Borrowing Our Way into Debt

On September 26, 2011, in economic theory, housing, monetary policy, tax policy, by Jon Lewis

Lost Decades: The Making of America’s Debt Crisis and the Long Recovery. Menzie D. Chinn and Jeffry A. Frieden. W.W. Norton & Company 2011, pp.284, $26.95 The United States is facing a debt crisis that will shape not only American politics, but also American culture for decades to come. Those policymakers tasked with solving this [...]

Lost Decades: The Making of America’s Debt Crisis and the Long Recovery. Menzie D. Chinn and Jeffry A. Frieden. W.W. Norton & Company 2011, pp.284, $26.95

The United States is facing a debt crisis that will shape not only American politics, but also American culture for decades to come. Those policymakers tasked with solving this crisis must do so in a context where the national unemployment rate in August was at 9.1%, many recent college graduates are underemployed and living at home with their parents, and the stock market is exhibiting increased volatility. How did the United States get to the point where the gross debt is about 98% of U.S. GDP and, more importantly, where do we go from here?

In Lost Decades, Menzie D. Chinn (University of Wisconsin-Madison) and Jeffry A. Frieden (Harvard University) argue that our current dire economic situation is, despite its unique attributes, a classic debt crisis, resulting from a capital flow cycle in which foreign capital flooded into the United States, stimulated a boom, and resulted in a subsequent bust. Although they are not hyper-partisan in their writing, Chinn and Frieden contend that flawed and shortsighted government policies are to blame for the current mess in which we find ourselves.

In their formulation, between 2001 and 2007, the United States pursued dangerous policies that, in the past, it had warned other countries against. These included “excessive borrowing, unproductive spending, foolish tax policies, and unwarranted speculation.” Much of the borrowed money from abroad was not utilized productively; rather, much of it was diverted into an unsustainable housing boom made possible by innovations in structured finance. These aforementioned dangerous policies, the authors argue, led to the near meltdown of the financial sector in 2008 and to the United States losing, in economic terms, the first decade of the twenty-first century. Should we collectively fail to respond adequately to the serious challenges facing the American economy, the authors warn, we shall lose another decade.

Due to the authors’ utilization of a comparative and an historical approach to explain America’s dire economic situation, Lost Decades stands out among recent scholarship on the financial crisis. Chinn and Frieden make a strong case for their argument that the American borrowing binge and its resultant debt was, in many ways, not all that different from other countries’ experiences. It was, however, different in its scope. The authors pull no punches; they contend that “there has rarely been a capital flow cycle quite so enormous in its upswing as the American borrowing boom of 2001-2007, and there has rarely been a crash quite so dramatic or so global as the American collapse of 2008.” Indeed, the authors point out that the United States is now the largest international debtor ever in world history. A stark warning of the unsustainability of our current course, if ever there were one.

Readers interested in globalization and the nuances of world trade will find much of value in Lost Decades. Particularly salient is the authors’ discussion of the U.S.-Chinese economic relationship and the need for global rebalancing. American policymakers, we are reminded, have to make their decisions within a global context and with global repercussions. This is notably the case with respect to American concerns regarding the Chinese government’s deliberate policy of keeping their currency, the renminbi, very weak or depreciated. The authors suggest that this conflict over the value of Chinese currency “is emblematic of the domestic and international conflicts the Great Recession will spark and deepen.” One could imagine other scholars taking up this point and conducting a study of how the Great Recession has already affected the American relationship with China and how it will continue to do so in the future.

For ideologues on both sides of the aisle, the most controversial portion of the Lost Decades will be the penultimate chapter. Here, the authors offer their policy recommendations on how the United States should proceed so as to avoid another lost decade. The authors, whose political views could be described as center-left, call for fiscal responsibility and are upfront in their belief that “true fiscal responsibility involves a willingness to raise sufficient tax revenue, over the longer term, to pay for the programs the government implements. Fiscal responsibility should not be equated with a small government, but rather with a commitment to pay for the government services provided.” Whether the American voting public agrees with this particular understanding of fiscal responsibility, of course, will be decided at the ballot box in 2012.

The authors, it should be noted, are not liberal ideologues, either. They rightly acknowledge that entitlement spending, particularly the challenges posed by Medicaid and Medicare, are driving the budget deficit. The only measures likely to make a real difference in countering the deficits and reducing the debt burden, they contend, are to both make substantial reductions in Medicare, Medicaid, and Social Security and to significantly increase taxes. Whether Democrats and Republicans will be able to put together such a deal, one that would anger both their political bases, remains to be seen.

While the authors are not without merit in criticizing the Bush Administration for creating the Medicaid prescription drug program without proper funding, they fail to take seriously the increasing probability that the Obama Administration’s signature health care reform legislation will have a deleterious effect on the American economy and job creation. In addition, for a work on the financial crisis of 2008, Lost Decades does not adequately address the impact that the Community Reinvestment Act had on aiding and abetting the housing bubble. Likewise, it could be argued that the authors let Fannie Mae and Freddie Mac off the hook a little too easily.

Despite these shortcomings, Lost Decades is a highly informative analysis of the American debt crisis. The authors explain difficult economic and financial concepts with great clarity. Even if one does not agree with all of the authors’ arguments, their work is one of most comprehensive on the financial crisis. To that extent, it is worth ample consideration by those interested in moving beyond platitudes and toward a workable solution to America’s economic woes.

Jon Lewis (c) 2011

Tagged with:  

Jobs in an Uncertain World

On September 10, 2011, in economic theory, by Jon Lewis

Little Bets: How Breakthrough Ideas Emerge from Small Discoveries. Peter Sims. Free Press, 2011, pp. 213, $25.00 With the dismal news about zero job growth in August 2011 and significant evidence that the United States might be entering another recession, it behooves policymakers to think critically about ways in which we might get the economy [...]

Little Bets: How Breakthrough Ideas Emerge from Small Discoveries. Peter Sims. Free Press, 2011, pp. 213, $25.00

With the dismal news about zero job growth in August 2011 and significant evidence that the United States might be entering another recession, it behooves policymakers to think critically about ways in which we might get the economy rolling again. While President Obama has called for payroll tax cuts and increased spending, the Federal Reserve has not yet signaled whether it will utilize any measures to stimulate the economy. The only certainty about the American economy, it would seem, would be that the future is increasingly uncertain for both businesses and households alike.

The immediate political concern in Washington is how to create jobs and get Americans working again. Often forgotten in the national discussion, however, is the fact that what the United States may really need is a new generation of risk-taking entrepreneurs who will be able to both create jobs and provide new goods and services that will enhance consumer welfare.

Although Peter Sims’s Little Bets is neither a political tome nor an work of political economy, it does provide a unique and welcome perspective on entrepreneurship that merits serious attention by both policymakers and those concerned about lagging job growth and America’s declining global competitiveness. Sims, a writer with an MBA from Stanford University and a career background in venture capital, challenges the reader’s assumptions about what successful entrepreneurship requires.

Sims, who acknowledges the inspiration and collaboration of George Kembel from Stanford’s d.school, draws upon contemporary academic scholarship and utilizes case studies. These include both the thinking and work of architect Frank Gehry, Amazon’s Jeff Bezos, and U.S. General McMaster, who developed the ‘clear and hold’ counterinsurgency strategy in Iraq, to make the case for experimental innovation. The author draws upon the concept of “little bets,” a phrase coined by former Hewlett-Packard Executive Vice President Ned Barnholt, to describe a way of thinking that embraces unpredictability, creativity, and nonlinear thinking in which entrepreneurs do not begin with a brilliant idea, but rather discover them through experimentation and an acceptance of failure.

The author describes Little Bets as being “based on the proposition that we can use a lot of little bets and certain creative methods to identify possibilities and build up to great outcomes. At the core of this experimental approach, little bets are concrete actions taken to discover, test, and develop ideas that are achievable and affordable.” He identifies the following as fundamental to the little bets approach to thinking: experimentation, playfulness, immersion in the world, defining specific problems and needs before solving them, reorientation and flexibility, and iteration. The methodology utilized by the comedian Chris Rock is of particular interest to Sims. To hone his craft, Rock regularly appears at a small comedy club in New Brunswick, New Jersey where he repeatedly tries out new jokes, many of which fail to resonate with the audience. It is through this repetitive process of experimentation, contends Sims, which makes Rock such a successful comedian.

One of the more important insights in Sims’s work is that rigid, linear thinking may no longer serve us well going forward in an uncertain, largely unpredictable era. Adaptability, rather than ideology or a reliance on the past to predict the future, may be the most useful skill. Although Sims is not a political writer, he does briefly reference how former Federal Chairman Greenspan had to rethink his ideological assumption in the wake of the financial crisis. “Just as former Chairman of the Federal Reserve Board Alan Greenspan acknowledged a ‘flaw’ in his understanding of markets during the 2008 economic crisis, we cannot rely on past assumptions to predict the future. In this era, being able to create, navigate amid uncertainty, and adapt increasingly be vital advantages.” If Sims is correct in his assessment, and there is no good reason to believe that he is not, the implication for formulating appropriate regulatory and tax policies is stark. It would seemingly imply that well-worn shibboleths about unfettered and deregulated free markets, spending, and taxation that harken back to the political debates of the 1980s are no longer workable in today’s complex, globalized world. Although he could have amplified upon this point further, Sims, referring to work of educational historians, rightly observes that the American system in its current form was designed for the industrial era and not for the knowledge economy.

In conclusion, creative types, entrepreneurs, and free thinkers who feel constrained by the rigidity that dominates much of the corporate world and federal bureaucracy today would likely agree wholeheartedly with Sims’s assessment that we are taught to be linear thinkers in a nonlinear world. Although he acknowledges that, “experimental innovation should not entirely replace linear thinking in our regular work processes,” Sims nevertheless does put forth a cogent argument as to why those individuals who are willing to think differently and persevere through likely failure have a distinct advantage in an ever-increasingly uncertain global economy. The future may no longer be so bright that we all have to wear shades; it may, however, be so uncertain and unknowable that we must learn to appreciate the merits of nonlinear thinking.

Jon Lewis (c) 2011

Tagged with:  

Rethinking Economic Competition

On September 7, 2011, in economic theory, tax policy, by Jon Lewis

The Darwin Economy: Liberty, Competition, and the Common Good. Robert H. Frank. Princeton University Press 2011, pp.240, $26.95 Following the financial crisis of 2008 and the subsequent automobile and bank bailouts, which solidified already-increasing ties between the federal government and the private sector, intellectual interest in free market economics has increased. This is particularly true [...]

The Darwin Economy: Liberty, Competition, and the Common Good. Robert H. Frank. Princeton University Press 2011, pp.240, $26.95

Following the financial crisis of 2008 and the subsequent automobile and bank bailouts, which solidified already-increasing ties between the federal government and the private sector, intellectual interest in free market economics has increased. This is particularly true for those members of the Millennial Generation who are attracted to the libertarian message of free market competition and social tolerance. But what if competition does not always lead to prosperity, but instead leads to mutual disadvantage? What if the framework for understanding how competition works has been fundamentally misunderstood and has only exacerbated the dismal budgetary outlook for the United States?

In The Darwin Economy, Cornell economics professor and New York Times columnist Robert H. Frank argues that the current gridlock in Washington is not the result of “irreconcilable differences in values, but of a simple but profound misunderstanding about how competition works.” Reflecting the title of his academic monograph, Frank argues that the insights of Charles Darwin, rather than those of Adam Smith, are more applicable to an understanding of economics. “Darwin’s analysis revealed a systemic flaw in the dynamics of competition. The failures he identified resulted not from too little competition, but from the very logic of the process itself.”

Frank posits that collective action problems, wherein what is good for individuals within a group are not good for the group as whole, pose a challenge to the libertarian belief in unfettered free markets. As an example, Frank discusses bull elk and their antlers; in the competition for female mates among male bull elk, it is the relative size of antlers that matters. Those bull elk males with the largest antlers would clearly be victors in the quest for female elk; what is good for individual male elk, however, is not necessarily good for elk as a collective. “Although each mutation along this path enhanced individual reproductive fitness, the cumulative effect of those mutations was to make life more miserable for bull elk as a group. Large antlers compromise mobility in densely wooded areas, for example, making bulls more likely to be killed and eaten by wolves.”

Frank emphasizes the significance of Darwin’s observation that “much of life is graded on the curve” and that relative position very much matters. In other words, what constitutes a large house that confers social status on a family depends not on objective criteria for largeness, but upon a house’s size relative to other houses. Applying that insight to contemporary economic theory, Frank argues that, “no economic model can hope to capture how markets actually function unless it begins with the assumption that context shapes evaluation in significant ways.” Similarly, it is his belief that relative purchasing power matters when it comes to achieve many life goals.

This leads Frank to a larger political argument. If libertarians are wrong about competition, as he repeatedly suggests they are, the left is equally wrong about why there is a need for regulation. According to Frank, the political left’s claim “that regulation is necessary to protect us from exploitation by sellers and employers with market power” is off the mark. In his formulation, “the real reason we regulate is to protect ourselves from the consequences of excessive competition with one another.” Those who studied economics or environmental law will likely recall the tragedy of the commons problem wherein individual incentives in fishing are not aligned with group incentives, thus leading to overfishing; indeed, Frank devotes a portion of Chapter 10 to that incentive structure problem and analogizes the traditional tragedy of the commons formulation with the problem of too many elite university graduates seeking employment in the winner-take-all markets on Wall Street, leading to wasteful overcrowding.

Frank’s conceptualization of the nature of competition leads him to endorse certain policy proposals and to reject others, particularly when it comes to ameliorating America’s current deficit woes. He draws upon John Stuart Mill’s harm principle, the notion that “the government may legitimately restrict individual behavior to prevent undue harm to others” to make the case that, contrary to libertarians, the government can and should place limits on individual economic behavior.

In Frank’s formulation, however, tax policy, rather than an overly burdensome regulatory policy, should be utilized to restrict behavior that is harmful to others. “Taxing harmful activities,” writes Frank “is the best way to raise the revenue essential for reducing deficits.” He proposes that these “new taxes should be phased in only after the economy is back at full employment,” but fails to recognize that anything looking like full employment may not be in the cards for the foreseeable future. Furthermore, the nature of work itself is changing in such a way as to fundamentally challenge the conception of what it means to be employed, thus posing a challenge to Frank’s timeline for implementing the proposed taxes.

The biggest problem in imposing Pigouvian taxes – taxes on harmful activities – is in defining what constitutes harmful behavior. Taxes could also be disguised as fees. In addition, from a purely fiscal viewpoint, readers would have good reason to remain skeptical as to whether taxing harmful activities, however defined, would raise enough revenue to pay down our current debt. Reforming the tax code to reduce spending through tax expenditures would be a more sensible approach. It is also one that would not lead to what would most certainly be a contentious debate as to what particular individual behaviors are harmful to society as a whole.

Policy analysts with an interest in economic theory, cost-benefit analysis and the work of the Nobel Prize-winning economist Ronald Coase, would find much to appreciate, if not necessarily to agree with, in Frank’s new book. Frank writes in an engaging manner, successfully making complex theories accessible to a general audience. He also can also be pithy, as in his discussion of environmental regulation. “If someone insists that the optimal level of every pollutant in every environment is zero, ask him why he isn’t at home vacuuming his living room at this very moment.” In conclusion, The Darwin Economy is worth consideration, particularly by both those liberals and libertarians who are willing to have their assumptions about tax policy challenged.

Jon Lewis (c) 2011

Tagged with:  
iblogpro theme