I think it’s highly likely that the dust will clear eventually and that our economy will come back to life at some point in the next two or three years. I know there are certain disaster scenarios that can’t be ruled out, but I think they are unlikely. I’m not going to guess when things will return to a semblance of normal. Really, no one knows.
The question for now is: what will that economy look like?
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:
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.
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:
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.
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.
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.
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.
My new book—Economism: Bad Economics and the Rise of Inequality—is coming out on January 10 (although, of course, you can pre-order it from your local monopoly now). If you’d like more information about the book, the book website is now up at economism.net. (I used Medium instead of WordPress.com this time.) The post below, which is also the top story on the book website, summarizes the main themes of the book.
Income inequality is at levels not seen for a century. Many working families are struggling to get by, only kept afloat by Medicaid and food stamps. The federal minimum wage is just $7.25 per hour—below the poverty line even for a family of two. The bright outlook for corporate profits has driven the S&P 500 to record levels. Surely it makes sense to raise the minimum wage, forcing companies to dip into those profits to pay their workers a bit more.
But that’s not what you learn in Economics 101. The impact of a minimum wage is blissfully easy to model using the supply-and-demand diagram that dominates first-year economics courses.
Looking at that chart, and at Furman’s triumphant tweet, you would think inequality had declined during the Obama administration.
Not so fast.
The first thing to understand is what that chart actually says. It does not say that the top 0.1 percent’s share of national income has gone down by almost one percentage point (rightmost column) since Barack Obama took office, nor does it say that the bottom 20 percent’s income share has gone up by more than half a percentage point (leftmost column).
Over at the Washington Post, Michael Strain of the American Enterprise Institute is upset that people are picking on Economics 101. He singles out Paul Krugman and Noah Smith in particular for claiming that “the pages of economics 101 textbooks are filled with errors, trivia and ‘useless fables.'” Instead, Strain insists, “an economics 101 textbook is a treasure.” He continues by discussing some of the key insights that you can gain from the basic models presented in an introductory economics class.
Except, for the most part, Strain is rebutting an argument that no one is making. He is right to say that Economics 101 provides many valuable lessons—the competitive market model, opportunity cost, diminishing marginal returns, comparative advantage, the labor-leisure tradeoff, etc. But no one denies the analytical power of those abstract concepts.
I have previously written about (here, for example) what I call economism, or excessive belief in the little bit that you remember from Economics 101. The problem is twofold. First, Economics 101 usually paints a highly stylized, unrealistic view of the world in which free markets always produce optimal outcomes. Second, most people in the world who have taken any economics have only taken first-year economics, and so they never learned that, from a practical perspective, just about everything in Economics 101 is wrong. (Complete information? Rational actors? Perfectly competitive markets?) This produces a nation of people like Paul Ryan, who repeats reflexively that free market solutions are always good, journalists who repeat what Paul Ryan says, and ordinary people who nod their heads in agreement.
The problem is not the economics profession per se. These days, to make your mark as an economist, it helps to be arguing (or, better yet, proving) that the free market caricature of Economics 101 is wrong. The problem is the way it is taught to first-year students, which pretty much assumes that Joseph Stiglitz, Daniel Kahnemann, Elinor Ostrom, and many others had never existed.
What we need, I have often thought, is a companion book for students in Economics 101, one that points out the problems with the standard material that is covered in the textbook. For a while I was thinking of writing such a book, but I decided against it for a number of reasons, one of them being that I am not actually an economist. Fortunately, John Komlos, who really is an economist, has written a book along these lines, titled What Every Economics Student Needs to Know and Doesn’t Get in the Usual Principles Text.
If there is a central argument to 13 Bankers, it is that politics matters. The financial crisis was the result of a long-term transformation of the financial sector and its place in the overall economy, and that transformation occurred because of—and contributed to—a shift in the political balance of power.
Daron Acemoglu and James Robinson, authors of Why Nations Fail, take up this theme on a much broader scale in their recent article in the Journal of Economic Perspectives, “Economics Versus Politics: Pitfalls of Policy Advice,” burnishing their reputations as two of the most subversive thinkers around. People have always known that economics and politics are related: that economic power produces political power and that political institutions constrain economic policy choices. Still, however, at least for the past several decades, the universal assumption has been that good economic policy is always good policy, full stop: for example, that it is always good to eliminate market failures.
This is a chart from “The Quiet Coup,” an article that we wrote for The Atlantic three years ago next month. Many people have noted that the financial sector has been getting bigger over the past thirty years, whether you look at its share of GDP or of profits.
The common defense of the financial sector is that this is a good thing: if finance is becoming a larger part of the economy, that’s because the rest of the economy is demanding financial services, and hence growth in finance helps overall economic growth. But is that true?
Christina and David Romer’s new paper, “The Incentive Effects of Marginal Tax Rates: Evidence from the Interwar Era,” is available as an NBER working paper (if you are so lucky). Given the current debates about taxes, the paper is likely to garner some attention.
In the central section of the paper, Romer and Romer regress reported taxable income against the policy-induced change in marginal after-tax income share. The after-tax income share is the percentage of your gross income that is left after taxes; policy-induced changes are those caused by tax changes rather than be macroeconomic changes. They do this for the top 0.05% of the income distribution, broken down into ten sub-groups by income, because the income tax only affected the very rich during the interwar years.
Their headline finding is that “The estimated impact of a rise in the after-tax share is consistently positive, small, and precisely estimated” pp. 15–16). They find an elasticity of taxable income with respect to changes in the after-tax income share of 0.19.
Andrew Lo’s review of twenty-one financial crisis books has been getting a fair amount of attention, including a recent mention in The Economist. Simply reading twenty-one books about the financial crisis is a demonstration of stamina that exceeds mine. I should also say at this point that I have no arguments with Lo’s description of 13 Bankers.
Lo’s main point, which he makes near the end of his article, is that it is important to get the facts straight. Too often people accept and repeat other people’s assertions—especially when they are published in reputable sources, and especially especially when those assertions back up their preexisting beliefs. This is a sentiment with which I could not agree more. One of the things I was struck by when writing 13 Bankers was learning that nonfiction books are not routinely fact-checked (Simon and I hire and pay for fact-checkers ourselves). As technology and the Internet produce a vast increase in the amount of writing on any particular subject, the base of actual facts on which all that writing rests remains the same (or even diminishes, as newspapers cut back on their staffs of journalists).
I’m not entirely convinced by Lo’s example, however. He focuses on a 2004 rule change by the SEC. According to Lo, in 2008, Lee Pickard claimed that “a rule change by the SEC in 2004 allowed broker-dealers to greatly increase their leverage, contributing to the ﬁnancial crisis” (p. 33). That is Lo’s summary, not Pickard’s original. This claim was picked up by other outlets, notably The New York Times, and combined with the observation that investment bank leverage ratios increased from 2004 to 2007, leading to the belief that the SEC’s rule change was a crucial factor behind the fragility of the financial system and hence the crisis.
After my post on Corey Robin’s new book, a friend recommended Albert O. Hirschman’s Rhetoric of Reaction. As the title suggests, the book is about the rhetorical style of conservative thought dating back to Burke. Hirschman identifies three common tropes: perversity (that great-sounding progressive idea you have will have the opposite of its intended effect), futility (that great-sounding progressive idea won’t change anything, because you don’t understand the fundamental laws of the world), and jeopardy (that great-sounding progressive idea will destroy some other thing that we all agree is valuable, making everyone worse off in the end). Hirschman doesn’t dwell on this specific point, but it’s obvious that, similar to the argument Robin makes, these rhetorical devices can only exist in opposition to some progressive reform movement.
I thought the description of the contemporary form of the perversity thesis (e.g., welfare programs create poverty) was especially good. “Here the failure of foresight of ordinary human actors is well-nigh total as their actions are shown to produce precisely the opposite of what was intended; the social scientists analyzing the perverse effect, on the other hand, experience a great feeling of superiority—and revel in it” (Belknap Press, 1991, p. 36). This seems to me an accurate description of why the Economics 101 ideology is so powerful. People get a sense of superiority from owning counter-intuitive theoretical insights—even if those insights are wrong.
“The general equilibirum view tends to lend support to those who want to make the economy more efficient in the sense of having fewer ‘distortions’—you know, all of these neutral economic words—from taxes, from labor unions, from minimum wages, and so on. Now, what has happened in the last thirty years—and this is what Hacker and Pearson note in their book [Winner-Take-All Politics]—is we have gotten ourselves into a feedback situation. As people have gotten richer, conservative people have funded organizations which generate economic research promoting their political views.”
That’s from an excellent interview with economic historian Peter Temin in The Straddler. Temin’s main point is that what he calls general equilibrium approaches to macroeconomics have a political agenda, but they hide that agenda behind an ideology of naturalness. The “natural,” perfectly clearing, perfectly efficient economy, of course, has never existed and can never exist, but it is used to justify certain political prescriptions.