States and Markets Sociology 2, Class 4 Copyright © 2010 by Evan Schofer Do not copy or distribute without permission.

States and Markets

Sociology 2, Class 4

Copyright © 2010 by Evan SchoferDo not copy or distribute without

permission

Announcements• Today:

• Lecture: States & Markets – basic concepts & definitions

• Next week: economic globalization

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…

Review: Fiscal Policy: Taxes

• Fiscal Policy: Government policy regarding taxation, public revenues, or public debt

• Taxes generate revenue for the state• Low taxes can create short term growth

– By increasing spending, consumption

• Low taxes also can increase investment, increasing long term growth

• Higher taxes support more government services– And allow greater redistribution of wealth in society.

• By taxing some things more than others, states can affect social and economic behavior.

Fiscal Policy: Spending

• Government can affect economy by adjusting how it spends money– 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

– Budget surpluses occur when the government spends less than it earns

• Current national debt: $12,300,000,000,000

• Over 40,000 per person• Large government debt can harm the economy

– Can lead to higher interest rates; high taxes to pay off debt.

Fiscal Policy: Spending

• Government spending can “jump-start” the economy

• State may spend directly, or give money to people

– Keynes: “Government should spent against the wind” • Example: “New Deal” spending, war spending

helped create jobs and economic growth

• But, consistent high government spending can harm economic growth

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

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 is 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 / conservative economists: Stimulus bill is a bad idea: causes too much debt

– Could cause inflation and inhibit long term growth

• Some conservative economists actually reject the idea that spending has a stimulative effect

• Conservatives more concerned about debt and inflation that unemployment & short term growth.

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 stores a 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!

– Also, 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.

The Credit Crisis• Krugman article: “Partying Like its 1929”

• Regulation and the financial crisis

– Banks were heavily regulated since 1930s, but didn’t like it• Banks began to circumvent regulation by creating

new organizations & services (e.g., Hedge funds) – a “shadow” banking system

• Result: Banks took greater and greater risks… and made billions of dollars of profits for years

– Many risky investments were in real estate

– Decline of real estate market in 2007-8 caused risky investments to lose tremendous amounts of money• Banks began to go bankrupt; bank runs began

– Entire economy was threatened…

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… • Banks were reckless, let them fail

– 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.

Democrats, Republicans, Markets

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

• But, they don’t match perfectly

– Ex: Nixon (R) instituted wage and price controls– Ex: Carter (D) oversaw substantial privatization– Clinton signed NAFTA (a free-market trade

treaty)– Reagan & Bush 1 & 2 created huge budget

deficits and greatly increased the national debt– Obama has not departed far from republican

policies in responding to the credit crisis• E.g., nationalizing banks…

Republican Fiscal Policy Cartoon (1)

Republican Fiscal Policy Cartoon (2)

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…