Category Archives: Economics

Playing Russian roulette with the country’s future.

We need more adults. Robert J. Samuelson brilliantly explains why:

The budget impasse raises comparable questions. Can we resolve it before some ill-defined crisis imposes its own terms? For years, there has been a “something for nothing” aspect to our politics. More people became dependent on government. From 1960 to 2010, the share of federal spending going for “payments to individuals” (Social Security, food stamps, Medicare and the like) climbed from 26 percent to 66 percent. Meanwhile, the tax burden barely budged. In 1960, federal taxes were 17.8 percent of national income (gross domestic product). In 2007, they were 18.5 percent of GDP.

This good fortune reflected falling military spending — from 52 percent of federal outlays in 1960 to 20 percent today — and solid economic growth that produced ample tax revenue. Generally modest budget deficits bridged any gap. But now this favorable arithmetic has collapsed under the weight of slower economic growth (even after a recovery from the recession), an aging population (increasing the number of recipients) and high health costs (already 26 percent of federal spending). Present and prospective deficits are gargantuan.

The trouble is that, while the economics of giveaway policies have changed, the politics haven’t. Liberals still want more spending, conservatives more tax cuts. (Although the tax burden has stayed steady, various “cuts” have offset projected increases and shifted the burden.) With a few exceptions, Democrats and Republicans haven’t embraced detailed takeaway policies to reconcile Americans’ appetite for government benefits with their distaste for taxes. President Obama has provided no leadership. Aside from Rep. Paul Ryan (Wis.), chairman of the House Budget Committee, few Republicans have.

What do we get from our elected leaders? “Scripted evasions.”

Liberals imply (wrongly) that taxing the rich will solve the long-term budget problem. It won’t. For example, the Forbes 400 richest Americans have a collective wealth of $1.5 trillion. If the government simply confiscated everything they own, and turned them into paupers, it would barely cover the one-time 2011 deficit of $1.3 trillion. Conservatives deplore “spending” in the abstract, ignoring the popularity of much spending, especially Social Security and Medicare.

So the political system is failing. It’s stuck in the past. It can’t make desirable choices about the future. It can’t resolve deep conflicts.

This article should be required reading for anyone running for public office.

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Rogoff on the sustainability of capitalism.

I’m catching up on some readings this morning, to include recent posts by Greg Mankiw at his blog. If you are unfamiliar, and are interested in economics explained in English, not jargon, his is an excellent site.

A recent post highlighted an article by Ken Rogoff, a Professor of Economics and Public Policy at Harvard University, and former chief economist at the IMF, discussing the sustainability of capitalism.

In principle, none of capitalism’s problems is insurmountable, and economists have offered a variety of market-based solutions. A high global price for carbon would induce firms and individuals to internalize the cost of their polluting activities. Tax systems can be designed to provide a greater measure of redistribution of income without necessarily involving crippling distortions, by minimizing non-transparent tax expenditures and keeping marginal rates low.  Effective pricing of health care, including the pricing of waiting times, could encourage a better balance between equality and efficiency. Financial systems could be better regulated, with stricter attention to excessive accumulations of debt.

Will capitalism be a victim of its own success in producing massive wealth? For now, as fashionable as the topic of capitalism’s demise might be, the possibility seems remote. Nevertheless, as pollution, financial instability, health problems, and inequality continue to grow, and as political systems remain paralyzed, capitalism’s future might not seem so secure in a few decades as it seems now.

 

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Unions cave to economic realities.

Manufacturers are hiring again in America, softening a long slide in factory employment. But for a new generation of blue-collar workers, even those protected by unions, the price of employment is likely to be lower wages stretching to retirement.

A price is determined by supply and demand. Wages, the price of labor, are determined based on the supply and demand for that labor. In a recession, there is excess supply (unemployment) and often, as is now, decreased demand. All of this means lower wages. This is clear to any student of elementary economics. I’m not sure that is news to anyone but a journalist. What is news is the phrase, “even those protected by unions.”

The NYT reports:

The wages for the new hires, however, are $10 to $15 an hour less than the pay scale for hourly employees already on staff — with the additional concession that the newcomers will not catch up for the foreseeable future. Such union-endorsed contracts are also showing up in the auto industry, at steel and tire companies, and at manufacturers of farm implements and other heavy equipment, according to Gordon Pavy, president of the Labor and Employment Relations Association and, until recently, the A.F.L.-C.I.O.’s director of collective bargaining.

“Some companies want to keep work here, or bring it back from Asia,” Mr. Pavy said, “but in order to do that they have to be competitive in the final prices of their products, and one way to be competitive is to lower the compensation of their American workers.”

The shrunken pay scale for newcomers — $12 to $19 an hour versus $21 to $32 an hour for longtime workers — threatens to undo the middle-class status of even the best-paid blue-collar jobs still left in manufacturing. A similar contract limits the wages of new hires at a nearby Ford Motor Company stamping plant, but neither G.E.’s 2,000 hourly workers nor Ford’s 2,900, nor their unions nor the mayor, Greg Fischer, have objected.

Quite the contrary, all argue that job creation must take precedence over holding the line on wages, given that the unemployment rate in this Ohio River city is above 9 percent and several thousand people apply for every unfilled, $13-an-hour factory job. “The trade-off is absolutely worth it,” Mayor Fischer said, arguing that while the city is actively subsidizing G.E.’s expansion here, mainly through tax rebates, that is not enough. “You must have a globally competitive wage to create jobs,” the mayor insisted.

Unions have long favored increased benefits for their members at the cost of higher unemployment within their respective sectors. This is true across time and place. Often growth can hide the effects as demand for labor increases, but there is no free lunch. Wages must come down, and will stay down until the imbalance between supply and demand is corrected – read, “globally competitive.” Then American manufacturers will demand more of it; employment and wages will rise.

It is kind of us to wish that those working in manufacturing made more. I don’t even pretend that my job is physically taxing, and can’t imagine swinging a nine-pound hammer as a career. But such wishes are arrested by economic realities.

Free market economists have long argued that inflated wages via union contracts push jobs overseas. It’s nice to see the unions finally acknowledge this.

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Three layers of the European debt crisis.

For those of you who are a bit confused about what exactly is happening, or not happening, in Europe.

This post is for Americans who know nothing about the debt crisis in Europe.  I am going to try to provide a big picture framework and draw attention to what I think should matter most to Americans.  If you have expertise in this topic I hope you’ll help me improve my analysis.  This topic is somewhat new for me.

I think of the European debt crisis in three layers:

  1. national debt crises in several European countries;

  2. a structural crisis of the Eurozone; and

  3. potential banking crises in Europe and the U.S.

Most current press coverage is about the middle layer: can European leaders prevent the Eurozone from dissolving? The top and bottom layers deserve more attention than they are receiving. American policymakers need to think hard about and plan for the possibility that a really bad outcome in Europe leads to another American banking crisis.

Why ultimately should the US care? (As a background, the author of this post, Keith Hennessey, is the former Assistant to the U.S. President for Economic Policy and Director of the U.S. National Economic Council under ‘W.’ Hardly a liberal.)

The bottom layer, the interaction between European sovereign governments and banks in Europe and the U.S., is not getting nearly enough policy or press attention, and it worries me a lot. From an American self-interest perspective, the direct economic effects of a Eurozone collapse on U.S. exports would be very bad and could easily tip the U.S. into recession. But the effects of a collapsed Eurozone or an Italian default on European banks, and the indirect effects that are passed through to American banks, could be far, far, worse. Think 2008 financial crisis worse.  The worst case scenarios for Europe appear to pose a low probability, high consequence threat of another horrific U.S. banking crisis.  This is why American policymakers should care deeply about Europe — because if the Europeans screw it up badly, it could do serious damage to the American economy, transmitted through still flawed and vulnerable banking systems.

Read the full post here.

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“Argentina has not yet chosen to grow.”

As I previously blogged, Argentina has put in new controls to prevent capital flight. Those controls will make the problem worse. Walter Russell Mead sees the same problem.

Argentina has had more than its fair share of booms and busts. Even slight turmoil in the markets makes Argentines jittery and worried. Analysts worry that efforts to stop capital flight by the government have only made things worse.  They are right.

Argentina has long seen itself as Brazil’s chief rival for the leadership of South America.  In the last twenty years, the gap between the two has grown.  Brazil has made serious economic and institutional reforms that have resulted in a society that is both more just and more prosperous.  Argentina has lunged from one failed experiment to the next.  Brazil is trying to control capital influx; Argentina is fighting capital flight.  Brazilian companies are investing around the world and becoming recognized as leaders in a number of fields; Argentine companies are trapped in labyrinthine restrictions and have yet to make much impression in the world beyond. Brazil still faces many obstacles and problems but has made a decisive break with the futility of underdevelopment; Argentina is still stuck in the quagmire.

He is a little more optimistic than I am:

At some point a critical mass of Argentines will note the difference between the development trajectories of the two countries and build a political movement to put Argentina on a sustainable course.

In my opinion, they have no yet begun to exhaust their reservoir of self-defeating policies, and the Argentine populace seems impervious to that realization.

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Dr. Doom Sees More Doom

Nouriel Roubini, a professor from NYU most famous for predicting the housing collapse, sees more disaster ahead. Writing in the Financial Times, Roubini, nicknamed Dr. Doom for predicting disaster in the housing market when everyone else was riding high, spells out the problem facing Europe, and thus the rest of the world.

Italy is too-big-to-fail, but also too-big-to bail. Even if it restructured its debt (2.58 trillion USD), it would still suffer from “a large current account deficit, lack of external competitiveness and a worsening plunge in gross domestic product and economic activity.” To resolve those problems Italy may “need to exit the monetary union and go back to a national currency, thus triggering an effective break-up of the eurozone.”

Until recently the argument was being made that Italy and Spain, unlike the clearly insolvent Greece, were illiquid but solvent given austerity and reforms. But once a country that is illiquid loses its market credibility, it takes time – usually a year or so – to restore such credibility with appropriate policy actions. Therefore unless there is a lender of last resort that can buy the sovereign debt while credibility is not yet restored, an illiquid but solvent sovereign may turn out insolvent. In this scenario sceptical investors will push the sovereign spreads to a level where it either loses access to the markets or where the debt dynamic becomes unsustainable.

Roubini continues:

So Italy and other illiquid, but solvent, sovereigns need a “big bazooka” to prevent the self-fulfilling bad equilibrium of a run on the public debt. The trouble is, however, that there is no credible lender of last resort in the eurozone.

He explains that Eurobonds are out of the question due to German politics – they’ve bailed out enough people, they say (rightly) – and the ECB is prevented from doing so: “as unlimited support of these countries would be obviously illegal and against the treaty no-bailout clause.” Roubini also dismisses other discussed options as ineffective or unrealistic.

The austerity necessary to pay down the debt and save the credit ratings, he argues, will make the recession worse: “Raising taxes, cutting spending and getting rid of inefficient labour and capital during structural reforms have a negative effect on disposable income, jobs, aggregate demand and supply. ”

Even a restructuring of the debt – that will cause significant damage and losses to creditors in Italy and abroad – will not restore growth and competitiveness. That requires a real depreciation that cannot occur via a weaker euro given German and ECB policies.

If you cannot devalue, grow, or deflate to a real depreciation, you must abandon the Euro. The eurozone could survive Greece or Portugal doing so, but not Italy (or Spain). That would effectively break-up the eurozone. That “slow-motion train wreck is now increasingly likely.”

Only if the ECB became an unlimited lender of last resort and cut policy rates to zero, combined with a fall in the value of the euro to parity with the dollar, plus a fiscal stimulus in Germany and the eurozone core while the periphery implements austerity, could we perhaps stop the upcoming disaster.

There are even odds that this will happen. Berlusconi has resigned as prime minister, but that will only calm the markets for so long. The structural problem of their debt remains. As does the threat of the collapse of the euro. They will continue regardless of who hosts the next bunga bunga party.

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A Primer on the Global Economy

The BBC has a great primer on the global economy, especially the Eurozone. Through a series of 60-second video clips, they explain the IMF, how banks go bust, quantitative easing, and the role of the ECB. They also have several articles that tackle those and similar subjects in both the Eurozone and the world economy. Very straightforward, nonpartisan information, and recommended for those who are a bit confused when reading today’s headlines.

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