States and Markets

Sociology 2, Class 4

Copyright © 2011 by Evan SchoferDo not copy or distribute without

permission

Announcements• Today:

• Lecture: States & Markets – basic concepts & definitions

• Next week:• Economic globalization• Multinational corporations

Review: State Control vs. “Free Markets”

• BIG debate over the last century: How much should states control (“regulate”) markets?State Control Free Markets

RegulationCentral Planning“Public” Services

Deregulation“Liberalization”Privatization

Commanding Heights: Keynes Hayek

Reich: Democratic Capitalism Supercapitalism Friedman: Golden Straightjacket

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 2009 (CIA World Factbook):– United States: $14,120,000,000,000 –

trillions!• $46,000 per capita

– Brazil: $2.01 trillion, $10,100 per cap– Liberia: $1.63 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 typically 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 also want growth, but have also 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

• Question: Can markets exist without states?

• 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 greatly disagree about how much… – But most favor some degree of regulation to prevent

monopolies, 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 reshape society– E.g., via incentives or government spending

• Change distribution of wealth• Reduce environmental degradation, reduce

discrimination, improve medical care, etc…• 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: Basics

• Fiscal Policy: State policy regarding taxation, public revenue, or public debt– Revenue: Money the government takes in

• Taxes generate revenue for the state•Revenue (together with borrowed money)

allow states to spend money

– Spending: Money the government spends• Allows the state to build infrastructure and

provide services.

Fiscal Policy: Basics

• What does the state spend money on?– The biggest budget items are:

• Helping elderly and sick: Social security, medicare, medicaid

• The Military• “Debt service”: Paying back money that the

government borrowed in the past

– Remark: Many politicians say they will shrink government & cut taxes…• But, once elected they rarely do. Why?• Answer: It is hard to cut such popular

programs…

US Spending as % of GDP

Fiscal Policy: Taxes

• Milton Freedman (economist): “To spend is to tax”

• If a government spends, it must tax to pay for it• Either tax now, or borrow money now and tax

later…

• What does the government tax?• Income (individual and/or corporate)• Transactions (sales tax, taxes on trade)• Property owners• Activities that require fees (e.g., driving,

fishing, etc).

Fiscal Policy: Tax Rates• How high should taxes be?

– Higher taxes allow more government services• Better schools, healthcare, roads, military• And greater possibility for redistribution: the welfare

state

– Low taxes can spur more investment…• Investment generates economic growth, makes us

richer• Companies are likely to build factories in places with

low taxes– Ex: The “golden straightjacket”…

– The United States is on the “low taxes”/low spending side of the spectrum

– Compared to other industrialized countries– US corporate taxes are high “on paper”, but with many

loopholes, so actual taxes paid are pretty low.

Fiscal Policy: Definitions

• Budget surpluses occur when the government spends less than it takes in

• 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

• National debt: the amount the US owes• Current national debt: $14,000,000,000,000• Over 45,250 per person.

US Budget Deficit Trends

Fiscal Policy: Spending

• Government spending can “jump-start” the economy

• Keynes: “Government should spent against the wind”

• Example: “New Deal” spending, war spending helped create jobs and economic growth in the depression

• But, consistent high government spending can harm economic growth

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

• Extremely high debt can cause a “debt crisis”– Costs of borrowing go way up… countries can even go

bankrupt!

Fiscal Policy: Stimulus• How does the government “boost” the

economy?– Answer: by increasing “consumption”…

• Either by spending money itself, or by reducing taxes in ways that cause others to spend

• As govt’s or people start to spend, there is more demand for goods and services…

– Companies make profits and hire more workers– Economic growth accelerates.

Example: The “Stimulus Bill”

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

• “American Recovery and Reinvestment Act of 2009” • Provides tax cuts and spending with the goal of

speeding up the economy during a recession

– Stated goals:• Reduce unemployment• Increase economic growth

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

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

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

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

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

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

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

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

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

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

generates 1.5 dollars of GDP.

Effects of Stimulus: Multipliers

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

Type of Spending Estimated Multiplier

Infrastructure projects 1 - 2.5

Transfers to people (ex: unemployment insurance)

.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 was 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 / free market economists: Stimulus bill was a bad idea: causes too much debt

– Could cause inflation and inhibit long term growth

• Conservatives more concerned about debt and inflation

– Assumption: unemployment will work it out in the long run– Keynes responds: “In the long run, we’re all dead.”

Keynes vs. Hayek Video• An amusing summary of the case

for/against using government stimulus to aid the economy during a recession/depression

• Video\Keynes Hayek Video.flv

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 pool of money to:– 1. Prevent financial disasters

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

– Banks collapsed and government didn’t help out

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

– Including TARP

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

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

The Fed and Interest Rates

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

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

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

• If rates are low, you can buy more now

• Critical issue: The Fed chooses the interest rate it will charge to lend money

• The Fed is so big that other banks follow its rates• Thus, the Fed effectively sets rates for the whole

economy.

Monetary Policy

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

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

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

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

monetary policy• High interest payments mean that businesses and

people are less likely to borrow, spend, invest.

US Interest Rates 2000-2009

Rates lowered during recession following dot-com

crash and 9/11

Rates drop to zero in current

recession

The “Lower Bound” Problem

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

• Traditional monetary policy loses effectiveness in extreme economic conditions

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

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

– Ex: Buying non-treasure assets

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

Laws and Regulations

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

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

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

– Laws regulating markets• Protect against fraud, volatility

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

Laws and Regulations

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

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

airlines• Ex: Federal Aviation Administration (FAA) inspects

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

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

future sales

• Are market incentives enough to make you trust airlines?

Laws and Regulations

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

competition• Created industry stability, at the cost of

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

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

competition; deregulation had the opposite effect.

Laws and Regulations

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

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

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

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

Laws and Regulations• Governments regulate banks to protect

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

money…

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

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

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

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

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

but they might go bankrupt!

Regulating Wages and Prices

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

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

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

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

Regulating Wages and Prices

• The minimum wage also reflects a trade off• Minimum wage laws are a big benefit to workers• But, the US economy would be more “competitive”

if corporations could pay workers less• The fact that wages in China are under $1 / hour

means that US companies are less competitive

• Questions to ponder:• What might happen of wages were “deregulated”?• What if the minimum wage was increased to $20/hr?

State Ownership• Governments can own factories, railroads,

electric power plants, etc. – or anything else.

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

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

– Definition: Privatization: when a 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!

– 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.

Keynesianism vs. Free Markets• The Free Market state:

• States that put on the “Golden Straightjacket”

– Fiscal Policies: Low taxes, low spending• Corporations & international investors are attracted

by low taxes

– Monetary policy: Conservative (high interest rates)• High interest rates keep inflation low

– As a consequence, unemployment is higher

– Regulation: Minimal• Companies are free to do as they please

– Ownership: Privatized• The state doesn’t own industries; it is all “private”.

The Credit Crisis of 2008-9• A story of banks evading state regulation…• Reading: Krugman: “Partying Like its 1929”

– Banks were heavily regulated since 1930s, but didn’t like it• Banks began to circumvent regulation: a “shadow”

banking system• Banks took greater and greater risks… and made

billions of dollars of profits for years

– Decline of real estate market in 2007-8 caused risky investments to lose HUGE amounts of money

– Banks began to go bankrupt; bank runs began– Without government intervention, many major banks would

have gone out of business…– Businesses need bank loans; the effect would have been

horrific.

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… No government intervention

• Banks were reckless, let them fail• A “free market” solution…

– 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

• President Bush chose this option…

Democrats, Republicans, Markets

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

• But, everyone has shifted more toward free markets

– Also, there are some exceptions• Democrats supported many free-market policies

– Ex: Carter (D) oversaw the start of deregulation– Clinton signed NAFTA (a free-market trade treaty)– Obama’s health plan involves relatively little gov’t control

» Similar to republican proposals in the past

• Republicans don’t always follow conservative policy– Ex: Nixon (R) instituted wage and price controls.– Despite goal of “low government spending”, Reagan & Bush

1 & 2 created huge budget deficits and hugely increased the national debt.

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…

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

Reconciliation Act of 2001 (EGTRRA)– Extended by congress/Obama…

• Reduced income tax rates• 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 $$... Stimulative effect = weak• Caused huge deficits… taxes were cut without

cutting spending…