Archive for the ‘Economics’ Category

Ever since the financial crash of 2008, the subject of global economics has been at the tip of everyone’s tongues. A period of remarkable economic growth came to an abrupt end, and to this day most of us are feeling the effects of it. Now when it comes to understanding the strange and often contradictory world of economics, there are definitely worse people to look to than Paul Krugman. Professor of Economics at Princeton University, New York Times columnist and Nobel Prize winner aside, Krugman was voted 6th in a poll of the world’s 100 top intellectuals by Prospect.

The Conscience of a Liberal (also the name of Krugman’s blog) traces the path of inequality in the United States from the late 19th century to the present day, and how – after a period of relative economic equality in the 60’s – income distribution in the United States today is as bad as, if not worse than, it was in the early 20th century. By inequality, we’re essentially talking about the difference in the income of the richest and poorest members of society.

Over the course of the book, Krugman describes the evolution of the two main political parties in the US, the Democrats and the Conservatives. He shows how during the 70’s and 80’s, the Republican party was hijacked by ‘movement conservatives’, or as some have described it, the ‘conservative labrynth’ – a network of media outlets, right-wing think tanks and corporations supported by wealthy benefactors dedicated to spreading a version of conservatism that is vehemently opposed to the tenets of the New Dealintroduced by Roosevelt in the 1930’s.

Krugman spends much of the book discussing the rise of movement conservatives and their hijack of the Republican Party. He also talks about how they were able to achieve so much support – to the extent that they were able to win elections consistently – with such unpopular economic policies. The economics of these movement conservatives, Krugman argues, increased inequality as they decreased taxes for the richest segments of society while weaking social safety nets. So how did a party with such policies manage to consistently win elections?

Krugman discusses a number of interesting and valid methods in which the Republican party were able to convince voters to vote for them, but the most influential – and ugliest – of their tactics, he argues, was for them to play the race card. According to him, the Republicans were able to convince a majority of voters to choose them despite unfair economic policies was to play on the fears of white voters, at a time when racism, whether hidden or overt, was a major factor in American life. Now to those of us who did not grow up in America during this time, it can seem a strange argument, particularly when reading a book written by a prominent Economist, not a sociologist or historian. However, Krugman backs his argument strongly, and convinces the reader of the validity of his argument.

Towards the end of the book, the author looks to the future, and claims that progressives and liberals need to focus on one major issue in the coming years: healthcare. Krugman claims that achieving universal healthcare is a must. Every other developed economy has universal healthcare, and so the US lags behind. Krugman outlines the main features that a healthcare plan must have, and the difficulties that would be involved in trying to implement this in the US. Now this book was written before the recent healthcare bills were passed, and so comparing Krugman’s ideas with the actual details of the current healthcare would certainly make for interesting reading for those interested in the subject.

Krugman packs many a punch in this book, and is not afraid to tread on any toes. Theodore Roosevelt once uttered these words:

“We had to struggle with the old enemies of peace – business and financial monopoly, speculation, reckless banking, class antagonism, sectionism, war profiteering. They had begun to consider the Government of the United States as a mere appendage to their own affairs.

We know that Government by organized money is just as dangerous as Government by organized mob. Never before in history have these forces been so united against one candidate as they stand today. They are unanimous in their hatred for me – and I welcome their hatred.”

Krugman shares Roosevelt’s spirit in this regard, and offers a stinging indictment of the state of the modern Republican party. While Obama may be attempting a bipartisan approach, reaching out to a Republican party that has no interest in playing ball, Krugman argues that in many cases a bipartisan approach is simply unworkable.

The focus of the book is ultimately inequality in the US, but by demonstrating the direct effect of movement conservatism’s harmful economic ideology, Krugman shows us how this inequality came about, and why a progressive Government must focus on healthcare reform (which Obama has now done) in order to halt the rise in inequality and take major step towards a fairer society. The book provides a fascinating look at the rise of the Republicans in their current form, and Krugman makes a strong argument for the rejuvination of public institutions in the US. A must read.

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Privatization, in a broad sense, refers to the transfer of a business, enterprise, or social function from public control to private ownership. It has been a cornerstone of the neoliberal economic mantra that has gripped policymakers for the last 3-4 decades, alongside private property, intellectual property rights, and the free market. In this time, hundreds of state-owned enterprises (SOEs) have been fully or partially privatized, in the belief that doing so would make them more efficient, and as a result serve to promote economic growth, and by highly questionable extension, prosperity.

Economists of the current orthodoxy will tell you that the theory is solid, and that the case for privatization is well grounded. The theoretical idea supporting privatization rests on three main pillars:

1) The Principal-Agent Problem: This broadly refers to the situation where the owners of an enterprise are disconnected from its operations. Instead, managers are hired to run them. The owners are the ‘principals’, and the managers are the ‘agents’. While it is in the interest of the owners to have the enterprise run as efficiently as possible, it is in the managers’ interest to work as little as possible while picking up a wage. Thus, the enterprise is inefficiently managed. With SOEs, the citizenry/taxpayers are the owners and so by privatizing, as the theory goes, the principal-agent problem will cease to exist.

2) Free Rider Problem: Individual citizens will not bother themselves with the day-to-day monitoring of hired managers, since they only own a fraction of the enterprise. If everyone owns a fraction and nobody is monitoring, then inefficiencies will arise. Since everyone is trying to ‘free ride’ but nobody is doing any actual monitoring, poor performance will result.

3) Soft Budget Constraint Problem: since SOEs are government owned, they are often available to work outside their budgets since they can rely on government assistance or bail-outs if they make losses or face bankruptcy. Therefore, they are able to get away with lax and inefficient management.

These are the arguments made against SOEs and in support of privatization. But do they hold on closer examination?

1) With regards to the principal-agent problem, it does appear to hold true for SOEs, but there is nothing in the theory to say that it does not also hold true for private firms! Most large corporations are held by varied and dispersed owners – think of the stock market, and how many different individuals, groups and organizations have ownership of a company. Private enterprises are thus also owned by a large number of shareholders, and management is delegated to a group of managers that are hired. Thus, there is little difference in ownership structure that would alleviate the principal-agent problem.

2) Similar to the above point, with diverse and widely spread ownership, the free-rider problem will exist for large, privately-held corporations as well. If I own 10 shares in Microsoft, I will not expend my time and effort to dilligently ensure that operations are being managed effectively – I leave it to someone else to do.

3) Politically generated soft budget constraints are not confined to just SOEs, as large, ‘important’, or politically influential companies can obtain funding and support from governments in times of trouble. We need not look further than the infamous bank bailouts in the US to know that this is just as true for private enterprises as SOEs.

So it seems that all the arguments made for privatization are in fact nothing of the sort. True, they are all valid arguments of pitfalls that can arise in public corporations, and should be kept in mind in their management. But they are also just as valid when it comes to private companies, and there is plenty of empirical evidence to back this up. Regardless, the conception is that SOEs are generally inefficient, after all we always hear about examples of bad state companies on the news, right?

What we rarely hear about are the well-run, highly effective SOEs that exist and operate all around the globe. To give just one example, Singapore Airlines is often talked of as one of the most highly regarded airlines in the world, and yet it is an SOE – 57% owned by Singapore’s Ministry of Finance. In fact Singpore – widely touted as one of the successes of the free market ideology – has an SOE sector that is four times larger than that of Argentina, widely cited as a state that has failed in its development due to the overextension of the state*.

So what gives? Why do only ever hear about bad SOEs, when there are in fact many, many good ones? Part of the reason is the sad nature of reporting. The news tends to focus on bad things: war, famine, sex scandals, and the like. Nobody cares about the ordinary decent citizen living out her life. And nobody cares about the silent, successful SOE, providing water or electricity or anything else to its customer base.

While these arguments do not strictly support state ownership, they make clear that the case against state ownership is highly misleading. The arguments made are, in fact, arguments in favor of effective systems of governance and regulation. The choice between private enterprise and SOE will always depend on many factors that are unique to the country, the industry, the time and the place. But there are specific situations where having an SOE is in fact the right choice:

1) When there are low short-term profitability prospects: the nature of private money is that it seeks a quick buck. As students are taught in economics 101, money now is worth money later, and so no investor will be willing to wait 15 years just to see a return on investment, even if the long-term prospects are sound. Such industries may be set up as SOEs, especially if they are in the strategic interests of the country.

2) ‘Natural Monopoly’: A natural monopoly exists when, due to technological conditions, having only one supplier is the most ideal way to serve a market. Such industries include water provision, or railroads (in the 19th century in the US, different railroad companies used to set up parallel tracks leading to the same places, a horrible inefficiency and waste of money). The main cost of production in these industries is building a distribution network. When there is a natural monopoly, especially in the case of a key service or product such as water, enterprises can charge whatever they want and customers must pay that price, as they have no other choice. This generates a social loss, as the item is priced so as to extract maximum profit, and at the same time, consumers are served less than they would ideally want. Introducing competition has no effect, as the incumbent has all the power. In natural monopolies, SOEs are strictly the best form of ownership.

3) Questions of equity: If left to the private sector, many essential services would not be delivered to those who are not profitable. For example, water provision to the poor, or delivering mail to those in rural locations. In this case, a SOE is necessary to provide these services, as the profit motive is overruled by the equity motive.

In conclusion, there is a time and a place for private enterprise. Only strict ideologues would, in today’s world, propose the strict outlawing of private enterprise. At the same time, only strict ideologues – like those at the World Bank, the IMF, and many academic institutions – would call for privatization at all costs, empirical evidence and common sense be damned. SOEs can often be inefficent and perform badly – but so can SOEs. The solution in both cases is effective regulatory structures, which take incentives into account. It is also crucial to accurate identify and prioritize objectives.

SOEs are often a very useful tool for governments, particularly developing country governments, in the industrial development of a country. Dogmatic ideology that insists at privatization at all costs is both ill informed and harmful to the prosperity of nations.

*in terms of its share of national income, not absolute terms.

** the ideas and data in this article are heavily drawn from Ha-Joon Chang’s excellent book “Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism.” Go read it now.

Today’s economic orthodoxy is heavily dependent on the idea of utilitarianism, because it is a convenient mechanism that allows economics to be taken more seriously as a natural science. It allows economists to bypass all the inconvenient complications that arise when delving into deeper considerations of ethics and human behavior. The adoption of utilitarianism allows for the use of an additive system that fits well into an economics that is based on mathematics, as we have today.

Before going further, it’s worth briefly exploring who Jeremy Bentham was, and what we mean by utilitarianism.

Utilitarianism, or the “greater good” argument, is the belief that is the idea that the “right” course of action is the one that maximizes the overall “good” of a situation. So actions should be judged right or wrong depending on whether they increase or decrease human happiness, or utility. In economic-speak, utilitarian is used as the rationale behind the crucial assumption of rationality of consumers – that agents (i.e. people) consume so as to maximize their “utility”. Bentham put it thus: “Nature has placed mankind under the governance of two sovereign masters, pain and pleasure. It is for them alone to point out what we ought to do.”

On the face of it, utilitarianism has some appeal. But a simple thought experiment, first articulated by American philosopher Robert Nozick in 1974, puts the simplicity of utilitarianism in stark focus. Nozick hypothetically proposes the “experience machine”: a machine that would give you any experience you so desire. So if you wanted to experience the thrill of climbing Machu Picchu, so be it. But all the while you would be hooked up to this machine, not knowing that you were there. In other words, you would actually believe you were climbing Machu Picchu. Would you plug yourself into the machine? As long as you’re living your hearts desire, does it matter whether its real or not?

Nozick believes that most people would choose not to be plugged into this experience machine. This implies that it is somehow important whether these experiences are real or not. The reality of life is important: people want to actually do certain things, achieve certain goals, rather than simply feel the pleasure associated with it. However, if utilitarianism held strong, then the pleasure associated with actions would be all that mattered, and we would choose the machine. It is clear then, that there are other things besides simple pleasure that people consider intrinsically valuable.

While different forms of utilitarianism have attempted to come to grips with this and other complications, this was not so for Jeremy Bentham. He proposed a form of ‘felicity calculus’, where the pleasure and pain that arises from different actions could be quantified and and determined by addition and subtraction. This sort of simplistic rationale is too tempting to resist for orthodox economists. For Bentham, different pleasures vary only in their intensity and duration, and not quality. He even said himself, “the game of push-pin is of equal value with the arts and sciences of music and poetry.” Reductionism at its finest. This form of thinking has given rise to “homo economicus”: economic man. Homo economicus, meant to represent each and every one of us, is a narrow, self-interested individual who’s only concern is to maximize his or her consumption of goods and services. In physical terms, the assumption that we are all homo economicus is akin to the assumption that, for practical purposes, all cows are spheres.

The concept of utility is core to understanding economic orthodoxy today, and yet the assumption of rationality is based on an outdated and unrealistic form of utilitarianism that is not, and has never been, applicable to real life. Luckily, we have fields of economics, such as behavioral economics, that have attempted to move beyond this mode of thinking, and incorporating knowledge from other fields such as psychology in altering models to be more realistic. But neo-classical economic theories are still based on this idea, and despite strong attempts from many directions to reform the discipline, it clings stubbornly to such discredited beliefs.

There is a problem with the way that economics is taught in classrooms today … it’s wrong. There are whole books written about the question of what exactly is wrong with economics today, but this blog post will focus on just one simple, yet extremely important aspect: reductionism. The dictionary defines reductionism as “the practice of simplifying a complex idea, issue, (or) condition … especially to the point of minimizing, obscuring, or distorting it.” We observe a degree of reductionism in every aspect of what we do, so why is it such a big deal, particularly in economics?

Lets start at the basic building blocks of textbook economics. An ‘market’ is a system where buyers and sellers meet. Buyers want something, and sellers offer that something to buyers, in exchange for currency. Suppose its a market for cars. Lets assume its a perfectly competitive market, meaning that all sellers are selling an identical product, have identical costs, and sell for an identical price, so that, for Joe Consumer, it doesn’t matter who he buys the car from, he’ll always pay the same price for the same car.

How much does a car cost? Well, in a perfectly competitive market, the price of a car equals the cost of producing that car (the marginal cost). Suppose that the cost of the car is made up of fixed costs (the factory, fixtures, etc) and variable costs (labor, materials, etc). The total cost of the car is the sum of all these costs for that car.

Economics, as taught in classrooms across the world, has little to add beyond that, in our small example. It is seen as a closed system, with no relations to other systems. The unit of measurement is the dollar (or whatever currency we choose), and it is about the flow of goods and services between firms and households. The impacts of economic activity on the environment, the ecosystem, society and culture are all ignored. But how can they be? Without the biosphere, there could be no economic activity! Oil is pulled up from out of the ground, and used to create goods and services, and transport them across the globe. Trees are felled for paper, wood, and other products. Coal from under the earth is used as a source of energy. The fish of our oceans are decimated for the satisfaction of our deep bellies. The biosphere is also crucial to absorb the products of our economic activity – no, not the goods and services, but the pollutants, the greenhouse gases, and other harmful byproducts.

In that sense, we cannot reduce the economy to a simple exchange of a few products without looking at the wider – and most certainly important – effects that result directly from our activity. The discipline has made some half-assed attempts at factoring these in, there the concept of “externalities”, i.e. stuff that is external to economic theory. And still the concept of monetizing these externalities is used, as if you can ever accurately put a price on such things. Can you put a price of climate change? On species extinction? No, you can’t.

The economy needs to be seen as a system within a system: a human system of trading goods and services, within the greater biosphere of our planet. It is especially crucial to recognize the role of economic activity in today’s world, where the threat of climate change looms larger than ever – according to this report, carbon emissions have hit a record high despite the recent recession. Economic policies can no longer be made in isolation of the global reality.

But frankly, its inconvenient. It’s not just a case of ignorance. Its a matter of interests. There is a reason that the economic discipline looks the way it does, and a reason why it is so powerful and well respected. We’ll leave that to future posts.

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Before I go, have a look at this blog post about Strauss-Kahn and the maid who accused him of sexual assault. It makes the very good point that, without union backing, she would likely have never been able to make such a complaint against such a powerful man.

Macroeconomics and Bridesmaids

Posted: May 25, 2011 by Zeddington in US Economy

Last night I read this excellent article on the blog New Deal 2.0, which I wanted to share. Have a look.

What is US Uncut?

Posted: February 22, 2011 by Zeddington in US Economy
Tags: , , , ,

On the 26th of February – this Saturday – something remarkable will take place. It will happen in the city I live in, but it will probably happen in the city you live in as well. On February 26th hundreds, maybe thousands, of Americans will take to the streets in 30 cities from Maine to Hawaii to protest the stringent cuts to public services across the US.

The latest budget from Washington has slashed spending on over 200 federal programs, a total of $1.1 trillion dollars over the next 10 years. Most of these programs are there to help the millions of lower and middle class Americans who work hard every day in order to make a decent living. We are told these cuts are necessary – austerity is the word of the day, we all need to make sacrifices in this, the worst financial crisis since The Great Depression.

But just who exactly is making all the sacrifices? The average working class American is, but are the people at Wall Street? Is Lloyd Blankfein, who’s just had his salary tripled, to two million dollars? Are all those massive corporations tightening their belts as well? Apparently not. According to CNN, nearly two-thirds of US corporations don’t pay income taxes. Tax havens alone are responsible for one trillion dollars of taxes not paid over the course of a decade, which would almost be enough to cover the entire magnitute of the budget’s proposed cuts.

Think about that for a second. Programs dedicated to publich health, job creation, energy subsidies for low-income households, and other essential and socially beneficial programs could be saved, if only the millionaires paid their dues to society.

And that is the reason why US Uncut exists. To compel those who refuse to uphold their obligation to the nation who’s public services they make use of, who’s infrastructure and labor force they employ to make their millions. US Uncut is based on a similar organization in the United Kingdom, UK Uncut, who have had remarkable success in organizing peaceful public protests, sit-ins, and demonstrations. Johann Hari has written an excellent article in The Nation on the origins of UK Uncut, their methods and the success they have had recently. The success of the model is built on the ease of organizing an action. If US Uncut doesn’t have anything organized for your town or city, organize it yourself! Contact the group, and they’ll tell you how.

This Saturday will be the first action by US Uncut, and will be an indication as to whether such tactics can work in the US. But with the amount of support the organization is getting, the signs are good. And as awareness grows with more media coverage, more and more ordinary Americans will realize that they can fight back, they can take action against those who would take advantage of the benefits granted of being in American company, without paying any dues. Every American must pay their taxes in order to enjoy all the benefits of living in this great country; corporations should too.

Click here to access US Uncut’s website, or go to www.usuncut.org