Normative Narratives

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Economic Outlook: “American Winter”`

Yesterday a friend of mine, Adam Blejer, pointed me towards an HBO documentary, “American Winter”. He thought, rightfully so, that the message conveyed in the documentary was one that I may be interested in and have some insight on. Always eager to learn from my followers and get them involved, I looked into the documentary.

I should say now that I was unable to actually watch the documentary, as I do not have HBO on demand. What I was able to do was read the summary of the documentary by the producer, which can be found here. This actually helped me analyze the documentary more clearly for two reasons. One, I have the meat and potatoes of the documentary spelled out in front of me, I did not have to watch and take notes or worry about missing anything, it is all there for me to go back and check on. Second, I was able to see the underlying argument without getting emotionally wrapped up in the struggles of the people in the documentary. This would have made an unbiased critique difficult if not impossible.

Without further ado, an analysis of the documentarian’s message:

The first thing I analyzed was any message conveyed based on economic indicators. In the first paragraph, I saw something that could not look right. “Yet 46% of this country is living in poverty, or near poverty, and today we have the highest number of poor since we began keeping records.” This is a slight of word, as the official U.S. poverty rate as of 2011 was 15%–31% of that 46% may be living “near poverty”, but are not actually living in poverty.

One has to be careful, as poverty rates are based on a benchmark rate; set that rate too high and everyone is in poverty, set that rate too low and some people who are truly struggling to survive will not be counted. The census bureau is very transparent about how they find their numbers; an explanation can be found here. I will leave it up to you to determine whether the numbers are too high or too low, but that 46% was an obvious shock value number—many of those 31% living “near poverty” have much much more than even the “wealthy” in less developed countries.

Which brings me to my next point, about inequality in the U.S.: “The Gini coefficient is commonly used as a measure of inequality of income or wealth and is accepted as a fair method to compare income inequality in different countries.  According to America’s Gini coefficient of 0.450, the U.S. ranks near the extreme end of the inequality scale, comparable with Cameroon, Madagascar, Rwanda, Uganda and Ecuador.  China is significantly more equal than the U.S. with a Gini coefficient of 0.415, and India is leagues ahead of the U.S. on income inequality, with a Gini coefficient 0.368.  Even Russia is less unequal than the U.S., at 0.422 Gini.”

The Gini coefficient ranges from 0-1; the closer to 0 the more equally a countries income is distributed.The .45 number checks out, although it is significant lower once you account for taxes and transfers. There are structural issues that have lead to this inequality; low investment in social programs, preferential tax rates on capital gains and other subsidies which disproportionately go to the wealthy, and the decline of union power are all common examples.

However, there are notorious shortcomings for comparing Gini coefficients between countries. For one thing, the same Gini coefficient for two countries can mean different things. Whenever you aggregate numbers, information gets lost in that aggregation. Also, in some countries such as China and India, the most impoverished experience “extreme poverty”. While relative poverty of course exists everywhere, extreme poverty exists only in the developing world. For these reasons, it is irresponsible to say “The Gini coefficient…is accepted as a fair method to compare income inequality in different countries.” This is far from a consensus amongst academics and policy makers.

Next I examined the ethical argument over the welfare state, the “makers vs. takers” argument if you will. Paul Krugman has done a great job of highlighting how transfer programs tend to amount to inter-generational consumption smoothing; you borrow when you’re young, work and contribute when you’re in the prime of your life, and then retire and take from the system again. This formula has underpinned political economy and tax philosophy for decades if not centuries, and it works. In fact, there is really no alternative that works remotely as well in creating the opportunity for social mobility.

Here’s the filmmakers take on the subject:

“How can nearly half of our country be in such dire circumstances and yet our politicians chose this time of the most need in 80 years to cut budgets and social services all across the country?  It’s because there are such pervasive myths and stereotypes about those families who need help—they are lazy, they are takers, they are incapable, they made bad decisions—so we don’t need to care about them.  But as we made American Winter we found a very different story.  The families who we followed for this film are struggling, yet they are just like our friends, neighbors and members of our own family.  They are hardworking, loving folks who have had a bit of bad luck, a job loss, a health issue, a death of a parent, a handicapped child.  These events have set them back and then life becomes an uphill battle to get back on their feet again.”

This is a problem I tend to have with documentaries, is that they cherry pick information. Certainly some people who need help actually need it temporarily to help them get back on their feet. But you can be equally certain that there are some lazy people who rely on handouts their whole lives, people who “game the system”. It is because people see the world as black and white that it is so hard to work on reforms that can strengthen the welfare state and make it work more effectively. This is why politicians talk past each other, instead of deliberating and debating in order to come to reasonable compromises that work for the American people.

Another issue the summary touches on is the inter-generational nature of poverty; what economists refer to as poverty traps:

“In making American Winter we saw firsthand how stressed and scared these parents are everyday by the prospect of losing their homes, and by the daily struggle to pay their bills.  However, the most overwhelming part was seeing the kids who have lost hope for their future.   These kids see their parents work extremely hard, and the kids say to themselves, “we’re barely getting by everyday, how am I going to make it when I grow up?”  And losing that sense of optimism and hope does not bode well for a child’s future.”

“Studies show that it is cheaper to help families before they become homeless.  And it is cheaper to help families before the kids are traumatized by living with food and housing insecurity, because those kids don’t do as well in school and they are more likely to wind up on drugs or in the prison system.  Those costs to society will affect all of us for ten, twenty, thirty years to come.  Yet even though it is cheaper to help families, to get them to a place where they are stable and productive, we seem to turn a blind eye and tell these families that they are on their own.

Every one of us needs help at some time in our lives.  But the idea that families who need social services are “takers” is one of the most destructive myths of all.  The perception is that our tax system and our government disproportionally helps the less affluent at the expense of the wealthy.  In fact, the U.S. government spends $400 billion a year on tax policies intended to help families save and invest.  In 2010, the wealthiest 5% of taxpayers averaged a net benefit of $95,000 each, while the bottom 60% received an average benefit of $5 each.”

I have written about poverty traps many times here at NN, just search poverty traps in the search bar and you will see in how many different contexts poverty traps exist. I fully agree that it is cheaper and more effective to attack the root causes of poverty before they become a problem. I do not know the methodology the filmmakers use to come to their conclusion, but it fits into a general philosophy I have on the subject; that any money saved in the short run by cutting social programs will be dwarfed by increased future spending in the welfare and penal systems.

So while some of the figures and concepts the documentary pronounces may be a bit stretched (as is common with documentaries, as they are meant to have shock value), the overall message is one that I cannot (and do not wish to( refute. Income inequality is too high in America, and it is this way due to structural flaws in our fiscal and tax policies. Sequestration and other short term budget cuts are like putting a Band-Aid on a gunshot wound, it may stop the bleeding for a little but in the long run the problem will be worse.

Capital gains taxes remain too low, even as they have risen from 15 to 20% following the “fiscal cliff” deal. Joseph Stiglitz explains quite eloquently how this perpetuates financial bubbles and takes talent away from more sustainable fields (such as medicine, teaching, manufacturing; basically anything not associated with capital gains).

Meanwhile, no meaningful financial reform has taken place since the financial crisis. The same concept of “securitization” is beginning to rear its ugly head again. We must learn as a country from our past failures, and demand our elected officials enact policies that our in our best interests as a nation (I have often said that the only special interest group Congress should be worried about is the American people).

It is the job of the American people to hold their elected officials accountable, and vote for the politicians that support the policies that we as a nation know are right (or at least vote against politicians who support policies that have been tried and failed).


Economic Outlook: The Cost-Benefit Analysis of Competent Governance–Revisiting the “Confidence Fairy”

Markets around the world reacted favorably to news of a deal reached by Congress Tuesday to avert the Fiscal Cliff. The deal reflects concessions from both sides, although is largely seen as a victory for Democrats, who secured most of the Bush-era tax cut expirations on the wealthiest Americans while preserving low rates of the middle class. Obama also got the short term stimulus needed to help along the weak U.S. economic recovery, which he could not have gotten by “going over the cliff”. Neither side emerged too optimistic from the bargaining table, which probably reflects that a fair deal was reached (although don’t tell a happy VP Biden that).

By raising the maximum threshold from $200,000 (single filer) and $250,000 (joint) to $400,000 and $450,000 respectively, the G.O.P. was able to spare the majority of small businesses that would have been affected by the expiration of the Bush era tax hikes. Lower rates for middle income earners and continued government spending are likely to benefit poorer voters, those who spend a larger % of their income and therefore stimulate the economy more for every dollar of income they have (compared to a wealthier person).

Concessions and approval by the G.O.P. in the House of Representatives, the fiscal bills toughest opponent, can be seen as a means of gaining popularity among voters after tough losses in the 2012 election. The bill received wide bipartisan support in Senate, if the House failed to pass the bill the majority of the blame would’ve fallen on specifically on G.O.P House Representatives.

There has been a continuous trend over the past few months (and really much longer than that), that there is a real benefit of government effectiveness and a real cost of political tumult. During the debt ceiling debates of the summer of 2011, S & P downgraded the status of U.S. Federal Debt for the first time in history, reflecting not the unsustainability of the level of debt, but the costs of even a whisper that the U.S. would not honor its past commitments. This is not an acceptable alternative in the eyes of President Obama:

“While I will negotiate over many things, I will not have another debate with this Congress over whether or not they should pay the bills they’ve already racked up through the laws they have passed,” he said. “Let me repeat we can’t not pay bills that we’ve already incurred.”

Markets in Europe (and around the world) have also reacted favorably to positive news of greater fiscal consolidation and ECB action in addressing the European Debt Crisis. On the other hand, markets have reacted negatively to news of austerity preconditions for emergency debt financing and general pessimism over the sustainability of GIPSI (Greek, Irish, Portuguese, Spanish and Italian) debt.

Check out Trading Economics global financial markets info (you will have to search each country individually unfortunately there does not seem to be a chart for market averages by region). Each peak and valley in recent history is likely to be associated with some government action or inaction, with too many to go through individually.

Hopefully the G.O.P. will learn by positive reinforcement; markets reacting favorably will lead to a favorable response by their constituent. As with any political party, the G.O.P. is ultimately accountable to the will of the people. If this is the case, and the G.O.P. is willing to be more flexible on its position of short term stimulus spending, targeting long term deficit reduction in the form of higher taxation while addressing future spending cuts once the economy has fully recovered from the recession, then Obama’s concessions will be well worth it (and the G.O.P. will find itself with a much broader support base come 2014, and a much stronger platform to run on).

If Congress uses the debt-ceiling, as it has stated in the past, to force contractionary spending cuts into the Federal Budget, then any goodwill generated by reaching a fiscal deal in Washington is likely to be short lived. The U.S. is out of the frying pan, but whether we are “into the fire” or “in the clear” is largely dependent, for better or for worse, on the future actions of our elected officials. Let’s hope the 113th congress is more responsive to the needs of the American people than the 112th was.

Deals should not be made simply because markets will react a certain way, that’s bad politics and bad economics. Deals should be made with long term debt sustainability, short term economic recovery, and social equality / mobility as the ultimate goal. Special interests should not dictate policy that affects hundreds of millions of people nationally and billions of people worldwide.

The “confidence fairy” is real, and policy does have both immediate and long term effects on markets and economic performance. It is not, however, “moral hazard”, or high levels of debt which drive the “confidence fairy” (especially not in the short run, which is the only place the confidence fairy exists anyways, as markets tend to forgive past mistakes very quickly in search of profitability, ask Argentina).

It is government competency that has a real impact on the global economy. When governments act courageously, and work out strong bi-partisan deals that protect the interests of the majority and promote overall economic strength, markets react positively. When elected officials squabble like schoolchildren, and remain accountable only to fringe groups, nobody wins. The confidence fairy is more of a gauge of confidence in our political process then confidence in short term budget sustainability.

When policy is perceived as sustainable, business flourishes and consumers are more confident, increasing growth and reducing unemployment. When uncertainty and partisanship are the order of the day, the economy stalls and everybody loses—even those who think they have “won”.

Hopefully we have learned a collective lesson as a country and a global community from our past mistakes, only time will tell.