The renewed interest in breaking up too-big-to-fail (TBTF) banks may remind people about the extraordinary influence that banks and financial institutions hold over our economy. The financial industry has experienced substantial growth over the last few decades. The financial sector’s share of corporate output (gross value added less Fed profits[1]) has grown rather steadily from 5.7 percent in 1960 to 14.1 percent in 2006 (see Graph 1).  Yet, the financial sector’s share of total corporate profits (net operating surplus less Fed profits) soared from slight losses to 22 percent (corresponds to an increase of $142 billion in 2006) in the same timeframe. This increase in finance’s share of profits far exceeded its gain in the share of corporate production. In the years leading up to the financial collapse (2001-2006), the financial industry enjoyed profits that were hugely disproportionate to their share of output. The disparity between the share of profits and production peaked in 2003 at a difference of 8.3 percentage points. The financial sector’s share of total corporate business profits has been very erratic over the last few decades with a general upward trend, contrasting to a more gradual increase for its share of output. It is important to remember that the high pay and bonuses of top executives and traders, which can run into the millions or tens of millions a year, do not count as profits.

Graph 1
(Click for a larger version)

The growth in the size of the financial industry provides an interesting juxtaposition to the growing inequality over the last few decades. Between 1970 and 2006, the bottom 40 percent of households’ share of aggregate income fell by almost 3 percentage points while the shares of the top 20 percent and 5 percent rose 7 and 6 percentage points, respectively. Many of the highest incomes were earned in the financial sector. (The pay of top executives and traders are counted as wages rather than profits in the National Income Accounts.)

When toxic assets threatened the operations of those prominent banks and financial institutions, bailout funds provided them liquidity. The total amount lent at below market interest rates was well over $10 trillion; although most of the loans were relatively short-term. These subsidized loans enabled the financial sector to return to its pre-recession profit levels by 2009. In contrast, American households are still recovering from income shocks, unemployment stints and wealth shocks.

Dean Baker
Truthout, April 22, 2013

That is quite literally what he told us in his column. His second paragraph tells readers:

"Among economists, there is no consensus on policies. Is “austerity” (government spending cuts and tax increases) self-defeating or the unavoidable response to high budget deficits and debt? Can central banks such as the Federal Reserve or the European Central Bank engineer recovery by holding short-term interest rates near zero and by buying massive amounts of bonds (so-called “quantitative easing”)? Or will these policies foster financial speculation, instability and inflation? The public is confused, because economists are divided."

See, we don't know what to do, so we just can't do anything. All those suckers who are unemployed or seeing stagnant wages, well we just don't know. And the fact that those on the top are getting rich with 60-year high shares of national income, well what can we do about that? It's just too confusing.

While Samuelson may be very confused by economics, those who understood their intro econ have little difficulty explaining the current situation. The housing bubble was driving the economy prior to its collapse. The collapse eliminated more than $600 billion in demand from residential construction and more than $500 billion in demand from consumption. There was also demand lost from a collapse of a smaller bubble in non-residential construction and from state and local government cutbacks forced by a loss of tax revenue. This is not complicated and it was predicted.

The NYT appears to be following the pattern of journalism practiced by the Washington Post in openly editorializing in its news section. Today the news section features a diatribe against the Danish welfare state that is headlined, "Danes Rethink a Welfare State Ample to a Fault." There's not much ambiguity in that one. The piece then proceeds to present a state of statistics that are grossly misleading and excluding other data points that are highly relevant.

The first paragraphs describe the generosity of the welfare state, then we get this ominous warning in the 5th paragraph:

"But Denmark’s long-term outlook is troubling. The population is aging, and in many regions of the country people without jobs now outnumber those with them."

Oooooh, scary! Yeah people are living longer in Denmark, that's something that's been happening for a couple of hundred years or so. Like every other wealthy country, people live longer in Denmark than in the United States. While they are projected to continue to see gains in life expectancy and further aging of the population, the increase is actually going to much slower than in the United States.

The NYT has difficulty finding pundits who can write knowledgeably about economics. Thomas Friedman made this point in his Sunday column. At one point he quotes Gary Green, the president of Forsyth Technical Community College, in Winston-Salem, N.C.:

"'We have a labor surplus in this country and a labor shortage at the same time,' Green explained to me. Workers in North Carolina, particularly in textiles and furniture, who lost jobs either to outsourcing or the recession in 2008, often 'do not have the skills required to get a new job today' in the biotech, health care and manufacturing centers that are opening in the state.

"If before, he added, 'you just needed a high school shop class or a short postsecondary certificate to work in a factory, now you need an associate degree in machining,' a two-year program that requires higher math, I.T. and systems skills. In addition, some employers are now demanding that you not only have an associate degree but that nationally recognized skill certifications be incorporated into the curriculum to show that you have mastered the skills they want, like computer-integrated machining."

Actually there are simple ways to identify labor shortages. First and foremost we should be seeing rapidly rising wages. If employers cannot get the workers they need then they raise the wages they offer to pull workers away from other employers. This is how markets work. (We should also see longer workweeks and increased vacancies.)

In fact there is no major sector of the economy where wages are rising rapidly. This shows rather conclusively that workers do not have skill shortages although it may be the case that many managers are so ignorant of markets that they don't know that the way to attract better workers is to raise wages. Of course that would suggest the need to better train managers, not workers.

There are some things that we can learn from economics, just as there are things we learn from astronomy. The vast majority of people in the United States believe that the earth goes around the sun because of what astronomers tell us. After all, we all see the opposite every day in the sky.

For this reason, when a major newspaper tells us that when it comes to economics it is all just so confusing (except for what they insist you believe), it is doing a serious disservice. While some aspects of economics are difficult, many of the fundamentals, such as why we have a prolonged economic slump and millions of people are unemployed, are not. (Lack of demand in the economy, if you have to ask.)

In this vein, the Post article, "It's an old numbers game. What if they're wrong?" seems almost like a deliberate effort to confuse readers into thinking there is nothing that can be done about the economy except to have the government reduce deficits.

The second paragraph tells people:

"How much debt can the nation manage? The United States was at about 102 percent in 2012, with the amount of debt held by the public closer to 75 percent. To some, that signals danger. Others say we could handle even more. In certain wonky circles, the debate over what ratio is sustainable is almost endless. And yet, serious people assess the president’s budget, indeed any budget, by how it decreases this ratio in years to come."

This is almost completely wrong. For example, many economists would not even look to the ratio of debt to GDP as being an important variable since debt can be quickly reduced by selling assets. If a high debt level is some horrible burden on the economy, then the United States could just sell several trillions of dollars of assets and immediately lower its burden. People who understand balance sheets know this.

Also, the price of debt fluctuates with interest rates. Debt issued at low interest rates can be repurchased at steep discounts when interest rates rise. This means that if debt-to-GDP ratios are what matters, we will have a great opportunity to quickly reduce this ratio when interest rates rise later in the decade as is widely predicted. This is a reason that serious people tend to focus on the interest burden, which is near a post-World War II low.

The IOM reported this week that over the last three months, some 27,000 people have left IDP camps, bringing the total amount remaining to around 320,000. The IOM credits the vast majority of this reduction, some 74 percent, on relocation programs – most often a one-year rental subsidy. The report’s “highlights” section says that “Evictions accounted for a 6% decrease in IDP household population.”  Yet the data in the report directly contradicts this. Of a reported reduction of 6,401 households, the IOM says 977 were forced to leave due to evictions, representing over 15 percent of the total reduction.

But even this is most likely an underestimate. Over previous months, there has been “a dramatic new wave of forced evictions,” according to the U.N.’s Office for the Coordination of Humanitarian Affairs (OCHA). One camp which has been under the threat of eviction, and from which some families have already been evicted, is Camp Gaston Margon. On March 22, Amnesty International released a statement, warning that:

Approximately 650 families living in Gaston Margon displacement camp in the Port-au-Prince municipality of Carrefour are currently under the threat of forced eviction. Already, on 15 February, 150 families were forcibly evicted from the camp by police officers and a group of men carrying machetes and knives who were accompanied by a local justice of the peace. The armed men began destroying the families’ shelters, while some people were still inside, and attacked individuals that attempted to stop them. The police also shot their firearms into the air to intimidate the families. One infant was reported to have suffered injuries when armed men and police damaged a shelter with the child still inside. The men reportedly threatened to burn down the entire camp and to kill the children of families who did not move.

During the previous IOM reporting period, Camp Margon had a population of 3,376. During the most recent reporting period, the population had decreased to 2,327. Given the reports of threats of eviction, and at least a partial eviction, it is clear that this reduction is not simply a case of “spontaneous return,” as the IOM report implicitly states.

The Carmen Reinhart and Ken Rogoff (R&R) paper purported to show that countries with debt-to-GDP ratios above 90 percent see sharply slower growth rates, and has been widely cited in policy discussions in the United States and Europe and used as a rationale for a near-term focus on deficit reduction. Politicians and policy analysts relied on the results of this paper to insist on spending cuts and tax increases even in economies that are operating at levels of output far below full employment. Based on R&R’s findings, they argued that it was important to keep debt levels from crossing the 90 percent threshold.

This debate is important because the threat to growth from high debt levels was one of the main arguments against the aggressive use of fiscal policy to boost growth. The work of HAP and UMass economist Arindrajit Dube has essentially undermined the basis for this argument. No one can still maintain that we have good evidence that debt levels of the size we could conceivably face in the near future would impair growth.

The new paper from HAP works off the original spreadsheet used by R&R and uncovers several important calculation errors.

• The most important of these errors was excluding four years of relevant data from New Zealand. Correcting this mistake raised New Zealand’s average growth rate in high debt years from the -7.9 percent R&R reported to a positive 2.6 percent.
• Because only 7 countries have crossed the 90 percent debt-to-GDP barrier highlighted by R&R, this change alone raises the growth rate among the high debt countries by 1.5 percentage points.

When this and other adjustments are made to R&R’s data, the sharp falloff in growth rates for countries with debt to GDP ratios above 90 percent disappears.

• While the corrected growth rate is still lower for high debt countries, the difference is much smaller and nowhere close to being statistically significant.
• Furthermore, the sharpest falloff in growth rates occurs at very low debt levels (less than 30 percent of GDP).
• If the corrected results from R&R could be taken as a basis for policy, then the implication would be that countries should strive to have extremely low debt to GDP ratios, certainly well below the levels that the United States and other wealthy countries have generally sustained.