Joseph Stiglitz: 'Trickle Up Economics' to Blame for Crisis

Why Joseph Stiglitz isn't in the Administration is beyond me. In this lecture given at the University of Queensland in Brisbane, Australia in late July, Dr. Stiglitz puts the blame squarely for our economic meltdow squarely where it needs to be placed: on Ronald Reagan and his free market and low taxation policies that have redistributed wealth upwards. He argues that "trickle up economics" created the credit bubble that triggered the recent financial crisis. "There was a party going on, and nobody wanted to be a party-pooper," says Stiglitz.

Since 1976, 58 percent of all income gains have accrued to the top one percent of US households. Meanwhile, 25 percent of American workers earn a wage that puts them at or below the poverty level. If the redistribution upwards since 1981 had not taken place, if the average American family in the bottom 90 percent were today getting the same share of the nation's income as the average bottom 90 percent family received in 1973 when income distribution was much more egalitarian, this average family would now be taking home in income over $10,000 more per year. The wealth of the top tenth has come by impoverishing the bottom 90 percent. That's the legacy of Ronald Reagan.

Joseph Stiglitz was chief economist at the World Bank until January 2000. Before that, he was the chairman of President Clinton's Council of Economic Advisers. He was awarded the Nobel Prize in economics in 2001. He is currently a finance and economics professor at Columbia University. He is the author of Globalization and Its Discontents and The Roaring Nineties. The full hour long lecture plus a 30 minute Q&A session is available at Fora TV.

Record Number of Americans Seeking Government Help

That the private sector has failed should be obvious but the takeaway that conservatives will draw from the news that one in six Americans, or 17 percent, is now aid-dependent for some or all of their needs is that these Americans are somehow lazy. 

The four government social safety programs most being accessed are Medicaid, Food Stamps, Unemployment Insurance and Welfare. USA Today breaks down the numbers:

More than 50 million Americans are on Medicaid, the federal-state program aimed principally at the poor, a survey of state data by USA TODAY shows. That's up at least 17% since the recession began in December 2007.

The program has grown even before the new health care law adds about 16 million people, beginning in 2014. That has strained doctors. "Private physicians are already indicating that they're at their limit," says Dan Hawkins of the National Association of Community Health Centers.

More than 40 million people get food stamps, an increase of nearly 50% during the economic downturn, according to government data through May. The program has grown steadily for three years.

Caseloads have risen as more people become eligible. The economic stimulus law signed by President Obama last year also boosted benefits.

"This program has proven to be incredibly responsive and effective," says Ellin Vollinger of the Food Research and Action Center.

Close to 10 million receive unemployment insurance, nearly four times the number from 2007. Benefits have been extended by Congress eight times beyond the basic 26-week program, enabling the long-term unemployed to get up to 99 weeks of benefits. Caseloads peaked at nearly 12 million in January — "the highest numbers on record," says Christine Riordan of the National Employment Law Project, which advocates for low-wage workers.

More than 4.4 million people are on welfare, an 18% increase during the recession. The program has grown slower than others, causing Brookings Institution expert Ron Haskins to question its effectiveness in the recession.

As caseloads for all the programs have soared, so have costs. The federal price tag for Medicaid has jumped 36% in two years, to $273 billion. Jobless benefits have soared from $43 billion to $160 billion. The food stamps program has risen 80%, to $70 billion. Welfare is up 24%, to $22 billion. Taken together, they cost more than Medicare.

The necessity of jump-starting the economy should be obvious. Conservatives worry that government programs won't contract after the recession and that we're creating some of sort lasting dependency to government assistance. "They're much harder to unwind in the long term," says Michael Tanner of the Cato Institute, a libertarian think tank. I guess Mr. Tanner and his libertarian ilk would prefer that Americans line up for private charities and soup kitchens. This isn't just the poor that we are talking about. Increasingly those accessing these social safety net programmes are those who formerly comprised the middle classes.

In 2006, the SEIU and the Center for American Progress published a report entitled Middle Class in Turmoil (pdf) that warned that "despite an economic recovery well into its fifth year, middle class families are struggling to pay for a home, health insurance, transportation and their children’s college education due to a weak labor market and sharply higher prices. To pay for these necessary expenditures, middle class families are borrowing record amounts of money, leaving them unable to put away hardly any cash for a rainy day."

Well, guess what that rainy day is here and it's not just a deluge but a monsoon.

Beyond the Efficient Market Hypothesis

I've got to run because I'm volunteering on two political campaigns. The thought of Barbara Boxer losing her Senate seat drives me to despair and I'm also volunteering for a local candidate for the Board of Supervisors.

A quick post on the efficient market hypothesis or EMH. “The Efficient Market Hypothesis is not only dead,” noted the financial blog Minyanville on July 29, 2010. “It’s really, most sincerely dead.” Perhaps, first, a quick definition is in order. From Investopedia:

The Efficient Market Hypothesis (EMH) is an investment theory that states it is impossible to "beat the market" because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information. According to the EMH, stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices. As such, it should be impossible to outperform the overall market through expert stock selection or market timing, and that the only way an investor can possibly obtain higher returns is by purchasing riskier investments.

The EMH is at cornerstone of our economic model because it lies at the Greenspanian (and conservative) notion that financial markets can be self-regulated, even though financial markets operate very distinctly from normal supply and demand economic principles. As The Economist has noted that “Financial markets do not operate the same way as those for other goods and services. When the price of a television set or software package goes up, demand for it generally falls. When the prices of a financial asset rises, demand generally rises.”

Financial markets are too often guided by a herd mentality that leads to financial asset bubbles. This was true in the Tulip Mania of the early 17th century in Holland and it was true in the more recent Dot Com Stock Market Crash and US housing bubbles. Irrational exuberance trumps information. The EMH is built on the assumptions of investor rationality. 

John Maynard Keynes, however, argued that the stock market should be seen as a "casino" guided by an "animal spirit". Keynes held that investors are guided by short-run speculative motives. They are not interested in assessing the present value of future dividends and holding an investment for a significant period, but rather in estimating the short-run price movements.

Today, Joseph Stiglitz in the Financial Times writes on the need for a new economic paradigm of moving beyond the efficient market hypothesis.

The blame game continues over who is responsible for the worst recession since the Great Depression – the financiers who did such a bad job of managing risk or the regulators who failed to stop them. But the economics profession bears more than a little culpability. It provided the models that gave comfort to regulators that markets could be self-regulated; that they were efficient and self-correcting. The efficient markets hypothesis – the notion that market prices fully revealed all the relevant information – ruled the day. Today, not only is our economy in a shambles but so too is the economic paradigm that predominated in the years before the crisis – or at least it should be.

It is hard for non-economists to understand how peculiar the predominant macroeconomic models were. Many assumed demand had to equal supply – and that meant there could be no unemployment. (Right now a lot of people are just enjoying an extra dose of leisure; why they are unhappy is a matter for psychiatry, not economics.) Many used “representative agent models” – all individuals were assumed to be identical, and this meant there could be no meaningful financial markets (who would be lending money to whom?). Information asymmetries, the cornerstone of modern economics, also had no place: they could arise only if individuals suffered from acute schizophrenia, an assumption incompatible with another of the favoured assumptions, full rationality.

Bad models lead to bad policy: central banks, for instance, focused on the small economic inefficiencies arising from inflation, to the exclusion of the far, far greater inefficiencies arising from dysfunctional financial markets and asset price bubbles. After all, their models said that financial markets were always efficient. Remarkably, standard macroeconomic models did not even incorporate adequate analyses of banks. No wonder former Federal Reserve chairman Alan Greenspan, in his famous mea culpa, could express his surprise that banks did not do a better job at risk management. The real surprise was his surprise: even a cursory look at the perverse incentives confronting banks and their managers would have predicted short-sighted behaviour with excessive risk-taking.

Stiglitz also points to the work at the George Soros funded Institute for New Economic Thinking (INET) that was founded in October 2009. Its mission is to create an environment nourished by open discourse and critical thinking where the next generation of scholars has the support to go beyond our prevailing economic paradigms and advance the culture of change. Two of my favorite economists are associated with the Institute: Simon Johnson of MIT and Richard Koo of Nomura Securities whose book on Japan's lost decade The Balance Sheet Recession has been my guide for looking at our economic situation.

Here's a short video on the INET:

There's more...

Understanding GOP Economics, An Exercise in Futility

Though I largely hold that trying to understand Republican economics is an exercise in futility, credit Martin Wolf, the chief economics commentator at the Financial Times, for writing the single most brilliant takedown of the GOP's economic approach that I've read perhaps ever. In a column entitled The Political Genius of Supply Side Economics details the transformation of the GOP from the party of the responsible frugality of Dwight D. Eisenhower to the party of the irresponsible profligacy of Ronald Reagan and George W. Bush.

To understand modern Republican thinking on fiscal policy, we need to go back to perhaps the most politically brilliant (albeit economically unconvincing) idea in the history of fiscal policy: “supply-side economics”. Supply-side economics liberated conservatives from any need to insist on fiscal rectitude and balanced budgets. Supply-side economics said that one could cut taxes and balance budgets, because incentive effects would generate new activity and so higher revenue.

The political genius of this idea is evident. Supply-side economics transformed Republicans from a minority party into a majority party. It allowed them to promise lower taxes, lower deficits and, in effect, unchanged spending. Why should people not like this combination? Who does not like a free lunch?

How did supply-side economics bring these benefits? First, it allowed conservatives to ignore deficits. They could argue that, whatever the impact of the tax cuts in the short run, they would bring the budget back into balance, in the longer run. Second, the theory gave an economic justification – the argument from incentives - for lowering taxes on politically important supporters. Finally, if deficits did not, in fact, disappear, conservatives could fall back on the “starve the beast” theory: deficits would create a fiscal crisis that would force the government to cut spending and even destroy the hated welfare state.

In this way, the Republicans were transformed from a balanced-budget party to a tax-cutting party. This innovative stance proved highly politically effective, consistently putting the Democrats at a political disadvantage. It also made the Republicans de facto Keynesians in a de facto Keynesian nation. Whatever the rhetoric, I have long considered the US the advanced world’s most Keynesian nation – the one in which government (including the Federal Reserve) is most expected to generate healthy demand at all times, largely because jobs are, in the US, the only safety net for those of working age.

True, the theory that cuts would pay for themselves has proved altogether wrong. That this might well be the case was evident: cutting tax rates from, say, 30 per cent to zero would unambiguously reduce revenue to zero. This is not to argue there were no incentive effects. But they were not large enough to offset the fiscal impact of the cuts (see, on this, Wikipedia and a nice chart from Paul Krugman).

Indeed, Greg Mankiw, no less, chairman of the Council of Economic Advisers under George W. Bush, has responded to the view that broad-based tax cuts would pay for themselves, as follows: “I did not find such a claim credible, based on the available evidence. I never have, and I still don’t.” Indeed, he has referred to those who believe this as “charlatans and cranks”. Those are his words, not mine, though I agree. They apply, in force, to contemporary Republicans, alas,

Since the fiscal theory of supply-side economics did not work, the tax-cutting eras of Ronald Reagan and George H. Bush and again of George W. Bush saw very substantial rises in ratios of federal debt to gross domestic product. Under Reagan and the first Bush, the ratio of public debt to GDP went from 33 per cent to 64 per cent. It fell to 57 per cent under Bill Clinton. It then rose to 69 per cent under the second George Bush. Equally, tax cuts in the era of George W. Bush, wars and the economic crisis account for almost all the dire fiscal outlook for the next ten years (see the Center on Budget and Policy Priorities).

Today’s extremely high deficits are also an inheritance from Bush-era tax-and-spending policies and the financial crisis, also, of course, inherited by the present administration. Thus, according to the International Monetary Fund, the impact of discretionary stimulus on the US fiscal deficit amounts to a cumulative total of 4.7 per cent of GDP in 2009 and 2010, while the cumulative deficit over these years is forecast at 23.5 per cent of GDP. In any case, the stimulus was certainly too small, not too large.

The evidence shows, then, that contemporary conservatives (unlike those of old) simply do not think deficits matter, as former vice-president Richard Cheney is reported to have told former treasury secretary Paul O’Neill. But this is not because the supply-side theory of self-financing tax cuts, on which Reagan era tax cuts were justified, has worked, but despite the fact it has not. The faith has outlived its economic (though not its political) rationale.

The sad fact remains that too many Americans believe that taxes are too high (reality: among OECD countries only Mexico, Turkey, Korea, and Japan have lower taxes than the United States as a percentage of GDP) and perhaps worse too many Americans believe that the only road to economic prosperity is cutting taxes. In this they have been duped by the GOP but we too are culpable in that we have not successfully made the case that a progressive tax scheme not only produces a more egalitarian country but a more broadly prosperous one.

There's more...

C is for Contrafibularity, R is for Refudiate, I is for Irrational

In the above scene from the BBC comedy Blackadder Series 3, Dr. Samuel Johnson arrives at the palace, having completed his life's work, to present the now finished dictionary of the English language to the daft and not quite all there Prince Regent played by Hugh Laurie when Blackadder played by Rowan Atkinson throws Dr. Johnson for a loop by offering him his contrafibularity, a made up word meaning congratulations. One wonders what Dr. Johnson might have thought of our newest wordsmith from Wasilla, Sarah Palin. However unlike in Blackadder, the linguistic creativity of Sarah Palin is no laughing matter. 

This is far from the most important news of the day, the truth is that Washington Post story on the national security apparatus built up since 9/11 with little oversight and seemingly little coordination is a much more important story, and yet writers across the world have devoted inordinate time and space to the Palin story. At one point this morning, "refudiate" was the second most searched topic on Google. As I write this, it is currently ninth.

Over at The Atlantic, Marc Ambinder finds that Palin "is getting quite savvy as a politician: when she makes a mistake, or appears to do something dumb, she is quick to exploit her own misfortune ... not in a way that excuses her original mistake, but that alludes to the improbable fact that there is some in-joke, some secret code that the rest of us aren't getting." He adds:

"Palin knows how to humanize herself. That's a rare talent for a politician to cultivate, and one that she's getting better at every day. What's more, she humanizes herself by somehow ascribing her misfortune to the establishment that's trying to tear her down. Her audience loves it.

It is certainly true that "her audience loves it." As I noted in my first post on this topic to her adoring base, no transgression can melt the polar adulation they have for her. The only time that there have been rumblings of discontent heretofore was over her endorsement of Carly Fiorina over the more conservative Chuck DeVore in the California GOP Senate primary. But the problem for Palin is that is only her audience who is eating this up. Say what you will about elitist publications but it is not a good thing that The Economist, on the Samuel Johnson Blog on Language no less, would take to criticize Palin. Over the course of the day, the mockery has been incessant. Twitter feeds on Movies with Refudiate or Shakespeare twists such as "The Laming of Shrew" or "Mid Summer's Night Moron" have a deleterious effect even if her supporters circle the wagons around her. The blind leading the blind, or in this case the dumb leading the dumb and dumber, isn't exactly a recipe for success.

But there is another point that needs to be made plainly evident and it is a serious character flaw that requires frank, explicit talk. Sarah Palin is psychologically incapable of admitting a mistake. She could have chalked this up to a simple typographical error (though her slip of the tongue earlier in the week would have left doubts) but no instead we got an unbounded narcissism. Rather than admit an error she compares herself to the greatest playwright in the English language, a language which she does not even master.

The inability to admit a mistake is, of course, a common conservative trait, though this is not to suggest that all conservatives are incapable of admitting errors. Mitch Daniels, the Governor of Indiana, for example reversed himself on the privatization of Indiana's welfare system cancelling a $1.34 billion contract with IBM noting that the state could do a better job of handling welfare claims. But among the more ideological members of the GOP, politics means never having to admit a mistake much less having to say you're sorry.

Just look at where we are now: the budget deficit this year will amount to 12.5 percent of GDP; 40 percent of the Federal budget is credit financed with more than half of that financing now coming from overseas. In 2011, the debt to GDP ratio will exceed 100 percent. Social inequality now matches levels not seen since before the Great Depression. The U6, the broadest measure of unemployment, is at 16.5 percent. In at least five states, the U6 is over 20 percent. A record number of Americans have been unemployed for 27 weeks or longer. For young African-American males, the unemployment rate is over 40 percent. Foreclosures rates are still climbing though they are expected to peak by year's end. And yet the GOP prescription is more of the same policies - lower taxes, fewer regulations, and a redistribution of wealth upwards - that put us in this predicament. Since 1976, 58 percent of all income gains have accrued to the top one percent of US households. Meanwhile, 25 percent of American workers earn a wage that puts them at or below the poverty level. 

One would have thought that after the near collapse of the US financial sector and the steepest economic decline in 80 years, the debate over market fundamentalism - the belief that unfettered, unregulated markets can deliver economic prosperity and a secure lifestyle for all Americans - would lead to at least some introspection and reflection over what went wrong. But no, what's the Speaker-in-waiting John Boehner's response to the rather lukewarm financial regulations that just passed? To repeal them. 

They have a blind faith in free markets but the blindest of them all are those closely associated with Tea Party movement, the Sarah Palins, the Michele Bachmans, the Sharron Angles, the Rand Pauls. Their faith in markets isn't rational. And their inability to admit even the most innocuous of errors suggests if entrusted with political power, they will drive us off a cliff for they are that committed to the failed policies of the past and are incapable of making any adjustments in their thinking. In short, they are irrational.


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