Financial regulation sounds a whole lot like high school

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I finally got around to listening to This American Life’s radio piece about Carmen Segarra and her secret recordings while working for the Federal Reserve Bank of New York. Even if the subject of financial regulation doesn’t typically blow your socks off, I’d highly recommend listening to the podcast, which features TAL’s typically tremendous mix of information and entertainment. At the very least, read the transcript.

The episode is about something called “regulatory capture”, which is a phenomenon we see in a lot of industries, particularly finance and banking. As the piece puts it, regulatory capture is a lot like when there’s “a watchdog who licks the face of an intruder and plays catch with the intruder instead of barking at him”.

Why does this happen? We often point to the “revolving door” separating industry and regulation, where people bounce back and forth between the private sector and the regulatory agencies, dulling their incentive to be tough on the companies they’re regulating now but might work for in the future. But the piece seems to suggest there’s something more purely psychological than that at play.

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Environment to economy: Let’s not fight

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A new report by the Global Commission on the Economy and Climate has gotten a lot of attention in the press recently. It finds that:

[T]he choice we face is not between “business and usual” and climate action, but between alternative pathways of growth: one that exacerbates climate risk, and another that reduces it. The evidence presented in this report suggests that the low-carbon growth path can lead to as much prosperity as the high carbon one, especially when account is taken of its multiple other benefits: from greater energy security, to cleaner air and improved health.

This is good news, as it helps bolster the intellectual argument for action and quiet the arguments of the “it’s too expensive” crowd, which claims that the adjustments necessary to avert catastrophic climate change would be too painful for the economy to be feasible. As the report finds, when you add in all the secondary benefits of a less carbon-intensive global economy — lower healthcare costs as a result of cleaner air, for instance — the total cost to the economy of acting is actually quite small, or maybe even zero.

While the report is justifiably making news and being celebrated by environmental advocates for its findings, its important to note that the economic argument for action on climate change is not new. Environmental economists have understood for a long time that while there may be some short-run costs involved in adjusting our global economy to avoid climate change, these short-run costs are small in comparison to the much more severe climate-related costs down the line if we do nothing.

In other words, the choice between good economics and good environmental policy is the ultimate false dichotomy; the two are one and the same. Continue reading

In the fight between capitalism and business, capitalism is getting whupped

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I recently finished reading Chrystia Freeland’s Plutocrats, which is about the world’s rising elite class and the enormous buildup of wealth at the top of the spectrum. Easily the most satisfying part of the book is towards the end, when she discusses the potential impact of this phenomenon for our economy and our democracy. Here she shares a brilliant quote from Luigi Zingales, an economics professor at UChicago’s Booth School of Business, which I felt compelled to share:

True capitalism lacks a strong lobby. That assertion might appear strange in light of the billions of dollars firms spend lobbying Congress in America, but that is exactly the point. Most lobbying seeks to tilt the playing field in one direction or another, not to level it. Most lobbying is pro-business, in the sense that it promotes the interests of existing businesses, not pro-market in the sense of fostering truly free and open competition. Open competition forces established firms to prove their competence again and again; strong successful market players therefore often use their muscle to restrict such competition, and to strengthen their positions. As a result, serious tensions emerge between a pro-market agenda and a pro-business one.

Industry has been throwing its weight around to the detriment or the larger marketplace — and to society in general — for decades, if not longer. As Zingales describes, this includes purposefully stifling open competition, and in doing so hurting other companies operating in the marketplace, as well as the consumers who would otherwise benefit from the better quality and prices that a competitive market would bring. To take one recent example we’ve already covered here on this blog, the lines separating media companies, political lobbyists/fundraisers, and government policymaking have been blurred, possibly paving the way for regulators to sign off on ever-growing oligopolies, and thus crowding out efficient competition from smaller firms. In other words… cable is too frigging expensive!

But beyond just stifling competition, there are innumerable ways that businesses and industry groups distort the free market with their political power. More than fifty years ago, Eisenhower prophetically warned of the “military industrial complex”, where an industry that stood to profit from war would skew the nation towards unnecessary debts and perpetual conflict. There are countless corollaries today in other industries. Big banks lobby against financial regulation, strengthening their bottom lines while potentially increasing the likelihood of another devastating financial crisis. Producers of fossil fuels quietly spend huge sums trying to confuse the scientific debate on climate change, holding the price of carbon emissions inefficiently low while the earth gradually warms. The farm lobby assiduously maintains the political backing for agricultural subsidies year after year, paid out of the pocket of the US Treasury.  Each case is an example of “extracting rents”, in economics speak. That is, a small and powerful minority with political power extracting value from the broader society and keeping it for itself, all the while compromising the efficiency of the free market.

This is not capitalism, or certainly not “true capitalism”, as Zingales puts it. True capitalism can be, and should be, ethical and egalitarian in its principles. And with the right rules and regulations, it can lead to generally fair and stable outcomes for society (see America for about thirty years following WWII). But not many people can spot the difference between “true capitalism” and what I’d call “rigged capitalism”, and most people nowadays appear hopelessly resigned to the latter.

What’s wrong with the world: Cable M&A edition

I’ve never been particularly fond of my cable company, wherever I’ve moved to. Like many, I’m sure, I’ve wondered why cable has gotten so expensive ($80/month or more for TV alone now seems routine) while the service often seems so unaccommodating (the infamous “4-hour window” for appointments is now a punchline). I’ve also wondered why, in almost every place I’ve lived, there are only one or two cable companies offering service, rather than multiple providers competing with one another on the basis of price or quality. Are there massive “economies of scale” in the cable service provider industry, like there are for energy companies or jumbo jet manufacturers, such that it would make sense to have just a handful of really big players in the market? Is cable a “natural” monopoly, the rare case in which a single company dominating an industry actually makes economic sense? I really don’t know.

The good news is that it’s not my job to figure out if there’s too little competition in cable. (That’s good, because I’m pretty busy these days.) In fact, we have multiple federal government offices for this, all charged with the responsibility of blocking inefficient monopolies and protecting the consumer from a lack of competition.

The bad news is that there is no way to know if those offices are in fact acting in the public interest, or if they’ve been influenced by political forces. That’s why I almost lost my egg sandwich last Thursday morning reading this article from the Washington Post, about media giant Comcast’s proposed merger with Time Warner Cable. On the subject of whether or not the merger would be approved by regulators, it reads (emphasis added):

[Comcast’s] executives are veteran negotiators with federal regulators, having won approval of the NBC Universal deal even when it was protested by many lawmakers and consumer interest groups. Its executive vice president… is a longtime Democratic insider who has hosted fundraisers for Obama and the Democratic National Committee. Earlier this week, he was invited with his wife to the White House state dinner for the president of France.

The point of this post is not to heap shame on Comcast’s leadership, the President, or his political party. Regular readers of this blog know that I have never sought to point a finger at specific individuals or political groups. This site is about identifying the moral disease and discussing its cure, not bickering over who’s more deeply infected.

I don’t know whether or not this merger should be approved. But that’s the point: I shouldn’t have to figure it out. I should have the trust in our democratic system that the right people will, in fact, make this judgement on the basis of the welfare of nation, not political backscratching.

This is a widespread problem, bigger than one company, bigger than one industry, bigger than one person, bigger than one party. When political self interest gets in the way of government making and enforcing policies for the common good, we should call it what it is: immoral and corrupt. That this is such a common reality that we barely bat an eyelash when it happens is especially sad.

Do deficits matter? Yes, and here’s the real reason why

Everyone seems to have an opinion these days on how to fix the US government’s debt issues. But these two paragraphs below, from Simon Johnson and James Kwak’s White House Burning, might be the best description of the issue I’ve read thus far:

Every time growth goes down and deficits go up, we’ll cut spending on government services and make modest reductions to Social Security and Medicare benefits. Growth will return as the business cycle turns up, deficits will come down for a few years, and the national debt will fall off the political agenda. But then deficits will come back because of a recession or because of demographic and health care trends. Then we’ll repeat the process, cutting spending some more. Each time, services and social insurance programs that lower- and middle-income people depend on will bear the brunt of the spending cuts, eroding away our already modest social safety net. Since many government programs, broadly speaking, distribute money from the rich (who pay more in taxes) to the poor (who benefit more from social insurance), these periodic rounds of deficit cutting will have the net effect of reversing this flow, shifting resources back toward the rich and increasing inequality above its already historic levels. A few rounds of this and the United States will look like a stereotypical Latin American country, with the super-rich living on private islands in the Caribbean, a comfortable professional class that holds the desirable jobs, and a large, struggling lower class.

America does face a long-term debt problem. Today, the specter of the national debt is a blunt instrument that is used to block needed investments and chip away at the modest programs that benefit the poor and the middle class. As long as we face the prospect of significant long-term deficits, our political system will continue to be dominated by hysteria, demagoguery, and delusion. Given the current balance of political power, the most likely outcome is that government deficits will be invoked to slash spending that ordinary people depend on — while continued tax cuts ensure that the deficits never go away. In other words, if we don’t solve our debt problem the right way, it is certain to be solved the wrong way. Our challenge is to defuse our national debt crisis in a way that is credible and fair, that maintains our ability to make vital productive investments, that preserves the services that most people value and depend on, and that encourages economic growth for decades to come.

This is basically the same argument I tried to make a while back, in the context of decaying public services. The poor and middle class disproportionately rely on those services, whereas the rich are impacted very little. (Think of someone who needs a publicly-funded commuter train or bus to get to work, compared with the person who takes a chauffeured car.) Because the former group lacks a political voice, they will always lose out when the debate shifts to how to fix the budget gap, probably in the form of cuts to services that the rich don’t need. Continue reading

Are debt ceiling deniers nuts? It depends on your definition of the word “nuts”.

The saga going on in Washington over the issue of fiscal management is slowly turning from worrying to downright depressing. We’ve seen this movie before, I realize. I’m not just talking about the government shutdown which set in at the beginning of this month, and which is frequently compared with the shutdown we experienced in the 1990s. I’m also, of course, talking about some politicians’ decision to use the raising of the US government’s debt ceiling as a negotiating tactic, a strategy which we horrifyingly watched play out a little more than two years ago, narrowly missing disaster.

To recap, the US is one of just a handful of countries which has a legislative cap on its debt level that is separate from the other legislative process of approving budgets. It’s a technical issue only, and one that previous generations of policymakers dealt with relatively unceremoniously, by voting to raise the debt ceiling when the barrier came close. No big deal.

But recently, some politicians have had the brilliant idea of blocking the raising of the debt ceiling as a way to get stuff that they want. As many observers have pointed out, this is analogous to a terrorist hijacking an airplane and demanding a million dollars in exchange for not crash landing and killing everyone. This time, the ransom being asked for is some policy concession, and the disaster being threatened is a worldwide financial crisis.

Now, there are many things to discuss here, and many reasons to be angry. But there is one particular side of the story which I find the most fascinating, which is some individuals’ insistence that not raising the debt ceiling is no big deal. This is not true, of course; according to pretty much every economist which knowledge of how the US Treasury works, without the ability to borrow, the Treasury will no longer have access to the cash necessary to pay its obligations. One such obligation is to pay out its regular interest payments to creditors, meaning that without a debt ceiling rise, the US government will default on these payments. That’s a nightmare scenario not only for this country but for the entire global economy, because US Treasury bills and bonds are so commonly owned, used as collateral, benchmarked against, etc. Basically, the entire worldwide financial system is at risk of grinding to a halt if Treasury instruments stop paying. And, according to most economists, that means another worldwide economic disaster potentially worse than the one we just experienced a few years ago.

So why are certain public officials denying the devastating impact of not raising the debt ceiling, and seemingly pushing us on purpose towards the abyss? In some cases, it may be that these individuals legitimately don’t understand the issue. But I find this impossible to believe. Never mind for a moment the steady stream of economists’ dire warnings in recent weeks pleading for a raising of the debt ceiling. Perhaps even more notably, every Congressman and Senator has key supporters and donors in the business community who are undoubtedly eager to voice their concerns.

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Don’t throw the capitalist baby out with his gross bathwater

My dad is a huge fan of Bill Moyers and encouraged me to watch Moyers’s recent interview with the economist Richard Wolff. The video is online Bill Moyers & Company: Richard Wolff interview.

In the interview, Wolff makes his case that our current capitalist system is corrupt and that we should be investigating alternatives. Here’s one thing he tells Moyers that caught my attention:

I think this is a capitalism that I would say has lost its sense of its social conditions, its social limits. It’s killing the mass support without which it cannot survive. So it is creating tensions and hostilities that will take left wing, right wing, a variety of forms. But it’s producing its own undoing and doesn’t imagine it because it focuses so much on making more money in a normal way of business that it somehow occludes from itself. It doesn’t see the larger social conditions and what its behavior is doing to them.

I completely agree with Wolff on this point. One of the most severe economic risks we face today as a global society is that individuals might lose faith in capitalism, and reject the system altogether in favor of a more state-centric model. That’s a story that’s been played out numerous times in Latin America, to take one example where over the years many countries have experienced the rejection of a capitalist strongman in favor of a populist, more socialist idealism. That promise is rarely fulfilled, and the remedy for capitalism often has turned out to be worse than the disease.

One might tend to shake one’s head at the foolishness of the Cubans, Venezuelans, and Bolivians who reached for that socialist dream at various points in history, and who are suffering under the weight of economic mismanagement today. But the real fools were the leaders who preceded these countries’ populist adventures, often enriching themselves and their class while doing little to improve the lives of the poor and disenfranchised. They were the ones who truly killed the goose for a few measly golden eggs, by creating an association between capitalism and their own failures.

I’m an unabashed supporter of free markets, not because I am a Baha’i, but because I am so hard pressed to find historical examples of sustainable economic growth, development, or poverty reduction when they are absent. But there is a difference between free markets and what Shoghi Effendi decried as “unbridled capitalism”, a system with little rules or protections. You can make the argument that the current economic system here in the US (and many other countries, for that matter) is worse than “unbridled capitalism”, in that our system has rules that are actually rigged in favor of the wealthy and powerful.

A well regulated capitalism — where people make their own choices about what to buy or sell or lend, the market drtermines prices and quantities, etc — is good. But a well-regulated capitalism is not what nearly drove us to economic oblivion in 2008, or is currently worsening the gap between rich and poor, or is driving up the costs of health are for all of us. To use faux-economics terminology, what we have now is not capitalism but institutionalized rent-seeking on an enormous scale. The solution isn’t dumping free markets altogether, just a different set of rules and a basic sense of modesty, justice, and integrity that’s required for those markets to work the way they’re intended. I hope people have enough patience to recognize that, channel their frustrations in the right direction, and avoid desperately reaching for an even more disastrous Plan B.

The Chinese boogeyman is too poor to be scary

Yasheng Huang is one of my favorite voices on China, and his recent Foreign Policy op-ed is a must read. In it, he makes the case that democratization is not only a moral imperative, but is in the best interests of both the larger Chinese populace and the Communist Party elite.

One of the things that Huang does in this piece is to dispel the notion that the Chinese government has discovered some superior economic formula. Sure, the market reforms of a generation ago set China up for decades of near double-digit growth. But as Huang lays out, that’s mostly a function of the fact that at the start of that period, China had a lot of catching up to do after years of stagnation. And Huang also reminds us that the typical Chinese citizen remains extremely poor as of today, even after so many years of rapid economic expansion. Here’s an excerpt:

Yes, in the last 30 years, China has done a remarkable job of lifting hundreds of millions of people out of poverty, but we must keep this achievement in perspective. One reason the post-Mao leadership lifted so many people out of poverty is because Mao Zedong kept so many Chinese poor. (In 1979, showing remarkable candor, the Chinese Communist Party itself publicly acknowledged that per capita grain consumption of Chinese remained stagnant between 1957 and 1978.) Second, the poverty threshold is commonly defined as living under $1 a day. Living above that line is an improvement — not prosperity. Based on data provided by the World Bank in 2008, roughly 30 percent of China’s population, or 390 million people, lived below $2 a day. By this measure, China has a comparable percentage of people living in poverty as Honduras, a country that never experienced China’s rapid GDP growth.

Besides, China’s overall performance in the last 60 years does not stack up well against its neighbors. Since World War II, the most successful economies have all been in East Asia: Japan, South Korea, Taiwan, Hong Kong, and Singapore. There are three exceptions to this East Asian rule of success: China, North Korea, and Mongolia. The first two are led by communist parties, while Mongolia was communist from 1924 until 1993. So the appropriate question is not why China has grown so fast in the last 30 years, but why it is still so poor compared with other countries in the region.

This point appears to have been lost on most people here in the US, who seem to believe that China is growing faster than we are because it is either working harder, cheating, or benefitting from the government’s more active role in the economy.

There is some truth to the cheating thing, but it is overblown. There are legitimate issues with regard to how the Chinese government addresses intellectual property and how it deals with foreign companies operating onshore. But the “currency manipulator” thing is no longer relevant; China’s trade surplus of recent years (the point of maintaining an artificially weak currency) has essentially vanished, and policymakers there are actually moving deliberately from a fixed to a floating exchange rate regime. You can comfortably make the case that Brazil is twice the currency manipulator that China is at this particular juncture. The notion of “declaring China a currency manipulator on day one”, as we in the US became accustomed to during this recent Presidential campaign, sounds catchy but doesn’t have much substance.

The point is, theory suggests that poor countries are supposed to grow faster than rich ones, and this is exactly what we see in real life, at least in the case of China and other less developed countries that have functioning free market economies. To ignore this reality, as many politicians and even some academics tend to do, would be to tacitly accept a world where the gap in living standards between rich and poor remains in place forever. That’s not the world that I, or most people I know, want to live in. And it’s certainly not consistent with the Baha’i vision of a world without today’s extremes of wealth and poverty.

Though it’s important to note that Chinese growth has slowed in recent years (the consensus is about 7.5-8.0% for 2012), we should be celebrating, not decrying, the fact that it is outpacing that of the US and other more developed economies. This is not just a matter of economic principle, but the right of the world’s poor to achieve something better than they have today, either for themselves or for the generations that follow.

Does the election matter?

One of my favorite passages from the Baha’i Writings is the one below, from the compilation Gleanings from the Writings of Baha’u’llah. After reading Gleanings for the first time as a teenager, I encountered this passage once again about a year ago. It resonated with me particularly strongly, and I ended up sharing it here, in a post written on the 10th anniversary of September 11th, 2001.

The 2012 US Presidential election has me looking to this passage once again. Let me paste it below, this time in slightly less abridged form, and then I’ll explain why. The emphasis below is mine.

So blind hath become the human heart that neither the disruption of the city, nor the reduction of the mountain in dust, nor even the cleaving of the earth, can shake off its torpor. The allusions made in the Scriptures have been unfolded, and the signs recorded therein have been revealed, and the prophetic cry is continually being raised. And yet all, except such as God was pleased to guide, are bewildered in the drunkenness of their heedlessness!

Witness how the world is being afflicted with a fresh calamity every day. Its tribulation is continually deepening. From the moment the Súriy-i-Ra’ís (Tablet to Ra’ís)* was revealed until the present day, neither hath the world been tranquillized, nor have the hearts of its peoples been at rest. At one time it hath been agitated by contentions and disputes, at another it hath been convulsed by wars, and fallen a victim to inveterate diseases. Its sickness is approaching the stage of utter hopelessness, inasmuch as the true Physician is debarred from administering the remedy, whilst unskilled practitioners are regarded with favor, and are accorded full freedom to act. …The dust of sedition hath clouded the hearts of men, and blinded their eyes. Erelong, they will perceive the consequences of what their hands have wrought in the Day of God. Thus warneth you He Who is the All-Informed, as bidden by One Who is the Most Powerful, the Almighty. (Gleanings, v. XVI, pp. 39-40)

What does this passage have to do with today’s election? Let me explain.

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Who exactly are the “job creators”?

If you follow American politics, you’re probably familiar with the term “job creators”. This term, which is essentially a euphemism for the wealthy, is used to argue that taxes on the top income earners should remain low (or even be lowered further). As the argument goes, rich people are society’s innovators, investors, and business owners. If we take away their capital or reduce their incentive to earn, then this class of individual will stop producing jobs for the rest of us.

As is often the case, it is convenient for the news media to frame the argument in adversarial terms for the purpose of entertainment. For example, a couple of weekends ago CNN pitted two individuals against each other to debate whether the wealthy or the middle class were the ones responsible for job creation.

On the one hand:

[The world] is awash in capital. What we lack today are consumers. The only reason any company invests, the only reason any company hires someone is because they believe they’re going to have a customer for that. Look. Anyone who’s ever run a business knows that a capitalist hires more people only as a course of last resort when there are no options available other than meeting increasing demand from customers.

And on the other:

[I]f you don’t have the investment in place first of all you don’t get the consumption after the fact… what matters is how much income you’ve created. And we are creating way more income at the median than Europe and Japan are creating. And that is because innovation is driving our economy.

But there is no class conflict here, and no legitimate intellectual debate as to who creates jobs. That’s because everyone does; the economy is an ecosystem made up of various people who come together and play different roles. One individual invents a product. Another individual puts forth the capital for its production. Another lends his labor towards building it. Someone else distributes and sells it. And at the end of the supply chain, someone must be there to buy it.

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