States and Markets Sociology 2, Class 4 Copyright © 2014 by Evan Schofer Do not copy or distribute without permission.

States and Markets

Sociology 2, Class 4

Copyright © 2014 by Evan SchoferDo not copy or distribute without

permission

Announcements• Today:

• Lecture: States & Markets – basic concepts & definitions

• Next week:• Economic globalization• Multinational corporations

Econ Basics: Definitions• Gross Domestic Product (GDP)

• “gross” means “total”– Definition: The total economic value of

goods & services produced within a country• Note: GDP is often measured “per capita,” which

gives a sense of production per person

• GDP in 2013:– United States: $16,000,000,000,000 –

trillions!• $51,000 per capita

– Brazil: $2.3 trillion, $11,700 per cap– Liberia: $2.63 billion, $700 per capita

GDP per capita: the world

Econ Basics: Definitions• Economic Growth: An increase in

GDP• Growth means: more production, more profits,

more wealth, more jobs, more income, more consumption, more everything!

• Most people think growth is good– But, we’ll discuss some critics who argue otherwise

• Recession: A period of decline in GDP• Fewer jobs, less consumption, etc…

• Depression: A period of severe and protracted decline in GDP

• Mass unemployment, poverty, hunger; political unrest.

Econ Basics: Growth• Why do economies grow?• Long term growth comes from:

– New technologies• Ex: Machines allow people to produce more

goods– Increased skills and efficiency of labor

force• Ex: Highly educated workers can get more

done– Investment

• Ex: Money spent to build more factories

• Short term growth can be sped up by:– Greater consumption by people, firms,

states• Spending $$ creates demand, speeds up

economy.

US GDP 1950-2012

GDP = Prosperity?• Question: What is the relationship

between GDP growth and prosperity?• Does increased production = make us “better

off”?– Greater GDP = more ipads, new cars,

bigger houses, more health care services…• People usually think that’s good…

– But, it isn’t always that simple…• Benefits of growth may not be shared equally

– Ex: Most recent growth in the United States has gone to a small number of wealthy people

• Beyond a certain point, increased consumption doesn’t make people much more happy/healthy.

Econ Basics: Business Cycles• Capitalist economies are prone to

cycles of “boom” and “bust”: the “business cycle”

Econ Basics: Business Cycles• In good times, everyone gets optimistic

– Build a lot of factories & houses• Economy does great• Unemployment falls; wages and prices go up

– Eventually economic capacity becomes too great• More is produced than people are willing to buy• Firms have layoffs or go bankrupt,

unemployment rises• Economy can go into a deflationary spiral…

– Ex: The Great Depression…

• Governments try to avoid extreme cycles

• Ex: by changing interest rates (discussed below)• Big debates about how much government should

do…

US GDP Growth 1980-2012

States and Markets

• Question: Why do states try to affect markets?

• 1. To improve how markets function• Encourage economic growth• To “smooth out” the business cycle• Avoid market failures

– Prevent fraud, monopolies, etc

• 2. To reshape society• Change distribution of wealth

– Ex: help the poor, elderly• Or other goals: Reduce environmental

degradation, reduce discrimination, improve medical care, etc…

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…

Fiscal Policy: Basics• Fiscal Policy: State policy regarding

taxation, public revenue, and debt– Revenue: Money the government takes in

• Taxes generate revenue for the state• Revenue (together with borrowed money)

allow states to spend money– Spending: Money the government

spends• Allows the state to build infrastructure, provide

services, have a military, etc

Fiscal Policy: Basics• What does the US gov’t spend money

on?– “An insurance company with an army”– The 3 biggest budget items are:

• Social insurance: Social security, medicare, medicaid

• The Military• “Debt service”: Paying back money that the

government borrowed in the past

An insurance company with an army

US government spending (detail)

An insurance company with an army• This observation solves a puzzle:• Many politicians say they will shrink

government & cut taxes…– But, once elected they rarely do. Why?– Answer: Biggest budget items are popular…

• Can’t pull the plug on grandma’s healthcare• Can’t cut grandma’s social security check• Politicians most interested in shrinking

government tend to like the military… so can’t shrink that either

– Other programs are much smaller• Huge cuts would be needed to affect overall

budget• And, many of those are popular, too!

Fiscal Policy: Taxes• Milton Freedman (economist): “To

spend is to tax”• If a government spends, it must tax to pay for it• Either tax now, or borrow money now and tax

later…

• What does the government tax?• Income (individual and/or corporate)• Transactions (sales tax, taxes on trade)• Property owners• Activities that require fees (e.g., driving,

fishing, etc).

Fiscal Policy: Tax Rates• How high should taxes be?

– Low taxes can spur more investment…• Investment generates economic growth, makes us

richer• Companies like to build factories in places with low

taxes– Higher taxes allow more government services

• Better schools, healthcare, roads, military• And greater possibility for redistribution: the

welfare state• Companies like to build factors in places with an

educated workforce– The United States is on the low taxes & low

spending side of the spectrum– Compared to other industrialized countries– US corporate taxes are high “on paper”, but with many

loopholes, so actual taxes paid are pretty low.

US Budget Deficit 1980-present

US tax rate is around 27%.

Average among rich countries is

36%

Fiscal Policy: Definitions

• Budget surpluses occur when the government spends less than it takes in

• 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

• National debt: the amount the US owes

• Consequence of prior budget deficits• Current national debt: $17,300,000,000,000• Around $54,500 per person.

US Budget Deficit 1980-present

Question: How bad is US debt?

• Debt is best measured in comparison to GDP

• Debt is around 17 trillion, GDP is around 16 trillion• US debt is just over 100% of GDP

• Everyone agrees that a little debt is harmless

• It can be good for governments to take on some debt in a recession/depression: the “New Deal”

• Everyone agrees that extreme debt is bad• Causes inflation; government can have a “debt

crisis”• Debt of 200% is definitely BAD

• US is on high side of “OK”• If economy improves, debt situation will look

pretty good• Probably the recession is a bigger issue in short

term…

Fiscal Policy: Spending

• Government spending can “jump-start” the economy

• Keynes: “Government should spent against the wind”

• Example: “New Deal” spending, war spending helped create jobs and economic growth in the depression

• But, consistent high government spending can harm economic growth

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

• Extremely high debt can cause a “debt crisis”– Costs of borrowing go up… countries can even go

bankrupt!

Fiscal Policy: Stimulus• How does the government “boost” the

economy?– Answer: by increasing “consumption”…

• Either by spending money itself, or by reducing taxes in ways that cause others to spend

• As gov’t or people start to spend, there is more demand for goods and services…

– Companies make profits and hire more workers– Economic growth accelerates.

Example: The “Stimulus Bill”• The “stimulus bill” is an example of fiscal

policy• “American Recovery and Reinvestment Act of

2009” • Provided 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.

The 2009 Stimulus Bill

The Stimulus Bill: Debates• Democrats / Keynesians: Stimulus bill

was a good idea… increases growth & employment

• Argument: Benefits outweigh the debt that is incurred

• In fact, some economists argue that we need a second round of stimulus…

– Ex: Week 1 reading: “Keynes Was Right”

• Republicans / free market economists: Stimulus bill was a bad idea: too much debt

• Argument: Could cause inflation and reduce growth

• Conservatives more concerned about debt and inflation

– We need “austerity” – reduce debt and economy will rebound

– Ex: Week 1 reading: “Keynes Can’t Help Us Now”

Keynes vs. Hayek Video• An amusing summary of the case

for/against using government stimulus to aid the economy during a recession/depression

• Video\Keynes Hayek Video.flv

Effects of Stimulus: Multipliers• How much does stimulus increase the

GDP?• Answer: It depends

– Stimulus doesn’t work if:• The economy is going strong, everyone employed• If the money is given to recipients that don’t

spend it– Stimulus can have a big effect if:

• The economy is depressed. Lots if idle workers• If the recipient spends, starting a “chain reaction”

– Ex: Gov’t gives it to a road building company, company gives it to a worker, worker buys food, grocery store hires workers, 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: Evidence• So, was the stimulus bill good or bad?

– 1. Evidence suggests that the stimulus bill did help the economy• Without stimulus, unemployment and growth

would’ve been even worse– Related issue: Countries that pursued

“austerity” instead of stimulus have not done especially well

– Indeed, recent S&P report suggests austerity has in some cases been self-defeating

– Austerity harmed growth, reduced tax revenues– Result was increasing (not decreasing) debt…– http://www.standardandpoors.com/ratings/articles/en/us/

?articleType=HTML&assetID=1245327305715

The Stimulus Bill: Evidence• Was the stimulus bill good or bad?

(cont’d)– 2. Predictions made by critics of the stimulus

bill haven’t proved correct (so far)• No sign of rampant inflation. Indeed, inflation is

very low• Stimulus isn’t main source of US debt

– Much debt came from 2001 tax cuts, cost of wars, recession.

– And, debt main source of long-term debt problems is healthcare costs, not stimulus spending.

– Conclusion: Stimulus basically worked• And a larger stimulus bill would have further

reduced unemployment.

Monetary Policy• The government acts as a bank:• The “Federal Reserve Bank” was set up by

the government to store a reserve of money-- But, operates somewhat independently from gov’t

• Called “The Fed”; general term: “central bank”– The Fed lends money to other banks

• Banks, in turn, lend to people and companies

Monetary Policy

• The “Fed” uses its 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 & unemployment 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

• The Fed chooses the interest rate it will charge to lend money

• The Fed is so big that other banks follow its rates• So, the Fed effectively sets rate for the whole economy.

Monetary Policy

• The impact of the Fed’s interest rate policies:• Low rates stimulate the economy

• Also called “expansionary” or “loose” monetary policy• Encourages people to spend, companies to invest• Downside: potentially higher inflation

• High rates slow the economy– And, can be used to reduce inflation

• “Tight”, contractionary, or conservative monetary policy• High interest payments mean that businesses and people

are less likely to borrow, spend, invest.

US Interest Rates 2000-2014

Rates lowered during recession

after dotcom crash & 9/11

Rates drop to zero in current

recession

The “Lower Bound” Problem• What if you want to speed up the economy

more, but interest rates are already near zero?– Answer: You’re stuck in a “liquidity trap”

• 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: “Quantitative easing” (buy assets to put $ into economy)

– Implication: At “lower bound”, 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

• Example: Airline Regulation– 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. In 1940s, US Gov’t 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– Higher prices for consumers

• Deregulation had the opposite effect.

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– Wages in China are WAY below US minimum wage… which

makes China a attractive place to invest

• Questions to ponder:• What might happen of wages were “deregulated”?• What if the minimum wage was increased to $20/hr?

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!

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…

The Credit Crisis of 2008-9• A story of banks evading state regulation…• Krugman: Rise of “shadow banking”

– Banks were heavily regulated since 1930s, but didn’t like it• Banks began to circumvent regulation: a “shadow”

banking system• Banks took greater and greater risks… and made $$$$

– Decline of real estate market in 2007-8 caused risky investments to lose HUGE losses

– Banks began to go bankrupt; bank runs began– Without government intervention, many major banks would have

gone out of business…» Since businesses need bank loans, the effect of banking

collapse would have been horrific.

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… No government intervention

• Banks were reckless, let them fail• A “free market” solution…

– 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

• President Bush chose this option…

State Ownership• Governments can own factories, railroads,

electric power plants, hospitals, etc.• Nationalized or “state-run” industry: a

business or industry that is run by the state– Nationalization is when the government takes

over formerly private companies or industries• Example: airport security screeners after 9/11

– 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 in some cases, they can be very efficient

– Ex: Social security vs. private savings funds– Ex: State-run health systems vs US system of private insurers

– 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.

Overview: 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: Some industries may be nationalized• “Private sector” is smaller.

Keynesianism vs. Free Markets

• The Free Market state:– Fiscal Policies: Low taxes, low spending

• Corporations & international investors are attracted by low taxes

– Monetary policy: Conservative (high interest rates)• High interest rates keep inflation low

– As a consequence, unemployment is higher

– Regulation: Minimal• Companies are free to do as they please

– Ownership: Privatized• The state doesn’t own industries; it is all “private”.

Democrats, Republicans, Markets• Democrats have been historically more

“Keynesian”, republicans more “free market”• But, everyone has shifted more toward free markets

– Also, there are plenty of exceptions• Democrats supported many free-market policies

– Ex: Carter (D) oversaw the start of deregulation– Clinton pursued many free-market policies

» Signed NAFTA; worked to reduce govt debt & spending• Republicans don’t always follow “conservative” policy

– Ex: Nixon (R) instituted wage and price controls.– Reagan & Bush 1 & 2 spent lots of money, creating huge budget

deficits and a huge amount of debt– Bush 2 created TARP: rescuing banks in 2008-9 rather than

“letting the market work”….

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…

US Budget Deficit Trends