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Tectonic Economics

from  Peter Radford

Martin Wolf, in this morning’s FT [no link sorry] gets into something really interesting, and it relates to my comment yesterday, on the RWER blog, about the US being in decline. Since that is contentious I need to spend some time on it.

Wolf’s point is that the recent crisis, to the extent that it now appears to be history rather than current, should be examined for its potential long term effects. One that he devotes his column to is that it accelerated some movements that were already in motion, but which were brought forward by the press of events. 

I agree. Tectonic shifts have taken place, and the world will not return to the way it was. America is diminished, and so to is orthodox economics. Ironically the two are connected.

One of those tectonic effects is the relative decline of the US, and the Western bloc generally, as world economic powers. Of course demographics has a lot to do with this. China, India, and Brazil, just to name three more obvious nations are all growing much more rapidly than any western counterpart so it is inevitable that they start to take up a larger share of global GDP. But the shift has taken place more rapidly than it would have done had the western banks not plunged us into a wicked recession. From now on US influence is severely reduced from what it was in the aftermath of the fall of the Soviet Union, which is a challenge to the world as a whole and not just to the US.

As you know, I look at the last three decades as being articulated in one narrative: illusion. Specifically the illusory benefits of free markets. Presented with the problems of the late 1970′s, when the oil crises made it very clear that the US depended far too heavily on foreign and unsustainable sources of energy, the voters of America turned their backs and looked inward. The implications of not doing so were too difficult. Up until that point the foundation of US growth was cheap energy. American lifestyles depended on it. US businesses were relatively wasteful. American cars were awful gas guzzlers. The average home was getting larger and more expensive to heat. Travel was easy, so commuting had opened up vast suburbs. Further, the “American way” relied heavily on discarding and quick replacement rather than old fashioned thrift and related values. At one point Nassau county, right next to New York City, had more cars registered than people living there. It was a consumption mania. It still is.

That this was unsustainable if, and when, the rest of the world sought to catch up, was inconvenient, but could be ignored for a while. Jimmy Carter’s depressing, but correct, reaction to the first sight of world commodity scarcity was to call for changes in that lifestyle. Reagan’s victory was built on the premiss that Carter was being unnecessarily gloomy and that American innovation could overcome that scarcity. Which it might have done had it been channeled into alternative energy sources and efficiency. Instead Reagan and his successors sought to extend the old model. They ignored the challenges of globalization and imagined that the private sector would provide the response. The error in this was that the private sector is mobile. Its response was to abandon its American roots and move its operations to cheaper bases. The irony in this is that the Capitalist-in-Chief ignored the basic tenets of capitalism. Business is not inherently “patriotic”. Self interest – profit – precludes it being so.  It has to be forced into it. Regulations matter.

A second error was thus forced on us by the logic of the first. Having decided to ignore the changes going on in the world, in particular the specter of energy problems emerging, the American geopolitical stance was heavily shifted towards maintaining its oil supplies. Thus US foreign policy became asymmetrically centered on the Middle East, where it started to prop up a number of corrupt but compliant regimes in order to secure its flow of oil. This has two consequences: one is that the US is overly committed to assisting authoritarian regimes whose populations are now in various stages of revolt. This leaves the US less able to influence events and appearing to be on the “wrong” side of social reform in the Islamic world. Indeed, America risks becoming less relevant as the Arab world shapes its own future, because the new generation in power can look back at the asymmetries of American foreign policy and draw some not too complimentary conclusions. The other major consequence of this emphasis on the Middle East has been the relatively lesser emphasis on the Pacific and China in particular. Had the US been more actively aware and engaged it might have responded to the rise of China more energetically, and earlier, than it now has. Our foreign policy was oil-centric and ignored our competitive position entirely.

This is of course speculative, but the narrative holds up well.

A third error, logically fitting with the first two, was the destabilization of the budget. As the American model was squeezed by global forces the reaction was to ignore fundamental infrastructural initiatives and to double down on a private sector based response. Once again the error being the assumption that the government has no role in developing general economic activity. We need to focus on three elements of this.

One is the willingness to use debt as a way to finance government. It was Reagan who first plunged the US into red ink. He was the first peacetime, and non-crisis driven, president to propose debt riddled budgets. He deliberately avoided forcing American voters to pay for the their foreign policy and military adventures, with the long term economic consequence that they still are unaware of the enormous burden they place on the Treasury. Cutting offense spending is next to impossible. No empire is immune to the cost of maintaining its spread, and the US is no exception. Even though it likes to think it is. The long term result of this is the fiscal tight jacket that now restricts the US as it digs out from the mess created by its private sector implosion.

Next is the near total abandonment of infrastructure. The US has slipped in nearly every category of basic service. It provides world class health service to an ever diminishing portion of its population; it cannot compete in any form of low cost transportation service; its education system no longer produces world class results; and even its technology, while still innovative is no longer manufactured here relies on an influx of foreign talent, and some of it – cell service and broad band to the home – lags behind its leading competitors.

A key observation in this is the the average service, when expressed as a mean, may look competitive, but when expressed as a median gaps open up. The rich in America experience world class service. The rest? They are falling behind in skills, service, and lifestyle. By ignoring the role of government in maintaining its infrastructure the US abandoned its middle class to fend for itself against the rest of the world. And it is losing.

The third element follows from this: just as the government budget was destabilized by the illusion, so too was the average household budget. As the cost of attaining an increase in living standards rose, and as government assistance was withdrawn, households felt under increasing pressure to borrow to fill in the gap opened up by the stagnation of wages. Those wages stagnated because the private sector was involved in a rush to improve returns on equity in an environment where there were insufficient domestic projects available to support those targets. So business held wages down, focused on profit, and substituted capital for labor, or cheap foreign labor for expensive American labor, at every opportunity. The squeeze on household balance sheets was steadily more extreme and helped add instability to an already vulnerable economy. Presented with a choice between experiencing declining standards and a temporary run up in debt, households chose debt. But that run up became permanent as wages never caught up with costs. America became debt dependent. This meant banking was more prominent. Unfortunately.

A fourth error in the illusion was the steady deregulation of business, and especially finance. Once it was committed to moving away from  the postwar consensus and social contract America, logically, found itself allowing its financial system to balloon in influence. This inevitably led to instability. Finance is, at its very core, unstable, depending as it does on judgements of risk, and the mediation of short term and long term assets and liabilities. In the absence of strong limitations banks will always find ways to engineer crises. Add in lax attitudes towards leverage and capital standards, reduced capital flow restrictions, floods of cheap capital, an inflow of poorly thought through “innovations”, and a regulatory regime that encouraged rather than prevented private sector risk taking, and instability is inevitable. It is no accident that the years of illusion saw two great asset bubbles. One that fortunately only hammered private investors, the other, unfortunately, that nearly destroyed the economy. Incidentally little of this has gone away. we are still vulnerable to the whims of banking.

These are just the headlines of the years of illusion.

What was the core illusion? That free markets articulate economies so efficiently that we need no government intervention. My narrative above threads together some, not all, of the consequences of this illusion. Wolf highlights the contemporary results.

America, by abandoning its postwar consensus when it was first stressed by world events back in the late 1970′s, has created for itself some very poor and presumably unintended consequences. They are very difficult to undo.

It is now a dramatically divided society. It is so deeply committed to the logic of the illusion that its only policy response seems to be to double down on the error. It has restricted its policy degrees of freedom by creating a massive debt overhang that could stop it from halting its relative descent. Instead of being able to invest, our government is now being forced into austerity, thus ensuring we lose more ground to our competition. We have a monopole elite, there is no strong counterweight to the drift towards private sector dependency for all services.

All these solutions are variations on the same old theme. Hence the rush towards austerity and the false fear of immediate debt crises. And we experience historically large income inequality that divides the everyday experience of our elite from that of the general populace. That divide is dangerous for our social fabric: it engenders envy, popular backlash, and elite disregard for the problems of the average voter. Our leaders have no personal experience of the problems they have created. They live aloof and within an increasingly self referential community.

Worse still, much of the illusion’s attraction is that it rested on a populist version of America’s self image. Individualist, not collective. Small not large government. Flag waving and militarism substituted for patriotism. A belief in unfettered capitalism. A disdain for all things social. Yet this collection of notions and beliefs is an inversion of what formed the foundation of the golden era just after World War II. Indeed they invert much of American reality: the reliance on small communities as the aWest was opened up; the establishment of large government programs to help returning veterans in 1945; and a historic aversion to standing, let alone large, armies.

We abandoned many of our strengths in order to pursue a giant experiment with history. We relied on the attractive fallacies of orthodox economic theories coupled with the sophistry of Reagan and his successors to solve problems that required more original and sophisticated thought. We fell for the illusory notion that keeping up with our competition did not mean having to face the pain of change. There was no evening to follow Reagan’s infamous morning in America.

Now we know better.

There has been a tectonic shift in world power. It was accelerated by our inattention to our problems. Or rather the belief that if only we deregulate one more time, reduce taxes just a little bit more, encourage just a bit more profit, and let business be free at all times, this pain will go away. America has not suddenly become a light weight or second world economy. It has simply been made less relevant. Its age of dominance is passing, but is not gone, and its problems are no longer amenable to the same old solutions. It needs to adapt. It needs to think clearly. It needs to leave behind the illusion.

And that is very difficult to do when our elite has no deep commitment to adaptation or change because it benefitted from that illusion. Such is the devil of inequality. We see how it drives change in places where it is more deeply entrenched. Eventually populations no longer tolerate being ignored or subject to the falsities of other worldly theoretical constructs. They rise up viscerally against elites who lose contact with everyday life.

My question is this: will history reveal that the recent crisis was the pivot point for change in America? Or will we need another crisis? Is Wolf right, did the crisis accelerate change? Or will it be postponed it again?

And within all this, what role will economics play?

  1. s h a r o n
    February 6, 2011 at 9:58 pm

    Whew!

    What other response than tail-between-the legs? I’m awaiting cogent replies/dialog.

  2. February 7, 2011 at 2:43 am

    The much touted “crisis” of 2008 was really a wealth transfer from the poor to the rich, using Naomi Klein’s “Shock Doctrine”. There is no organized group in the US capable of taking on the parasites at this time. So they will keep on stealing as long as they can get away with it, and perhaps look for another host as needed.

  3. Jorge Buzaglo
    February 7, 2011 at 4:37 pm

    As I see it, the question is, will USA’s hegemony be superseded by a new one (China), or will USA promote the formation of a democratic world system? If indebted USA intends to prolong its domination by further wars (by the way, financed by China among others), that will only I think have the opposite effect of accelerating its demise and replacement by a new world hegemon. If, one the other hand, it discovers that its real long term interest is the same as the long term interest of world society, it will try to radically change its ways, and committedly and honestly work for a world system that assures universal human rights (including social and economic rights) for everybody on earth. That will of course imply very important and necessary changes in the USA, China and elsewhere.

    • Peter Radford
      February 7, 2011 at 6:28 pm

      You are much more idealistic than I am. Why would China forego the opportunity to rent seek in the same way the US and other empires have done? I hope your vision is correct. Just call me skeptical!

  4. KEyNES
    February 7, 2011 at 6:12 pm

    I do agree with your analysis, but I think it is a bit naive believe that the behaviour you point is because americans believe the virtues of neoclassical(ortodox) economics.Would not be more right to think they USE that ideology just because is the one that benefit them?.

    • Peter Radford
      February 7, 2011 at 6:26 pm

      Excellent point. My view is that most ordinary Americans “believe” in free markets because it conforms with their national mythology, they have no idea what the theory says, but they simply contrast it with “socialism” which they are told is “bad”. They have no practical experience of alternatives – unlike people elsewhere. During the years of illusion, since Reagan, I believe history reveals that neoclassical theory was employed to benefit a group who knew roughly what it was, didn’t care about whether it was false, but could use it to game the system to their own advantage. The conflation of free market theory with individualist politics plays well with regular people who want to believe that they, too, can become rich, and thus tolerate the excesses of the few who truly are rich. That this is all illusion doesn’t enter the equation as long as people still believe the opportunity exists for everyone equally.

  5. KEyNES
    February 7, 2011 at 6:15 pm

    Sorry, when I said “americans” I meant the very rich. You Know, the ones who rule the country.

  6. KEyNES
    February 7, 2011 at 6:48 pm

    Yes. And when something is repeated and repeated…”ab nauseam”, most people really believe that, especially when the message is simple enough (public expendure..bad;free trade.. good).
    By the way, my #7 was written before your #6

  7. February 8, 2011 at 9:24 am

    No country can replace the US as global hegemon. China has a GDP PPP of $7,000 and holds trillions in ‘dead’ US treasuries as a result of the insane export strategy they are treadmilled to.

    We should welcome the collapse of US empire; it will create openings for real democratic and social change. Egypt being a current example.

  8. February 8, 2011 at 9:28 am

    I also object to the use of the word ‘us’ when describing US policy. We are not all in the same boat.

    ‘Us’ is workers, which not a nationality

    ‘They’ are bosses.

    And bosses do not think in terms of country only in profits.

    Likewise, workers should not think in terms of country, only power.

  9. Raul Gadea
    February 13, 2011 at 10:02 pm

    Why don´t you mention Roosevelt´s New Deal?

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