How America got Gipped

Ben Funnell has a very interesting column up at the Financial Times on the weaknesses of the American (and British) flavors of capitalism:

Just why is there so much debt in the Anglo-Saxon world?...The answer is capitalism’s dirty little secret: excessive lending was the only way to maintain the living standards of the vast bulk of the population [even as their incomes fell].

This is a very interesting and provocative thesis. The implication is that people will do things that are not in their long-term best interest, just to keep their incomes from falling or stagnating in the short term. Lots of economic models produce this result - models where people become addicted to a certain level of consumption, for instance, or behavioral-economic models in which people are short-sighted.

But there's also another possibility: that (Republican) politicians used deregulation and tolerance of dodgy lending practices to encourage households to increase their debt unsustainably, so that people wouldn't get angry at Reagan and Bush, under whose regimes their incomes stagnated or fell:

Put simply, the benefits of economic growth have gone into the pockets of plutocrats rather than the bulk of the population. So why has there been no revolution? Because there was a solution: debt. If you couldn’t earn it, you could borrow it. Cheap financing was made widely available. Financial innovations such as the asset-backed securities market aided this process, as did government-sponsored agencies such as Fannie Mae and Freddie Mac. Regulators welcomed it all while perhaps taking insufficient account of the moral hazard problem it posed: that ever-increasing leverage meant the authorities had to keep interest rates low, otherwise the debt burden would cripple consumption. This prompted more leverage, which exacerbated the problem.

And people's incomes have indeed been stagnating:

According to Société Générale economists, the inflation-adjusted income of the highest-paid fifth of US earners has risen by 60 per cent since 1970, while it has fallen by more than 10 per cent for the rest...the share of profits in gross domestic product is at a 100-year high, or was until very recently.

As to why this is happening, the reasons are probably a lot more complicated than "the rich people took all the money." The entrance of vast numbers of poor workers from China, India, East Europe, and Southeast Asia onto the newly globalized markets created a labor surplus and a capital shortage: a perfect recipe for the rich getting richer and the poor getting poorer. And the information technology revolution has forced huge transitions and adjustments on our economy, which take time to work through; in the short-term, lots of people's skills become obsolete.

So I don't blame the late-20th-century Republicans for causing the income stagnation (though they certainly didn't try very hard to fight it)...I blame them for encouraging debt as a "solution" to the problem. What's to be done about all the debt (besides decades of slow growth while we pay it off, I mean)? The author suggests that inflation will stop us from beig able to pay it back:

The debt burden has to come down, which means more saving and lower economic growth for many years to come. Along the way inflation is likely to return, probably sooner and more violently than most expect, which will prompt investors to demand a higher return and make it even harder for governments to tackle the debt.

I disagree. Inflation does all kinds of harm to the economy, but one thing it does is make debt go away faster. We may find that inflation is the inevitable price we have to pay for the Bush/Reagan years of fake prosperity. That is not the way I would have wanted it, but it may be inevitable.

But I do pretty much agree with the author's prescription for digging ourselves out of the debt pit:

[W]e should redouble our efforts to increase productivity through innovation and creating new markets; simply squeezing lower-income workers is a bad option, which helped get us into this mess in the first place. This requires investment in education and research. Second, we have to learn to live within our means. This means spending less than we earn, perhaps doing without the BMWs, flat-screen television sets and leather sofas. Third, we should be careful in distributing the higher tax burden that we will inevitably have to bear over the coming decade. Very high marginal tax rates did not work in the 1970s and will not work now. That said, income disparity at current levels is a political time-bomb that needs to be dealt with. Finally, we should all come to terms with the fact that these are structural issues needing structural solutions; they need to be enforced over a longer time period than any one government’s term. So we need a new political consensus, one aimed at reducing overall debt levels while reducing inequality by encouraging education, entrepreneurship and investment in innovation.

Well said. There's not much I can add to that.

But if anyone still thinks that "cut taxes and deregulate" is the right strategy for solving our economic problems, I would politely request that they rapidly disabuse themselves of that notion (that being British for "pull your head out of Ronald Reagan's semi-mythical ass"). Those nice-sounding 30-year-old libertarian bromides turned out to be a cover for what we were really doing - maxing out the credit cards. If we want to ever clean up the mess, then investment promotion - infrastructure building, innovation promotion, better education, and smart regulation - are the wave of the future.