Deja Vu Economics

John Lauritz Larson, a historian from Purdue University, has an interesting article in the LA Times reviewing the previous economic meltdowns experienced by the US:

To listen to the pundits, one would think that today's banking crisis and financial meltdown is something rare and exotic. But those who stayed awake in their history classes know that financial panic is a familiar "plot device" in the drama of modern capitalism. Speculation has been followed by collapse at least as far back as the South Sea bubble of 1720. The American experience with such wholesale crises began in 1819.

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The next three big panics -- in 1857, 1873 and 1893 -- fed off railroad development accompanied by currency and stock speculation. Every boom fed the dreams of small-town boosters, that one more mile of shiny rails would buy them a seat at the rich man's table. Each panic squeezed out the excess but also cut to the bone of subsistence for men and women who lived from payroll to payroll. In the speculators' game, the hammer always falls, but rarely on those who deserve it.

In the 20th century, we erected safeguards against these devastating cycles. In 1913, our Federal Reserve system was established to rescue banks from such sudden crises of confidence. Still, the Crash of 1929 yielded a worldwide Great Depression. New Deal reforms -- especially the Glass-Steagall Act of 1933, which created the FDIC and barred commercial banks from Wall Street speculation -- helped limit the effect of panics on ordinary people. But capitalists always invent new ways to cheat on the rules, like the now-infamous "credit default swaps." Beginning in the 1980s, the enemies of New Deal policies stripped away regulations and allowed speculators to take outrageous risks that former Fed Chairman Alan Greenspan claims he could not have imagined. Too bad he never looked in the rearview mirror!

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Panics expose how the game of chance can ruin the core economy. These days, we cannot retreat into semi-subsistence, grow our own food and sit tight under our own vine or fig tree -- advice freely given in 1819. Still, there is no reason to submit to absurd abuses by self-serving gamblers who toy with the people's welfare. The history of panics ought to remind us that independence was the first objective of America's founders. A market economy can be made to serve the common good, but when you license it to make a killing, you just might get killed.

An End to Extortion Pay

Wait as second... I mean exorbitant pay.

No, no... make that "executive" pay. You know, as in we took the economy out back and "executed" it.

Here's an article that examines CEO pay and the author argues that even though US CEOs get outrageous pay compared to CEOs around the world -- and produce weak company performance and delivered a faltering US economy -- that letting them have astronomical pay is well, OK because they "deserve" those big bucks. This is an opinion piece by Robert H. Frank in the NY Times:

It’s no wonder that voters’ outrage over exorbitant executive pay is mounting. After all, the government just had to bail out financial firms that paid big bonuses last year to many of the same executives who helped precipitate the current financial crisis.

Nor is it any wonder that Congress is considering measures to limit executive pay — not just in the financial industry, but economywide. So far, the only formal legislative proposal is “say on pay,” which would require a nonbinding shareholder vote on executive pay proposals. But critics complain that this would have little impact and are hungry for stronger measures.

One popular proposal would cap the chief executive’s pay at each company at 20 times its average worker’s salary. But while Congress may well have compelling reasons to limit executive pay in companies seeking bailout money, voter anger is not a good reason to extend pay caps more generally.

To be sure, executive pay in the United States is vastly higher than necessary. Executives in other countries, whose pay is often less than one-fifth that of their American counterparts, seem to work just as hard and perform just as well. The same was true of American executives in the 1980s.

I find this funny because the US experiment with giving ridiculously high pay to their CEOs has destroyed their economy... and brought the rest of the world down as well. Despite this, the author argues that (except for the financial industry) these obscene pay packets are "justified".

Hmm... I guess to really hit the ball out of the park in terms of a pay packet you literally have to crater the entire world's economy. Then you will truly "deserve" the outrageously over-the-top pay. It seems that the Americans measure success not by products produced or services rendered, but by the size of the economic catastrophe, the size of shareholder holdings shredded, the total number of jobs destroyed, or the number of communities left derelict when the jobs are taken away. In this race, the Americans are leading the world, and their CEO pay reflects their ability to excel well past what the poorly paid CEOs in other countries can muster. Hurrah!

Will Homo Economicus Evolve?

Paul Seabright, an economist who wrote The Company of Strangers: A Natural History of Economic Life, has a nice piece in the Financial Times that points out how economists have missed the Darwinian revolution:

If the news that 2009 will see worldwide celebrations of Charles Darwin’s 200th birthday has passed you by, you may have spent the last year living on Mars, or being home schooled in Kansas. Or you may just have been hanging out with economists.

The economics profession has paid little attention to the intellectual revolution that followed the publication of Darwin’s Origin of Species, whose 150th anniversary is also celebrated this year.

There have been, it is true, many attempts to draw analogies between economic competition and the struggle for survival that drives natural selection. The current crisis may even bring these back into fashion, though the survivors of the bloodbath in banking may turn out to be the most politically well-connected rather than the fittest in any other sense.

But economics as a discipline, also some two centuries old, sees little use for the insight that human beings share recent common ancestors with the apes. Economic man crunches data like a computer, pursuing private goals that are simply too personal to be worth discussing.

Nowadays, behavioural economics is booming. But it is largely a descriptive science, documenting the way man has short-sighted preferences, or miscalculates risks.

These are conceived as flaws in the make-up of Homo economicus rather than adapted traits in the make-up of Homo sapiens. The methods of evolutionary biology play almost no part in behavioural economics as it is done today.

If Darwin had been around to reflect on the financial crisis, he might have reminded us, in his diffident way, to think of human beings not as inadequate calculating machines, but as remarkably well-adapted apes.

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The problem is that many primates do not adapt well to life in zoos, and Wall Street is the biggest and strangest zoo of them all.

It presents our large primate brain with vast challenges, of which the greatest has been solving strategic reasoning of the thousandth degree.

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The big surprise of the last three months to economists has been that professional investors behave with as much of a group instinct as retail investors.

But it would not have surprised Darwin: professional investors are just another primate population. If you want to change their behaviour you have to change the way it feeds back not just into their pay packets, but into the status competition and coalition formation in their chosen peer-group.

Slate Reviews the Worst of the Worst

Here is a video clip from Slate looking at the bad bumps in the road of 2008...

Krugman Nails the Republicans

In his latest NY Times op-ed, Paul Krugman looks at how the Republican party ended up in such a mess. His analysis is spot on. It traces by to Nixon's "southern strategy" through the Reagon "government is the problem, not the solution" to the absolute incompetence of Bush II where you hired for "loyalty, not competence":

But most of the whining takes the form of claims that the Bush administration’s failure was simply a matter of bad luck — either the bad luck of President Bush himself, who just happened to have disasters happen on his watch, or the bad luck of the G.O.P., which just happened to send the wrong man to the White House.

The fault, however, lies not in Republicans’ stars but in themselves. Forty years ago the G.O.P. decided, in effect, to make itself the party of racial backlash. And everything that has happened in recent years, from the choice of Mr. Bush as the party’s champion, to the Bush administration’s pervasive incompetence, to the party’s shrinking base, is a consequence of that decision.

If the Bush administration became a byword for policy bungles, for government by the unqualified, well, it was just following the advice of leading conservative think tanks: after the 2000 election the Heritage Foundation specifically urged the new team to “make appointments based on loyalty first and expertise second.”

Contempt for expertise, in turn, rested on contempt for government in general. “Government is not the solution to our problem,” declared Ronald Reagan. “Government is the problem.” So why worry about governing well?

Where did this hostility to government come from? In 1981 Lee Atwater, the famed Republican political consultant, explained the evolution of the G.O.P.’s “Southern strategy,” which originally focused on opposition to the Voting Rights Act but eventually took a more coded form: “You’re getting so abstract now you’re talking about cutting taxes, and all these things you’re talking about are totally economic things and a byproduct of them is blacks get hurt worse than whites.” In other words, government is the problem because it takes your money and gives it to Those People.

The Logic of Make-work Projects

Mark Thoma has a blog entry addressing an article by Samuel Brittan in the Financial Times. I wan't particularly impressed by Brittan's material, but I did enjoy this observation by Mark Thoma:

Keynesians also note that even if the government spending has zero value initially, e.g. paying half the idle workers to dig ditches, and the other half to follow behind and fill the ditches in again, as those workers spend their new income in the community it will generate productive private sector activity. Thus, even if the initial projects are of little or no value, it can still be the case that we are better off having the government intervene than we would be if we did nothing at all. The government should do everything that it can to pursue the highest value projects, but the fact that there may be some waste in the process does not, in and of itself, mean that we'd be better off leaving those resources completely idle and doing nothing at all.

Frank Talk by Thomas Frank

In a Wall Street Journal opinion piece, Thomas Frank spells out the disaster that 2008 was, the year that the ideologues delivered a Katrina-like deluge to the world...

And who makes sure that Moody's and its competitors downgrade what deserves to be downgraded? In 1999 the obvious answer would have been: the market, with its fantastic self-regulating powers.

But something went wrong on the road to privatopia. If everything is for sale, why shouldn't the guardians put themselves on the block as well? Now we find that the profit motive, unleashed to work its magic within the credit-rating agencies, apparently exposed them to pressure from debt issuers and led them to give high ratings to the mortgage-backed securities that eventually blew the economy to pieces.

And so it has gone with many other shibboleths of the free-market consensus in this tragic year.

For example, it was only a short while ago that simply everyone knew deregulation to be the path to prosperity as well as the distilled essence of human freedom. Today, though, it seems this folly permitted a 100-year flood of fraud. Consider the Office of Thrift Supervision (OTS), the subject of a withering examination in the Washington Post last month. As part of what the Post called the "aggressively deregulatory stance" the OTS adopted toward the savings and loan industry in the years of George W. Bush, it slashed staff, rolled back enforcement, and came to regard the industry it was supposed to oversee as its "customers." Maybe it's only a coincidence that some of the biggest banks -- Washington Mutual and IndyMac -- ever to fail were regulated by that agency, but I doubt it.

Or consider the theory, once possible to proffer with a straight face, that lavishing princely bonuses and stock options on top management was a good idea since they drew executives' interests into happy alignment with those of the shareholders. Instead, CEOs were only too happy to gorge themselves and turn shareholders into bag holders. In the subprime mortgage industry, bankers handed out iffy loans like candy at a parade because such loans meant revenue and, hence, bonuses for executives in the here-and-now. The consequences would be borne down the line by the suckers who bought mortgage-backed securities. And, of course, by the shareholders.

I like Thomas Frank. Two of his books are on my all-time best reading list:

• The Wrecking Crew: How Conservatives Rule
• What's the Matter with Kansas?