Stationary Bandit

Was Marx Right?

As I was preparing for my history of economic thought course, I came across the following prediction from Karl Marx.  Marx claimed, as communism emerges from capitalism, a number reforms will take place.  The following caught my attention.

5. Centralization of credit in the banks of the state, by means of a national bank with state capital and an exclusive monopoly.

Advice from Turgot regarding the next bailout bill

From "In Praise of Gournay":

“To suppose all consumers are dupes, and all merchants and manufactures to be cheats, has the effect of authorizing them to do so, and of degrading all the working members of the community.”

Does Washington believe the Washington Consensus?

NO.  The bailout bill ignores the macro policy prescriptions that the US government advocates for developing countries.  When crisis hits, uphold the rule of law and engage in fiscal responsibility.  Congress sees the situation differently.  Robert Shimer succintly states that long-run problem.

In closing, let me mention one other issue that I take very seriously. I recognize that this might not matter much to my Congressman, but in my view it may be the most important issue for global welfare. The U.S. has long been a beacon of free markets. When economic conditions turn sour in Argentina or Indonesia, we give very clear instructions on what to do: balance the budget, cut government employment, maintain free trade and the rule of law, and do not prop up failing enterprises. Opponents of free markets argue that this advice benefits international financiers, not the domestic market. I have always believed (at least since I began to understand economics) that the U.S. approach was correct. But when the U.S. ignores its own advice in this situation, it reduces the credibility of this stance. Rewriting the rules of the game at this stage will therefore have serious ramifications not only for people in this country but for the future of global capitalism. The social cost of that is far, far greater than $700 billion.

Once some form of the bailout bill passes, the debate over the desirability global capitalism will continue and the stakes are high.  For example, who needs the rule of law if the US Congress does not? Now I understand why so many people compare the current situation to the 1930s. 

(HT: Mankiw)

Will the New Finanical Order Undermine Economic Growth?

Maybe.  As the financial markets falter, demand for regulation has increased.  But regulation is not a free lunch.  Regulation substitutes for trust between firms and citizens in the short-run.  As firms take actions that the public views negatively, they ask for more regulation.  The public sector responds accordingly.  The new regulatory agencies hopefully will correct the behavior of shady firms.  However, in long-run, corruption replaces the well-meaning regulation.  Why?  As regulations become more extensive, individuals invest in less social capital.  They do so because the returns to investing in social capital declines.  What is the benefit of building trust in a regulated relationship?  As social capital declines, corruption increases (the self-enforcement constraint weakens).  Individuals use resources to protect their wealth or hide it rather than create wealth.  Economic growth decreases.  Here are two papers (1, 2) that make the point.

The Stiglitz Solution

With typical humility, Joseph Stiglitz writes

Many seem taken aback by the depth and severity of the current financial turmoil. I was among several economists who saw it coming and warned about the risks.

His policy proposals are not surprising.

1. We need first to correct incentives for executives, reducing the scope for conflicts of interest and improving shareholder information about dilution in share value as a result of stock options. ..

2. Secondly, we need to create a financial product safety commission, to make sure that products bought and sold by banks, pension funds, etc. are safe for "human consumption."...

3. We need to create a financial systems stability commission to take an overview of the entire financial system, recognizing the interrelations among the various parts, and to prevent the excessive systemic leveraging that we have just experienced.

4. We need to impose other regulations to improve the safety and soundness of our financial system, such as "speed bumps" to limit borrowing...

5. We need better consumer protection laws, including laws that prevent predatory lending.

6. We need better competition laws.

Two comments.  Where are the public choice considerations?  Laws require enforcement by real people and members of commissions are corruptible.  When dealing with large amounts of money, then it becomes increasingly likely those involved will engage in corruption.  Sometimes it is cheaper to bribe the judges and regulators then to pay the fines and/or go to jail.  Edward Glaeser and Andrei Shleifer's "The Rise of the Regulatory State" made this point.  Furthermore, regulations often have the effect of spurring innovation to avoid the regulation.  New types of financial instruments emerge and no commission monitors them.  Without perfect foresight, how can a commission prevent the current problems?  How does Stiglitz or anyone else propose to avoid these problems?

Too big to fail?

The decision to nationalize Freddie Mac and Fannie Mae has been justified on the grounds that a failure to take such a measure would have led to a macro-level disaster.  The spillover effects would have been enormous.  The U.S. and other countries would experience a deep recession and the associated hardships would manifest themselves.  They were simply too big to fail.  This is a common argument in favor of government intervention.  One problem I have with this approach (I will assume away public choice considerations) is that too open-ended.  Is any large financial institution not too big fail?  Theory does not offer a threshold; it simply posits one.