Who’s specifically to blame for the economic situation we find ourselves in leading up to the $700B Federal bailout bill that is just about to be signed into law?

Assuming you have read my previous post (“U.S. Financial Crisis! What Is Really Happening?”) on this topic posted last week on this blog site, a related and logical question might be who is most to blame for the unfortunate economic situation we find ourselves in?

As you can imagine, there is plenty of blame to go around! Republicans are blaming Democrats and Democrats are blaming Republicans. Many are blaming household decision makers, greedy executives, and bank regulators “asleep at the switch”. In short, everyone is blaming everyone except for themselves. I have yet to see one person blame themselves, their agency, or their companies!

I see the answers to the “who is to blame” question as a 6-point answer. Keep in mind that these 6 reasons are strictly my opinions and many would either disagree or add to the list:

1. Imprecise regulatory law allowed the financial institutions to carry too high a ratio of mortgage-backed securities to collateralized debt.
2. Banking regulators (Banking Committee, FED, Regulators, etc.) should have screamed louder earlier! Although there are many documented attempts from specific people that did warn of this problem it was more a whisper than a scream.
3. Private lenders (and their CEOs) got greedy either lowering or violating their own lending standards in hopes of making more interest income by loaning to people who were very risk bets.
4. New law had been passed several years ago, urging that Fannie Mae and Freddie Mac make more loans to lower income households that carried much more risk.
5. Households borrowed more than they could afford. Citizens that borrowed need to share the blame with lenders, although I place lenders at a higher standard than borrowers.
6. New accounting regulations under Sarbanes Oxley (regulation passed after Enron) are too conservative causing assets like mortgage-related securities to be valued less than their economic value (true worth), which caused the bank debtor run on the bank.

Yes, there is a lot of blame to go around on this one! If there is any good news it is the hope that new regulation and oversight will occur in our “mixed” economy to help prevent this from ever happening again. Of course, there will be many other “next problems” but, hopefully, we will learn from our mistakes!

Discussion questions:

1. Who do you believe is most to blame for the circumstances leading up to this bailout?
2. Have you remained unbiased in learning that this issue is neither solely a Republican nor a Democratic issue?
3. Which presidential candidate gave you the most comfort as to how he explained his views on the bailout?

Thanks to my friend Jerry from Shanghai for posting this cartoon to his Facebook profile!

How timely, just as my year 2 IB Economics class is studying the pitfalls of expansionary fiscal policy in times of economic slowdowns. Now, many critics would say that Clinton was the luckiest president of recent decades as he happened to ride a wave of technological innovation fueled by the internet that led to unprecedented grown in income and tax revenue during the 1990s. Sustained 5% growth combined with a period of relative peace on the foreign fronts in between the two Gulf Wars allowed Clinton to balance the budget and begin putting a dent in the country’s $3 trillion deficit during his final years in office.

Along come the “fiscally conservative” Republicans and their faithful leader GWB, just in time to evaporate our budget surplus and add $6 trillion to our national debt over the next eight years. Today, after a long period of “fiscal conservatism” the debt stands at $9.3 trillion, and last year’s budget deficit of $400+ billion broke a record for the largest gap between tax revenue and government spending in US history.

Yeah, you can blame it one the times: a War on Terror costing the US roughly a billion bucks a day, a slowdown in new technology creation, diminishing returns on internet investments, out-sourcing of American industry and jobs, yada yada… but the cartoon does hold some truth. The Democratic Party, long labeled as the “tax and spend liberals”, managed to do what few other administrations have done since the ’60s in balancing the budget, proving that the old stereotype is simply wrong.

Some now consider the Democrats the fiscally conservative party, based only on the simple observation that they tend to spend closer to what they collect in taxes. The Republicans, on the other hand, have had no qualms about spending what they DON’T collect in taxes, in other words, running up huge budget deficits through borrowing from the public and abroad. Are the Republicans the an even worse incarnation of the “tax and spend liberals”? Are they the “DON’T tax and STILL spend Conservatives”?

Discussion questions:

1. How did the Bush administration’s $160 billion “fiscal stimulus package” that sent $600 checks to every American worker demonstrate the Republican party’s willingness to deficit spend.
2. What effect will deficit spending by the government have on interest rates and private investment in the economy? What is this effect known as?
3. In times of weak aggregate demand, as in the US earlier this year, what sort of approach would a “supply-sider” recommend as an alternative to Bush’s deficit-financed expansionary fiscal policy?

Wednesday’s class this week was one of my favorite of the year. Why? We got to talk taxes. Oh my goodness, you say, what’s wrong with Welker? How could he actually enjoy talking about taxes? As I said at the beginning of class, there are only two certainties in life: death and taxes.

For most people, taxes are a dismal subject, to say the least. But for teachers of economics, especially in this presidential election year, taxes make for an exciting economic, political and philosophical debate.

The premise of our discussion in class was the idea put forth by Arthur Laffer nearly 30 years ago towards the beginning of the Regan administration: that if the government would cut taxes on businesses and households, the incentive to invest and work would increase so much that gains in total output and income would be such that the government’s tax revenue might actually increase, despite the tax cut! Cutting taxes on the wealthy would have the greatest positive effect, however, since it’s the wealthy who do most of the investing and much of the spending in the economy.

This basic philosophy underpinned the tax cuts the wealthy enjoyed during Regan’s presidency, and again during George W. Bush’s term in 2001 and 2003. The debate about whether taxes cuts made by the current president is one at the heart of the Democratic/Republican divide today.

Watch the videos below, then answer the questions that follow:

First, the Democratic view:

Then the Republican view:

Discussion questions:

1. Why do Obama and Clinton promise that if they’re elected we’ll “go back to the tax rates we had before President Bush”?
2. What is McCain’s criticism of Obama’s view on taxes?
3. What do you think about the “supply-side” argument that lower taxes will stimulate spending, growth, employment, and possibly even the amount of tax revenue collected by the government? Do you buy it?
4. Are you a “supply-sider” or more of a Keynesian when it comes to the role of government in the economy? What’s the difference?

OECD Cuts Growth Forecast to Below 2% - Bloomberg.com

The Organization for Economic Cooperation and Development predicts a global slowdown in growth. Among its 30 member nations, the OECD predicts growth of below 2% for 2008.

The [OECD] cut its forecast for expansion this year in its 30 member nations to “less than” 2 percent, the weakest since 2003. This “will be a difficult year of lower growth and some more unpleasant surprises,” OECD Secretary General Angel Gurria said in an interview in Oslo. “We have revised downwards a number of our projections.”

Okay, 2% isn’t that bad, right? I mean, it’s still growth. In fact, the OECD believes the strongest growth will be in emerging economies such as China and India, which it predicts will grow at 6.9%. The US and Europe may not enjoy such comfortable rates of expansion in this time of restricted credit, low consumption and investment and dwindling optimism among households and firms.

Jean-Luc Schneider, deputy director of the OECD’s economics department, said the agency is “not yet completely convinced there will be a recession” in the U.S., though it will be “flirting” with contraction. That will affect other OECD economies, especially those in Europe, said Gurria.

While European growth won’t be as “uncomfortable” as in the U.S., it’ll “probably be worse than we know today…”

In times of macroeconomic weakness as described above, an active role for government may be required in order to stimulate consumption and investment, increase aggregate demand and restore a healthy rate of economic growth.

Keynesian economists advocate an active role for government and central banks in times of recession. The Keynesian school of economics rests on the theory of downwardly inflexible wages and prices, the implication being that in times of declining demand (low investment and consumption), the economy slides into recession characterized by rising unemployment and slow or negative growth. (as illustrated in the graph here)

The classical view of recession, however, holds that as employment and output decline, the price level will fall due to weak aggregate demand. This “flexible price” theory leads classical economists to argue that if left alone, the economy will self-correct because workers will eventually accept lower wages, leading firms to hire more workers, increase output, and restore full-employment (as shown in the graph on the left). No government intervention is needed in such a scenario.

Keynesians argue that “flexible prices” are a myth, that in times of recession prices may remain high or even rise (in the case of a supply-shock as illustrated in the graph below). Due to the “sticky prices”, workers are not willing to work for lower wages, thus firms are not able to increase their employment in a time of weak aggregate demand. Without downwardly flexible wages, aggregate supply will not adjust outwards to restore full employment output.

Keynesian economists therefore support action by the government and central banks in times of slow or negative growth. In America today, the mainstream view adopted by most macroeconomic policy makers is still rooted in Keynesian theory, which explains the government’s recent fiscal stimulus package and expansionary monetary policies undertaken by the Fed.

Expansionary policies like a tax rebate, the Fed’s buying of bonds on the open market, and the lowering of the discount rate are aimed at shifting Aggregate Demand outward to restore full employment. The problem is that in addition to weak demand, the world economy is simultaneously experiencing rising costs of production as a result of record energy and food prices.

Cost-push inflation and rising unemployment pose a whole new policy challenge for central bankers and politicians. To combat recession in the face of rising prices is tricky, as the trade-off between unemployment and inflation is tenuous. The Phillips Curve illustrates the inverse relationship between the inflation rate and the unemployment rate. To understand the logic of this model it is useful to examine the current challenge face by the Fed.

Both unemployment and inflation are rising in the US right now. The reason for this is the rising costs faced by firms due to a weak dollar combined with high energy and food prices. Normally, a Keynesian approach to recession alleviation would be in order to restore full employment. Stimulating spending through expansionary policies, however, will only worsen the inflation problem.

The “supply shock” faced by America today has caused both unemployment and inflation to increase, which is illustrated by an outward shift in the Phillips Curve. The best policy action in this scenario may, in fact, be to allow the US to enter a recession; in other words, no policy, or laissez faire.

If the US and European economies are allowed to experience a significant slowd0wn or contraction in growth, the global demand for commodities such as fossil fuels, minerals, and other raw materials for production should decline, putting downward pressure on these commodity prices. In addition, rising unemployment should eventually result in workers accepting lower wages. The combination of falling commodity prices and wages should encourage firms to increase output, shifting aggregate supply outward and the Phillips Curve inward, restoring full-employment and price level stability.

In all likelihood we will not see the above scenario transpire. Governments and central bankers are already making moves to maintain growth and low unemployment, even in the face of rising prices. The Keynesian/classical debate, however, will continue. For now, at least, it seems as if the Keynesians are still winning the battle of the hearts and minds of political and economic leaders today.

Recession prevention - Los Angeles Times

Much of the sub-prime debacle is hard to fathom, though the simplest explanation is probably the most correct: inadequate regulation led to excessively risky loans, which were then packaged attractively and handed on to the major financial institutions.

The policy responses, however, have been simple–right in line with a textbook analysis. Most fascinatingly, some free-market fundamentalists have called for Keynesian economic stimuli and the US government has responded. Moreover, those pursuing monetary policies have admitted that lags and the banks’ timidity in extending loans (which results in excessive excess reserves) may render the recent cut in the Fed Funds Rate ineffective.

A lot of good relevant articles are around, but you may like the following debate. What side would you be on? Continue Reading »

Two heterodox economists respond to an article I blogged about last week, Hip Heterodoxy, published in the Nation, written by Chris Hayes.

Challenging Orthodox Economics – Part I | TPMCafe by Thomas Palley

Economics Outside the Mainstream | TPMCafe by David Ruccio

As our year winds down and we begin getting our materials and lessons in order for our next batch of AP Econ students, it’s unlikely we’ll pause to ask a rather important question: “Is the economics I’m teaching my students the correct and immutable truth?”

After all, isn’t economics still a young science? It’s only been a few generations since Smith, Riccardo and Locke laid the groundwork for what has become the mainstream, neo-classical/neo-Keynesian theory that makes up every major economics text and principles course out there. Who’s to say that in another one hundred years these views, products of the late 20th century themselves, will still be considered the correct solutions for dealing with the economic problem?

As mentioned in a previous post “Keynesian vs. Neo-classical Economics - and what is Heterodox Economics?”, the field loosely described as “heterodox economics” raises difficult questions of human behavior and thinking that challenges the neo-classical view of perfectly rational actors and the efficiency and perfectibility of free markets (the view that we teach in AP Economics). David Ruccio, econ professor at Notre Dame, laments on mainstream economists:

All reasonable arguments are accepted in the marketplace of ideas. Except they (mainstream economists) never read any heterodox economics, and have no idea how the hegemony of their favorite theory shuts out all other ideas…That’s the situation that heterodox economists are trying to change. By using economic theories other than those of the mainstream… By forming journals and associations apart from those of the mainstream (in which their ideas never get aired). And by challenging the mainstream conception of the discipline itself
(including its notions of what science is, and what it means to “think like an economist”).

We do heterodox economics, or what some refer to as political economy—as against economics (which, as Chris correctly argues, has become identified with a tiny number of theoretical approaches). We write about rates of exploitation and the role of power in increasing inequality and the existence of patriarchy and structural racism. Not only do we want to argue that economic actors are sometimes irrational or guided by norms and values; some of us also want to analyze economic institutions and events without even starting from individual actors. Or efficiency. Or constrained optimization.

So, do you feel guilty yet about teaching only the mainstream view in your course? Don’t fret, even Professor Ruccio has to teach his students the neo-classical approach; here’s how he deals with the status quo in his courses:

In all honesty, I mostly prefer not to read maintream economics these days. Either it says nothing of interest, or it gets me very angry. But I teach it, and I teach it in a way that is more rigorous than my mainstream colleagues. Because I teach its basic assumptions (and not as a kind of common sense) and because I present alternative views, heterodox economics. And then I read and do heterodox economics, independently of the mainstream. Because if we spend all our time worrying about mainstream economics, attempting to do mainstream economics (with a tweak here and a changed assumption there), we’ll never get around to developing alternatives.

Professor Ruccio makes an important point here. Before students can become agents of positive change, aware and capable of making the world a better place (and the field of economics a better science) they must first know what needs fixing. I know as much as any AP Econ teacher how rushed this course is, how little time is really left for discussions beyond the basic principles in the syllabus; but in the future, I think I’ll challenge myself and my students to take a little time and find out what alternative approaches to the economic problem are being researched, published, and put into action out there. Technology, the web, blogs: these are the tools that will enable us to easily connect our students to alternative, heterodox economics despite the hectic pace of our AP course. And if your school has access to online journal databases, here’s a few suggestions for economics publications that give a voice to heterodox economists like Professor Ruccio:

The Review of Income and Wealth, the Cambridge Journal of Economics, the European Journal of Comparative Economics, Research in Economic History, Industrial and Corporate Change, CES Ifo Economic Studies, the Eastern Economic Journal, the BNL Quarterly Review and The Economist’s Voice.

Powered by ScribeFire.

NCEE | EconomicsAmerica® | National Standards

A CRITIQUE OF “STANDARDS OF ECONOMICS” from the URPE

What is Heterodox Economics? Perhaps it’s easier to start by saying what it is NOT. Heterodox Economics is NOT what we teach in Advanced Placement Economics. It is not what most major universities and colleges teach in their undergraduate and graduate economics courses. It is not widely accepted as a mainstream view in the field of professional economics. Its economists are not widely published in the top five economic journals. It is not neo-classical in its views that “humans are rational, utility-maximizing agents with fixed preferences, that they make decisions “at the margins” and that the mechanisms of supply and demand (operating free of government interference) will lead to a general equilibrium whereby resources are allocated efficiently.” In other words, heterodox economics challenges the widely accepted view that free markets and free individuals acting in their own self interest will perfectly allocate resources and achieve a general equilibrium where resources are put to their most efficient uses and goods and services are distributed efficiently among individuals in society. Markets are imperfect, and human institutions should offer Adam Smith’s “invisible hand” a helping hand when it comes to allocation of resources and output.

The National Council for Economics Education (NCEE, which publishes the widely used workbook “Advanced Placement Economics”) released in 2000 its National Standards on Economic Education, based on the “essential principles of economics”. High school economics courses, including AP, are rooted in these standards, which themselves are rooted in neo-classical theory originating with Adam Smith and carrying on to Milton Friedman and today’s mainstream economists whose work receives the most acclaim in top economic journals.

On the other end of the spectrum from the NCEE is the Union for Radical Political Economics (URPE), originally founded in the 1960’s by heterodox economics with the following goals:

First, to promote a new interdisciplinary approach to political economy which
includes also relevant themes from political science, sociology and social psychology.
Secondly, to develop new courses and research areas which reflect the urgencies of the day
and a new value premise. Such areas include the economics of the ghetto, poverty,
imperialism, interest groups, and the military-industry complex. And thirdly, political
economics should be sensitive to the needs of the social movements of our day, and have
more group research, with an approach that links all issues to a broad framework of
analysis.

To better understand the differences between heterodox economics and mainstream, neo-classical economics, it may help to examine the heterodox critique of the NCEE’s 20 Standards on Economic Education. The links above will take you to the full critique, but here’s a short excerpt that I think illustrates rather clearly the differing philosophies of these two modern schools of economic thought. The NCEE standards are in bold, the URPE’s critique is italicized:

1 and 2. Resources are limited so people cannot have all they want.
This is the traditional “starting point” of neo-classical economics which focuses our attention on how to allocate scare resources. The focus is on efficiency, which is understood to mean maximizing total production. Thus the central question is how to CHOOSE – how to trade-off one thing for another. Classical economists, such as Adam Smith, looked not only at total production but at how it was distributed between classes (landlords, capitalists and workers), and Marx viewed the appropriation of surplus production (over and above what was necessary for working people) as “theft” by the ruling classes. A total “disinterest” in distribution is one of the defining characteristics of neoclassical economics. An alternative focus for economics would be how to insure a decent standard of living for the people of the world..

3. People choose different methods of allocation of goods and services.
Note throughout the use of terms such as “people” and “individuals” with no distinction between capitalists and workers. Thus “people” choose their economic systems. The assumption here is that the “choice” is merely a matter of the level at which government decisions are made rather than any disagreement about a system which relies on profit-making as the motive force behind the private provision of goods and services, Thus the “command economy” (which is implicitly identified with communism) is presented as one in which the market plays no role, and there is absolutely no mention of the communists’ abolition of the capitalism class, and subsequent end to distribution on the basis of ownership of property.

4 and 5. People respond to incentives and voluntary exchange is beneficial.
There is not reference here to the starting point of this “voluntary exchange. The poverty-stricken will take starvation wages and even sell themselves or their children into slavery – this is, of course, “voluntary” in one sense but a more comprehensive approach recognizes that “they have no choice.”

The list goes on. It’s very interesting to compare the reasonable critique offered by heterodox economists to the “truths” of economics that we teach in our principles courses. It also frustrates me that in our limited time in the AP course we are unable to further explore these alternative, yet very valid and important approaches to understanding economic behavior and policy. I will encourage my students to seek courses in university that challenge the neo-classical view taught in AP Economics. The field of heterodox economic, while it has not yet achieved mainstream status, surely will play a crucial role in the evolution of this science in the decades to come, as social unrest, political turmoil, conflict, scarcity, environmental and social ills continue to plague our ever-changing world.

While adherents of heterodoxy may not yet be widely accepted in the mainstream field, their “human” approach to the “economic problem” will surely gain appeal as growth continues to broaden the divide between rich and poor, haves and have nots, urban and rural. Bright young students who have been exposed first hand to the challenges and downsides of economic growth (such as those faced by the millions o poor migrant workers here in Shanghai) are just the kind of students who can go on to make valuable contributions to heterodox economics.

Powered by ScribeFire.