Download Class 4: States and Markets 2

States and Markets
Sociology 2, Class 4
Copyright © 2010 by Evan Schofer
Do not copy or distribute without permission
Announcements
• Today:
• Lecture: States & Markets – basic concepts & definitions
• Next week: economic globalization
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…
Review: Fiscal Policy: Taxes
• Fiscal Policy: Government policy regarding
taxation, public revenues, or public debt
• Taxes generate revenue for the state
• Low taxes can create short term growth
– By increasing spending, consumption
• Low taxes also can increase investment, increasing
long term growth
• Higher taxes support more government services
– And allow greater redistribution of wealth in society.
• By taxing some things more than others,
states can affect social and economic
behavior.
Fiscal Policy: Spending
• Government can affect economy by adjusting
how it spends money
– 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
– Budget surpluses occur when the government
spends less than it earns
• Current national debt: $12,300,000,000,000
• Over 40,000 per person
• Large government debt can harm the economy
– Can lead to higher interest rates; high taxes to pay off debt.
Fiscal Policy: Spending
• Government spending can “jump-start” the
economy
• State may spend directly, or give money to people
– Keynes: “Government should spent against the
wind”
• Example: “New Deal” spending, war spending helped
create jobs and economic growth
• But, consistent high government spending
can harm economic growth
• High deficits, debt can lead to inflation
• Example: “stagflation” in 1970s.
Example: The “Stimulus Bill”
• The “stimulus bill” is an example of fiscal policy
• “American Recovery and Reinvestment Act of 2009”
• Provides 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)
Tax cuts for wealthy
.8 - 2.2
.1 - .5
Impact of US Fiscal Policy on GDP
US fiscal policy
has large
positive impact
on GDP from
mid-2009 to
mid-2010.
US spending
peters out after
that…
Source: Goldman Sachs, via Krugman NYT Blog
The Stimulus Bill: Debates
• Current debate:
– Democrats / Keynesians: Stimulus bill is a good
idea… increases growth & employment
• Benefits outweight the debt that is incurred
• In fact, some economists argue that we need a second
round of stimulus…
– Republicans / conservative economists: Stimulus
bill is a bad idea: causes too much debt
– Could cause inflation and inhibit long term growth
• Some conservative economists actually reject the idea
that spending has a stimulative effect
• Conservatives more concerned about debt and inflation
that unemployment & short term growth.
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 stores a 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
• Critical issue: 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
• “Tight”, “contractionary,” or “conservative” monetary
policy
• High interest payments mean that businesses and people
are less likely to borrow, spend, invest.
US Interest Rates 2000-2009
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 (mostly)
• 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: Buying non-treasure assets
– 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 governmentrun 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!
– Also, 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.
The Credit Crisis
• Krugman article: “Partying Like its 1929”
• Regulation and the financial crisis
– Banks were heavily regulated since 1930s, but
didn’t like it
• Banks began to circumvent regulation by creating new
organizations & services (e.g., Hedge funds)
– a “shadow” banking system
• Result: Banks took greater and greater risks… and made
billions of dollars of profits for years
– Many risky investments were in real estate
– Decline of real estate market in 2007-8 caused risky
investments to lose tremendous amounts of money
• Banks began to go bankrupt; bank runs began
– Entire economy was threatened…
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…
• Banks were reckless, let them fail
– 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.
Democrats, Republicans, Markets
• Democrats have been historically more
“Keynesian” and republicans more “free market”
• But, they don’t match perfectly
–
–
–
–
Ex: Nixon (R) instituted wage and price controls
Ex: Carter (D) oversaw substantial privatization
Clinton signed NAFTA (a free-market trade treaty)
Reagan & Bush 1 & 2 created huge budget deficits
and greatly increased the national debt
– Obama has not departed far from republican
policies in responding to the credit crisis
• E.g., nationalizing banks…
Republican Fiscal Policy Cartoon (1)
Republican Fiscal Policy Cartoon (2)
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…