Friday, November 12, 2010

Choosing or Supporting Presidents

In my lifetime, at least during that time period when I have been very aware of the political process, I have come to the following two conclusions relating to the election of Presidents in the United States and to the support or lack of support they receive during their presidencies.

The first conclusion is that the United States has either a center or center-right bias in terms of politics. Most Americans want to live their lives in peace, pay their bills and taxes on time, be respected as human beings, be patriotic, support the less advantaged, and enjoy their families. To me the major reason the Tea Party arose over the past year or so is that a lot of people felt
that they had lived their lives following these behavior patterns and that, somehow, they were being penalized for acting that way.

In the same vein, populism has never won national elections. Even the Clintons realized this as is reported in Robert Rubin’s book “In An Uncertain World.” To me Al Gore lost the election of 2000 because his campaign for the presidency took a “populist” turn. Otherwise, he seemed to be a certainty.

The second conclusion I have reached is that presidents are elected more by who people vote against rather than who they vote for. I would contend that the last president who was voted into the White House on the basis of people voting “for” them was Dwight Eisenhower. Not only was Eisenhower extremely popular as an individual, he was the face of the World War II victory.

But, let me give you my reasoning. John F. Kennedy was elected because people voted against Richard Nixon. Lyndon Johnson was elected because people voted against Barry Goldwater. Richard Nixon was elected because people voted against the very liberal and populist Hubert Humphrey. Richard Nixon was re-elected and re-elected by such a large majority because people voted against George McGovern. People voted against Gerald Ford because of the Nixon “thing” and elected Jimmy Carter.

Ronald Regan then became president as people voted against Jimmy Carter. Ronald Regan was re-elected and won by such a large margin because the electorate voted against the liberal Walter Mondale and the very liberal Geraldine Ferraro. George H. W. Bush was elected because people voted against the very liberal Massachusetts Governor Michael Dukakis.

Bill Clinton won over George H. W. Bush because people were tired of Republicans and voted against Bush. Clinton was also centrist enough to not frighten anyone (I had a good Republican friend tell be before the election that Bill Clinton would be the best “Republican” Democratic President we would ever see…and he was right!) Clinton was re-elected and re-elected by a large margin because people voted against Bob Dole.

Above, I gave you the reason why I believe that George W. Bush was elected in 2000: people voted against the “populist” Al Gore. Bush was re-elected because people voted against the very liberal John Kerry. And, the obvious conclusion one can draw from this is that in 2008 people voted against George W. Bush and what he and the Republicans had come to stand for. Obama was neither threatening enough to prevent his election, nor the election of a Democratic Senate and House of Representatives.

Where do we stand after the mid-term elections which took place recently? My interpretation: people perceive President Obama and the Democratic Congress as too far away from their center or center-right leanings. They seem too “populist”. Second, they voters voted against the Democratic President and the Democratic Congress.

To me, this second point is very, very important. When people believe that they are “elected in” because of either who they are or who their party is, they develop a hubris that almost immediately plants the seeds of their downfall.

If someone from the “left”, or from the “right”, gets elected and takes the position that “The public overwhelmingly gave me a mandate to carry out my program”…they are in trouble. Early on they discover that the “centrist” electorate didn’t really give them a “mandate” they just voted the other “guys” out. As the new president then tries to get his program enacted he runs into quite a bit of difficulty and he also finds his popularity rating declining. These are tendencies are tough to overcome in the next election.

Failure occurs, not because of the president’s inability to popularize his program. It is not the president’s inability to be more political. It is not because the president had been “too substantive” or “too serious”. It is not because the American people are under stress and don’t think clearly.

It is because the American electorate is center to center-right in its political leanings and that the new president is in office, not because he and his program were elected overwhelming by the people, but because they voted against the other guy.

Rather than carrying the election-day hubris into the Oval Office, maybe a new president needs be a little more humble about the reason he was elected in the first place.

Wednesday, October 13, 2010

Ages: Part II

Sara Robinson presented us with a thought-provoking piece in the New Republic this week. (See “Building the Progressive Brand”:

She starts off with, “Every American over the age of ten knows what the GOP and the conservative movement stand for.” Then she lists four items: low taxes, small government, strong defense and traditional families.

Robinson then asks, “OK, now: What do Democrats and progressives stand for?”

Then, “Take your time. It’s a tough question.”

When I was growing up, the tables were turned. People seemed to know what the Democrats and liberals stood for. The Republicans did not have a brand, at least one that was credible. This was developed in the 1960s and 1970s leading up to the election of Ronald Reagan.

Now the shoe seems to be on the other foot.

This is my first “crack” at trying to go back and see what it was that the Democrats stood for and comment on what happened to this “branding.”

My initial list of the four things I think about when I go back and reflect on what the Democrats stood for I come up with the following list: freedom, equal opportunity, economic security and anti-discrimination.

Expanding on these I would argue that freedom meant more than just free speech and free movement. It meant freedom of religion, freedom of expression, freedom of lifestyles and so forth, at least if people living these freedoms did not act in a way that interfered with the ability of others to also enjoy these freedoms.

Equal opportunity could be translated into the possibility that anyone could achieve any outcome available to those in the society. Anyone, for example, could become President of the United States, or, President of General Motors, or, anything they set their mind on.

Economic security related to the goal to secure individuals the minimum standard of living and a job that one could achieve a degree of self-respect in.

Anti-discrimination meant that every individual should be treated in a similar fashion; that it did not matter whether one was black or brown, or, Roman Catholic or Jewish, or, a woman, or whatever. All people were human beings and they should be treated as human beings.

What happened to these beliefs? To the “liberal” brand?

One could say that, over time, the Democrats and liberals didn’t maintain their brand. They either abused the brand or lost control of its content or allowed others to define what their brand was.

For example, freedom morphed into the “me” generation, “my way or the highway”, or “doin’ your own thing.” Freedom became “license”. This movement has been dissected in Jonathan Franzen’s recent bestseller carrying the title of “Freedom”.

The second of these, equal opportunity for everyone has evolved into the idea that everyone has a right to equal outcomes. Rather than have a chance to become anything in this society, a lot of people believe that many people think that it is their right to positions or wealth or attention.

This may not be what “the Democrats and liberals” are saying, but it has gotten to the point where many believe this is what they mean.

Third, economic security has been translated into the belief that government is to provide “entitlements” to everyone. People are entitled to a job, people are entitled to own a home, people are entitled to have a car, and so on and so on. The government must almost constantly stimulate the economy through budget deficits and credit growth in order to provide the jobs and income so that all economic insecurity is banished. This philosophy, of course, is said to lead to “big” government.

Again, that may not be what “the Democrats and liberals” are saying, but this is how many see the consequences of their objectives and programs.

Finally, the aim to reduce bias and discrimination in society has been seen as allowing people to claim “victim-hood”. Thus, rather than looking at this effort in a positive context, the attempt has been seen as giving people an “excuse” for their psychological problems, their failures, and their exclusion. They can now claim that they are “victims” indicating that their problems are the result of someone else, something which they have no responsibility for and should be compensated in some way for this treatment.

Personally, I can relate to the brand of “the Democrats and liberals” and progressives that I have defined above. Not, of course, as they have been converted to, but in terms of their original intent.

To me, it is not so much a question of developing a new brand for the Democrats and progressives, it is a matter of converting these basic ideas into terms and concepts that people in the 21st century relate to. In this respect, I know what I stand for. People just are not expressing it in a way that I can say…”Yes, I stand for that!”

This has been what the Republicans and conservatives have strived for. This is what the Republicans and conservatives, to a great extent, have achieved.

I believe that these fundamental “liberal” ideas still resonate…just not in the way they are being presented.

Monday, September 13, 2010

Ages: Part I

Maybe we need to be a little more cognizant of what might be called “the Age of the Times.” That is, the dominating forces that seem to be at work during a particular period of time that, in a real sense, help to define what is going on.

There was a column in the New York Times yesterday, September 12, 2010, titled “The Presidency, Chained to the World” that set me off thinking in this way. To quote: “The farther we get from presidencies, after all, the more we tend to view them as belonging to periods rather than individuals, as sometimes overlapping clusters along the country’s historical continuum.”

The specific concern of this piece was this: “When historians look back 50 years from now, in what era will they place Mr. Obama’s presidency, and what does it say about the challenges he faces?”

I have been trying to put the major issues of my lifetime into a perspective to help me define what went on.

Of course, one of the major things to take place in my lifetime was the Viet Nam war and the events of the 1960s. My daughter asked me one time, several years ago, what was the big deal about the 1960s.

I had the chance to talk with Andrew Young one time when he visited the campus on which I was teaching. After discussing several other things, I mentioned to him the question that my daughter had asked me. And, I then asked him: “You were there. You were on the front lines. You faced smoke bombs and dogs attacking you. What do your children ask you about that period of time?”

His answer: “The same question that your daughter ask you.”

I was taken aback by this answer.

Certainly, a person that went through this period could honestly say that the person they were entering the 1960s was entirely different from the person they were beginning the decade of the 1970s. But, what was the difference? What defines the era?

Or, does this period have to be put into a larger picture?

Going into the 1960s, America was a country that became the predominant economy in the world during the 1930s. The country emerged from World War II as the unquestioned military power in the world. We were at the top!

Within this context, maybe the 1960s saw how the hubris built up over the past 30 years or so got applied to a little, insignificant war over in Southeast Asia. And, this war channeled feelings that were growing in the 1950s relating to civil rights and equality for women. And, these were all “hot buttons” for the young growing up during this time.

The young had been raised on becoming individuals, individual authenticity, and ideas about freedom and rebellion from the stuffing old society and norms of their fathers and mothers. Marlon Brando, James Dean, and others were our role models. There were also the Beat Generation…and there was the war!

I saw some of the effects of this war in my teaching at Lansing Community College in the 1963-1964 period. I had grown up with the expectation that I would go to college and graduate, get a job, and work for the next forty-some years and then retire and play golf. The “kids” I taught at this time…they saw themselves as getting out of community college, getting drafted, and getting killed…all within the next two to three years. Their future collapsed into a very short horizon and they believed that with such a future…what was wrong getting drunk on a regular basis…taking drugs…having sex where ever one could…and so on and so on.

Attitudes like this began to permeate the culture…at least to the younger folk.

But, this also got tied into civil rights. We were talking about freedom. And, then there was the women’s movement. Note that this came along with the “pill” giving women the opportunity to have casual sex on a regular basis…just like the guys. Of course “the guys” supported this liberation, this freedom…what a gift…girls became readily available when it used to be so hard to have sex with any of them on a regular basis!

This was not all, but the future was never the same.

Was this a part of something still bigger? Information technology was advancing and information was spreading in a way and at a speed it had never advanced before. I remember seeing the war in Korea on television and George Wallace fight integration in the south. I saw John F. Kennedy speak to the 1956 Democratic convention. I saw a Vietnamese general shoot someone in the side of the head on national television. And, there was, of course, a lot more. But, many people were a lot more aware of the world…in real time!

Let me put this in another context. Going back to the New York Times article: “What historians are suggesting is that the modern president may simply not be able to exercise that same firm grasp—or at least not most of the time.” The reason is that we have moved into an age of global interdependence.

“With global interdependence comes a certain lack of control, a vulnerability to disparate influences beyond our territorial borders that are less obvious and less easily answered than the launch of a Soviet satellite. And those influences, perhaps, directly undermine our ideal of what a president should be.”

In the 1950s, the United States was at the “top of the heap.” It was Number One. In the 2010s, the United States is one among many…at least in a lot of things.

I was growing up in the 1950s. I am near the end of my career in the 2010s. What took place during this time period? How can one define this age?

Something happened after the 1950s. I feel that something else is happening now, something that is moving us on to the next “Age”.

I saw a movie a week ago Friday. The movie was called “Going the Distance” and starred Drew Barrymore, Justin Long, and Christina Applegate (the daughter on TV’s Married with Children). The movie, seemed to me, to present a glimpse of what young people are facing today…few jobs, no leaders to provide role-models, no direction, nothing to believe in, and basically searching for something to latch onto, to hold onto, and such. No one is confident about the future. The main characters seemed adrift in a way I didn’t recognize, in a way I didn’t feel a part of.

So my quest in these posts is to try and add some definition to the last sixty years. To interpret how this time period led up to where we are now. And, to try and get a hold of where things are going. Thus, this commentary will consist of a number of parts. Of course, it is just my interpretation.

Tuesday, February 10, 2009

The Two Sides of the Coin

Well, three weeks into the Obama administration and we are getting a real lesson in the two major alternative approaches to macroeconomic analysis that exist within the profession of economics today. The first approach, generally favored by those supporting President Obama, is Keynesian in nature. The second approach, generally favored by those not supporting President Obama, but not necessarily Conservative in their leanings, nor do these people necessarily believe that they are of the Republican Party, tend to work with a different model of the macroeconomy.

The Keynesian approach, developed in the post-World War I era, contends there is a problem in how the macroeconomy works itself out if there is insufficient demand coming from the private sector. This initiating factor in this model is that business expectations about the future drop off considerably…there is a decline in “animal spirits”…and as a consequence investment expenditures collapse. The normal response to this when the economy has not fallen apart is to have the monetary authorities lower interest rates and this action will stimulate investment demand and re-charge the economy.

The problem with this is that when “animal spirits” really collapse and there seems to be a cumulative downward movement in the economy, the monetary authorities cannot stimulate business investment expenditures so that the central bank cannot stop and reverse the downward spiral. Keynes suggested that in such situations the only possible vehicle to stop the cumulative collapse is for the government to come into the picture and substitute government expenditures for the business expenditures that have gone away.

The government can either finance these expenditures by printing money or issuing debt. The idea here is that this spending, even if financed by printing money, will not have an impact on prices (inflation) because of the un-used resources in the economy. That is, the government expenditures will just pick up the slack in demand and then through the multiplier effect created by increasing incomes and consumption expenditures, aggregate economic activity will pick up.

The major question here is about the size of the multiplier. There is much speculation on this, but the figure most people feel that people in the Obama administration are using is 1.5. That is, if the stimulus bill totals about $850 billion, then the total impact on the economy of this program will be $1.275 trillion…a hefty boost to aggregate economic activity.

There are several attacks on this way of thinking that lead us into the conclusions presented by the second approach under review. The first one is that the Keynesian approach, as described above, does not take into account that Keynes constructed his model in a period in which international capital flows were severely limit. Thus, what was done in a sovereign country generally stayed in that country.

The international financial system broke down during World War I…this was the old gold standard system. Keynes fought hard at the Paris Peace Conference which followed the war for fixed currency exchange rates between countries and limited international flows of capital. One of the things that Keynes was most worried about was the Russian Revolution and the spread of the ideas connected with the uprising of the workers and the leadership of the Proletariat. This seemed to be a worldwide concern that lasted in the mid-thirties. The worst fears of many, many people were that economic collapse or depression would result in a movement in which the workers took over.

Economic nationalism was designed to prevent such an occurrence. Fixed exchange rates, restricted international capital flows, and protective tariffs were designed to achieve this result. This was why Keynes wanted countries to be independent of one another so that those that wanted to could follow they own stimulus program without having to worry about currency depreciation or an international loss of capital. His stimulus programs were designed to work in such a country.

This is not the world that we find ourselves…we have floating exchange rates…we have relatively open world capital markets and a free flow of capital to almost anywhere…and in recent years there has been great efforts to promote and expand free trade. The government expenditures promoted by those that support the Keynesian approach have not accounted for the difference between the construction of the world in the 1930s and the construction of the world in the 2000s. The modern argument is that the spending of the government will just be dissipated through open world markets and capital flows and will not be able to achieve the level of stimulus they hope for.

Furthermore, the Keynesian effort will just increase…by substantial amounts…the amount of debt that exists within the world. As I have reported in recent posts, Niall Ferguson has claimed that the proposals of these “born-again” Keynesians are treating a situation where too much debt exists by adding on major amounts of new debt. Or, in other words these proposals are attempting to solve the problem of too much leverage in the system by adding on more leverage. Ferguson, as reported, does not believe that this will work.

In terms of the alternative economic model we find two major editorials published in recent days that lay out some of the concerns of this other school of thought. These are the articles by Robert Barro, “Government Spending is No Free Lunch,” WSJ on January 22, 2009, (, and Gary Becker and Kevin Murphy, “There’s No Stimulus Free Lunch,” WSJ on February 10, 2009, ( They are not too optimistic that the Obama stimulus plan will be very effective.

This school of thought emphasizes more the supply side of the economy and is concerned that the appropriate incentives are set up. For one, both articles contend that the multiplier is substantially below 1.0…I have used 0.4 in my writing. If the multiplier is 0.4 then the $850 billion in government spending will only produce approximately $340 billion in additional output…not much bang for the buck. The reason why is that the spending part of the program will draw resources away from other, private spending so there will not be the add-on effect, but a substitution effect in which resources that would have been used in other areas of the economy are now drawn to these areas. In terms of tax cuts, they argue that the way the tax cuts are structured the additional funds available to consumers will go into savings or a “rainy day” fund to protect against future economic difficulties. Thus, in neither effort is the government getting much for its spending.

In terms of the “right” incentives, Barro would like to see a reduction or elimination of the corporate income tax. In this way Barro believes that the incentives would be right for businesses to spend and put resources to work for they would be getting that extra boost from the lower or non-existent tax rates. In this way the supply side of the economy is stimulated…which Barro contends will be much more effective than the spending and tax-reduction programs that have been proposed.

The differences are great and they are now starting to get full exposure. We will talk more about these in the future.

Saturday, February 7, 2009

Government and "Economic Shocks"

Elected officials, in general, have two fundamental incentives; the first is to get elected or re-elected; and the second is to do some good. The first is very straightforward and easily understandable. The second…well, the second creates a question…do some good…for whom? Generally, this question can be answered by saying that “for whom?” refers to people that will elect the officials…or will re-elect them.

Elected officials are often asked to behave in ways that reflect the common good…that ignore total self-interest. But, the very cynical argue that you can count on one hand the number of times that an elected official acted in ways that were solely for the good of all and did not reflect just self-interest. Others would argue that the number is larger than that…but to understand the elected official you must not ignore the fact that his or her position depends upon them acting in their own self-interest.

If a subset of the electorate elects an official, they do so on the expectation that the official will represent them and support their interests. If the official does not represent the subset’s interest to the degree that they expect the official to…then they have incentive to support another candidate. So, elected officials really only have one incentive in running for office…to get elected or to get re-elected.

The point here is that elected officials may have incentives that are different from the incentives that exist within the economic system. For example, if economic growth is slowing down…elected officials or those appointed by elected officials may have an incentive to stimulate the economy and increase employment if an election is near at hand. If elected officials or those appointed by elected officials express concern that the stock market may collapse, they may try and keep interest rates extremely low in order to avoid a stock market correction or a readjustment to a more realistic level. If elected officials or those appointed by elected officials believe that every American…or almost every American…should own a home, they will create and support programs that encourage such a result.

Every one of these efforts…and many more like them…can be traced back to efforts to get elected officials re-elected…and they are all aimed at a “good” thing…or a “good” cause. No one can disagree with the basic attempt by the elected officials or those appointed people.

Each of these efforts, however, is what the economist would call a “shock” to the economic system. Each of these efforts represents a response to a different set of incentives than those that exist within the functioning of markets and relationships in the economic system, itself. Economic models attempt to separate out the different factors that are at work within an economic system. Factors that do not respond to the regular incentives that exist within the economic system are called “exogenous” variables and changes in these variables are introduced independently of the system. Other variables that respond to the incentives that exist within the system, both those created by other non-exogenous variables as well as to the incentives created by the exogenous variables are called “endogenous” variables.

The importance of this distinction is that many of the “shocks” that an economic system receives is of the “exogenous” variety and are introduced into the economy for reasons other than allowing the economic system to work out all the incentives and dis-incentives that currently exist. In effect, these “exogenous” shocks are often aimed at preventing the economic system to work itself out in the direction it is going. And, as stated above, many of these interventions are for the “good” of the economy or for the “good” of, at least, some of the people in the economy.

The fact of the matter is that we don’t really have good theory to examine how these “exogenous” shocks come about. If we did, obviously, then they could be incorporated into the economic model and would become “endogenous” variables. Therefore, these “exogenous” shocks…government decisions…must stay exogenous and be introduced as they happen or are expected to happen.

Economics is a study of human behavior. Therefore, the predictions that come from economic models are going to be highly imprecise. Economic models are all incomplete and fallible. We just can’t do better than that when dealing with human behavior. Some situations lend themselves to more consistent behavior that allow for the making of better predictions…but other situations…like government decision making…are not systematic and so are almost impossible to model. And, we are finding out through the research in areas such as behavioral economics and behavioral finance that some situations that were, in the past, assumed to be fairly regular, are not that regular and need to be modeled with much less confidence about the accuracy of their predictions.

The name of John Maynard Keynes has surfaced a lot these days…and I am going to refer back to something that he wrote that, I believe, pertains to this very issue. In his commentary of the great economist Alfred Marshall after the great man died, Keynes discusses what makes an exceptional economist. In terms of Marshall, Keynes remarked that he was very learned in history. And then Keynes followed up on this by saying that anyone that wanted to be a top level economist needed to incorporate history into his or her explanation of how things worked. And, Keynes did not mean by history, incorporating a huge amount of statistical data into the model building process. Keynes was referring to the need to understand specific individuals and how those individuals made decision…how they were affected by their time…and how they were affected by their own experience and upbringing. He concluded that good economics required a good knowledge of history and biography…not something that is often taught in Ph. D. programs in economics or finance.

The point of this post is that in the policy making issues that government has to deal with we cannot just rely on assumptions of completely self-correcting free market economic systems where the incentives generated within the system are sufficient to work themselves out in a deterministic fashion. These systems will be continuously impacted by “exogenous” shocks that will bump the system one way or another, preventing the system from working itself out into a “new equilibrium” where everything is OK. These systems…for better or for worse…will be buffeted by these “exogenous” shocks and this will mean that we, in order to understand what is happening or what has happened, will need to introduce history and biography into the analysis we are going through. That is…economics cannot stand alone and provide all the answers.

This leads us into the position that we can…and must…look for bumps and shifts in the economy that are caused by governmental interference…usually with good intentions…and see how the government changes incentives…and how these changed incentives can divert the economy from one path onto another.

A good example of this comes in situations that create what economists call “moral hazard”…actions that lead people to do perverse things that they would not do under other circumstances. For example, people have to take risks in what they do…starting a business, buying a home, investing in securities, and so on. If a situation arises in which the people that have done one or more of these things get into dire straights…that is, they may face foreclosure or bankruptcy…elected officials can decide…for good reason…to protect them in some way. This presents a situation of “moral hazard” because those people that get protected may, in the future, decide to take on even higher levels of risk and make the economic or financial system more fragile. One can applaud of condemn actions that create “moral hazard” but it is a judgment decision. The elected officials must make a decision relating to the trade off between avoiding a bad situation now…protecting the people who have gotten in trouble…versus not protecting the people now and facing a economic or financial catastrophe. Where you set the tradeoff is a personal decision.

Tuesday, February 3, 2009

Liberal Democracy

Liberal democracy has its benefits and it has its problems. One of the things the founders of the United States seemed to want to avoid was the creation of a democracy…instead they wanted to produce a republic. Why would this be the case?

A democracy, Webster’s tells us, is “rule of the majority.” A republic, Webster’s states, is “a government in which supreme power resides in a body of citizens entitled to vote and is exercised by elected officers and representatives responsible to the citizens and governing according to law.” In addition, a republic is “a government having a chief of state who is not a monarch.”

The difference in emphasis is dramatic…a democracy…the majority rules. In a republic…people govern who are representatives of the people…and are elected to use their own judgment. A democracy can also have an elected body, but the people serving in that government are expected to be conduits of the will of the people.

The founders and many other individuals of a “liberal” persuasion tended to shy away from the idea of a democracy because they equated democracy with a rule by the crowd or the mob. The thing that these people were concerned about is the tendency for the crowd to be moved by emotion and to swing first one way and then another. Representatives in a republic are responsible to bring with them their intelligence and experience and judgment…they are not expected to be swayed by the emotion of the moment or by this trend or that trend.

The problem that occurs when a republic becomes dominated by “public opinion” they begin to act more like a democracy. That is, they pay less attention to their own judgment and abdicate their responsibility to the “will of the moment.”

History has shown that incentives exist for politicians to extend the voting franchise whenever it is in their best interest to enlarge the number of people that are allowed to vote. We see this to be the case in England…Disraeli and Gladstone both increased the franchise to get them elected and serve their own purposes. We see that happening over-and-over again in the United States. The effort of the politicians is to play to the preferences of different “interest” groups and ride them into office and into power.

To discuss this in very modern terms, I refer once again to the recent work of Niall Ferguson, especially his latest book titled “The Ascent of Money.” There are two specific areas that I would like to focus on specifically in this post. The first area concerns how capitalism and, more specifically, the financial aspects of capitalism can create opportunities for politicians to build large constituencies that can help them attain office perhaps to the potential detriment of the health of the country. The second has to do with “housing” democracy, the idea that all…or at least the vast majority…of Americans should own their own home.

The first of these areas relates to the “bad press” that finance and financiers have gotten over time. Historically, finance and financiers have been depicted as parasites that prey on the “real” economic activities that are carried on by the rest of the society. Somehow these people attach themselves to what is really going on in an economy and “suck” the system for what it is worth. Essentially, what is being said about finance and financiers is that they are peripheral to the real work of the economy contributing little or nothing to the output produced real workers.

One of the things that Ferguson presents and stresses is that economic development requires that finance exist within an economy and without a financial system (private property and the rule of law) little enterprise, innovation, or expansion takes place. Finance brings resources, particularly financial resources, to where they can be the most productive in a society. Without this allocation function, societies tend to remain dormant…listless…poor.

With this said, Ferguson goes on to write that debtors have seldom felt well disposed toward creditors and the former has tended to outnumber the latter by a large amount. Because of this debtors have tended to get better coverage in the press and a wider audience for their complaints among intellectuals and people with particular political leanings. Politicians can count and are very aware that debtors outnumber creditors.

Furthermore, financial crises and scandals occur frequently enough to make finance appear to be a cause of poverty rather than prosperity, volatility rather than stability. That is, finance disrupts people’s lives…it seems to make things more difficult…it is identified with “cheats” and “frauds”. Again, the thing that seems to “stick” in people’s minds is the “bad stuff” and not the “good stuff” that comes from a well-functioning financial system.

There are two other factors that seem to permeate the image of the financier to “common” citizens. First, there are wide disparities in income and wealth distribution separating “financiers” from the rest of society. This doesn’t seem very democratic and fair…especially if these people are parasites. Second, for centuries, financial services have been disproportionately provided by members of ethnic or religious minorities who have been excluded from other important positions in the society.

The point of this is that people that have or can have negative feelings about finance and those people that work in financial institutions. These negative feelings can be played upon by those that can gain from obtaining support from these large numbers of people. That is, politicians and others can play on the emotions of the discontented, the dislocated, and the disenfranchised. In this way they can play down or tarnish the image of the good that comes from the financial system.

The other topic I wanted to emphasize is what has been titled “housing” democracy…the concept that all…or, at least, most…Americans should own their own home. This move started in the 1930s as laws and institutions were created to make it easier for people to own their own home. This effort increased after the close of World War II and gathered speed in the 1960s with the “Great Society” and did not slow down into the Nixon years.

I remember working on something called a mortgage backed security during the time I was in the Washington, D. C. in the 1971-72 period. The rationale, as least the one I heard, for this effort was to help get Republicans re-elected to Congress as well as to bring more Republicans into government. How could this happen? Well, if we could get thrift institutions, the primary organizations that originated mortgages, to package their mortgages and sell them to other financial institutions, like insurance companies and pension funds that purchased long term assets, then the thrift institutions could go out and originate more mortgages. More people could own their own homes…and since the Republicans created this process…the voters would reward them by electing or re-electing them to public office.

During the rest of the century this idea was not lost on either Republicans or Democrats. Basically, this effort became a part of the American dream…the creation of everyone owning their own home. So, financial innovation built on financial innovation…and these innovations were constantly celebrated. As a consequence, mortgage-related securities are the most prominent financial asset in the world in terms of outstanding amounts. And, this promotion of “housing” democracy has brought us to the brink of financial collapse…or worse. But, it reportedly got a lot of happy homeowners to vote.

If these politicians have pushed America…and other countries…into more and more of a democratic mode…the question is…has this been helpful? Has this made things better off or worse off? Another question follows…if this process of “democratization” has actually taken place and has not been the most beneficial approach to the health and welfare of the country…what can be done to counteract it? This last point will be discussed in my next post.

Friday, January 30, 2009

Big Government

So much discussion is going on today about “Big Government.” The urgency of the talk is, of course, a result of the Obama stimulus plan…and TARP…and a possible “bad bank”…and possibly even more spending and tax cuts coming down the line. There is even a new book out called “The Case for Big Government,” by Jeff Madrick.

Has anyone been to Washington, D. C. lately?

Tell me what someone means when they say…”small government”?

It’s all relative…right?

To me the talk about “Big Government” or “small government” is so much wasted energy. The United States government IS big! It is going to STAY big! There is no way that I can see it becoming smaller. And, this doesn’t even take into account that we are faced, throughout the world, with dealing with other BIG governments.

The question to me is not about the size of the government. I would even argue that the size and complexity of other organizations within the country and the problems that must be dealt with require that the government be big. To me the question is about how this government goes about its business…that is how the public sector interacts with the private sector.

Last February, I put up a post on this site titled “More on Hamiltonian Government” (2/27/2008). In this post I argued that government faces three problems that put a limit on its power. These problems relate to the creation of incentives, the lack of sufficient information, and the speed at which events are taking place in the modern world. These limits, as I saw the situation, restricts what a government can achieve and directs us to those things a government can do that are actually helpful. The conclusion is that a government can have a positive effect on the private sector if it focuses on process rather than outcomes. If it focuses on outcomes, a government may create more problems than it solves.

Let’s just looking at the first of these problems today, the problem of incentives: the basic incentive for government is to “improve” something…make something better…or less bad. (On January 10, 2009, I wrote a post called “Improvers” to discuss the topic a little more deeply.) The government doesn’t have a lot of specific incentives…except in cases like the military…win wars…keep the peace…and so forth. So the primary goal is to “improve” things.

The problem with this is that in trying to “improve” things, the government can often create other incentives that have undesirable results or results that are the exact opposite of what they would like to achieve. (To see some specific cases please refer to the popular book…and blog…called “Freakonomics” developed by Steven D. Levitt and Stephen J. Dubner.) The difficulty occurs when people attempt to focus outcomes and state their objectives in specific goals. Setting the specific goals can then create other incentives that can harm or destroy the purpose of the whole effort the government has undertaken to “improve” things.

This often happens in situations involving the government’s monetary and fiscal policies. For example, the goal to avoid recessions can create government policies that send out messages to the private sector that can totally destroy the initial goal of the government. When Alan Greenspan, chairman of the Board of Governors of the Federal Reserve System became so concerned about the possibilities of an extended recession following the bursting of the stock market bubble in the early 2000s that he kept the target interest rate of the Fed excessively low for an extended period of time, lower than the rate of inflation the economy was experiencing.

The result…excessive borrowing took place because the real rate of interest was negative…it paid people to borrow…a bubble in asset prices occurred in housing markets…this was passed into the capital markets through securitization…and this funneled into other areas of the capital market, especially more and more exotic derivative instruments…and as people continued to create credit at an exponential rate and as people continued to leverage up their balance sheets…the financial markets…and the whole economy…became more and more fragile.

Why did people…even sensible people…do these things?

The incentives created in the credit expansion distorted things. If, for example, I run a hedge fund and I want to earn a slightly better return on my portfolio than you I can, say, try one of two things. For one I can increase the riskiness of the assets I hold…maybe purchase securities backed by subprime loans rather than corporate bonds. Or, I can increase the leverage on my balance sheet to stimulate higher net returns on my portfolio. In either case I am increasing the riskiness of my portfolio in order to gain an advantage over you.

And, how can I get away with this. Well, I know that Alan Greenspan is so worried about avoiding a recession that he will continue to support the credit expansion even in the face of riskier asset portfolios or greater use of leverage in the system. And if this continues on for two or three years, the competitive pressure to do well and outperform my competitors will grow and grow. I will continue to increase the risk of my portfolios and to increase how much leverage I introduce to my balance sheet.

And, if I don’t do it? Suppose I am a relatively conservative portfolio manager and I don’t believe that I should either increase the riskiness of my asset portfolio or raise the amount of leverage on my balance sheet…what happens? Over time, as my competitors earn, even a few more basis points on the return on their portfolio…my clients will start withdrawing money from my funds and placing it with my competitor. If this environment is sustained by the government, I will either have to close my fund or capitulate and change my beliefs and become more aggressive. And, if I don’t have that choice and work for someone else…I will be replaced with someone that is more aggressive.

Is this outright greed that is driving this scenario? Are these people “bad” or “excessively crass” in their behavior?

These people want to perform well…that is true…but, I don’t believe that they are addicted to avarice any more or less than most people. The incentives changed on them and they just responded to the competitive pressures that were present in the market place. In my estimation…these incentives were set up by the government in following the incentive they placed high on their priority list…government officials wanted to improve things…they wanted to keep a recession from happening.

Government is going to have its incentives; and the private sector is going to have its incentives. The problem is not one of whether or not the government is big. The problem is related to how the government is going to implement its actions to achieve the goals it sets for itself. Often, as in the example I have given, the “good intentions” of the government can be translated into actions that create the “wrong” incentives for the private sector. If the private sector responds to these “wrong” incentives…and they will…the ultimate result may be totally the opposite of what the government was trying to achieve in the first place.

The problem is that the ultimate results occur at such a distance from the cause that the two are not tied together. Do people tie Greenspan’s attempt to avoid recession early in this decade with the current financial collapse?