Stiglitz on the Great Recession

Here is a bit from an article in Vanity Fair by Nobel prizing-winning economist Joseph Stiglitz looking at the similarity between now and the 1930s. It is dismal reading:

The trauma we’re experiencing right now resembles the trauma we experienced 80 years ago, during the Great Depression, and it has been brought on by an analogous set of circumstances. Then, as now, we faced a breakdown of the banking system. But then, as now, the breakdown of the banking system was in part a consequence of deeper problems. Even if we correctly respond to the trauma—the failures of the financial sector—it will take a decade or more to achieve full recovery. Under the best of conditions, we will endure a Long Slump. If we respond incorrectly, as we have been, the Long Slump will last even longer, and the parallel with the Depression will take on a tragic new dimension.

Until now, the Depression was the last time in American history that unemployment exceeded 8 percent four years after the onset of recession. And never in the last 60 years has economic output been barely greater, four years after a recession, than it was before the recession started. The percentage of the civilian population at work has fallen by twice as much as in any post-World War II downturn. Not surprisingly, economists have begun to reflect on the similarities and differences between our Long Slump and the Great Depression. Extracting the right lessons is not easy.

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The argument has been made that the Fed caused the Depression by tightening money, and if only the Fed back then had increased the money supply—in other words, had done what the Fed has done today—a full-blown Depression would likely have been averted. In economics, it’s difficult to test hypotheses with controlled experiments of the kind the hard sciences can conduct. But the inability of the monetary expansion to counteract this current recession should forever lay to rest the idea that monetary policy was the prime culprit in the 1930s. The problem today, as it was then, is something else. The problem today is the so-called real economy. It’s a problem rooted in the kinds of jobs we have, the kind we need, and the kind we’re losing, and rooted as well in the kind of workers we want and the kind we don’t know what to do with. The real economy has been in a state of wrenching transition for decades, and its dislocations have never been squarely faced. A crisis of the real economy lies behind the Long Slump, just as it lay behind the Great Depression.

For the past several years, Bruce Greenwald and I have been engaged in research on an alternative theory of the Depression—and an alternative analysis of what is ailing the economy today. This explanation sees the financial crisis of the 1930s as a consequence not so much of a financial implosion but of the economy’s underlying weakness. The breakdown of the banking system didn’t culminate until 1933, long after the Depression began and long after unemployment had started to soar. By 1931 unemployment was already around 16 percent, and it reached 23 percent in 1932. Shantytown “Hoovervilles” were springing up everywhere. The underlying cause was a structural change in the real economy: the widespread decline in agricultural prices and incomes, caused by what is ordinarily a “good thing”—greater productivity.

At the beginning of the Depression, more than a fifth of all Americans worked on farms. Between 1929 and 1932, these people saw their incomes cut by somewhere between one-third and two-thirds, compounding problems that farmers had faced for years. Agriculture had been a victim of its own success. In 1900, it took a large portion of the U.S. population to produce enough food for the country as a whole. Then came a revolution in agriculture that would gain pace throughout the century—better seeds, better fertilizer, better farming practices, along with widespread mechanization. Today, 2 percent of Americans produce more food than we can consume.

What this transition meant, however, is that jobs and livelihoods on the farm were being destroyed. Because of accelerating productivity, output was increasing faster than demand, and prices fell sharply. It was this, more than anything else, that led to rapidly declining incomes. Farmers then (like workers now) borrowed heavily to sustain living standards and production. Because neither the farmers nor their bankers anticipated the steepness of the price declines, a credit crunch quickly ensued. Farmers simply couldn’t pay back what they owed. The financial sector was swept into the vortex of declining farm incomes.

The cities weren’t spared—far from it. As rural incomes fell, farmers had less and less money to buy goods produced in factories. Manufacturers had to lay off workers, which further diminished demand for agricultural produce, driving down prices even more. Before long, this vicious circle affected the entire national economy.

The value of assets (such as homes) often declines when incomes do. Farmers got trapped in their declining sector and in their depressed locales. Diminished income and wealth made migration to the cities more difficult; high urban unemployment made migration less attractive. Throughout the 1930s, in spite of the massive drop in farm income, there was little overall out-migration. Meanwhile, the farmers continued to produce, sometimes working even harder to make up for lower prices. Individually, that made sense; collectively, it didn’t, as any increased output kept forcing prices down.

Given the magnitude of the decline in farm income, it’s no wonder that the New Deal itself could not bring the country out of crisis. The programs were too small, and many were soon abandoned. By 1937, F.D.R., giving way to the deficit hawks, had cut back on stimulus efforts—a disastrous error. Meanwhile, hard-pressed states and localities were being forced to let employees go, just as they are now. The banking crisis undoubtedly compounded all these problems, and extended and deepened the downturn. But any analysis of financial disruption has to begin with what started off the chain reaction.

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The parallels between the story of the origin of the Great Depression and that of our Long Slump are strong. Back then we were moving from agriculture to manufacturing. Today we are moving from manufacturing to a service economy. The decline in manufacturing jobs has been dramatic—from about a third of the workforce 60 years ago to less than a tenth of it today. The pace has quickened markedly during the past decade. There are two reasons for the decline. One is greater productivity—the same dynamic that revolutionized agriculture and forced a majority of American farmers to look for work elsewhere. The other is globalization, which has sent millions of jobs overseas, to low-wage countries or those that have been investing more in infrastructure or technology. (As Greenwald has pointed out, most of the job loss in the 1990s was related to productivity increases, not to globalization.) Whatever the specific cause, the inevitable result is precisely the same as it was 80 years ago: a decline in income and jobs. The millions of jobless former factory workers once employed in cities such as Youngstown and Birmingham and Gary and Detroit are the modern-day equivalent of the Depression’s doomed farmers.

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Can we actually bring ourselves to do this, in the absence of mobilization for global war? Maybe not. The good news (in a sense) is that the United States has under-invested in infrastructure, technology, and education for decades, so the return on additional investment is high, while the cost of capital is at an unprecedented low. If we borrow today to finance high-return investments, our debt-to-G.D.P. ratio—the usual measure of debt sustainability—will be markedly improved. If we simultaneously increased taxes—for instance, on the top 1 percent of all households, measured by income—our debt sustainability would be improved even more.

The private sector by itself won’t, and can’t, undertake structural transformation of the magnitude needed—even if the Fed were to keep interest rates at zero for years to come. The only way it will happen is through a government stimulus designed not to preserve the old economy but to focus instead on creating a new one. We have to transition out of manufacturing and into services that people want—into productive activities that increase living standards, not those that increase risk and inequality. To that end, there are many high-return investments we can make. Education is a crucial one—a highly educated population is a fundamental driver of economic growth. Support is needed for basic research. Government investment in earlier decades—for instance, to develop the Internet and biotechnology—helped fuel economic growth. Without investment in basic research, what will fuel the next spurt of innovation?

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Americans in general are coming to understand what has happened. Protesters around the country, galvanized by the Occupy Wall Street movement, already know.

Shocking that greater productivity can cause an economic disaster. It should mean more goodies for everyone. But if you can't organize economic life in a way that everybody gets a fair share and decent opportunity, you are asking for a broken system that collapses around you. The Republicans and Democrats fail to address the fundamental problems of the current situation. Obama, the great hope of 2008, has been a complete bust, a flailing, useless, clueless fool who self-satisfiedly claimed he had done a "just right" stimulus as the economy flat-lined.

These are historic times and they require radical solutions under a leader of vision. Sadly the US has the oddly impassive Obama and the clearly incompetent and clueless Republican presidential candidates as the possible leaders after 2012. This says only one thing: the future will be incredibly bleak. There is a desperate need for a visionary leader with an understanding of economics and instead the US is stuck with buffoons and timid pretenders.

Sylvia Nasar's "Grand Pursuit"

This book is an intellectual history of economics with a focus on a handful of names: Karl Marx, Alfred Marshall, Beatrice Webb, Irving Fisher, Joseph Schumpeter, John Maynard Keynes, Friedrich Hayek, Joan Robinson, Milton Friedman, Paul Samuelson, and Amartya Sen.

As you can see, those choices are idiosyncratic. Most modern economists would not include Marx, Webb, and Robinson since they are off in the dead end of Marxist "economics". But for me they are part of the spice of this book. This isn't a text to teach you economics. It is really more of a history of personalities and circumstances. The stories are delightful. The sketches of economics are thin gruel, so don't come here to understand economic theory. Come to savour history, personalities, and ideas.

What I found delightful is that the book reinforced my prejudices. Economics is not a "science". It is a liberal art with the pretension of science through its mathematicization of its arguments. The formalism doesn't make the models and arguments any more right. They do provide a bit more formal clarity but they also lead to obscurantism with dithering over details and ridiculous "simplifying" assumptions. I had a mathematician as a friend who made this point by arguing about cows by first stating "consider a sphere". Yep... mathematics does some wonderful leaps in simplification to make the mathematics "tractable".

Here are some snippets to give you a feel for the writing style:

Before resuming his journey north to the Scottish highlands, Alfred Marshall, a twenty-four-year-old mathematician and fellow of St. Hohn's College in Cambridge, spent hours walking through factory districts and the surrounding slums "looking into the faces of the poorest people." He was debating whether to make German philosophy or Austrian psychology his life's work. These were his first steps away from metaphysics and the beginning of a dogged pursuit of social reality. He later said that these walks forced him to consider the "justification of existing conditions of society."

In Manchester, Marshall found the smoky brown sky, muddy brown streets, and long piles of warehouses, cavernous mills, and insalubrious tenements -- all within a few hundred yards of glittering shops, gracious parks, and grand hotels -- that novels such as Elizabeth Gaskell's North and South had led him to expect. In the narrow backstreets he encountered sallow, undersized men and stunted, pale factory girls with thin shawls and hair flecked with wisps of cotton. The sight of "so much want" amid "so much wealth" prompted Marshall to ask whether the existence of a proletariat was indeed a "necessity of nature," as he had been taught to believe. "Why not make every man a gentleman?" he asked himself.

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He took great pains to demolish Socialists' claim that but for oppression by the rich, the poor could live in "absolute luxury." England's annual income totaled about £900 million, he told the women. The wages paid to manual workers amounted to a total of £400 million. Most of the remaining £500 million, Marshall pointed out, represented the wages of workers who did not belong to the so-called working classes: semiskilled and skilled workers, government officials and military, professionals, and managers. In fact, an absolutely equal division of Britain's annual income would provide less than £37 per capita. Reducing poverty required expanding output and increasing efficiency; in other words, economic growth.

One of the points that Nasar makes is that modern societies organized around liberal economic principles has unleashed productivity and wealth. But as I read the above I keep picturing the billionaire tycoons on Wall Street and the masses in the street with their Occupy Wall Street protests. Sure there has been progress, but the economic injustice is still just as bad. The greed and indifference is there which exacerbates the pain. The fact that the billionaires can buy the politicians means that nothing will ever change. The fact that the rich are pushing to cut education and social services while cutting taxes on the rich as their "solution" to the current Lesser Depression is very depressing.

Sylvia Nasar's story points out that the same humbug and foot-dragging that blocked a real solution to the Great Depression was very, very similar to the humbug and foot-dragging of today:

Despite his financial straits, damaged reputation, and advancing age, the sixty-five-year-old Fisher seemed more energized than depressed by the economic calamity. In 1932 he published an extraordinary number of scientific papers and newspaper pieces. He bombarded the Hoover administration and the Federal Reserve with advice and organized other economists to do the same. His chief objective was to convince President Hoover to take the United States off the gold standard, if not de jure then de facto by having the Federal Reserve do nothing to prevent the foreign exchange value of the dollar from falling. He met with the bankers at the Federal Reserve to urge them to adopt an aggressive program to buy bonds from the banks and the public in order to pump money into the banking system. To his frustration, the "Federal Reserve men thought it would be 'safer' if they waited!" as he later complained. "That waiting, in my opinion, cost the country the major part of the depression."

In January 1932, Fisher attended a second meeting of monetary experts at the University of Chicago. This time, he organized a telegram urging the president to permit the federal budget deficit to rise, pump reserves into the crippled banking system, slash tariffs, and cancel inter-allied debts. Thirty-two prominent economists from Chicago, Wisconsin, and Harvard universities signed the statement, in which Fisher pointed out that Sweden, Japan, and Britain were recovering after going off gold the previous year. The signatories reflected the extent to which Fisher and Keynes's view of the crisis with its emphasis on its global nature, monetary causes, forecasts of its future course, and the need for concerted monetary intervention had gained adherents. On the other hand, theirs was still a minority view.

Sadly, today Obama ignores neo-Keynesian solutions. He shows himself to be uneducated about economics and has surrounded himself with the same fanatical deregulation libertarian economists who created this Lesser Depression. There has been absolutely no progress in economic "science" in 80 years. The same humbug and "morality play" rationalizing goes on to protect bondholders at the expense of the 25 million unemployed, the 10 million who are losing their homes, the youth who have given up on education because it is too expensive, and those nearing retirement who are desperate because their savings are exhausted. It is a social disaster, but Obama is acting like a modern Hoover and the 2012 Republican presidential candidates would make Hoover look like a bleeding-heart liberal. Tragic.

Sylvia Nasar traces out Keynes' thinking:

As the Great Depression dragged on, Keynes's faith in the effectiveness of monetary policy ebbed further. By the time A Treatise on Money appeared, he was beginning to pose a theory of the causes of unemployment. Cambridge undergraduates were his first audience. The nub of the new theory was that, as he put it in an article published in the American Economic Review in December 1933, "circumstances can arise, and have recently arisen, when neither control of the short-rate of interest nor control of the long-rate will be effective, with the result that direct stimulation of investment by government is a necessary means."

In a severe depression, prices fell even faster than interest rates. So reductions in nominal rates did not prevent real rates from climbing. Once nominal rates fell to zero, there was nothing further that the central bank could do to make borrowing cheaper or to ease debt burdens and thus to end the depression -- with incalculable political consequences, what Keynes called The Liquidity Trap. As he had once observed, "The inability of the interest rate to fall has brought down empires." Once monetary policy was rendered ineffectual, the only option for shoring up demand was getting money into the hands of those who could spend it.

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As Herbert Stein, the economist, pointed out, Keynes asked a very different question from the one posed by Hayek and Schumpeter. In explaining depressions, in terms of the preceding booms, the Austrians were trying to figure out how the economy had gotten there. Keynes was less interested in the genesis of slumps than in the more basic puzzle of how high unemployment and slack capacity could persist for long in a free market economy with unrestricted competition.

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Thus what made the General Theory so radical was Keynes' proof that it was possible for a free market economy to settle into states in which workers and machines remained idle for prolonged periods of time -- that there were depressions that, unlike the garden-variety ones, were not brief and didn't end of their own accord as a result of falling prices and interest rates, or, at an extreme, that free market economies tended naturally to stagnate even when there were idle workers and machines available. In such depressions, unfreezing credit flows through monetary policy didn't provide a sufficient stimulus, because even zero-percent interest rates could not tempt businesses to borrow while prices were falling and there was [no] reason to think that demand would recover. The only way to revive business confidence and get the private sector spending again was by cutting taxes and letting businesses and individuals keep more of their income so that they could spend it. Or, better yet, having the government spend more money directly, since that would guarantee that 100 percent of it would be spent rather than saved. If the private sector couldn't or wouldn't spend, then the government had to do it. For Keynes, the government had to be prepared to act as the spender of last resort, just as the central bank acted as the lender of last resort.

This is the same intellectual landscape that has policy makers hung up today. Bernanke and the Federal Reserve have been too timid in using monetary policy and now the only tool left is fiscal stimulus, but you have right wing nuts screaming about "inflation!" and "debt!". Obama is too timid to properly stimulate the economy and instead falls into the trap of Hoover and FDR in 1937 of worrying about deficits and debts. They ignore the ruined lives and the lost production that can never be retrieved while the country stays mired in a depression. The arguments of 80 years ago are lost to policy makers today because they are illiterate about history and economics. Oh, and they are blinded by their ideology, an ideology bought and paid for by the billionaire ultra-rich who are quite happy to leave the system just as it is, a system that has let them exploit it for billions in personal gain. This is a tragedy for the bottom 99%. The top 1% are laughing, but the bottom 1% are paying in ruined lives... and they will also pay through taxes to cover the lost monies and even provide the billionaire bonuses for the frauds and cheats who created the mess. Sorrows heaped on woes, and smothered with injustice.

This is a good read and it is highly relevant. This book will give you useful background to understand the economic arguments of today and the tragedy that today is a maddening repeat of the 1930s.

A Day Late and a Dollar Short

The "poltics" in America is pathetic. Nobody is addressing the real needs. The major parties are playing a three card monte game with posturing and distractions. This day late and a dollar short politics has got to end.

Here's a bit from a relevant Robert Reich post:

Republicans are debating again tomorrow night. And once again, Americans will hear the standard regressive litany: government is bad, Medicare and Medicaid should be cut, “Obamacare” is killing the economy, undocumented immigrants are taking our jobs, the military should get more money, taxes should be lowered on corporations and the rich, and regulations should be gutted.

Four years ago the most widely-watched TV debate among Republican aspirants attracted 3.2 million viewers. This year it’s almost twice that number. And for every viewer assume a multiplier effect as he or she shares what’s heard with friends and family.

Americans are listening more intently this time around because they’re hurting and they want answers. But the answers they’re getting from Republican candidates – tripping over themselves trying to appeal to hard-core regressives – are the wrong ones.

The correct ones aren’t being aired.

That’s partly because there’s no primary contest in the Democratic party. So Republicans automatically get loads of free broadcast time to air their regressive nonsense while the Democrats get none.

But even if the President had equal time, the debate about what to do about the crisis would still be frighteningly narrow.

That’s because the President’s answers don’t nearly match up to the magnitude of the crisis.

Without bold alternatives, Americans desperate for big solutions are attracted to bold crackpot ideas like Herman Cain’s “9-9-9” proposal, which would raise taxes on the poor and cut them for the rich.

This is where the inchoate Occupy Wall Street movement could come in. What’s needed isn’t just big ideas. It’s people fulminating for them – making enough of a ruckus that the ideas can’t be ignored. They become part of the debate because the public demands it.

The biggest thing the President has proposed is a plan to create 2 million jobs. But that’s not nearly big enough. Today, 14 million Americans are out of work, and 11 million more are working part-time who’d rather be working full time.

The nation needs a real jobs plan, one of sufficient size and scope to do the job – including a WPA and a Civilian Conservation Corps, to put the millions of long-term unemployed and young unemployed to work rebuilding America.

I'm reading material from the 1930s and we've been down this path before. The politics is a distraction. We know how to fix the economy. It takes a big jolt of spending to fix the huge number of people caught in a credit squeeze. Pussyfooting around only stretches out the pain. Most politicians know this, but they aren't honest with the public. They would rather play their games and go for personal gain rather than do their duty and build a better tomorrow.