States and Markets

Sociology 2, Class 3

Copyright © 2010 by Evan SchoferDo not copy or distribute without

permission

Announcements• Add cards:

• Class remains pretty much full, but I can sign a few more. See me after class

• Class schedule:• States and Markets• Next topic: Economic globalization

• Today:• Wrap up Commanding Heights Part I

– Apologies to those in Thursday section… it will be out of order…

• Lecture: States & Markets – basic concepts & definitions.

Airline Bankruptcies 2001-9

Airline Bankruptcies• A partial list of airlines that went

bankrupt in the last decade:• Northwest Airlines• US Airways• Delta• United• TWA• Aloha• Sun Country

– In 2004 there was a period where 4 of the 7 largest airlines were all operating under “Chapter 11” bankruptcy protection.

Airline Bankruptcies• What does “Chapter 11” mean?

• Is it really that bad? After all, the planes keep flying…

• In short: Happens when a company can’t pay the bills… is losing money badly

• Owes a lot of money to “creditors” (banks, etc)

• Option #1: “Liquidate” – Close the company, fire all the workers, sell all the planes

• The “proceeds” of the sale go to the creditors• Like when a car is “repossessed”• Downsides: Destroys the company; but usually

doesn’t raise enough money to pay off debts; workers feel “pain”.

Airline Bankruptcies• Option #2: “Restructure”

– Filing Chapter 11 protects a company from creditors• Under court supervision, the company negotiates with

creditors• OK… I can’t pay you 500 million in September… how

about if I pay you 300 million in October?

– There is the potential for “win/win”• Creditors get paid back more $$ compared to liquidation• Company keeps operating

– BUT: the company has to radically cut costs & increase profits to please creditors• Union contracts are re-negotiated, workers are fired,etc.

Airline Bankruptcies• Issues to reflect on:

– Why did deregulation/competition led to bankruptcies?

– Was deregulation worth it?• It produced 30 years of cheap flights

– improved competition; better “service”– stockholders & executives made millions

• But, now we have a “bust”… – Workers feel pain – lost jobs and reduced wages– Government bailed out airlines after 9/11– Government bailed out many airline pension plans; etc.

– Would slightly more regulation have helped?

Commanding Heights Video

• Background– Total dominance of Keynesian ideas from

1950-70• State ownership of many industries

– Ex: Coal in Britain

• Strong regulation of industries– Ex: Airlines

– Strong economic growth in 50s/60s, but severe recession in 1970s• Some blamed Keynesian policies• Revival of Hayek’s ideas: free markets, increased

competition, less regulation

– Video: Airline deregulation & the Reagan/Thatcher revolution…

Commanding Heights Video

• Chapter 14 (Airline deregulation) – to end…

Econ Basics: Definitions• Gross Domestic Product (GDP)

• “gross” means “total”

– Definition: The total economic value of goods & services produced within a country• Note: GDP is often measured “per capita,” which

gives a sense of wealth per person

• GDP in 2008 (CIA World Factbook):– United States: $14,400,000,000,000 –

trillions!• $46,800 per capita

– Brazil: $2 trillion, $10,200 per cap– Liberia: $1.5 billion, $500 per capita.

Econ Basics: Definitions• Economic Growth: An increase in GDP

– Growth means: more production, more profits, more wealth, more jobs, more income, more consumption, more everything!

– Growth is generally considered a good thing• But, environmentalists foresee ecological limits

• Recession: A period of decline in GDP• Fewer jobs, less consumption, etc…

• Depression: A period of severe and protracted decline in GDP

• Massive unemployment, poverty, hunger; political unrest.

Econ Basics: Growth• Why do economies grow?• Long term growth comes from:

– New technologies• Ex: Machines allow people to produce more goods

– Increased skills and efficiency of labor force• Ex: Highly educated workers can get more done

– Investment• Ex: Money spent to build more factories

• Short term growth can be sped up by:– Greater consumption by people, firms, states

• Spending $$ creates demand, speeds up economy.

GDP = Prosperity?• Question: What is the relationship

between GDP growth and prosperity?– Answer: It depends on who you ask– Political conservatives argue that growth is

the best route to prosperity• In the long run, the poor are better off in a fast

growing economy, even if the rich get most of the reward

• Imagery: Rather than divide the “pie” evenly, the pie needs to grow so everyone’s piece gets bigger…

– Political liberals have generally stressed the importance of social equality• Plus, other concerns like the environment.

Econ Basics: Business Cycles• Issue: Economic growth isn’t always

smooth• Capitalist economies are prone to cycles of

“boom” and “bust” – the “business cycle”– In good times, everyone gets optimistic, builds a

lot of factories… economy and jobs boom• Unemployment is very low, wages and prices go up

– Eventually economic capacity becomes too great• More is produced than people are willing to buy• Firms have layoffs or go bankrupt, unemployment

goes up, prices go down.

Econ Basics: Business Cycles• Issue: If unemployment goes too high

then consumption drops• Without consumer spending, economy can go

into a deflationary spiral…• Ex: The Great Depression…

• In general, governments use policies to avoid extreme cycles

• Example: Unemployment insurance– Provides money to the unemployed to avoid a

downward spiral

• Example: Setting interest rates– We’ll discuss this later.

US GDP Growth 1970-2010

States and Markets• Issue: How is the state related to

markets?• Marx was right about some things:

• We all depend on the economy for our well being!

• States cannot exist and function without resources from the economy

• Historically, states have tried to generate economic growth

• Either for the collective good, or in order to wage war.

States and Markets

• Question: Can markets exist without states?• What do you think? What does capitalism require?

• Answer: No! (at least not on a large scale)• Capitalism requires:

• Private property – protected by laws, police, courts• Legal systems – to enforce private property, contracts• Infrastructure – roads, ports, etc…• National defense• Regulation of markets

– People disagree about how much… but most favor some degree of regulation to prevent huge disasters, fraud, etc…

States and Markets

• Question: Why do states try to affect markets?

• 1. To improve the economy• Encourage growth• To “smooth out” the business cycle

• 2. To affect society more broadly– E.g., via incentives or government spending

• Change distribution of wealth• Reduce environmental degradation, reduce

discrimination, improve medical care, etc…• In short: To achieve things that markets don’t

always do by themselves: “Collective goods”.

States and Markets

• Question: How can states affect markets?– 1. Fiscal policy – taxes and spending– 2. Monetary (money) policy – printing &

lending money– 3. Laws and Regulations– 4. Direct ownership of production

• I’ll discuss examples of each…

Fiscal Policy: Taxes

• Fiscal Policy: Government policy regarding taxation, public revenues, or public debt

• Taxes generate revenue for the state• What does the government tax?

• Individual income• Corporate income• Transactions (sales tax, taxes on trade)• Property owners• Activities that require fees (e.g., driving, fishing,

etc)

– By taxing some things more than others, states can affect social and economic behavior.

Fiscal Policy: Taxes

• 1. Government can adjust economy by setting the overall tax rate– Highest federal income tax rate in US is around

35%• Actual taxes paid are lower due to loopholes, etc.

– Low taxes can create short term growth• By increasing spending, consumption

– Low taxes also can increase investment, increasing long term growth

– Higher taxes support more government services• And allow greater redistribution of wealth in society.

Fiscal Policy: Taxes• 2. Government can use taxes as

incentives• High taxes on cigarettes may reduce consumption• Tax breaks for “clean energy” may increase usage• High taxes on imported goods reduce trade

• 3. Government can tax to redistribute wealth

• Government can target groups:– Wealthy vs. poor, old vs. young, people vs. companies

• “Progressive” tax system = shifts $ toward poor• “Regressive” tax system = shifts $ toward rich

– Ex: Sales taxes & flat taxes tend to be regressive.

Examples: Bush Tax Cuts• 2001: Economic Growth and Tax Relief

Reconciliation Act of 2001 (EGTRRA)– Reduced income tax rates (percentage people

must pay)– Dividend tax rate reduction

• Dividends = profits given to investors

– Goals: Encourage people to spend, invest: speed up the economy…

– Reaction from economists: Mixed. • Cuts mostly benefits the rich, who may not spend

the extra $$ (which stimulates the economy)• Very costly (government already had budget

deficit).

Fiscal Policy: Spending

• Government can also affect economy by adjusting how it spends money

• Budget deficits occur when the government spends more than it earns in taxes in a year

• The government can do this by borrowing money…• Result: the national debt increases

• Budget surpluses occur when the government spends less than it earns

• Current national debt: 12,300,000,000,000

• Over 40,000 per person• Large government debt can harm the economy.

Fiscal Policy: Spending

• Government spending can “jump-start” the economy

• State may spend directly, or give money to people

– Keynes: “Government should spent against the wind” • Example: “New Deal” spending, war spending

helped create jobs and economic growth

• But, consistent high government spending can harm economic growth

• High deficits, debt can lead to inflation• Example: “stagflation” in 1970s.

Example: The “Stimulus Bill”

• The “stimulus bill” is an example of fiscal policy

• Provides tax cuts and spending with the goal of speeding up the economy during a recession

• “American Recovery and Reinvestment Act of 2009”

– States goals:• Reduce unemployment• Increase economic growth

– Main Provisions:• 288 billion in tax cuts to individuals and businesses• 224 billion in additional funding for education, health

care & entitlement programs– Extending unemployment benefits, aid to schools, etc

• 275 billion for federal contracts, grants, loans– Build roads, renewable energy, weatherizing homes, etc.

Effects of Stimulus: Multipliers• How much does each dollar of stimulus

increase the GDP?• Answer: It depends on where the money

goes• Stimulus has no effect if the recipient doesn’t

spend it• Stimulus can have a large effect if the recipient

spends it in a way that starts a “chain reaction”– Ex: An infrastructure project: Gov’t gives it to a road

building company, company gives it to a worker, worker buys food, grocery store owner expands business… etc

• The size of the effect is called a “multiplier”– Ex: A multiplier of 1.5 means that each dollar of stimulus

generates 1.5 dollars of GDP.

Effects of Stimulus: Multipliers

• Multiplier estimates from the Congressional Budget Office (CBO), March 2009

Type of Spending Estimated Multiplier

Infrastructure projects 1 - 2.5

Transfers to people (ex: unemployment insurance)

.8 - 2.2

Tax cuts for wealthy .1 - .5

Impact of US Fiscal Policy on GDP

Source: Goldman Sachs, via Krugman NYT Blog

US fiscal policy has large

positive impact on GDP from mid-2009 to mid-2010.

US spending peters out after

that…

The Stimulus Bill: Debates• Current debate:

– Democrats / Keynesians: Stimulus bill is a good idea… increases growth & employment• Benefits outweight the debt that is incurred• In fact, some economists argue that we need a

second round of stimulus…

– Republicans / conservative economists: Stimulus bill is a bad idea: causes too much debt

– Could cause inflation and inhibit long term growth

• Some conservative economists actually reject the idea that spending has a stimulative effect

• Conservatives more concerned about debt and inflation that unemployment & short term growth.

Monetary Policy

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

by the government to store a reserve of money

– Operates independently of political control

• Called “The Fed”

– Other countries have them, too• General term: “central bank”

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

Monetary Policy

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

• Example: The “run” on banks in the Great Depression

– Banks collapsed and government didn’t help out

• Example: In 2008 banks collapsed and the government aggressively stepped in

– Including TARP

– 2. To adjust the economy• Prevent boom/bust cycles, keep inflation low• It does this by setting interest rates

– And, recently, by intervening directly (buying or selling things).

The Fed and Interest Rates

• What are “interest rates”; why do they matter?

• Interest rates are like rates on a credit card, car loan, or student loan

• If rates are high, you will buy or spend less– Because you’ll have to pay a LOT of interest later…

• If rates are low, you can buy more now

• Critical issue: The Fed chooses the interest rate it will charge to lend money– The Fed is so big that other banks follow its rates

• Thus, the Fed effectively sets rates for the whole economy.

Monetary Policy

• The impact of the “Fed’s” rate policies:• Low rates stimulate the economy

• Also called “expansionary” or “loose” monetary policy

• Encourages people to spend, companies to invest• Downside: higher inflation

• High rates slow the economy• “Tight”, “contractionary,” or “conservative”

monetary policy• High interest payments mean that businesses and

people are less likely to borrow, spend, invest.

US Interest Rates 2000-2009

Rates lowered during recession following dot-com

crash and 9/11

Rates drop to zero in current

recession

The “Lower Bound” Problem

• Issue: What if you want to speed up the economy more, but you’ve already lowered interest rates to zero?– Answer: You’re stuck (mostly)

• Traditional monetary policy loses effectiveness in extreme economic conditions

» See Krugman book: “The Return of Depression Economics”

• Japan in the 1990s – the “lost decade”• But, the Fed tries ‘non-traditional’ strategies

– Ex: Buying non-treasure assets

– Implication: Fiscal stimulus is the main strategy to deal with the current recession.

Laws and Regulations

• States affect markets by imposing laws and regulations of many kinds– Competitiveness laws: prevent monopolies

or limit what monopolies can charge• Ex: Prevent price gouging

– Consumer protection laws• Ex: FDA prevents sale of tainted meat

– Laws regulating markets• Protect against fraud, volatility

– Regulating particular industries• Prices, access to markets, etc.

Laws and Regulations

• States affect markets by imposing laws and regulations of many kinds

• Example: Airlines– 1. States impose safety regulations on

airlines• Ex: Federal Aviation Administration (FAA) inspects

planes, requires airlines to do regular maintenance• Why bother? Companies have a market incentive

to avoid crashes, which are costly…– Planes destroyed, reputation damaged… which harms

future sales

• Are market incentives enough to make you trust airlines?

Laws and Regulations

• Example: Airlines– 2. States regulated airline prices to reduce

competition• Created industry stability, at the cost of

competition• But, those regulations were ended in the 1970s

– Note the trade-off: stability vs. efficiency• Ex: Regulation stabilized airlines, but reduced

competition; deregulation had the opposite effect.

Laws and Regulations

• States affect markets by imposing laws and regulations of many kinds

• Example: Subsidies to agriculture• US gives tens of billions a year to farmers

– Keeps industry stable – fewer bankruptcies• US farmers don’t have to be as efficient

– Issue for future discussion: This harms farmers in poor countries…

Laws and Regulations• Governments regulate banks to protect

consumers– Generally, limiting the risks banks can take with your

money…

• Ex: FDIC – government guaranty that your money is safe in a savings account (up to 250K per bank)

– Banks are forced to pay money for such insurance; they’d rather not

• Ex: Reserve requirements – Banks must keep some money on hand, just in case of crisis

– They’d rather not do this… because they could make more $ otherwise

• Ex: Limits on “leverage” – risky investments– Banks can make more profits if they take more risks…

but they might go bankrupt!

Regulating Wages and Prices

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

1938 established minimum wage, overtime pay, recordkeeping, and child labor standards affecting full-time and part-time workers in the private sector and in Federal, State, and local governments. • Covered workers are entitled to a minimum

wage of not less than $7.25 an hour.– Source: http://www.dol.gov/esa/whd/flsa/

• Note: California has another minimum wage law, raising the minimum to $8.00.

Regulating Wages and Prices

• The minimum wage also reflects a trade off

• Minimum wage laws are a big benefit to workers• But, the US economy would be more

“competitive” if corporations could pay workers less

• The fact that wages in China are under $1 / hour means that US companies are less competitive

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

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

State Ownership• Governments can own factories, railroads,

electric power plants, etc. – or anything else.

• Nationalized or “state-run” industry: a business or industry that is run by the state– Definition: “Nationalization” is when the

government takes over formerly private companies or industries• Example: airport security screeners after 9/11

– Definition: Privatization: when a 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 (sometimes)• Government organizations are often subject to

greater scrutiny and accountability, compared to private firms

– Ex: monitoring by government accounting offices; FOI Act

• Private firms that do terrible things usually just go bankrupt and leave others to clean up the mess

– Ex: Mining companies that damaged the environment.

State Ownership• Disadvantages of state ownership

– Little or no competition: • Less pressure to be efficient or innovate• Though, some are quite efficient

– Ex: Social security vs. private savings funds– Ex: State-run health systems vs US system of private

insurers

• Also, even private firms are may avoid competition– E.g., by lobbying the state for subsidies; corporate

welfare– Often, lobbying is cheaper than innovating!

– Also, state firms can become corrupt or under influence of government elites…• Ex: Oil companies in Nigeria and Russia

– Some have stolen the oil wealth of entire nations…

Keynesianism vs. Free Markets• The Keynesian state:

– Fiscal Policies: Higher taxes, higher spending• To support health care, welfare, keep full

employment

– Monetary policy: Expansionary (low interest rates)• Low interest rates keeps unemployment low

– But, inflation & debt tends to be higher

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

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

The Credit Crisis• Krugman article: “Partying Like its 1929”

• Regulation and the financial crisis

– Banks were heavily regulated since 1930s, but didn’t like it• Banks began to circumvent regulation by creating

new organizations & services (e.g., Hedge funds) – a “shadow” banking system

• Result: Banks took greater and greater risks… and made billions of dollars of profits for years

– Many risky investments were in real estate

– Decline of real estate market in 2007-8 caused risky investments to lose tremendous amounts of money• Banks began to go bankrupt; bank runs began

– Entire economy was threatened…

Credit Crisis Video• The Credit Crisis Visualized

• Jonathan Jarvis• Direct video link: http://crisisofcredit.com/• Local link:

Responses to the Credit Crisis

• What could the government do?• Many big banks owed lots more than they could

pay

• 1. Do nothing… • Banks were reckless, let them fail

– Benefit: cheap, easy– Problem: This would make the economy

worse• The entire economy needs functioning banks• Businesses depend heavily on loans to operate…

without access to cash, MANY would go bankrupt• A major collapse would almost certainly cause a

depression: mass bankruptcy and unemployment.

Responses to the Credit Crisis

• What could the government do?• 2. Nationalize the banks – take them

over• Run them for a while and then re-sell to private

owners• Sweden did that in the 1990s…

– Benefits:• Quickly restores banking system• Allows government to fire the bankers that caused

the problems

– Problems:• Politically unpopular

– Seen as “socialist” or “communist”.

Responses to the Credit Crisis

• What could the government do?• 3. “Recapitalize” the banks

• Give them a ton of money to weather the crisis

– Benefits:• Keeps the banks going, averts disaster

– Costs:• Rewards people who caused the crisis

– Lets them pay themselves big bonuses

• No control: banks may choose to not loan money• Can lead to “zombie banks” (Japan in 1990s)

– Banks are kept alive, but not really functioning.

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.

Democrats, Republicans, Markets

• Democrats have been historically more “Keynesian” and republicans more “free market”

• But, they don’t match perfectly

– Ex: Nixon (R) instituted wage and price controls– Ex: Carter (D) oversaw substantial privatization– Clinton signed NAFTA (a free-market trade

treaty)– Reagan & Bush 1 & 2 created huge budget

deficits and greatly increased the national debt– Obama has not (yet) done much to increase

regulation of banking system• Despite obvious failures in 2008-9.

Republican Fiscal Policy Cartoon (1)

Republican Fiscal Policy Cartoon (2)

States, Markets, Globalization

• Since around 1980 governments have shifted

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

• This has implications for globalization– State-run industries limit global trade

• And limit the expansion of multi-national corporations

– High taxes (including on trade) limit global trade– High regulation limits trade & foreign investment– Many regulations limited trade, foreign

investment• Etc. etc. etc.

• In sum: Shift toward free markets removed obstacles to economic globalization…

Economic Globalization

• Important economic changes:• 1. Growth of international trade• 2. Increase of Foreign Direct Investment

• Ex: building factories in another country

• 3. Increased international capital mobility• Movement of money across national borders

• 4. Growth of multi-national corporations• Each has an effect on the ability of states

to control their economies.

States, Markets, Globalization

• Issue: Economic globalization puts further pressure on governments... To be pro-market

• Globalization reinforces pressures away from Keynesian policies and toward even freer markets…

– Where do companies build new factories?• In a high-tax country with lots of regulations?• Or in a free-market country with low taxes?• If states want to attract investment, they are

compelled to move toward free-market policies

– Ex: Thomas Friedman: The Golden Straitjacket• The “electronic herd” – Global investors that look

around the world for places to invest money• They force countries to “tighten the straightjacket” of

free market policies…

Economic Globalization

• Globalization has strong implications for the ability of states to control markets

• For instance:• Globalization reduces states options for fiscal

policy• Globalization reduces effectiveness of

monetary policy• Globalization harms economies that try to

regulate or nationalize industry

– We’ll discuss this more in coming weeks…