Reports from the Economic Front

Economists are fond of presenting themselves as above the fray.  They theorize that people are self-interested maximizers.  Well, all people but economists.  Economists don’t have any vested interest in policy outcomes.  They just study economic dynamics and argue for policies that are in the public interest. 

Well, that is the story they tell.  Perhaps they believe it, perhaps not. 

What is true, is that many of our leading economists have significant financial ties to powerful economic interests who are not above the fray and have a real material stake in promoting continued liberalization and deregulation regardless of its effect on the overall economy.

Here are some examples drawn from an article by Charles Ferguson (who is also director of the documentary “Inside Job” which highlights the growing conflict of interest that appears to affect many prominent economists):

Martin Feldstein, a Harvard professor, a major architect of deregulation in the Reagan administration, president for 30 years of the National Bureau of Economic Research, and for 20 years on the boards of directors of both AIG, which paid him more than $6 million, and AIG Financial Products, whose derivatives deals destroyed the company. Feldstein has written several hundred papers, on many subjects; none of them address the dangers of unregulated financial derivatives or financial-industry compensation.

Glenn Hubbard, chairman of the Council of Economic Advisers in the first George W. Bush administration, dean of Columbia Business School, adviser to many financial firms, on the board of Metropolitan Life ($250,000 per year), and formerly on the board of Capmark, a major commercial mortgage lender, from which he resigned shortly before its bankruptcy, in 2009. In 2004, Hubbard wrote a paper with William C. Dudley, then chief economist of Goldman Sachs, praising securitization and derivatives as improving the stability of both financial markets and the wider economy.

Frederic Mishkin, a professor at the Columbia Business School, and a member of the Federal Reserve Board from 2006 to 2008. He was paid $124,000 by the Icelandic Chamber of Commerce to write a paper praising its regulatory and banking systems, two years before the Icelandic banks’ Ponzi scheme collapsed, causing $100-billion in losses. His 2006 federal financial-disclosure form listed his net worth as $6 million to $17 million.

Laura Tyson, a professor at Berkeley, director of the National Economic Council in the Clinton administration, and also on the Board of Directors of Morgan Stanley, which pays her $350,000 per year.

Larry Summers, who recently resigned from his position as Obama’s leading economic advisor, is probably the poster economist for this problem.

Consider: As a rising economist at Harvard and at the World Bank, Summers argued for privatization and deregulation in many domains, including finance. Later, as deputy secretary of the treasury and then treasury secretary in the Clinton administration, he implemented those policies. Summers oversaw passage of the Gramm-Leach-Bliley Act, which repealed Glass-Steagall, permitted the previously illegal merger that created Citigroup, and allowed further consolidation in the financial sector. He also successfully fought attempts by Brooksley Born, chair of the Commodity Futures Trading Commission in the Clinton administration, to regulate the financial derivatives that would cause so much damage in the housing bubble and the 2008 economic crisis. He then oversaw passage of the Commodity Futures Modernization Act, which banned all regulation of derivatives, including exempting them from state antigambling laws.

After Summers left the Clinton administration, his candidacy for president of Harvard was championed by his mentor Robert Rubin, a former CEO of Goldman Sachs, who was his boss and predecessor as treasury secretary. Rubin, after leaving the Treasury Department—where he championed the law that made Citigroup’s creation legal—became both vice chairman of Citigroup and a powerful member of Harvard’s governing board.

Over the past decade, Summers continued to advocate financial deregulation, both as president of Harvard and as a University Professor after being forced out of the presidency. During this time, Summers became wealthy through consulting and speaking engagements with financial firms. Between 2001 and his entry into the Obama administration, he made more than $20-million from the financial-services industry. (His 2009 federal financial-disclosure form listed his net worth as $17-million to $39-million.)

Summers remained close to Rubin and to Alan Greenspan, a former chairman of the Federal Reserve. When other economists began warning of abuses and systemic risk in the financial system deriving from the environment that Summers, Greenspan, and Rubin had created, Summers mocked and dismissed those warnings. In 2005, at the annual Jackson Hole, Wyo., conference of the world’s leading central bankers, the chief economist of the International Monetary Fund, Raghuram Rajan, presented a brilliant paper that constituted the first prominent warning of the coming crisis. Rajan pointed out that the structure of financial-sector compensation, in combination with complex financial products, gave bankers huge cash incentives to take risks with other people’s money, while imposing no penalties for any subsequent losses. Rajan warned that this bonus culture rewarded bankers for actions that could destroy their own institutions, or even the entire system, and that this could generate a “full-blown financial crisis” and a “catastrophic meltdown.”

When Rajan finished speaking, Summers rose up from the audience and attacked him, calling him a “Luddite,” dismissing his concerns, and warning that increased regulation would reduce the productivity of the financial sector. (Ben Bernanke, Tim Geithner, and Alan Greenspan were also in the audience.)

Soon after that, Summers lost his job as president of Harvard after suggesting that women might be innately inferior to men at scientific work. In another part of the same speech, he had used laissez-faire economic theory to argue that discrimination was unlikely to be a major cause of women’s underrepresentation in either science or business. After all, he argued, if discrimination existed, then others, seeking a competitive advantage, would have access to a superior work force, causing those who discriminate to fail in the marketplace. It appeared that Summers had denied even the possibility of decades, indeed centuries, of racial, gender, and other discrimination in America and other societies. After the resulting outcry forced him to resign, Summers remained at Harvard as a faculty member, and he accelerated his financial-sector activities, receiving $135,000 for one speech at Goldman Sachs.

Then, after the 2008 financial crisis and its consequent recession, Summers was placed in charge of coordinating U.S. economic policy, deftly marginalizing others who challenged him. Under the stewardship of Summers, Geithner, and Bernanke, the Obama administration adopted policies as favorable toward the financial sector as those of the Clinton and Bush administrations—quite a feat. Never once has Summers publicly apologized or admitted any responsibility for causing the crisis. And now Harvard is welcoming him back.

Summers is unique but not alone. By now we are all familiar with the role of lobbying and campaign contributions, and with the revolving door between industry and government. What few Americans realize is that the revolving door is now a three-way intersection. Summers’s career is the result of an extraordinary and underappreciated scandal in American society: the convergence of academic economics, Wall Street, and political power.

So—tell me—how much trust do you have in our leading economists and the advice they give? 

Sometimes a picture is worth a thousand words.  Here is a two minute video clip from the film Inside Job that showcases the above mentioned Professor Frederic Mishkin and his ”objective” research on Iceland.

[youtube] http://www.youtube.com/watch?v=yygWXpYoab4 [/youtube]

Understandably, our media has focused its economic reporting on the US and secondarily other advanced capitalist countries, like Germany and France.  Developments in the rest of the world have largely been ignored.  As a consequence we are missing a lot.

Studying the third world means confronting the International Monetary Fund (IMF).  The IMF has long been criticized for its heavy handed attempts to promote neoliberal restructuring.  Starting in the early 2000s, third world countries, flush with foreign exchange from rising commodity prices, began paying off their debts to the IMF.  Faced with a loss of leverage and also interest income, the IMF had little choice but to start cutting its own staff.

The global economic crisis changed everything.  Many third world countries are again desperate for funds, and the IMF is happy to supply them—although as always with conditions.

The IMF claims to have learned its lessons.  Its own internal review of past practices highlighted a number of past loan conditions that the IMF now agrees were counterproductive.  Thus, it claims that it is now willing to support capital controls, at least for a limited period.  It also claims that it now supports counter-cyclical policies—which means that it will no longer force governments to implement austerity policies during a period of deepening economic crisis.

Unfortunately, despite its claims, the IMF appears back to its old tricks.  Most importantly, at the same time that it supports counter-cyclical policies in the developed world—for example, encouraging the US and EU to fight the Great Recession with deficit spending and low interest rates—it continues to oppose them in the third world.   A Center for Economic and Policy Research study of 41 countries that had agreements with the IMF in 2009 found that “31 of these agreements involved tightening either fiscal or monetary policy, or both, during a downturn.”

For example, according to Mark Weisbrot, one of the authors of the study:

The Fund is currently squeezing Ukraine . . . to reduce its spending, and suspended its disbursement of funds to the government in order to force budget tightening. This despite the fact that Ukraine’s economy shrank by about 15 percent last year [2009], and its public debt was only 10.6 percent of GDP. A country in this situation should be able to borrow as needed to stimulate the economy, and reduce its deficit after it has accomplished a robust recovery. In nearby Latvia, the IMF and European Commission are lending with conditions that have already resulted in the worst cyclical downturn on record, and it is not clear when or how fast the economy will eventually recover.

The case of Hungry is perhaps the clearest example of the class-bias underlying IMF policies, a bias shared by European elites.  As Jayati Ghosh reported:

In November 2008, Hungary signed a Stand-By Arrangement with the IMF for SDR 10.5 billion, as part of a joint rescue package worked out with the European Union. Various IMF reviews found that Hungary complied with all the very severely procyclical conditions imposed, including a massive reduction of the fiscal deficit from more than 9 per cent of GDP in the last quarter of 2008 to around 3.8 per cent thereafter. At least partly as a result of this, real GDP declined by 6.2 per cent in 2009.

The collapse of the Hungarian economy produced incredible social pain—and not surprisingly, the social democratic party that implemented the IMF mandated policies was defeated in June elections by a center-right party that had campaigned on a promise of less austerity.  However, once in power, the new government found that the economic collapse had made the budget deficit worse and that more severe fiscal measures were required to meet IMF budget deficit targets.

The government proposed new cuts in public sector wages and pensions as well as tax cuts for the wealthy, and asked the IMF for more support.  One might think that this would be enough for the IMF.  But it wasn’t.  The IMF asked for additional privatization of state owned enterprises and further reductions in state spending.  Perhaps most surprising, the IMF also demanded that the Hungarian government cancel an action that would have actually help to cut the deficit—a proposed tax on the banking sector expected to raise nearly $1 billion.  The IMF determined that this tax was too “high” and likely to “adversely affect lending and growth.”

Faced with a popular revolt, the Hungarian government rejected IMF demands for further cuts in spending and also refused to cancel its planned tax increase on the banks.  The IMF responded by breaking off talks.

The government is now seeking to reverse course and promote expansion.  Among other things, it is trying to force the (largely independent) central bank to lower interest rates; the bank (in tune with the IMF) had kept rates high despite the economic collapse.   As a first step, the government has cut the salary of the head of the central bank by 75 percent.

What does all of this mean?  Mark Weisbrot explains as follows:

As the New York Times reported on [August 2], the fight in Hungary “reflects a larger struggle that is expected to play out over the next year or so as most European politicians . . . seek to impose fiscal discipline on their increasingly unruly citizens.”

We can only hope that they get more unruly. The governments of Spain and Greece, for example, have a lot more bargaining power and a lot more alternatives than they have been willing to use. It is ironic that a center-right government in Hungary has taken the lead here; but if the socialist governments of Spain and Greece were to stand up to the European authorities and the IMF, they could also rally popular support. And then we would see a new playing field in Europe that would allow for a more rapid recovery, and possibly end the current assault on the living standards of the majority.