On Regulatory Capture: Prof. Johnson says he is a follower of George Stigler, who made the point that when you regulate industry, industry will attempt to capture the regulators. Bankers are able to capture the regulation and get themselves huge commissions to take on risk. We witnessed one of the most sophisticated episodes of regulatory capture in the history of humankind.
On who benefitted: The benefit of this kind of rent-seeking accrues to executives in the bank – and not to shareholders.
Following a couple of articles last week on how economists don’t do the “Big Think” anymore, NPR offers us up some stories on “thinkers who have had a lasting influence on economic policymakers.”
Who are these thinkers, you ask? Well, first up is Ayn Rand, the notable “objectivist” author of the classics The Fountainhead and Atlas Shrugged. Probably wouldn’t have been my first choice as a big economic thinker, but she is certainly still making headlines. Ouch.
The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.
This fall, Professor Galambos and I will be leading a group read of F.A. Hayek’s The Road to Serfdom. The course will be offered for one unit as DS 391 — On the Road with Hayek, and we will have a sign up and coordinate times at the beginning of fall term. I expect with this book we will probably meet eight of the ten weeks.
Felix Salmon, citing a WSJ piece, reflects upon the very large taters being made by the financial sector. Without some frame of reference, it is hard to know what to make of the financial sector banking 35% of all of US profits. So, for some perspective check out Simon Johnson in his Atlantic Monthly piece:
From 1973 to 1985, the financial sector never earned more than 16 percent of domestic corporate profits. In 1986, that figure reached 19 percent. In the 1990s, it oscillated between 21 percent and 30 percent, higher than it had ever been in the postwar period. This decade, it reached 41 percent. Pay rose just as dramatically. From 1948 to 1982, average compensation in the financial sector ranged between 99 percent and 108 percent of the average for all domestic private industries. From 1983, it shot upward, reaching 181 percent in 2007
I was discussing an opportunity to attend a financial markets seminar with one of my colleagues, and he correctly pointed out that financial regulations are something I really don’t think about that much. Yet, as time marches on, this seems like a very interesting place to be looking. Let’s take a peek.
First, there’s Richard Sylla’s review of Rajan and Zingales Saving Capitalism from the Capitalists. In his review, Sylla provocatively compares Rajan and Zingales to Joseph Schumpeter in their roles as prognosticators of the future of capitalism.
What is the nature of the threat to capitalism? Rajan and Zingales argue that it arises from within the heart of the system, not from limousine liberals, social critics, reformers, and disadvantaged groups on capitalism’s fringes. Established enterprises, the “incumbents,” constantly seek to co-opt the political system and use it to stifle entry to industry, access to financial services, and competitive markets in order to protect their privileged positions and profits. “Capitalism’s biggest political enemies are not the firebrand trade unionists spewing vitriol against the system but the executives in pin-striped suits extolling the virtues of competitive markets with every breath while attempting to extinguish them with every action.” (Sylla, p. 392 citing Rajan & Zingales, p. 276).
I had seen this type of “regulatory capture” argument before, notably from Simon Johnson’s piece that I assign to my regulation class, but I was surprised to see it from the relatively more pro-market Rajan & Zingales.
But they aren’t the only ones. In “The Inequality that Matters,” libertarian Tyler Cowen looks at the role of the financial sector in increasing income inequality, and comes to this rather unsettling conclusion:
For the time being, we need to accept the possibility that the financial sector has learned how to game the American (and UK-based) system of state capitalism. It’s no longer obvious that the system is stable at a macro level, and extreme income inequality at the top has been one result of that imbalance. Income inequality is a symptom, however, rather than a cause of the real problem. The root cause of income inequality, viewed in the most general terms, is extreme human ingenuity, albeit of a perverse kind. That is why it is so hard to control.
One thing about capitalism that’s pretty certain is that it’s changing. Capitalism a hundred years ago looked very different from capitalism today, and capitalism looks different in different countries. The field of comparative economic systems was born out of the socialism vs. capitalism debate, and, for that reason, those of us interested in that field should be thankful for that debate. At the same time, the socialism vs. capitalism debate has done and is doing much harm to intelligent discussion of economic systems. Those of us reading Capitalism, Socialism and Democracy this term know that Schumpeter thought socialism could follow capitalism naturally, in Marxian fashion, but it really wouldn’t look very different from the super-big-business capitalism that would exist at that time.
Today’s OnPoint on NPR featured two distinguished guests who were discussing the future of capitalism. Business guru and Harvard professor Michael Porter (remember the 5-forces analysis?) talked about his recent article in the Harvard Business Review on the new capitalism, based on Shared Value, in which firms recognize that the way to be truly profitable is to align their goals with societies and to do good while doing well. But not in that outdated Corporate Social Responsibility (CSR) way, relegating to a CSR department the task of undoing the harm done by the core business, but by integrating the doing good part into the core business mission. Porter argued that the best companies are doing this already, and that capitalism will be made better not through more regulation and more government, but, au contraire, by businesses moving to the “shared value” model.
Robert Reich, author of Supercapitalism, was the other guest, and he was not buying any of that feel-good talk. He couldn’t help but remember the many examples he personally saw of companies investing a lot into what was clearly bad for society but good for profit. His book on the future of capitalism, Supercapitalism, agrees with Porter in finding the CSR model wanting, but thinks that the future lies in separating capitalism from democracy as much as possible. These were questions Schumpeter struggled with in his book. It is easy (apparently, for some) to dismiss those musings from 1942 as idle speculation, but these contemporary contributions and debates remind us that we still know little about how economic and political systems work, that knowing more would still be extremely important, and that capitalism is changing in perhaps fundamental ways even as we continue to talk about a model of a market economy that never really existed. Porter’s view seems to be going in the direction of moving government and business closer to each other. Reich thinks the way to progress is through separating those two as much as possible.
Although we economists tend to be a “size of the pie” crowd, the subject of the causes and consequences of income and wealth inequality does not completely escape our notice. Certainly, this has large political and policy implications, especially as inequality and political polarization seem to be proceeding in lockstep.
A recent EconTalk has John Quiggin, left-of-center author of Zombie Economics, discussing ideas with Russ Roberts, moderator and pro-market guy. Quiggin names his book such because he asserts that there are many economists clinging to ideas that have been thoroughly thrashed and should be discarded, yet they continue to emerge and thrive. Foreign Policy has a summary of Quiggin’s five most egregious “undead” ideas:
The Great Moderation: the idea that the period beginning in 1985 was one of unparalleled macroeconomic stability that could be expected to endure indefinitely.
The Efficient Markets Hypothesis: the idea that the prices generated by financial markets represent the best possible estimate of the value of any investment. (In the version most relevant to public policy, the efficient markets hypothesis states that it is impossible to outperform market valuations on the basis of any public information.)
Dynamic Stochastic General Equilibrium (DSGE): the idea that macroeconomic analysis should not be concerned with observable realities like booms and slumps, but with the theoretical consequences of optimizing behavior by perfectly rational (or almost perfectly rational) consumers, firms, and workers.
The Trickle-Down Hypothesis: the idea that policies that benefit the wealthy will ultimately help everybody.
Privatization: the idea that nearly any function now undertaken by government could be done better by private firms.
Roberts certainly doesn’t agree with Quiggin’s overall assessment, though they do find much to agree on. This is a great EconTalk for those who think that economists all drink from the same cup.
Econ 300 students might listen to the part about the Efficient Markets Hypothesis and compare it to what Landsburg says in Chapter 9.
We bought Toxie for $1,000 earlier this year. Every month, we get a check. It’s a small piece of the payments people are making on their mortgages. And every month, more houses get foreclosed on and sold off by the bank. When enough houses get sold off by the bank, Toxie will be dead.
She’s not dead yet — but things are looking grim. Last month, we got $72.41; so far, we’ve received a total of $449. This month, our payment was zero dollars and zero cents. We could still get another payment next month — maybe.
Well, it looks as she’s pretty much dead now, and as the value of the “Toxie” is converging to the paper it’s printed on. So, in a final hurrah, NPR gives us some back story from before Toxie was toxic. This in includes a rather spectacular aerial photo of a neighborhood that was planned but never developed.
The Toxie Cam was part of an NPR series that seems pretty engaging. Certainly not the worst thing you’ll read about the financial crisis.