States and Markets

Sociology 2, Class 4

Copyright © 2013 by Evan SchoferDo not copy or distribute without

permission

Announcements• No discussion sections on Monday

January 21 due to holiday• Today:

• Lecture: States & Markets – basic concepts & definitions

• Next week:• Economic globalization• Multinational corporations

Review: State Control vs. “Free Markets”

• BIG debate over the last century: How much should states control (“regulate”) markets?State Control Free Markets

RegulationCentral Planning“Public” Services

Deregulation“Liberalization”Privatization

Commanding Heights: Keynes Hayek

Reich: Democratic Capitalism Supercapitalism Friedman: Golden Straightjacket

Video: Commanding Heights

• Wrapup: Deregulation, rise of free market

• Airline deregulation (late 1970s): - 1:25:20-1:28:15.

• Shift from Keynes to Free Markets: 1:32:15 – 1:40:30

– Reagan/Thatcher revolution

• Watch the entire end of Episode I online:• http://www.pbs.org/wgbh/commandingheights/

Airline Deregulation• The airline industry exemplifies the good

and bad of both regulation and deregulation– Deregulation in 1930s: Industry growth but

instability, bankruptcies– Regulation in the 60s: Industry stability, but

high prices– Deregulation in the 1970/80s: Industry

growth• Lower consumer prices; increased choice• Overall industry growth (more employment)• But, will instability return?

Airline Bankruptcies 2001-10

Airline Bankruptcies• Issues to reflect on:

– Why did deregulation/competition led to bankruptcies?

– Was deregulation worth it?• It produced 30 years of cheap flights

– improved competition; better “service”– stockholders & executives made millions

• But, now we have a “bust”… – Workers feel pain – lost jobs and reduced wages– Government bailed out airlines after 9/11– Government bailed out many airline pension plans; etc.

– Would more regulation have helped?

Econ Basics: Definitions• Gross Domestic Product (GDP)

• “gross” means “total”

– Definition: The total economic value of goods & services produced within a country• Note: GDP is often measured “per capita,” which

gives a sense of production per person

• GDP in 2011 (World Bank Data):– United States: $15,230,000,000,000 –

trillions!• $48,400 per capita

– Brazil: $2.43 trillion, $12,600 per cap– Liberia: 1.04 billion, $281 per capita.

Econ Basics: Definitions• Economic Growth: An increase in GDP

• Growth means: more production, more profits, more wealth, more jobs, more income, more consumption, more everything!

• Most people think growth is good– But, we’ll discuss some critics who argue otherwise

• Recession: A period of decline in GDP• Fewer jobs, less consumption, etc…

• Depression: A period of severe and protracted decline in GDP

• Mass unemployment, poverty, hunger; political unrest.

Econ Basics: Growth• Why do economies grow?• Long term growth comes from:

– New technologies• Ex: Machines allow people to produce more goods

– Increased skills and efficiency of labor force• Ex: Highly educated workers can get more done

– Investment• Ex: Money spent to build more factories

• Short term growth can be sped up by:– Greater consumption by people, firms, states

• Spending $$ creates demand, speeds up economy.

GDP = Prosperity?• Question: What is the relationship between

GDP growth and prosperity?• Does increased production = make us “better off”?

– Greater GDP = more ipads, new cars, bigger/nicer houses, more health care services…• People usually think that’s good…

– But, it isn’t always that simple…• Ex: A lot of recent economic growth in the United

States has gone to a small number of wealthy people– Benefits are not necessarily widespread

• Beyond a certain point, increased consumption doesn’t necessarily make people more happy/healthy.

GDP = Prosperity?• Despite its faults, GDP is still used as a

crude measure of prosperity– Political conservatives typically argue that

growth is the best route to prosperity• In the long run, the poor are better off in a fast

growing economy, even if the rich get most of the reward

• Imagery: Rather than divide the “pie” evenly, the pie needs to grow so everyone’s piece gets bigger…

– Political liberals also want growth, but have also stressed the importance of social equality• Plus, other concerns like environmental protection.

Econ Basics: Business Cycles• Issue: Economic growth isn’t always

smooth• Capitalist economies are prone to cycles of

“boom” and “bust” – the “business cycle”– In good times, everyone gets optimistic, builds

a lot of factories… economy and jobs boom• Unemployment falls; wages and prices go up

– Eventually economic capacity becomes too great• More is produced than people are willing to buy• Firms have layoffs or go bankrupt, unemployment

goes up, prices go down.

Econ Basics: Business Cycles• Issue: If unemployment goes too high

then consumption drops• Without consumer spending, economy can go

into a deflationary spiral…• Ex: The Great Depression…

• In general, governments use policies to avoid extreme cycles

• Example: Unemployment insurance– Provides money to the unemployed to avoid a

downward spiral

• Example: Setting interest rates– We’ll discuss this later.

US GDP Growth 1980-2012

States and Markets

• Question: Can markets exist without states?

• Answer: No! (at least not on a large scale)

• Capitalism requires:• Private property – protected by laws, police,

courts• Legal systems – to enforce private property,

contracts• Infrastructure – roads, ports, etc…• National defense• Regulation of markets

– People greatly disagree about how much… – But most favor some degree of regulation to prevent

monopolies, fraud, etc…

States and Markets

• Question: Why do states try to affect markets?

• 1. To improve how markets function• Prevent fraud, monopolies, etc• Encourage growth• To “smooth out” the business cycle

• 2. To reshape society– E.g., via incentives or government spending

• Change distribution of wealth• Reduce environmental degradation, reduce

discrimination, improve medical care, etc…• To achieve things that markets don’t always do by

themselves: “collective goods”.

States and Markets

• Question: How can states affect markets?– 1. Fiscal policy – taxes and spending– 2. Monetary (money) policy – printing &

lending money– 3. Laws and Regulations– 4. Direct ownership of production

• I’ll discuss examples of each…

Fiscal Policy: Basics

• Fiscal Policy: State policy regarding taxation, public revenue, or public debt– Revenue: Money the government takes in

• Taxes generate revenue for the state•Revenue (together with borrowed money)

allow states to spend money

– Spending: Money the government spends• Allows the state to build infrastructure, provide

services, have a military, etc

Fiscal Policy: Basics

• What does the US gov’t spend money on?– The 3 biggest budget items are:

• Helping elderly and sick: Social security, medicare, medicaid

• The Military• “Debt service”: Paying back money that the

government borrowed in the past

– Remark: Many politicians say they will shrink government & cut taxes…• But, once elected they rarely do. Why?• Answer: Biggest budget items are all popular…

– Cutting other programs won’t make a dent in debt.

US Gov’t Spending as % of GDP

Fiscal Policy: Taxes

• Milton Freedman (economist): “To spend is to tax”

• If a government spends, it must tax to pay for it• Either tax now, or borrow money now and tax

later…

• What does the government tax?• Income (individual and/or corporate)• Transactions (sales tax, taxes on trade)• Property owners• Activities that require fees (e.g., driving,

fishing, etc).

Fiscal Policy: Tax Rates• How high should taxes be?

– Higher taxes allow more government services• Better schools, healthcare, roads, military• And greater possibility for redistribution: the welfare

state

– Low taxes can spur more investment…• Investment generates economic growth, makes us

richer• Companies are likely to build factories in places with

low taxes– Ex: The “golden straightjacket”…

– The United States is on the “low taxes”/low spending side of the spectrum

– Compared to other industrialized countries– US corporate taxes are high “on paper”, but with many

loopholes, so actual taxes paid are pretty low.

Fiscal Policy: Definitions

• Budget surpluses occur when the government spends less than it takes in

• Budget deficits occur when the government spends more than it earns in taxes in a year

• The government can do this by borrowing money…• Result: the national debt increases

• National debt: the amount the US owes• Current national debt: $16,400,000,000,000• Around $52,000 per person.

US Budget Deficit

Fiscal Policy: Spending

• Government spending can “jump-start” the economy

• Keynes: “Government should spent against the wind” • Example: “New Deal” spending, war spending helped

create jobs and economic growth in the depression

• But, consistent high government spending can harm economic growth

• High deficits, debt can lead to inflation– Example: “stagflation” in 1970s

• Extremely high debt can cause a “debt crisis”– Costs of borrowing go way up… countries can even go

bankrupt!

Fiscal Policy: Stimulus• How does the government “boost” the

economy?– Answer: by increasing “consumption”…

• Either by spending money itself, or by reducing taxes in ways that cause others to spend

• As govt’s or people start to spend, there is more demand for goods and services…

– Companies make profits and hire more workers– Economic growth accelerates.

Example: The “Stimulus Bill”

• The “stimulus bill” is an example of fiscal policy

• “American Recovery and Reinvestment Act of 2009” • Provided tax cuts and spending with the goal of

speeding up the economy during a recession

– Stated goals:• Reduce unemployment• Increase economic growth

– Main Provisions:• 288 billion in tax cuts to individuals and businesses• 224 billion in additional funding for education, health

care & entitlement programs– Extending unemployment benefits, aid to schools, etc

• 275 billion for federal contracts, grants, loans– Build roads, renewable energy, weatherizing homes, etc.

Effects of Stimulus: Multipliers• How much does each dollar of stimulus

increase the GDP?• Answer: It depends on where the money

goes• Stimulus has no effect if the recipient doesn’t

spend it• Stimulus can have a large effect if the recipient

spends it in a way that starts a “chain reaction”– Ex: An infrastructure project: Gov’t gives it to a road

building company, company gives it to a worker, worker buys food, grocery store owner expands business… etc

• The size of the effect is called a “multiplier”– Ex: A multiplier of 1.5 means that each dollar of stimulus

generates 1.5 dollars of GDP.

Effects of Stimulus: Multipliers

• Multiplier estimates from the Congressional Budget Office (CBO), March 2009

Type of Spending Estimated Multiplier

Infrastructure projects 1 - 2.5

Transfers to people (ex: unemployment insurance)

.8 - 2.2

Tax cuts for wealthy .1 - .5

Impact of US Fiscal Policy on GDP

Source: Goldman Sachs, via Krugman NYT Blog

US fiscal policy has large

positive impact on GDP from mid-2009 to mid-2010.

US spending peters out after

that…

The Stimulus Bill: Debates• Current debate:

– Democrats / Keynesians: Stimulus bill was a good idea… increases growth & employment• Benefits outweigh the debt that is incurred• In fact, some economists argue that we need a second

round of stimulus…– Ex: Week 1 reading: “Keynes Was Right”

– Republicans / free market economists: Stimulus bill was a bad idea: causes too much debt

– Could cause inflation and inhibit long term growth

• Conservatives more concerned about debt and inflation– We need “austerity” – reduce debt and economy will rebound– Ex: Week 1 reading: “Keynes Can’t Help Us Now”

Keynes vs. Hayek Video• An amusing summary of the case

for/against using government stimulus to aid the economy during a recession/depression

• Video\Keynes Hayek Video.flv

The Stimulus Bill: Evidence

• So, who was right? Was the stimulus bill good or bad?– 1. Evidence suggests that the stimulus bill

did help the economy• Unemployment & growth would’ve been worse

without it

– Related issue: Countries that pursued “austerity” instead of stimulus have not done especially well

– Indeed, recent S&P report suggests austerity has in some cases been self-defeating

– Austerity harmed growth, reduced tax revenues– Result was increasing (not decreasing) debt…– http://www.standardandpoors.com/ratings/articles/en/us/

?articleType=HTML&assetID=1245327305715

The Stimulus Bill: Evidence

• Was the stimulus bill good or bad? (cont’d)– 2. Predictions made by critics of the stimulus

bill haven’t proved correct (so far)• No sign of rampant inflation. Indeed, inflation is

very low• Stimulus isn’t main source of US debt

– Much debt came from 2001 tax cuts, cost of wars, etc.– And, debt main source of long-term debt problems is

healthcare costs, not stimulus spending.

– Conclusion: Stimulus basically worked• And a larger stimulus bill would’ve further reduced

unemployment.

Monetary Policy

• The government also acts as a bank:• The “Federal Reserve Bank” was set up

by the government to store a reserve of money

– Operates independently of political control

• Called “The Fed”– Other countries have them, too

• General term: “central bank”

– The Fed lends money to other banks• Who in turn, lend to people and companies

Monetary Policy

• The “Fed” uses its pool of money to:– 1. Prevent financial disasters

• Example: The “run” on banks in the Great Depression

– Banks collapsed and government didn’t help out

• Example: In 2008 banks collapsed and the government aggressively stepped in

– Including TARP

– 2. To adjust the economy• Prevent boom/bust cycles, keep inflation low• It does this by setting interest rates

– And, recently, by intervening directly (buying or selling things).

The Fed and Interest Rates

• What are interest rates & why do they matter?

• Interest rates are like rates on a credit card, car loan, or student loan

• If rates are high, you will buy or spend less– Because you’ll have to pay a LOT of interest later…

• If rates are low, you can buy more now

• The Fed chooses the interest rate it will charge to lend money

• The Fed is so big that other banks follow its rates• Thus, the Fed effectively sets rates for the whole

economy.

Monetary Policy

• The impact of the “Fed’s” rate policies:• Low rates stimulate the economy

• Also called “expansionary” or “loose” monetary policy

• Encourages people to spend, companies to invest• Downside: higher inflation

• High rates slow the economy– And, can be used to reduce inflation

• “Tight”, “contractionary,” or “conservative” monetary policy

• High interest payments mean that businesses and people are less likely to borrow, spend, invest.

US Interest Rates 2000-2011

Rates lowered during recession following dot-com

crash and 9/11

Rates drop to zero in current

recession

The “Lower Bound” Problem

• Issue: What if you want to speed up the economy more, but you’ve already lowered interest rates to zero?– Answer: You’re stuck in a “liquidity trap”

• Traditional monetary policy loses effectiveness in extreme economic conditions

» See Krugman book: “The Return of Depression Economics”

• Japan in the 1990s – the “lost decade”• But, the Fed tries ‘non-traditional’ strategies

– Ex: “Quantitative easing” (buy assets; put money into economy)

– Implication: Fiscal stimulus is the main strategy to deal with the current recession.

Laws and Regulations

• States affect markets by imposing laws and regulations of many kinds– Competitiveness laws: prevent monopolies

or limit what monopolies can charge• Ex: Prevent price gouging

– Consumer protection laws• Ex: FDA prevents sale of tainted meat

– Laws regulating markets• Protect against fraud, volatility

– Regulating particular industries• Prices, access to markets, etc.

Laws and Regulations

• States affect markets by imposing laws and regulations of many kinds

• Example: Airlines– 1. States impose safety regulations on

airlines• Ex: Federal Aviation Administration (FAA) inspects

planes, requires airlines to do regular maintenance• Why bother? Companies have a market incentive

to avoid crashes, which are costly…– Planes destroyed, reputation damaged… which harms

future sales

• Are market incentives enough to make you trust airlines?

Laws and Regulations

• Example: Airlines– 2. States regulated airline prices to reduce

competition• Created industry stability, at the cost of

competition• But, those regulations were ended in the 1970s

– Note the trade-off: stability vs. efficiency• Ex: Regulation stabilized airlines, but reduced

competition; deregulation had the opposite effect.

Laws and Regulations

• States affect markets by imposing laws and regulations of many kinds

• Example: Subsidies to agriculture• US gives tens of billions a year to farmers

– Keeps industry stable – fewer bankruptcies• US farmers don’t have to be as efficient

– Issue for future discussion: This harms farmers in poor countries…

Laws and Regulations• Governments regulate banks to protect

consumers– Generally, limiting the risks banks can take with your

money…

• Ex: FDIC – government guaranty that your money is safe in a savings account (up to 250K per bank)

– Banks are forced to pay money for such insurance; they’d rather not

• Ex: Reserve requirements – Banks must keep some money on hand, just in case of crisis

– They’d rather not do this… because they could make more $ otherwise

• Ex: Limits on “leverage” – risky investments– Banks can make more profits if they take more risks…

but they might go bankrupt!

Regulating Wages and Prices

• Example: The federal gov’t minimum wage– The Fair Labor Standards Act (FLSA) of

1938 established minimum wage, overtime pay, recordkeeping, and child labor standards affecting full-time and part-time workers in the private sector and in Federal, State, and local governments. • Covered workers are entitled to a minimum

wage of not less than $7.25 an hour.– Source: http://www.dol.gov/esa/whd/flsa/

• Note: California has another minimum wage law, raising the minimum to $8.00.

Regulating Wages and Prices

• The minimum wage also reflects a trade off• Minimum wage laws are a big benefit to workers• But, the US economy would be more “competitive” if

corporations could pay workers less• The fact that wages in China are under $1 / hour

means that US companies are less competitive

• Questions to ponder:• What might happen of wages were “deregulated”?• What if the minimum wage was increased to

$20/hr?

State Ownership• Governments can own factories, railroads,

electric power plants, etc. – or anything else.

• Nationalized or “state-run” industry: a business or industry that is run by the state– Definition: “Nationalization” is when the

government takes over formerly private companies or industries• Example: airport security screeners after 9/11

– Definition: Privatization: when a government-run business is sold to private owners• Examples: many prisons, even some schools• Heavy industries in Britain & Russia (historically).

State Ownership• Advantages of state-run industries:

– Highly stable – no bankruptcies• Tax money can keep them afloat in hard times

– Works in collective interests (usually)• Not driven by greed; nicer to workers (usually)• Won’t try to co-opt the state: Bribes/lobbying…

– Greater accountability (sometimes)• Government organizations are often subject to

greater scrutiny and accountability, compared to private firms

– Ex: monitoring by government accounting offices; FOI Act

• Private firms that do terrible things usually just go bankrupt and leave others to clean up the mess

– Ex: Mining companies that damaged the environment.

State Ownership• Disadvantages of state ownership

– Little or no competition: • Less pressure to be efficient or innovate• Though, some are quite efficient

– Ex: Social security vs. private savings funds– Ex: State-run health systems vs US system of private

insurers

• Also, even private firms are may avoid competition– E.g., by lobbying the state for subsidies; corporate

welfare– Often, lobbying is cheaper than innovating!

– State firms can become corrupt or under influence of government elites…• Ex: Oil companies in Nigeria and Russia

– Some have stolen the oil wealth of entire nations…

Keynesianism vs. Free Markets• The Keynesian state:

– Fiscal Policies: Higher taxes, higher spending• To support health care, welfare, keep full

employment

– Monetary policy: Expansionary (low interest rates)• Low interest rates keeps unemployment low

– But, inflation & debt tends to be higher

– Regulation: Expanded, elaborate• Industries and markets are stabilized, controlled

– Ownership: Many industries are nationalized• “Private sector” is smaller.

Keynesianism vs. Free Markets• The Free Market state:

• States that put on the “Golden Straightjacket”

– Fiscal Policies: Low taxes, low spending• Corporations & international investors are attracted

by low taxes

– Monetary policy: Conservative (high interest rates)• High interest rates keep inflation low

– As a consequence, unemployment is higher

– Regulation: Minimal• Companies are free to do as they please

– Ownership: Privatized• The state doesn’t own industries; it is all “private”.

The Credit Crisis of 2008-9• A story of banks evading state regulation…• Reading: Krugman: “Partying Like its 1929”

– Banks were heavily regulated since 1930s, but didn’t like it• Banks began to circumvent regulation: a “shadow”

banking system• Banks took greater and greater risks… and made

billions of dollars of profits for years

– Decline of real estate market in 2007-8 caused risky investments to lose HUGE amounts of money

– Banks began to go bankrupt; bank runs began– Without government intervention, many major banks would

have gone out of business…– Businesses need bank loans; the effect would have been

horrific.

Credit Crisis Video• The Credit Crisis Visualized

• Jonathan Jarvis• Direct video link: http://crisisofcredit.com/• Local link:

Responses to the Credit Crisis

• What could the government do?• Many big banks owed lots more than they could pay

• 1. Do nothing… No government intervention

• Banks were reckless, let them fail• A “free market” solution…

– Benefit: cheap, easy– Problem: This would make the economy worse

• The entire economy needs functioning banks• Businesses depend heavily on loans to operate…

without access to cash, MANY would go bankrupt• A major collapse would almost certainly cause a

depression: mass bankruptcy and unemployment.

Responses to the Credit Crisis

• What could the government do?• 2. Nationalize the banks – take them

over• Run them for a while and then re-sell to private

owners• Sweden did that in the 1990s…

– Benefits:• Quickly restores banking system• Allows government to fire the bankers that caused

the problems

– Problems:• Politically unpopular

– Seen as “socialist” or “communist”.

Responses to the Credit Crisis

• What could the government do?• 3. “Recapitalize” the banks

• Give them a ton of money to weather the crisis

– Benefits:• Keeps the banks going, averts disaster

– Costs:• Rewards people who caused the crisis

– Lets them pay themselves big bonuses

• No control: banks may choose to not loan money• Can lead to “zombie banks” (Japan in 1990s)

– Banks are kept alive, but not really functioning

• President Bush chose this option…

Democrats, Republicans, Markets

• Democrats have been historically more “Keynesian”, republicans more “free market”

• But, everyone has shifted more toward free markets

– Also, there are some exceptions• Democrats supported many free-market policies

– Ex: Carter (D) oversaw the start of deregulation– Clinton signed NAFTA (a free-market trade treaty)– Obama’s health plan involves relatively little gov’t control

» Similar to republican proposals in the past

• Republicans don’t always follow conservative policy– Ex: Nixon (R) instituted wage and price controls.– Despite goal of “low government spending”, Reagan & Bush

1 & 2 created huge budget deficits and hugely increased the national debt.

States, Markets, Globalization

• Since around 1980 governments have shifted

• Away from Keynesian / Welfare-state systems• Toward free market capitalism

• This has implications for globalization– State-run industries limit global trade

• And limit the expansion of multi-national corporations

– High taxes (including on trade) limit global trade– High regulation limits trade & foreign investment– Many regulations limited trade, foreign

investment• Etc. etc. etc.

• In sum: Shift toward free markets removed obstacles to economic globalization…

Economic Globalization

• Important economic changes:• 1. Growth of international trade• 2. Increase of Foreign Direct Investment

• Ex: building factories in another country

• 3. Increased international capital mobility• Movement of money across national borders

• 4. Growth of multi-national corporations• Each has an effect on the ability of states

to control their economies.

States, Markets, Globalization

• Issue: Economic globalization puts further pressure on governments... To be pro-market

• Globalization reinforces pressures away from Keynesian policies and toward even freer markets…

– Where do companies build new factories?• In a high-tax country with lots of regulations?• Or in a free-market country with low taxes?• If states want to attract investment, they are

compelled to move toward free-market policies

– Ex: Thomas Friedman: The Golden Straitjacket• The “electronic herd” – Global investors that look

around the world for places to invest money• They force countries to “tighten the straightjacket” of

free market policies…

Economic Globalization

• Globalization has strong implications for the ability of states to control markets

• For instance:• Globalization reduces states options for fiscal

policy• Globalization reduces effectiveness of

monetary policy• Globalization harms economies that try to

regulate or nationalize industry

– We’ll discuss this more in coming weeks…

US Budget Deficit Trends