Posts Tagged ‘finance’


As James Surowiecki explains in his review of Joseph Stiglitz’s most recent books, “the fundamental truth about American economic growth today is that while the work is done by many, the real rewards largely go to the few.”

Economic inequality is clearly back on the agenda in the United States, in political discourse as well as in the discipline of economics.

Historically, inequality was not something that academic economists, at least in the dominant neoclassical tradition, worried much about. Economics was about production and allocation, and the efficient use of scarce resources. It was about increasing the size of the pie, not figuring out how it should be divided. Indeed, for many economists, discussions of equity were seen as perilous, because there was assumed to be a necessary “tradeoff” between efficiency and equity: tinkering with the way the market divided the pie would end up making the pie smaller. As the University of Chicago economist Robert Lucas put it, in an oft-cited quote: “Of the tendencies that are harmful to sound economics, the most seductive, and…the most poisonous, is to focus on questions of distribution.”

Today, the landscape of economic debate has changed. Inequality was at the heart of the most popular economics book in recent memory, the economist Thomas Piketty’s Capital. The work of Piketty and his colleague Emmanuel Saez has been instrumental in documenting the rise of income inequality, not just in the US but around the world. Major economic institutions, like the IMF and the OECD, have published studies arguing that inequality, far from enhancing economic growth, actually damages it. And it’s now easy to find discussions of the subject in academic journals.

First, after decades of simply ignoring the problem, mainstream economists tried to make sense of growing inequality in terms of “earnings inequality,” that is payments to different amounts of human capital (measured, for example, in terms of years of education). But that couldn’t account for huge differences within the top 10 percent, most of whom have college degrees. A second, more recent attempt has focused on the “rent-seeking” behavior of individuals (like CEOs) and sectors (such as pharmaceuticals and finance). The idea is that a small group of individuals and industries at the top are able to capture excess payments—”rents”—because they’re able to keep competitive forces from driving returns down. From Stiglitz’s perspective, the issue is

the economy suffers when “more efforts go into ‘rent seeking’—getting a larger slice of the country’s economic pie—than into enlarging the size of the pie.”

As I’ve explained before, the idea of rent-seeking behavior puts the final nail in the coffin of neoclassical marginal productivity theory, that is, the idea that “everybody gets what they deserve, according to their marginal contributions to production.”

But rent-seeking theory fails to account for where the extra value that takes the form of rents comes from, that is, it doesn’t offer an explanation of how a surplus is created, which can then be captured—in competitive situations (so-called normal profits) as well as in noncompetitive situations (which give rise to rents).

The fact is those at the top, in the immediate postwar period (when income inequality was much less than it is today), were left with both the incentive and the means to remake the circumstances to capture the surplus that was being created. And, of course, they eventually did so, beginning in the 1970s—allowing them both to make sure more surplus was pumped out of the workers (by paying wages that remained stagnant) and to capture more of that surplus (by funneling it into areas like finance and pharmaceuticals and by paying CEOs higher and higher salaries).

That, in my view, is the “fundamental truth about American economic growth.”


Branko Milanovic has put forward an idea he thinks “will gradually become more popular”:

The idea is simple: the presence of the ideology of socialism (abolition of private property) and its embodiment in the Soviet Union and other Communist states made capitalists careful: they knew that if they tried to push workers too hard, the workers might retaliate and capitalists might end up by losing all.

The idea reminds me of an argument Etienne Balibar made many years ago (unfortunately, I can no long remember or find the original source but here’s a link [pdf] to one version of it)—that the “European project” was more progressive during the Cold War in the sense that the welfare state was constructed, by forces from above and below, as a response to the Soviet model of socialism, in order to prevent the working classes from adopting a communist ideology. (Since then, as Balibar has recently argued, the European project has fundamentally changed, as it has been assimilated by globalized finance capitalism and, under German hegemony, a strategy of industrial competitiveness based on low wages.)

Milanovice discusses some recent empirical work on three channels through which socialism “disciplined” income inequality under capitalism: (a) ideology/politics (e.g., the electoral importance of Communist and some socialist parties), (b) trade unions (some of which were affiliated with Communist or Labor parties), and (c) the “policing” device of the Soviet military power. He then offers his own analysis:

Communism, was a global movement. It does not require much reading of the literature from the 1920s to realize how scared capitalists and those who defended the free market were of socialism. After all, that’s why capitalist countries militarily intervened in the Russian Civil War, and then imposed the trade embargo and the cordon sanitaire on the USSR.  Not a sort of policies you would do if you were not ideologically afraid (because militarily the Soviet Union was then very weak). The threat intensified again after the World War II when the Communist influence through all three channels was at its peak. And then it steadily declined so much that by mid-1970s, it was definitely small. The Communist parties reached their maximum influence in the early 1970s but Eurocomunism had already expunged from its program any ideas of nationalization of property. It was rapidly transforming itself into social democracy. The trade unions declined. And both the demonstration effect and the fear of the Soviet Union receded. So capitalism could go back to what it would be doing anyway, that is to the levels of inequality it achieved at the end of the 19th century. “El periodo especial” of capitalism was over.

He admits the implication of such a story may be rather unpleasant:

left to itself, without any countervailing powers, capitalism will keep on generating high inequality and so the US may soon look like South Africa.

This is not to suggest we need another Cold War for the United States not to move even closer to looking like South Africa. But it does mean there will be a significant move from above toward more democracy and less inequality only if there’s a real threat to move outside of capitalism from below.


Special mention

www.usnews David Simonds Grexit cartoon 14.06.15

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Seven years after the global financial crash, we’re still in the midst of a full-scale war of finance.

On one side of the Atlantic, U.S. Court of Claims Judge Thomas Wheeler found that former AIG head Hank Greenberg was indeed correct in claiming the government overstepped its legal boundaries in its “unduly harsh treatment of AIG in comparison to other institutions” that was “misguided and had no legitimate purpose.” The ruling basically confirmed the Fed’s right to create a gigantic bailout of Wall Street but denied its ability to actually determine the use of the funds by the “taking of equity” in essentially worthless financial institutions like AIG.

Finance thus continues to win the war in the United States.

And, as Ambrose Evans-­Pritchard [ht: sw] explains, finance is engaged in all-out war in Europe.

Rarely in modern times have we witnessed such a display of petulance and bad judgment by those supposed to be in charge of global financial stability, and by those who set the tone for the Western world.

The spectacle is astonishing. The European Central Bank, the EMU bail­out fund, and the International Monetary Fund, among others, are lashing out in fury against an elected government that refuses to do what it is told. They entirely duck their own responsibility for five years of policy blunders that have led to this impasse.

They want to see these rebel Klephts hanged from the columns of the Parthenon – or impaled as Ottoman forces preferred, deeming them bandits ­ even if they degrade their own institutions in the process.

The European Central Bank is actively inciting a bank run in Greece and threatening to throw that country out of the euro zone if it resists the demands of the creditors, represented by the troika, without ever seriously considering the proposals put forward by the democratically elected Syriza government.

The truth is that the creditor power structure never even looked at the Greek proposals. They never entertained the possibility of tearing up their own stale, discredited, legalistic, fatuous Troika script.

The decision was made from the outset to demand strict enforcement of the terms agreed in the original Memorandum, which even the last conservative pro­Troika government was unable to implement ­ regardless of whether it makes any sense, or actually increases the chance that Germany and other lenders will recoup their money.

At best, it is bureaucratic inertia, a prime exhibit of why the EU has become unworkable, almost genetically incapable of recognising and correcting its own errors.

At worst, it is nasty, bullying, insistence on ritual capitulation for the sake of it.

The troika, in other words, is acting like a unified debt collector, and is willing to go so far as to threaten to topple a democratically elected government to set an example that, in Greece and elsewhere in Europe, finance is willing to do anything and everything to win the war.

Chart of the day

Posted: 11 April 2015 in Uncategorized
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source [pdf]

Much of the sloppy coverage of General Electric’s decision spinoff GE Capital, it’s financial division, blithely asserts that “it has become harder for financial services businesses to make big profits in the postfinancial crisis environment of tighter regulation and lower risk.”

As readers can see from the charts above, while GE’s move may represent the end of an era for one corporation, the financial sector itself has rebounded remarkably well from the crash of 2008.


Harvard economics professor Sendhil Mullainathan is worried that too many of his students are taking jobs in finance. He should be worried for other reasons, too.

Mullainathan’s concern stems from the idea that much of the activity in the financial sector involves “rent-seeking”:

Instead of creating wealth, rent seekers simply transfer it — from others to themselves. . .

The economists Eric Budish at the Booth School of Business and Peter Cramton at the University of Maryland, and John J. Shim, a Ph.D. candidate at Booth, have shown in a study how extreme this financial gold rush has become in at least one corner of the financial world. From 2005 to 2011, they found that the duration of arbitrage opportunities in the Chicago Mercantile Exchange and the New York Stock Exchange declined from a median of 97 milliseconds to seven milliseconds. No doubt that’s an achievement, but correcting mispricing at this speed is unlikely to have any real social benefit: What serious investment is being guided by prices at the millisecond level? Short-term arbitrage, while lucrative, seems to be mainly rent-seeking.

This kind of rent-seeking behavior is widespread in other parts of finance. Banks sometimes make money by using hidden fees rather than adding true value. Debt collection agencies may use unscrupulous practices. Lenders to poor people buying used cars can make profits with business models that encourage high rates of default — making money by taking advantage of people’s overconfidence about what cars they can afford and by repossessing vehicles. These kinds of practices may be both lucrative — and socially pernicious.

Mullainathan makes clear that that kind of rent-seeking behavior is ubiquitous in the world of finance. But, it seems to me, he has an even bigger problem: it’s not clear there’s an area in finance that doesn’t involve some kind of rent-seeking (or, as I prefer, surplus-seeking) behavior. The best Mullainathan can come up with is a general summary of the effects of the division of labor in Adam Smith and a movie, It’s a Wonderful Life.

Mainstream economists and Wall Street bankers have tried mightily to come up with concepts and measures of how the financial sector creates value and thus has an economic or social benefit. But, in the end (to judge by Mullainathan’s column), they’ve failed.

Finance may be very lucrative, for banking institutions and Harvard students alike, but all it does is capture some of the value created elsewhere in the economy. And in an attempt to capture more and more of that value, by taking advantage of arbitrage opportunities and developing new financial instruments, it created the worst crisis since the first Great Depression.

Not even George Bailey would have been able to prevent that from happening.



Special mention

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