States and Markets 2

Sociology 2, Class 5Copyright © 2008 by Evan SchoferDo not copy or distribute without

permission

Announcements• I’m signing add cards…

• Today’s class• Wrap up “States and Markets”

• Start new topic: Economic globalization

In the News…• Frontier Files for Bankruptcy Protection

• AP, DENVER - Frontier Airlines sought bankruptcy protection Friday, the fourth carrier to do so over the past several weeks as exorbitant fuel prices eat into earnings and a weak U.S. economy keeps more people grounded.

• But, something different here:• Frontier Airlines, the latest airline to file for bankruptcy, was

pushed over the brink by a problem that could spread to other carriers: credit card troubles.

• Reuters: "This was very sudden and unexpected," said Menke in a letter to Frontier's employees. "We are the victims of a credit market that is very fragile and the tolerance for risk is extremely low."

In the News…• Issue: Credit crisis intersects with airline troubles

• All companies depend on credit (borrowed money)

• Credit processing firms became unwilling to extend credit to Frontier airlines

• Result: Frontier suddenly didn’t have enough cash to operate…

– Why did the credit processing firm “cut off” Frontier?• Answer: The credit crisis is spreading…

• Mortgage banks and other lenders got in trouble for lending too much… Now EVERYBODY is lending less…

• Since some airlines went bankrupt, credit firms started to worry about Frontier airlines... And stopped lending money to them

– But, it ended up being a self-fulfilling prophesy

– Fears of problems no more credit/loans real bankruptcy!

In the News• Fewer Options Open to Pay for Costs of College

– New York Times, April 12, 2008.

• Credit crisis is also affecting college loans…– Companies are hesitant to loan money to anyone… Including you…

• “Parents will have to navigate unfamiliar and difficult terrain when it comes time to pay for college this year, with student loan companies in turmoil and banks tightening their standards and raising rates on other types of borrowing.”

• “Lawmakers and the administration are trying to head off any crisis by making sure that “lenders of last resort” stand ready to take the place of companies that have left the federal loan program.”

– In short: the state is stepping in to help provide loans, since markets aren’t working so well right now…

States and Markets

• 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

• Government can control economy via taxes

• Decreasing taxes can:– Create short term growth

• By increasing spending, consumption

– Encourage investment, increasing long term growth

• But, there is a trade-off. Low taxes mean either:– 1. Limited government services

• Less infrastructure, education, etc.

– 2. Or, more debt• Which leads to inflation and eventually limits growth.

Review: Fiscal Policy

• 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.

Monetary Policy

• The government also acts as a bank:• The “Federal Reserve Bank” is a bank set up by

the government to store a reserve of money• Also called “The Fed”; general term: “central bank”

– The Fed lends money to other banks• Who in turn, lend to people and companies

• The “Fed” uses its stores a pool of money to:– 1. Prevent financial disasters

• Example: The “run” on banks in the Great Depression• Rescuing Bear Sterns in 2008

– 2. To adjust the economy• Prevent boom/bust cycles via “monetary policy”.

The Fed and Interest Rates

• What are “interest rates” and 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

• Upside: short-term growth, lower unemployment

• 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.

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 100K)

– 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

– Krugman article: Banks chafed against regulations…• They circumvented regulation by creating new orgazations &

services (e.g., Hedge funds) – a “shadow” banking system• Result: Banks took huge risks; some made billions. Some

went bankrupt.– But, bankruptcy is on such a large scale that it is hurting the entire

economy!

Regulating Wages and Prices

• Example: The federal gov’t minimum wage– The Fair Labor Standards Act (FLSA)

establishes 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 $5.15 an hour.

• Source: http://www.dol.gov/esa/whd/flsa/

– Note: California has another minimum wage law, raising it 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

• Question: What might happen of wages were “deregulated”?

• Question: What if the minimum wage was increased to $20/hr?

State Ownership

• Finally, governments can own factories, railroads, electric power plants, etc. – or anything else.

• Definition: 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 government-run 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 (usually)• Government organizations tend to be subject to greater

scrutiny and accountability, compared to private companies– 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– No competition: Little 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 tempted to 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 tends to be high

– Regulation: Expanded, elaborate• Industries and markets are stabilized, controlled

– Ownership: Many industries are nationalized• “Private sector” is smaller.

Keynesianism vs. Free Markets

• The “Free Market” state:– Fiscal Policies: Low taxes, low spending

• Minimal government; Money controlled by people, firms

– Monetary policy: Conservative (higher interest rates)• Inflation is kept low. Less effort made to keep

unemployment low. (Workers experience more “pain”)

– Regulation: Minimal• Industries are free to do as they wish

– Ownership: Industries are “privatized”• Government keeps out of business.

States, Markets, Globalization• From 1980 to the present, governments have shifted

• Away from Keynesian / Welfare-state systems• Toward free market capitalism

• Result: Economic globalization has accelerated– 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 even more pro-market• Globalization reinforces pressures away from Keynesian

policies and toward even freer markets…

– Where is a multinational likely to 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

– Example: 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…