Saturday, November 8, 2008

The Wages of Ignorance by John de Waal, MBA. (1831 words)

Everyone knows all about economics and everyone knows that, at this time, our economy is not going in the right direction: jobs are going south (or to Asia), prices are going up, and health care is out of reach, yet we spend $685 billion (or $2,300 for every man, woman and child) per year on our military! Even though our president says we are not, almost all pundits say that we are heading for a depression and predict that it will be as bad as, or worse than, the Great Depression of 1929 .

What is the problem? There are many, but I believe that one is our collective conservatism along with two reasons that are closely related: (1) ignorance of the science of economics and (2) abuse of this ignorance by those who we put in power. The latter have been making changes that serve only special interests at the expense of everyone else and clothe these changes such that we actually think that they are good for us. Two examples: (a) since 9/11 we are at war against terrorists, so we invade Iraq, a country wholly innocent of this terrible act, because it is better to “fight the terrorists there than here”. (b) Republicans removed most regulations from the financial industry to set them “free” because that is good for us. But let’s talk a little about economics:

What is economics ?

Economics is “the science which studies human behavior as a relationship between ends and scarce means which have alternative uses”. [Lionel Robbins, 1921]. The subject thus defined involves the study of rational choice theory as these relationships are affected by incentives and resources and it is widely used as an assumption of the behavior of individuals in microeconomic models and analysis. To be sure, all the models assume that individuals choose the best action according to stable preference functions and constraints facing them, but most have additional assumptions. Moreover, the term 'rationality' is different from the colloquial and most philosophical uses of rationality because models of rational choice are diverse.
Proponents of rational choice models do not claim that a model's assumptions are a full description of reality, only that good models can aid reasoning and provide help in formulating falsifiable hypotheses, whether intuitive or not. Successful hypotheses are those that survive empirical tests .

If you had a little trouble reading the above information, than you can appreciate that economics is a science that is not easily understood, let alone worked with. Even professional economists have difficulties in interpreting economic data, are often not able to predict the outcome of any given situation any better than you and I, and they disagree with each other constantly. The science of economics is useful to explain how systems work and what the relationships are between the economic players in society at large afterwards. Should a similar set of circumstances recur, perhaps then the outcome can be predicted with some confidence and its negative consequences ameliorated or prevented. It can also be used to obfuscate matters by authorities.

Methods of economic analysis are applied to virtually all fields that involve people (officials included) who make choices in a social context, including crime, education, the family, politics, finance and war among others. Officials (politicians and legislators) use the outcomes to justify their decisions even though they do not understand the real economic ramifications any better than you and I. Therefore they heed economists that claim to know, provided that these support their decisions. Economists with differing opinions are brushed aside. One of these was John Kenneth Galbraith (1908-2006), the liberal Canadian-American economist.

Even though Galbraith was a former president of the American Economic Association, he was considered an iconoclast by some of his colleagues and the whole conservative establishment because he rejected technical analyses and mathematical models of neoclassical economics. He insisted that economic activity cannot be distilled into inviolable laws, but remains a complex product of the cultural and political milieu in which it occurs. Specifically, he derided the fact that important factors such as: (1) advertising, (2) the separation between corporate ownership and management, (3) oligopoly , and (4) the influence of government and military spending, are largely neglected because they are not easily amenable to self-evident descriptions. He would admit that classical economic theory works in times of "poverty", but as society becomes relatively more affluent, private business creates consumer wants through the use of advertising and thereby generates an artificial affluence, mostly at the expense of the public sector”. [See: The Affluent Society, Houghton Mifflin Co., New York, NY 10003, 1958]. The conservatives in our country regarded Galbraith as an anachronism and their thinking became evident from the Nixon presidency onwards. Their clamoring for pro-market, anti-regulation, small-government and low-tax orthodoxies became law during the Reagan presidency and they are still the law today.
What was so anachronistic about Galbraith’s ideas? In a word: nothing! His ideas were based on simple common sense and recognition of human moral frailties. But these features are not shared by many of our contemporaries nor are studying statistics and other economic data a typical past-time for most. Thus it is possible that, when decisions are made that are not good for the country, but only for a certain segment, no alarms go off even if some columnists try to make us aware. A good example is the deregulation of the finance industry because it opened the door to many new financial instruments, including those that allowed issuance of sub-prime loans:
What are sub-prime loans? Sub-prime loans are loans made at a higher rate than prime, to borrowers with a poor credit history. Collateral is the house or the car for which the loan is needed, or the employment in case of credit cards. It seems pretty simple, but the practice is controversial because deliberately lending to borrowers who might not be able to meet the terms of these loans will lead to default, seizure of the collateral, and foreclosure. So why do it? Because these loans are risky, profits on them are much higher. That the victims end up in misery is of no concern to the lenders. How can the financial industry get away with it? Because conservatives had removed regulations and governmental oversight, this lucrative practice went unchallenged and was aggressively advertised creating the artificial affluence Galbraith had warned us about in 1958. Where did all the money come from? Because sub-prime lending is so risky, these loans sold by major financial institutions would be “repackaged” into REMIC trusts, making them all but invisible. REMIC trusts are used for issuing bonds, securities and other investment vehicles that are sold to pension funds and other fixed income investments, as well as to the world’s financial markets.
When defaults started to happen and then cascaded into hundreds of thousands of foreclosures over a short period of time, over one hundred major American sub-prime lenders filed for bankruptcy and a restriction of available credit followed. The sub-prime loan industry (mortgages, car loans and credit card balances) made a few people incredibly rich, but when things went south our conservative government did little for the sub-prime victims: on December 6, 2007, President Bush announced a voluntarily and temporary freeze of the mortgages of a limited number of mortgage debtors holding ARMs by the Hope Now Alliance , called for modernizing FHA, Freddie Mac and Fannie Mae, temporarily reforming the tax code and to pass funding for mortgage counseling. It sounds good, but that’s about it. The plight of the billionaires was addressed more effectively: Bear Sterns was bailed out with $30 billion and there are more billions earmarked for such purposes. There finally is some talk about regulating the industry, albeit after the fact, but if consumer rights attorney Irv Ackelsberg is correct in his prediction to the U.S. Senate Banking Committee that there will be about five million foreclosures over the next few years, it will not only be our economy, but the entire global economy, that may melt-down.
Thus, credit, as a private good, was 'over provided' through advertising without regards to the consequences. Government protects the wealthy and offers a band-aid for the gaping sub-prime loan wound, and there is no money for public goods such as infra-structure etc. Dr. Galbraith’s insight is illustrated by the recent bridge collapse in Minnesota, the poor condition of other bridges, neglected public parks and forests, poorly maintained public schools, the slow recovery of St. Louis after hurricane Katrina, overcrowded hospital emergency rooms, and widespread hunger in the USA, to name but a few.
When Galbraith proposed to regulate consumption of certain products to counter such deficiencies, he drew sharp criticism from conservative ‘free-market’ gurus like Milton Friedman of the Chicago School and Paul Krugman of Princeton University. The former asserted that (1) “Galbraith believed in the superiority of the aristocracy and in its paternalistic authority”, (2) that consumers should not be allowed choice and (3) that all should be determined by those with "higher minds". The latter called Galbraith a "policy entrepreneur who makes unwarranted diagnoses and offers over-simplistic answers to complex economic problems”. Exactly how these two square their disparaging remarks with Reagan’s ‘trickle down’ theories that: (1) provide the wealthy American aristocracy large tax cuts and other loopholes, (2) do not consider consumers, but (3) place a ‘responsibility’ for making the US economy prosper on the “high minds” of the rich, is hard to see, while doing away with regulations and trade unions is hardly a solution for “complex economic problems”. Ken Galbraith’s sophisticated economic governmental interventions which “protect consumers from corporate exploitation and manipulation through advertising and manufactured demand” , while not a textbook ‘model of ‘free markets’, is clearly better.
In view of what is happening, don’t you think that it is high time that we rid the House and Senate of the conservatives who have been using their elected offices to work against their constituents on behalf of their corporate bosses. In their stead we must elect representatives who understand economics and its consequences, know what to do and have the political will to do it. They also must have their priorities in the right order for what is at stake is no less than the immediate future of our country and the world. Therefore they need a mandate to fight the real enemy of the people: the corporate and military power that controls our country. In order to elect such persons we must have an educated electorate that makes a real effort to understand the issues and its ramifications so we can elect our representatives with intelligence. If we do not, we will – once again – elect representatives who will lead us by the nose until frustrations rises to the point where revolution may break out. Such a development can make things worse, but to continue our descent into third-world nation status is also not very good.

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