Robert Reich Connects The Dots to Tell What’s Happened To Our Economy In 2 Minutes

Berkeley Professor and former U.S. Department of Labor Secretary Robert Reich has put together a good, short 2 minute 15 second video that explains a large part of what’s happened to the economy over the last 30 years.

In summary, Reich connects five “dots”:

  1. The economy has doubled since 1980 but wages have been flat.  So where did the money go?
  2. All the gains have gone to the super rich.   And…
  3. With money goes political power.  Taxes on the super rich have been slashed, government revenues have fallen, leading to…
  4. Huge budget deficits. The middle class gets agitated.  To balance budgets, governments slash spending and set middle class to fighting amongst itself…
  5. Middle class is divided.  It fights for scraps.  When borrowing ability dries up, spending slows and can’t return…
  6. We get an anemic recover.

He explains it better (and draws neat pictures, too), but that’s the jist of it.  I would add more such as how the financial industry gained such power in Washington and pushed an ideological but economically flawed agenda of deregulation that led to the monumental but avoidable financial crises in 2007-2009.  But Reich gets the basics right.

Why Students and Young People Should Care About Social Security

James Kwak at Baseline Scenario asks “are Social Security and Medicare programs that benefit the elderly?”  He then proceeds to answer his question with a no and lengthy (but worth reading) explanation in “The Elderly” for Beginners. I agree and I want to emphasize a couple of points he makes.

As Kwak points out, much political discussion about Social Security and Medicare tries to label these successful programs as simply benefits that the elderly are able to grab from younger taxpayers – a form of redistribution of income for charitable purposes. That’s the wrong way to think of these programs.  Other critics of these programs, particularly Social Security, claim they’re just government-run pension schemes that produce lower rates of return than private pension schemes (usually these critics are using distorted rates of return on private pensions that don’t reflect risk, but that’s another discussion).

So how should we think about Social Security and Medicare?  First off, we need to realize that “the elderly” are not some static group of people that’s different from young people, students,or middle-age folks.  The makeup of just who is “elderly” changes every year.  We all get a year older each year.  That means that if you’re a student now or young person or middle-aged person, you’ll be part of the elderly someday (unless you die first, but that’s not much of an alternative).  We all face the prospect of spending part of our lives as one of the elderly. So it’s not about the benefits to the “elderly” as if that’s some other group.  It’s about benefits for all of us, just with different timing.*

Social Security and Medicare aren’t income redistribution charities.  They’re insurance programs. The “benefit” of Social Security and Medicare isn’t just the financial checks paid each year, it’s the protection they provide to everybody, both this year’s elderly and this year’s younger workers.  Protection against what?  Well, it’s protection against some uncertainties of life and of living in our modern industrial society.  None of us knows how long we will live.  Life’s too uncertain. But unlike 200 years ago, there’s a very high probability that most of us will live longer than we can be productive and earn an income.  That means we have to make arrangement while we’re younger and working to put aside some income (savings) for use in our old age.  But how much?  That depends on three factors: what standard of living we want in old age, how long we will live, and what rate of return we can get on our savings.  While we have some choice over standard of living, we really don’t have as much we think since we don’t know what inflation will be in the future.  More importantly, we have absolutely no good idea about either how long we’ll live (and therefore need income) or what rate of return we’ll get.  You see, “long-run average” rates of return aren’t much help.  Markets fluctuate. Returns vary depending on years.  Ask people who retired in 2009 year after the stock market crash of 2008 about “long-run average rates of return”.

Social Security and Medicare are insurance programs.  They protect all of us from these uncertainties about the future.  How do they benefit workers today?  Well, for one thing, the rate of return is certain and the risk is zero.  Without Social Security workers would need to put away even more money into savings than Social Security taxes right now**.  Workers would assume a tremendous risk.  As Kwak describes it:

 would you pay 12.4 percent of your wages for roughly 40-45 years in order to get back [55% of preretirement income] for about 20-25 years.**** There are a few different ways to think about this.

… Most obviously, there is no way to replicate Social Security for yourself. You can’t find an insurance company that will sell you an annuity on Social Security’s terms in exchange for 12.4 percent of lifetime earnings, and that’s not just because Social Security exists. No insurance company could afford to offer such a product without mandatory participation, because of adverse selection; and if any insurance company does offer you such a product, you shouldn’t believe that they will still be around when it comes time to collect your benefits.

More importantly, you don’t know at age 21 whether you will be a low earner, a median earner, or a high earner, although you may have some idea. The progressive benefit formula gives you insurance against your career not working out as well as you might have hoped. Sure, if you’re a 45-year-old corporate executive making half a million dollars a year, you will be a net loser from Social Security, but that’s not the question; you can’t decide whether to buy insurance after you find out if the insurable event occurs. There are certainly some people who would opt out at age 21 if they could — notably, the scions of the rich, who don’t need old age insurance — but rationally speaking, it’s not just the people with below-median earnings potential who benefit from the existence of Social Security, it’s also a lot of the people with above-median earnings potential.

These type of insurance programs fall into the realm of what economists call “social insurance”.  That is, they only work well if everybody is covered  – all of society without some people being able to opt out.  Second, the program needs to be government operated since it’s the only organization that can be relied upon to be here to pay off. No private corporation can make that assurance.  Programs such as this work very successfully in all developed industrialized nations.

* Social Security also provides significant payments each year to younger people: child survivors of deceased SS beneficiaries and the disabled.

** There’s also a macro economic issue here.  If there were no Social Security, private savings would likely be too high to support ongoing GDP growth in aggregate demand, leading to recurring recession and slow or no growth.  

What to Call This Unpleasantness? Little Depression or Workers’ Depression?

Brad Delong has had enough.  So have I.

“The Little Depression”

Back in late 2008 people asked me: is this a recession or a depression? I said that I would call it a depression if the unemployment rate kissed 12%. I said that I would call it a depression if the unemployment rate stayed above 10% for a year.

Neither of those has come to pass. But the unemployment rate has kissed 10%, and has stayed at or above 9% for two years now.

So I am moving the goalposts. I am adopting a suggestion in comments of Full Employment Hawk . Henceforth, I will call the current unpleasantness not “The Great Recession,” but rather “The Little Depression.”

It’s a good question.  In late 2008 when people were asking me, I said I wasn’t sure.  It would either be “The Great Recession” or “The Lesser Depression”, I said.  Eventually I fell in line with most commentators and referred to it as “Great Recession”.  But with the continuing bad, very bad, news on employment, wages, and growth, I’m with Brad.  We need to call this what it is.  It’s not been a “Great Recession”.  Recessions are events when the central bank says things have gotten out of hand, they raise interest rates, and everybody sobers up.  Then after an appropriate time of perhaps 6-12 months, the growth machine fires up and we start to regain lost territory.  This is different. We aren’t regaining lost ground and people are suffering.

What most folks are calling the “Great Recession” I think we ought to call the “Panic of 2008”.  It was, after all, a good old-fashioned financial panic updated with 21st century technology and corporate forms. It lasted roughly the time period the NBER says was the recession.

What has me going though is the continuing poor conditions for the millions of Americans.  This unpleasantness has gone on too long and been too severe to call it recession.  It’s a depression of some form.  The problem here is how to distinquish it semantically from the Great Depression of 1929-1940, or the Long Depression of 1873-1896.  My personal preference is for Workers’ Depression.  I think it sums it up.  For the banks and rentier classes, it’s good times again.  It’s only for working stiffs that things continue so ugly.  But if people want to use “Little Depression”, I could go along for the sake of clarity.

Solar Power Looking Brighter Economically

John Quiggin of Crooked Timber sends us to for “Solar Gets Cheap Fast” for good news about solar power.  The cost of producing solar photovoltaic cells (the silicon-based cells that convert sunlight to electricity) has been declining consistently at 20% per year since the early 1980’s.  Solar power is now close to the point where it is cost-competitive with fossil-fuel (coal, natural gas) and nuclear.  When we consider that any new coal-fired power plants will take 5 years or more to build (nuke even longer), then solar is now in the competitive horizon.  This is great news.

It really shouldn’t be news though.  We should have expected it.  Anytime a new product/technology goes into production, per-unit costs generally decline.  And, they generally decline at a predictable rate.  Two micro-economic phenomena combine to produce this predictable declining cost curve.  The first is often described in principles textbooks (although often over-stated):  economies of scale.  As production volumes get larger, often (not always) per unit costs decline because cheaper production technologies become feasible – it’s the phenomenon of mass production.  But another curve is involved.  It’s called an experience curve. Basically an experience curve summarizes how, even with using the same scale technology, as producers get more cumulative experience with producing the item, they produce it more efficiently.  In plain talk it’s called learning-by-doing.  It’s a staple of many business strategies, particularly in electronics.  While the specific improvements aren’t foreseeable ahead of time, the fact that costs will decline is predictable.  In other words, it’s predictable that we will learn.

Socially and economically, the arrival of wide-scale solar electricity generation is a good thing.  Solar electricity generation doesn’t create green house gases or other pollutants. It can be more effectively decentralized, relying less on huge power plants. The systems involved aren’t dependent on the kind of complex safety systems that make nuke power and coal dangerous. It doesn’t require a huge distribution and logistics network to mine/drill and transport a scarce natural resource like coal or gas.  And, solar installations can do double duty.  Unlike growing plants for bio-fuel or strip mining for coal, solar can be generated on top of existing buildings.   Critics often claim that solar is unreliable because “the sun doesn’t always shine”.  But solar system fit well with the demand for electricity.  Demand for electricity peaks in summer when the sun shines the most (think air conditioning). So the condition that creates peak demand for electricity is exactly the condition that generates solar power.  Further, newer solar systems are increasingly capable of generating electricity (albeit not as much) from just daylight even when bright sunlight is not present (does your solar-powered calculator stop indoors?).  Personally I’d rather trust the sun to rise each  day and provide daylight than to trust that engineers have perfect control of the safety of an inherently dangerous and polluting power plant (Fukushima anyone?).

The arrival of cost-effective solar power is also an object lesson in why government subsidies are often justified for new technologies.  Often, when new technologies are invented, the costs (“business case”) are too high to be practical or competitive with existing alternatives, despite the conceptual attractiveness.  We have a “new technology chicken-and-egg”.  Private investors and private firms won’t touch the new technology because it will take too long for costs to decline to a point where they can make the kind of high returns they want.  It’s too risky for them and too-long range.  Private investors and corporations really don’t think very long term.  But, until somebody actually begins producing the item we don’t gain the benefits of economies of scale or learning experience.  It’s at times like this that governments can play a great role.  Governments, by borrowing at the lowest interest rates, can take the long-run view.  They can invest because the benefits will be social and benefit the larger economy later.  Governments have, in fact, been key to creating new technologies and economic growth throughout the last several hundred years.  The telegraph, the telephone, electrical generation/distribution, canals, railroads, improved ocean navigation, computers, networks (including the Internet and World Wide Web that brings you this story), automobiles, aircraft and airlines — all these were dependent upon government early on and would not have happened had it not been for government.

That’s not to say government should always own, operate, and scale up the businesses that do it.  There’s a variety of mechanisms for government to seed and feed new technologies.  But that’s a different discussion.

U.S. Life Expectancy Falling In Some Parts

I learned long ago when working in applied economics that averages (means or median data) often hide as much information as they impart.  To really understand an issue, we need to look at the variation or distribution.  Therein always lies a tale.  Yves Smith at Naked Capitalism (also the author of Econned), brings our attention to one such disturbing long-run indicator: life expectancy.  Despite the overall average life expectancy in the U.S. having risen significantly over the last decades, this longer lifespan is not evenly distributed.  In some counties in the U.S., life expectancy has been declining – and that was before the Great Recession/Workers Depression/Financial Unpleasantness.  (italic emphasis is mine; bold is from original):

Life Expectancy Fell in Many Counties in the US BEFORE the Crisis

A rising tide did not lift all boats even when the economy looked a lot better than it does now. As Francois T, an MD and medical researcher, wrote:

If you need ONE Indicator of how a nation is doing, it ought to be female life expectancy at birth. It is a tell tale sign that a lot of good things, (or bad things) are happening in the nation under study. … people severely underestimate the real repercussions and total costs of a decrease in female life expectancy at birth.

He pointed to a just-released study, Falling behind: life expectancy in US counties from 2000 to 2007 in an international context. Some of its major findings:

Large swaths of the United States are showing decreasing or stagnating life expectancy even as the nation’s overall longevity trend has continued upwards, according to a county-by-county study of life expectancy over two decades.

In one-quarter of the country, girls born today may live shorter lives than their mothers, and the country as a whole is falling behind other industrialized nations in the march toward longer life…

Some US counties have a life expectancy today that nations with the best health outcomes had in 1957 … Five counties in Mississippi have the lowest life expectancies for women, all below 74.5 years, putting them behind nations such as Honduras, El Salvador, and Peru. Four of those counties, along with Humphreys County, MS, have the lowest life expectancies for men, all below 67 years, meaning they are behind Brazil, Latvia, and the Philippines.

And get a load of this:

Despite the fact that the US spends more per capita than any other nation on health, eight out of every 10 counties are not keeping pace in terms of health outcomes. That’s a staggering statistic.

Yet looking at this map (click to enlarge), …

And remember, the data in this study goes through 2007. It will take a few years to find out what impact the crisis has had on the health of America’s citizens.

Life expectancy is strongly correlated with real income and socio-economic status within society.   Yes, from a medical standpoint, it’s smoking, type 2 diabetes, obesity, and hypertension that are what limit life expectancy (once child mortality is defeated).  But the incidence of smoking, obesity, etc. is all highly correlated with real income, status, and quality of health care.   Rich people generally don’t smoke, can afford to eat high-quality nutritious food, and get quality health care.  Poor people tend to smoke, get high-fructose corn syrup instead of nutrition, and get lousy health care, if any.

The U.S. simply doesn’t get value for money for all the money it spends on healthcare.  It’s the healthcare system that’s broken.

We’ve Had Class Warfare Since 1980 – The Workers Lost

Whenever some politician, typically a progressive, begins to talk about redistribution of income,  the more conservative politicians, backed by “serious political pundits” counterattack by claiming “class warfare”.  It’s apparently one of the givens in Washington that any form of redistribution of income, be it by progressive taxes, measures to protect unions, help to the unemployed, or limits on the power of bank executives to pay themselves bonuses from bailout monies, is off-limits.  The problem with this self-censorship of the political debate is that it ignores reality. Class warfare was already launched 30 years ago in the early 1980’s.  The catch is that capital, that is the owners and managers of capital, declared the war and they’ve been winning.

As the graph shows, the share of non-farm income that goes to labor was relatively constant for the 30-some year “golden age” after World War II and until around 1980. It fluctuated significantly with the business cycle, but maintained a long-run relatively constant share. This was consistent with the institutional, cultural, and political economy arrangements of the period. There was essentially a social contract that said labor cooperated with capital to achieve productivity improvements with the understanding that gains would be shared: both workers and owners of capital would benefit. This is basis of the rising real median incomes that I’ve noted elsewhere for the period.

But starting in the 1980’s there was  a shift in American politics.  Initially it was with conservatives and Republicans, but it soon included Democrats. Capital came to be favored. Unions were disfavored. Income taxes were lowered on high incomes while payroll taxes (social security and Medicare) were raised on workers.  The result was a trend where workers found it difficult to keep pace.  In fact, their real incomes didn’t.  If workers were in the lower quintiles, their real incomes actually declined.  Starting in 2000 the trend accelerated.  Workers get less and less of the value of what’s produced.  Corporate profits and financiers get more and more.

Instead of false debates about debt ceilings based on provably false doctrines, I think this is the type of thing we should be debating in politics.  Is this good? I don’t think so. It feeds income inequality.  It’s part of what’s destroying the “American Dream” for hundreds of millions of Americans.

Are High Oil Prices All About Supply & Demand? Maybe Not

A couple of days ago I talked about how high oil and gas prices pose a threat to the “recovery” of the economy. Now I want to turn to the causes.  Why are oil and prices high?  Is it all just supply and demand, or are there more sinister forces at work?

Many, and I’d venture to say most, mainstream economists tend to say it’s simply supply and demand.  The world, particularly China, is consuming and demanding larger quantities of oil at the existing prices (demand curve is shifting rightward).  They also assert that the cost of getting new oil is increasing as easy-to-get reserves dwindle and drilling for new oil gets more exotic and costly. This shifts the supply curve to the left. That’s a textbook description of how to get rising prices.

I’ll accept that this may be a major part of the story, but to me there’s still something else going on.  Simple supply and demand in the cash delivery markets for oil don’t seem to explain the specifics of either the 2008 spike or the 2011 spike in prices.  In 2008 prices spiked significantly in a few short months with gas reaching $4.00 a gallon by summer.  Yet the U.S. and the other major developed, industrial countries were actually slowly sliding into recession at the time.  Recession reduces the demand for oil.  Earlier this year, the supposed story was the sudden stoppage of Libyan shipments of oil in February.  But Libya only accounts for a little less than 2% of world supply.  Even with a very inelastic demand curve, the price increases seemed out of line.

Of course I’m not alone in thinking there’s something else going on.  Two common ideas are that oil speculators are causing the damage by driving the oil futures price too high and that oil companies are conspiring to raise the prices.  I’ll take the latter first.  I’m skeptical of an oil company conspiracy to raise prices.  It’s not that I doubt they would if they could, it’s just that even with the concentration in the oil industry, I don’t see a price fixing cartel as being feasible.  Too many different cultures of companies and way too many ways to cheat on the cartel.  Historically OPEC has had a hard time getting it’s member producing countries to hold to their own quotas.  I just don’t see it.  Besides such an oil company conspiracy doesn’t explain the timing.  Don’t get me wrong, I fully expect the oil companies are milking the market increase in prices for all it’s worth, including shady practices.  Yes, they mark up the refined inventory immediately to match replacement costs for new crude when price goes up, but they won’t mark down inventory prices until it’s sold when crude prices decline.  Not a savory bunch of characters, but I still don’t see them as the cause.

Instead, I’m inclined toward the speculators theory as being significant.  Normally, most economists are loathe to blame speculators as the cause of high prices for delivered & produced oil.  This is because most speculators don’t actually buy oil. They buy “futures contracts”. (for an explanation of futures contracts, see my post “What’s A Derivative?“).  Economic theory of futures contract markets suggests that it’s extraordinarily difficult to artificially manipulate the eventual delivered price of a commodity by driving up the futures prices.  Or at least the theory suggests it’s tough to do for a long period of time.  If futures prices are irrationally high, meaning they are higher than physical supply-and-demand justify, speculators who buy at the too-high futures price will eventually lose money when the contract fulfills physically.  For example, suppose they contract now in June to buy a barrel next December at a fixed price of $110 even though today’s June delivered price is only $100.  That’s speculation.  They are speculating that the physical price in December will be even higher than $110, say at $120.  They’ll take their barrel at $110 in December and sell it in the open December physical market and make a profit. They hope, that is.  If the futures prices are consistently too high – meaning they forecast future high delivered prices – but the physical delivered prices never get that high, then the speculators take a loss.  That’s mainstream accepted theory and dynamics.

But the mainstream (and theoretical) view is based on the assumption that now player (buyer) in the market is large enough to manipulate the market.  The mainstream view also holds that the “fundamental prices”, meaning the physical supply-and-demand, must ultimately keep the futures market honest.  Historically that’s been true for oil and a few other very widely traded commodities.  But it’s also been possible in the past for some thinner traded commodity futures contracts to get manipulated.  The Hunt brothers in the 1979-1980 got caught in a famous attempt to corner the silver market. One of the keys to Hunt brothers’ attempt was extraordinary financial leverage.

What I’ve wondered about in both 2008 and this year is the possibility of the major banks, the global scale too-big-to-fail banks, through favored hedge funds and off-balance sheet trading operations could be manipulating the market.  In my scenario, I picture a classic 1920’s style stock market “corner” style operation.  A few major operators with deep pockets keep trading with each other. They keep driving the futures price up and up.  Then as the rising prices attract attention, the littler investors begin to enter the market to get in on the “action”.  That’s when the bank traders start to sell. Initially they keep the price rising, but eventually the bank shorts oil futures and pulls the rug out.  Futures prices collapse back to more realistic levels and the banks get richer – trading profits it’s called.

I have no real evidence of this, nor do I have the time to investigate.  I think it’s a possibility though.  After all the big banks are showing record profits this year and last, and they sure aren’t doing it by making constructive loans to get the economy going.  It’s mostly all “trading profits”.

Recently this news came out that the Commodities Futures Trading Commision has filed charges against some speculators alleging a scheme in 2008 to manipulate physical inventories to create the appearance of tight supplies and then make a killing in the leveraged futures market on the price moves.  So may indeed be possible.  And the speculators charged here are relatively small beans compared to the financial resources of the big banks and hedge funds.

I’m just sayin’ I’m not convinced at all that it’s just all supply and demand in the physical market.