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What Obama needs to do

November 8th, 2008 · No Comments

Some observations and priorities. First some immediate action to arrest the precarious slide in the US economy, second a more enduring task to reinforce America’s brand of free-market capitalism, which has much to recommend it, but also has some deep flaws, as will be obvious by no to all but the most fanatical supporters of completely free markets. The financial sector especially needs considerable redisign, care should be taken not to destroy incentives for innovation though, even in the financial sector.

Stimulating the economy

  1. Now is not the time to worry about the buget deficit. It’s scary enough, but what’s going on in the real economy is even more scary.
  2. The large scale interventions in the financial markets finally show sings that they are starting to work. However, this situation can become undone if the economy worsens a lot more (as looks all but inevitable now) as this will trigger another round of deleveraging, (forced) asset selling, and swelling of bad debt (forcing more retrenchment and even less credit available). The economy needs to be stabilized a.s.a.p., not only to safeguard all that work to revive the financial system, but to keep us falling off a really big cliff.
  3. The authorities should look for the most effective way to achieve that (and put aside any ideological hang-ups). According to us, some of this should include:
  4. Put money in people’s pockets were this is likely to provide the most ‘bang for the buck’, that is, those people that are most likely to spend it all (instead of just saving it). These are usually the poor, but also on the state level new money will have a high leverage as many states are bound to balance the books and any shortfall obliges them to make severe cutbacks (even in essential services) and firing a lot of people, reinforcing the slide downwards.
  5. Another point of maximum leverage seems to be the housing market. Breaking the vicious cycle of lower house prices leading to more (fire-sale) foreclosures, leading to even lower house prices and more banking trouble will be paramount. One idea is to subsidze people who struggle with their mortgages in return for a stake in the increase in value when the market recovers
  6. Infrastructure spending is also a good idea, it creates jobs in the short-run and viable infrastructure in the long-run benefitting long-term economic growth, and the spending is temporary as projects will be finished, just what is needed. One area especially beneficial would be alternative energy, another would be education.

Recalibrating the US form of capitalism, reinforcing the free market system through better regulation and redefining the role of the state

  1. The US form of free market capitalism has much to recommend it. But that doesn’t mean it doesn’t have weaknesses and it most certainly doesn’t mean these weaknesses are part and parcel of the system. But, the margins for change are not endless, an economic system evolved  for centuries from a particular history and culture into a finely calibrated puzzle. Change, especially radical change, in one part, will have ramifications in other parts, so tinkering with the system should be very careful. One wouldn’t want to lessen the incentives for innovation (even financial innovation), for instance. However,
  2. Free markets can only function well when properly regulated. By now, even in hard-core free market corners, the notion that markets are not always the solution and government not always the problem has hit home, albeit perhaps only for tactical reasons. However, the recognition that markets cannot work without proper regulation, especially financial markets, should now receive not only the recognition they warrant, but concrete action.
  3. This recognition and action is by no means a move to ‘socialism’, as some have tried to argue. It is, in fact, entirely the opposite, safeguarding the free market system by ensuring they function well and making them work more efficient. Only when that happens can Schumpeter’s process of creative destruction, that is, the machinery of steady improvement and more radical innovation, the process that is at the core of the unprecedented wealth creation function well.
  4. Jeff Flake, Republican and member of the House for Arizona argued that the Republicans should return to the era of small government and free markets. He argued that changing economic incentives for political ones is not the recipe for creating wealth. We completely agree with the latter, but (apart from noticing that the Bush government did little for smaller government (to put it mildly), we cannot stress enough, markets do not work in a vacuum. Republicans also need to learn the lesson of the causes of the financial crisis. Unregulated (or badly regulated) markets can run amok, especially those in the financial sector. It’s not the first priority now, but new regulation should be enacted to prevent similar occurrences in the future
  5. A smaller state yes, but one has to realize that markets cannot function without one. We also have to explain that the state tends to grow by itself, basically because most of what it produces is not much amenable to the steady increase of productivity that characterizes much of the private sector (a teacher, nurse, bureaucrat cannot increase his output 3-4% per year as a factory worker can and if salaries grow at similar rates, that makes government output steadily more expensive, a phenomenon known as (‘Baumol’s disease’). This is a main reason why we embrace that mantra of a smaller state, as Baumol’s disease needs counterforce’s. However, there is much misunderstanding about what kind of state involvement a capitalist economy can tolerate. Scandinavian economies have almost twice the size of the state and still manage to be prosperous, stable, and innovating countries. Reducing the size of the state at this particular juncture is not top priority either, to put it mildly.
  6. Tax should be progressive. This is not socialism either. We would argue that it is in the interest of the rich themselves. Money, like almost anything in life, is also subject to the laws of diminishing returns, once you have a lot, getting even more means less. But this is not the most important reason. One of the main problems with a free market system is that unchecked, it has a tendency to create such a divergence of income and wealth as to become a threat to the social fabric of society. And this is reinforced by other tendencies, like the disappearance of a unified media experience. People now can chose to receive news through the filter of their choice and see others almost as aliens. The rich themselves share an interest in maintining some kind of social cohesion.
  7. The US has more tolerance for this than most nations, but even its tolerance has a limit. The US is a big country, and the rich can (and, to a considerable degree already do) retreat into gated communities and disconnect from society at large, urging for even more tax cuts reinforcing these tendencies. Is that really the society they want to live in? Do they really believe there will never be a backlash against this?
  8. We belief in equal opportunities and recognize that this will produce unequal outcomes, but these outcomes should not be given total free reign, especially because the possibilities for abuse at the top are far greater than at the bottom
  9. Something of a backlash against the big bonuses and ‘golden parachute’s’ in finance is already under way, and insofar as these do not have a strong relation to performance (which research show there rarely is), this backlash is entirely justified as when unrelated to performance, these bonusus are more of a sign of a corrupted system “Yes we can (get away with it)!” rather than the workings of any ‘free’ markets. In combination with the big bail-outs these practices become even more difficult to accept (we’ve called this ‘Socialism for the Rich‘ earlier on).
  10. Regulation of the financial sector should achieve:
  11. A circuit braker for over-leveraging. Put strict limits on what banks and other financial institutions can do in terms of leverage, on the balance sheet and off it. Stricter capital requirements for banks would be one way, although this should wait until things have improved as to not risk lending taking another lurch downward
  12. Remove the one-sided incentives for very risky behaviour, especially at the top of the financial system.
  13. Regulation with relation to new financial products has gotten behind the curve (even Alan Greenspan, one of the staunchest supporters of financial liberation had to admit that recently)
  14. Put in place more stringent requirements for allowing people to take out a mortgage (although here as well, now is not the best moment to implement that, needless to say things should wait until we’re well and truly out of the hole we’re in at the present). Not everybody can own their own home. There are other ways of getting affordable houses for the poor.

Tags: Credit Crisis