Keynesian illusions

Thomas Palley

Yesterday I received an invitation to read a paper on the financial crisis written by Thomas Palley, a Schwartz Economic Growth Fellow at the New America Foundation. Titled “America’s Exhausted Paradigm: Macroeconomic Causes of the Financial Crisis and Great Recession,” it makes a basic distinction between macro and micro explanations for the current mess and adds that unless we see things in macro terms, we will never be able to solve what is arguably the biggest crisis since the Great Depression. He writes:

The current financial crisis is widely recognized as being tied to the bursting of the house price bubble and the debts accumulated in financing that bubble. Most commentary has therefore focused on market failure in the housing and credit markets. But what if the house price bubble developed because the economy needed a bubble to ensure continued growth? In that case the real cause of the crisis would be the economy’s underlying macroeconomic structure. A focus on the housing and credit markets would miss that.

Despite the relevance of macroeconomic factors for explaining the financial crisis, there is resistance to such an explanation. In part, this is because such factors operate indirectly and gradually, while microeconomic explanations that emphasize regulatory failure and flawed incentives within financial markets operate directly. Regulatory and incentive failures are specific, easy to understand, and offer a concrete “fixit” agenda that appeals to politicians who want to show they are doing something. They also tend to be associated with tales of villainy that attract media interest (such as Bernie Madoff’s massive Ponzi scheme or the bonus scandals at AIG and Merrill Lynch). Finally, and perhaps most important, a microeconomic focus does not challenge the larger structure of economic arrangements, while a macroeconomic focus invites controversy by placing these matters squarely on the table.

The macroeconomic approach consists of an examination of policies that were ushered in during the Reagan administration and have been continued by Democrats and Republicans alike. They include:

Globalization: a policy characterized by free trade and capital mobility that leaves American workers at a disadvantage

Small government: this includes privatization of public services such as the school system, deregulation, and the erosion of working class and poor people’s rights. Clinton’s attack on welfare is just one example.

Labor market flexibility: this involves attacking unions, the minimum wage, unemployment benefits, employment protections, and employee rights.

Abandonment of full employment: this prioritizes low inflation even if it means rising unemployment.

The article is worth reading if only for its most useful array of statistics, all designed to prove how much of a one-sided class war has taken place since Reagan first took office. For example, a chart showing manufacturing employment from 1997 to 2007 reflects declining numbers. In 1997, there were 17.42 million manufacturing jobs; 10 years later there were only 13.88. If the table included figures up until the current day, the loss would be even more dramatic.

For Palley, 1980 is a watershed year. That is when—for some reason—a new economic policy was introduced, one that he characterizes as the Neo-liberal Growth Model. Before 1980, there was a kind of Golden Age that was ushered in by FDR. Like a wicked king in a fairy tale, Reagan came along and destroyed a policy that benefited workers and businessmen alike. Palley writes:

Before 1980, economic policy was designed to achieve full employment, and the economy was characterized by a system in which wages grew with productivity. This 4 configuration created a virtuous circle of growth. Rising wages meant robust aggregate demand, which contributed to full employment. Full employment in turn provided an incentive to invest, which raised productivity, thereby supporting higher wages.

After 1980, with the advent of the new growth model, the commitment to full employment was abandoned as inflationary, with the result that the link between productivity growth and wages was severed. In place of wage growth as the engine of demand growth, the new model substituted borrowing and asset price inflation. Adherents of the neo-liberal orthodoxy made controlling inflation their primary policy concern, and set about attacking unions, the minimum wage, and other worker protections. Meanwhile, globalization brought increased foreign competition from lower-wage economies and the prospect of off-shoring of employment.

What we need apparently is a wise king like FDR who can restore a new partnership between labor and capital that would provide “an incentive to invest, which raised productivity, thereby supporting higher wages.”

In keeping with the growing disgust with the president who some envisioned as a new FDR, Palley has harsh words for Obama who seems bent on preserving the Reagan policy. (Of course, if during the primary his friends in the press had paid attention to Obama’s gushing over Reagan’s presidency, this disappointment might have been a few degrees less bitter.) Palley writes:

Judging by its top economics personnel, the Obama administration has decided to maintain the system rather than change it. The administration may yet manage to create another bubble, this time probably an interest-rate bubble in Treasury bonds that will weakly jump-start the borrowing cycle one more time.

So why in the world would the American ruling class (please excuse my old-fashioned and dogmatic way of expressing myself) opt for Reaganomics when the New Deal institutions that were maintained even during the Eisenhower presidency were so good for boss and worker alike? Was Reagan some kind of psychopath like Bernie Madoff? Oddly enough, despite Palley’s preference for macro explanations of the current crisis rather than micro ones that border on conspiracy theory, he seems to flirt with such an explanation when it comes to Reagan’s role. Surely, there were wiser heads in the permanent government that could have whispered in the Gipper’s ear: “This ain’t gonna work”.

I think it is best to take a step back and look at the deeper economic forces which made it inevitable for neo-liberalism to prevail. The attack on working people and the poor was dictated by rivalries between the US and other capitalist powers that had fully recovered from WWII, especially Japan and Germany.

My recommendation is that Thomas Palley and my readers take a look at Harry Shutt’s “The Trouble with Capitalism”, a Zed Press book written in 1998 that is now available in excerpts on Google Books. The main merit of Shutt’s book is that it sheds light on the inevitability of neo-liberalism, a policy that is best understood not in terms of the whims of an Ebenezer Scrooge but in the hard realities of global competition. I especially recommend chapter three, titled “The End of the Boom and the Neo-Classical Reaction”, and especially the first section “Market Saturation” which begins:

The increasing maturity of most consumer markets in the industrialised countries was becoming a noticeable constraint to economic growth in the industrialised world by the end of the 1960s. This meant that in addition to static demand for non-durable goods (food, drink, clothing) the markets for most durable products (automobiles, television sets etc.) tended more and more to be governed mainly by replacement demand rather than by the continuous opening up of new groups of first-time buyers, which had been possible throughout the 1950s and early 1960s. Hence demand for goods generally began to grow more in line with population—which was in any case increasing more slowly than in the immediate postwar period—rather than at the rapid rates recorded up to the mid-1960s.

I would argue that these brute economic facts had more to do with the advent of neoliberalism than ideology, which of course is the point that Shutt makes throughout this excellent study. If anything, the current implosion of US auto (and Japan’s problems as well) has a lot to do with the market saturation described by Shutt in 1998 and which has only deepened. While Keynsian ideology might dictate keeping the auto industry thriving with well-paying jobs, the CEO’s might have other ideas whether they are rock-ribbed Republicans or liberal Democrats. Indeed, the distinction between the two types has almost vanished in recent years.

While the decline of manufacturing would certainly explain the rush toward the types of investments that have come under scrutiny over the past year or so (packaged subprime mortgages, derivatives, etc.), Shutt had his eye on other novel investments back in 1998:

The maturing of established consumer product markets helps to explain the intensifying effort to open up new areas of consumption and the consequently growing pressure on governments and legislators to relax constraints on the range of goods and services that could be respectably offered to consumers. In the United States this was manifested notably in the abolition of legal restrictions on pornography in 1973 and in more explicit depictions of violence in television and motion pictures, even including such critically acclaimed films as The Godfather (1972). Likewise in Britain this tendency was reflected in moves to relax restrictions on gambling and pornography—a symptom of the “permissive sixties” which many current detractors of that era continue to profit from.

The same kind of thinking is apparently at work today as reported in Alternet :

Is our recession-plagued present a good time for a joint? Legalizing, taxing and regulating marijuana, would pull the rug out from under pot dealers in urban America, and create a crisis for them, but it would likely prove a boon for state budgets. In an oft-cited 2006 report on U.S. marijuana production, expert Jon Gettman used “conservative price estimates” to peg the value of the annual crop at $36 billion–more valuable than corn and wheat combined.

Three national polls this year showed a surprising number of Americans think marijuana should be legal. Zogby, CBS News and Rasmussen all recorded support for legalization hovering at around 40 percent. Nadelmann of the DPA believes support would have been higher if the question was whether or not marijuana should be taxed and regulated.

California Assemblyman Tom Ammiano has proposed a bill to tax and regulate legal marijuana, which he says would generate $1 billion in revenue for the Golden State’s anemic budget. Ammiano, who represents areas of San Francisco, says his proposal, unveiled last month, is “simply common sense,” considering the unprecedented economic emergency. The measure would also save California an estimated $150 million in enforcement costs.

I would only conclude with this observation. Judging by Obama’s failure to enact anything vaguely resembling New Deal legislation at this point, I doubt that prohibition laws against marijuana will be lifted any time soon. Indeed, the only thing that did get the U.S. out of the Great Depression was deficit spending associated with the arms build-up after Pearl Harbor. I suppose that we can envision increased arms spending under an Obama administration but I doubt that this kind of deficit spending would do much to endear him to his liberal base. Yesterday the Washington Post reported that Public Opinion in U.S. Turns Against Afghan War. Given the almost certain continuation of economic hard times and a waste of life and treasure abroad, dissatisfaction with Obama will mount. Under such circumstances, working people and the poor will benefit more from a revival of Marxism than in Keynesian illusions and it is our job to make the case for socialism even as the current occupant of the White House is undeservedly given that august label.