Questions for Galbraith

What are the four powers of the modern corporation that Galbraith enumerates that make it a political instrument? For Galbraith, where does the emancipation of the state from economic interest begin? In its early years, economics was subject to censorship by whom? What was the overriding problem that Galbraith saw with the new paradigms in economics? Questions for Galbraith

Alfred Marshall was the first to be broadly recognized as using mathematical formulas, charts, and graphs to represent, in a shorthand manner, complex economic theories. • “I had a growing feeling in the later years of my work at the subject that a good mathematical theorem dealing with economic hypotheses was very unlikely to be good economics: and I went more and more on the rules – (1) Use mathematics as a shorthand language, rather than as an engine of inquiry. (2) Keep to them till you have done. (3) Translate into English. (4) Then illustrate by examples that are important to real life. (5) Burn the mathematics. (6) If you can’t succeed in 4, burn 3. This last I did often.” (Pigou, Memorials, p. 427) (Ekelund, 346) • Ekelund, Robert, and Robert Hebert. A History of Economic Theory and Method. 5th ed. Long Grove, IL: Waveland Press, Inc., 2007. Print. • What is presented in language is seen as opinion or theory. What is presented in mathematical form is seen as fact. Problem: human behavior cannot be represented mathematically as it varies to such a great degree On economics and the real world

“I shall argue that the postulates of the classical theory are applicable to a special case only and not to the general case, the situation which it assumes being a limiting point of the possible positions of equilibrium. Moreover, the characteristics of the special case assumed by the classical theory happen not to be those of the economic society in which we actually live, with the result that its teaching is misleading and disastrous if we attempt to apply it to the facts of experience.” “All production is for the purpose of ultimately satisfying a consumer.” John Maynard Keynes, 1935

“Thus political theory has suffered because it has not taken into account certain economic realities. On the other hand, economic theory has suffered because it has not taken into account the political realities of government decision-making.” (Anthony Downs. 1957. An Economic Theory of Political Action in a Democracy) Downs 1957

As Myrdal and Robbins have pointed out in this generation, the individualist-utilitarian creed did, indeed, make the case for free competitive markets and for private property; but it also contained within its presuppositions the case for free elections, on a one-man-one-vote basis; for destroying or controlling monopolies; for social legislation which would set considerations of human welfare off against profit incentives; and, above all, for the progressive income tax. (W.W. Rostow. 1959. The Stages of Economic Growth) http://www.taxfoundation.org/taxdata/show/151.html Rostow 1959

“I came to see that there are no economic, sociological, or psychological problems, but just problems, and they are all mixed and composite. In research, the only permissible demarcation is between relevant and irrelevant conditions. The problems are regularly also political and, moreover, must be seen in historical perspective.” (Gunnar Myrdal. 1977. Institutional Economics) Myrdal 1977

”If citizens are unequal in economic resources, so are they likely to be unequal in political resources; and political equality will be impossible to achieve. In the extreme case, a minority of rich will possess so much greater political resources than other citizens that they will control the state, dominate the majority of citizens, and empty the democratic process of all content.” “My aim instead is to describe in very general terms some of the dynamics of equality and inequality, and to assess briefly the play of forces pushing in the two opposing directions in our own time, particularly the forces of democracy and capitalism.” Democracy requires equality while the outcome of laissez-faire capitalism is inequality. Dahl 1985

The decisive weakness in neoclassical and neo-Keynesian economics is not the error in the assumptions by which it elides the problem of power. The capacity for erroneous belief is very great, especially where it coincides with convenience. Rather in eliding power--in making economics a nonpolitical subject---neoclassical theory, by the same process, destroys its relation with the real world. Gailbraith 1973

This is what Gailbraith saw economics as becoming. An oversimplified representation of a complex system that offered the benefit of ease of use. It’s downside was that it bore no resemblance to reality and effectively disguised the reality of growing economic power. “Economics is insufficiently normative. Model building has become an end, not a means.”

“The men who guide the modern corporation, including the financial, legal, technical, advertising, and other sacerdotal authorities in corporate function, are the most respectable, affluent, and prestigious members of the national community. They are the Establishment. Their interest tends to become the public interest. It is an interest that even some economists find it comfortable and rewarding to avow. That interest, needless to say, is profoundly concerned with power with winning acceptance by others of the collective or corporate purpose.” Galbraith is identifying two things that corporations need to wrest power from the government, the support of economists and the support of public opinion. They need the first to gain the second. Astroturfing and public opinion

“Power being so comprehensively deployed in a very large part of the total economy, there can no longer, except for reasons of game-playing or more deliberate intellectual evasion, be any separation by economists between economics and politics. When the modern corporation acquires power over markets, power in the community, power over the state, power over belief, it is a political instrument, different in form and degree but not in kind from the state itself. To hold otherwise - to deny the political character of the modern corporation - is not merely to avoid the reality. It is to disguise the reality. The victims of that disguise are those we instruct in error. The beneficiaries are the institutions whose power we so disguise. Let there be no question: Economics, so long as it is thus taught, becomes, however unconsciously, a part of an arrangement by which the citizen or student is kept from seeing how he is, or will be, governed.” Gailbraith’s main point

“I have spoken of the emancipation of the state from economic interest. For the economist there can be no doubt as to where this task begins. It is with the emancipation of economic belief.” Emancipation of the state

Unemployment and inflation move together in opposite directions. If we want lower levels of unemployment, we have to accept higher levels of inflation. Solid monetary policy can help us dial in the right amount of each, but monetary policy is no substitute for sound fiscal policy. A trade off balance that would be seen as providing better balance of these two evils is an inflation rate of 1.5%-2.5% and a non-accelerating inflation rate of unemployment (nairu) estimated at around 5.5% to 7.5%. Unemployment and inflation

Line LRAS is the Long Range Aggregate Supply. This is the amount of goods and services that can be produced by a society when land, labor, capital, and energy resources are being used to produce potential GDP. In order to exceed this capacity, higher returns must be provided for workers and capital that may have stood idle, thereby driving up the costs. If the government spends money in a healthy economy with low unemployment and a low rate of inflation, then unemployment will drop below its natural level and inflation will increase, and will continue to increase until unemployment returns to its “natural” level. This is what we saw at the height of the Vietnam War.

As unemployment dropped below the nairu we saw an increase in inflation. Highest rate of inflation during LBJ administration was 4.19%. Nixon abandoned Bretton Woods and instituted wage and price controls (similar to those during WWII) and brought inflation under control. By 1972, inflation was back to a little over 3%.

Why do we need economic growth? • What if population growth is negative? -.28 vs .96 • Comparing economic growth: Apples to oranges • GDP per capita from $1,000 to $1,050 is 5% • GDP per capita from $50,000 to $51,000 is only 2%. • Easier to implement technologies already proven in other countries. • Harder to develop new technologies that do not yet exist. GDP vs population

Economic growth must keep up with population growth, otherwise per capita income decreases. Monetary policy must be set to increase the money supply to match economic growth. If the money supply remains the same and the economy is growing we have deflation, which is worse than inflation as it encourages hoarding and freezes the credit markets. This is why the emphasis of mercantilism was to bring specie into the economy. Deflation is what was occurring during the Great Depression. With banks closing daily, the rational response to circumstances was stuffing your money in a mattress. Fiscal and monetary policy

Monetary policy controls the money supply, or the amount of money circulating in the economy. This is primarily achieved through interest rates and other lending criteria set by the Federal Reserve Board. Fiscal policy controls the distribution of where in the economy that money is circulating. Who is taxed and how much. How the government spends money. When these tools are used effectively, we see long term economic stability characterized by low unemployment and inflation rates as in the Keynesian era from 1932 to 1980. Fiscal and monetary policy

Discount rate – The rate at which the FED lends to member banks. If the discount rate is low there is no incentive to pay higher interest to savings accounts, thus discouraging saving by households and encouraging the use of credit. Open market operations – The buying and selling of government securities Reserve requirements – What portion of deposits must be held in reserve. Least frequently used as a tool. Monetary policy tools

Monetary policy – 3 tools • High Inflation – too much money in the economy. Contractionary monetary policy to correct. • Increase the discount rate – Banks borrow less money as the discount rate goes up, reducing lending. Note: Banks have become more accustomed to borrowing from the FED and less from borrowing from depositors. Intended to be the lender of last resort, we now have a discount rate and savings rates that are well below the rate of inflation. • Open-market operations – Selling government bonds. This decreases the supply of money. • Increase reserve requirements – Banks are required to keep more money in reserve, reducing the amount of money available for loans. • High Unemployment – not enough money in the economy. Expansionary monetary policy to correct. • Decrease the discount rate – This encourages banks to borrow more money and make more loans. • Open-market operations – Buying government bonds. By buying back government bonds, the FED puts more money in the hands of banks to then lend out. • Decrease reserve requirements – This allows banks to lend more of the money that they have on hand by keeping less in reserve.

Chairmen since 1980 • Paul Volcker 1979-1987 appointed by Jimmy Carter often credited with getting inflation under control (oil crisis to oil glut) Joseph Stiglitz has claimed that he was fired by Reagan because he did not get on board with deregulation. • Alan Greenspan 1987-2006 appointed by Reagan often given credit for the boom of the 1990s as well as the blame for the bust of the 2000s • Ben Bernanke 2006 – appointed by George W Bush • These last two were admirers of Milton Friedman • Please note from Figure 17.3 (Pg 534) that the resources and personnel of the Federal Reserve comes from member banks. Is the Fed independent, or subject to the desires of member banks? The federal reserve board

“I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.” Thomas Jefferson

Involves both the tax code and how the government spends money • Tax cuts and tax increases • Government spending and investment • Not as nimble as monetary policy • Requires planning – ten year projections • Requires sufficient consensus between Congress and the executive to pass a budget • Tends to have a more long term outlook as opposed to short term changes for immediate concerns. Lag times – humans adapting to a new environment. Fiscal policy

Fiscal policy (expansionary) • Keynesian/Rostow approach: • Progressive tax structure: low rates at lower incomes, high rates at higher incomes. Has a self-regulating effect on inflation. Increases consumption within the economy while reducing leakages. • Government investment in infrastructure, education, job training, and other goods and services that are underprovided by the market, but increase the capacity of society as well as the quality of life. • Government spending to help low income individuals meet a minimum standard of living. These people having money to spend on basic human needs puts more money into the economy. The working poor. • Washington Consensus approach: • Flat or low taxes at the highest levels. Providing more money for the job creators to invest in the economy. • Minimize government investment in infrastructure. Belief that investments should be driven by market demand and that the private sector will make the investments that are worthwhile. Taxes taken for questionable government investments are seen as displacing worthwhile private investments. Capital gains rates substantially lower than tax rates for work. • If individuals get hungry enough, they will eventually take a job that is subsistence level or below. Social safety net programs generates a society of takers and actually increases unemployment levels.

Note that according to this fictitious diagram of how the economy works, spending, income, revenues, and costs are all equal to each other. If revenues equal costs, profits do not exist. Theoretical model of the economy

The diagram below includes leakages from and injections to the economy. This is a more accurate picture of the US economy, but still lacks sufficient detail to adequately depict reality. Closer to reality With high marginal tax rates firms seek to reduce taxes by: Reducing profits by increasing costs through higher payments to workers and investors, or providing a higher quality product. Reducing profits by reducing the price to consumers. Reducing their tax burden by taking tax deductions for investments in production expansion. With low marginal tax rates there are no incentives to do any of these and every incentive to increase profits.

Rational choice vs empirical evidence • 25% tax - Goal is to increase profits • 75% tax - Goal is to reduce tax burden

The value of what a country exports (injection) compared with what it imports (leakages). The theory of free trade is to open foreign markets to US exports (injection). In reality, it has allowed manufacturers to take advantage of cheaper labor and exchange rates through outsourcing to where we find the products manufactured by American companies are now imports (leakage). Balance of payments

Better described as having twin economies. • Main Street: the markets for goods and services in which we all participate. • Wall Street: Asset markets in which money is exchanged for goods (real estate, artwork, gold, stocks, and bonds) in order to be sold at a later date for more money. In the previous diagram, these purchases would be considered saving rather than investment as they are often preexisting assets that are not meant to be consumed. Main street and Wall street

Since the mid-1970s, the overlap between Main Street and Wall Street has been growing. As banks were deregulated and interest on savings accounts dropped to below the level of inflation, more Americans moved into the stock market with their savings. This was further encouraged through tax free investment plans like IRAs and 401ks. Deregulation of the financial industry, the privatization of Fannie Mae and Freddie Mac, and the repeal of Glass-Steagall increased the overlap of the two markets through the real estate market.

In theory, the reduction in taxes at higher rates of income and for capital gains was meant to reduce the leakage of taxes while providing injections into the economy through investment and exporting. In reality, over time, reduced taxes incentivized higher profits through outsourcing and the injection of exporting became the leakage of importing. As the American manufacturing base declined, investments in the American economy were displaced with investments overseas or saving by purchasing already overvalued assets in the capital markets.

American monetary policy now has very little control over the money supply available for the Main Street market. As firms increase profits, (the difference between what it costs to make something and what they charge consumers for it) and more of the money supply finds its way overseas, sitting in cash, or chasing the most recent hot asset, money becomes more difficult for consumers to access for use in the Main Street market.

Rise of wall street

Decline of main street

Introduction from old text: • Inevitable in the Keynesian paradigm, baffling in the WC paradigm. • 2001-8 Job growth and an active real estate market. GDP growth, record profits. Taxcuts at the top, deregulation, and free trade. Outsourcing, record HH debt and low savings rates. • 2008 2.6 million lost jobs, real estate market crashed, banks were close to collapse, commodity prices spiked Chapter 18 Economic Policy A glut of loanable funds drives down interest rates. Basic economics: when supply increases, prices come down.

Low interest rates discourage saving and encourages consumption and borrowing. Consumption previously supported by saving becomes supported by borrowing. Low interest rates and increased spending today leads to decreased spending tomorrow. Interest rates and consumption

Second –period consumption, C2 Figure 10 Intertemporal Spending with high interest rates Budget constraint with high interest rate B C2H C1H First –period consumption, C1

Second –period consumption, C2 Figure 11 Intertemporal Spending with low interest rates C2L A Budget constraint with low interest rate C1L First –period consumption, C1

Deregulation of the financial industry made the glut of loanable funds available for speculative ventures. Specifically, Mortgage-backed securities like those that led to the 1920s real estate boom and bust made a comeback. Investments in real estate became highly speculative as more homes were built to feed a demand for investments that was not mirrored in a demand for housing. Deregulation and financial instruments

With an oversupply of housing and home prices far above investment value (capitalization rates), it was a matter of time before investors liquidated assets and abandoned the market. It became a rational choice for homeowners to abandon a home that they owed $100,000 more on than it is now worth. Even if the homeowner could still make the payments. Texas communities did not have the bubble evident in other states. Texas real estate was relatively undervalued and showed only minor swings in home values. Why? Many arguments including consumer protections and high property taxes as a result of the savings and loan crisis of the late 1980s. http://blogs.wsj.com/developments/2010/04/06/did-consumer-protection-laws-prevent-texas-housing-bubble/ inevitable

Capital shifted from one bubble to the next. • Real estate bubble bursts 2nd and 3rd quarter 2006. • Bubbles in commodity and stock markets Market shift

Advocated for by business to allow them to sell in foreign markets. Fine in theory, but in practice, the United States still faces obstacles to export. Often this is not necessarily an issue of the trade agreement, but the failure of the Trade Commission to enforce the agreement. Actual result, US businesses offshore production to take advantage of wage disparities; producing in a low wage economy and selling in a high wage economy, pocketing larger profits by dramatically reducing their costs but not reducing their prices. Obviously unsustainable over the long term, but easy consumer credit maintained, or even increased, the level of consumption while wages were stagnating or declining. Free trade

"The fundamental business of the country, that is the production and distribution of commodities, is on a sound and prosperous basis." Herbert Hoover the day after the market crash in 1929. • “the fundamentals of the economy are sound.” or some variation • George Bush – LA Times August 15, 2002 • Bush Treasury Secretary Henry Paulson – former CEO of Goldman-Sachs – attributed to him a few months before Fannie Mae and Freddie Mac went under • John McCain – 9-15-08 Dow industrial average drops 778 points in a single day (worst ever) – 9-29-08 • Christina Romer – 3-15-09 Economic advisor to President Obama Talking points

Most developed nations of the world are mixed economies. Predominantly capitalist systems with some level of government intervention through progressive taxation, regulation, and social services. Highest per capita GDP nations tend to have more economic intervention and social safety nets than the US. US has been pursuing policies of reduced intervention in the economy since 1981. Mixed economy

Monopoly – a single seller in a market who acts as a price-setter and not a price taker. Sells fewer goods at a higher price, profits are high. Harmful to economy as it creates both shortages and high prices. Interstate Commerce Act of 1887. Railroads have natural monopolies, they own the tracks. Sherman Anti-Trust Act of 1890. Monopolies of commodities that have some level of inelasticity – Revenues increase as production is reduced and price increases. Teddy Roosevelt, Woodrow Wilson(our only political scientist President), FDR, Harry Truman, and LBJ all put forward legislation to curb corporate influence and improve consumer protection. What about a government monopoly? It is being operated on a not-for-profit basis. monopolies

Monopoly output

Monopoly – single seller Duopoly – two sellers Oligopoly – A limited number of sellers facing a market. The oligopoly still has market power and the firms will have higher prices and profits than would be realized in a competitive market. Cartel – An organized oligopoly that conspires to regulate prices and output. Amount produced by an oligopoly: where x = the number of sellers and y = the amount produced in the absence of market power. Oligopoly

Another way of stating Washington Consensus vs Keynesian/Rostow. Recovery was under way prior to FDR’s inauguration. Glass-Steagall Act (1933) separation of commercial and investment banking. Repealed in 1999 in the Gramm–Leach–Bliley Act. Federal Reserve could regulate interest rates in savings accounts. Repealed by the Depository Institutions Deregulation and Monetary Control Act of 1980. Enabled banks to pay interest rates that are less than the rate of inflation, discouraging saving. Laissez-faire vs interventionist

Consumer Product Safety, OSHA, EPA, Mining Safety Are these social issues or economic issues? In the process of pursuing profits, businesses may take shortcuts or be unconcerned regarding the negative effects of their business practices. These negative effects are referred to as negative externalities. These agencies and regulations are developed to either prevent or heavily discourage these negative externalities. Negative externality: when an individual or firm making a decision does not have to pay the full cost of the decision. OSHA (and other bureaucracies) as a law-making body, known as administrative law. Businesses took exception to these government-made laws. “social” regulatory agencies

Questions for Galbraith