Malaysia, is trying to replicate Silicon Valley.” On top of that, as Paul Krugman explains in his masterful NYRB review, the forces described by Piketty are more likely to be self-reinforcing than they are to carry the seeds of their own destruction:

Falling tax rates for the rich have in effect emboldened the earnings elite. When a top manager could expect to keep only a small fraction of the income he might get by flouting social norms and extracting a very large salary, he might have decided that the opprobrium wasn’t worth it. Cut his marginal tax rate drastically, and he may behave differently. As more and more of the supersalaried flout the norms, the norms themselves will change.

Which means that ultimately I have to disagree with Freeland. Her syllogism runs something like this:

-Capitalism has survived this far because it delivered strong, widely-shared growth.
-If capitalism fails to continue to deliver strong, widely-shared growth, then it will fail and die.
-Thanks in part to Piketty, the leaders of the major western democracies — both the politicians and the plutocrats — now understand this.
-Therefore, they will, of necessity and of self-interest, alter the structure of society to preserve (what’s left of) the middle classes.

This starts off well, but becomes increasingly improbable as it goes on. As Piketty shows, capitalism can continue indefinitely with obscene levels of inequality. Politicians and plutocrats are not focused on what’s going to happen decades from now; instead, they’re engaged in a constant battle to maximize their own personal power, even — especially — if that means amassing enormous quantities of wealth for themselves. And finally, for all that it’s the job of politicians (including Freeland) to campaign on the basis that they can change the world in effective and predictable ways, there’s precious little evidence that really they can. Just as the forces of capitalism are bigger than any individual robber baron, so are they bigger than any individual politician or political party.

The many reviews of Piketty’s book are surprisingly unanimous on one point: that the weakest part of the book is the final part, where Piketty moves away from diagnosis and starts attempting to formulate a solution. Piketty’s rather French idea of a global wealth tax isn’t getting nearly the same amount of acclaim as the rest of the book is, and is very unlikely to happen: countries will always compete with each other to attract the stateless rich by not taxing them.

Which means that my reading of Piketty is ultimately pessimistic. The dynamics of the world economy are bad, and they’re getting worse; inequality is natural in human history, and right now we’re reverting to a state of affairs which is highly unfair but also both sustainable and, in its own way, unsurprising. Piketty has diagnosed a nasty condition. But I don’t think there’s a cure.


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