Tuesday, December 7, 2010

It's the economy, stupid. (Part 1 of many)

Where to begin? From my perspective, virtually everything related to governing and the philosophy thereof is related to economics. Other things, particularly social issues which are so important to some people, are simply window-dressing when it comes to governance compared to the fundamental purpose of our government, which is to provide a safe environment in which our economy can grow and our people can be well fed, clothed, and pursue life, liberty, and happiness to their heart's content. 

Unfortunately, our government has done a poor job of this in the past 30 or so years.  It began with the misguided economic principles of Ronald Reagan and Alan Greenspan and has continued through each administration since, culminating with the near collapse of our credit markets in the early days of the financial crisis. Those were the dark days when the Troubled Assets Relief Program (TARP) was driven through Congress like a nail through balsa wood. No time to deliberate. No time to read and reflect. Must pass this legislation immediately or our banking system will collapse. 

It wasn't true. I won't go into the details. Movies like Inside Job and books like  13 Bankers provide plenty of insight into what happened during the crash and how it could have been prevented. How TARP could have been better managed. How that moment provided an opportunity to put regulations in place that would prevent a future bubble/burst of that magnitude from happening again. But since the TARP program was administered by former financial industry executives, they had no incentive to handcuff the industry that had made them wealthy beyond most of our imaginations.

Suffice it to say, a huge windfall befell the financial services industry, an industry that had grown from just 4% of GDP in the late 1970s to over 8% of GDP in the late 2000s. A doubling of a century old industry in just 30 years. How? Well, look no further than Reagan & Greenspan - deregulation of the banking industry. Investment houses went from private partnerships playing with their own money to publicly traded corporations with stockholders interested in short term gains over long term viability. And again from publicly traded corporations to publicly traded corporations gambling with bank deposits from regular banking customers.

Coupled with this deregulation of the banking industry, which had provided walls of protection between bank deposits and risky speculation, was the creation of a completely unregulated market of derivatives trading and the unregulated rating of these derivatives by the private ratings agencies and you have a recipe for disaster. 

That leaves us where we are today.

We're clearly in deep economic doldrums. Our economy's growth is sluggish. New jobs are not even keeping up with new workforce additions (every month people finish school or turn 18 and want to start working) so our latest jobs report shows that unemployment has risen from an atrocious 9.5% to an abysmal 9.8%. Underemployment is much higher - people who would like to work full-time but can only find part-time work. The stimulus plan, implemented almost 2 years ago, is fast coming to an end - it was a 2 year program.

Congressional Republicans have remained entrenched and unified in their support of Ronald Reagan's trickle down economic theory. That theory which in 1980 was presciently referred to by future President George H.W. Bush as "voodoo economics". 

It's actually not a bad theory, in theory, when the economy is soundly based on manufacturing and service industries and the economy is growing at a robust rate. But our economy has been increasingly converted to a paper dragon. The real economy, that based on concrete commodities or usable services, has been shrinking in many sectors, particularly wholesale goods manufacturing and construction. Meanwhile, the financial industry has more than doubled in size. And virtually all of the wealth in the last boom was created inside this industry. And they created nothing. Nothing of value. They traded in derivatives, which do not spur economic growth, do not spur job creation, do not spur technological innovation. Because nothing of value has been created and we've been shedding the kinds of jobs that do actually create something of value, we're in bad shape. 

Here we can take a step back for a moment.

Businesses create jobs when their output no longer meets the demand for their goods and services. The other reason a business might create jobs is if forecasts suggests there will be increased demand soon and there are incentives in place to develop that capacity now rather than waiting for when the demand hits. This is manipulated by the Federal Reserve through interest rate reductions. Most companies take out loans to develop additional infrastructure - when interest rates are low those loans are most attractive.

Demand for goods and services increases when the working classes have more income to spend. Tax cuts to the middle class, unemployment insurance, Welfare payments - all of these programs put money into the hands of people who will spend that money. Tax cuts for the wealthy result in investment in securities (e.g., derivatives), not increased demand for goods and services. 

Each $1 the U.S. government doles out to the unemployed results in $1.61 in economic stimulus. Welfare/food stamps are even better: $1.74. The Bush tax cuts? $0.32. The way this works is that when an unemployed person or welfare recipient gets their check, they spend what they're given. The people they pay for goods and services then spend the money they earn so the money goes right back into the economy a 2nd time. Thus each $1 can result in more than $1 in stimulus. Much of the Bush Tax cuts (and that's all of them, not just the tax cuts for the wealthy) go into people's pockets without additional spending for the economy, because most of the tax benefit goes to higher income earners - either the wealthy, who get the lions share, or the middle class who is still working, who is currently focused on reducing family debt levels and saving more for the future. So just $0.32 out of each $1 goes back into the economy. It's still stimulative, but at less than 1/5th the stimulative effect of extending unemployment benefits. 

This chart shows how much of the tax cuts go to each income group.



The most stimulative of these tax savings are in the lowest income brackets, probably those <$100,000 or so. Those are the people most likely to put the money directly back into the economy through increased purchasing power. Everyone else is much more likely to save money or invest it, which while theoretically a force for the economy, is much less so now that investment firms traffic so heavily in the derivatives markets.

And as you can see, the Republican plan, which is the plan that has just been agreed upon in yesterday's compromise between the Obama Administration and Congressional Republicans, gives by far the largest tax break to the wealthy who will be the least stimulative - they're not only least likely to spend their money, they're also the most likely to actively seek out complex securities for investment.

I realize this one rambles a bit, but I had to get that off my chest. I'm not too happy with the tax cut plan. 


  1. How would you describe the president's negotiating skills? I sure-as-hell don't need his help the next time I purchase a car.

    "I want that station wagon and I won't pay more than 1% over invoice."
    "Nope. I make more commission on that coupe and you're paying sticker price."
    "Ok, let's compromise. I'll buy the coupe for 2% over invoice."
    "Compromise, sure. You're getting the coupe at sticker price. And you have to be the designated driver for me and my friends whenever we want."
    "It's a deal. I'm all about compromise."

    He missed the mark on healthcare in similar fashion, giving away the only true reform (single payer) just to get the republicans to the table.

    Maybe we're a lot closer to oligarchal banana republic status than I care to admit.

  2. A strong middle class is a DEPENDENT variable for Democracy. The middle class is defined as comprising white-collar (non-manual) workers, low-level managers, and small business owners. The incomes of this class is higher than that of the working-class but lower than that of the upper-middle class (doctors, engineers, lawyers, middle-size business owners) and the upper class. Having the basic necessities of life (3 square meals a day, proper shelter from the elements, etc.) are required before being able to engage in political matters. People who live in poverty are more concerned with survival than with participating in local politics.

    One of the basic theories of politics, put forth by Aristotle centuries ago, is the theory of the middle class and its causal link with democracy. According to Aristotle, a large, prosperous middle class mediates between rich and poor, creating the structural foundation upon which democratic political processes may operate. Beyond Aristotelian theory, the specifically commercial nature of the middle class is also central, as the democratic institutions of law, power limitation, and electoral participation were carried by a commercial middle class. A strong middle class can be traced through the development of democracy and the rise of the commercial middle class from ancient Greece to Renaissance Italy, to post-feudal Europe.