Take Back Our Party, Chapter 1

By James Kwak

78389258_115250926626517_1629993578354704384_n

Chapter 1 of my new book is now available at The American Prospect. (If you missed the introduction, you can find all the chapters here as they are released).

This chapter, “Their Democratic Party,” is a brief history of the takeover of the party by the New Democrats in the 1980s and 1990s. It describes how, in the aftermath of the crushing electoral defeats of 1980 and 1984, a new generation of party leaders—including Bruce Babbitt, Chuck Robb, Lloyd Bentsen, and of course Bill Clinton and Al Gore—chose to run away from the historical Democratic legacy as the party of workers and the poor. Instead, they trailed in the rightward footsteps of the Republicans, associating the party with business, the private sector, finance, and economic growth.

Their economic platform was that markets are the sole source of prosperity and that government should limit itself to nurturing the private sector and ensuring that all people can participate in the benefits of growth. That’s why the principal Democratic domestic policy achievements of the past three decades have been welfare reform, financial deregulation, and a health care reform plan based on private competition and initially conceived by the Heritage Foundation.

This is still the dominant ideology of the Democratic establishment:

“Leaving aside the recent progressive insurrection … it is a party devoid of any compelling idea of how to address the fundamental economic challenges our country faces today: wage stagnation, the rising cost of health care and urban housing, the precariousness of most jobs, and extreme inequality. After defining themselves in opposition to old-fashioned government spending programs that smacked suspiciously of redistribution, after embracing the doctrine of market-based solutions, and after insisting for decades that economic growth would solve all problems, establishment Democrats today have nothing left to offer.”

Enjoy!

New Book — Completely Free!

By James Kwak

After Simon’s book with Jon Gruber earlier this year, it’s my turn to release a book. Take Back Our Party: Restoring the Democratic Legacy is now available starting today at The American Prospect. Actually, today the introduction is available. The remaining chapters will be released between now and Wednesday next week. As David Dayen (executive editor of the Prospect) said, now that we’re in the Second Gilded Age, we’re adopting one of the publishing models of the First Gilded Age: serialization in a magazine.

The book is a political sequel to Economism. The basic argument is that the Democratic Party has been taken over by market-oriented centrists who think that effective management of private sector markets is the best way to help ordinary people (think of welfare reform, financial deregulation, Obamacare, etc.); that they have failed, both as policy and as politics; and that the party should adopt an economic platform dedicated to ensuring that all people have the basic necessities of life in the twenty-first century, including healthcare, pre-K through college education, affordable housing, and adequate retirement income.

Enjoy!

Jump-Starting America

Can the United States grow faster, create more good jobs, and genuinely spread opportunity?

Yes: by investing more in science and technology, by placing those investments strategically around the country, and by creating an Innovation Dividend – paying cash to all Americans every year, based on the success of public investments in the tech sector.

What technologies should receive support?  Which cities have the potential to become the next generation tech hubs?  How do we ensure that benefits from the next tech boom are shared more broadly?

Join Jon Gruber and Simon Johnson in discussing their new book, Jump-Starting America: How Breakthrough Science Can Revive Economic Growth and the American Dream, in a series of events and media appearances around the country.

The first public event is on Tuesday, April 9, organized by Harvard Book Store and held at the Brattle Theater in Cambridge, MA: http://www.harvard.com/event/jonathan_gruber_and_simon_johnson/

All are welcome!

Hey Democrats, the Problem Isn’t Jobs and Growth

It’s inequality.

By James Kwak

This American Life‘s forays into politics and economics are generally less satisfying than their ordinary storytelling fare. That’s especially true when they try to answer some specific question, like “What is wrong with the Democratic Party?”—the subject of a segment last month. The story did have some telling moments, however, most vividly when moderate Congresswoman Cheri Bustos was trying to pitch the party’s forgettable and already-forgotten “Better Deal” message (which she helped design) to a local newspaper. Here are a couple of excerpts. (The audio begins at 53:50, or you can read the transcript).

First, on jobs:

Cheri Bustos

We want to be in a position to help create 10 million good-paying, full-time jobs. There are still people hurting, and I think we need to acknowledge that and say that we want to do something about that.

Chuck Sweeney

Right. Well, Donald Trump says that, too. … He says exactly the same thing. Too many people are still out of work. You know, we need to do something about bringing back jobs.

And on Democratic support for cutting corporate taxes:

Cheri Bustos

And so as long as [the corporate tax rate is] highest in the world, we’re not going to have corporations who are going to bring that money home. So there’s got to be some incentive.

Chuck Sweeney

OK. I didn’t—see, I think, once again, I have no idea what the Democratic Party actually stands for anymore. I didn’t during the 2016 campaign, either, which is probably why it wasn’t the winning campaign.

Continue reading “Hey Democrats, the Problem Isn’t Jobs and Growth”

Tax Rates and Entrepreneurship

By James Kwak

My friend and co-founder Marcus Ryu wrote an op-ed in the Times today. Here’s how it begins:

The tax cut framework recently put forward by President Trump relies on a central claim: that reducing taxes on corporations and wealthy individuals will open the wellsprings of entrepreneurship and investment, turbocharging job growth and the American economy. Were this premise true, reasonable people might countenance giving a vast majority of benefits to the very rich, as Mr. Trump’s plan does, in exchange for greater prosperity for all. But it’s not.

I don’t have a lot to add, since Marcus makes the case very well. I’ll just expand on two of his points. One is that lower tax rates do not actually encourage people to start companies. When we started our company in 2001, there were a lot of factors I considered: the risk of leaving a well-paying job in the middle of a recession; my simultaneous move across the country to a place without a lot of technology jobs; the difficulty of raising money from venture capital firms; the relatively large pool of talented developers looking for interesting jobs; the poor competition in the field we had chosen; the difficulty of saying “no” to Marcus; and so on. Tax rates weren’t on the list. As I like to say, I didn’t even know what the tax rate on capital gains (the one that matters for startup founders) was, so it’s hard to see how it could have had any effect on me.

The second point, which is only a bit more complicated, has to do with the impact of corporate tax rates on company behavior. One of the common arguments for a corporate tax cut is that it will encourage capital investment, which will create jobs. This happens, in theory, because a lower tax rate increases the after-tax value of corporate profits (technically speaking, expected future dividends) to shareholders. This means investors will pay more for the stock of what is otherwise the same corporation. For the most part, that just results in a one-time increase in the stock price in the secondary market, which has no direct impact on the company itself. The company only benefits if it issues new stock in a secondary offering, because it can raise a bit more cash for the same number of shares. As Marcus points out, however, a corporate tax cut can only increase investment if companies are actually having trouble raising capital, which has emphatically not been the case for the past several years. In other words, if we actually want to increase capital investment by U.S. corporations, lower tax rates are just about the last place where we should look. (Raising workers’ wages, to increase demand for the stuff those corporations sell, is probably a better place to start.)

I haven’t been writing about the Trump tax cut because (a) a bunch of personal reasons, (b) intellectually speaking, it’s like shooting fish in a barrel, and (c) lots of other people with much bigger audiences are doing it anyway. So please read what Marcus has to say.

A New Economic Vision, in 27 Words

By James Kwak

A couple of weeks ago I posted a 6,000-word essay laying out a new economic vision for the Democratic Party. It kind of vanished into the ether, although Stephen Metcalf was kind enough to say this:

https://twitter.com/Metlandia/status/875682939912192000

So here it is, in 27 words:

All people need a few basic things:

  • An education
  • A job
  • A place to live
  • Health care
  • A decent retirement

Let’s make sure everyone has these things.

If you want more, there is always the long version.

The Importance of Fairness: A New Economic Vision for the Democratic Party

By James Kwak

A lot has been written recently about the direction of the Democratic Party. This is what I think.

I have been a Democrat my entire life. Today, the Democratic Party matters more than ever because it is the only organization currently capable, at least theoretically, of preventing the Republicans from turning the United States into a fully-fledged banana republic, ruled by and for a handful of billionaire families and corporate chieftains, with a stagnant economy and pre-modern levels of inequality. Yet I cannot find anything to disagree with in Senator Bernie Sanders’s assessment:

“The model the Democrats have followed for the last 10 to 20 years has been an ultimate failure. That’s just the objective evidence. We are taking on a right-wing extremist party whose agenda is opposed time after time and on issue after issue by the vast majority of the American people. Yet we have lost the White House, the U.S. House, the U.S. Senate, almost two-thirds of the governors’ chairs and close to 900 legislative seats across this country. How can anyone not conclude that the Democratic agenda and approach has been a failure?”

A central shortcoming of the party is that, on economic issues, it has nothing to say to people trapped on the wrong side of our country’s growing inequality divide. Hillary Clinton won the “working class” (household income less than $50,000) vote, but by a much smaller margin than Barack Obama in 2012 or 2008—despite Donald Trump’s ardent efforts to alienate African-Americans and Latinos. Some people voted for Trump because of racism or misogyny. But Clinton was also flattened by Trump among voters who feel their financial situation was worse than a year before or who think that life will be worse for the next generation. She lost the Electoral College in the “rust belt” states of the Upper Midwest, whose economies have never fully recovered from the decline of American manufacturing.

The Democratic Party was once the party of working people. So why is it increasingly becoming the party of well-educated, socially tolerant, cosmopolitan city-dwellers? Because, in an age of stagnant median incomes and a disintegrating social safety net, Democrats have no economic message for the many people who are struggling to make ends meet, to pay for college, to stay in a home, or to save for retirement.

Continue reading “The Importance of Fairness: A New Economic Vision for the Democratic Party”

Economism and Arbitration Clauses

By James Kwak

As banking scandals go, Wells Fargo opening millions of new accounts for existing customers so that it could pump up its cross-selling metrics for investors is about as clear-cut as it gets. It’s up there with HSBC telling its employees how to get around U.S. regulations in order to launder money for drug cartels, or traders and treasury officials at several banks conspiring to fix LIBOR.

Holding Wells responsible, however, was a bit trickier. The bank agreed to restitution (i.e, refunding the fees it had collected from its customers for the phony accounts) and a paltry $185 million in fines. When customers sued for damages, however, Wells hid behind its mandatory arbitration clauses, which were so broadly written that they even applied to accounts that the customer never intended to exist and that the bank had fraudulently created. Wells eventually reached a settlement with the class of plaintiff customers, but the settlement amount was no doubt influenced by the bank’s ability to compel arbitration.

The Consumer Financial Protection Bureau has proposed to eliminate the Wells Fargo defense by prohibiting class action waivers—clauses that take away customers’ right to participate in class action lawsuits—in arbitration clauses of financial contracts. (Class actions are crucial to deterring and punishing systematic fraud against consumers, because the harm to any single person will not be worth the expense of pursuing a lawsuit; without a class action, no one will sue, and the company will escape unharmed.)

Continue reading “Economism and Arbitration Clauses”

How Markets Work

By James Kwak

The Congressional Budget Office’s assessment of the Republican health care plan, as passed in the House, is out. The bottom line is that many more people will lack health coverage than under current law—23 million by 2026—even though the bill allows states to relax the essential health benefits package, which should in theory attract younger, healthier people. This is not a surprise.

I just want to comment on the role of markets in all of this, which I think is not fully understood. For example, the Times article by the very up-to-speed Margot Sanger-Katz explains that the American Health Care Act of 2017 will make markets “dysfunctional.”

Screen Shot 2017-05-25 at 2.29.31 PM

This is consistent with the rosy view that many people, particularly centrist Democrats, have of health care: if we could only get markets to behave properly (correct for market failures, to use the jargon), everything would be great.

But that’s not how markets work.

Continue reading “How Markets Work”

Fees Add Up

By James Kwak

Public pension funds are having a tough time. On the one hand, the average funding ratio (assets as a percentage of the present value of future obligations) is below 80% because of inadequate contributions by sponsors (states and municipalities) and poor investment returns since the collapse of the technology bubble in 2000. On the other hand, because pensions responded to low returns by shifting more of their money into hedge funds and private equity funds, a larger proportion of their assets is siphoned off as investment fees each year.

Unlike some people, I am not against hedge funds and private equity funds in principle. I think it’s highly likely that there are people who can beat the market on a sustained basis—particularly if they are people who are especially good with computers—both for theoretical reasons (someone has to be the first person to discover each relevant piece of information or actionable pattern) and empirical reasons (see Fama and French 2010, for example). Hedge funds have lagged the stock market in recent years, but what critics sometimes overlook is that they are supposed to trail the market in boom periods, because many target a beta of around 0.5. But I am mystified by the fact that, in what is supposed to be a highly competitive and innovative industry, the price of investing in a hedge fund has stayed virtually fixed at 2-and-20 (2% of assets, plus 20% of investment returns) for decades.

The consequences of these high prices are added up in The Big Squeeze, a new report sponsored by the American Federation of Teachers. Because true investment fees are usually not disclosed—fund managers insist that they are confidential and require investors not to divulge them—the report simply quantifies the potential savings from reducing fees from 1.8-and-18 to 0.9-and-9. This may seem arbitrary, but I know anecdotally that some funds, even big ones, are charging something like 1-and-10 even to ordinary investors. Since state pension funds are some of the biggest investors that exist, you would think they would be able to negotiate even lower fees.

Not surprisingly, the numbers involved add up quickly. Lower fees over the past five years would have saved the average pension fund included in the study $1.6 billion; to put things in perspective, it would have improved the aggregate funding ratio for these funds by more than two percentage points, which is nothing to sneeze at.

The important question is why high fees persist despite the potential market power of big pension funds. There are probably multiple explanations. One is a culture of secrecy, which makes it difficult for any fund to find out what other funds are paying. Another is the marketing prowess of fund managers, who are adept at explaining when their fund is unlike any other in the world and therefore merits its high fees. A third is that pension fund managers are playing with other people’s money (in this case, the other people are the fund’s beneficiaries—teachers, firefighters, and other government employees)—and may be more interested in ingratiating themselves with the asset management industry than with getting the best deal they can. (This is even more likely the case for the investment consultants who match pension funds with asset managers.) But in a political climate that makes tax increases on rich fund managers unlikely, state governments could achieve the same results by taking a harder line on investment management fees: requiring public disclosure of all fees or even imposing hard fee caps for pension fund investments. With the amount of money involved, it’s hard to imagine that major pension funds couldn’t find anyone competent to take their money for 0.9-and-9.

Soak the Poor, Feed the Rich

By James Kwak

After the dangerous clown show that has been the Trump White House, it’s comforting to return to some good, old-fashioned conservative policymaking: bashing the poor to cut taxes on the rich. I’m talking, of course, about the Republican plan to repeal and replace Obamacare.

Health care financing can sometimes seem like a complicated topic. Adverse selection, risk adjustment, blah blah blah. But it’s easy to understand the American Health Care Act or, as it is sure to be known, Trumpcare. In the medium term, financing policies have little effect on the price of health care. At most we can hope to “bend the [long-term] cost curve.” So health care policy essentially comes down to a single question: Who pays?

Continue reading “Soak the Poor, Feed the Rich”

Review Copies of Economism

By James Kwak

If you teach introductory economics or introductory micro, at either the high school or university level, and you’re interested in possibly using Economism in your class, let me know and I’ll send you a (free) review copy. Just email me at james.kwak@uconn.edu from your school account, tell me what class you are thinking of assigning the book to, and let me know your shipping address, and I’ll order a copy for you.*

Quick summary: The central theme of Economism is that some of the basic models taught in “Economics 101” have acquired disproportionate influence in contemporary society and are routinely and systematically misapplied to important policy questions. The problem is not that introductory models are wrong, but that too many people forget their limitations and believe that their simple conclusions can be reflexively applied to the real world. As Paul Samuelson said in the first edition of his textbook, the idea that “any interference with free competition by government was almost certain to be injurious … is all that some of our leading citizens remember, 30 years later, of their college course in economics.” In chapters on labor markets, taxes, trade, and other topics, Economism first walks through the implications of introductory models before explaining how a richer understanding of economic reality, including empirical research, teaches different and more interesting lessons.

If you worry that the typical first-year curriculum produces too many students who think unregulated markets are the answer to every problem, Economism may be the antidote you need. In the Financial Times, Martin Sandbu wrote, “Economics lecturers, take note: include [Economism] on your syllabus and set aside ample time to discuss its arguments in class.” The book has also received praise from many economists including Ian Ayres (Yale Law School), Jared Bernstein (former chief economic adviser to Vice President Joe Biden), Heather Boushey (chief economist, Washington Center for Equitable Growth), Simon Johnson (MIT Sloan; former chief economist, IMF; and my frequent co-author), Dani Rodrik (Harvard), and Noah Smith (Bloomberg View).

For more about the book, you can visit economism.netThe Atlantic also published an excerpt. (It’s basically the first half of the labor market chapter, on the minimum wage; the second half of that chapter deals with the compensation of very high earners.) And again, email me if you want a review copy.

(Note: I’m not doing this for the money; I’m doing it to get the book in the hands of as many students as possible. I have donated all of my royalties from 13 BankersWhite House Burning, and Economism to charitable organizations. I can’t anticipate my financial situation for the rest of my life, but I will donate all royalties from Economism for at least the next five years.)

* The fine print (updated): In the past twelve hours, the large majority of requests I’ve gotten have not actually been from people who teach introductory economics classes, so here are some clarifications:

  • You know how publishers send you review copies of textbooks, hoping that you’ll assign them to your students? This is the same thing. That’s why I ask that you tell me what class you might use the book in. If it isn’t introductory economics or introductory micro, or if you don’t specify a class, I may send you a review copy, but only after seeing how many requests I get from people who are teaching those classes.
  • I’m not actually going to try to check what your teaching schedule is, so this is on the honor system. But please remember that I’m paying for these books, not the publisher.
  • Let me know if you prefer hard copy or Kindle. If the latter, I need to know the email address of your Amazon account.
  • Non-U.S. requests: I can’t send hard copies outside the U.S. because I’m ordering the books individually from Amazon. (It’s too much work for me to mail them individually.) I can send you a Kindle copy. So please send me the email address of your Amazon U.S. account; I don’t think the book is for sale from most other Amazon subsidiaries, and in any case I’m buying the books with my Amazon U.S. account.

 

Why Is Connecticut Giving Its Employees’ Money to the Asset Management Industry?

By James Kwak

In general, the State of Connecticut offers pretty good defined contribution retirement plans to its employees. Most importantly, it offers several low-cost index funds in institutional share classes. For example, you can invest in the Vanguard Institutional Index Fund Institutional Plus Shares, which tracks the S&P 500 for just 2 basis points, or the TIAA-CREF Small-Cap Blend Index Institutional Class, which tracks the Russell 2000 for just 7 basis points. Administrative fees are unbundled, and are only 5 basis points. For no good reason I can discern, however, you can also invest in actively managed stock funds like the JPMorgan Mid Cap Value Fund, which costs 80 basis points.

As I’ve previously said, I have mixed feelings about target date funds. In principle, they do the reallocation and rebalancing for you, so they could be appropriate for people who want to make one choice and then forget about their investments (which, in many ways, is a good strategy). The hitch is that a target date fund is only as good as the funds inside it. Fidelity, for example, puts twenty-five different funds inside one of its target date funds, including thirteen U.S. stock funds, eleven of which appear to be actively managed. This is just a clever way to sneak expensive active management back in through the back door.

The Connecticut retirement plans do have target date funds, but luckily they use Vanguard’s versions, which are made up of index funds and only charge 14–16 bp (as opposed to 77 bp for the Fidelity Freedom 2040 fund) … until now. As of February, the Connecticut defined contribution plans are switching away from Vanguard to something called “GoalMaker,” which takes your money and spreads it out among the various funds offered by the plan—including those expensive, actively managed funds. For example, if you say you have a moderate risk tolerance and want to retire in 2034, it puts your money in fourteen different funds—including six U.S. stock funds, three of which are actively managed.

This is just fake diversification. On one level, it may seem more prudent to have money in both the Vanguard S&P index fund and the Fidelity VIP Contrafund Portfolio (wow, “VIP,” that must be special!). But mutual funds are already diversified—particularly index funds. If you have some reason for thinking that the VIP Contrafund Portfolio will beat the index, then you might choose to invest in it—but, in fact, it’s trailed the S&P 500 over 1, 3, 5, and 10 years.

Most likely, the people who are currently invested in Vanguard target date funds will get shifted into GoalMaker portfolios. They will pay several times as much in fees for basically the same thing, except with a little additional risk due to managers’ attempts to beat the market. It’s hard to see how this makes anyone better off—except the asset managers themselves.

The Right to Have Rights

By James Kwak

There’s a story you hear often these days. The story is that America has too many lawsuits: too many lawyers, too many people filing frivolous suits, too many excessive damages awards by juries, and so on. This story is the reason for all the “litigation reform” in recent decades: the Private Securities Litigation Reform Act of 1995, Prison Litigation Reform Act of 1996, the state-level tort reform movement, Bell Atlantic v. TwomblyAshcroft v. Iqbal, and so on.

There are two problems with this story. The first is that it isn’t true. Take medical malpractice, for example—a frequent target of tort reform advocates. Only a tiny fraction—probably under 2%—of people harmed by negligent medical care actually file suit. Of suits that are filed, according to an after-the-fact review by unaffiliated doctors, 63% involved errors by doctors, and another 17% showed some evidence of error. According to the most basic economic theory of torts, we want people harmed by negligence to sue, because otherwise potential defendants (doctors, companies, etc.) will not have sufficient incentive to make the efficient level of investments in preventing injuries. In short, it is highly likely that we suffer from not enough lawsuits, not from too many lawsuits.

The second problem is more important, however. That problem is that while the costs of litigation are real—not just money but also defensive medicine, intimidation of startups by patent trolls, intimidation of the media by billionaires—the exclusive focus on costs overlooks the crucial role of litigation in our democracy. That is the focus of the new book In Praise of Litigation by Alexandra Lahav, a colleague of mine at the University of Connecticut School of Law. (The book is also where I got the statistics in the previous paragraph.)

Continue reading “The Right to Have Rights”

Economism and Economics

By James Kwak

One point I try to be clear about in my new book is that economism—the assumption that simple Economics 101 models accurately describe the real world—is not the same as economics. There are people who think that all of economics, or at least all of modern, mathematically inclined, “neoclassical” economics, is at fault for the growth of neoliberal capitalism and the increase in inequality in rich countries. I am not one of them.

In my mind, the problem is knowing just a little bit of economics—the proverbial little bit of knowledge. (My favorite form of that proverb, despite its religious origins, is the following: “A little knowledge is apt to puff up, and make men giddy, but a greater share of it will set them right, and bring them to low and humble thoughts of themselves.”) When you learn more economics, you learn that the world has more than just supply, demand, price, and quantity.

Matt Yglesias has even tried to argue that “on a whole lot of issues the basic econ 101 view supports the liberal position.” I think he’s exaggerating his point—on a whole lot of issues, Economics 101 tells you that market failures are possible, but that doesn’t necessarily dictate a liberal policy outcome. But whatever is actually in an introductory textbook, the problem is that what people think they remember—or what people who never took economics think the subject teaches—is that competitive markets produce optimal outcomes. As Paul Samuelson wrote in the first edition of his textbook (and I never tire of quoting), the idea that “any interference with free competition by government was almost certain to be injurious … is all that some of our leading citizens remember, 30 years later, of their college course in economics.”

The historical development of economism, and its divergence from economics, is the subject of chapter 3 of my book, and also of my new article in the Chronicle Review. The article also includes some of my thoughts on how the teaching of economics might be modified to give students a richer and more balanced understanding of the discipline. For more, head on over there.