Productive and Unproductive Labor

I'm definitely guilty of overusing the above graph but what it illustrates so well is the level of greed that motivated the leaders of the world's investment banks. Their bonuses were so large that they eventually exceeded the net income of their companies bankrupting the companies and allowing them to escape with billions as they helped bring down the world economy.

This is an example of a problem that is ill-described in traditional economics - the problem of unproductive versus productive labor. In the case of the financial crisis, it appears that a larger and larger proportion of our nation's output was siphoned off to a growing parasitical class which used their very rich human capital to create new financial instruments and marketing techniques which in fact created no wealth. In fact, they appeared to have destroyed a lot of human, physical and financial capital in a process that added nothing to our society.

The concept of productive versus unproductive labor has a history in Marxist economics. In Marx's complex and unfinished work, Theories of Surplus Value, in Chapter 4, Marx lays out a description of what he believed added value to the economy and what appeared to subtract value from society.

Marx made a couple of big mistakes here. One was that capitalists (or today's entrepreneurs or managers) didn't add value, only labor did. He assumed that the creativity, acumen and management ability of a capitalists was no different than any other kind of labor. There is considerable evidence that the risk-taking and management expertise of capitalists is perhaps a different factor of production than other forms of labor.

However, his analysis of finance capital appears particularly germane today. Thomas Philippon in an article last month "Has the U.S. Finance Industry Become Less Efficient?, argues that, "Surprisingly, the finance industry has become less efficient: the unit cost of intermediation is higher today than it was a century ago. Improvements in information technology seem to have been cancelled out by increases in trading activities whose social value is difficult to assess."

The sad part of Phillippon's analysis is that wasted capital in finance does not seem to have diminished as the great recession has dragged on. The question appears to be, Have we learned anything?

The Deficit- Creating our Own Nightmare

Listening to politicians in Washington, there is no doubt that America's huge deficit is leading to the end of the world as we know it. They never fail to describe in horror the effects of ballooning government spending on the future of our children.

Here's the problem. It ain't that bad.

According to the nation's official budget scorekeeper, the nonpartisan Congressional Budget Office, if politicians simply do nothing, the deficit will fall from today's 8.5% in 2010 to 1.2% in 2021. The historical average from 1971 to 2007 was 2.8%.

So what's the catch? Real simple. Congressional leaders are simply unable to let the current tax cuts expire. Allowing taxes to rise to their pre-2001 level in late 2012 would drop the deficit to less than half their historical average. Don't let the pre-2001 tax level scare you, taxes as a percentage of GDP were below the post-war average in the late 90s, the budget was balanced and the economy was roaring.

That doesn't mean we pull the trigger if the economy is still growing slowly and it doesn't mean that we don't still have work to do on the budget.

What it does mean is that current hyperbole is simply out of control.

The Myth of Overuse: Health Care Co-payments

There are few things people agree on when it comes to health care reform but one of them is the importance of provider co-pays in reducing health care costs. Liberals and conservatives alike delight on the ability of this simple device to reduce overuse of health care resources. Businesses and governments who fund health care payments enjoy the cost savings of co-pays while benefiting from the warm glow of serving the greater good of health care reform and cost containment.

The assumption is that health care consumers make a trade-off between the price of the care and its true benefits. This usual policy logic dictates that we use elasticity of demand (the change in quantity demanded divided by the change in price) for a category of care to set co-payments. The data indicates a high demand elasticity meaning that the care is of low value. If a small change in price results in less use, than the value of the care must not be very high.

But what if that isn't how people make decisions? What if people have biases in judging in making decisions? A particular difficulty with medical procedures is that many people tend to judge them much worse before than after the procedure. Their fear of the procedure makes them subject a bias again the care that is confirmed by the co-pay. People suffer from a great deal of confusion and anxiety when making health care decisions.

What if people aren't very good had judging the medical risks of various procedures? Could people myopically discount adverse health outcomes?

There is disturbing evidence that small changes in co-pays have huge effects utilization.

While there everyone agrees that co-pays create lower utilization rates, the important question is, do co-pays end up limiting overconsumption of medical care or does it lead to underconsumption of medical care. Do patients reduce the amount of care they purchase based on inaccurate assumptions of risk thus leading to higher long term costs for consumers as well as higher social costs for society?

This is particularly likely to be true in the case of low-income patients. A $50 co-pay may reduce overconsumption by high income patients while creating underconsumption for low income patient.

There are alternatives to simple using a meat ax on health care. Differential pricing could be valuable in this process. One idea would be to increase the co-pay as the number of visits increase. Another would be to set the co-pay as a percentage of income. Co-pays may just be another excuse to cut services to those of us who are less well off.

The Media and Confidence

This morning's Seattle Times headline screamed "Greek Debt Vote Rocks Markets" . The article went on to proclaim that "U.S. stocks plunged as investors fretted that Europe's problems, believed largely resolved, now appear far from settled and threaten a week recovery." The Dow Jones fell nearly 300 points.

Today, the market has already made up over 2/3 of yesterday's loss buoyed by good news of private sector job creation.

Hmmm. Do you think that the uptick will make the Times headline? Did the Times headline last week's good news on GDP growth?

The point is that people tend to take in news with the emotional part of the brain not the rational part. The constant outflow of bad news accumulate into declining consumer confidence. Any good news is generally off the media radar screen.

In reality, a recovery is very slowly building and markets have been relatively stable on a monthly basis over the past year. But consumer confidence has lagged. We are mere mortals who forecast the future primarily on the mood of today, when things are good, they are good forever. When they are bad, they are bad forever. The Seattle Times is merely doing it's job, but the effect is to tamp down consumer confidence.

Lack of Confidence, Frustration and Alienation

The Congressional Budget Office just released a report Monday indicating that household income between 1979 and 2007 grew by 275% for the top 1% of earners and fell by 2 to 3% for middle class Americans. This disparity has risen even more since 2007.

There are many, many ramifications of this growing income disparity for public policy. One is the sense of unfairness that Americans feel both about the economy and our government. This sense of alienation has contributed to the volatility and polarization we are seeing in politics today. The lack of response by Democrats and Republicans alike has led to spontaneous movements like the Tea Party and Occupy Wall Street.

Secondly, if a higher proportion of the nation's income and wealth is going to the very richest, a segment that spends significantly less of their income than the middle class, could that be contributing a lack of consumer demand in the economy?

On top of this, recent BLS data indicates that the wages of college graduates has fallen steeply since 2000 as college tuition has increased and student debt has sky-rocketed. The estrangement and frustration felt by young people today does not forebode well for the future productivity of our country as college debt increases to record levels in response to sky-rocketing tuition.

The Animal Spirits of Capitalism Continued

I hope that most Americans have finally gotten the message that financial markets aren't necessarily rational and on the down and upside of the business cycle can be absolutely crazy and horribly damaging.

There does seem to be a fair amount of agreement that our economic troubles are caused by a "lack of confidence" in the future, The question is how do you calm these skittish wrecks and move the economy forward. I mean how do you restore confidence to our economy?

I think there are basically two competing paradigms on the restoration of confidence. A supply side approach and a demand side approach.

The supply side approach is the primary approach of the Republicans but also seems to be the dominant theme for Obama's economic advisers. The first step is to restore the confidence of Wall Street by demonstrating calm and moderation. Secondly, you make a commitment to keeping future interest rates and taxes down by cutting the size of government and closing the deficit. Finally, you create even more incentives for investment by lowering tax rates, simplifying the tax system and deregulating the economy. Add to that recipe free trade agreements and tax-free repatriation of foreign profits.

The demand siders assume that the problem is lack of effective demand in the economy. That businesses aren't investing because they are not confident anyone will buy their products. Furthermore, lower taxes or incentives will have little impact since firms are making huge profits and have even larger accumulations of cash which they are not investing. Furthermore, they would argue, that it is deregulation that got us here in the first place.

They would suggest restoring the confidence of consumes by quenching their desire for fairness and ensuring that the people who created the crisis are those who are paying for it. The public doesn't have any confidence in government to a large extent because they believe the government looks after the interest of big corporation and banks and does little to represent them. Perhaps, if there was an effort to create more fairness in the distribution in the costs of the recession and lay the blame where they think it belongs, then consumers may have more confidence, provide more political support for a bigger stimulus and perhaps be willing to go out and spend more. This approach incentivizes buying.

Supply siders respond by saying, nonsense, now you'll really scare them and they will never invest again and take all their money to Greece or China.

What is the answer for restoring confidence? I think a little of each perhaps. Signal to the public that you believe that the middle class and the poor have paid too much of the cost of the recession and that Wall Street and their owners need to pony up a larger share. But combine this with a thoughtful and certain long term deficit plan.

The Animal Spirits of Capitalism

The story of the economy today is a story about confidence. Investors and consumers alike are uncertain about the future and thus they tend to hold on to their money and spend less on big durable goods and investments. The fact that this crisis was precipitated by an over investment in housing making restoring confidence doubly hard.

John Maynard Keynes famously said, "Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than mathematical expectations, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits - a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.^[3]

Wall Street is the tale of the bulls and the bears. And the problem is they tend to run in herds. When things look good, investors run with the bulls and when things look bad, they run away with the bears. Rational thought has some bearing on this trend but not so much on either end of the spectrum. When things are going particularly well, irrational exuberance sets in leading to a chain of overinvestment in the latest thing, corruption and ultimately a crash of confidence.

This is all very well and good but what do we do about it? How do we restore confidence, that is the question.

How Comfortable Will Americans be in our Newly Third World Country?

The gini index measures the degree of inequality in the distribution of family income in a country. Because it can have an effect on political stability, income inequality is one of the economic indicators tracked worldwide by the Central Intelligence Agency. Its current World Factbook puts the United States just inside the most unequal third among 184 nations, between Uruguay and Cameroon. Immediately below the USA and Cameroon in the rankings – that is more equal -- are Ivory Coast, Iran, Nigeria, Guyana, Nicaragua, and Cambodia. There are no developed countries with greater inequality. Stability and development tend to go hand in hand.

America has avoided much of the instability, violence and strife that has plagued much of the world largely because of the degree of equality of opportunity that our nation has treasured. This appears to be changing and changing very rapidly.

We have reached the greatest inequality of wealth since statistics have been kept. The top 1% of our wealthiest citizens controls a great percentage of our nation’s wealth than the time of the gilded age of Rockefellers, Carnegies and Mellons.

The financial collapse has hit the poor and the middle class the hardest. Accompanying the economic hit, governments, like the state of Washington, have slashed the safety net, housing, and health care assistance. While the rich have managed to dodge the bullet, Washington's tax system remains that most regressive in the nation. The poor and middle class pay 2 to 4 times the percentage of their income in taxes than the rich. Washington policy-makers have thwarted efforts to maintain some semblance of a safety net by imposing progressive taxes that more closely mirror those of our neighboring states.

One of the key predictors of prosperity is the level of education in a society (the other is union density). Sadly, investment in these arena have been slashed. Washington state has cut funding for higher education by nearly 50% over the past four years as citizens aged 25 to 34 are reported to have less education than those 34 and older.

Will all this lead to greater political and economic instability in the U.S.? Much of that depends on what we do next. How comfortable will middle-class Americans be as a newly third world country?

The gini index measures the degree of inequality in the distribution of family income in a country. The index is calculated from the Lorenz curve, in which cumulative family income is plotted against the number of families arranged from the poorest to the richest. The index is the ratio of (a) the area between a country's Lorenz curve and the 45 degree helping line to (b) the entire triangular area under the 45 degree line. The more nearly equal a country's income distribution, the closer its Lorenz curve to the 45 degree line and the lower its Gini index, e.g., a Scandinavian country with an index of 25. The more unequal a country's income distribution, the farther its Lorenz curve from the 45 degree line and the higher its Gini index, e.g., a Sub-Saharan country with an index of 50. If income were distributed with perfect equality, the Lorenz curve would coincide with the 45 degree line and the index would be zero; if income were distributed with perfect inequality, the Lorenz curve would coincide with the horizontal axis and the right vertical axis and the index would be 100.

A tragedy of our time – jobs go unfilled as the unemployed can’t find jobs

A few weeks ago on September 13, Dr. Douglas W. Elmendorf, director of the Government's official nonpartisan scorekeeper, the Congressional Budget Office testified in front of the newly formed Joint Select Committee on Deficit Reduction. Within the first few minutes of his testimony he said, "Weakness in the demand for goods and services is the principal restraint on hiring, but structural impediments in the labor market—such as a mismatch between the requirements of existing job openings and the characteristics of job seekers—appear to be hindering hiring as well."

The next day, the Wall Street Journal reported that the number of small businesses seeing a skills shortage has crept up this year. In August, 33% of small businesses reported having few or no qualified applicants for job openings, according to a National Federation of Independent Business survey. That was up from 21% in December 2009.

The State Workforce Training and Education Coordinating Board reported last week that key industries in Seattle including Business services, accounting, health care and manufacturing are all expecting major shortages of skilled workers within the next few years. Shortages are expected in occupations like accounting assistants and technicians, industrial machinery mechanics, telecommunications equipment installer and repairers, lab technician and registered nurses.

Is this really the time to make huge cutbacks in education and training? Is it actually costing us less to pay out unemployment benefits, foodstamps and emergency health care?

The Populist Moment: Part 2

Business Week reported last month that the median pay of chief executives jumped 35%, to $8.4 million, for Standard and Poor's 500 CEOs in 2010.

Meanwhile, back in our home towns, average weekly earnings of Americans fell in 2010 and median family income has fallen quarterly since 2008. The number of people living in poverty has increased by nearly 20% during that period as well.

Clearly, there is no evidence of shared sacrifice during this great recession. Provisions in the Dodd-Frank act that were allegedly written to quell the greed that caused the downturn appear to be a sham.

Now is the Populist Moment - Part I

The current long period of stagnation has created a level of cynicism, disengagement and distrust greater than any other time in my life.

The public is convinced that a culture of greed in our financial sectors has brought the economy to it's knees, causing massive unemployment. A stalemate in Washington has curtailed any effort to stimulate the economy or even create the leadership to improve consumer confidence that could help spur things forward.

Stopping at a Union 76 station off I-5 in Tukwila, Washington, the station manager vented his frustration, "these greedy bastards should have to pay for this but if the government tries to fix it, they'll end up making me pay."

This is the populist moment. We are living in a time that too closely parallels the Gilded Age of the late 19th century when huge corporations and financial institutions gobbled up a bigger and bigger share of our nation's wealth.

Economist Robert Gilman in a 1969 study for the Bureau of Economic Research revealed that the share of wealth owned by the top one percent of the population increased from 21% in 1810 to 24% in 1860 to 31% in 1900.

This aggregation of wealth and it's ostentatious display led to a populist movement that resulted in the creation of labor unions, regulation of trusts and government reforms.

Today, according to a recent paper by Edward Wolfe, wealth has become event more concentrated then that earlier age of robber barons and trusts with the top 1% controlling 34% of the wealth in this country and the top 10%, 84% of the wealth.

Where is this populist movement today as luxury spending goes up and long term unemployment reaches record highs? Are citizens so cynical disengaged from civic government that they are willing to just sit and watch?

The only truly grass roots response has come from the right, the T-Party.

Is our friend in Tukwila right? That government, owned by special interests, can only make this worst?

Inequality and Democratic Responsivness

Martin Gilen's Public Opinion Quarterly article, "Inequality and Democratic Responsiveness" asks the question, "do elections help ensure that the voice of the people is heard in the halls of government"?

Gilens asks 1,935 survey questions of national samples of the population between 1981 and 2002. The surveys are undertaken by Gallup, Harris and other reputable and independent pollsters. Each survey question asks whether respondents support or oppose some change in U.S. government policy. After compiling the answers, Giles then divides the population by income level and compares the preferences of those surveyed with the actual decisions by U.S. policy-makers.

The first part of his finding is encouraging. It confirms previous research that indicates that overwhelmingly unpopular proposals are unlikely to be adopted.

The second part is disturbing. When Gilens organized the responses by income group on policy questions in which well-off and poor Americans disagreed by 8% points or more, outcomes fairly strongly related to the preferences of the well-to-do but wholly unrelated to the preferences of the poor. Median-income Americans fare little better than the poor when their policy preferences diverge from those of the well-off.

The probability of a proposed policy change being implemented rises almost 30% as support among high-income respondents increases but only rises 6% as attitudes among median-income respondents shift from strong opposition to strong support.

Gilens concludes, " Most middle-income Americans think that public officials do not care much about the preferences of 'people like me'. Sadly, the results presented above suggest they may be right."

The Irony of the Financial Collapse

I've often thought it ironic that many, many Americans blame the government for the financial collapse and believe that less not more government is the solution. After all, the collapse, at least in part, was caused by lack of regulation and certainly not because of it.

The only true grass roots response to the collapse was the rise of the T-Party, an organization that largely promotes libertarian and conservative policies. No such populist movement has arisen from the left to call for more government regulation or even more stimulus to get the economy moving again.

Perhaps this isn't so surprising given that the public believes that government or at least it's elected officials are clearly in the pockets of the special interests that appear to have caused the collapse. A Pew Memorial Trust poll indicated that Americans truly believe that government looks after big banks and big corporations and cares little about the middle class, poor people or small business.

There is some reason to believe that their fears are well founded. Research by political scientist Dr. Martin Giles from Princeton University concludes that policymaker's decision almost always reflect the views of the wealthiest members of our society.

We shouldn't be too surprised if Americans are unwilling to hand over more power to a leadership that seems to care so little about their interests.

Getting the economy all wrong

The Wall Street Journal and the Seattle Times editorial page as well as democrats and republicans alike all argue that the problem with the economy is a lack of incentives to invest. That's why we need to lower taxes (and why they opposed an income tax on the wealthy), cut workers compensation benefits and cut budgets.

But on the economics page of the journal today, their economist argue the opposite and warn that the problem isn't supply it's demand.

In an article entitled, "The Economy Needs a Borrower of Last Resort", Kelly Evans argues that "The U.S. economy needs a borrower, not a lender, of last resort.The federal government, through its stimulus program and other measures, took on that role. Yet it, too, is now backing away. That will make it increasingly difficult for the U.S. economy to continue to grow"

So where is the money going if investors aren't lending it or investing it? According to another article on the same page, at least some of it is going to purchases of luxury goods. In an article entitled "May Retail Sales Favor High-End" the journal points out that while consumer spending is barely growing in most sectors, that is hardly the case in the luxury goods end of retail trade.

The author Karen Talley quotes Saks Fifth Avenue, ""What you have right now is a bifurcation in the market," said Steve Sadove, chief executive of Saks, in an interview. "The higher-end customer has been feeling better about overall the markets, their own personal situation. ...But at the lower end, you've still got a lot of concern in the housing markets, you've got a lot of concern with gas prices. So you're seeing the higher end performing better than at the lower end."

Lower taxes on the rich aren't leading to more investments and cutting government spending is not going to lead to growth. Most of our policy makers just don't get it.

Seattle's Forgotten Middle......

A lot of attention these days is being paid to the needs of research universities and the highest paying jobs at high tech and biotechnology companies. But the vast majority of workers in the Seattle region have worked in middle skills job with family wages and good benefits. These are the folks that have been hit the hardest by the deep recession and the folks whose wage recovery is the key to our recovery. And there simply isn’t going to be a recovery if these hard working people are unable to get the skills that are required by the jobs that are growing as the economy begins to slowly lift off.

The vast majority of jobs in the Seattle area are skilled professional and technical positions that range from health care on First Hill and throughout the city to aerospace, construction and manufacturing jobs in SODO and the Duwamish, and to office occupations such as accounting and office management in the city’s big downtown business and financial service industries.

The jobs we lost going into the recession are not the same ones that are going to get us out of it. Nobody has been hit harder by the great recession than the middle wage skilled workers in these companies and organizations. People such as John Woeck, for instance, who worked for seven years as an electrician just as his wife lost her job of 14 years, exhausted his savings, and was almost out of unemployment funding to support their three children. Vinita Vigil, enrolled at Seattle Central Community College, worked for a digital graphics company before she was laid off. She was the primary source of income for her family of five, and she was forced to sell her house.

One of the most distressing features about today’s recession is that Seattle has thousands of job openings at the same time it has high unemployment. Economists say this is because the recession accelerated the decline of some industries, such as housing construction, at the same that that others requiring far different skills, including health care, emerged stronger. Some economists predict that this disconnect is likely to grow as the economy continues to develop jobs that require specialized skills. And the difference for those who have lost their jobs could be fine-tuning of their skills in a job training program that takes six months to two years to complete.

Construction, real estate, and financial service workers have seen jobs with their expertise disappear, while skilled work in health care, accounting, fashion design and I-T remain unfilled. A State’s Workforce Training and Education Coordinating Board 2010 survey of employers indicated that the vast majority of these job openings require a post-secondary vocational certificate or degree. The survey indicated that 62% of employers hired people and 26% or 10,500 firms in King County were unable to find skilled employees.

Fortunately, there is a solution. The Community and Technical College Worker Retraining Program was designed to get people who lost their jobs in declining occupations back to work in new and growing fields. Even in the depth of the recessions, three out of four graduates were able to find work within 6 months of completing their programs.

John Woeck retrained from work as an electrician in the housing industry to job in the heating, air-conditioning and ventilation industry. He was also able to convince his employer to hire two of his classmates. Vinita Vigil was able to find work in the ….. and now has an income to support her family.

This year, in order to meet record demand from individuals and families such as the Woecks and Vigils, the state legislature bumped up funding for the program to allow the program to serve more 14,000 unemployed individuals across the state. However, the funding was for one year only and on July 1, the program will be forced to cut services nearly in half leaving thousands of unemployed workers stranded midway through their programs. This will leave thousands of jobs unfilled and perhaps create a bottleneck in the economic recovery of our region.

The Donner Party

Former Gardner Chief of Staff and entrepreneur Denny Heck once characterized the current legislative session as "the Donner Party". My take on it - a session where year after year of economic disaster and budget cuts has led to the increasing starvation of human services and education programs. Program advocates, normally allies, have resorted to eating their own in order to keep their programs alive.

Nowhere is this more true than in higher education.

The Washington Labor Council has been trying to increase unemployment benefits to long time unemployed workers who have been laid off from the recession and lived on low paying unemployment insurance for years. Last week, out of fear that community colleges were trying redirect that money to save the Worker Retraining Program, the Labor Council began to tell legislators that the worker retraining program is a disaster and a waste of money (despite evidence to the contrary). Labor's tactic is nothing new. They learned it from the Association of Washington Business, who in the mid-90s attacked the quality of the program as a way to attack the funding source which at that time was a diversion from the UI trust fund.

Organized labor and community and technical colleges have long been allies in promoting the worker retraining program, which provides unemployed workers the opportunity to train in high demand fields. Labors fears turn out to be wrong in this case. No legislative proposals to use unemployment funds for worker retraining has been proposed this year. But the damage to the program from labor's threats are severe and unemployed workers could find their program cut off midway through the year.

Advocates for the University of Washington and other public universities have decided that there best hope for minimizing cuts is to cannibalize community college funding. University trustee Craig Cole and major backer Dan Evans have began to publically attack colleges as a "the worst possible place to start a college education". Community college advocates have found themselves under attack in conversations with the Seattle Times and other Seattle downtown establishment figures after university advocates have been in to see them.

This kind of cannibalization should be no surprise in these tough times. In the end, unfortunately, all of players could end up being losers.