Gangster Capitalism: Same as it ever was?

If you are going to read one thing and just one thing on the financial crisis and how it is working itself out you need to read this blog post at naked capitalism:  the one stop shop for understanding contemporary finance.

After the September 2008 crash, Iceland’s government took over the old, collapsed, banks and created new ones in their place. Original bondholders of the old banks off-loaded the Icelandic bank bonds in the market for pennies on the dollar. The buyers were vulture funds. These bondholders became the owners of the old banks, as all shareholders were wiped out. In October, the government’s monetary authority appointed new boards to control the banks. Three new banks were set up, and all the deposits, mortgages and other bank loans were transferred to these new, healthier banks – at a steep discount. These new banks received 80 percent of the assets, the old banks 20 percent.

Then, owners of the old banks were given control over two of the new banks (87% and 95% respectively). The owners of these new banks were called vultures not only because of the steep discount at which the financial assets and claims of the old banks were transferred, but mainly because they already had bought control of the old banks at pennies on the dollar.

The result is that instead of the government keeping the banks and simply wiping them out in bankruptcy, the government kept aside and let vulture investors reap a giant windfall – that now threatens to plunge Iceland’s economy into chronic financial austerity. In retrospect, none of this was necessary. The question is, what can the government do to clean up the mess that it has created by so gullibly taking bad IMF advice?

In the United States, banks receiving TARP bailout money were supposed to negotiate with mortgage debtors to write down the debts to market prices and/or the ability to pay. This was not done. Likewise in Iceland, the vulture funds that bought the bad “old bank” loans were supposed to pass on the debt write-downs to the debtors. This was not done either. In fact, the loan principals continued to be revalued upward in keeping with Iceland’s unique indexing designed to save banks from taking a loss – that is, to make sure that the economy as a whole suffers, even suffering a fatal austerity attack, so that bankers will be “made whole.” This means making a windfall fortune for the vultures who buy bad loans on the cheap.

Go read the whole article.

Returns to education: from a sure thing to a trip to vegas

Paul Krugman has pointed out, here and here that the meme that most of the inequality we have been experiencing of late has much to do with differences in educational attainment is bogus.  Mankiw responds in typical fashion by changing the standards by which that claim is judged.  Krugman presented solid evidence that the returns to education have been declining.  To which one should add that if we did a real ROI calculation the returns have gone negative.  Mankiw counters by saying that may be true but if you do not have an education you are less likely to get a chance to become the top 1%.

The difference between the two as near as I can tell is that Krugman demonstrates that buying a lottery ticket has worse odds of paying out than ever before and Mankiw’s master stroke is apparently that if you don’t buy a lottery ticket you have no chance at winning.

Sad, really.

The economy lab, the dark age of free trade theory, and the naive view on natural resources and economic development

Over at the Economy Lab in the Globe which Failed, which itself has gone from bad to worse, one of the economists they keep in their stable has either produced an extraordinarily naive analysis or a dishonest one.  I am going to go with naive for the sake of professional courtesy.  Not that that is the MO of economists but I am atheist fan of Jesus and not an economist…so here goes.

To be honest I can’t figure out which vintage trade model Gordon is using.  My informed gut tells me something like an off the shelve H-O-S intro text book model of free trade.  That would fit with his own vintage and the fact that he is an econometrician.  Although that creates a paradox because, as surely Gordn knows, the H-O-S free trade theorem preforms dismally–by even economic standards–in econometric work outs.  In layman’s terms: the work-horse model of free trade which is standard in introductory economics texts fails at a predictive level.

There are any number of reasons for this but just for fun here are few in no particular order:

  1. The economies entering into trade were in a state of autarky (self sufficiency) and full employment.  Both of which are patently false.  More often than not nations pursue trade in the search for a remedy to chronic underemployment and unemployment and have already been engaged in trade.
  2. Product and capital markets are perfectly competitive.  Again patently false.
  3. Factors (capital and labour) are perfectly mobile within a national jurisdiction but not between.  You might get me to agree on labour but the whole point of neoliberal globalisation and its animating quintessential core is the free movement of capital.
  4. As a corollary, capital (investors) is made up of 100% domestic nationals.  Extremely dubious assumption with respect to mining, oil and gas and a whole host of other sectors.
  5. There are no firms.  While capital and labour are the only inputs (and resource endowments) there are no firms.  Just one large something or other allocating labour and capital according to their scarcities.  A model without firms that actually do the trading?  Bizarre me thinks.  This becomes particularly important with respect to determining who benefits from the gains of trade.
  6. Capital is a natural endowment.  Which translated means that for the standard model the explanation is that some countries have lots of capital some do not.  Why that is; the model does not care.  But saying that you don’t care is far cry from saying anything remotely interesting.  Capital is after all nothing other than produced means of production in its physical form and its ephemeral and essential form a complex social relation.  Sorry I can’t really simplify that at this time.  But to get a sense of what I am getting at just recall that the origins of Canada is a colonial enterprise in which colonial settlement was driven by the desire to expropriate natural resources from the original inhabitants.  The origins of Canada, and its rich endowment of natural resources is thus the history of politically constituted property and not some “natural” process of economic development.

O.k. so that is that.  Of course the OEM version of free trade theory is going to be a predictive disaster.  Why anybody bothers to teach it outside of using it is an example of what happens when liberal geeks go wild is beyond me.  But let me do a real world work-out.

Let us take Newfoundland and Labrador as a historical case in point.  Here is region that has leaped from one natural resource boom to another and it has always ended in some form of administration.  The failure to develop a modern diversified economy in which resources play a role but not the primary role.  Contrast the fortunes of early diversifiers in the union, who did so via a tariff wall and you get the picture.

In Newfoundland and Labrador Gordon’s advice is being followed as the mining and oil and gas sectors account for around 40-45% of provincial output but only 4-5% of direct employment including temporary construction employment.  Neither the oil, nor the profits touch land (outside of royalties taxes and wage payments which are all relatively low) in that province because of the weak to non-existent processing of raw materials.

Gordon thinks this is the road map to economic success, I think it leads to ruin.  He is willing to bet standard trade theory on it, I am going with history.

Here is why.  Two seconds of reflection will reveal that in Newfoundland and Labrador almost every single assumption built into the standard free trade model is violated: most certainly 1 through 6 outlined above.  Perhaps most interestingly is that Newfoundland and Labrador would not have a comparative advantage in oil and gas had it not been for the federal and provincial governments.  I am sure Gordon was decrying Hibernia as white elephant back in the day.  The problem is today the two levels of government are fighting over the allocation of royalty payments as the project is paid in full and is churning out lucrative profits for all involved.

Maybe Gordon can write something about that in his next post to the Economy Lab.  I won’t hold my breath.  My discipline right or wrong and all that jazz.

How to read economic language for bias: “wage inflation” in Newfoundland and Labrador

Sometimes we read things and we get that gut feeling that we are being subtly manipulated.  Economics is of course full of this subtle manipulation.  Words like “choice”, and “efficiency” and even phrases like “free trade,” “efficient markets” and my favourite “the natural rate of X” have a very specific meaning in neoclassical economics which do not not have much connection to what the layperson might think they mean.  What is curious about the above terms is that they all lead the layperson in the right ideological direction even if they (the layperson) have no idea what the terms really mean in economic practice.

To my mind one of the most egregious ‘tells’ is the phrase “wage inflation.”  Here even the pedigree of the phrase is suspect.  In economics the word inflation is generally reserved to refer to an increase in the price level.  If just one good rises in price what we have is a relative shift in prices.  Sometimes when, for example, we disaggregate inflation data we talk about the relative contribution of specific  items like food, and energy to the overall measure of inflation.  But to talk of wage inflation is just bizarre.  Economists do not talk about profit inflation; so why would we talk about wage inflation?  The only reason I can come up with is that when an economist does talk about wage inflation they are either too ignorant to bother listening to, or too biased to bother taking seriously.  There is the third possibility that they think inflation is anywhere and everywhere a function of wage increases which normally goes by the name of a wage cost push theory of inflation.  So the third is really an expression of the soft bigotry that comes from being too biased.

Lest anyone think I am making up false examples or hitting at straw men just click on this document.  Here an economist talks specifically about “wage inflation” in Newfoundland and Labrador.  Now I am sure he is a fine economist but why would Mr. Locke talk about wage inflation?  If he were simply unbiased but confused about what the word inflation meant why would he choose to not also talk about profit inflation?  Indeed, in 2008 profits as a percent of wages were running at 125%.  The decadal average was over 70% whereas the national average was around 25%.  If anything it sounds more like a case of profit push inflation but then again Newfoundland and Labrador do not have an inflation problem: prices rose on average 2.45.  So why talk about inflation at all?  Even more embarrassingly Mr. Locke’s own graph plots wages in Newfoundland and Labrador as a percent of the Canadian average.  His stellar proof (p.10) that wages are the cause of an almost non-existent general rise in the price level in Newfoundland and Labrador is that wages in the province have risen to less than 95% of the national average.

The only answer I can come up with is that in such a context the use of the word “inflation” after the word “wages” is designed to tell the reader that increasing wages are BAD.  Why is it bad?  Because inflation is BAD.  And not as in Michael Jackson’s Bad, but you know BAD.

In any case when you read the phrase “wage inflation” stop reading and do something more intellectually rewarding like cleaning your toilet.  And as you watch the water rise in your bowl ask your partner to come in and watch the “inflation” in the water level.  At least with specific reference to the general level of water in your toilet bowl you will be on safer linguistic and scientific ground than talking about wage inflation.

Delicious and dangerous irony: China to buy Italian bonds

How much of a disaster is the EMU?  Look no further than the spectacle of the Italians going cap in hand to the Chinese for a bail out.  The fact that the Italians are tapping the Chinese is not the issue.  The issue is that they cannot tap the EU or the by now ideologically impotent ECB.  I have always thought of neoliberalism as the ideological gloss on an accumulation strategy.  Me thinks I might have it exactly backwards.

Never count on economists to defend the public interest

This is something that should always be kept in mind in economic policy discussions: most economists are pro-Market, not pro-Public Interest.

It is especially important to keep this in mind when we read commentary such as this, in which an economist from one of Canada’s smaller economics departments conflates being pro-market with being in the public interest.

This point is sometimes hard to see, especially since many economists hold to the deeply ingrained syllogism that being pro-market is straightforwardly being in the public interest.

But they are a lobby group like any other, and cannot be relied upon to defend the general public interest.*

Economists, particularly academic economists (and like all academics), rely on, for their social status, research funding and a quiet concious, having the public view them as working in the public interest. And given the majority of economists are true believers in the “market” that inevitably gets conflated with being in the public interest

Cloaking oneself as being in the public interest is of course one of the oldest rhetorical stances to take since like wearing the national flag it clearly puts the speaker in the role of the hero and casts those being spoken against in the role of the villains. This is all the more easy to to do when the terms of conversation are being articulated in fuzzy, ill defined concepts such as the “public interest” and “pro-market”. When an economist uses those terms they have very exotic definitions in mind that most lay people would not readily grasp. Perhaps I am being too charitable: I can’t, in fact, find a definition of the public interest in any my economics text-books.

The public interest is a rather fuzzy notion. We can perhaps all agree that it has something to do with public goods but that just raises the thorny issue of what is and what is not a public good. In any case the argument at least has to be made that a specific policy is in the public good and why. Just standing around hands waiving in the air mindlessly chanting pro-market rhetoric like “free trade” or deregulation does not really cut the mustard.

Indeed after a generation of pro-market policies like financial liberalization and deregulation with cascading financial crises of increasingly damaging intensity culminating in the Great Financial Crisis that was 2007 and from which no advanced capitalist economy has yet to emerge; in which whole nations like Iceland, Greece and Ireland were raised; in which untold millions of workers were put and remain out of work; and as a consequence a massive hole was blown in public finances around the world, it should be clear that pro-market policies are not always or even in the majority of cases un-problematically in the public good to say the very least.

Notice that even if you are want to argue that it was bad government regulation in the US which caused the Great Financial Crisis the fact is that decades of financial liberalization and deregulation (pro-market policies) directly led to the formation of global investment and insurance markets which made sure that a “made in the USA” problem had serious global consequences. And it is not just that economists did not foresee these negative consequences they actually argued in favour of these policies on the grounds that such a crisis was less likely to occur and that the consequences would be less severe in the event that it did occur because these pro-market policies allowed risk to be more evenly spread. So much for theory.

That a pro-market economist is given a national soap-box on which to conflate being Pro-market with being in the Public Interest does not bode well for the Public Interest.

* The first four paragraphs are an inverted paraphrase of the linked commentary. I apologize to my readers for reproducing a very clichéd prose style.

Austrian Gold Bugs behind the TeaParty?

An article in the Financial Times makes the link between the right-wing Tea party movement and a classic pump-and-dump scheme being run by a group of gold sellers. Basically the scam works like this. The gold sellers provide funding for key Tea Party spokespersons and in return they (the spokespeople) push the line that massive inflation and massive currency devaluations are looming and thus their supporters ought to buy gold to protect themselves.

The twist on the classic pump and dump is that the gold sellers, as the article in the FT seems to indicate, are not just looking to hype the price of gold but are also selling denuded gold products (how very gold standard of them). Now if they are selling gold products which they bought a lower prices then they win three times and some of those “profits” get recycled back to the Tea Party movement. There is just too much irony here.

As Krugman might want to point out this is going to be another area where the right is wrong and all those poor dupes that listen to them are going to be materially worse-off. Suckers are as suckers do…I suppose.