Maxine Udall (girl economist)

'Tis the Season...

I started blogging a little over a year ago. Last night over dinner, a friend asked me why I do it. The answers I gave him were: I love to write and I want to be part of the really exciting conversation about economics and economic thought that has been a byproduct of the financial sector's mismanagement of risk.

I didn't say it last night, but I think I also started blogging because I grew up in a family business and have become increasingly appalled over the last 10 years or so by what seems to me to be a very limited view of the duties, obligations, and responsibilities of business.

I remember the sense of incompleteness and confusion I felt when first exposed to the theory of the firm. You see, in our business we were not profit maximizers. We were business men and women, embedded in a community, our fate intertwined with that of the community. We had to make enough money to stay in business for the long-haul. That meant that our customers had to keep coming back, we had to provide value, and we had to work, to sell. No one who walked into our business was greeted with "Let me know if I can help you." The customer was like a sacred guest. Our job was to find out what she needed, to tell him as much as we could about the merits of our merchandise, to help them identify and purchase the best match for their preferences and their pocketbook, or to send them to a competitor, with directions on how to get there, if we didn't have and couldn't get what they were looking for.

Our long-term survival depended on some amount of profits, but equally important were reputation and civic responsibility. These three are what we optimized over, not profits alone. We viewed all of these as interdependent. That meant that sometimes reputation and civic obligation were a constraint on profits.

We were also a small firm. The kind of firm economists like to imagine populates the ideal of a competitive market. And so they do. And our market was local, better suited to enhancing our moral sentiments about and our ethical commitments to our customers. our employees, and our community than global markets are, perhaps.

Now, after a year of blogging, I'm discouraged and puzzled.

I can understand that someone who has managed to capture a privileged economic and political position, one where they are backed by US taxpayers as they gamble for personal gain in financial casinos, will do whatever they must to maintain it. And I expect that over time, if unchecked and unchastized, they will take on increasing amounts of risk, underwritten by the rest of us. What I didn't expect was the magnitude of the moral failure: that financiers would help to create securities designed to fail, sell them to clients, and then bet against them. 

What I can't understand is the willingness of the citizenry to protect and reward someone who has harmed or is continung to harm them. I do not understand voting for politicians who support tax cuts for and neutered regulation of these same destructive speculators. Nor do I understand voters' apparent willingness to eviscerate all of the social programs and safety nets that are all that stand between them and what can only be regarded as neo-feudalism. I conjecture that the reason for this counterintuitive behavior is that the moral narrative that accompanies a technocratic tax cut for the wealthy is more compelling that the moral narrative that accompanies a technocratic stimulus of aggregate demand or support for families harmed by the financial sector's market and moral failures.

If you had told me 10 years ago that I would become a critic of investment bankers and an advocate for labor, I would have said that you were crazy. I was weaned on horror stories about the New Deal, the WPA and CCC, wage and price controls, and the horror of unions. (And, if we ever return to a point where unions become so powerful that they impede business, I will blog against them.)

I grew up in relatively egalitarian (at the time) Appalachia. My family had more money than most. I had two best friends. One friend's father was a (union member) coal miner who died of black lung disease when he was in his sixties. The other's father pumped gas at the local gas station, while his wife baked the most delicious bread and sold it to her neighbors. There was a compression that occurred in coal-mining and steel-producing towns. I think it's something about the landscape and the drear tar-paper brick houses and the fact that we all lived so close to each other. It causes those at the top of the income distribution to want not to seem too far above. But it may also be that money just isn't that important when most people don't have much of it. It also helps that the most you can spend on a dinner out is $20 per person (with wine) because that is the most the best restaurant in town charges for the top-of-the-menu T-bone steak with two vegetables (where mac and cheese and jello are both considered vegetables) and a glass of the "house wine."

I remember thinking until I was about 8 years old, that my only job options would be five and dime store clerk or bookkeeper, because those were the jobs women seemed to hold in my town. Mercifully, I didn't have to become a store clerk (although I've worked as one and was darn good at it, too) or a bookkeeper, but I remember feeling despair at the prospect even as an 8 year old. Maybe that is why I care so much about educational opportunity for anyone, anyone, who wants it.

And I remember that nearly every strikingly beautiful mountain vista was marred by a gas well or a coal tipple or a boney pile. It was the price, I told myself, of progress and the American dream. They kept my friends' fathers employed and my family in business.

Now I find myself wondering if the price is becoming too high, paid by those who can least afford it, and collected disproportionately by those who no longer generate the jobs or the universal opulence that used to be justification for that disproportionate allocation. I'm also increasingly concerned about how that price is set and the one-sided and self-serving (for those at the top) discourse that surrounds it.

I got into this conversation because I felt I might be able to contribute clarity for those not trained in economics and a different perspective. It has been an exciting and stimulating conversation. I've thought and read more about macroeconomics than I ever did in grad school. I have developed a real fondness and respect for my readers and their very thoughtful comments and for my fellow economics, anthropology, sociology, and biology bloggers, especially Mark Thoma, without whom only five people would ever have read this blog.

Now I find myself in need a a break, partly because I feel so discouraged by recent political events and the apparent triumph of zombie economics; partly because I have a paper and a grant proposal that need my attention. Barring some major new development, I'm going to take some time between now and New Years to reflect on what I've learned this past year and on the conversation we have had. I'll be back online around the New Year. In the meantime, if you're in the mood for a more seasonal essay, you might want to read my winter solstice post on my other blog. It contains the words "GDP" and "incentives," but is more in the spirit of the holiday season than this blog has been.

Happy Holidays and Best Wishes for a prosperous, opulent, full-employment, non-volatile, no negative externalities New Year for us all!

From the Archives: On Why Sound Macro Policies Are Political Losers

I've been thinking about where we were a year ago and how it stacks up with where we are now. This is what I wrote on December 1, 2009. Somehow, in the intervening months, Mr. Potter has appealed to enough people politically to redirect the nation back to Potterville. At least that is what I believe will happen if our newly come to power political leaders really do believe that regulators are there to serve the banks and bankers. I'm not sure I understand how this has come to pass, but it discourages me in this holiday season.

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A few days ago, Brad Delong posted a good blog on Why Good Macro Policies are Political Losers, which in my opinion misses the point in some ways. (Specifically where he said: "The fact that investment bankers did not go bankrupt last December and are profiting immensely this year is a side issue.") I contributed to the comments, but I want to expand a bit here.

Joan Robinson (girl economist) said something in her Richard T. Ely Lecture to the American Economic Association in 1972 during another economic crisis that I believe accounts for some of the "political loser" characteristics of good macro policies:

"A sure sign of a crisis is the prevalence of cranks. It is characteristic of a crisis in theory that cranks get a hearing from the public which orthodoxy if failing to satisfy. ... The cranks are to be preferred to the orthodox because they see that there is a problem."

I believe that the failure of "good macro policies" to be political winners is that they "fail to satisfy" on the dimension that matters most and is most visible and understandable to the public: fairness or justice.

Research in behavioral econ indicates that people care about fairness and are willing to take a loss in order to inflict pain (i.e., a loss) on someone who has failed to cooperate or who has been unfair. This is a direct contradiction of the assumptions underlying neoclassical econ theory where more is always and everywhere preferred to less.

Research also shows that people's sense of fairness can be engaged simply by shaping the information they receive about a situation. Someone perceived as receiving an unfair advantage or someone perceived as taking unfair advantage elicits a desire to punish them. For this reason, narrative matters. The story that accompanies a redistribution of income, say, will shape perceptions of fairness. Think "Robin Hood" here. Except among devotees of the late Ayn Rand, Robin Hood is nearly universally regarded as a good guy because he stole from people who were not only rich, but also corrupt, exploitive, unproductive aristocratic thieves to (in effect) return to hard-working peasants in a feudal society the product of their labor. It's hard to imagine how you can turn him into a villain, unless you tell a story in which the people he is stealing from are in fact the wealthy, productive members of society whose earnest and honest labors benefit the lazy, ne'er-do-well, grasping masses who desire only to loll about while others supply their provender. Think "welfare queen."

See how easy it is?

With the approach of a major Christan High Holy Day, 'tis the time of year when Frank Capra's film, It's a Wonderful Life, with Jimmy Stewart playing everyman's banker, George Bailey, and Lionel Barrymore cast as "old man Potter," banker to the Scrooges of the world, will be ubiquitous. I think the story is particularly salient this year in understanding public sentiment about the bailout. The movie culminates in the town bailing out George Bailey, the man who made their homes and housing developments and good lives possible, after money goes missing from his bank. The town folk gather, every one of them well aware of the ways in which Bailey has enriched their lives by extending credit at affordable interest and reasonable terms. If there's any doubt in the viewer's mind that Bailey deserves the town's forgiveness and largess, she has only to reflect on the scenes (shown to a despondent Bailey by Clarence the Angel) of Bedford Falls as it would have been had Bailey never lived. In that scenario, it is Potterville, a dark and dreary place where homes are ill-made, employment is only in Potter's companies, and everyone is in debt to wealthy, avaricious, cold-hearted Mr. Potter.

People in the US who are living with unemployment, no health insurance, and home foreclosures don't have Clarence the Angel showing them what their lives would have been like had Wall Street not been bailed out. They do not see the counterfactual (what the world would have been like with out the stimulus). All they see is something that looks worse than it used to be with no sign whatsoever that Mr. Potter has any intention of helping to restore Bedford Falls to its former economically sound and thriving state. On top of that, they get to watch Mr. Potter skate away fatter, richer, with health insurance, AND speculating on the next financial bubble no matter where it might be and no matter what the consequences to the people of Bedford Falls.

Is it any wonder then that good macro ideas are political losers? Much of the US is staring at Potterville or watching their own little Bedford Falls morph into Potterville. On top of that, old man Potter is raking in money again, while the people of Bedford Falls (soon to be Potterville) are staring at empty houses, lawns that haven't been mowed, unemployment figures that strike fear in the heart of every hard working, god-fearing man and woman who prides themselves on paying their own way and being beholden to no one.

Mr. Potter (i.e., Wall Street) must feel some pain and it needs to be soon (and more than a $500 million "donation" back to the people who bailed him out). And it needs to be pain that only Wall Street and it's shareholders feel. Most of the US is probably willing to take a hit to punish them. It would satisfy our hunger for some justice and it would help with the moral hazard that almost certainly has grown to large proportions because of the no-strings-attached bailout.

If the elected lawmakers in the US Congress and the elected chief executive are unable to muster the will to inflict pain on Mr. Potter, then they had better get busy bailing out Bedford Falls. This has nothing to do with political party or ideology. This is about the hard-working people of Bedford Falls... I mean the United States... who deserve better than to bailout out Mr. Potter and then watch him foreclose on their homes because he can't bestir himself to restructure their underwater loans.

If they don't, sound macro policies will continue to "fail to satisfy" moral sentiments about fairness and will continue to be political losers to the detriment of us all.

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Here's Huffington Post's take which is similar to mine (it was posted on youtube after the above was written and posted).

 

Rent-Seeking, Innovation, and Dancing to Someone Else's Tune

My regular readers know that from time to time I see parallels between real life economics and the movies (see, for example, here and here). It's happening again. This time the movie is Strictly Ballroom.

At first glance, this is a chick flick in which an awkward plain jane named Fran (I don't think we ever learn her last name) manages to get the good-looking ballroom dance champion, Scott Hastings, to dance with her. She does this mainly by being bold and willing to take chances at an opportune moment. Her appeal to Scott is her willingness to dance steps that Scott has made up and to dance them at the Pan-Pacific Grand Prix Amateur Five-Dance Latin Championships, no less.

Unfortunately, there's a lot of pressure for Scott to conform to the formulaic steps prescribed by the Australian Dance Federation. His regular partner has abandoned him because he won't "dance the steps you're supposed to."

"Well, of course, you can dance any steps you like," says Australian Dance Federation president, Barry Fife. "But that doesn't mean you'll.....win."

It's a fun movie on many levels: romance, transformation, redemption. But it is also notable for the economics in it.

"Economics?" you say. "Maxine, I've seen the movie. There is nothing remotely related to economics in it."

Ah, but you would be wrong. The whole movie is about economics. Consider this exchange between Scott and ADF prez Fife:

Fife: "Where do you think we'd be if everyone went around making up their own steps?"

Scott: "Out of a job."

You see? It's a movie about rent-seeking. As long as the ADF maintains control of the steps that are danced and as long as its members control the steps that are taught and the judges that judge the competitions, they're guaranteed income for life. (As an aside, one of my grad school classmates, after seeing the movie, took to referring to his dissertation committee as the Australian Dance Federation. And, no, none of them were Australian or dancers.)

As the plot unfolds, we learn that Scott's parents, who were the reigning Australian champions 20 years earlier, confronted a fateful choice in their own dance careers. Scott's father, Doug, wanted to dance his own steps at the Pan-Pacifics, but Shirley was afraid that if they did they would never be able to teach, they had to conform in order to be sure of having an income later in life. As a result, she opts to dance with someone else, instead of Doug, and loses the competition anyway.

All this is revealed, just as Scott is about to take the dance floor at his own Pan Pacifics, having dumped Fran and returned to his previous partner who had refused to dance with him until he agreed to dance Federation steps. He's planning to conform and dance the ADF steps when we hear Doug say to Shirley: "You lost anyway, Shirley. You should have stuck by me."

And then, as Shirley shoves Scott out to the dance floor, Doug says to Scott: "We had the chance, but we were scared. We walked away." (And then, shouting) "WE LIVED OUR LIVES IN FEAR!" (Cue echo chamber on "fear.")

So why have I been thinking about Strictly Ballroom?  Well, lots of reasons, I think. Not least is that I've been watching rent-seekers structuring finance and politics in ways that assure that they will continue to secure rents at the expense of more able, talented, and creative individuals. Individuals who, if they could retain those rents for themselves, could almost certainly put them to better use, investing in human capital, physical capital, preservation of environmental resources, and even just good old consumption. They would dance new steps, create new products, and make us all better off.

I hope some of you have noticed that I just used the same argument to motivate reining in investment banker compensation, bank fees, and lending practices, that is often used by so-called conservatives to argue for lower taxes. You see, rent-seekers' profits, are like a tax on us all. It is money that flows out of our pockets into their's with no commensurate return in benefits to us. The loss of income to rent seekers through higher prices, fees, and interest rates that they charge tends to impede the creativity, productivity, and economic advancement of the more able and innovative among us.

Another reason I've been thinking about the movie is the phrase, "we lived our lives in fear." We seem to be living in a fear-based world. We have gradually ceded individual liberties (think TSA for starters) out of fear. The Dems are afraid to allow tax cuts to expire because they could be accused of "raising taxes."  We fear to tax the wealthiest, because they might work less. This last despite an impressive array of wealthy businessmen and women who say they should be and would like to be taxed more. We fear to act because we imagine the unintended consequences of our actions will somehow be worse than what now confronts us. We are afraid to provide health insurance to all Americans, for fear it will move us to excessive state control. If we allow gays to marry, some fear heterosexual marriage will...well, I'm not sure what they're afraid of, but they are afraid.

In the movie, Fran morphs from plain jane to beauty, but her strong suit is courage. "Vivir con miedo es como vivir a medias." she tells Scott as she persuades him to take a chance and dance with her. "A life lived in fear is a life half-lived." This is why his father's words, "We lived our lives in fear" resonate with him and inspire him to take the chance and do the right thing: dance his own steps with Fran at the Pan Pacifics even if he doesn't win.

One reason having ethical principles and living by them is important is that they guide us when our emotions are tending to over-ride sound judgement. Prudence tempered with compassion. Beneficence that preserves and enables autonomy for the least and last and those in the middle by those who are relatively better off. Duty and obligation that might require greater sacrifice by those who have benefitted most from the last 30 years of deregulation and socialized risk. Investment in education and infrastructure that benefits everyone. Anyone whose life or politics are guided by these principles would do well to stand by them now, rather than capitulate in hopes of "winning" next time.

But I think the primary reason the movie has been on my mind is Doug Hastings.

"You lost anyway, Shirley. You should have stuck by me."

I keep thinking the Democrats, including Mr. Obama, should pay attention to this. They lost anyway. They should have stuck by their principles and the change they originally promised, instead of becoming Republican light. I, for one, would rather lose because I stuck by something I believe in, than abandon my most deeply held ethical principles and lose anyway. Sometimes virtue is the only reward.

It's not too late. The Democrats and Mr. Obama could still decide to dance their own steps to their own tune. I wonder if they've forgotten how.

Two Papers Worth Reading

Historian of Economic Thought, Bruce Caldwell's presentation at the INET Inaugural Conference on Hayek, Keynes, the Depression, and the recent crisis.

Jonathan Weinstein, Kellogg School of Management, Northwestern U, Fairness and Tax Policy--A Response to Mankiw's Proposed "Just Deserts" (HT Steve from Virginia)

Good Blog on Income Inequality and Crisis from The Economist

I was going to blog on a couple of recently posted blogs about income inequality and the recent crisis, but R.A. at The Economist does a much better job.

Company Store Redux

Nick Krafft at Open Economics sends us to this IMF working paper by Michael Kumhof and Romain Ranciere, “Inequality, Leverage, and Crises.” In it, the authors develop a model in which income inequality gives rise to different preferences and behaviors within two income groups: workers and investors.

The impacts of the two groups' preferences and behaviors play out differently depending which group is favored in terms of bargaining power within an economy. In the United States, where rising income inequality has been accompanied by erosion of labor union membership and political power and a rise in the political influence of financial and commercial interests, it's no surprise that bargaining power has favored so-called "investors." I say so-called, because usually when one "invests," one produces something, often of value to the rest of us: more productive physical capital; more jobs; innovation; or better and cheaper products. Something that doesn't require a taxpayer bailout and result in a near-10% unemployment rate. But I digress.

Kumhof and Ranciere note that as income inequality has grown in the US, it has fueled a recirculating flow of borrowing by working and middle class families and lending by the "investor" class, borrowing that has been necessary to maintain working and middle class consumption as real working and middle class incomes have stagnated or fallen:

The key mechanism [in the model] is that investors use part of their increased income to purchase additional financial assets backed by loans to workers. By doing so, they allow workers to limit their drop in consumption following their loss of income, but the large and highly persistent rise of workers’ debt-to-income ratios generates financial fragility which eventually can lead to a financial crisis. Prior to the crisis, increased saving at the top and increased borrowing at the bottom results in consumption inequality increasing significantly less than income inequality. Saving and borrowing patterns of both groups create an increased need for financial services and intermediation. As a consequence the size of the financial sector, as measured by the ratio of banks’ liabilities to GDP, increases. 

Kumhof and Ranciere's paper is chock full of interesting and thought provoking insights into the dynamics of income inequality and the economic fragility it induces, but I want to highlight one particular aspect of it that really crystallized as I read their paper. Our current situation in which 5% of the population captures and owns a disproportionate share of national output, which it then lends to the teeming masses whose share of output has been stagnant or dwindling, is really just a new variant of the company store.

Miners worked in company mines with company tools and equipment, which they were required to lease. The rent for company housing and cost of items from the company store were deducted from their pay. The stores themselves charged over-inflated prices, since there was no alternative for purchasing goods. To ensure that miners spent their wages at the store, coal companies developed their own monetary system. Miners were paid by scrip, in the form of tokens, currency, or credit, which could be used only at the company store. Therefore, even when wages were increased, coal companies simply increased prices at the company store to balance what they lost in pay.

And just in case you're thinking that this doesn't seem too unfair, consider that:

Miners were also denied their proper pay through a system known as cribbing. Workers were paid based on tons of coal mined. Each car brought from the mines supposedly held a specific amount of coal, such as 2,000 pounds. However, cars were altered to hold more coal than the specified amount, so miners would be paid for 2,000 pounds when they actually had brought in 2,500. In addition, workers were docked pay for slate and rock mixed in with the coal. Since docking was a judgment on the part of the checkweighman, miners were frequently cheated.

I first wrote about company stores last summer:

In Kumhof and Ranciere's model, increasing concentration of wealth in a small "investor" class leads to higher demand for investment assets, such as securitized pools of loans made to wage earners who must borrow to maintain consumption as their real income declines. This sets up the same type of dynamic as a company store. Over time and as wage-earner bargaining power weakens, the investor class is able to capture greater proportions of workers' declining or stagnant real wages. The effect is that an increasing portion of middle-class wages circulate back to the financial sector as interest and fees instead of into the larger economy (except, of course, as it occasionally "trickles down" from the investor class to what over time is likely to become the equivalent of a servant class).

"But wait," you say, "surely dollars that go back to investors are then distributed as investment in new, more highly productive capital that generates new jobs?" And so it may, but probably not in this country, at least not right now when we need it most. K and R's model is a closed economy. Ours is not. Investment will seek the highest return that is compatible with risk preferences. Right now that looks to be India and China (see also here).

"Well, how about managing risk?" you say. Yes, that's an important contribution from the financial sector, but recently it looks more like they collude to obscure it, often to their own benefit and at our expense, rather than manage it. And they may knowingly or unknowingly increase it. But, let's get on with the model.

In Kumhof and Ranciere's model, an eventual crisis causes a collapse of asset values, including those that wage earners have been borrowing to finance. The authors show through a series of simulations that only a restoration of wage-earner bargaining power (and therefore an increase in workers' relative incomes) produces the sustained reduction in worker leverage that is necessary to reduce the probability of another crisis.  

But without the prospect of a recovery in the incomes of poor and middle income households over a reasonable time horizon, the inevitable result is that loans keep growing, and therefore so does leverage and the probability of a major crisis that, in the real world, typically also has severe implications for the real economy. More importantly, unless loan defaults in a crisis are extremely large by historical standards, and unless the accompanying real contraction is very small, the effect on leverage and therefore on the probability of a further crisis is quite limited. By contrast, restoration of poor and middle-income households’ bargaining power can be very effective, leading to the prospect of a sustained reduction in leverage that should reduce the probability of a further crisis. [Emphasis added]

Unfortunately, as with most technical models, it does not indicate how the restoration of wage-earner bargaining power will occur, only that it should, if we wish to avoid another financial crisis.

The problem as I see it is that after an economic collapse like the one we just barely dodged (so far), high unemployment will continue to undermine wage earner bargaining power. In addition, it appears that even as corporate profits rebound, hiring has not. If this reflects a new normal, then wage-earner bargaining power is not likely to rise anytime soon. The availability of large supplies of cheap labor in a global economy also does little to strengthen the bargaining power of US workers, particularly those who lack higher education and technical skills that are likely to become the comparative advantage of US labor in the coming years.

The authors conclude that any success in reducing income inequality is likely to reduce the likelihood of future economic collapses. They suggest that taxing economic rents, including land, natural resources, and financial sector rents (profits) would be the least distortionary way to achieve this.

I will suggest, in addition to the above, that improving the financial literacy of the US population so that we all manage what income we have better and borrow more wisely; adopting policies and regulation aimed at aligning financiers' private incentives with objectives that serve the public interest; and strengthening the oversight and regulation of consumer financial products should also help to reduce income inequalities going forward. Increasing educational attainment of younger Americans would also better prepare them to enter and compete at the upper end of the global income distribution.

In fact, any policy that increases the incomes of the bottom 95% relative to the top 5% would be beneficial. For example, Obama's original plan to retain the Bush tax cuts for the bottom 98%, while allowing them to expire for the top 2% of wage earners would have moved us closer to this. A higher estate tax with a lower threshold than $5 million would also serve this goal.

If the model is right (it does seem a rather good fit with reality), all of these measures require that a government constituted to be of, by, and for the people enact policies that support wage earners, that its elected representatives start serving 95% of the people rather than the top 5% that has so effectively commandeered it. It also requires that we the people find ways to become less dependent on a financial sector that no longer serves our best interests. Unfortunately, the last will likely contract an already fragile economy, at least in the short run.

For the last 30 years, the government has been part of the problem in this trend to increasing income inequality. It's time for government to become part of the solution in reining in financial sector excesses and restoring workers to something that approximates a fair share of national output. Otherwise, most of us will eventually find out what its like to "owe our soul to the company store."

Another Conversation about Health Care Costs

I recently had a conversation about rising health care costs with my businessman father. I suspect it typifies how many people think about health care costs and health care markets.

"It's an easy solution that will be difficult to implement," dad said. "We've got to cut labor costs. It's the only way to reduce costs in any business."

It makes sense, doesn't it? Just ratchet down labor costs and we're done. It's the argument I've heard advanced (by dad and some of my older relatives) to oppose minimum wage laws or to oppose unions. If we could just get workers to accept lower wages, we could cure all the evils of commerce practically overnight. Pesky, recalcitrant workers!

How, I asked myself, do I explain health and health care to him? The information asymmetries; the third-party (insurance) payment that insulates purchasers from prices and prices from accurately reflecting resource costs; the agency problems; the pharmaceutical industry that capitalizes on taxpayer financed research and retains the apparently unfailing profits for itself; the other large, wealthy interest groups that work daily to undermine any effort to rein in health care costs...how, I thought, do I make this sector understandable to him?

"Dad," I said, "imagine that you're in a business where the more you sell, the more money you make. Only imagine that you're in a business where the customer believes that you know way more about what she needs than she does. In fact, you do know more than she does. She comes to you and asks your opinion about what you should sell her and what she should buy. And she trusts you to recommend only what she needs, that you will not be influenced by any conflicting incentives you might have to make more money or publish more papers or bring in more research grants.

"Gee, Maxine, that's not much different from my own business. What's your point?" said dad.

"OK. Let's talk about the differences between your business and health care," I said. "Your customers are usually not feeling fear or desperation about their symptoms or their need to make a purchase. In addition, your customers can comparison shop on quality and price all over town and the internet.  If you were a physician or hospital selling medical treatment, your patient won't be able to comparison shop because it's nearly impossible to find out what different providers charge for the same procedure. There's another difference, too. If she's insured, she'll pay out of pocket only a fraction of whatever you charge her. The combination of ignorance about price, quality, and whether or not something is even marginally beneficial to her combined with desperation and someone else picking up most of the tab is a potent demand enhancement mechanism. In the absence of a fee schedule or strong market or moral constraints, you could pretty much charge her whatever you felt like charging. The reasons you wouldn't do that are that there are still some weak market forces constraining you and you are trustworthy and moral and insurers won't pay you any price you like."

"Now imagine that what you as a health care provider sell has been shaped over time to favor curing disease rather than preventing it. The technology you use has been shaped by market forces that favor diagnosis and treatment over prevention. And you're not paid for prevention. You're paid by piece work, so everything you sell, you can bill and get paid for (if she has insurance). If you make a mistake, you don't have to accept returned merchandise and refund the payment. In fact, you may actually get paid more for trying to fix the mistake."

"So, dad, you're operating in a very non-competitive market where you are  better off financially if there are more sick people than well people. Healthy people are not revenue generators for you. Understand, you're not a bad person. You're a product of markets and science that evolved from a mindset that viewed disease, not as the preventable culmination of a lifetime of sometimes bad consumption decisions, but as something outside of our control that happens to us randomly and requires intervention only after the fact. You're also in a world of animal spirits. When people become ill or disabled, they're willing to pay much more in hopes of a cure than they might have been willing to pay to prevent a hypothetical, sometime-in-the-future, episode of the same illness or injury."

"On top of all this, dad, a drug rep shows up every couple of weeks with materials aimed at persuading you to prescribe the most recent, expensive, still-under-patent drugs, rather than older, but nearly as effective and a lot less expensive drugs. Even if you try to prescribe the lower cost, older drugs, your patients have seen the direct-to-consumer ads on television and (praise be to the market) demand that you prescribe the newest, most expensive, still-under-patent,  side-effects-may-include-lymphoma treatment for the most recently medicalized aspect of their lives (yellow toenails being my personal favorite)."

"So, here's the question, dad. What's better for the country, for health care costs and for patients: to reduce the number of sick people, to increase the number of healthy people by preventing disease, reducing injuries and disability, and promoting health (thereby increasing the number of people able to work and enjoy their lives) or to continue with a business model that spends a lot of money on high tech after-the-fact treatments delivered after people become ill or disabled, money that could be spent on other things like education, infrastructure, and just plain old fun?"

"Well, prevention, I guess." he said. "But that's going to put a lot of doctors and hospitals out of business."

"Yes, it will." said I. "That's the whole point, dad. The same market forces that drove you to sell higher quality goods at lower prices are virtually non-existent in health care. Instead health care costs trend higher each year with no guarantee of higher quality. More and more of our resources go to care that could have been prevented or reduced with a little foresight and better access to care. Unfortunately, we're a pretty myopic species and some of that myopia is actually rational. As a result, there are often only weak private incentives to prevent the development of chronic diseases that are among the major cost drivers of 21st century health care. In fact, private incentives to sell "fun foods," like chips and candy for profit, may promote obesity and accompanying chronic diseases, like diabetes.

Medicare is trying to change this by tying its payments to quality indicators that target chronic disease management and by paying for some forms of prevention services and counseling. The recent health reform legislation contains many provisions aimed at reshaping the mix of services provided to favor prevention and chronic disease management, thereby reducing costs of after-the-fact rescue care."

Always a quick study, dad got it.

"So what you're saying, Maxine, is that to reduce health care costs, I would have to run my business in a way that ultimately puts me out of business. If I do a good job of preventing illness and making my customers healthier, they won't come see me as often or buy as much from me. Eventually, I'll have to close my doors or figure out some other way to make money."

"Yes, dad. That's exactly what you would have to do, if you were serious about reducing health care costs. Or you would have to change your business so that you make money from healthy people. Now what market forces would produce that result? (And don't say: convince healthy people that they're in reality sick. The pharmaceutical industry already does that and you see where it's gotten us.)"

I'm still waiting for his answer.

Another Way of Doing Business and Finance

Financier, Halla Tomasdottir, describes an alternative approach to finance, investment, profits, and business. (Here's the link from TED Talks, if the video below doesn't work: http://www.ted.com/talks/view/id/1030)

 

I think she might be on to something. Let's try it her way for a while.

Addendum: A female friend and corporate executive points out that Tomasdottir's approach isn't a "feminine approach." It's a "decent person" approach. I have to agree. It's an approach my father, uncles, and grandfather would have agreed with.

Bang per (Borrowed) Stimulus Buck

From James Galbraith, writing in Mother Jones in 2008, we have this chart from Mark Zandi, chief economist for Moody’s Analytics (ht rjs), depicting estimated stimulus bang per buck based on how the buck is spent:

Where is infrastructure and human capital investment in the current bargain struck between President Obama and Congressional Republicans and why are tax cuts that are net negative the centerpiece of the Republicans' demands?

Nick Krafft at Open Economics sends us to Ed Fullbrook where I deduce one possible answer. Here's an excerpt from a Citigroup report on plutonomy that is no longer available on line (quelle surprise!):

Back in October, we coined the term ‘Plutonomy’ (The Global Investigator, Plutonomy: Buying Luxury, Explaining Global Imbalances, October 14 2005). Our thesis is that the rich are the dominant drivers of demand in many economies around the world (the US, UK, Canada and Australia). These economies have seen the rich take an increasing share of income and wealth over the last 20 years, to the extent that the rich now dominate income, wealth and spending in these countries. Asset booms, a rising profit share and favourable treatment by market-friendly governments have allowed the rich to prosper and become a greater share of the economy in the plutonomy countries...Indeed, David Gordon and Ian Dew-Becker of the NBER demonstrate that the top 10%, particularly the top 1% of the US – the plutonomists in our parlance – have benefited disproportionately from the recent productivity surge in the US.

So the rich are calling the shots. No surprise there. But the above was written in 2006. The "productivity surge" it's referring to is the sub-prime mortgage debacle and the derivatives-based house of cards that put us in this hole and that the financial sector continues to erect:

Global derivatives trading in over- the-counter and exchange-traded futures and options will represent a $700 trillion market with $3.7 quadrillion in annual turnover by the end of this year, research company TABB Group said.

Rules to have central clearing for over-the-counter trading would require additional collateral of as much as $2.2 trillion, Westborough, Massachusetts-based TABB said in a statement on its website, citing a report it completed at the request of the World Federation of Exchanges.

As a reference point, US GDP in 2009 was around $14-15 trillion.

So here's the question my mundane, raised-in-Appalachia, offspring-of-simple-business-men-and-women, forget-the-PhD-in-economics brain keeps asking: What does the financial sector produce, besides economic chaos? Where's the benefit for most of us or for most of the US? And if the financial sector isn't going to provide the service of deploying capital to support investments that benefit the rest of us, who will?

In an ideal world, the US government would. In an ideal world, where most of the populace who would benefit from such investment do not respond to the dog-whistle term "socialist" by forming political groups funded by plutonomists to protect plutonomists, US taxpayer dollars would support investment in infrastructure and human capital that would prepare us all, not just the top 1%, to be productive participants in a 21st century global economy. Instead, our tax dollars have been deployed to no-pain, no-downside bailouts of guys who turned around and awarded themselves bonuses for running us into the ditch. Now, finance and US politics seem committed to sustaining and feeding a casino and fostering an increasingly unstable and unfair plutonomy, instead of rebuilding a nation dominated by a productive, hard-working, ambitious middle class.

This is the most unsatisfying morality play I have ever watched.

Best Thing on Simpson-Bowles I've Read

Michael Hudson at Credit Writedowns asks:

What would Adam Smith have said about the Bowles-Simpson economic report last week?

And then he answers.

Read it all at: http://www.creditwritedowns.com/2010/12/americas-neofeudal-economy.html