Category Archives: Economy

Managing Capitalism 2: The Pictures

As promised, here is a picture of how capitalist economies, like ours, work over a long period of time. “GDP” stands for Gross Domestic Product, which is the common way of measuring how much total wealth national economies like ours produces over the course of a year. All capitalist economies go through “cycles” of growth (“boom” economies) and decline (“recessions” or “slumps” or “busts”).

simple biz cycle

 If you are a few decades old, you’ve seen this happen more than once. For a few years, the economy grows, it’s easy to find a job, wages rise, and companies make good profits. When things are going well, we expect that to continue,and we take more chances on borrowing and spending, and sometimes we get in over our heads.

Then something happens. People and businesses realize they have to repay all the money they borrowed, and when they buy new items, they notice that prices have (usually) gone up as well during the “boom.” At some point, businesses and consumers (the “private sector”) start borrowing less and cut back their spending. As more and more spenders cut back, there is an economic effect like a snowball growing as it rolls downhill. Consumers buy less, so businesses lay off production workers, then those laid-off workers buy even less, so businesses invest less, and so on. Unemployment, low wages, low investment and low profits spread through the whole economy. Some businesses close, some laid-off workers can’t pay their mortgages, some face foreclosure, and so on. The economy is in recession.

Eventually, after a couple or a few hard years, most debts are paid down, bankruptcies are settled, people start to buy again, companies start hiring, and the “cycle” repeats.   This has been happening for the past two hundred years in all capitalist economies, so we may as well get used to it, and plan accordingly.

Most people and most businesses, of course, would prefer steady and predictable growth. This is where the national government can step in and make a difference. Smart governments (beginning with the Roosevelt Administration in the U.S.) have learned to spend less (or at least run smaller deficits) when private businesses and individuals are spending more – and then spend more (hiring workers directly, or paying higher unemployment benefits, and so on) when the private sector slows down.

bizCycle2Chart above shows how government spending (green line) SHOULD move in OPPOSITE direction from economic growth (black line).

 When the private economy is “booming,” government spending or deficits fall; and when the private sector is in recession, government spending partly makes up for that by spending MORE. Overall, economic production stays closer to the straight line in the center, with fewer and smaller ups and downs. In modern terms, government should STIMULATE the economy in hard times, and consider some AUSTERITY when the economy is growing fast and prices are rising.

This is called “counter-cyclical” government spending, because government spending goes in the opposite direction of the “private sector” – it counters that spending cycle.

A question many people ask is why is it that a national government can spend more when it is collecting less in taxes? This is the opposite of what most of us must do, and it seems contrary to “common sense”. But national governments are unique, all over the world, because they can actually create money and wealth, up to a point. That is one of their indispensable roles – printing money. They are NOT like individuals. “Common sense” comparisons of governments and individuals are just wrong, as history has proved over and over.

  Finally, here is a picture of what should result when government gets it right. While the economy still goes through up and down cycles, over the long run, the economy (the straight, dotted line) generally moves up.

                                        bizCycleGrowth

By smoothing out the boom-and-bust “cycle,” smart governments   make the economy more predictable, make advance planning more realistic, prevent a lot of dumb gambles and painful bankruptcies, and generally help the economy to grow more over a long period of time.

Most Presidents since World War II, including Republicans Eisenhower and Nixon, and Democrats Kennedy and Johnson also did this. President Eisenhower, for example, started building the very expensive Interstate Highway System as a way of getting the economy out of recession in the 1950’s. Presidents Reagan, the first Bush and Clinton also generally understood the rules. One exception: President George W. Bush, who took office in 2001, when the economy was already growing fast – and then stimulated the economy still further by increasing spending to pay for wars in Iraq and Afghanistan (while also cutting taxes, another way of increasing private spending). This dangerous spending increase in an already hot economy encouraged the excessive risk-taking in the financial sector that resulted in the economic crash at the end of his term.

Another example of how these ideas really work? Just look at what happened after the financial crisis of 2008. The governments of the European Community did NOT follow the U.S. example of stimulating the economy (increasing spending) following the collapse of Wall Street banks around 2008. Instead, led by Germany, they cut spending during the recession. They prescribed austerity, instead of stimulus.

What was the result of these opposite policies in the U.S. and Europe? Europe is still struggling to recover from the recession, while the U.S. is well out of it, and into another period of growth. In effect, the world just tried a big experiment as to which government policy – stimulus or austerity – works best in a recession. And the U.S. was right.

Newspapers recently are reporting that Europe has recognized its mistake. The European central bank is starting do what the U.S. Federal Reserve did seven years ago. They have begun to encourage borrowing and spending more money (except for Greece, unfortunately) – and if what you have read here is right, Europe will now complete its economic recovery. In the next recession, let’s hope they get it right the first time.

MANAGING CAPITALISM

Capitalism Needs Government Management

Capitalist economies need strong central management.  A key management role: to modify the wild swings from “boom” to “bust” that inevitably result when many risk-taking competitors pursue their different economic interests.   Only national governments can manage national economies in a way that most competitors will accept as reasonably fair. And as corporations and the private economy grow larger, only a strong government, able to invest and spend enough on its own to make a difference in the overall economy, can do the job.

It took about one hundred fifty years for the first U.S. government, business and labor leaders to understand the need for central economic management, and still longer to learn how to do it right. For many years, for example,everyone believed the government could only print an amount of money equal to the gold bullion it held, at Fort Knox or elsewhere. One effect of tying the government’s hands in this way was that economic Panics and Depressions came and went, with the government doing little or nothing to make things better. Then during the Great Depression of the 1930’s, we learned a couple of new things, mostly by accident.

First, many of us learned that a national government can help get us out of a Depression by spending more than it has in bullion, and more than it collects in taxes. For the first three years of the Depression, Republican President Herbert Hoover did what the “experts” of his day thought he should do: he cut government spending sharply, because the government was collecting less in taxes. And things got worse and worse. One quarter of the former workforce was out of work. Many thousands hit the road as “tramps,” hitching free rides on freight trades, and sleeping in corn cribs. And many banks didn’t have enough money to pay all their debts.

When he ran against Hoover for President in 1932, Franklin Delano Roosevelt (FDR) promised more of the same cost-cutting as Hoover – but when he took office, he did something dramatic and different. He began by closing ALL the banks for a few days, and then allowing only the solvent banks to reopen. Now, people who had some money felt safe to put it in a bank again, where it could be loaned out to buy goods or grow businesses.   Then, the U.S. went off the “gold standard” altogether, with the government spending as much as was needed to address the nation’s problems, especially unemployment and farm bankruptcies.  And things got better!  It turned out that a dollar was still worth a dollar as long as retailers and bankers were willing to give you goods or interest for it. Trust was what mattered. Gold became just one more product on the market.

Even more importantly, FDR also did what he had done before on a small scale, as Governor of New York:  when he saw a lot of people out of work, he hired them to work for the government.  They cut trails through forests, built dams that produced electricity, built a lot of train stations and public buildings. This put money in their pockets.  Of course, the workers on those projects spent every penny they earned as fast as they could. That meant other Americans now found money in their pockets. Usually, they also spent it as fast as they could, and so on. In that way, over the course of a year, each new wage dollar added multiple dollars to the economy, which started to grow again.

The Roosevelt Administration, and the Congress, also started a number of new programs to put money in the pockets of ordinary people, including Social Security, a minimum wage, unemployment insurance, and a National Labor Relations Board. These programs, besides boosting the economy, addressed the radical inequality between huge corporations and individual workers, and between people of property who could live without work, and former wage workers who had no income in old age or unemployment. With all this new purchasing power in people’s pockets, the economy began to GROW again. The government had “primed the pump,” and the private economy began pumping again on its own. With all the new economic activity, tax collections also rose.

By 1937, people figured the Great Depression was history. All that spending by the government was no longer needed! So the Roosevelt government cut spending way back – and we went back into recession! It turned out we had cut government spending too soon and too far for an economy that was still in recovery. At this point — unfortunately for the world, but fortunately for the U.S. economy – Hitler, Mussolini and Tojo launched a war to take over the world. To build weapons and pay soldiers and sailors, the U.S. turned to really huge levels of deficit spending. The economy recovered for good this time, and grew quickly, year after year, long after the war was won. We were finally out of the Depression.   We began thirty years of huge growth (with occasional short recessions), which was widely shared with a new kind of people – the American Middle Class: blue collar and service workers with money in their pockets.

Before and after Roosevelt and the war, a British economist, John Maynard Keynes, had written books explaining how a government should manage the economy, and why. His new theory, “Keynesian economics,” called for deficit spending as a way to get out of recessions, just as the Roosevelt Administration had done for its own reasons. Keynes also said government deficits should be cut when the private sector was booming. Now, confirmed by Roosevelt’s actions, Keynes’ theory became the guide to government economic management from that point forward.

Many business people, and other conservatives, were offended by the idea that government could borrow and print the money it needed to pay its debts. They saw that competition from government “make-work” tended to increase the wages they had to pay to hire employees. They worried that government might have more power than they did. But as the new system prevented downturns from becoming Depressions, growth benefited business along with everyone else, so they grumbled all the way to the bank.

Since the 1930’s, the Federal Government spends more than it has (deficit spending) in hard times, and then cuts back spending once the private sector grows strongly again.  In the 1960’s, Republican President Nixon settled the issue for many people when he said, “we are all Keynesians now.”

In my next blog, we’ll look at some pictures of how this system works.

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MANAGING CAPITALISM:  THE PICTURE

As promised, here is a picture of how capitalist economies, like ours, work over a long period of time. “GDP” stands for Gross Domestic Product, which is the common way of measuring how much total wealth national economies like ours produces over the course of a year. All capitalist economies go through “cycles” of growth (“boom” economies) and decline (“recessions” or “slumps” or “busts”).

simple biz cycle

 If you are a few decades old, you’ve seen this happen more than once. For a few years, the economy grows, it’s easy to find a job, wages rise, and companies make good profits. When things are going well, we expect that to continue,and we take more chances on borrowing and spending, and sometimes we get in over our heads.

Then something happens. People and businesses realize they have to repay all the money they borrowed, and when they buy new items, they notice that prices have (usually) gone up as well during the “boom.” At some point, businesses and consumers (the “private sector”) start borrowing less and cut back their spending. As more and more spenders cut back, there is an economic effect like a snowball growing as it rolls downhill. Consumers buy less, so businesses lay off production workers, then those laid-off workers buy even less, so businesses invest less, and so on. Unemployment, low wages, low investment and low profits spread through the whole economy. Some businesses close, some laid-off workers can’t pay their mortgages, some face foreclosure, and so on. The economy is in recession.

Eventually, after a couple or a few hard years, most debts are paid down, bankruptcies are settled, people start to buy again, companies start hiring, and the “cycle” repeats.   This has been happening for the past two hundred years in all capitalist economies, so we may as well get used to it, and plan accordingly.

Most people and most businesses, of course, would prefer steady and predictable growth. This is where the national government can step in and make a difference. Smart governments (beginning with the Roosevelt Administration in the U.S.) have learned to spend less (or at least run smaller deficits) when private businesses and individuals are spending more – and then spend more (hiring workers directly, or paying higher unemployment benefits, and so on) when the private sector slows down.

bizCycle2Chart above shows how government spending (green line) SHOULD move in OPPOSITE direction from economic growth (black line).

 When the private economy is “booming,” government spending or deficits fall; and when the private sector is in recession, government spending partly makes up for that by spending MORE. Overall, economic production stays closer to the straight line in the center, with fewer and smaller ups and downs. In modern terms, government should STIMULATE the economy in hard times, and consider some AUSTERITY when the economy is growing fast and prices are rising.

This is called “counter-cyclical” government spending, because government spending goes in the opposite direction of the “private sector” – it counters that spending cycle.

A question many people ask is why is it that a national government can spend more when it is collecting less in taxes? This is the opposite of what most of us must do, and it seems contrary to “common sense”. But national governments are unique, all over the world, because they can actually create money and wealth, up to a point. That is one of their indispensable roles – printing money. They are NOT like individuals. “Common sense” comparisons of governments and individuals are just wrong, as history has proved over and over.

  Finally, here is a picture of what should result when government gets it right. While the economy still goes through up and down cycles, over the long run, the economy (the straight, dotted line) generally moves up.

                                        bizCycleGrowth

By smoothing out the boom-and-bust “cycle,” smart governments   make the economy more predictable, make advance planning more realistic, prevent a lot of dumb gambles and painful bankruptcies, and generally help the economy to grow more over a long period of time.

Most Presidents since World War II, including Republicans Eisenhower and Nixon, and Democrats Kennedy and Johnson also did this. President Eisenhower, for example, started building the very expensive Interstate Highway System as a way of getting the economy out of recession in the 1950’s. Presidents Reagan, the first Bush and Clinton also generally understood the rules. One exception: President George W. Bush, who took office in 2001, when the economy was already growing fast – and then stimulated the economy still further by increasing spending to pay for wars in Iraq and Afghanistan (while also cutting taxes, another way of increasing private spending). This dangerous spending increase in an already hot economy encouraged the excessive risk-taking in the financial sector that resulted in the economic crash at the end of his term.

Another example of how these ideas really work? Just look at what happened after the financial crisis of 2008. The governments of the European Community did NOT follow the U.S. example of stimulating the economy (increasing spending) following the collapse of Wall Street banks around 2008. Instead, led by Germany, they cut spending during the recession. They prescribed austerity, instead of stimulus.

What was the result of these opposite policies in the U.S. and Europe? Europe is still struggling to recover from the recession, while the U.S. is well out of it, and into another period of growth. In effect, the world just tried a big experiment as to which government policy – stimulus or austerity – works best in a recession. And the U.S. was right.

Newspapers recently are reporting that Europe has recognized its mistake. The European central bank is starting do what the U.S. Federal Reserve did seven years ago. They have begun to encourage borrowing and spending more money (except for Greece, unfortunately) – and if what you have read here is right, Europe will now complete its economic recovery. In the next recession, let’s hope they get it right the first time.