The slide of the ‘average’

Much more has been written than read about the divisive subject of income and wealth inequality in America over the last decade. It is the reading equivalent of a dance marathon, painting a gloomy picture of American society. If we are to address it successfully, we must start by enacting policies that recognize the importance of the middle class rather than simply relying on the invisible hand of the free market.

Earlier this year, the number one book on the Amazon bestseller list was “Capital in the Twenty-First Century” by French economist Thomas Piketty. Its central message is a call for wealth redistribution to reduce inequality, an approach that has never been popular in America, a country where economic growth comes first and distribution last.

Despite President Obama’s repeated statements that inequality is the “defining challenge of our time,” things continue to slide for the average American. For those living close to the ground, inequality is alive and well in America.

While there is disagreement about how to measure inequality, most studies focus on income, wages and wealth. For example, the bottom quarter of American households have seen almost no increase in real income for the last 25 years.

The top one percent of Americans, however, seems to be getting on quite well. They have seen their real incomes almost triple during the same period. Their share of national income has reached 20 percent and they own nearly 35 percent of the country’s wealth, figures not seen since the Roaring Twenties. The rich are running up the score.

As few as 16,000 families have a combined wealth equal to 5 percent of America’s gross domestic product, a level of concentration reminiscent of business monopolies. There’s also the legitimate concern that as the economic power of the richest one percent increases, their political power increases with it and they shape the rules governing our economy and society. Can you imagine this group raising taxes on themselves to finance new investments in education, job retraining and infrastructure that are routinely suggested as solutions to the inequality problem.

Americans are witnessing the Matthew effect. To paraphrase Matthew 25:29 in the King James version of the bible: “that to those who have, more will be given, while to those who have less, even that will be taken away.” Or in popular parlance, the rich get richer and the poor get poorer.

This widening gap between the rich and the poor brings with it all kinds of bad implications. Rising income and wealth inequality and the lack of opportunity to move up the income ladder threaten the nation’s economic growth and fundamental values; the middle class is growing thinner and thinner.

A strict free-market capitalist, the economic equivalent of a religious fundamentalist, argues that because inequality puts more resources into the hands of capitalists, it promotes savings and investment that in tum generate economic growth and increase the size of the economic pie. Just lower taxes on rich folks, cut the federal deficit, and deregulate and they will invest in the economy, creating millions of new jobs and lifting the unemployed out of poverty. This holds a grain of truth, but just.

While the issue of what is to be done about economic inequality is not one that lends itself to easy answers, especially in our politically polarized environment, we must start with policies that recognize the important role the middle class plays in driving economic growth.

originally published: July 19, 2014

Applying Radford’s ‘Economic Organization’ to economists

Since the days of Adam Smith, more nonsense has been written about capitalism than any subject except religion.

During the 19th century and the first half of the 20th century, economists from David Ricardo to Alfred Marshall raised the status of the free market, guided by its miraculous “invisible hand,” to something like a beneficent secular priest that was supposed to rule worldly lives.

Beginning in the latter part of the 20th century, things got even worse.

Ivory-tower economists started developing a host of “rigorous” quantitative models that claimed to show how markets actually work. Tagged with such intimidating names as “The Efficient Market Hypothesis ,” “Modem Portfolio Theory,” “The Capital Asset Pricing Model” and “The Black- ScholesĀ­ Merton Option Pricing Model,” they focused primarily on markets for common stocks and other financial securities assumed to represent the closest real-world approximation to the free market ideal.

And they were all wrong. They were based on a misapplication of Gaussian statistics, epitomized by that overworked bell-shaped curve, which supposedly demonstrates that female college students have less aptitude for math and science than males. For good measure, they also used antiquated principles of Newtonian physics that had long been discredited.

But these theories still became conventional wisdom among Wall Street rocket scientists during the 1980s and ’90s. Not to mention winning for several of their developers the Nobel Prize in economics, despite the havoc they raised for the financial firms that actually tried to put them into practice.

It may come as a surprise to many, but markets are not artificial hothouse entities. They are, in fact, entirely natural and instinctive products of everyday human pragmatism.

Nowhere is this illustrated more clearly than in the informal markets that developed among American and British bomber crews in German prisoner-of-war camps during World War II. It’s the basis for a fascinating article by British economist R.A. Radford titled “The Economic Organization of a P.O.W. Camp.”

Prisoners received weekly food parcels from the International Red Cross that typically included Spam, powdered milk, jam, chocolate bars, soap and five packs of cigarettes. With lots of time on their hands and regular weekly deliveries of identical parcels, the POWs began trading these goods among themselves.

In a surprisingly short time, each barrack became a hotbed of informal “barter markets.” These activities soon expanded to include trading between barracks and even featured “bid and offer” notes for various goods that aggressive POWs looking for trading action would pin to the bulletin boards in each barrack.

As volume grows, the barter system is an awkward way to conduct trading activity. But human ingenuity quickly solved this problem by pricing all goods in terms of a single good, known formally as the “medium of exchange”- in other words, money. The POWs instinctively chose cigarettes as their money, since each Red Cross parcel contained five packs, with 20 cigarettes in each pack.

Once the POWs had a reliable and widely accepted form of money, their trading activities increased by leaps and bounds. Soon they allowed for credit, futures markets, arbitrage, investment, entrepreneurship, rules and institutions to facilitate market activity, and- because there were nonsmokers- savers. There was something universal and spontaneous about the development of a market economy.

After the war, these thoughtful members of the greatest generation went to college on the G.I. Bill and built highly successful careers. The descriptions of markets in their college economics courses bore little resemblance to how markets actually worked naturally in their POW camps. From which we can learn a great deal about how markets really work in a world of full-blooded human beings.

originally published: August 10, 2013

Free trade’s ‘golden age’ is lacking in luster

“So, Tony, it sounds like you’re not a big fan of free trade”

“Oh, I think free trade’s great- so long as it doesn’t get in the way of anything really important, like putting Americans back to work.”

“What do you mean?”

“Look, Sean. Any economist will tell you free trade is even better than macaroni and cheese. But tell that to a tool and die maker whose unemployment insurance is about to run out.”

“I guess so.”

“Some people do have a way of making free trade work for them.”

“What do you mean? “

“Look at the CEO who’s just moved 17,000 jobs from Cleveland to Jakarta so he can announce record profits next quarter from lower labor costs. Wall Street runs his stock up five or 10 points”


“Think of it this way, Sean. We can’t trust the invisible hand of the market to allocate economic resources like capital and labor among nations if we all want to prosper.”

“What’s the alternative?” “Intelligent strategic management.” “Like trade agreements?”
“Right. Make deals; it’s a sacred free-market principle.”

“True. “

“Suppose a car is speeding down a twisting mountain road. Is any sane person going to argue that guiding this car around the inevitable sharp curves should be left entirely to the invisible hand?’

“What invisible hand? “

“You know, the subtle grooves in the road’s pavement; the way it’s banked on the turns.”

“I see what you mean. “

“Obviously, the car needs a driver to avoid running off a cliff.”

“And trade is no different?”

“Right. Trade needs the federal government to manage it intelligently on behalf of the American public.”

“Do you mean industrial policy, picking  winners?”

“Actually, the record shows that the feds have a pretty good history of picking winners. Look at World War II.”

World War II? “

“Sure. Who did President Roosevelt pick to manage the war? General Marshall, General Eisenhower, Admiral Nimitz- all-stars in any league. Germany and Japan couldn’t come close.”

“I guess you’re right. “

“And look at the big spending programs the Roosevelt administration picked to create a massive amount of armaments and superior technology in a flash. Like the Manhattan Project to produce nuclear bombs and the B-29 program.”


“For all Germany’s technological know-how, efficiency and discipline, Hitler’s government had a bad habit of picking losers and choosing managers who were forefathers of the people who drove General Motors off a cliff. So what’s wrong with having the federal government manage trade to benefit the American public?”

“But won’t the academics insist that isn’t free  trade at all? It seems to violate the hands-off principles supposedly espoused by Adam Smith and other big thinkers”

“So we’ll keep everybody happy by calling our approach something like ‘free trade with American characteristics,’ like Beijing describes its version of capitalism as ‘socialism with Chinese characteristics.”‘

“I should have known. “

“The patron saint of America as an industrial powerhouse was Alexander Hamilton. As George Washington’s treasury secretary, he pushed his vision of our nation growing into a land of urban-based industries that created widespread prosperity by making things. Hamilton persuaded Congress to pass a wide range of tariffs to protect and nurture home-grown industries that made things an increasing number of Americans wanted. He protected the prosperity of American workers by forcing our trading partners to play by sensible rules.

“Yeah. “

“Now fans of economic theorists who let logic run away with common sense may have trouble getting their minds around Hamilton’s unorthodox wisdom. But putting it into practice is what gave America the capacity to out-produce Germany and Japan combined during the 1940s.”

“I guess that makes sense. “

“The heroes of Hamilton’s America are people like those masterful tool and die makers, the Michelangelos of the machinist’s trade whose artful minds and skilled hands can sculpt metal into the jigs and tools of efficient mass production.”

Yeah, I knew of one of those guys. “

“But too many like him have been sacrificed at the altar of free trade and are trying to make ends meet by flipping burgers. But not to worry; the mainstream economists tell us everything will be fine. According to them, we are living in the golden age of free trade. Sadly, what really surrounds us are copper and lead.

originally published: September 15, 2012