Monthly Archives: April 2011

By Michael Hudson

A year ago, in March 2010, Iceland’s economy was so small that it did not warrant much attention when 93% of its voters rejected the Social Democratic-Green government’s surrender to demands by Gordon Brown and the Dutch, the European Union (EU) bureaucracy and IMF that the island nation impose austerity. Britain and the Netherlands wanted to be reimbursed for having paid out more than $5 billion to some 340,000 of their own depositors – whom their own bank oversight agencies had failed to warn about the looting that was going on.

Iceland’s taxpayers were told to bear the cost, as virtual tribute. In effect, it was to be penance for believing the neoliberal fairy tales about how bank deregulation and “free markets” would make it the richest, happiest country in the world. Indeed it seemed to be, according to United Nations data. But the dream was dashed after the Icesave electronic Internet bank branches abroad were emptied out by their proprietors.

The dream was the neoliberal promise that running into debt was the way to get rich. Nobody at the time anticipated that taking private (and indeed, fraudulent) bank losses onto the public balance sheet would become the theme dividing Europe over the coming year, dividing European politics and even threatening to break up the Eurozone.

A landmark in this fight is to occur this Saturday, April 9. Icelanders will vote on whether to subject their economy to decades of poverty, bankruptcy and emigration of their work force. At least, that is the program supported by the existing Social Democratic-Green coalition government in urging a “Yes” vote on the Icesave bailout. Their financial surrender policy endorses the European Central Bank’s lobbying for the neoliberal deregulation that led to the real estate bubble and debt leveraging as if it were a success story rather than the road to national debt peonage. The reality was an enormous banking fraud and insider dealing as bank managers lent the money to themselves, leaving an empty shell – and then saying that this was all how “free markets” operate. Running into debt was promised to be the way to get rich. But the price to Iceland was for housing prices to plunge 70% (in a country where mortgage debtors are personally liable for their negative equity), a falling GDP, rising unemployment, defaults and foreclosures.

To put Saturday’s vote in perspective, it is helpful to see what has occurred in the past year along remarkably similar lines throughout Europe. For starters, the year has seen a new acronym: PIIGS, for Portugal, Ireland, Italy, Greece and Spain.

The eruption started in Greece. One legacy of the colonels’ regime was tax evasion by the rich. This led to budget deficits, and Wall Street banks helped the government conceal its public debt in “free enterprise” junk accounting. German and French creditors then made a fortune jacking up the interest rate that Greece had to pay for its increasing credit risk.

Greece was told to make up the tax shortfall by taxing labor and charging more for public services. This increases the cost of living and doing business, making the economy less competitive. That is the textbook neoliberal response: to turn the economy into a giant set of tollbooths. The idea is to slash government employment, lowering public-sector salaries to lead private-sector wages downward, while sharply cutting back social services and raising the cost of living with tollbooth charges on highways and other basic infrastructure.

The Baltic Tigers had led the way, and should have stood as a warning to the rest of Europe. Latvia set a record in 2008-09 by obeying EU Economics and Currency Commissioner Joaquin Almunia’s dictate and slashing its GDP by over 25% and public-sector wages by 30%. Latvia will not recover even its 2007 pre-crisis GDP peak until 2016 – an entire lost decade spent in financial penance for believing neoliberal promises that its real estate bubble was a success story.

In autumn 2009, Socialist premier George Papandreou promised an EU summit that Greece would not default on its €298bn debt, but warned: “We did not come to power to tear down the social state. Salaried workers will not pay for this situation: we will not proceed with wage freezes or cuts.” [1] But that seems to be what socialist and social democratic parties are for these days: to tighten the screws to a degree that conservative parties cannot get away with. Wage deflation is to go hand in hand with debt deflation and tax increases to shrink the economy.

The EU and IMF program inspired the modern version of Latin America’s “IMF riots” familiar from the 1970s and ‘80s. Mr. Almunia, the butcher of Latvia’s economy, demanded reforms in the form of cutbacks in health care, pensions and public employment, coupled with a proliferation of taxes, fees and tolls from roads to other basic infrastructure.

The word “reform” has been turned into a euphemism for downsizing the public sector and privatization sell-offs to creditors at giveaway prices. In Greece this policy inspired an “I won’t pay” civil disobedience revolt that grew quickly into “a nationwide anti-austerity movement. The movement’s supporters refuse to pay highway tolls. In Athens they ride buses and the metro without tickets to protest against an ’unfair’ 40 per cent increase in fares.” [2] The police evidently are sympathetic enough to refrain from fining most protesters.

All this is changing traditional political alignments not only in Greece but throughout Europe. The guiding mentality of Tony Blair-style “New Labour” policy is economic loyalty to Europe’s financial centers as government spending is slashed, public infrastructure privatized and banks bailed out with “taxpayer” burdens that fall mainly on labor. “Both the conservative and communist leaders have refused to support the EU-IMF programme. ‘This programme is strangling the Greek economy … it needs renegotiation and radical change,’ said Antonis Samaras, the conservative leader.” (Ibid.)

A Le Monde article accused the EU-IMF plan of riding “roughshod over the most elementary rules of democracy. If this plan is implemented, it will result in a collapse of the economy and of peoples’ incomes without precedent in Europe since the 1930s. Equally glaring is the collusion of markets, central banks and governments to make the people pay the bill for the arbitrary caprice of the system.” [3]

Ireland is the hardest hit Eurozone economy. Its long-term ruling Fianna Fail party agreed to take bank losses onto the public balance sheet, imposing what looks like decades of austerity – and the largest forced emigration since the Potato Famine of the mid-19th century. Voters responded by throwing the party out of office (it lost two-thirds of its seats in Parliament) when the opposition Fine Gael party promised to renegotiate last November’s $115-billion EU-IMF bailout loan and its accompanying austerity program.

A Financial Times editorial referred to the “rescue” package (a euphemism for financial destruction) as turning the nation into “Europe’s indentured slave.” [4] EU bureaucrats “want Irish taxpayers to throw more money into holes dug by private banks. As part of the rescue, Dublin must run down a pension fund built up when Berlin and Paris were violating the Maastricht rules. … so long as senior bondholders are seen as sacrosanct, fire sales of assets carry a risk of even greater losses to be billed to taxpayers.” EU offers to renegotiate the deal promise only token concessions that fail to rescue Ireland from making labor and industry pay for the nation’s reckless bank loans. Ireland’s choice is thus between rejection of or submission to EU demands that its government “make bankers whole” at the expense of labor and industry. It is reminiscent of when the economist William Nassau Senior (who took over Thomas Malthus’s position at the East India College) was told that a million people had died in Ireland’s potato famine. He remarked succinctly: “It is not enough.” So neoliberal junk economics has a long pedigree.

The result has radically reshaped the idea of national sovereignty and even the basic assumption underlying all political theory: the premise that governments act in the national interest. As Yves Smith’s Naked Capitalism website has pointed out:

The eurozone is up against Dani Rodrik’s trilemma: Democratic politics and the Nation State vs globalism based on the Bretton Woods system. You cannot have all three corners of the triangle at once. The creators of the European Union knew that the end game was the dissolution of nation states. …

But what they failed to anticipate is that the costs of these crises would be visited on the inhabitants of particular nation states, and that would lead them to rebel against the “inevitable” integration. As long as democratic mechanisms are intact in enough of the countries being pressed to wear the austerity hairshirt, revolt is indeed possible. Economists argue that the cost for any nation to exit the eurozone is prohibitive. But how does that stack up with a “rescue” program that virtually guarantees continued economic contraction and depopulation for Ireland? Faced with two unattractive alternatives, the desire for self-determination and for punishment of coercive European technocrats may make supposedly irrational moves seem compelling. [5]

The shape of Europe that is emerging is not the original view of mobilizing technology to raise living standards. The leaders who originally sponsored the EU viewed nation states as having plunged the continent into a millennium of warfare. But today, finance is the new mode of warfare. Its objective is the same as military conquest: to seize the land and basic infrastructure, and to levy tribute – euphemized as bailout repayments, as if the financial system were necessary to fuel industry and labor rather than siphoning off their surplus.

The Irish government’s €10 billion interest payments are projected to absorb 80% of the government’s 2010 income tax revenue. This is beyond the ability of any national government or economy to survive. It means that all growth must be paid as tribute to the EU for having bailed out reckless bankers in Germany and other countries that failed to realize the seemingly obvious fact that debts that can’t be paid won’t be. The problem is that during the interim it takes to realize this, economies will be destroyed, assets stripped, capital depleted and much labor obliged to emigrate. Latvia is the poster child for this, with a third of its population between 20 and 40 years old already having emigrated or reported to be planning to leave the country within the next few years.

The EU’s nightmare is that voters may wake up in the same way that Argentina finally did when it announced that the neoliberal advice it had taken from U.S. and IMF advisors had destroyed the economy so much that it could not pay. As matters turned out, it had little trouble in imposing a 70% write-down on foreign creditors. Its economy is now booming – because it became credit-worthy again, once it freed itself from its financial albatross!

Much the same occurred in Latin America and other Third World countries after Mexico announced that it could not pay its foreign debts in 1982. A wave of defaults spread – inspiring negotiated debt write-downs in the form of Brady Bonds. U.S. and other creditors calculated what debtors realistically could pay, and replaced the old irresponsible bank loans with new bonds. The United States and IMF members applauded the write-downs as a success story.

But Ireland, Greece and Iceland are now being told horror stories about what might happen if governments do not commit financial suicide. The fear is that debtors may revolt, leading the Eurozone to break up over demands that financialized economies turn over their entire surplus to creditors for as many years as the eye of forecasters can see, acquiescing to bank demands that they subject themselves to a generation of austerity, shrinkage and emigration.

That is the issue in Iceland’s election this Saturday. It is the issue now facing European voters as a whole: Are today’s economies to be run for the banks, bailing them out of unpayably high reckless loans at public expense? Or, will the financial system be reined in to serve the economy and raise wage levels instead of imposing austerity.

It seems ironic that the Socialist parties (Spain and Greece), the British Labour Party and various Social Democratic parties have moved to the pro-banker right wing of the political spectrum, committed to imposing anti-labor austerity not only in Europe, but also in New Zealand (the 1990s poster child for Thatcherite privatization) and even Australia. Their policy of downsizing public social services and embrace of privatization is the opposite of their position a century ago. How did they become so decoupled from their original labor constituencies? It seems as if their function is to impose whatever right-wing agenda the Conservative parties cannot get away with – not unlike Obama neutering possible Democratic Party alternatives to Republican lobbying for more Rubinomics.

Is it simply gullibility? That may have been the case in Russia, whose leaders seemed to have little idea of how to fend off destructive advice from the Harvard Boys and Jeffrey Sachs. But something more deliberate plagues Britain’s own Labour Party in out-Thatchering the Conservatives in privatizing the railroads and other key economic infrastructure with their Public-Private Partnership. It is the attitude that led Gordon Brown to threaten to blackball Icelandic membership in the EU if its voters oppose bailing out the failure of Britain’s own neoliberal bank insurance agency to prevent banksters from emptying out Icesave.

What seems remarkable is that Icelandic voters may take seriously their prime minister’s threat that a “No” vote on the Icesave bailout would lead the UK and Holland to blackball Icelandic entry. The new Conservative Prime Minister has little love for Mr. Brown, and realizes that his own voters are not eager to support membership of a country that is willing to sacrifice the domestic economy to pay bankers for what looks like shady loans. And what of the rest of Europe? Is buckling under to unfair bank demands really the way to make friends with the indebted PIIGS countries? Do these countries want to admit another neoliberal advocate favoring banks over their domestic economies? Or would Iceland make more friends by voting “No”?

Last weekend half a million British citizens marched in London to protest the threatened cutbacks in social services, education and transportation, and tax increases to pay for Gordon Brown’s bailout of Northern Rock and the Royal Bank of Scotland. The burden is to fall on labor and industry, not Britain’s financial class. The Daily Express, a traditionally campaigning national paper, is now running a full throttle campaign for Britain to leave the EU, on much the same ground that Britain has long rejected joining the euro.

What is the rationale of Iceland and other debtor countries paying, especially at this time? The proposed agreements would give Britain and Holland more than EU directives would. Iceland has a strong legal case. Social Democratic warnings about the EU seem so overblown that one wonders whether the Althing members are simply hoping to avoid an investigation as to what actually happened to Landsbanki’s Icesave deposits. Britain’s Serous Fraud Office recently became more serious in investigating what happened to the money, and has begun to arrest former directors. So this is a strange time indeed for Iceland’s government to agree to take bad bank debts onto its own balance sheet.

The EU has given Iceland bad advice: “Pay the Icesave debts, guarantee the bad bank loans, it really won’t cost too much. It will be fairly easy for your government to take it on.” One now can see that this is the same bad advice given to Ireland, Greece and other countries. “Fairly easy” is a euphemism for decades of economic shrinkage and emigration.

The problem is that the more Iceland’s economy shrinks, the more impossible it becomes to pay foreign debts. Iceland’s government is desperately begging to join Europe without asking just what the cost will be. It would plunge the krona’s exchange rate, shrink the economy, drive young workers to emigrate to find jobs and to avoid the bankruptcy foreclosures that would result from subjecting the nation to austerity.

Nobody really knows just how deep the hole is. Iceland’s government has not made a serious attempt to make a risk analysis. What is clear is that the EU and IMF have been irresponsibly optimistic. Each new statistical report is “surprising” and “unexpected.” On the basis of the IMF’s working assumption about the króna’s exchange rate at end-2009, for example, the IMF staff projected that gross external debt would be 160% of GDP. To be sure, they added that a further depreciation of the exchange rate of 30 percent would cause a precipitous rise in the debt ratio. This indeed has occurred. Back in November 2008, the IMF warned that the foreign debt it projected by yearend 2009 might reach 240% of GDP, a level it called “clearly unsustainable.” But today’s debt level has been estimated to stand at 260% of Icelandic GDP – even without including the government-sponsored Icesave debt and some other debt categories.

Creditors lose nothing by providing junk-economic advice. They have shown themselves quite willing to encourage economies to destroy themselves in the process of trying to pay – something like applauding nuclear power plant workers for walking into radiation to help put out a fire. For Ireland, the EU pressed the government to take responsibility for bank loans that turned out to be only about 30% (not a misprint!) of estimated market price. It said that this could “easily” be done. Ireland’s government agreed, at the cost of condemning the economy to two or more decades of poverty, emigration and bankruptcy.

What makes the problem worse is that foreign-currency debt is not paid out of GDP (whose transactions are in domestic currency), but out of net export earnings – plus whatever the government can be persuaded to sell off to private buyers. For Iceland, the question would become one of how many of its products and services – and natural resources and companies – Britain and the Netherlands would buy.

It is supposed to be the creditor’s responsibility to work with debtors and negotiate payment in exports. Instead of doing this, today’s creditors simply demand that governments sell off their land, mineral resources, basic infrastructure and natural monopolies to pay foreign creditors. These assets are forfeited in what is, in effect, a pre-bankruptcy proceeding. The new buyers then turn the economy into a set of tollbooths by raising access fees to transportation, phone service and other privatized sectors.

One would think that the normal response of a government in this kind of foreign debt negotiation would be to appoint a Group of Experts to lay out the economy’s position so as to evaluate the ability to pay foreign debts – and to structure the deal around the ability to pay. But there has been no risk assessment. The Althing has simply accepted the demands of the UK and Holland without any negotiation. It has not even protested the fact that Britain and Holland are still running up the interest clock on the charges they are demanding.

Why doesn’t Iceland’s population behave like that of Ireland or Greece, not to mention Argentina or the United States, and say to Europe’s financial negotiators: “Nice try! But we’re not falling for it. Your creditor game is over! No nation can be expected to keep committing financial suicide Ireland-style, imposing economic depression and forcing a large portion of the labor force to emigrate, simply to pay bank depositors for the crimes or negligence of bankers.”

The credit rating agencies have tried to reinforce the Althing’s attempt to panic the population into a “Yes” vote. On February 23, Moody’s threatened: “If the agreement is rejected, we would likely downgrade Iceland’s ratings to Ba1 or below.” If voters approve the agreement, however, “we would likely change the outlook on the government’s current Baa3 ratings to stable from negative,” in view of a likely “cut-off in the remaining US$1.1 billion committed by the other Nordic countries and probably also to delays in Iceland’s IMF program.”

Perhaps not many Icelanders realize that credit ratings agencies are, in effect, lobbyists for their clients, the financial sector. One would think that they had utterly lost their reputation for honesty – not to mention competence – by pasting AAA ratings on junk mortgages as prime enablers of the present global financial crash. The explanation is, they did it all for money. They are no more honest than was Arthur Andersen in approving Enron’s junk accounting.

My own view of ratings agencies is based in no small part on the story that Dennis Kucinich told me about the time when he was mayor of Cleveland, Ohio. The banks and some of their leading clients had set their eyes on privatizing the city’s publicly owned electric company. The privatizers wanted buy it on credit (with the tax-deductible interest charges depriving the government of collecting income tax on their takings), and sharply raise prices to pay for exorbitant executive salaries, outrageous underwriting fees to the banks, stock options for the big raiders, heavy interest charges to the banks and a nice free lunch to the ratings agencies. The banks asked Mayor Kucinich to sell them the bank, promising to help him be governor if he would sell out his constituency.

Mr. Kucinich said “No.” So the banks brought in their bullyboys, the ratings agencies. They threatened to downgrade Cleveland’s rating, so that it could not roll over the loan balances that it ran as a normal course with the banks. “Let us take your power company or we will wreck your city’s finances,” they said in effect.

Mr. Kucinich again said no. The banks carried out their threat – but the mayor had saved the city from having its incomes squeezed by predatory privatization charges. In due course its voters sent Mr. Kucinich to Congress, where he subsequently became an important presidential candidate.

So returning to the problem of the credit rating agencies, how can anyone believe that agreeing to pay an unpayably high debt would improve Iceland’s credit rating? Investors have learned to depend on their own common sense since losing hundreds of billions of dollars on the ratings agencies’ reckless ratings. The agencies managed to avoid criminal prosecution by noting that the small print of their contracts said that they were only providing an “opinion,” not a realistic analysis for which they could be expected to take any honest professional responsibility!

Argentina’s experience should provide the model for how writing off a significant portion of foreign debt makes the economy more creditworthy, not less. And as far as possible lawsuits are concerned, it is a central assumption of international law that no sovereign country should be forced to commit economic suicide by imposing financial austerity to the point of forcing emigration and demographic shrinkage. Nations are sovereign entities.

It thus would be legally as well as morally wrong for Iceland’s citizens to spend the rest of their lives paying off debts owed for money that should rather be an issue between Britain’s Serious Fraud Office and the British bank insurance agencies.

Overarching the vote is how high a price Iceland is willing to pay to join the EU. In fact, as the Eurozone faces a crisis from the PIIGS debtors, what kind of EU is going to emerge from today’s conflict between creditors and debtors? Fears have been growing that the euro-zone may break up in any case. So Iceland’s Social Democratic government may be trying to join an illusion – one that now seems to be breaking up, at least as far as its neoliberal extremism is concerned. Just yesterday (Thursday, April 7) a Financial Times editorial commented on what it deemed to be Portugal’s premature cave-in to EU demands:

Another eurozone country has been humbled by its banks. Earlier this week, Portugal’s banks were threatening a bond-buyers’ go-slow unless the caretaker government sought financial help from other European Union countries. … Lisbon should have stuck to its position. … it should still resist doing what the banks demanded: seeking an immediate bridging loan. … By jumping the gun, the government risks having scared markets away entirely. That may prejudice the outcome of negotiations about the longer-term facility.

The caretaker government has neither the moral nor the political authority to determine Portugal’s future in this way. It should not precipitately abandon the markets. That may mean paying high yields on debt issues in coming months – higher than they might have been had the government not folded its hand too soon. … The right time to opt for an external rescue would have been at the end of a national debate.” [6]

The same should be true for Iceland. Looking over the past year, it seems that the island nation has been used as a target for a psychological and political experiment – a cruel one – to see how much a population will be willing to pay that it does not really owe for what bank insiders have stolen or lent to themselves.

This is not only an Icelandic problem. It remains a problem in Ireland, and in the United States for that matter, as well as in Britain itself.

The moral is that creditor foreclosure – or voluntary forfeiture to pay international bankers – has become today’s preferred mode of economic warfare. It is cheaper than military conquest, but its aim is similar: to gain control of foreign property and levy tribute – in a way that the tribute-payers accept voluntarily. Land is appropriated and foreclosed on – or, what turns out to be the same thing, its rental income is pledged to foreign bank branches extending mortgage credit that absorbs the net rent. The result is economic austerity and chronic depression, ending the upsweep in living standards promised a generation ago.

Iceland’s government seems to have become decoupled from what is good for voters and for the very survival of Iceland’s economy. It thus challenges the assumption that underlies all social science and economics: that nations will act in their own self-interest. This is the assumption that underlies democracy: that voters will realize their self-interest and elect representatives to apply such policies. For the political scientist this is an anomaly. How does one explain why a national parliament is acting on behalf of Britain and the Dutch as creditors, rather than in the interest of their own country? Voters in other countries have removed their governments for agreeing to pay such questionable debts.

[1] Ambrose Evans-Pritchard, “Greece defies Europe as EMU crisis turns deadly serious,” The Telegraph (UK), December 18, 2009.

[2] Kerin Hope, “Greeks adopt ‘won’t pay’ attitude,” Financial Times, March 10, 2011.

[3] Olivier Besancenot and Pierre-François Grond, “The Greek People are the Victims of an Extortion Racket,”
Le Monde, May 14, 2010.

[4] Ireland’s winter of discontent,” Financial Times editorial, March 1, 2011.

[5] Yves Smith, “Will Ireland Threaten to Default?” Naked Capitalism, March 15, 2011

[6] “Banks 1, Portugal 0,” Financial Times editorial, April 7, 2011.

By L. Randall Wray

In a Wall Street Journal article this week three Hoover Institute economists (Gary Becker, George Schultz and John Taylor) endorsed Republican efforts to make large federal government budget cuts.  I will not address all the arguments made in defense of a “Hooverian” approach to economics (we tried that in the early 1930s!). Here I want to focus on the two main points made:

1. “When private investment is high, unemployment is low. In 2006, investment—business fixed investment plus residential investment—as a share of GDP was high, at 17%, and unemployment was low, at 5%. By 2010 private investment as a share of GDP was down to 12%, and unemployment was up to more than 9%. In the year 2000, investment as a share of GDP was 17% while unemployment averaged around 4%. This is a regular pattern.”
2. “In contrast, higher government spending is not associated with lower unemployment. For example, when government purchases of goods and services came down as a share of GDP in the 1990s, unemployment didn’t rise. In fact it fell, and the higher level of government purchases as a share of GDP since 2000 has clearly not been associated with lower unemployment.”

The authors supply a graph showing investment and government spending as a share of GDP to demonstrate these two points. Based on that data, these economists argue that the solution is to cut federal spending and then to hold its growth rate below that of GDP. This will allow the share of government spending to fall—while economic growth will let tax revenues rise a bit faster so that the budget will move toward balance.

By framing their argument in terms of ratios to GDP, the authors provide a misleading characterization of cause and effect. It is true that high investment spending tends to increase GDP while lowering unemployment—that is the Keynesian “multiplier” at work. High growth of GDP, in turn, lowers the ratio of government spending to GDP so that we will observe a correlation between falling unemployment and a falling government share of GDP—but that is a correlation of no causal significance. When an investment boom collapses—as it did in 2006-2007—GDP growth then falls and the government share of a smaller GDP will rise. Our Hooverians interpret that as “proof” that a rising government share does not help to fight unemployment.

In fact, however, relatively stable government spending over a cycle helps to cushion a private sector “bust”. While it is hard to prove the counterfactual—how bad would things have been without sustained government spending—it is hard to believe their argument that a loss of 8% of GDP due to reduction of private spending would not have led to a much deeper recession (or depression) without the stabilizing force of our government spending.

Let us take a look at the components of GDP over the past two decades. Recall from your Econ 101 course that the aggregate measure of a nation’s output of goods and services (GDP) is equal to the sum of consumption, private investment, government purchases, and net exports (for the US that is of course negative). We can further divide investment into residential (housing) and nonresidential (investment by firms). Finally, we can divide government spending between federal government and state and local government. The following chart graphs the domestic components of GDP (net imports are left out), indexing each component to 100 in 1990. (This makes the scale easier to show in the graph, and simplifies comparison of growth by component. For example, if consumption spending doubles between 1990 and 2000, its index increases from 100 to 200.)

What we see in this graph is that the slowest growing component over the two decades was federal government spending—it actually did not grow much until the term of President George W. Bush. (A substantial portion of federal government growth since 2000 can be attributed to our multiple wars, as well as to domestic spending on security.) By 2010, federal government spending was just over 2.3 times bigger (in nominal terms) than its spending in 1990. Private consumption as well as state and local government spending grew steadily, increasing by about 267% before the deep recession led to some retrenchment. By contrast, residential investment boomed in the real estate bubble, growing by 350% until 2005. It then collapsed so that it stood at an index of just 150 in 2010 (fifty percent higher than in 1990). Nonresidential investment shows a clear cyclical nature, and it too collapsed in the aftermath of the global financial collapse. Viewed in this light, it is not at all surprising that when total investment (residential plus nonresidential) is growing rapidly, unemployment tends to fall; but when investment spending collapses we lose jobs at a stupendous pace.

This has long been the concern of Keynesian economists: investment by its very nature is highly cyclical, subject to what J.M. Keynes called “whirlwinds of optimism and pessimism”. That is not all bad. J. Schumpeter referred to the “creative destruction” that makes capitalism dynamic—waves of innovation generate new investment, wiping out firms that get left behind. But if an entire economy is whipped about by unstable investment, we oscillate between the extremes of boom and bust. That is why we need some spending that is more stable—better yet, we need a source of spending that can act in a countercyclical manner to offset the swings of investment.

And that is precisely what we created in the aftermath of the Great Depression. First, we grew the federal government—from about 3% of GDP in 1929 to above 20% after WWII. As the chart above shows, federal government spending is not subject to the wild swings that afflict investment, so it helps to stabilize GDP and jobs. Second, we put in place a variety of federal government programs that help to stabilize household consumption (unemployment benefits, Social Security retirement, and “welfare” for households, firms, and farms). That is, again, reflected in the chart above—even when the financial sector crashed and unemployment exploded, consumption dipped only slightly, thanks in large part to government “transfer” payments like unemployment benefits.

Our modern Hooverians would like to return to the “good old days” of President Hoover, when the government was smaller and both unwilling and unable to offset the swings of private investment spending. Back then, when investment collapsed unemployment did not go to 9 or 10 percent, it went all the way to 25 percent. Hooverian economics would turn back the clock to ring in another Great Depression with the same old pre-Keynesian ideas that failed us in the 1930s.

By William K. Black

(cross-posted with Benzinga.com)

My next columns address three writings by Stephen Moore, the Wall Street Journal’s “senior economics writer.”

White Collar Witch Hunt: Why do Republicans so easily accept Neobolshevism as a cost of doing business? [The article appeared in the American Spectator in September 2005.] “Bullish on Bush: How the Ownership Society Is Making America Richer.” [Madison Books, 2004.] We’ve Become a Nation of Takers, Not Makers. [Wall Street Journal, April 1, 2011.]

Moore’s column deplores the debasement of the American economy by government employees.

“More Americans work for the government than work in construction, farming, fishing, forestry, manufacturing, mining and utilities combined. We have moved decisively from a nation of makers to a nation of takers.”

The claim that employees involved in making physical things that are purchased in the markets are uniquely valorous is an odd argument for someone with his professional career (Moore ran the ultra conservative, “supply side” anti-tax group, the Club for Growth). The trade and tax policies he embraces encouraged U.S. businesses to export their manufacturing plants (and their jobs) to low-wage/low-tax nations and to import food produced in those low-wage/low-tax nations. Moore has praised both states and nations that serve as tax havens. He has singled out the Texas model – low wage, low tax, low government services, and hostile to safety rules. Moore has worked for years to punish the “makers” and produce the condition he deplores in which the number of U.S. “makers” has fallen sharply. His column decries the budgetary crises in states and localities, but it was the Great Recession driven by the criminogenic environment his anti-regulatory policies created together with the anti-tax hysteria generated by his repeatedly falsified fantasy that slashing taxes for the rich increases tax revenues that drove that budgetary crisis. Architects of the crisis like Moore who write primarily to excuse their consistent failures should stop. They have done enough damage to the world for a dozen lifetimes.

Consider the implications of Moore’s assertion that people who do not work in manufacturing and farming are “takers.” Under this dichotomy the world is divided between “makers” and “takers,” the biggest “takers” in the world work on Wall Street, the City of London, and the worst kleptocracies – the Wall Street Journal’s core readership. If “makers” of manufactured goods and crops are uniquely valorous, then Moore’s logic requires that it is the workers in these sectors – not the managers, professionals, and clerical workers – who are the actual “makers” who embody that unique valor. (Again, it is passing strange that Moore has dedicated his life to rewarding these uniquely valorous Americans by exporting their jobs and leaving them unemployed or employed at lower wages.) If one can claim to be a “maker” by performing functions that merely assist the actual “makers” make things, then we are all “makers.”

Moore, however, implicitly makes two assertions about government employees – all government employees are “takers” and only government employees are “takers.” Moore doesn’t attempt to support any of his assertions, and they are logically inconsistent. These truths are apparently self-evident to Mr. Moore – people are not created equal. Americans who choose to be government employees are inferior because they are not endowed by their creator with an adequate taste for risk.

“Surveys of college graduates are finding that more and more of our top minds want to work for the government. Why? Because in recent years only government agencies have been hiring, and because the offer of near lifetime security is highly valued in these times of economic turbulence. When 23-year-olds aren’t willing to take career risks, we have a real problem on our hands. Sadly, we could end up with a generation of Americans who want to work at the Department of Motor Vehicles.”

In Moore’s world, an American who wishes to work as a “maker” and develops the skills to be a “maker” has no inalienable right to a job as a “maker” at a living wage. Why? If (1) there really is something particularly virtuous about working in manufacturing or farming, (2) there are too few Americans working in those industries, and (3) the Americans who wish to work in those industries embrace “tak[ing] career risks” and have prepared themselves by education to be able to be productive “makers” why not commit the U.S. to ensure that these virtuous, risk-loving young people can find jobs in manufacturing and farming in the U.S.

Moore is not strong on nuance. All government employees are “bureaucrats” in his parable of “makers” and “takers.” No corporations are bureaucratic. Moore’s fable is crude propaganda. Let us add some reality. Our largest group of federal employees provides national security (DoD, CIA, NSA, DHS, DOJ/FBI, VA, etc.). Many of these “bureaucrats” are living their parasitical life of ease as “takers” in Iraq and Afghanistan. (The virtuous Taliban are busy being “makers” – cultivating poppies.) I do not recommend telling our troops that they are risk-averse “takers” and bureaucrats. The exact number of federal employees engaged in national security is unknown because many employees in other agencies, e.g., NASA, actually work on national security under various degrees of deliberately misleading information. There are over a million federal military personnel. DoD, Homeland Security (DHS), and the VA have nearly a million civilian employees.

The only other federal sector with very large numbers of employees is the Postal Service (around 600,000 – less than one-third the size of the federal workforce in the national security sector). The Postal Service, of course, provides a productive service – communications. Moore does not even attempt to explain why our federal troops or our federal communications workers are supposedly parasitical “takers.” Moore does not even attempt to prove that Americans choose to work for the nation or their State because they fear taking risks. I took far more risks as a federal employee than as a private sector employee. Charles Keating hired private detectives twice to investigate me. He sued me for $400 million in my individual capacity. Another fraudulent CEO also sued me for millions of dollars. Speaker of the House James Wright sought to get me fired. One of the presidential appointees running my agency conducted what he claimed was an investigation of me with the hope that he would be able to get me fired or sued. Charles Keating gave a “secret file” to senior members of my agency that he purported had adverse information about me. The agency excluded me from meetings with Keating and removed our jurisdiction over Lincoln Savings. The head of my agency attacked me publicly in the press and in congressional testimony. (I returned the favor – he resigned in disgrace.) I was a mere financial regulator.

The overwhelmingly dominant sectors of state and local governmental employment are teaching, police, fire, and prison officers and staff. Each of these jobs would be shunned by those afraid to take risks. Moore views this hypothetical as his nightmare of American decline:

“Sadly, we could end up with a generation of Americans who want to work at the Department of Motor Vehicles.”

I have never met a college graduate (the context of this excerpt from Moore’s column) who aspires to work at DMV. I doubt that Moore has ever met one with that career goal. Moore chooses DMV as his example in order to disparage government and government employees. Moore believes that government workers are mediocre. Too scared and too incompetent to work in real jobs, government workers are parasitical “takers.”

“One way that private companies spur productivity is by firing underperforming employees and rewarding excellence. In government employment, tenure for teachers and near lifetime employment for other civil servants shields workers from this basic system of reward and punishment. It is a system that breeds mediocrity, which is what we’ve gotten.”

Ah, yes, the “rank and yank” system and executive and professional compensation have been a brilliant success in “private companies.” Private systems have worked so brilliantly that they destroyed tens of trillions of dollars of wealth by creating a criminogenic environment in which private incentives became so perverse that they drove the epidemic of accounting control fraud that produced a massive financial crisis and the Great Recession. Moore thinks that failed private system should be our model for the public sector. Moore has been disastrously wrong about nearly every major economic policy issue of importance. He has learned nothing useful from his failures.

Mr. Raines explained in response to a media question what was causing the repeated scandals at elite financial institutions:

We’ve had a terrible scandal on Wall Street. What is your view?

Investment banking is a business that’s so denominated in dollars that the temptations are great, so you have to have very strong rules. My experience is where there is a one-to-one relation between if I do X, money will hit my pocket, you tend to see people doing X a lot. You’ve got to be very careful about that. Don’t just say: “If you hit this revenue number, your bonus is going to be this.” It sets up an incentive that’s overwhelming. You wave enough money in front of people, and good people will do bad things.

Mr. Raines was speaking on behalf of the Business Roundtable, which picked him as its spokesperson to explain to the media why the epidemic of Enron-era accounting control frauds was occurring. (You can’t compete with unintended self-parody.) Raines knew what he was talking about – as Fannie’s CEO he employed an executive compensation system that created these perverse incentives. During the crisis, the fraudulent CEOs running the fraudulent liar’s lenders deliberately created intense, perverse incentives among their loan brokers, loan officers, appraisers, auditors, and rating agencies by creating a “Gresham’s” dynamic in which bad ethics drove good ethics out of the marketplace. They were exceptionally effective in achieving the desired results. The CEOs were consistently able to get overstated appraisals, overstated borrower income, clean opinions for financial statements that were not prepared in accordance with GAAP, and “AAA” ratings for toxic waste. CEOs can and do use compensation for good or evil.

Moore’s discussion reveals more about him than about government employees. He can’t imagine employee excellence not based overwhelmingly on fear or quasi-bribery. He can’t imagine anyone wanting to be a teacher, a regulator, a soldier, a firefighter, a CDC scientist, a VA doctor, an FBI special agent, or a police officer. He can’t imagine people who voluntarily accept lower pay than they could get in the private sector because they want to protect people from harm. He can’t even imagine people who want a job in the local prison because they live in rural areas with high unemployment and the prison job is the best way to continue to live and work where they can help a sick mother. People work for the government for myriad reasons. Effective leaders, whether they are in the private or public sector, do not rely on threats or bribes to motivate their teams. They choose good people, train them, praise them, and give them constructive feedback. Effective leaders demonstrate through their actions integrity and dedication to the mission. Accomplishing that mission – teaching a child to read, closing fraudulent banks, putting out fires, arresting rapists, preventing a terrorist attack, or preventing criminals from escaping prison – becomes a matter of the best kind of pride and purpose. Government employees often work far longer hours than required for no additional compensation. This is, for example, overwhelmingly true of teachers.

Why does Moore believe that human capital is so unimportant? His supposed “takers” are the leading “makers” and protectors of the “makers” he claims epitomize valor. It is teachers that help us become productive (and civilized). The police, firefighters, CDC, and the FDA safeguard lives. Does Moore find that unproductive?

The literature on performance pay shows that even when it is not used deliberately by fraudulent leaders to create perverse incentives it can often disrupt work teams and make them less effective by creating divisiveness. It is as if a mother declared that certain of her children were superior to others.

The effort to create performance pay is also perverse because it leads to demands for quantification of performance. Moore errs when he claims the government does not use performance pay. The “Reinventing Government” movement (championed by Vice President Gore and (then) Texas Governor Bush as well as many academics was premised on applying private sector management practices in the public sector. For example, Moore’s column complains about students’ test scores not improving. Student test scores did, infamously, improve dramatically in Houston, as did graduation rates, in response to performance pay tied to test performance and dropout rates. The Houston “miracle” led to Bush’s education program (“No child left behind”). The miracle was actually a fraud. The dropout rates were scammed by the Houston leadership and teachers simply taught to the test.

The SEC and Justice Department use “objective” performance measures to determine bonuses. This increases the perverse incentive to bring cases against minor wrongdoers rather than against the most damaging frauds in which it is far more difficult and time-consuming to obtain convictions.

The other bright idea of Reinventing Government was to order the bank regulators to refer to the banks they were supposed to regulate as their “customers.” That too was a direct steal from private sector management. It is a destructive practice in the regulatory context.

Moore claims that the private sector is always more efficient in providing services.

“Most reasonable steps to restrain public-sector employment costs are smothered by the unions. Study after study has shown that states and cities could shave 20% to 40% off the cost of many services—fire fighting, public transportation, garbage collection, administrative functions, even prison operations—through competitive contracting to private providers. But unions have blocked many of those efforts. Public employees maintain that they are underpaid relative to equally qualified private-sector workers, yet they are deathly afraid of competitive bidding for government services.”

Yes, there are badly designed studies that make these claims, and then there is the reality of privatization. For example, some studies on prison operations find that private prisons are cheaper than public prisons. The problem is that these studies compare average costs of public imprisonment with the costs of private prisons for the lowest risk prisoners. Security drives prison expense, so these studies are meaningless. Privatization can also create perverse incentives. The most notorious example is the CEO of the private prison who bribed judges to sentence innocent juveniles to extensive imprisonment in order to increase the CEO’s compensation.

The private sector can always cream skim some aspects of public services at what appears to the uninformed to be a saving. A private school that does not provide services to special needs students is not more efficient – it is simply taking advantage of a cross subsidy from the public sector.

Privatization does not typically lead to “competitive bidding for government services” by “equally qualified private-sector workers.” The sales of public assets are often not competitive and are not made at market prices. Privatization tends to be a giveaway, making the cronies with the strongest political connections wealthy (think Mexico). I have provided examples of why the “government services” provided under privatization of prisons and schools are often not equivalent because the private sector cream skims the lowest cost aspects of those services, which does nothing to reduce overall costs. The private parties often do not provide “equally qualified private-sector workers.” In college education, for example, GAO studies have found that “for profit” schools have a terrible reputation for endemic fraud. They do not provide equally qualified staff. Private prisons often do the same. Private military contractors are more expensive than government troops and produce recurrent scandals because of their CEOs’ perverse incentives.

American workers do fear the dynamic Moore has long championed. What is the American worker supposed to do if the outsourcing to the private sector is to India and the wages there are one-twentieth of the U.S. wages? That dynamic would lead to the impoverishment of tens of millions of American workers.

In the regulatory world we have just run a real world experiment with applying private sector management theories to the private sector. We privatized many regulatory activities by adopting self-regulation. We used “early outs” to shrink the FDIC (losing many of our most experienced federal employees). We shrank the FDIC by more than three-quarters. The FDIC adopted “MERIT” (non) examination of banks (the “M” and “E” stood for “maximum efficiency). We brought the bank lobbyists “inside the tent” in financial rulemaking, i.e., in creating Basel II. We gave performance bonuses to senior FDIC officials for dramatically reducing FDIC employees. We preempted the State regulators and AGs seeking to protect consumers from predatory nonprime lenders. Each of these actions contributed to the abject regulatory failure.

To sum it up, private sector financial employees, due to the perverse incentives their CEOs put in place and that Moore wishes to spread, were far worse than “mediocre” at hundreds of lenders. The incentives became so perverse that they produced multiple epidemics of fraud and led our most prestigious professionals to aid those frauds. The results were catastrophic. Moore wants to spread those perverse compensation systems and incentives throughout the public sector, where they are even more inappropriate and destructive. We have a catastrophe because the private sector incentives were perverse and the political leaders appointed anti-regulatory leaders to run the agencies. Moore invariably bases his solutions to the problems of the public sector on the private sector approach without examining the problems of the private sector approach or whether that approach makes sense in the public sector. Moore’s theme song is a straight steal from My Fair Lady: “Why can’t a woman be more like a man?” Real men (“makers”) embrace risk and work in the private sector. If only government workers (“takers” – women and men too scared to take those risks) could be made more like the private sector employees all would be solved. In the movie, the song is satire designed to expose male prejudice. Moore doesn’t get the satire.