Monthly Archives: June 2013

A draft paper by Economist Greg Mankiw was recently released, boldly titled “Defending the One Percent“.  According to Wikipedia Greg Mankiw is a professor of economics at Harvard, and the “32nd most widely cited economist in the world today.”  He also served as Chairman of the Council of Economic Advisers under George W. Bush, and was presidential candidate Mitt Romey’s economic adviser.  Learning that, the title makes a little more sense.  Whether it’s divine right or some farcical aquatic ceremony involving a lady in a lake and a sword, those who’ve accumulated (or been given) vast stores of wealth and power have felt at least somewhat compelled to justify themselves to the multitudes who have little of those things.  Hence a piece like this from Mankiw.

It’s a pretty short, breezy read, beginning with a thought experiment involving a perfectly equitable society that becomes topsey turvey due to a hypothetical, Jobs like genius who offers an awesome product that everyone buys, thus accumulating an equilibrium smashing amount of wealth.  Thus the paper is kicked off with a question about what, if anything, should be done about this inequality.

Though about those people buying the awesome new genius product, there is a sentence thrown in there that stood out to me:

The transaction is a voluntary exchange, so it must make both the buyer
and the seller better off.

I have read a fair amount of economic commentary, but admit that I haven’t actually read much “economics”, i.e. the august prose turned out by trained and respected economists.  So I was a little surprised by the popping off of such an assured statement…especially when, as far as I can tell, it doesn’t really add anything to his argument anyway.  Is this really how economists write, and think?  Because I’m pretty sure I know what “voluntary” means, and I’m quite sure I know what “must” means, so if that sentence is written in English, I’m certain it’s just not true.

So it was an odd introduction to the ‘economese’ language for me.  The meat of the paper addresses the question of where the great gains made in the last 40 years or so by the one percent have come from.  And the gains have been great.  Mankiw, citing figures tabulated form tax returns, states that the share of income earned by the top one percent rose from 7.7 percent to 17..4 percent from 1971 to 2010.  For the top .01 percent it has risen from 0.5 percent to 3.3 percent from 1973 to 2010.

But why?  Mankiw addresses two possibilites:  successful rent seeking by the elite (essentially gaming the system), and the elite simply growing that much more productive.  Manikow opts for the essentially Galtian explanation that the advance of technology creates outsized rewards for those with the proper education and talent.  It’s the iron law of the market that provides the unique, irreplaceable geniuses with their increasingly large piece of the pie, as Mankiw puts it:  “rising inequality if about supply and demand.”.  A piece at the The Economist provides a good takedown of the entire paper, but of this idea in particular:

But now let’s imagine that just before these geniuses are able to bring their creations into the world, they die. No iPod, no Harry Potter, no Jaws. What happens then?

Here’s what happens then. Instead of Apple dominating the market for MP3 players in the early 2000s, Sony and Samsung do; a little later, when smartphones come along, the battle for mobile operating ecosystems revolves around BlackBerry, Samsung/Google and Nokia/Microsoft. Instead of Harry Potter, some other children’s fantasy book becomes the dominant franchise of the 2000s. And instead of “Jaws”, some other movie becomes the first immense blockbuster of the 1970s, and a different brilliant director’s career is launched. All of the money that was spent over the past few decades to make Mr Jobs, Ms Rowling and Mr Spielberg immensely wealthy would instead have gone to three other hard-working creative geniuses, of which the world has no shortage. There would be just as much inequality as there is now.

So why does Mr Mankiw pick three figures from the entertainment and computer industries, where everyone knows the “superstar” phenomenon is strongest? Because if he used examples from other industries, it would be even more difficult to convince the reader that the immense rewards being reaped by those at the top had anything to do with their unique contributions to the economy. Last year the highest-paid chief executive in the country, at $131m, was a guy named John Hammergren, who runs a medical and pharmaceuticals business called McKesson. If he hadn’t been running McKesson, some other guy would have been. If Michael Vascitelli ($64m) hadn’t been running Vornado Realty Trust, somebody else would have. Perhaps those other guys wouldn’t have been as good at their jobs; in that case, these firms would have lost market share to competitors. So what?

As marginally less interesting or less convenient as the world would perhaps be if it were missing the warm glow of our creative and business geniuses, it would not spin off its axis and hurdle into the sun.  As unsatisfying as the fact may be, none of us are indispensable, culturally, spiritually, or economically.  Our world doesn’t rest on any individual’s shoulders.  Atlas was, is, and will certainly continue to be a myth, a childish Ayn Rand fantasy beloved by those stuck in a permanent state of emotional adolescence.  If all the CEOs of all the Fortune 500 companies, or hell, even all of the C level executives were to be blinked out of existence, would civilization collapse?  Or would things hum along pretty much as before?  Is that hypothetical really that difficult to answer?  If things would hum along as before, is that answer important to how we think about the trajectory of income distribution these last 40 years?

Mankiw concludes that “the most natural explanation of high CEO pay is that the value of a good CEO is extraordinarily high.”  Because while high CEO pay at publicly help companies boards may be too cozy with CEOs, but “A private equity group with a controlling interest in a firm does not face the alleged principal-agent problem between shareholders and boards, and yet these closely-held firms also pay their CEOs handsomely.”  There are no possible “market imperfections” to be found there, so if a CEO is paid highly, by definition his outsized productivity earned his pay.

It’s not surprising that the global financial meltdown and attendant bailouts, under whose shadow we still labor, go largely unmentioned.  That story is one long, brutal, messy, and ongoing guantlet of “market imperfections”.  There isn’t much at all said about the finance industry except to point out the incredible skills needed by those who perform the critical function of allocating capital, per Mankiw “It makes sense that a nation would allocate many of its most talented and thus highly compensated individuals to this activity.”  He only begrudgingly mentions that “On the other hand, some of what occurs in financial firms does smack of rent seeking”.  But he only goes on to mention high frequency trading as a possible rent seeking activity engaged in by the finance sector.  Leaving one to wonder about Mankiw’s powers of recall and imagination.  Oh, and he uses the word ‘desideratum’…I’m not sure if that’s an economist thing or just a Mankiw thing.

After reading this stuff, it’s easy to see the utility, the enormous practical and ideological heavy lifting that the conception of the natural and immaculately efficacious “free market” does for justifying whatever the elite can accumulate for themselves.  Andrew Sullivan titles a post on the paper “Is Meritocracy Moral?“, which, of course, assumes a meritocracy, assumes that the top is getting what they have earned, which is actually the question at hand.  Sullivan responds to Jonathan Chait in the post: “I sure can see the innate moral intuition in thinking that a talented person deserves to keep the fruits of her talent, even if it is beyond Chait’s imagination.”  So this is just a problem of the talented simply being so much more talented than they used to be, sucking up so much more of the money…if they hadn’t earned it the market wouldn’t have given it to them, right?  Because like the Lady of the Lake, her arm clad in the purest shimmering samite, held aloft Excalibur to Arthur, signifying him King, the invisible hand of the market is distributing increasingly large amounts of cash to the increasingly productive elite.  What else could possibly explain it?



That is the title of a Rolling Stone piece and couple of follow up blog posts by Matt Taibbi.  They serve as a good illustration of the principle that no one likes a fair fight if they can avoid it, that if someone can rig the game to get an advantage they will at least try.  The series is an eye opening list of the various markets/indexes that have been rigged or suspected of being rigged and a rogues gallery of banks who’ve paid millions in fines for doing the rigging and/or are suspected of doing the rigging.  A quick summary:

LIBOR – The London Inerbank Offered Rate, it is an interest rate used in trillions of dollars of all kind of derivatives.  Here is a bit of a primer.

ISDAfix – Weird name, an interest rate used for interest rate swaps.


Gold and Silver

FX – Foreign Exchange markets

There has already been hundreds of millions of dollars paid out in fines by banks for the LIBOR stuff, investigations for the rest seem to be in progress.  At the end of the main Taibbi piece he quotes from a report by the European Federation of Financial Services Users:

In general those markets which are based on non-attested, voluntary submission of data from agents whose benefits depend on such benchmarks are especially vulnerable of market abuse and distortion.

Well you don’t say.  You’d think their love of the free market, of its stern yet fair hand, of the purity of competition, would prevent them from seizing the opportunity to game the system and rake in some filthy, ill gotten lucre.  Most of these schemes require at least some cooperation between the participants.  Michael Hausfeld, one of the lead attorneys for a plaintiff in one of the LIBOR lawsuits, is quoted in the same piece:

It’s now evident that there is a ubiquitous culture among the banks to collude and cheat their customers as many times as they can in as many forms as they can conceive.  And that’s not just surmising. This is just based upon what they’ve been caught at.

So these large banks, the paragons of the creative destruction of the dog eat dog world of cut throat competition, do understand the utility of cooperation.  It’s just with themselves against pretty much everyone else.  So what have we learned?

  • Yes, market participants will collude and cheat if it can give them an advantage and increase their profits
  • No, there is nothing magical about markets that will prevent this by itself, no invisible hand will come down and dispense market justice

That leaves regulations, paired with a robust regulatory apparatus for enforcement to police the markets.  But given that TBTF means too big to jail ( as Attorney General noted in a memo in 1999, you have to be careful of “collateral consequences” when prosecuting corporate crimes ), there seems that little can be done, except hand out fines that in the end amount to a fraction of the gains that the criminal behavior netted.  There is also a cultural problem, put succinctly buy commenter tongorad at Naked Capitalism:

The problem is that the market is posited so firmly in the public mind as a state of nature, rather than a political arrangement.

So a common conception is that at best, regulations do little to impact the tectonic forces of nature as they march inexorably on, and at worst they are a perversion of nature’s work, leading to bad, horribly mutated outcomes and widespread misery.  It’s a conception of markets that is tightly woven into the national mythos, and it would probably be best for most of us if it gets torn out and set aside.  Preferably before the next financial crisis.


In the last post on TBTF, I described austerity as more of a quasi-religious ritual, closer to a kind of mortification of the flesh intended to expiate sin than a valid economic strategy.  You see, we have spent too much and consumed too greedily and now we must suffer for it.  Though who exactly this “we” is who must feel the pain is an interesting, and often unanswered, question.  I’ve found a good article and video on the topic and thought they would provide a solid follow up.

The first is a piece by Philip Pilkington, commenting on a NY Times article extolling the success of austerity in Latvia.  Pilkington finds the article far closer to a morality tale than a serious piece of economic analysis.

Next is a video of a talk by Mark Blyth, Professor of International Political Economy in the Department of Political Science at Brown University.  He gave the talk at Google, and the subject is the same as his newest book “Austerity: The History of a Dangerous Idea”.  Boing boing describes him as a “delightfully sweary Scottish economist”, and he is.  Words like bullshit need to be used far more often in economic discussions.  He does talk very fast though, covers a lot of ground, and makes lots of references to numbers and dead philosophers, so it can be pretty hard to follow at times, but pausing and googling can help.  Even without googling though you should get something out of it.  I’ve embedded it below, and added a few notes.

  • Why did he write the book? – “I got really really pissed of with people with lots of money telling people that don’t have any money that they need to pay shit back.”
  • Why do you need a state?  To create markets in the first place, they don’t just pop out of the ground.
  • “Reignhard and Ragoff 90% my ass.”

If you don’t have the hour for the video, here is a much shorter podcast he did covering the same basic topics, and he speaks at a less frenetic pace.  It also includes this great quote:

So when people talk about the idea that we all need to tighter our belts, I’m all in favor of that the minute we’re all wearing the same pants.

Along with the lack of any significant criminal prosecutions, the continued existence, indeed further consolidation of, TBTF (Too Big to Fail) institutions remains one of the more maddening legacies of the global financial crisis.  TBTF status, which justified the enormous bailouts and subsidies given to financial institutions deemed too systemically important to be allowed to fail, remains in full effect.  It remains a tool large financial can use to gain a competitive advantage over other banks not large enough to be deemed TBTF and to push off the cost of any future disasters their speculation causes onto the tax payers again.  New York Times columnist Gretchen Mortgenson discussed this recently on Bill Moyers.

So what to do?  A while back I had read somewhere about a paper put out by the Federal Reserve Bank of Dallas on ending TBTF, it’s titled “Choosing the Road to Prosperity : Why We Must End Too Big to Fail -Now” .  I’d intended to read it for some time but kept finding better, more useless ways to spend my time.  Recently I got around the reading the thing.  I quickly grew bored.  It’s not long, about 25 pages of fairly sparse writing padded out with pictures and graphs.  The steady, milquetoast prose wasn’t exactly a surprise, but did justify my lengthly procrastination.  Prominent is a running technocratic discussion of the “engine” of monetary policy, complete with strained analogies like the misfiring piston of bank loans, or problems with bank capital “lubricant”.

Well and good enough, though I’m unimpressed with mechanistic analogies related to the economy, with gauges and clearly defined buttons and levers to be pushed and pulled, resulting in clear and predictable outcomes.  But the paper became truly irritating with a side-bar titled “TBTF” A Perversion of Capitalism”.  The section frets about the erosion of faith in American capitalism caused by the TBTF phenomenon, listing three “basic tenants” of Capitalism that TBTF supposedly vioaltes:

  • Capitalism requires the freedom to succeed and the freedom to fail
  • Capitalism requires government to enforce the rule of law
  • Capitalism requires businesses and individuals be held accountable for the consequences of their actions

What these holy tenants of Capitalism represent is some ridiculous, perfect Platonic Form version of Capitalism.  It’s bullshit.  If Capitalism is about competition, and I hear that it is, far from being a perversion, becoming TBTF is the most natural goal there is.  Firms didn’t become TBTF because they liked the acronym, or didn’t understand the rules of capitalism.  They grew so large because that gave them a competitive advantage and provided a huge safety net for any missteps they made.  The paper mentions the “creative destruction” of Capitalism several times.  The creative part is nice, but the destruction part isn’t as much fun.  And a destruction, mind you, that the paper admits could be the result of  nothing more than simple bad luck  (not outdated products or mismanagement).  If you could shield yourself from the “destruction” side of that equation, wouldn’t you?  Perhaps you could say the success of such an effort was a “perversion” of some idealized capitalism, but it would only be a natural response to a capitalism as practiced in the real world.

Because an even playing field might be fine if you’re playing a game of Monopoly with the family, or a game of checkers with your nephew, but it becomes much less appealing when the stakes are raised.  If you were flipping a coin for a million dollars, and you could make the rules, would it be unnatural, or surprising, if you came up with “head I win tails you lose”?  No one is really looking for a “fair fight”.  Not really.  Not if we can help it, anyway.  No general, who isn’t a moron, is going to seek to engage the enemy on terms that aren’t advantageous to his die.  NFL teams play the regular season trying to gain home field advantage during the playoffs because it is just that, an advantage.  So it goes with war and sports, so it goes with economic competition.

The Fed paper essentially acknowledges all this, in an early section on the “flaws” that led to the TBTF problem titled “Concentration”:

In the financial crisis, the human traits of complacency, greed, complicity and exuberance were intertwined with concentration, the result of businesses’ natural desire to grow into a bigger, more important and dominant force in their industries.

But this sentiment is contradicted later by the claim that “concentration in the financial sector is anything but natural.”  It is only “artificial” advantages that have allowed banks to grow so large.  It would be difficult to argue what would be more natural, in a competitive, capitalist situation, than for financial institutions to concentrate in order to gain more power and advantages.

Unless markets are magic, and I haven’t seen any evidence to suggest that.  I’m convinced that when some future archaeologists pick through the rubble of our civilization, they’ll look at our present economists and their reverent invocation of “the market”, that invisible hand that justly allocates goods, the same way we look at some shaman in a benighted part of the world entering the spirit realm.  Whatever else is there, there will be some pitied bemusement.  For isn’t all the talk of austerity, really, a call for some to sacrifice to propitiate an angry and vengeful god?

How can one not see the religious, fetishistic way the idea of the market is approached when reading a line like: “Human weakness will cause occasional market disruptions.”  Witness the odd suggestion of the “market” as some sort of perfect ideal existing separately from humanity, a Garden of Eden before Adam and Eve.  It is only the weakness, the sin, of humans that blight the otherwise pristine “market” with disruptions.

To give the paper its due, it does reward reading to the end.  I wouldn’t have thought that a Fed paper would use the phrase “oligopoly power”, but sure enough:

The TBTF survivors of the financial crisis look a lot like they did in 2008.  They maintain corporate cultures based on short-term incentives of fees and bonuses derived from increased oligopoly power.

And then the paper explicitly calls for breaking up the biggest banks into smaller units.  Will it be easy?  Nope, to state the obvious, the power TBTF institutions have managed to accrue to themselves due to their market dominance makes then hard to bring to heel.  As the paper puts it:  “…the political economy of TBTF suggests that the big financial institutions will dig in to contest any breakups.”  How do we break them up?  The paper doesn’t get into that…though there are legislators trying to do it through the law.  What is clear is that TBTF won’t end by praying to the “invisible hand’ to come down and cleanse the human stain from the Market.