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The Great Transformation: Mainstream Economics and an Introduction to a New Series

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I’m on the road, but fortunately finished with the If this is Tuesday it must be Brussels part, so back to my usual posting.

Joseph Stiglitz has written several books on inequality recently, The Great Divide: Unequal Societies and What We Can Do About Them, Rewriting the Rules of the American Economy: An Agenda for Growth and Shared Prosperity (available at www.rewritetherules.org), and Creating a Learning Society: A New Approach to Growth, Development, and Social Progress. James Surowiecki reviews these in the New York Review of Books. He is the economics writer at the New Yorker, and as far as I can tell from reading his columns, he is fairly liberal on economic issues. Therefore, the review is a good example of the hidden assumptions of liberal economics and liberal economics reporting.

Surowiecki agrees that inequality has increased in the US, to the point that even Jeb Bush has raised it in a campaign speech. He agrees that the very top incomes are dramatically greater than 50 years ago. He says Stiglitz focuses on two issues, rent-seeking by the rich, and poor corporate governance. Rent-seeking is the practice of rigging the laws and institutions of the market to jack up the profitability of a business. One recent example is Martin Shkreli, who uses monopoly power to suck money from sick people and their insurance companies. Poor corporate governance is shorthand for sycophantic boards of directors who pay unreasonable compensation to top management.

Suroweicki focuses, as Stiglitz does, on income inequality. Stiglitz says that inequality is not only a social problem, it is bad for economic growth. Surowiecki explains his thinking: inequality

… hurts demand, because rich people consume less of their incomes. It leads to excessive debt, because people feel the need to borrow to make up for their stagnant incomes and keep up with the Joneses. And it promotes financial instability, as central banks try to make up for stagnant incomes by inflating bubbles, which eventually burst.

Surowiecki has several objections to Stiglitz’ diagnosis of the problems of the economy. First, like Stiglitz, he isn’t going to address wealth inequality, because “…the rise of high-end incomes in the US is still largely about labor income rather than capital income.“ As to the impact of inequality on economic growth, he says the evidence is weak, though fixing it couldn’t hurt. And he disagrees that poor corporate governance is the cause of bloated C-Suite pay.

Of course, incomes at the bloated level of the top .01% aren’t about labor at all. They are either a sort of golden handshake by which the richest invite new members to the rich club, or a simple money grab. There is no evidence of a connection between the pay and the competence of the work done or its value, which Suroweicki acknowledges.

Suroweicki has a different explanation for the rise in top incomes. Asset managers and financial people generally make more because more money is under management. Other CEOs make more not because of special competence or better results, but because of “… the rise of ideological assumptions about the indispensability of CEOs, and changes in social norms that made it seem like executives should take whatever they could get.”

On the issue of the impact of growth, both Surowiecki and Stiglitz seem to accept the idea that growth will help solve the problem of inequality. This is a form of an argument liberals often make to conservatives: See, the thing we prefer is also good for you. But Surowiecki begins his review with the statement that all growth is going to the top of the income distribution, and the vast majority of workers aren’t getting any of it. Stiglitz knows this also. Why bother with this argument, then, since they know that the thing rich people want, namely growth, is of no value to the vast majority? And that’s besides the question of the possibility of unlimited growth, or the areas in which growth occurs. If health care sector grows because of increased pollution, why is that a good thing?

Both Suroweicki and Stiglitz recommend the usual array of solutions, but Suroweicki is less confident that they will work. They might affect some people at the margins, but that’s apparently all anyone can reasonably expect, and getting those changes is unimaginable in this sour political atmosphere. I agree with both that just because the solutions seem familiar to the point of boredom, we shouldn’t give up on pushing for them.

It all seems so distressing. I think in part that’s because it doesn’t seem to get at the reasons things are as they are. It simply accepts that the way things are is the only way things could be and we just need to try to work with that system. That won’t work. The rich have too much control. And the problem seems deeper than just a few tweaks. Suroweicki hints at the real problem when he says that we are missing the changes in social norms that make it seem natural that the C-Suite Class grab all the money, without mentioning the abandonment by that class of any pretense of interest in their employees or the wider society. I spent most of the first part of this year looking at whether mainstream economics made sense. It doesn’t, even if it enabled Krugman to get some things right. So now I want to look at a different way of imagining the entire subject area.

The main text for this series will be The Great Transformation by Karl Polanyi, published in 1944. As I get deeper into the book, I will be looking at other early economists, including at least Adam Smith (I trust commenter Alan will correct the errors I will doubtless make), and Marx, including this in particular. For those interested, here’s a discussion of Polanyi’s book that offers a starting place.

He said that to understand pivotal historical events, including the breakup of the Gold Standard and the breakdown of international relations during the first half of the twentieth century, we have to consider the role of economic thought accumulated over centuries which influenced how those events took place and were understood.

We did not become a neoliberal society by accident. For a brief treatment, see this article, particularly Part 1.C, at p. 444. We will not emerge from neoliberalism without a massive struggle. And we will never emerge from neoliberalism until we have a more compelling world view.
(Minor edits for spelling, grammar and clarity.)

Neo-Feudalism and the Housing Crisis

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A number of people have linked to the part of this Joseph Stiglitz interview where he says we won’t fix the economy without some good old fashioned prosecutions. But I wanted to highlight where he describes the way our system of debt imposes a kind of indentured servitude on the debtors.

Can we draw a direct line from the outsize influence of the executives and the bankers — because these skewed incentives and penalties out of whack didn’t just arise out of a vacuum. How did we get to where we are?

It’s clearly the influence of campaign contributions and lobbyists. Let me give you another example of where the legal system has gotten very much out of whack, and which contributed to the financial crisis.

In 2005, we passed a bankruptcy reform. It was a reform pushed by the banks. It was designed to allow them to make bad loans to people to who didn’t understand what was going on, and then basically choke them. Squeeze them dry. And we should have called it, “the new indentured servitude law.” Because that’s what it did.

Let me just tell you how bad it is. I don’t think Americans understand how bad it is. It becomes really very difficult for individuals to discharge their debt. The basic principle in the past in America was people should have the right for a fresh start. People make mistakes. Especially when they’re preyed upon. And so you should be able to start afresh again. Get a clean slate. Pay what you can and start again. Now if you do it over and over again that’s a different thing. But at least when there are these lenders preying on you should be able to get a fresh start.

But they [the banks] said, “No, no, you can’t discharge your debt,” or you can’t discharge it very easily. They have a right, now, to take 25% of your before-tax income. Now imagine what that means. Let’s assume that you wound up, as it’s not that hard to do, with a debt equal to 100% of your income. You’re making $40,000, and your debt is $40,000. You have to turn over to the credit card company, to the bank, $10,000 of your before-tax income every year. But, the banks can now charge you 30% interest.

So what does that mean? At the end of the year, you’ve paid the bank $10,000, a quarter of your income. But what you owe the bank has gone from $40,000 to an even larger number because they’re charging you 30%. So you’re debt is larger. So the next year you have to give a quarter of your income again to the bank. And the year after. Until you die.

This is indentured servitude. And we criticize other countries for having indentured servitude of this kind, bonded labor. But in America we instituted this in 2005 with almost no discussion of the consequences. But what it did was encourage the banks to engage in even worse lending practices.

We’ve made it so difficult for individuals to discharge their debt and have this fresh start, and yet it is just taken for granted that a corporation or a company can blow up and then they can file for bankruptcy and then they can start over.

We give rights to corporations that we don’t give to ordinary Americans. One of my proposals in my book Freefall — one of the ways to deal with this foreclosure problem, the fact that one out of four Americans who have a mortgage are underwater: They owe more money on their home than the value of their home. Their home used to be what they used as the reserve for paying their kids college education, for their retirement. Now it’s a liability, not an asset.

So what I’ve argued is, we have these laws called Chapter 11 to give a fresh start to corporations. We say it’s very important to be able to do this quickly, we want to keep jobs, we want to keep the corporation going as an ongoing enterprise.

Families are as important as corporations. Keeping kids in school, not forcing them out of their home, keeping the community together, is certainly as important as keeping a corporation alive.

He calls this indentured servitude, but I call it (because I’m also factoring things in like the privatization of security and decline of the nation-state) neo-feudalism. In either case it’s an observation that people who used to be citizens have been turned into profit centers for the very powerful. Through a variety of means, these very powerful entities have secured the ability to oblige those profit center people to turn over large chunks of their  worldly gain for the foreseeable future, and even though those powerful entities offer little in return, the people bound to them have little hope of escape. Hell, in many states, mortgages serve as a similar kind of legal bind to a piece of territory, one ultimately owned (if they can prove they have the note) by these powerful entities.

And as Stiglitz notes, a key to pulling this shift off is to write the law to favor the powerful entities and disempower the weak. And (as he points out elsewhere in this interview) to make sure that only those powerful entities have access to justice.

Yet, as a recent study made clear, the access to justice for the poor in this country rivals that of Mexico and Croatia.

In January 2008, well before the financial crisis became an emergency, I asked Chuck Schumer why Democrats didn’t repeal the 2005 Bankruptcy Bill Stiglitz addresses above. I pointed out that repealing it might mitigate the problem of foreclosures and with it, stave off a larger crisis.

Schumer responded by saying we did not yet have the votes to make the kind of substantive overhaul that was necessary. We had to wait, he said in January 2008, eight months before foreclosures contributed to the the collapse of financial system, until 2009, when we had a larger majority.

We just lost the majority that Schumer claimed we would use to repeal the bankruptcy bill. During the entire time the Democrats had the majority, families were losing their homes in ever increasing numbers.

And yet Democrats never used their vaunted majority to stem the advance of neo-feudalism in this country.