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
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.
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…
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 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.
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 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 SpendingEstimated Multiplier Infrastructure projects1 - 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/?articleT ype=HTML&assetID=1245327305715http://www.standardandpoors.com/ratings/articles/en/us/?articleT ype=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/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…